Own crypto? If so, I hope you've made a fortune with it. Or, at the very least, I hope you sidestepped the huge drubbing most of them -- including the biggies like Bitcoin (BTC +0.37%) and Ethereum (ETH +0.87%) -- have suffered since May's highs. Perhaps you're plowing into some new cryptocurrency positions following the recent sell-off, confident that digital currencies not regulated by governments are the future.
Just for the record, though, I'm still not buying into any cryptos... now, or ever.
Sure, I've seen how cryptos like Bitcoin and Dogecoin (DOGE +1.17%) meet (more or less) the six critical traits of a successful currency. You're probably familiar with this list yourself. Bitcoin and its peers are durable, portable, divisible, uniform, limited in supply, and acceptable. At least some merchants accept Bitcoin as payment, and even more are entertaining the idea.
Contrary to the internet's readily found list of what qualifies money as money, however, these six characteristics oversimplify some standards of currencies, and downright omit other important attributes. Three big problems stand out from the rest as practically insurmountable.
1. It's not actually scarce
According to the most recent figures, the United States' Federal Reserve is managing a pool of about $20 trillion worth of its government-issued money; most of that is in electronic form only.
That's a lot to be sure, but it's a finite figure. The Fed adds to and subtracts from this pool to throttle economic growth, and other nations do the same with their currencies for the same reason. That's why you have to give up U.S. dollars if you want Japanese Yen, euros, Brazilian reals, or any other foreign currency. Each country's -- and the entire world's -- amount of currency is closely controlled, which is why exchange rates change over time.
Technically speaking, because the supply of fiat-currency is limited, it's scarce... at least on a per-capita basis.
Image source: Getty Images.
But Bitcoin (and other cryptocurrencies) are scarce too. It's true that only 21 million Bitcoins will ever be "mined," or calculated. There's no limit, however, to the total number of cryptocurrencies that can be created to compete with Bitcoin. The aforementioned Dogecoin and Ethereum are just a couple of examples of alternatives that will be embraced should Bitcoin become too expensive or too cheap to continue using.
A currency's value only holds up when it's the only one that can be used to buy and sell goods and services in a regulated economic market, or when it must be traded with other currencies that are similarly scarce.
2. It's not actually widely accepted either
Crypto fans will be quick to point out that cryptocurrencies are increasingly being accepted as a means of payment. For a short while, Tesla (TSLA 5.46%) accepted Bitcoin as a means of paying for its electric vehicles, joining a few thousand companies all over the world that offer such a convenience. And El Salvador has officially made Bitcoin legal tender within the country, becoming the first nation to take such a progressive step.
Now read the fine print. Tesla may have briefly accepted payments in Bitcoin, but the purchase price of these vehicles was always, ultimately, based on U.S. dollars. Tesla merely facilitated a U.S. dollar-based transaction using the popular cryptocurrency, as is the case with many other outfits accepting crypto-based payments.
As for El Salvador, President Nayib Bukele made clear that "The government will guarantee the convertibility to the exact value in [U.S.] dollars at the moment of the [Bitcoin] transaction." Moreover, the U.S. dollar is still El Salvador's reference currency for accounting purposes.
In other words, these commitments to crypto aren't actual commitments.
3. Traditional banking institutions don't want to make, or take, a conventional loan using cryptocurrencies
Finally, while plenty of people are willing to do business in the present using cryptocurrencies, have you noticed how nobody's making long-term deals -- like loans -- with the likes of Bitcoin or Dogecoin? Contracts that require stability and predictability for both parties still name U.S. dollars or localized currencies as the only way to convey value in the future.
This is telling, but not surprising, given just a bit of thought.
Although it's not one of the usual six attributes of a useful currency, nobody can argue that money's value should not be relatively predictable from one day to the next, or from one year to the next. Thus far, cryptos have been anything but.
Indeed, borrowers agreeing just a few months ago to make loan payments in Bitcoins (not the dollar-based value of Bitcoin, but a total number of Bitcoins, akin to the way you pay your mortgage lender back in a fixed number of dollars every month) could be in serious trouble now, as the cost/value of each Bitcoin is still nearly five times what it was just a year ago despite the recent sell-off.
It matters because wealth creation is often built on borrowed money, to the benefit of the lender and the borrower. Their unpredictable value makes cryptocurrencies downright dangerous to use as the basis for the $10.3 trillion worth of mortgage debt alone that Experian says U.S. consumers are currently shouldering. Never even mind corporate debt and credit card debt levels.
(Dis)connecting the dots
Don't misunderstand. I know plenty of people have made good money with cryptocurrencies, and more will make good money with them in the future. There's lots of volatility here to cash in on if you can time your trades right.
This volatility that so many folks love, however, is the very same volatility that prevents cryptos like Dogecoin and Ethereum from being trusted as a true, stand-alone money that replaces fiat currencies. Regulatory oversight and mining limitations could and would curb this volatility, but such oversight defeats the entire purpose of cryptos in the first place. Talk about a catch-22!
The market doesn't really see this disconnect yet, but once it does, it'll work against all their values. Good luck between now and then.
