Cryptocurrency: Modern-Day Dutch Tulips Without the Beauty
At least the tulips were pleasing to behold and didn't pointlessly destroy ecosystems
Sometimes the emperor is naked, and finally everyone says so aloud. The collapse of so-called cryptocurrencies is one of those times. The explanation is simple to anyone who has a smattering of classical economics. I offer it below.
The word “currency” is a term used to denote “money.” The two terms are interchangeable and refer to the same thing. The term “cryptocurrency” refers to a particular kind of money — one that in theory doesn’t rely on the intermediation of a bank or other financial institution. Instead, it is supposed to be used to consummate direct transactions between sellers and buyers, who for these sales and purchases use a digital money that is impossible to counterfeit, limited in quantity, and exchanged on an impenetrable, foolproof, and anonymous blockchain. No intermediaries or meddlesome governments are supposed to have any role or say in these direct transactions. According to peddlers of the various cryptocurrencies, a brave new world awaits those wise enough to accumulate a good cryptocurrency in its early days.
It all sounds great in theory. But it has never worked that way for any of the cryptocurrencies. None of them has ever functioned as a workable, usable currency — not even in the one country in the world, El Salvador, where Bitcoin has been decreed legal tender (i.e., money that by law can be used to pay for goods or services).
This simple observation is easily demonstrated.
By definition, a currency serves as a medium of exchange, a unit of account, and a store of value. Those are the original and only uses of any money. A usable currency must have all three attributes to be fit for purpose. A currency that does not accomplish any of these purposes is worthless, which is the approximate value of cryptocurrencies before their ruinous environmental cost is taken into account.
Let’s begin with the first attribute of any serviceable currency: does it function as a reliable, widely accepted medium of exchange?
That term refers to our countless, everyday exchanges of goods and services, by which we survive and try to prosper. I do not offer, say, five minutes of antitrust counseling to a baker when I visit his store to purchase some bread. He has no use for my advice and would run me out of his store rather than part with his bread in exchange for it.
So instead I offer him money, which he can use for goods and services that he wants, and which a client who required antitrust counseling paid to me for my services. Nor did my client first offer to furnish me with its medical devices in exchange for my advice, since I personally had no more use for its devices than my baker has for my insights into American antitrust law.
In other words, we do not barter for goods and services: in an advanced economy, it is impossible to exchange products and services for one another. Even if such a system were physically possible, it would be hopelessly inefficient and reduce us all to abject poverty of the kind that prevailed in antiquity before civilized society first arose in Mesopotamia.
Instead, we all use money. It serves as a medium of exchange that pays for the value of each good and service: specifically, a person collects money in exchange for a good or service that he furnishes and pays money in exchange for goods and services that he receives.
Direct barter can work only in a primitive society in its earliest state of advancement. Perhaps a caveman will chisel a cave for a fellow member of his tribe in exchange for a specified number of bearskins that he can use to clothe himself during the harsh winter that lies ahead. Once we get much beyond that state of affairs, direct barter becomes unworkable. Instead, we use money as our necessary medium of exchange.
To be fit for this purpose, a given money must have a relatively stable value and must be commonly accepted as a means of payment. If I offer to purchase your house in sixty days for a stated quantity of a given currency, you will not accept the offer unless you have confidence that it will have approximately the same value in sixty days as it does now.
Since cryptocurrencies fluctuate dramatically in value, none of them has ever fulfilled this first and most basic purpose of money, which is to serve as a medium of exchange for most kinds of transactions.
Would you accept a given quantity of Bitcoin, payable sixty days from today, in exchange for your home? Of course not. Nor would any buyer agree to pay it. No seller, buyer or lender will assume such a risk for any substantial transaction that will be performed at a future date or over time.
Further examples confirm the point beyond any possible debate. Take, for example, companies that make large-scale purchases under long-term contracts, such as a steel company that buys vast quantities of iron-ore, coal, smelters, shipping services, and electricity. Consider the mining and shipping companies that supply this steel company, as well as the railroad operators and truckers that ship its rolled steel, as well as its industrial customers that purchase it. Such companies typically use long-term contracts for large-scale purchases that run to the hundreds of millions of dollars or more. No such company would ever use any cryptocurrency as a means of payment for any such contract.
The explanation is as simple as it gets. Every cryptocurrency’s value is unstable and likely to surge upwards or downwards by the day and unforeseeably. It is largely impossible to conduct business with any such “currency.” Cryptocurrencies thus fail to fulfill the first necessary function of any usable money: they do not serve as a medium of exchange.
Nor does any of them fulfill either of the other two purposes of a usable money, which are to serve as units of account and stores of value.
The term units of account means assigning approximate values to assets and liabilities. For example, Acme Corporation’s accountant might certify that Acme holds $2 million in accounts receivable for widgets already shipped, holds another $1 million of widgets in its existing inventory, owes $1 million in debt to different creditors, and holds a renewable insurance policy that covers the first $15 million of any loss caused by an insured event. These figures, once audited, can be used by investors, vendors, customers, and others to determine whether they wish to do business with Acme, which for its part can use these same figures to make important business decisions.
In the foregoing example, I have used U.S. dollars to serve as the unit of account. It serves as a reasonably reliable measure of the current value of Acme’s assets and liabilities.
No cryptocurrency can be used for this purpose, since all of them fluctuate in value too much, too often, and too unpredictably. Cryptocurrencies therefore lack the second necessary attribute of a currency: they are not reasonable units of account.
Nor can any cryptocurrency serve as a sound store of value, which refers to the safeguarding of assets in order to preserve or increase their value over time.
A usable money should always serve as an imperfect, but reliable store of value, one that is diminished by inflation, but is otherwise dependable. If you deposit U.S. dollars in a bank account or money-market fund, your deposit will have approximately the same value when withdrawn as it did when deposited, less any loss caused by inflation, but plus any interest paid on the deposit. Usually, the deposit will buy approximately the same amount of goods and services when withdrawn as it would have done when deposited, with a predictable, modest markdown because of inflation.
That cannot be said of any cryptocurrency, since its value fluctuates unpredictably and wildly and therefore serves as a very poor, highly uncertain store of value.
So there you have it: cryptocurrencies fail to offer any of the three necessary attributes of money. None of them serves as a reliable, commonly accepted medium of exchange, unit of account, or store of value. In other words, none of them functions as usable money.
Nor is any cryptocurrency backed by the full faith and credit of an issuing sovereign power, which can make good on its promises to pay its debts because of its power to tax — i.e., its power to take part of the assets, income, and sales of those subject to its taxing power.
What use, then, do any of the cryptocurrencies actually have?
Their proponents, sometimes called “Crypto bros,” cannot give a straight or satisfactory answer to this simple question. They usually offer all kinds of confusing and mystifying explanations, which mostly make no sense at all, or which at best are overly complicated, murky ways of arguing that we shouldn’t have governments or organized societies, but only direct, anonymous transactions between private parties. That is an outcome that very few people really wish to have once the implications are fairly considered.
In fact, cryptocurrencies fulfill no service or function at a reasonable cost in any modern economy. In particular, they don’t facilitate digital transactions at a reasonable cost. It is vastly more practical and less expensive to use a financial institution’s debit card, credit card, or electronic transfer than it is to make crypto-transfers on a blockchain, assuming you can even find a seller or buyer willing to do a transaction in a cryptocurrency.
Indeed, making crypto units (coins) costs a fortune in energy, much of it coal-powered. A crypto-miner must operate warehouses stacked to the rafters with powerful computer servers that perform the complex mathematical calculations necessary to create each new unit. What an absurd waste of resources.
Also, when a fraudster diverts a banking transaction or misuses credit-card information, the victim can usually obtain timely redress. Not so in the unregulated world of crypto.
In short, cryptocurrencies are mere electronic digits stated on a blockchain that have no practical use for anyone — except to pay for criminal transactions and scattershot transactions with unhappy sellers in El Salvador, whose current president has authorized the use of Bitcoin in a ruinous, speculative scheme to prop up his government’s doubtful finances.
That brings us to the real and everyday purpose of cryptocurrency as it is actually used. Its real purpose has been to serve as the object of idle, old-fashioned speculation. Punters venture gigantic sums on crypto-coins in the hope of attaining effortless fortunes.
More specifically, a punter (i.e., a gambler) buys a given amount of a cryptocurrency today with a quantity of US dollars. He then holds it for a time. He does so in the mere hope that at a later date he can sell it to another punter for an even greater quantity of US dollars. Otherwise, the cryptocurrency has no value to him or anyone else at all.
That is pure speculation, untethered to anything productive or useful, and all of it at a great cost to our society in every way that matters.
The same was true of Dutch tulips during an earlier speculative bubble, except that the tulips caused no environmental harm, were pleasing to the eye, and always retained modest value as ornamental flowers. Cryptocurrencies lack even these redeeming features. Don’t buy them, would be my advice.