Can Bitcoin, or any other crypto-asset, become a durable currency, or is its value a pure bubble? In his October 2020 paper entitled “Fiat Money, Cryptocurrencies, and the Pure Theory of Money Edward Elgar Handbook on Blockchain and Cryptocurrencies”, David Glasner applies basic concepts and doctrines of the economic theory of money to address the value of bitcoins and other crypto-assets. He focuses on rationalizations for a positive equilibrium value for bitcoin and other crypto-assets. Based on his interpretation of theory, he concludes that:
- For a fiat currency to have value (demand), users must trust that others will accept it in exchange for goods and services (network effect). Current demand for bitcoin as a trusted medium of exchange strongly concentrates among users wanting anonymity for transactions and seems much too low to account for observed fluctuations in its value (it’s a bubble).
- By making its fiat currency acceptable (required) for paying taxes, a (stable) government creates a durable source of demand for it, beyond its use in private transactions. Its value derives from these two demands and the government-controlled supply. The stabilizing anchor of tax payments is unavailable to bitcoin and other crypto-assets, so risk of collapses in their values is much higher than that for a (stable) government fiat currency.
- Even if values of bitcoin and other crypto-assets are bubbles, network effects may lock some existing users into continued use. However, prospects for wide use of bitcoin are dim, because: (1) the transaction process is too slow: and, (2) the cap on the number of bitcoins implies that significant expansion in demand would force dramatic appreciation and hoarding incompatible with a medium of exchange.
- A differently specified crypto-asset might have a better chance as an alternative to government fiat currency, but impetus for widespread adoption seems very dubious.
In summary, theory suggests that bitcoin is in a bubble, and the prospect that it or any other crypto-asset will expand its market beyond a narrow clientele of speculators, traders in illicit goods/services and extreme libertarians seems remote.
Cautions regarding conclusions include
- The “theory” of money is more a set of soft beliefs than hard proofs.
- Financial entities can perhaps circumvent transactional limitations of bitcoin by using it as foundation for more flexible crypto-assets.
For counterpoint, see “Crypto Transformation of Finance?”.
