More than 20 years after Friedman’s prediction, the speculative mania surrounding cryptocurrencies is breathtaking. Just consider that Bitcoin’s price has skyrocketed 1,030 percent in the past twelve months and that its market capitalization has soared to $1.1 trillion, which makes it the world’s sixth‐most valuable asset.
With Elon Musk’s announcement that Tesla would purchase $1.5 billion worth of Bitcoin in order to start “accepting bitcoin as a form of payment for [its] products in the near future,” the frequency of Bitcoin’s mentions on Google and its trading volume have risen sharply and in lockstep in 2021.
Putting aside Bitcoin’s meteoric ascent in price, which has been punctuated by dramatic booms and busts, it is important to note that its designation as a “cryptocurrency” is a misnomer. A currency is characterized by four fundamental features. To qualify, it must be unit of account, must be a standard for deferred payment, must be a store of value, and must serve as a medium of exchange.
Just how does Bitcoin stack up when it comes to these currency criteria? Bitcoin’s volatility turns out to be its Achilles’ heel. In 2020, Bitcoin’s annualized daily volatility was an astonishing 67 percent. If we look at the most important price in the world, the USD–euro exchange rate, and the world’s international currency, the U.S. dollar, the dollar’s annualized daily volatility in 2020 was only 7.8 percent. Since Bitcoin’s source code predetermines that Bitcoin’s supply will ultimately be fixed and totally inelastic, all market adjustments can take place only via price changes, not quantity changes. As a result, it is destined to be inherently subject to extreme price volatility. This means that Bitcoin will never serve as a reliable unit of account. You will rarely see items with Bitcoin price tags attached. You will also never see deferred contracts (contracts under which payment is made under a long‐term credit arrangement) written in Bitcoin. Can you imagine someone writing a mortgage contract denominated in Bitcoin?
Bitcoin’s volatility also renders it unattractive for most corporations to hold in lieu of cash reserves. Indeed, Bitcoin, which is considered an intangible (something, incidentally, that brings inconsistent and opaque accounting treatment in its wake), throws considerable risk on to balance sheets. In short, it is not a reliable store of value. It’s no surprise, therefore, that most corporations are unwilling to take on the risks associated with holding Bitcoin on their balance sheets. A recent survey found that roughly 5 percent of finance executives said that “they planned to hold bitcoin as a corporate asset in 2021” and “84 percent of respondents said they did not plan to ever hold bitcoin as a corporate asset,” citing volatility as their foremost concern.
Furthermore, very few items are purchased with Bitcoin. Items are not only not priced in Bitcoin, but the transaction costs associated with Bitcoin are excessively high for both buyers and sellers.