One of the most notable things about the digital currency bitcoin is that while there is great excitement over the technology it is built on, there is no consensus on what function it may be best suited for filling. Furthermore, the most popular ideas are quite disparate, even contradictory, and they each suggest different things about where it should trade.
Cryptocurrencies like bitcoin — a segment of the market currently valued at nearly $700 billion, according to pricing website CoinMarketCap — are considered a new asset class, though they have elements of more traditional ones. Bitcoin was designed as a kind of currency, and it can been used as such, though it is classified as a commodity by the U.S. Commodity Futures Trading Commission and the IRS views it as property. It also trades like a stock, though not on traditional exchanges, and it is such a Wild West in terms of regulation that the prospects for a bitcoin exchange-traded fund look to be a no-go.
The three major use cases for it each involve one element of those properties. Some view it as a speculative vehicle, akin to a high-flying internet stock in the dot-com era; some view it as a means of transaction, similar to cash or credit cards, only without the backing of a government or central bank; finally, some see it as a store of value, a kind of digital gold that can be transported anywhere and can’t be seized.
The first idea has come under the most attack by skeptics. Given cryptocurrencies have no earnings or revenue, aren’t backed by anything like stocks or commodities are, and they don’t comport to traditional measures of valuation, the value of bitcoin or its rivals as speculative instruments is essentially dependant on what investors are willing to pay for it. For this reason, financial-industry giants like Warren Buffet and Jamie Dimon have called the industry a bubble or fraud.
While bitcoin has weathered major price swings, including multiple massive crashes over its nearly 10-year lifespan, it continues to be highly volatile. Currently, bitcoin (BTCUSD) is trading at $13,544.99, down 9% on the day on reports that South Korea plans to ban all cryptocurrency trading. While it is up significantly over the past 12 months — it was trading around $800 a year ago — it is also down sharply from a peak above $19,000, hit in December.
Bitcoin as a store of value has more proponents, though elements of the digital currency also suggest limitations on this front.
“One thing I have noticed about bitcoin’s most vocal naysayers: They are almost all wealthy Westerners,” wrote Nicholas Colas, co-founder of DataTrek Research. Colas related his own family’s history, where his parents left Cuba in the 1960 revolution and came to the United States with little money and few prospects.
“Step outside the safe confines of Western democracies, and my parents’ history is a relevant and cautionary tale. Similar stories happen every day, across multiple continents. Of course there is intrinsic value in a decentralized store of value that governments cannot control or confiscate. To think otherwise is myopic.”
Goldman Sachs noted that because cryptocurrencies don’t have the backing of a central bank, they could function as a hedge against inflation, and others have said it can serve a diversifying purpose in one’s portfolio given its lack of correlation with other asset classes. However, Goldman added that any positive qualities on this front were more than offset by bitcoin’s volatility, which nears 5% a day, on average — several times the average daily move of gold (GCG8) , the S&P 500 (SPX) or other major investment types.
Those steep gyrations may be catnip to speculative traders, who hope to capitalize on its short-term movements, but they dampen bitcoin’s effectiveness for other uses. A store of value isn’t valuable if the value changes dramatically from day to day, and it also hurts the case of bitcoin being a means of exchange.
“Such volatility makes [cryptocurrencies] poorly suited as a substitute for money generally — which is why most nations eventually abandoned the gold standard in favor of fiat currencies that can more easily stabilize the purchasing power of money by making the necessary supply adjustments in response to changes in money demand,” Goldman wrote.
The investment bank added, “Volatility would likely need to come down dramatically (either naturally or through the widespread adoption of cryptocurrencies designed to better stabilize purchasing power via supply adjustments) before we see broader adoption.”
There are other factors that diminish bitcoin as a means of transaction. According to Morgan Stanley, it takes bitcoin 10 minutes to clear and settle a single transaction — a factor related to its scalability, or its limited process capacity compared with other payment options. For example, the networks that Visa (V) and Mastercard (MA) use can process, in aggregate, “more than 5,000 transactions per second with capacity to process volumes multiple times that number,” the investment bank wrote. In addition, credit cards are also accepted far more widely than bitcoin, and bitcoin comes with sizable fees that further diminish its attractiveness in this usage, though proponents argue that these issues will fade as the technology improves or becomes more widely used.
Bitcoin’s volatility, fees, and processing time means that its best use for people in developed economies may be as a speculative vehicle, if only because they have other, better options for making purchases or storing value.
“That said, bitcoin (and cryptocurrencies more generally) may offer viable alternatives in countries and corners of the financial system where the traditional services of money are inadequately supplied,” Goldman wrote, listing Zimbabwe, Peru and Ecuador as candidates.
“In these circumstances, it is natural to see how alternative — possibly digital — anchor currencies could be useful as well.”