Lesson

Bitcoin as a Currency

The paper that created Bitcoin in 2009, described it as a peer-to-peer electronic cash system and for the first few years of its life, much of the talk was about how it was eventually going to be how you’d pay for a pack of gum at the corner store. Instead, it more often serves as an investment vehicle, or of a store of value. But it can be used for transactions, just like several other forms of money. Let’s take a look at those other forms in a historical perspective to understand how Bitcoin is different from them.

We’ll look at five aspects of each kind of money. The forms they take, whether they work well online, the authority that guarantees their value, what your recourse is if you spend it and then want to take it back without getting lawyers involved, and the overall cost of use, taking the risks into account. As a point of reference, we’ll start with Bitcoin. In form, it’s a purely digital currency. It doesn’t exist in another place and so it’s completely online ready.

Its authority comes from an online network of individual players, there is no central authority. When you spend Bitcoin, it is absolutely spent. There’s no way to get it back. Finally, the cost of use for Bitcoin used to be very low, typically only a few pennies per transaction. But as the Bitcoin network has become overcrowded, transaction fees went way up in late 2017. Technical measures to lower them are being attempted as I record this, but it’s unclear how successful they’ll be in the long run.

So that’s Bitcoin. Now let’s jump in our time machine and go back to the very first form of money, barter, or trading one thing for another. Gold falls in this category because you have to physically exchange it for whatever you’re getting. In barter, you have to bring a physical object from one place to another, as such, it is not in any way online ready. The only authority when you barter is physical proof, that is, seeing and probing the object. There’s no central authority guaranteeing its value.

Once you’ve made the exchange, there’s no recourse, and the cost of use is actually very high because of the cost to carry and secure the physical objects. Eventually, cash came to stand in as tokens for those unwieldy physical objects. Now cash is also purely physical, so it doesn’t really work online. The authority is whatever government backs the cash, whether it’s the United States, or Zimbabwe, or anywhere else. When you spend cash, you have no recourse, it’s just gone.

Finally, its cost of use is actually pretty low. Moving forward in time, we come to checks. These are mostly physical, although that is changing somewhat, in that you can now take pictures of checks and deposit them digitally in that way. As such, they’re a little bit online ready, but mostly they’re a physical form. The authority comes from whatever bank issued them and you do have recourse by going to that bank. The cost of use for checks is moderate. That is, you have to spend a certain amount in fees and overdraft protection and so forth in order to make the checking system work.

Plus of course, you have to have the money on reserve at the bank. Finally, we come to that most modern invention, credit cards. At this point, credit cards are mostly digital, and you can use them online quite well. As with checks, the authority is the bank that issues them, which can give us recourse if you want your money back. The cost of use however, is very high, because the bank is guaranteeing the value until the transaction closes, which can be weeks or even months later.

Now the point of this comparison isn’t to say, Bitcoin is great, or Bitcoin is awful, but rather to help you discover those situations where Bitcoin is the right form of payment to use.