UPDATED on 4/24/21

Bitcoin is not money.  There are three main functions of money: 1) a unit of account (a measurement of value); 2) a medium of exchange; and 3) a store of value.  The most important and unique function of money is to serve as a unit of account.  Because bitcoin is not a unit of account, it is not money.

If bitcoin is not money, what is it?  Bitcoin is mainly a store of value like stocks, bonds, rare baseball cards, and lottery tickets.  None of these are money because they do not serve the first two functions of money.  Bitcoin is closer to a form of money than stocks because bitcoin is also occasionally used as a medium of exchange, and this is where bitcoin is unique.  All other mediums of exchange are also used as units of account, but bitcoin, uniquely, is occasionally used as a medium of exchange that is never used as a unit of account.  Every bitcoin transaction uses prices not in bitcoin, but in dollars (or another money).  Bitcoin’s failure at the primary function of money is why bitcoin is not money and no economy could operate on bitcoin alone. Capitalism needs money to function and the most fundamental function of money is to serve as a unit of account.

Only the first two functions are really unique to money. Whereas everything we buy can serve as a store of value, money is generally one of the worst long-run stores of value.  So although value storage is an inherent function of money, it is a distant third-place function behind the other two. There is is also an inherent tension between the store-of-value function and the medium-of-exchange function because you can’t store your money and exchange it too just like you cannot have your cake and eat it too. Whenever people have a choice between different mediums of exchange, they always whichever medium is the worst store of value. That is the point of Gresham’s Law which says that whenever there is a choice between different currencies, everyone will hoard the one that is a better store of value and the worst store of value will circulate as money. If everyone thought that the value of bitcoin was going to steadily and slowly drop whereas the value of the dollar was going to start a long-run appreciation, then, ceteris paribus, people would stop hoarding bitcoin and start using it as money and they would start hoarding dollars instead.  But that isn’t going to happen because we have a competent central bank that will never let dollars appreciate in value.

The last time the dollar appreciated dramatically was the Great Depression and it was the rise in the value of the dollar that was a major that made the Depression so “Great”.  If the central bank had kept the value of the dollar from appreciating, it could have mostly avoided the Great Depression because when the dollar started rising in value, people started hoarding dollars rather then spending.  Spending plummeted as everyone tried to buy as little as possible which caused incomes to plummet in a vicious cycle. The reason central banks let the dollar rise was their attempt to maintain the gold standard.  Gold has a much less stable (short-run) value than modern fiat dollars and every time gold/money appreciated, it caused recessionary pressures.  That led to more regular recessions than we have had since abandoning the gold standard. 

Bitcoin is more like gold than money and neither are used for money anymore for the same reason. Both gold and bitcoin have very volatile values because they are both mainly used as speculative stores of value. If bitcoin continues to grow in popularity, it won’t replace money, but it could become an increasing substitute for investing in gold and cause the value of gold to drop!  Bitcoin is a fantastic substitute for gold because both are used to hedge system failure.

Goods that are primarily used as a speculative store of value have volatile prices because speculators capriciously speculate about future values rising which drives up prices, or they sell when they think future values will fall which drives prices down out of pure speculation.  In fact, the more that something comes to be seen as primarily a store of value rather than as something that is valued for its intrinsic usefulness, the more volatile its price becomes. For example, housing bubbles are not caused by people who just want use a house as a place to live, but by speculators who see housing as a growing store of value and are hoping to resell at a profit in the future.  Housing bubbles pop when speculators suddenly think that housing prices will fall and they all try to sell before the price falls farther. 

Although bitcoin proponents like to tout bitcoin’s rising “market capitalization” as a sign of success, that is a concept that is used for valuing property, not money.  Note that they measure the “success” of bitcoin’s market capitalization in dollars!   But currency appreciation is deflation which has caused a major problem for bitcoin as a medium of exchange because nobody wants to exchange anything that it rapidly rising in value.  When something is rapidly appreciating in value, people want to hoard it.  If they need to exchange something, they should rationally use something else instead that is not expected to appreciate as rapidly.

In contrast, a modern fiat money almost never goes up in value, so there is almost no incentive to hoard it as a store of value.  The main reason people hold ordinary money is to use as a medium of exchange. Central banks actively engineer a little inflation which steadily reduces the long-run value of money. That inflation gives speculators an incentive to buy other things (like stocks, bonds, money-market shares, gold or bitcoin) as stores of value rather than money. It is the “animal spirits” of speculators that cause most price volatility in financial markets and by making money unattractive for speculation, central banks reduce its volatility.  A primary responsibility of all central banks is to minimize the volatility of inflation and maintaining a little inflation helps reduce the volatility of inflation.  Because money is held for use as a medium of exchange, there is little speculation about how much it should be worth and speculators focus their volatility-inducing attention on other assets like bitcoin and gold instead.  The lower the volatility of the value of money, the more useful it is both as a unit of account and a medium of exchange.

Bitcoin is not money because nobody uses bitcoin (nor gold) as a unit of account (for measuring value) and that is the most important function of money.  Bitcoin sucks as a unit of account because the value of bitcoin jumps around much more capriciously than almost anything that is actively traded.  Even fresh pork bellies would be a better unit of account than bitcoin because pork bellies have a more stable value! 

The US dollar has been the best money in the world for many decades because it is the best medium of exchange in the world. For example, oil producers in the Middle East use the dollar as their unit of account for selling to everyone because it is the most convenient unit of account for everyone around the world.  It is also frequently used as a medium of exchange between companies that do not use dollars at home.  For example, Airbus has often sold airplanes in places like Argentina using dollars.  Even though Airbus is a European consortium and neither Airbus nor their customer use dollars at home, it can be more convenient to exchange pesos for dollars and then dollars for airplanes and then exchange the dollars for euros, than to exchange pesos for euros directly and buy with euros.

According to Mark Williams, as of 2014, bitcoin had volatility seven times greater than gold, eight times greater than the S&P 500, and 18 times greater than the U.S. dollar.  Even the Bitcoin Foundation sets its employee’s salaries in dollars rather than in bitcoins.  Because bitcoin (and gold) are bad units of account, they are rarely used as a medium of exchange except by criminals. Cryptocurrency has a major advantage for criminal exchanges because it is much harder for police to trace, but for everyone else, the transactions costs due to high price volatility outweighs any other advantage of bitcoin for use as money.

A unit of account is the most fundamental use of money because it is hard to have any exchange without agreeing upon a unit of account.  This is why barter doesn’t work for complex economies.  Barter uses every product as a unit of account.  If you have four products, then a barter economy will have 4^2=16 prices instead of just the four prices that you have with money.  The number of prices for a market with n goods is n^2 in a barter economy which causes exchange to break down.  If there are 100 goods, there will be 100^2=1,000 prices and because every product before mass production was unique, everything was a unique product which caused pricing to explode in complexity without a money as a unit of account.  Imagine trying to invent accounting in a barter economy!

Whatever currency is used as the unit of account also has a big advantage for use as the medium of exchange unless there is a fixed exchange rate because otherwise prices in the unit of account have to be converted into the medium of exchange which adds extra complexity and cost.  That added transactions cost means that bitcoin will always be at a disadvantage for transactions compared with a stable fiat currency like dollars because dollars are an infinitely better unit of account and every transaction requires a unit of account. 

Bitcoin uses block chain technology and that technology could offer a more efficient way of making payments at some point, but prices will always be quoted in money (a unit of account) such as dollars because dollars have a stable value. And as long as dollars are used as the unit of account, they will also be used as primary medium of exchange too because having a single currency that serves both purposes reduces transactions costs. For this reason bitcoin will never replace money as a medium of exchange, but perhaps someday someone will invent a blockchain stablecoin that will be able to replace dollars as a unit of account.  If so, it will undoubtedly then replace bitcoin too. 

Blockchain technology may come to have some advantages for reducing some kinds of transactions costs but then blockchain technologies will then be adopted by the dollar-based banking system to reduce transactions costs.   It would be great to modernize our antiquated money transfer system, but even that lousy system is better than bitcoin and as new technologies for exchange come along, they will still use dollars for payments rather than bitcoins.

The big long-run problem with bitcoin specifically is that it will go obsolete as soon as a newer block-chain technology is produced that works better than bitcoin.  Bitcoin cannot change (or only with extreme difficulty) and all technology platforms that cannot change get replaced by newer technologies sooner rather than later. The probability that bitcoin will be replaced by a better blockchain technology in the near future is the biggest long-run threat to bitcoin.  There are already more than 13,015 digital currencies according to CoinMarketCap, and the oldest technology is rarely the best. Newer technologies will inevitably make bitcoin obsolete eventually, and then the value of bitcoin will collapse like the value of telegraph companies. Or bitcoin could collapse in value overnight when its security is successfully attacked by newer technologies because bitcoin cannot evolve to meet new threats. 

Bitcoin is just an information technology that is competing with other rapidly evolving technologies.  Bitcoin itself is almost impossible to update and so as other technologies continue to progress, at some point bitcoin’s technology will seem like a 1970s mainframe computer in comparison to a vastly superior Iphone 13.  Bitcoin will look so inferior to newer alternatives that its value will collapse a bit like the Confederate dollar or other defunct currencies that went obsolete overnight.  Bitcoin is mainly popular because it was the first blockchain currency, but it is such an old, inefficient technology that it is unlikely that it will always be the best blockchain technology.  It has already been surpassed in transactions by Ethereum e-currency and more competition will continue to come.  Bitcoin was invented in 2009 and so it is going to seem increasingly elderly and decrepit compared to new technologies when it is 20 or 30 years old. 

All stores of value must have some underlying value. Fiat money (like the dollar) is truly useful because it  minimizes transactions costs as a medium of exchange and that usefulness produces its underlying value.  If there were some other technology that was better at facilitating exchange transactions, we would use it instead of dollars and the dollar would become worthless because it has no other fundamental source of value. The fact that bitcoin is mostly used as a store of value and not as a medium of exchange demonstrates that it isn’t money and it isn’t threatening the dollar. 

Fiat monies get their value from being useful as a medium of exchange and become worthless when something else replaces them.  In contrast, the value of commodity monies like gold and silver cannot fall to zero and when fiat money replaced them for transactions, they remained valuable because they are inherently useful for other things besides facilitating transactions.

But even a poorly-managed fiat money cannot fall completely to zero value if a government requires that everyone pay taxes using it.  Almost a quarter of US income is paid in taxes each year and that would prevent the value of dollars from falling to zero even if the Fed were so incompetent that everyone tried to avoid dollars for all other transactions. But the Fed manages the dollar well and that makes it the best kind of money for all legal transactions in America.  It is so useful, it dominates a huge share of international transactions too.

Bitcoin gets much of its fundamental value because cryptocurrency is the best form of money for a peculiar kind of transactions.  It is the cheapest and best form of payment for evading taxes, criminal transactions, and funding terrorism.  In 2017, researchers estimated that 46% of bitcoin transactions were for facilitating criminal activities.  Although the main comparative advantage of bitcoin for transactions has been facilitating criminal transactions, it isn’t even ideal for that because every transaction made from every account is public information.  Bitcoin does provide a degree of confidentiality because account holders are not named, but it is anything but anonymous.  Other technologies provide both confidentiality and anonymity, including good old-fashioned cash.

Although there are also some ideologues who are willing to use bitcoin for legal transactions despite its higher cost, most legal users treat bitcoin as a speculative asset and do not use it for making transactions other than for adjusting their investment portfolio.  Similarly, there are a lot of transactions of Tesla stock which are exclusively for the purpose of adjusting investment portfolios.  We don’t call Tesla stock money even though the main difference between Tesla stock and bitcoin is that stocks are rarely used to facilitate illegal transactions. A notable difference between those who use bitcoin for legal purposes versus illegal purposes is that illegal users tend to hold less bitcoin as an asset (a stock) relative to the amount that they use for transactions (flows).

So a big part of the bitcoin economy depends upon how much governments are willing to tolerate the black-markets it sustains.  Because bitcoin’s main advantage as a medium of exchange is for use by terrorists and criminals, governments have an incentive to shut down the companies that exchange bitcoin for real money and that would make bitcoin worthless for criminals who rely upon real money for most of their legal transactions.

Trendon Shavers founded Bitcoin Savings and Trust and defrauded investors out of more than 4.5 million dollars worth of bitcoins.  In court he argued in defense that bitcoin is not money because it is not legal tender anywhere in the world and therefore cannot be regulated under financial fraud laws.  Similarly,  Ross William Ulbricht who owned the Silk Road website argued that he did not facilitate money laundering on the site because it used bitcoin which is not money.  These arguments did not succeed even though they were correct because fraud doesn’t require money.  One can commit fraud with any sort of property.  Legally, bitcoin is a form of property according to America’s IRS.  They got it right. 

Most people are excited about bitcoin based on the theory that it could eventually become a new global money, but as long as governments are functional, bitcoin is never going to beat government money as a medium of exchange (for legal transactions), nor as a unit of account.  But what about if  governments collapse?  How reasonable is the argument that bitcoin should get intrinsic value from being a hedge against civilizational collapse. After all, this function gives gold some of its fundamental value.

…one reason gold is valuable is that some people see it as a hedge against the collapse of governments. In medieval and early modern Europe, as well as in many other premodern states, gold was used as money for cross-border payments because governments weren’t stable enough to be able to maintain stable fiat currencies. Even if we never return to that sort of anarchic world, people might want some kind of insurance against the possibility.

Gold’s current total market cap is estimated at a bit over $10.6 trillion. Bitcoin’s market cap, as of this writing, is about a tenth of that. So if Bitcoin were to become as big of a hedge against global disaster as gold is, it would probably be worth a lot more than it is now.

Another fundamental reason for Bitcoin to have long-term value is its usefulness in [illegal activities] or use as a currency in places where the government has broken down, [such as] where hyperinflation makes local fiat currency effectively useless…

In general, all of these uses can be grouped under a single umbrella concept: System failure. The system of governments, banks, financial regulations, etc. etc. that currently runs the world is not infinitely robust. In the places and times and future conditions in which that system fails, peer-to-peer financial solutions like Bitcoin are inherently very valuable. That gives Bitcoin fundamental value.

So bitcoin could be useful if the ordinary banking system collapses, but again, this is a motive for using bitcoin as a store of value because it could become useful as a form of money at some point if our ordinary monetary system collapses.

Ordinarily a fiat money like the US dollar is cheaper to use than bitcoin as a medium of exchange because

1) its value is more stable because it is actively managed by the central bank.  A stable value makes it a much better unit of account.

2) it is required for paying taxes so Americans have to use lots of dollars every year. 

3) the fact that everyone uses dollars creates a kind of economy of scale called a network effect which makes dollars more convenient to use simply because all other Americans are already using them. 

4) bitcoin is structurally prone to deflation which would contribute to recessions if it were adopted for an entire economy.  That fact alone will prevent any sovereign economy from adopting it.

5) Bitcoin is expensive to store and gets more expensive and environmentally destructive to manage as the bitcoin economy expands (see below).

6) Bitcoin transactions are extremely expensive and slow relative to dollar transactions in the conventional banking system.  This is one of the biggest failures of bitcoin as a money.  As Marketwatch points out, “Credit cards can settle 5,000 transactions per second. One bitcoin transaction takes 10 minutes.”  Visa and Mastercard charge about 3% transaction fee which is a ridiculously large, inefficient monopolistic fee. Hopefully a blockchain technology will someday be able compete with the banks to force down their fees at some point, but so far the credit card duopoly is safe because bitcoin transactions are much more expensive than Mastercard:

to use bitcoin to buy a $4 latte at Starbucks, you might have to either wait several hours for the purchase to go through or pay $5 to speed it up. “One of the biggest challenges for bitcoin has been that the fees are too high for it to be used as a simple transaction account, and it takes too long,” O’Hara said. “The number of bitcoin transactions that can be added in any given time is orders of magnitude smaller than, say, Visa cards.”

Even the “free” work that is done to process bitcoin transactions have high real costs.  Those costs are actually paid by bitcoin “miners” who do the calculations that process transactions for which the system “prints” them new bitcoins.  In the process they consume an incredible amount of electricity.  It is tremendously expensive and wasteful.

Bitcoin mining alone uses more electricity than 159 different countries and in order to make it worthwhile for miners to continue processing transactions, bitcoin will have to deflate in value because there is a finite amount of bitcoin that can be “mined” and as we approach that hard limit, the costs of mining (processing transactions) continues to rise, plus there are limits to how many blockchain transactions can be processed per minute.  Perhaps that is why we reached peak Bitcoin transactions way back in 2016 or 2017 depending on how the data is collected:

Bitcoinity.org shows an even bigger decline in bitcoin as it is replaced by better technologies:

Meanwhile, the rising expense of processing transactions won’t be worthwhile unless the value of bitcoin continually rises.  That may sound good, but a rising value of a currency is called deflation and deflation is extremely harmful for an economy when it is caused by a money supply that does not expand as fast as the number of transactions that people want to make.  Because the costs of processing Bitcoin transactions must rise over time, it will continue to get even worse as a medium of exchange.  Inflation is much healthier for macroeconomic stability than the same amount of deflation because deflation turns money into a store of value which causes hoarding rather than the transactions that make the economy go round.

Bitcoin’s technology definitely has some advantages over conventional transactions, but the dollar is better so far for almost all legal transactions. Plus, as the technological advances of blockchain become truly important, the dollar banking system will copy them perhaps using a stable-coin denominated in dollars. 

So far bitcoin speculators have been hoping that bitcoin’s technological advantages will eventually prove to be so much better than the dollar as a medium of exchange that everyone will someday want bitcoins for conducting all their daily business. But it is more likely is that the dollar system will eventually adopt some of bitcoin’s technologies and wipe out what little advantages bitcoin currently has for exchanges.  Plus, because bitcoin’s main advantage for exchange has been its ability to fund illegal activities, it will probably eventually be used to fund a major terrorist act and that will motivate large governments to clamp down on the exchanges that connect the bitcoin network to the global financial network.  That would be the sudden end of bitcoin except as a historical curiosity like the great tulip bubble of 1637.

I hope that doesn’t happen because bitcoin is that it provides a backstop alternative for the fiat monies of the world.  A fiat money is always in peril of being managed badly and that has dire consequences for the people who depend upon it such as in the Zimbabwe hyperinflation.  But if a fiat money ever becomes a worse option than bitcoin, then people could switch and bitcoin might be used as a backstop in that case.  Bitcoin may be inefficient, but it would be better to have a really inefficient form of money than no money.

But I’d rather have gold, because if the US government collapses, then our communications and electric grid will also probably collapse and that would make bitcoin useless.  So bitcoin provides some insurance against economic collapse, but it isn’t a very secure insurance.  For example, Zimbabwe had an economic collapse and most locals have been using the cash of other nations, most commonly, the US dollar, rather than bitcoin. There is simply no major economy where bitcoin has replaced fiat currencies as the main medium of exchange.  Cryptocurrencies have only been dominant in some online marketplaces in the criminal underworld and even there they still rely upon real money to serve as the unit of account.

Bitcoin is a fascinating new kind of store-of-value, a lot like baseball cards and other collectables and it is also occasionally used as a medium of exchange, but it isn’t money.