Why Bitcoin Can't Serve As A Currency

| About: Bitcoin Investment (GBTC)
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Summary

Bitcoin can't serve as a currency.

This is shown by the very solution which allows merchants to sell goods and services priced in Bitcoin.

The Bitcoin Investment Trust still trades at a large premium to this failed currency.

This will be rather a short and obvious article. What prompted me to write it was Bitcoin Investment Trust (OTCQX:GBTC) trading at a large premium to the Bitcoin market quote, as I explained in my article titled "Bitcoin And AMD: Dejá Vu All Over Again". Since then, Bitcoin lost 23.7%, and GBTC lost 42.4%.

Now, with Bitcoin having previously rallied so much, it's likely that many "investors" in this "digital currency" were convinced that not only did it serve its purpose as a currency, but it also was actually a pretty good one. However, to be a currency/money, what's usually asked of a candidate is for it to fulfill three functions: to be a medium of exchange, unit of account, and store of value.

Bitcoin, unfortunately, cannot fill that last function (store of value). To be a store of value, a currency needs to keep its value reasonably stable over time. And also, unfortunately, if Bitcoin can't keep its value over time, it can't also work as a medium of exchange - but more on that later.

First, I must focus on keeping the value over time. This isn't about Bitcoin going up in value as much as it is about the volatility it suffers. For instance, Bitcoin was at ~$3,000 3 days ago, and as I write this, it sits at $2,170, for a ~28% drop from the top.

This kind of volatility has extreme consequences for anyone doing commerce (selling goods and services) and accepting Bitcoin as payment (a currency). Many businesses will trade on tight margins, most businesses will have gross margins over 28%, but on average they'll struggle to have 10% in net margins (after not just direct product/service costs, but all the overhead of running a business).

What this means is that most businesses cannot sell a product/service at 100, and then see the proceeds from the sale turn into 72 in a matter of days. This would risk turning profitable sales into unprofitable ones. Of course, those businesses could accept Bitcoin and then trade out of the accepted Bitcoin immediately (for USD or another currency).

That seems like a solution, doesn't it? It so happens that this solution - which would be perfectly necessary - also represents the failure of Bitcoin as a currency. And funny enough, this can be illustrated with another event of a currency failing: Weimar Germany, known for its hyperinflation.

During the worst of the hyperinflationary days, workers were paid twice a day. Their spouses would go to their jobs, collect their wages and immediately spend them - since raging inflation meant as time went by, the same money would be worth less and less.

What does that mean? It means that the solution to sell goods or services in Bitcoin and then having to get rid of Bitcoin as fast as possible is a direct parallel to what happens during currency failure. Also, this would mean that if there was enough commerce taking place in Bitcoin, it would probably put systemic downward pressure on its price since each sale of a good or service priced in Bitcoin would represent an immediate outflow from Bitcoin (with no compensating inflow since there would be no need to buy Bitcoin to buy the good or service in the first place).

Counter-Arguments

Obviously, one could come up with a host of reasons why this present difficulty won't last forever. For instance:

  • "Bitcoin might find stability in the future". For a merchant thinking of accepting Bitcoin, the present reality is what counts. Most reasonable merchants would thus have to use the solution I described. The result from an increased number of merchants would thus not be stability but the opposite, due to the increased selling pressure.
  • Also, on stability. Nothing says that it has to be attained at a market cap in the tens of billions of USD. Indeed, for goods-trading purposes only Bitcoin could find stability at incredibly low levels, as all it would represent would be a token to enable transactions.
  • Finally, someone could say that the USD also swings a lot versus the JPY, or EUR, or GBP. However, that's not the proper way to look at it. You have to see the stability of prices in USD itself. They're pretty stable - low inflation means that. The prices aren't stable on Bitcoin. Two pizzas cost 10,000 Bitcoin back in 2010. Now they cost 0.01 Bitcoin. In a few months, they might cost 0.10 Bitcoin. They still cost around the same $20 today, though.

Conclusion

To put it short, the solution to offer Bitcoin as a means of payment (trading it off immediately) is the very solution which represents the failure of Bitcoin as a currency. And now, if Bitcoin can't be a currency, what is it? In my view, it's two things:

  • A tulip-like bubble.
  • A means of avoiding regulation and doing un-regulated money transfers.

As a side note: As of right now, with GBTC at $311 and BTC at $2,170, the GBTC premium has fallen to 54.3% from the 103% it traded at when I last wrote on it. It's still significantly more expensive to hold GBTC than to hold the underlying Bitcoins.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.