Since its launch with little fanfare roughly 9 years ago, when creator Satoshi Nakamoto released the genesis block with the message “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”, Bitcoin has grown exponentially and is reaching a critical mass as we enter 2018, with mainstream adoption just beginning, and the price of Bitcoin increasing in a potentially dangerous parabolic fashion.
Bitcoin is the first cryptocurrency to be created, but in its short 9 year lifespan we have seen more than 1,300 other cryptocurrencies born, with hundreds more just waiting for their time in the sun. Gains and losses for this asset class have been nothing short of remarkable, with Bitcoin itself gaining some 1,800% in 2017, and other coins seeing gains in excess of 20,000%. Conversely, it is just as easy for a coin to crash and burn, giving back all its gains and more, and sometimes this surge higher and following crash occurs in a matter of days.
While billions have been made in the cryptocurrency markets already, there remains one critical definition that hasn’t yet been settled.
Is Bitcoin a Currency or a Commodity?
A currency is used to facilitate commerce. Bitcoin can do this, but has been utilized less and less as a transactional coin, mainly due to the increasing transaction fees imposed by the Bitcoin network when transferring the coin. A commodity is something that has intrinsic value, like crude oil or gold, and whose price rises and falls based on changes in supply and demand.
Government regulators seem to be falling on the side of Bitcoin being a commodity, and both the U.S. and South Korean regulators have already classified Bitcoin as an asset class similar to a commodity. However, the European Union has come down of the side of Bitcoin being a currency.
In some cases a currency is treated like a commodity, with speculators buying and selling the currency to take advantage of changes in its value relative to other assets. But the primary purpose of a currency is not for speculation, but rather to facilitate trade. The earlier alternative to currencies was the barter system, where any type of goods and service can be traded for other goods and service. The problem with barter is that there is no standardization, making it difficult for trade partners who now need to determine the value of their product in corn, wheat, cows, wool, or some other item.
Another characteristic of currencies is that they have price stability. A currency that fluctuates wildly become inefficient as a pricing mechanism. Certainly changes in the value of a given currency are acceptable, but they shouldn’t be so great that buyers and sellers hesitate to set prices in that currency due to a fear of price moving against them. In cases where the value of a currency plunges rapidly the outcome is almost certainly political chaos and economic paralysis. And currencies rarely rocket higher in value in a short time period.
It is often said that modern fiat currencies such as the U.S. dollar and Euro, which are not backed by any physical asset like gold, are not stores of value. But fiat currencies are backed by your ability to use them in their respective countries to purchase goods and services. And there is a relatively certain guarantee that the value of the currency won’t change dramatically in a short period of time. In the case of the U.S. dollar, you are guaranteed that you can use it to purchase any item within the U.S. economy, and then transport that item where you will. And because the U.S. dollar is the reserve currency of the world, you can be certain that it will be accepted in many other countries of the world, or you will at least be able to convert it into that nation’s currency and then convert back as necessary. In this way the U.S. dollar gives users access to nearly all of the world’s marketplaces, and allows its users to exchange value for value.
Bitcoin Does Not Behave Like a Currency
Thus far the behavior of Bitcoin has had little in common with the behavior of a currency. The continual volatility and huge upward surge in value is certainly applauded by some, but it also creates massive uncertainties. One of the greatest is whether a holder of Bitcoin should use it now to purchase a good or service, or should they wait because their Bitcoins will almost surely be worth more next month, or even next week. Others wonder when the value of Bitcoin will decline substantially, as media outlets continue reporting about the “bubble” in Bitcoin.
These are issues and questions that don’t arise regarding healthy currencies. Sure, there are fluctuations in the value of individual currencies, but they are rarely more than 1% daily or a few percentage points in the course of a month. Certainly the value doesn’t change so dramatically that people consider all their purchases as potential bets on the ever-changing value of the currency.
Is Bitcoin a Commodity Then?
Even though it is called a cryptocurrency or digital currency regularly, Bitcoin has actually been behaving far more like a commodity. Surges and extended strong rallies in commodities are not unusual, though to be sure they typically aren’t on the scale seen in Bitcoin recently. And though commodities have been used for barter, they typically aren’t used a currencies. But if Bitcoin is a commodity, we have to ask what commodity is it? Because a commodity is an asset with a use value, and it is the use value that then creates exchange value. The changing price is a function of the market expectations of supply and demand.
It seems as if Bitcoin’s value is totally determined by market expectations. As a commodity, Bitcoin only has an exchange value. There seems to be no underlying use value for Bitcoin outside of market expectations.
Of course any object has value if others are willing to buy it. And consider that the use value of Bitcoin might be in its use as a store of value. It is also extremely useful to those who wish to participate in other areas of the cryptocurrency markets. Currently it is extremely difficult to buy most other cryptocurrencies with fiat currencies such as the U.S. dollar, Euro and Yen. Instead, most cryptocurrency purchases are made using Bitcoin. This has kept the value of Bitcoin rising, but for how long?
The Bitcoin Millionaires
The possibility of a dramatic decline in Bitcoin’s price comes in response to the parabolic rise in the price of Bitcoin. There are many Bitcoin millionaires who made their fortunes by holding Bitcoins. Now we have institutional investors beginning to enter the market. The original Bitcoin adopters have a mentality to hold onto their Bitcoin no matter what, believing price will continue climbing to $100,000 or even $1,000,000. But institutional investors have a much shorter time-horizon, and like to lock in profits on a monthly or quarterly basis. Once profit taking begins, how far can Bitcoin slide? Remember, it has no use value itself, other than that ascribed to it by the confidence of Bitcoin adopters. History has shown us that confidence can be a volatile and fleeting commodity in the human race.
Bitcoin is neither completely currency, nor is it completely commodity, and there are those that will tell you that this is one of its virtues. Even so, trying to define it as both currency and commodity will continue to create problems, because it makes it difficult to see what Bitcoin really is. Bitcoin’s true strength come from its decentralized nature, its lack of regulation, and because it isn’t issued by any government.
Bitcoin’s problem right now is that most people don’t understand what it is, and by calling it both currency and commodity you slow that understanding further. People know it can’t be both, so they doubt it can be either. Once people can see what Bitcoin truly is – how it will change trade and economics – that’s when the real explosion in adoption and usage will begin. And once that time comes we won’t have to debate whether it is a currency of commodity, because it will simply be Bitcoin – the genesis of the cryptocurrency shift.