Is Cryptocurrency a Currency?

By Teri | February 28, 2022

The recent downward trend in cryptocurrency prices has created skepticism about crypto as an “inflation hedge” or crypto as a “store of value”.

Instead of providing diversification as a separate asset class, crypto now appears to be closely correlated to stock prices.

What’s going on? Are cryptocurrencies really currencies?

Let’s start with a basic question:

What is a currency? Our currency is the U.S. dollar. Who controls the value of the dollar? Is there a Who?

Yes there is a Who and the Who is the central bank also known as the Federal Reserve.

Who controls the value of cryptocurrencies? I guess that is the point, there is no Who because crypto is decentralized as in DeFi – decentralized finance.

But I still need answers: how is the value of a currency determined and why is knowing how value is determined important?

The amount of money, or currency in an economy is controlled by a central bank.

The credibility of a central bank often determines how volatile a currency is.

The Federal Reserve is responsible for implementing monetary policies that stabilize our economy. And in turn stabilize the value of the dollar.

The Fed also controls the demand and supply of money in our economy.

One of the monetary policy tools the Fed uses to control the money supply is by raising or lowering interest rates.

Changing interest rates impact the value of the dollar.

How?

When interest rates on U.S. treasury securities go up, treasuries become more attractive . Everyone wants to earn a higher rate of interest.

Today the yield on a 10-year Treasury note is 1.97%.

In Japan the yield on a 10-year government bond, denominated in Yen, is 0.187%

In Germany the yield on a 10-year government bond, denominated in Euro, is 0.172%.

When interest rates in the U.S. are HIGHER than interest rates in Japan , the Japanese government will sell yen, buy dollars, and use the dollars to buy U.S. Treasuries.

Or the European Central Bank will sell Euros, buy dollars, and use dollars to buy U.S. Treasuries.

This means the demand for dollars increases. As the demand for dollars increases, the value of the dollar increases relative to other currencies.

The stability in the value of the dollar is one of the reasons the dollar is thought of as a reserve currency.

Another reason the stability of the dollar is important is that commodities like oil are traded in dollars. Regardless of the country you live in you need dollars to buy oil.

People believe that the dollar is “money good” because the dollar is backed by the “Full Faith and Credit of the U.S. Government”.

Across the globe the “full faith and credit” backing carries a lot of weight. Investors and savers believe that dollars will be honored by the government.

If I electronically transfer $100.00 between bank accounts, one account will show a debit of a $100 and one bank will show a credit of a $100.

I trust that my $100 in the bank will be available to me at anytime.

It sounds cliché but what also backs the value of our currency is trust.

The reason I am going through this lengthy explanation of the dollar is to imagine what an alternate world of cryptocurrency might look like.

If today my bank gave me the option to convert my dollars to bitcoin what would happen?

Let’s say I have a checking account I use to pay my utility bills, insurance bills, rent or mortgage and credit card bills.

If I deposit dollars to pay bills, I expect the value of the dollar to stay the same.

Something may end up costing more ( inflation ) but that is not the same as seeing the value of my dollars fluctuate wildly.

Imagine that I can now pay all those bills with bitcoin. Instead of depositing money into a bank I use my dollars to buy bitcoin.

At the beginning of the month I have $2,000.00 worth of bitcoin. Before I pay my bills, the value of bitcoin drops and now I have $1500.00 worth of bitcoin . Based on the change in the value of bitcoin, I am now short $500.00 that I was counting on.

I can’t exactly wait and hope the price of bitcoin goes up before the rent is due or the credit card bill is due.

Now I am checking my bitcoin account every few minutes because the price of bitcoin is volatile. Maybe I will be lucky, bitcoin will go up, I will sell it and have enough to pay my bills.

Do I want to rely on luck to determine if I have enough money to pay my bills?

And guess what? If your bitcoin disappears, c’est la vie!

Oh, did I mention the transaction fees to buy and sell bitcoin and other crypto’s?

And why the New Mayor of New York City committed to exchanging his first three paychecks to Bitcoin and Ethereum is beyond comprehension:

Does he have a lot of other money (dollars) sitting around to pay HIS bills since the value of his first paycheck has dropped significantly.?

Is he suggesting that people who depend on a paycheck should convert dollars to Bitcoin and Ethereum?

I thought risky, speculative investments by politicians although not illegal was certainly discouraged.

Since Crypto is DeFi, there is no central bank that is going to stabilize the value of crypto.

There is no central bank that is going to monitor inflation and take steps to adjust the supply of money so that your dollars are still worth dollars.

Cryptocurrencies are speculative and risky “investments” . An investment where you can lose money.

I think crypto is here to stay and there is no question that there is a marketplace for cryptocurrency.

I am realistic though and do not believe that crypto is a replacement currency for the dollar.

Resources for this article:

Digital Assets | Investor.gov

“The Future of Money: How the Digital Revolution is Transforming Currencies and Finance” by Eswar S. Prasad.

“The Business of Blockchain: Promise, Practice, and Application of the Next Internet Technology” by William Mougayar.

“The Currency Exchange” by Teri Frisch.

This website is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation for any security, nor does it constitute an offer to provide investment advisory or other services by The Modest Economist LLC.