Is Bitcoin Real Money?7 min read
As the adoption of Bitcoin grows and it continues to gain acceptance across the world, it’s important to consider what makes it a superior form of money. For something to be considered money, it must perform three primary functions:
- a store of value
- a medium of exchange
- a unit of account
What makes Bitcoin a good store of value?
In order to evaluate Bitcoin as a store of value, it helps to consider the history of money. Over the course of human history, there have been several iterations of money such as cattle, animal pelts, mollusk shells, precious metals, and the coins manufactured from these metals. The underlying principle behind why these items were considered valuable was the fact that they were scarce at the time. These items became less scarce over time and of the precious metals used as currency, gold was found to be the most scarce since it is one of the rarest naturally occurring metals on earth, and mining it is difficult and dangerous. As we’ll discuss later in this article, the amount of gold mined every year is a small percentage of the total supply of gold in the world. This is what made it a good store of value and useful as a currency.
However, gold can also be heavy and hard to transport which is why it started being used in the form of coins. The problem with coins was that traveling with a large amount of them could be a security issue because if anyone came to know about them, the traveler would become a target for thieves and robbers. Additionally, they could be counterfeited and a regular person would not have the knowledge or equipment required to verify that they were real which led to people relying on goldsmiths as safe-keepers and verifiers because of the inability to verify it themselves. In return for their deposit, the goldsmith would give them a receipt and if the goldsmith was well-known and reliable, this receipt could itself be used as currency because it was redeemable for gold. This is how gold-backed paper currencies became popularized and were used for centuries.
Governments realized that having currencies backed by gold was restrictive to their monetary and fiscal policies so, in the 1970s, the US followed by the rest of the world abandoned this gold standard in favor of the fiat currencies they use now. Fiat currencies are currencies that are no longer redeemable for a scarce and valuable asset but instead are supposed to hold value because of the authority of the governments that issue them. This makes it easy for governments to create new money for spending but is an issue for citizens because the creation of new money diminishes their purchasing power. For example, the US government has increased the money supply by over 25% just in 2020 from $15.33 trillion at the end of 2019 to $19.19 trillion at the end of 2020, which will undoubtedly lead to inflation and loss of purchasing power for citizens. Despite moving away from the gold standard, most sovereign governments still hold large gold reserves because of its scarcity properties.
Bitcoin is often referred to as “digital gold” because of its scarcity but the comparison doesn’t really paint the complete picture. While gold has relative scarcity, Bitcoin has absolute scarcity. There will only ever be 21 million coins mined, with the mining scheduled to end in 2140. Bitcoin has a predetermined schedule of new supply being mined every 10 minutes and this new supply is halved every four years making it scarcer over time regardless of demand or price increases. In comparison, the total supply of gold is estimated to be 197,576 tonnes by the World Gold Council but independent estimates vary by as much as 20%, while its new supply being mined has also been increasing over time.
As mentioned before, gold can be counterfeited and it’s hard for an average person to verify its authenticity. In contrast, it is theoretically impossible to counterfeit Bitcoin and it is simple to verify. Due to gold’s issues of divisibility and transport, it has been stored by governments and central banks in vaults giving them power over record keeping and seizure while Bitcoin uses a decentralized network for settlement which means no government or entity has control over it.
What makes Bitcoin a good medium of exchange?
Bitcoin addresses the issues of portability and divisibility of gold. Unlike gold, Bitcoin can be transmitted over several communications channels with a high level of security making it highly transportable. It would also be much easier to travel across borders with Bitcoin than gold since gold has historically been a target of confiscation by governments.
As a medium of exchange, Bitcoin’s base layer currently has some issues with scaling. With the growth of the network and Bitcoin’s popularity, the number of transactions has grown and the fees have gotten more expensive but although the throughput was increased with the Segwit protocol, it still requires the need for a proper scaling solution to handle micropayments. This causes congestion in the blockchain in which those who pay lower fees have to wait longer for their transactions to be confirmed. The Lightning Network was created as a second-layer solution to address these issues. Fees on the lightning network are minuscule compared to base layer transaction fees and it is also capable of millions of transactions per second settled almost instantly. With the Lightning Network continuing to be adopted as the scaling solution for Bitcoin payments, the use of Bitcoin as a medium of exchange will continue to grow as well. Many businesses today are already enjoying the benefits of the Lightning Network for accepting Bitcoin as it comes with faster settlement times and lower transaction fees than any fiat payment processor.
What makes Bitcoin a good unit of account?
Each Bitcoin is divisible into 100 million units referred to as “satoshis” and gold is hard to divide into units of small value due to its density. As time goes on and Bitcoin’s value increases, satoshis are looking to be the unit of account we will refer to when pricing items. Just as the Dollar or the Euro can be broken down into cents, a Bitcoin can be broken down into sats for pricing goods or services. Additionally, satoshis can be further divided into milli-satoshis on second-layer protocols like the lightning network. At the time of writing, 1 sat is equal to .000520 USD and with 100 million sats per Bitcoin, sats make it easy to do microtransactions in Bitcoin. Also, unlike paper cash that currently acts as a unit of account for currencies like USD or the Euro, sats can not be hyper-inflated as there will only be 21 Million Bitcoin in existence, thus giving sats the case to be a great unit of account.
One of the issues that make it difficult for Bitcoin to be used as a medium of exchange and unit of account is its volatility in terms of fiat currencies. At OpenNode, we address the issue of Bitcoin’s price volatility with our instant exchange feature. This allows the user to instantly convert their Bitcoin into one of the many fiat currencies that we provide the option to convert to. We also make it easy for merchants and individuals to use the lightning network and take advantage of the lower fees and faster transactions.