By Scott Anderson Chief Economist Bank of the West

Jun 27th 2022

Sustainable LivingTaking Action

Are Cryptocurrencies Money?

Jun 27th 2022

Now is a good time to know the difference between cryptocurrency and traditional money. California wants to spur crypto and blockchain innovations, and 401(k) accounts may soon offer crypto-based investments. Meanwhile, the most popular cryptocurrency, Bitcoin, has lost a third of its value this year.

You’ll never find a Dogecoin on the sidewalk because cryptocurrencies exist solely in the digital world—stored in digital wallets and bought and sold through online exchanges. They are not issued or backed by a government authority, which gives stability to traditional currencies like the euro or the Kenyan shilling. Because they are only digital, investing in cryptocurrencies or using them to buy groceries at Whole Foods or a Starbucks latte requires that transactions be verified by a vast network of computers known as the blockchain.

Here are the basics you should know about crypto versus traditional money:

  1. Today, there are more than 10,000 different cryptocurrencies—far more than the 180 currencies recognized by the UN. Part of the reason there are so many is that anyone skilled in computer programming can create a new one. They also range widely in value. A single Bitcoin recently cost more than $31,000, but it costs less than a penny to purchase a Digibyte—a relatively unknown Bitcoin knockoff.

  2. Cryptocurrencies are highly speculative, meaning many people buy them hoping to make a quick windfall rather than investing for the long term. This also makes them extremely volatile and risky as investments.

  3. Economists say cryptocurrencies don’t currently meet two basic criteria used to define “money.” First, they are unstable and therefore not a good “store of value,” which is a fundamental purpose of money. Secondly, they are not what economists call “a widely accepted medium of exchange,” meaning they are not widely accepted for buying and selling goods and services.

  4. Unlike the dollar, which is backed by the “full faith and credit of the US government,” a cryptocurrency’s value often depends on people expecting its future value to hold steady or go up. Many cryptocurrencies are not backed by anyone or anything, and they have no inherent or fundamental value like a precious metal.

  5. Cryptocurrencies can also help facilitate fraud, terrorism, and money laundering. Someone making a transaction can obscure their identity, and this anonymity in the crypto marketplace makes it attractive to criminals. The network of computers that make up the blockchain work to confirm the validity of any crypto transaction, but they do not track who makes transactions.

  6. Crypto transactions use a lot of electricity. Buy a cup of coffee with Bitcoin, and you’ve just used more electricity than an average household uses in a month. That’s because every transaction has to be verified, so the massive network of computers around the world is constantly working to validate every crypto transaction. It’s estimated Bitcoin uses more electricity than the entire country of Argentina.

  7. Cryptocurrency has attracted the attention of governments interested in creating their own digital currency that would overcome some of the risks and drawbacks of the existing crypto marketplace. The US Federal Reserve is studying the idea of a central bank digital currency (CBDC).

  8. To improve stability, cryptocurrency can also be backed by a traditional currency like the dollar and regulated by federal agencies. A bipartisan bill was introduced in June in the US Senate to give federal agencies more authority and oversight of cryptocurrencies.

Cryptocurrencies have proven it’s easier than ever to create something that is like money for people to use to store value and facilitate transactions. But to truly become the money of the future, they’ll need to evolve into something much more stable and far more widely used than they are today.

While the cost to make a humble penny is more than its face value, when it comes to meeting the basic criteria for money, it still has an edge over cryptocurrency.

Want more thoughts on the economy? Check out my Explain It Like I’m 5 video series. Economics made simple.

And keep updated on my latest economic forecasts and analysis with my US Outlook.

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Scott Anderson Chief Economist Bank of the West

Scott Anderson is Chief Economist at Bank of the West. He has consistently been recognized as one of the top economic forecasters in the country by Bloomberg and USA Today.

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