Bank of New York Mellon announced this past February it will begin financing bitcoin and other digital currencies by the end of the year. The major custody bank will provide integrated services to their clients who want to hold, invest or transact utilizing cryptocurrencies. In March, Goldman Sachs disclosed they will soon offer bitcoin and similar digital assets to their wealth management clients.
And then PayPal and Visa both indicated they would allow customers to settle transactions with third-party vendors utilizing cryptocurrencies in their wallets. They would handle the swap out of the digital currency into dollars behind the scenes, freeing the vendor from the transaction risks and technical complexities.
It appears that digital cryptocurrencies are on the verge of being legitimate currencies. But despite their names and these current tailwinds, can cryptocurrencies become an actual currency?
Let’s start with the basics and see what it would take for that to happen.
A currency is a universally accepted medium of exchange for goods and services. Inherent to this definition is that a currency is easily transferrable and maintains a relatively stable valuation. Difficulty moving a currency from a buyer of goods or services to a seller creates a challenge for consistent commerce and economic growth. A volatile and wildly fluctuating unit of currency loses credibility as a store of value. Consumers and merchants must trust they are receiving the same value in a timely transaction.
Cryptocurrencies are digital units (coins) that utilize blockchain technology to encrypt and regulate the generation (mining) of units and to verify transactions. The blockchain is both nearly impossible to hack and shields the holders’ level of funds and identities from exposure, providing greater security and anonymity.
Cryptocurrencies are decentralized, which means they operate outside any government or central bank. This secrecy and independence were the goals of the original cryptocurrency creators. They desired a means of transaction and storer of wealth hidden from the scrutiny and control of the government.
As others have stated, cryptocurrencies should be considered digital gold. Technology has allowed holders to use cryptocurrencies for real-time barter for goods and services, mimicking a currency. However, they are actually an asset rather than a currency. Their primary use is not for transactions but as investments or speculation. Due to the private nature of cryptocurrencies, they are also used to hide wealth from governments and limiting knowledge of the source or use of those funds. As the Oxford Dictionary states, “decentralized cryptocurrencies such as bitcoin now provide an outlet for personal wealth that is beyond restriction and confiscation”. This lack of control by governments is why cryptocurrencies will not be true currencies.
Governments will not allow private currencies to exist no matter how technologically advanced. A government will not allow anything that it can not monitor, control, regulate or (most importantly) tax. The Indian government has taken the extreme measure to attempt to outlaw cryptocurrencies. While improbable, it demonstrates the opposition governments have in allowing non-sponsored currencies.
In 1933, the United States abandoned the gold standard as the backing of the dollar. Before that, the supply of money was tied directly to the amount of gold reserves held by the government. It was exceedingly difficult to increase the money in circulation. During the Depression, President Franklin Roosevelt dropped the gold standard allowing the government to pump money into the economy and reduce interest rates, thus reigniting economic growth.
The Quantitative Easing that pulled the economy out of the Financial Crisis of 2008, and the stimulus provided and proposed to spur the economy during the recent pandemic would never have been possible if the dollar value were still pegged to the value of another asset like gold. Cryptocurrencies themselves have value due to the fact that there is a finite amount of each one. Global central banks can not easily issue more cryptocurrencies, thereby restricting their ability to add money into their economies when necessary.
But what about PayPal, Visa, Bank of New York Mellon, Goldman Sachs and other payment processing companies and financial institutions accepting cryptocurrencies? They have developed the technologies that allows them to hold and process them for the sole purpose of charging fees. They are happy to be the middleman between holders and vendors, or to hold cryptocurrencies in custody, as long as they get paid for those services.
These actions are neither an indictment of the established currency nor an expectation of universal acceptance. It is simply the recognition of a growing asset class. Also, each transaction utilizing a cryptocurrency creates a tax liability for the holder as the IRS also views them as assets. Similar to buying a house with stocks, that cash out is subject to capital gains taxes. So, if you buy a slice of pizza with bitcoin, it becomes a taxable event!
Thus, while cryptocurrencies will remain as an asset class, their inherent structures exclude them from utilization as true currencies for the buying and selling of goods and services.
As the recent announcement by China that their central bank will create a digital yuan, there will be digital currencies. Each government will sponsor their own digital version in order to track, control and tax securely this inevitable technological evolution of money. These too will present unforeseen issues of money supply management, global trade balances and stability. However, cryptocurrencies will not be used as a medium of exchange. They will still exist, but solely as assets for wealth storage, investment and speculation.