Chief Economist at BBVA Mexico
This month El Salvador recognized bitcoin as legal tender. Bitcoin is the first and largest of the cryptocurrencies.
Could bitcoin be a currency in which everyday transactions such as going to the supermarket, paying rent, or making investments are carried out? I doubt it. To better understand why, it is convenient to define money. Economists define money as an instrument that fulfills three fundamental functions in an economy: means of payment, unit of account and store of value. Money fulfills the function of a means of payment if it can be used to pay for goods and services, rather than having to resort to bartering. Coins and notes issued by a central bank certainly fulfill this function. By unit of account I mean that all goods and services in an economy can be expressed in money and not in terms of other goods and services: for example, how many books does a shirt equate to? And finally, the store of value function implies that money can maintain its purchasing power over time (when this function is lost in the midst of hyperinflationary processes, people abandon the national currency – which stops acting as money – in favor of a hard currency).
Bitcoin does not fulfill at least two of these three functions due to its high volatility. In this year alone, the value of a bitcoin went from $ 63,000 in April to $ 30,000 in July, to now stand at 43,000. This behavior makes it difficult for it to fulfill the function of unit of account -as it would require constant adjustments in the prices of goods-, but it also undermines the function of store of value: would you have the savings from your children’s university in an instrument that loses half of its value in 4 months as it happened this year?
On the other hand, although its technological characteristics could make it possible to use it as a means of payment, its level of acceptance is very limited, in part because it does not fulfill the first two functions of money. In fact, when it appeared in 2009, many predicted that it would soon be a common currency. The reality is that not even in advanced economies can it be used on a daily basis: twelve years after its creation, it is not usual to pay for the supermarket or a meal in a restaurant with bitcoin, as some claimed would happen.
Now, an important characteristic of bitcoin is that it allows transactions to be carried out anonymously. Therefore, it is very common to find out that it is used for criminal purposes. A few months ago, the ransom that was paid to hackers that had taken control of a gas pipeline in the United States was paid precisely with bitcoin. For this reason, judicial authorities in several countries plan to regulate its use.
Many people have made large amounts of money by investing in bitcoin. Someone who invested a thousand dollars in 2011 today would have almost 8 million dollars. It cannot be ruled out that its value will continue to grow for longer, however, in any case it seems to me that we are possibly facing a speculative bubble.
For many economists, the intrinsic value of a bitcoin is zero. Unlike the currencies that central banks issue, bitcoin does not have any assets to back it up. Today it is worth what it is worth because there are those who are willing to pay it. And it does so, fundamentally, in the hope that it will be worth more in the future. But if the sentiment changes, its value can easily collapse. This is a reality that investors must be aware of.
Therefore, the president of the United States securities regulatory body, Gary Gensler, an expert on the subject (he recently taught a cryptocurrency course at MIT), has announced that the regulation will be designed to prevent bitcoin from being placed to investors unsophisticated who do not understand the risks they would be taking.
Regardless of its value as an investment instrument, I believe that bitcoin will not become money in El Salvador or elsewhere. That is not to say that the technology behind (blockchain) may not have valuable uses for society or that eventually there are digital currencies issued by central banks. I will talk about it in future installments to The financial.