What is Money? A tale of two currencies...

October 09, 2019

Image of Gold and Bitcoin for What is Money

What is the gold vs. bitcoin debate really about? Currency.
Is it about which makes the better investment? Sure and yet if you look deeper at the arguments supporting either side, you might suppose it is a question of "what is money?" You would be correct in the investing world and yet more broadly a fundamental social question arises. That is, which of these are currency?
Currency is the instrument that individuals use to exchange for goods and services, and is expressed as the standard unit in which prices and debts are measured.
Primitive exchange was largely based on a barter system. The ancient Hebrews paid in livestock, the Egyptians used sticks and staves, and the Persians oxen. This cumbersome and impractical system ultimately lead to a tender based system. Tender, also known as money, takes many forms worldwide. The US Dollar and the Pound sterling are but two examples. Tender takes shape through coin or banknotes (bills) that are printed by an authority government and put into circulation at a fixed value by a central bank. Interestingly, there are some forms of currency that are outside these traditional currency rules.

This article will analyze two of the aforementioned types: gold and bitcoin. Both of these currencies are unique in many ways, but particularly in that, they are unrestricted from the shackles of country origin and a federal reserve. While their value is denoted in currency, they are staunchly independent of economic disaster or hyperinflation. Also particularly interesting is that one has been around millennia while the other less than a decade. One you can physically hold, bend, create art with, and has many practical uses--the other, is in the digital stratosphere that exists, but yet, physically does not.
Gold, Bitcoin, and the Currency Question

Should Bitcoin and Gold be considered currency? In Canada and the USA, currency is described as noted before, bills and coins produced by a central bank. With that, to some degree currency in the form of bartering is whatever someone is willing to pay or exchange for another thing/service/good, etc...

Gold is granted special status in that all banks have to buy it in exchange for Canadian currency. Bitcoin does not retain this status. While Bitcoin is not a currency in Canada, it does hold value because people are buying and selling coins. As well, coins can be sold in exchange for money. So Bitcoin is not sufficiently currency in the strict sense, it does hold value.

What is Money, if not Gold? Should Gold be a Currency?

Gold has a long history with humans. It was an instrument for exchange and acted as currency for some of the earliest human civilizations. If Christopher Columbus were to were to appear today, gold would be one of the few common grounds he would share with present society. At varying points in history, both the US and Canada had their currency tied to gold reserves.

To this day it can be used anywhere in the world as currency which is determined by a tight global network. Gold has survived many financial crises, wars, and disasters. Its supply and demand are tightly controlled. In 2013 Warren Buffet stated that all the gold in the world ever mined would only fill a football field. The Gold market is determined by two agencies: the LBMA is a group that consists of some of the world’s largest financial institutions who are loosely overseen by the Bank of England and meet daily to determine the actual price of gold for immediate transaction and exchange. The COMEX is apart of the New York Mercantile Exchange, which determines the prices of gold futures and trades in form of contracts--one locks in via contract for future delivery of gold at a current price.

These two exchanges are tightly regulated. The malleable, tarnish free, and borderline indestructible nature of Gold provides for many products uses. Jewelry aside, gold is a reliable conductor and is found in many circuit boards and microchip fabrications. As well, gold is found in car exhausts, teeth, and even spaceships.

All of these various factors have largely secured gold’s financial presence.

As result, gold has always been considered a stable inflation protector. If we think back to currency, bartering was the transfer of goods. Coinage and tender used to be attached to gold reserves. In both of the aforementioned, there was a material attached to the currency. At present, some argue that money is simply paper, and susceptible to hyperinflation. A central bank can continue to print money as it sees fit, which can largely determine its value. The value of money is derived from subjective views--the US dollar is a reflection of many factors including confidence in the dollar. Without this subjective value, tender and coins are simply paper and metal.

Certain factors can drastically alter the subjective value of a currency.

For example, a recession can cause a given currency to plummet in value. Gold’s value is not as vulnerable because it’s value is determined by strict supply and demand scales. One agency cannot just print or create more gold. A Country defaulting on its loans will cripple that countries currency, but will pose little jeopardy for gold.

For example, if A was to have a million dollars in US currency, that sum would be susceptible to the inflation of the US economy. If for the purposes of example, we assume that the US economy suffered inimical harm and US dollar to tanked, A’s million would tank with it and A would be in a precarious financial predicament. Alternatively, if B were to use a million to purchase gold, the value of that million in gold would be independent of the US economy. B’s million of gold is protected by a worldwide market, and she could sell her million of gold — which at this point has probably increased in profit because of US dollar’s nosedive (a topic for another article) — on the gold market. Gold is accepted worldwide at the market price.

Thus, Gold is essentially a universal currency that’s accepted anywhere and everywhere. These factors suggest that buying gold is a stable security in which investors can be confident in its long-term strength.

Bitcoin Changes Everything — or does it?

Bitcoin is a complicated crypto-currency, that is still in its infancy. Users mine through their computers solving complex equations to maintain the public ledger. This ledger records every transaction and stores it publically on every user's computer.

When a coin is exchanged the transaction is recorded and grouped together with other transactions into a block. Miners use their computers to solve complex equations that maintain this ledger, in exchange for pieces of a bitcoin. Enough of these pieces will ultimately create a new whole coin that is introduced on the Bitcoin market.

The Bitcoin system is capped at 21 million coins, with approximately 17 million presently mined. With no governing body, Bitcoin is a completely open source and unregulated. This provides for independence similar to that of gold, in which a nation’s financial troubles do not jeopardize the value of Bitcoins. Is the lack of regulation a good thing, or does it present a dog-eat-dog wild west of sorts? Securities Lawyer, Jim Richards, made an interesting argument in an interview with Business Insider.

Simply put: all markets — bonds, stocks, tender — are all subject to manipulation. Hence, the necessity of agencies such as the SEC and other regulatory bodies. The Bitcoin market is completely unregulated, so what’s protecting it from any form of manipulation? This is also an interesting question given the black market ties such as money laundering and terrorism attached to Bitcoins.

Does what is Bitcoin answer what is money? Arguably, Bitcoin has more in common with early 20th-century stocks than money.

An interesting example Richards gives is where two buyers A and B, trade a large number of coins back and forth inflating the price. Since all of these transactions are recorded, a third party C is dubiously lead to believe that the prices are going up when instead A and B are doing an old Wolf of Wall Street trick known as painting the tape.

Another concern for bitcoin is that its cost to mine is already treading into unsustainable. The use of computers to solve complex Bitcoin equations requires a lot of processing horsepower. At present, China has the biggest density of miners. The Bitcoin mining community as a whole consumes more power than Ireland and will soon surpass Japan. Some allege that this is only sustainable because of China’s cheap coal power and energy subsidies. An increase in power costs could be problematic. If power costs surpass profitably of mining, then there will be no incentive to mine, and thus the ledger could be affected. In short, the whole community could be derailed. Many critics argue this hypothetical will soon enough be a reality.

Furthermore, the market of Bitcoin is susceptible to hacks.

In early, 2018 South Korean cryptocurrency exchange Coinrail was compromised which sent the price of Bitcoin plunging 10% in one hour. The cyber intrusion stole approximately $36m USD worth of coins. In 2014 the exchange, Mt. Gox was hacked with customers losing $450 million worth of coins and causing the trading company’s bankruptcy. These are all important concerns that investors ought to consider when deciding to buy into Bitcoin.

In whole, these factors suggest Bitcoin could be an unstable investment with an uncertain future. While the price of coins exploded in late 2017, the coins have since fallen to under $7000 USD at the time of this writing. In February of 1637 market trends caused the tulip to surge in price, which became known as tulip mania. The craze was short-lived and never repeated. Some argue that Bitcoin simply experienced a tulip mania in late 2017, with no hope to ever repeat.

In Conclusion:

Investors need to be aware of the relevant factors that affect the stability of their investments. No doubt, many people have profited huge returns from Bitcoins, but many have also lost exorbitant amounts of money. The Bitcoin platform is unpredictable, unregulated, and risky. In terms of the future, many detrimental concerns seemingly threaten Bitcoin’s future.

Alternatively, gold provides investors with a stable platform to place their money. The uses for Gold will not disappear overnight, and regulation is tight and protected from nefarious forces such as hackers. This isn’t to suggest that Bitcoin is devoid of any value, but instead to suggest to investors: buyer beware.

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