Bitcoin as a Currency

The concept of currency goes back thousands of years, at the point where we evolved from being limited to trading goods for goods to adopting other items which represented common value. In earliest times, items like seashells or commodities like cattle were exchanged, which evolved into exchanging precious metals and then coinage to represent this value.

With currency, the object itself would represent a certain amount of wealth, and we eventually denominated coins to denote this value. We could then exchange these coins for goods or services where the coins would be accepted as payment, and then used to pay for other goods and services.

Bitcoin as a CurrencyCurrency therefore functions as a medium which facilitates exchanges of value, where we no longer require that the needs of parties in an exchange correspond in any way. If you want to buy a cow and the person wants to buy feed, you can give the person with the cow currency and the farmer can then use the currency to buy feed, instead of your needing to give the farmer something he wants for the cow.

Currency at one time was backed by precious metals such as gold or silver but we eventually evolved to having the value of our currency decreed by the power of law, where by these verdicts others are required to accept it for payment.

Most of our money supply is just on paper these days, and since the proliferation of computers, exists in the digital realm, and hard currency only represents about 10% of what we call money. The other 90% consists of credit, money that is not backed by currency but functions as if it were, numbers on balance sheets that get exchanged between parties.

The latest evolution of currency was the idea that a currency could entirely exist in digital form, a possibility that came into being in the digital age. Purely digital money is not so different from traditional currency actually, at least the kind we have today, and the major distinction between cybercurrency and fiat currency is the fact that cybercurrency is not centrally managed, but instead managed purely by users.

What Really Makes Bitcoin Different

Some may think that cybercurrency is distinguished by deriving its value from the market, and while that is the case, so called hard currencies get their value from the market as well. If there were a single currency in the world, this would be different, but currencies are traded among each other and their value relative to other currencies do fluctuate.

These differences in valuations with so called hard currency is an issue whenever one currency is traded for another, and in domestic economies, this doesn’t come up most of the time as the common currency of a country or region dominates.

Given that Bitcoin is so new, and that the overwhelming majority of the world’s currency is held in hard currency, exchange rates matter much more with Bitcoin, and how much it is worth matters fundamentally in any Bitcoin transaction, where if you were using dollars you know it’s worth one dollar and what it is worth in other currencies generally does not matter.

The reason for this difference is that if all of our transactions are in a single currency, its value does not matter, and it only does if and when you are looking to trade it for another currency.

Currency valuations do matter quite a bit to governments, as they seek to manage the value of their currency versus others, as this does affect trade between countries which affects the economy in general of a country significantly.

Given that Bitcoin’s relative value is so prominent, this does tend to increase its volatility relative to other currencies, and given that stability is such a benefit and a goal with any currency, this does pose a challenge to the growth of cybercurrencies such as Bitcoin.

Currencies Require Wide Acceptance to Reach Their Potential

The biggest challenge for Bitcoin as a currency is to gain wide enough acceptance in the market as a medium of exchange, as a way for people to use it to make payments with. In spite of all the noise that Bitcoin has made recently, this aspect of it has a long way to go.

This is to be expected, as the things that Bitcoin seeks to address, the ability to send payments anonymously, the security of payments being verified by the blockchain, and the idea of using a currency that isn’t managed by governments just isn’t seen as that important to most people currently.

None of these issues are really that important to people actually, and in the battle between Bitcoin and the world’s major currencies, Bitcoin hasn’t even been able to make a dent in them, from a transactional perspective at least.

The relative long period of time that it takes to confirm Bitcoin payments, as well as its lack of stability, makes people and especially merchants leery of accepting it. If the demand were strong enough, and that may happen someday, this would probably lead to a change of heart, especially if competitors seek to gain the business of consumers who prefer Bitcoin.

We have already seen this happen in the U.S. online gambling market, where Bitcoin offers such advantages that it has become the payment method of choice, and gambling operators have had to accept it or lose a lot of business. This has resulted in Bitcoin becoming the predominant payment method in this market, due to these payments being off the grid and away from prying government eyes completely.

Even though Bitcoin has been catching on more and more and is accepted in more and more places over time, the gap here remains huge, and it may take years before it is able to be used as a common payment method. We may even wonder whether the infrastructure would support that, given the amount it now takes to confirm payments.

If the use of Bitcoin underwent the exponential growth that would be required to elevate it as a common payment method, the burden upon the current system would be overwhelming, which would likely serve as a limiting factor on its growth as a means of transacting.

How Bitcoin Transactions Work

Bitcoin transactions and verified and processed by what is called the blockchain, and blockchain transactions are certainly an interesting way to approach this. Instead of being processed centrally, Bitcoin utilizes a completely decentralized approach and a log of all transactions ever processed are kept on computers around the world.

This does serve as a superior means of verifying transactions, but it is very resource intensive, and people are already starting to complain about how much energy it is taking to process these transactions, as well as the massive amount of resources used to create new Bitcoin by mining operations.

In an era where global warming is such a concern, and large power users are seen as something that should be curtailed, we may wonder how much these concerns will be a limiting factor in the growth of Bitcoin as a currency. In order for it to be a competitive means of payment, this will require much more resources to be devoted to it, many times what is devoted today. If this is even feasible, and it may not be given that there is only so much energy on current grids to go around, there will certainly be a lot of people who will become upset about this, and these misgivings are already making the rounds in popular media.

This all assumes that the ultimate goal of Bitcoin is to unseat traditional currencies to a large degree though, and while that may simply not be practical, this does not mean that Bitcoin cannot end up with a larger impact upon commerce than it has currently achieved.

At least some of the excitement surrounding Bitcoin is based upon projections of its growth as a currency, although this has been vastly exceeded by people’s expectations of the rising value of Bitcoin period.

It is important to fully appreciate the challenges that Bitcoin will face on the road to its growth as a currency, even though the challenges of its value rising from its being used as an investment does not seem to be much of an issue at present.

In a real sense, Bitcoin’s goal of being a digital currency has been greatly surpassed already by its perceived investment value, which is not surprising given its meteoric rise.

This will only be accentuated by the industry creating things like Bitcoin futures, which we already have, as well as planned Bitcoin based ETFs and other investment vehicles. Institutional investors are already starting to invest in Bitcoin as well, ones with very deep pockets and these institutions drive the market to a large degree and could care less about Bitcoin’s value or potential as a currency.

Bitcoin’s popularity or lack of popularity as a currency may not even matter in the end, and we could even say that it hardly matters already, and few people these days seem to care about that side of Bitcoin.

This may even be akin to saying gold is pretty where the real value of gold is how much people will pay for it, its value as a commodity in other words. Bitcoin has already reached this level for all practical purposes although the fact that you can spend it as money certainly can’t hurt things, and may be seen by some at least as an added benefit, although thus far not by many.

Still though, there is some promise at least for Bitcoin to make more noise as an actual currency, as a means to accept and make payments, but this part of Bitcoin is growing far more slowly than the frenzy driving its price sky high.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.