In paraphrasing the protest song War, I am not suggesting that cryptocurrency is good for absolutely nothing. However, it’s a good question deserving a thoughtful answer and the subject in general certainly deserves more scrutiny and consideration than given by the media and the financial industry. To be clear upfront, I am neither a cryptocurrency evangelist or a harsh critic suggesting it’s a cultish fad that invariably will end poorly. It’s even plausible that there are some valid points raised by those with extreme views on both sides of the divide. As to who is more right than wrong it’s largely speculation at this juncture and it’s for you to form your own opinions. For now, I will layout the present landscape as we see it in its early development.
Let’s start by defining currency. Merriam – Webster defines currency as 1) circulation as a medium of exchange 2) general use, acceptance or prevalence. One would deduce by the name cryptocurrency that it would be a digital medium of exchange or widely accepted. At best we can say it aspires to be both. Merriam – Webster offers this definition for cryptocurrency: any form of currency that only exists digitally that usually has no central issuing or regulatory authority but instead uses a decentralized system to record transactions and manage the issue of new units and that relies on cryptography to prevent counterfeiting and fraudulent transactions. That’s a lot to ponder.
It’s an open question when and if cryptocurrency will be accepted widely as a medium of exchange. Yes, there’s a lot of excitement surrounding its possibilities. Indicative of the headlines surrounding cryptocurrency as a medium of exchange, Tesla founder Elon Musk had Tweeted over the summer that Tesla would accept Bitcoin, arguably the best-known cryptocurrency, as car payment. Then weeks later he retracted the statement when apparently informed that crypto-mining annually uses as much energy as the entire nation of Belgium. Weeks later Musk changed his mind again when announcing that Tesla will accept Bitcoin once crypto-mining relies on at least 50% renewable energy. Apparently if crypto-mining uses only as much energy as say Denmark, the Tesla registers are open for Bitcoin.
One of the issues surrounding cryptocurrency is its creation, referred to as mining. It takes incredible amounts of computer power, energy to create cryptocurrency. In China which largely relies on coal for energy consumption, it’s estimated the 2/3 of crypto mining has been located there over the last decade. As a result, this has put incredible strain in some Chinese regions on its electricity grid, leading to rationing and the likely relocation of much of its crypto mining.
Further, consider the purchasing power volatility of cryptocurrency. Even evangelists should be able to concede it’s far from stable. Imagine going to close on a home, transacting in Bitcoin. What price will be agreed to? In its approximately 10 years, Bitcoin has suffered three declines of 80% or more. In fact, during one wild session earlier this year, May 18th Bitcoin would fall as much as 30% intraday.
Let’s compare the volatility of Bitcoin relative to gold, the stock market represented by the S&P 500 and bonds by the Bloomberg Barclays Aggregate bond index. The table above illustrates the 5 - year standard deviation for each of the asset classes. We define standard deviation as a statistical measure of market volatility. It specifically measures how widely prices are dispersed from the average price. So, for instance if prices trade in a narrow trading range the standard deviation will be low such as the bond index. Bitcoin prices trade in a very wide trading range resulting in a high standard deviation.
For those that sometimes get queasy over stock market volatility, evaluate how you would feel about owning Bitcoin which is almost 6 times more volatile. We do not transact directly in equities. Nobody buys a new automobile directly in Apple shares or the S&P 500 index. We would not refer to its stock shares as currency. As of today, one sells, shares first to raise the cash in order to buy the automobile. It seems implausible that one can buy goods transacting directly in Bitcoin, which is almost 6 times more volatile than the stock market without first converting to a widely accepted currency such as US dollars.
Number of Cryptocurrencies Worldwide from 2013 to August 2021
For those excited by the prospects for cryptocurrency I believe that it will survive in some form, perhaps even flourish, whether it’s Bitcoin or one of its nearly 6,000 competing cryptocurrencies such as Ethereum. Cryptocurrency remains early in its development and a lot remains to be determined. However, at this time it’s not a medium for exchange primarily because it’s far too volatile. It’s the wild west. Future writing will consider cryptocurrency as a store of value and as an investment.
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