Can Bitcoin Act as Money?

An analysis of bitcoin's ultimate credibility

Since 24 January, bitcoin has risen 65% and gold rose about 7% priced in US dollars. Before gold began its current successful but relatively modest leap into new high ground, there is little doubt that hedge funds and others sold down their Comex gold contracts and bought some bitcoin ETFs instead. The listing permissions for bitcoin ETFs made regulated investment possible. And attracted by the limitations of supply, an investment cohort moved in for the kill.

This raises the often debated question yet again as to whether BTC will become money, which is the long-stop argument of its supporters. For the avoidance of doubt, I approach this topic not as a goldbug insisting on an old-school argument. Defending bitcoin, Colonel Macgregor put it in a recent interview that Macleod has a vested interest as a gold bug. I maybe a gold bug, but that does not mean that I am one through bias. I try to look at all matters objectively, which is how I approach an examination of bitcoin without any bias against or in favour. But there are some factors that investors should bear in mind and that is what this posting is about.

I draw your attention to the correlation between BTC and US tech stocks, illustrated in the chart below.

I constructed the tech index by taking the weekly close of seven large-cap stocks, rebasing them all to 100 on 24 February 2020 and then taking the arithmetic average of all of them to construct an index. It is therefore a pure price index instead of the weighted by capitalisation approach. This is then compared with bitcoin’s (BTC) weekly closing price, similarly rebased. Since bitcoin has far higher volatility than even the tech stocks, I put them on different axes to facilitate visual comparison. The current bull markets in both tech stocks and bitcoin commenced at that same time. A Beginner’s Gui... Kratter, Matthew R. Best Price: $1.36 Buy New $6.99 (as of 02:07 UTC - Details)

The result is striking. Until early November 2021, the correlation was loose, though both were in bull phases. But remarkably, bull phases ended at the same time, and a bear phase ensued until both markets bottomed a year later in November 2022. The correlation in that correction was then much tighter, as it has been in the subsequent bull phase, particularly in recent months.

This begs the question: is bitcoin to be regarded as a new form of money, escaping from government currency debasement, or does it merely act as an investment or speculative substitute for tech stocks? This is important, because many hodlers[i] argue that the tech bubble is being fuelled by “money printing”, the very evil that justifies their hodling. But the reality is that by their actions they appear to be chasing profits as if they were punting in momentum-driven tech stocks, instead of genuinely hedging out of fiat currencies.

Is bitcoin money?

To answer this question requires an understanding of both money and credit and how they differ, something which is generally lacking even among economists. If bitcoin is to be the “new money”, replacing gold, then it must satisfy all the functions of money: a medium of exchange, a unit of account, and a store of value. To this which was Aristotle’s definition, my colleague James Turk added a fourth to take account of modern credit conditions: to act as the final payment for transactions.[ii]

This last function links money, properly describing physical gold in international law whose possession has no counterparty risk, with credit where there is always counterparty risk. Credit encompasses currency, bank deposits, bonds, bills, equities, and personal commitments to pay for something already received. It is always matched with an obligation, or debt. Ownership of an equity, for example, is matched by a promise to pay an income stream. Credit is not only matched by debtor’s obligations, but it also represents wealth.

It is not that true money circulates. As long as credit can be exchanged for it, credit can happily continue to circulate in its various forms, because money guarantees credit’s value other than its counterparty risk. This was why gold standards always worked until they became abused by the currency issuers.

Since 1971, this final function of true money has been removed from the global financial system, creating the conditions of fiat currencies without the guarantee of convertibility into money as the final payment available for transactions.

Any goldbug or hodler who mistakenly believes that money circulates and in a financial Armageddon will replace credit, fails to understand money’s true function and its distinction from ubiquitous credit. Money can be used for direct exchange, but that is always a last resort. If in a financial anarchist’s imagination credit and all its evils somehow disappear, we would quickly return to the dark ages.

Presumably, hodlers think that bitcoin will be used as payment for transactions by electronic means. That is undoubtedly true between consenting parties. But in the absence of credit, it is hard to envisage any trade taking place, except on a very limited basis because of the intensely deflationary conditions that would be the result.

It is a vital function of any form of money to introduce monetary stability, upon which credit can be based. No one will enter into a contract involving credit without some certainty of final value. This is why money is objective in its value, which means that parties to a transaction can agree that all subjectivity, or variation in a transaction’s value is in the goods or services subject to the transaction. Catching Up to Crypto:... Armstrong, Ben Best Price: $12.24 Buy New $14.79 (as of 02:32 UTC - Details)

But find me a hodler who expects BTC to provide objective value: they are all enthusiastic supporters because they expect BTC’s value, measured in fiat credit, to rise ad infinitum. And here we hit a real problem: without fiat currencies to value it, would bitcoin and other cryptocurrencies have any value themselves? To have that value it must be freely exchangeable for goods and services and must have the agreed objectivity, which with bitcoin’s disruptive volatility is a problem.

Bitcoin is equally unsuited for valuing capital. Capital is required for financing businesses and comes in the form of credit. In any business, this credit is required to finance production, which means that a significant period of time must elapse between acquiring or providing finance and being able to pay it down through profitable sales. Without stability of value in the medium of exchange, it is impossible to make business calculations. Admittedly, this stability is absent with a fiat currency, but through its mild devaluation a business benefits, so long as the interest cost is reasonable. It is this feature promoted by Keynesian economists as a virtue, which eventually destroys a fiat currency.

Bitcoin has as its enthusiasts who recognise the damage done by governments to the purchasing power of their currencies. But they are a generally tech-savvy investors. The extent of bitcoin and other cryptocurrencies would be unlikely to find wider support in the seven billion transacting humans with a different concept of money, even if its volatility could become tamed.

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