Are Cryptocurrencies Real Money?

September 15, 2019 | by V. Henry Astarjian | Posted in Blog

“Why can’t we use cryptocurrencies for anything we want to buy?” Nick asked.

With this straightforward question, one of my summer interns nailed the reason why mention of the term cryptocurrency still causes a lot of blank stares despite the fact that cryptocurrencies have been in existence for a decade and are now a $264 billion market. Young people have an incredibly wonderful way of cutting to the heart of a matter with a simple question. With age can come pre-set notions that can be limiting. To those with an open mind, everything is possible, and why shouldn’t it be?

Nick’s question was fascinating for me on several levels, not least of which was the way in which he asked it, full of expectation  and incredulity that the legal use of a digital currency would even be questioned. 

Perhaps his question had a lot to do with the stratospheric rise in the price of Bitcoin in recent years. Yet, in essence, he was asking why there has been such resistance to cryptocurrencies in this day and age when technology and digital products are so widely and readily embraced. His question was an excellent one and it got me thinking and wondering. After all, why can’t we use cryptocurrencies to pay the mortgage, or buy a European vacation, or send money to a daughter studying in London? Why can’t we use cryptocurrencies for legitimate commerce, investments, and personal payments? What’s the problem with cryptocurrencies?

Short lesson on the History of Money

As much as we rely daily on exchanging money for goods & services, chances are most people don’t know much about the evolution of this fact of life. Yet, when understood, the history of money makes cryptocurrencies vastly less mystical.  

It’s perhaps little-known today that back when America was being colonized and up to the mid-19th century, early settlers and then the United States government actually had multiple currencies. In fact, colonies used to issue their own currencies in pretty much an unregulated fashion, and as the need arose. If you were Massachusetts Bay Colony, for example, and you wanted to help the French fight against enemy forces in Canada in the 1690s, you simply issued debt notes to raise funds, and those notes could then be treated as currency and be circulated for commerce. 

During the 19th century there were up to 7,000 different bank notes in circulation in the United States, each with a different value per dollar denomination. They were secured by the full faith and credit of the issuing bank, which meant they may not have been honored by other banks, or might have become completely worthless if the issuing bank became insolvent. For example, if you had the experience of  getting your dollars from an issuing bank in Tennessee, a bank in New York might either not accept your money, or might apply an exchange rate to it, as if it were a completely foreign currency!

Over the last 243 years since the founding of the United States, our monetary system has undergone many changes, and it hasn’t always been a smooth process. When viewed in hindsight, it’s clear that many monetary ideas were simply experimental and had no chance of surviving, or they were borne of immediate needs, such as funding wars and paying debts. 

When we talk about the “American experiment”, meaning our experiment with democracy, we should also add our experiment with our currency as a facet of that experience. The notion that a politically unified country such as the United States can have multiple currencies lasted for almost a century after the country’s founding in 1776. Unlike established countries of the day that had one unifying currency each, the pound, the franc, the mark, we were like young and curious children experimenting with multiple currencies and seeing how it all might turn out. We seem to be carrying on that  experiment even now, this time with cryptocurrencies. 

At it’s most basic level money is anything that people agree is a store of value and a medium of exchange for other things of value. An article published by the University of Groningen in the Netherlands states, “Money is a psychological abstraction. Literally anything can serve in this capacity as long as people are willing to accept it as a medium of exchange, if it maintains its purchasing power reasonably over time, and if it can serve as a convenient unit of measure. An official government edict is not necessary to create money.” If there is general agreement, then there is value. 

At various times in history, various things have been used as money including gold, silver, copper, stones, sea shells, and salt, among others. I would argue that other than salt which has an everyday purpose, namely preserving and flavoring food and maintaining our physical health, the rest have little or no utilitarian value. This fact was so apparent to Roman emperors that they used to pay their soldiers partly in salt as a “salarium”, from which we get the  word salary. For the most part then, money is an abstraction of value. It’s mostly in our heads!

When viewed from a broad historical perspective, and knowing that many things have been used as currencies over the centuries, why then can’t cryptocurrencies such as Bitcoin also be used in the same way, to buy and sell things, or to invest across oceans?

A Brief Cryptocurrency Primer

Let’s look for a moment at what a “crypto” currency is. 

At its core, a cryptocurrency has three main features. First, it’s completely decentralized, meaning that no government or bank controls its creation or its flow between buyer to seller, or across borders. Its opposite is centralized currencies such as the U.S. Dollar or the British Pound where each government strictly regulates the production of currency, and then banks closely monitor its flows around the globe. Second, a cryptocurrency is a non-transparent medium of exchange. You and I can’t know where a cryptocurrency is moving or how much of it there is unless we have access to the cyberspace blockchain that records such movements – access to a blockchain is a complex endeavor. And third, it is fully digital, meaning that you cannot hold a physical stash of Bitcoins or any other cryptocurrency as you could with gold coins or with greenbacks. This makes it difficult to keep your cryptocurrency secure in a nice thick steel vault somewhere, but instead requires you to have complex electronic security features on your computer that could get hacked anyway. 

In a completely utopian world where national borders don’t matter and where there is unfettered flow of economic and human capital from one region to the next, and where there is peace and harmony between nations, a common currency that’s not controlled by one government or another might make sense. In a world where the common good is the focus of global governance, currency flows and capital flows might not matter so much as long as the whole benefits.

Unfortunately, that is not our reality. We live in a world of competitive nation states, national self-interests, and economic disparities between one country and another. National sovereignty and economic stability make it necessary for countries to have their own single currency. An America that blesses both the U.S. dollar and a cryptocurrency as parallel legitimate currencies, is an America that is a weaker country than it is today. 

Here’s why. 

At its heart, a single national currency confers power, control, and stability to a national government, and incentivizes the national banking system to conduct lending and borrowing in an orderly, transparent, lower-cost, and accountable fashion. A cryptocurrency, by its very “crypto” nature would be unworkable in this scenario because of the secrecy in which it is  wrapped. It allows for control by no one, a situation that sounds good to freethinkers, but one that’s fraught with danger for both borrower and lender, and buyer and seller. 

A single currency permits governments to moderate economic activity through the money supply, increasing it when economic conditions are weak, and reducing it when the economy overheats. It acts as a feedback tool on the current health of the economy. This can be a significant stabilizing factor for employment, for consumer spending, and for corporate profitability that might not be possible with multiple currencies floating in circulation. 

A single currency also acts as a signaling mechanism to governments, banks, and companies who look upon that currency as a barometer of future business activity – a strong dollar, for example, could be a deterrent to exports, while a weak one could be a boon for exporting firms who then can use this one important factor, the currency’s strength or weakness, to help plan their future activities. 

A single currency also boosts national unity and identity, much like belonging to the same sports team. Most Americans are proud of the U.S. dollar’s prominence globally as the world’s major reserve currency. We know that almost everywhere we travel, our dollar has value and can be used as a medium of exchange! We may not have the same experience with a cryptocurrency.

And a single currency is transferable and worth exactly the same throughout the country so that a dollar in Tennessee is exactly the same as a dollar in New York and does not need to be converted through an arbitrary exchange rate in order to be used!

Prognostication

An inquisitive young intern’s open-minded question has taken us on a short journey, questioning what money means and what it is. Our national experiment with money continues to this day and is very much worth exploring and paying attention to as the American story continues to unfold. 

My own prediction is that cryptocurrencies will eventually become regulated by governments and banks. They know that a sound global economic system relies on order, predictability, and accountability. Eventually, regulation will take the steam out of the cryptocurrency mystique and make it as normal, and maybe as bland, as any other currency market. Or it may give it a boost as part of a new global monetary arrangement. Only time will tell. 

If you would like to have a conversation about cryptocurrencies, or anything else in the complex and sometimes arcane world of investments, please don’t hesitate to contact me. My door is always open and I welcome your questions! 

Disclosures

Waterstone Advisors LLC is a Massachusetts registered investment advisor with clients in Massachusetts, New Hampshire, Connecticut, and California. Registration with securities authorities does not imply a certain level of skill or training. Investment results are not guaranteed. The value of accounts can decrease. Past performance is not indicative of future results. For additional information and disclosures, please see our ADV Part 2 (the “Firm Brochure”) in the Our Approach page of our website, www.waterstoneadvisorsllc.com , or contact us at 978-828-2188.