On Value and Cryptocurrencies – Matias Andrade – Medium
In my experience, the first reaction that someone has when introduced to the concept of digital money is asking where it gets its value. In their favor, it is a rather deep question, for one has to think about what properties give currency value. Starting with the properties of money listed in the introduction to most economics textbooks, we get five properties of currencies:
- Scarcity: a limit in supply, specifically with respect to the supply of currency outstanding.
- Fungibility: all the representations of a currency are interchangeable, and thus have the same value, as other equal representations, e.g. ten $1 bills have the same value as one $10 bill.
- Divisibility: the units of this currency are easily divisible, and more importantly, there exist a precise enough representation of value for most exchanges to be possible.
- Durability: the ability for a currency’s value not to decrease over time, either due to material degradation of the currency stock or because of large variations in price levels due to changes in supply or demand for currency relative to the total supply of the currency.
- Transferability: the ease, speed, and confidence that one party may have when transacting with another party.
Scarcity is a value shared by both national currencies as well as most cryptocurrencies, such as Bitcoin, Ethereum, etc. At any one point in time there is a limited amount of these available to be owned and used by a population, and that groups are unable to produce or counterfeit more currency as they please. Note this does not mean that low and predictable changes in the supply affect scarcity, as all these currencies have low levels of inflation as well.
Fungibility is an interesting and surprisingly slippery concept to implement, I think that I will write about it sometime in the future. However, the takeaway is that all the units of a currency must be freely interchangeable between themselves at an invariant rate, ignoring previous owner, date created, etc. Imagine that a store pops up and only accepts new $20 bills, something that is actually illegal in many countries. With cryptocurrencies one has to ensure that, for example, all Bitcoin can be accepted anywhere no matter what addresses have owned that Bitcoin, how long ago it was issued, etc. This is actually does not hold in Bitcoin, since transaction history is public anyone is capable of arbitrary discrimination against certain UTXOs based on their origin. However, some cryptocurrencies like Monero (and private transactions in Zcash) rigorously hold this property, since all transactions are private and unlinked to any address, all of these assets are totally exchangeable for one another.
Divisibility is sufficiently met by regular currencies, and especially banks which use more precision than our generally accepted $1/100. However, cryptocurrencies can issue much more precise measures of their currency, bitcoin manages around 1/1000000 of a unit, and Ethereum 1/10000000000000000. This can come very useful when making mini-transactions, which are a potential for IoT or new innovative business models that would like to dynamically stream value as payment for utilities, insurance, data, etc.
Durability is actually better in cryptocurrencies, since short of forgetting your password and the network catastrophically collapsing there is nothing that will affect the amount of currency held. Due to its distributed nature, these networks are notoriously hard to destroy. Compare this to regular money which can be broken, easily lost, etc. However, there is a lot of volatility associated with this asset, mostly due to its relatively low market capitalization with respect to other stores of value, such as gold, the American dollar, etc.
Transferability is also well-developed in cryptocurrency, to the point that you can probably transfer a greater amount of wealth using it than through most other methods. Additionally, this transfer cannot easily be stopped by any agency. This requires certain equipment, such as a smartphone or a computer with Internet connection, and the industry should continue helping expand the set of people that could use this service, but this alone is already good for ~3 billion people.