Today I’ll share my thoughts about bitcoin. As you all probably know, an ETF of the most famous digital currency was recently rejected by the SEC. This idea was proposed by the famous Winklevoss brothers, the same brothers that apparently were in the beginning of a famous social network that you probably have heard: Facebook.
The reasons for this decision are due to “concerns about the potential for fraudulent or manipulative acts and practices” in the bitcoin market. It lost nearly 20% of its value short after. And then recovered.
Definition of Digital and Physical Currency
Bitcoin is a digital currency. The US dollar (USD/$), the Euro (EUR/€) and the British Pound (GBP/£) are perceived as a physical currency (also known as “Fiat money”), in the way that you can convert your “digital” dollars in real tangible dollars. Thus converting numbers on a monitor into real paper.
A physical currency is backed by a central authority (US government in the case of the dollar, and the EU in the case of the euro). Bitcoin in the other hand is backed by a widely distributed network.
Another characteristic is that digitized currency transactions can be anonymous in the case of bitcoin. With other physical currencies they are transparent (think wire transfers, credit card purchases).
I believe that at the heart of ANY currency is trust. When you think about it, everything can be used as the medium of exchange, as long as it’s scarce, and provided that we all agree on the value.
So why don’t we use anything else in a massive way? Why do we insist on using dollars, or euros, or pounds, or swiss francs? In my opinion, and when I think about money as a currency I always think of the following features that are very difficult to replicate.
- Store of Value: It generally holds value. You can argue that inflation will decrease its value over time. And maybe it will. But in short periods (and when I say short I say in some years), as long as the inflation remains low and steady, we can trust in the value of the physical currency. Can I trust that 10 dollars will buy the same thing 5 years in the future? I do.
- Medium of Exchange: Think about it, you can use it online or convert and use in the “real” world. In a matter of seconds and using an ATM. You can carry around, in a convenient and easy way. We know that it’s generally accepted by the population. It’s divisible, as you can break down into smaller denominations. It allows goods and services to be traded very efficiently. If you have a pig that costs 110 euros, and I have 6 chickens that cost 20 euros each, and we agree to exchange the pig for chickens, I don’t have to cut in half the last chicken to make the transaction. I can use euros instead. Thus making the transaction more efficient.
- Unit of Account: Physical money allows the value of something to be expressed in an understandable way. Think about Fahrenheit or Celsius degrees when expressing temperature. If you tell me that something is worth 100 euros, I can immediately have an idea of the value of that item. Therefore the Euro is a good unit of account.
If bitcoin or any other currency, like physical currencies from countries with high rates of inflation or hyperinflation, don’t have (or obtain) these characteristics I highly doubt that they will gain the full trust of the general population. In conclusion, I believe that everyone prefers those 3 characteristics well defined and stable through time.
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