Understanding Cryptocurrency as a Form of Payment and Investment - Part 1
As a self-proclaimed technophile and with a wall street background I regularly find myself in a position of trying to explain cryptocurrencies and my passion for them. More specifically, my confidence in them as an asset class, albeit a risky one, worthy of consideration and dare I say investment. This explanation consistently takes the same form and so I thought I would share these thoughts with the collective group for questions, comments and contributions. I will frame my thoughts into two parts, the first looking at what defines a currency, fiat or otherwise, and see how that definition extends to cryptocurrencies. The second part will look more specifically at cryptocurrencies as an asset class and briefly touch on utility tokens. Enjoy.
Once upon a time we had the gold standard, paper money that was exchanged back and forth was a physical representation of a fractional unit of actual gold held in reserve. For reasons that are beyond the scope of this discussion the gold standard has been disassociated with paper currency. Therefore, in today’s economy, the value of currency (paper or coin) is backed by the full faith and credit of the issuing country and its ability to support that value through its monetary policy. Tools that the governments have at their disposal include taxes, the ability to control the money supply, and lending rates. There are other factors that contribute to the value of a currency such as the perception of the global public in the stability of a country, its purchasing power relative to other currencies or commodities etc.
The above description is steeped in economic theory, and therefore I would like to offer a more plebeian explanation that I feel makes more sense. Currency is a store of value that society recognizes as a means of bartering one unit of labor with one another.
Let me explain further, take a fictional laborer. This laborer receives a salary for his efforts. The number that he and his employer (or sponsor, or patron) have agreed to can ultimately be reduced to a single unit of currency – here in the United States, a dollar. The laborer knows how much ‘work’ he does to earn a dollar. Presumably he is satisfied with his wage and agrees to labor for it – so we have an equilibrium of his assessment of his worth and his value of a dollar. He takes that dollar to the market and exchanges it for a soda. The producer of the can of soda has, through their own similar calculations, determined that a dollar would be a fair value for the soda. The physical dollar that is passed between the two individuals, the laborer and the soda provider, facilitates the exchange. In an alternate version of events, if the soda provider wanted the laborer’s work product the laborer could have bartered his work directly in exchange for the soda. As this is not usually the case, society has standardized the process with the production of currency.
In today’s digital society, many transactions occur without the physical exchange of hard currency. Payments are made by automatic fund transfer and purchases are made through debit or credit cards or digital wallets. As a society we are very comfortable with virtual currencies, when we believe those currencies are virtual representations of our fiat accounts. The difference with cryptocurrencies is one based on potential fraud or counterfeiting. Let’s suspend that concern for a moment and come back to it later. If we can accept that cryptocurrencies are immutable, then we can examine whether they can serve as a surrogate means of barter and exchange as we have already described.
The answer is emphatically yes. As we have already explained, there is no intrinsic value to a unit of currency other than the willingness of all parties to accept that currency as a medium of exchange for one unit of their labor. Provided I am willing to recognize it, then there is no difference between a Bitcoin, a Dollar or a Euro.
We see this in everyday activity all the time. Companies will offer their product or service for payment in different global denominations from euro, to dollar, to yuan to peso. Let’s extend this example ad absurdum with a fictitious case of a wealthy individual who like the fabled Rip van Winkle falls asleep for twenty years. In the interim time, the currency in which he held his fortune is discontinued (in a similar way that Italian Lira were replaced by the Euro or Israeli Shekel were replaced with New Israeli Shekel). He would be a pauper since the currency notes only have their collector value but are no longer legal tender. This means that people no longer recognize these notes as a medium of exchange for labor.
My point is that value is arbitrary. If our willingness as a society is the only power that gives a currency its value and function, then cryptocurrencies pose no different a unit of measure than their fiat counterparts.
As for the security of these units and the technology that gives rise to their immutable nature, I will save that discussion for another time.