The Principles of Money and How You Should Think of Bitcoin

To really understand bitcoin and what it aims to do, you need to understand what money is. The two terms that get thrown around a lot in regards to whether bitcoin or any other digital currency is a good investment are “medium of transfer” and “store of value”. These are important components of monetary assets, but aren’t the end of the conversation.

What Makes a Monetary Good

There are three main purposes you need to think of when you determine how useful a monetary good is: medium of exchange, store of value and unit of account.

Store of value means that users are comfortable storing their wealth in terms of that monetary good. This is generally a sign of stability and trust in the long-term value of the monetary good.

Next, you have medium of transfer, which is basically a “cash” use case. Everyone is willing to transfer value to each other by using the asset. They might not necessarily hold this for long, but it is widely used enough that you can trust in its usefulness.

The less heard of quality for a currency to have is being a unit of account. This means that people value their goods in terms of that particular currency. If you were to ask someone how much something costs, chances are they would quote the value in terms of their local currency. That makes the local currency the unit of account.

Right now, bitcoin is not a unit of account because there is no set bitcoin price a good would be sold in. Instead, you have values quoted based on the current BTC/USD exchange rate, which is very different.

The Path of Monetary Evolution

It can take decades for a good to go through the full evolution of its use as a monetary good, and that use can change with shifts in the economy. For example, gold would have been used for all three purposes, but is now only used as a store of value. Similarly, PayPal captured the medium of transfer use case, but never developed a meaningful solution to become a unit of account or store of value.

So where is bitcoin now? Based on the way it is being traded, it is mostly a store of value. In the beginning, there were lots of situations where users would spend bitcoin on trivial objects, but now with the meme “HODL” and the number of rabid bitcoin supporters, it is mostly a long-term investment.

This is the standard path a new monetary good takes. Nobody would want to use it as a medium of transfer because the value is fluctuating so much that it is infeasible for daily use. Until the equilibrium amount of demand for the good comes online and the price somewhat stabilizes, it is unlikely to become a medium of transfer. The same applies to unit of account, as mentioned above.

No Defined Outcome

A common gripe against bitcoin is that it is not a useful currency because it does not fulfill the store of value condition, but this ignores the shortcomings of fiat currency. Nobody holds more than a small proportion of their net worth in fiat, because it is not a good store of value. Inflation is constantly eroding the value of the currency and that is its core weakness.

Additionally, when you look at unstable countries, such as Argentina, there are multiple monetary assets in use. They use the Argentinian peso as a medium of transfer, but opt for the US dollar as a store of value.

So there is no defined outcome for bitcoin’s evolution. It doesn’t have to fulfill all the use cases for it to be useful, it just has to be better than our current options for a use case.

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