Given the volatile nature of cryptocurrencies, should they be considered a legitimate form of currency or merely speculative assets?

Answered at Oct 11, 2024

Cryptocurrencies: Volatile Assets or Legitimate Currency?

The rise of cryptocurrencies has sparked intense debate about their role in the financial ecosystem. While proponents tout their potential to revolutionize payments and store value, critics point to their extreme volatility as a major barrier to widespread adoption as a legitimate currency.

Volatility: A Double-Edged Sword

Cryptocurrencies, particularly Bitcoin, have experienced dramatic price swings that far exceed traditional currencies or assets. In late 2021, Bitcoin surged to nearly $65,000 before plummeting to around $20,000 just 18 months later (Investopedia). This volatility stems from several factors:

  • Lack of intrinsic value: Unlike fiat currencies backed by governments, cryptocurrencies derive value solely from market demand and speculation (Forbes).
  • Purely digital nature: With no physical assets backing them, crypto prices are determined entirely by supply and demand dynamics (Emerald Insight).
  • Developing technology: The nascent state of blockchain and crypto infrastructure contributes to market uncertainty.
  • Media influence: News and social media can rapidly impact sentiment and prices.
  • Speculative trading: Many investors view crypto as a vehicle for short-term gains rather than long-term value.

This volatility severely undermines cryptocurrencies' ability to function as a stable medium of exchange or unit of account - two key properties of money. As one study notes, "Bitcoin is a cryptocurrency but does not work as a currency due to its excess volatility" (Springer).

Strengths as a Currency

Despite volatility concerns, cryptocurrencies do possess some advantageous monetary properties:

  • Global accessibility: Transactions can occur instantly worldwide, unrestricted by borders or banking hours.
  • Divisibility: Most cryptocurrencies can be divided into tiny fractions, enabling micro-transactions.
  • Portability: Digital wallets allow users to carry large sums securely and conveniently.
  • Transparency: Public blockchains provide an immutable record of all transactions.
  • Potential inflation hedge: Fixed supply cryptocurrencies like Bitcoin are seen by some as protection against fiat currency devaluation.

Regulatory Landscape and Adoption

The legal status of cryptocurrencies varies widely by jurisdiction, impacting their viability as currency:

  • El Salvador made Bitcoin legal tender in 2021, mandating its acceptance for taxes and debts. However, implementation challenges have hindered widespread adoption (NBER).
  • The Central African Republic also adopted Bitcoin as legal tender but faced significant infrastructure and education hurdles (RUSI).
  • Many countries are exploring central bank digital currencies (CBDCs) as a government-controlled alternative to decentralized cryptocurrencies.

Current Reality: Speculative Asset or Currency?

Given the evidence, cryptocurrencies currently function more as speculative assets than stable currencies:

  1. Store of value: While highly volatile in the short term, some argue Bitcoin can serve as a long-term store of value due to its fixed supply (Springer).

  2. Medium of exchange: Extreme price fluctuations make it impractical for day-to-day transactions and pricing goods/services.

  3. Unit of account: Volatility prevents cryptocurrencies from reliably measuring and comparing value across time and markets.

  4. Investment vehicle: Many treat crypto as a high-risk, high-reward investment rather than a currency for transactions.

  5. Financial inclusion: Crypto has potential to bank the unbanked, but adoption barriers remain high in many developing economies.

Conclusion

While cryptocurrencies exhibit some desirable monetary properties, their extreme volatility currently precludes them from functioning effectively as legitimate currencies for most practical purposes. Instead, they primarily serve as speculative assets and potential stores of value for risk-tolerant investors.

For cryptocurrencies to transition into viable currencies, they must achieve greater price stability through wider adoption, improved technology, and potentially some form of price stabilization mechanism. Until then, they will likely remain on the fringes of the global financial system - an intriguing technological innovation with unfulfilled potential as a true alternative to traditional currencies.

References:

Investopedia Forbes Emerald Insight Springer NBER RUSI