A tulip by another name is still not a lasting currency

Over the past 18 months, the price of the cryptocurrency bitcoin has risen eightfold. This extraordinary performance has piqued global interest.

Cryptocurrencies are digital currencies whose supply is managed by computer algorithms. For their supporters, they represent valuable assets with the potential to become global instruments of exchange through which prices can be set and purchases transacted at low cost everywhere.

Critics argue that cryptocurrencies are not money and investors will be deceived — just as those who lost their savings in the Dutch tulip bulb bubble of 1637.

Money is a critical component of modern economies. Without it, prices and value cannot be measured and the exchange of goods and services is almost impossible.

Yet the banknotes and deposits in our bank accounts have no value in their own right. Their value is derived from the transactions for which they can be employed. So, a central requirement for the long-term use of money is a strong societal sense of trust.

In the days of the gold standard, central banks could ensure this by promising to pay the bearer of any banknotes their value in gold if required. Today our banknotes carry no promise at all. We must trust that the notes we use are indeed worth their face value.

If trust fails, money has no intrinsic value and economic transactions grind to a halt.

Zimbabwe is the most obvious example of this. Gross economic mismanagement led to an increase in the money supply. Trust eroded until the Zimbabwe dollar had no value whatsoever. To sustain commercial transactions, Zimbabwe was forced to use the US dollar. The greenback retains the trust of the public, but the benefits of this switch are limited because US dollar banknotes are in short supply.

The Zimbabwe central bank has sought to alleviate this by printing domestic bond notes that are officially said to be backed by equal amounts of US dollars borrowed by the government. But no one believes this, so these bond notes have also plunged in value. They may have worsened the situation because citizens are hoarding their US dollars in the event Zimbabwe decides to reintroduce its own currency.

In theory, popular distrust in governments’ ability to “print” money is the underpinning of the new cryptocurrencies. Since the supply of such currencies is computer-controlled, their supporters are convinced they can never lose value as no politicians can influence their supply. Cryptocurrencies are also said to facilitate global transactions without the need for currency exchanges.

But these views ignore one problem. The cryptocurrencies are not actually money. Nor can they ever become a global currency. There are several reasons for this. The first is that for money to fulfil its role as a measure of value, its value must be relatively stable in the country where transactions occur. Imagine if R100 today will be able to buy the equivalent of R140 worth of goods next week. No transactions would take place today, since buyers would wait until next week when the same amount of money can purchase 40% more. Likewise, if we know R100 today will only secure R60 worth of goods tomorrow, buyers will bring forward their future purchases to today. However, sellers will not want to sell anything today, as the money they receive now will be worth much less next week.

Viewed in this way, we see why the soaring value of bitcoins (and their sharp falls previously) preclude them from securing the stable measure of value that is the key characteristic of money.

Nor can bitcoins ever become a global currency. Their limited supply, which is the key determinant of their support, means there can never be enough bitcoins to be used for more than a tiny fraction of global transactions.

At least Dutch speculators could still grow tulips from the overpriced bulbs they bought. If investors ever lose interest in bitcoins, their owners will be left with nothing.

THEIR LIMITED SUPPLY … MEANS THERE CAN NEVER BE ENOUGH BITCOINS FOR MORE THAN A TINY FRACTION OF GLOBAL TRANSACTIONS IN THEORY, POPULAR DISTRUST IN GOVERNMENTS’ ABILITY TO ‘PRINT’ MONEY IS THE UNDERPINNING OF THE NEW CRYPTOCURRENCIES