Cryptocurrency Needs a New Name

In January, Bitcoin celebrated its 13^th birthday. To be more specific, the idea of a tradable and decentralized currency came to existence when the creator Satoshi Nakamoto mined the initial coins dubbed the “Genesis Block”. Though the idea for a digital currency had existed for decades, Bitcoin is notable for its innovative use of a decentralized blockchain, or list of records stored in multiple places.

The public does not know much about Nakamoto. The name is widely believed to be a pseudonym, and may represent an individual or multiple people. Fortunately, there is a summary of the technology authored by Nakamoto (“Bitcoin: A Peer-to-Peer Electronic Cash System”, readily available online) that was released about two months prior to the inaugural mining. It highlights the main functionality of Bitcoin as not requiring a third-party (namely, banks) to verify a payment. In the world of debit cards and digital payment systems like Venmo, a bank is ultimately the link that verifies the payer has the funds to make the transaction. With blockchain currencies all transactions are public, and verification means simply checking one user’s blockchain of transactions against the others. While you can protect your identity by remaining anonymous (like Nakamoto), all of your transactions are traceable. In theory, this is a cost-saving technology because it removes a middleman from a financial transaction.

Shortly after Bitcoin’s release, others saw different advantages in Bitcoin. These advocates note that cryptocurrencies offer protections against risk not available with traditional financial assets. Those with wealth in the stock market, or even just a bank account, can be impacted by inflation, fraud, civil conflict, or poor public policy to name a few. Last month, the Canadian government froze the financial accounts of hundreds involved with the vaccine protests. While this was over in less than a week, for some it was proof-of-concept that a government could seize control of your wealth.

However, these arguments are based on cryptocurrencies being used as a medium of exchange. In other words, people are using it to buy things. How does a currency become a medium of exchange? First, sellers have to accept it. In the U.S., there are several large businesses that accept Bitcoin, but a comparably tiny percentage of small- and medium-sized companies have followed suit. Even at firms that accept Bitcoin for payment, there are still conversion fees that often erase any savings of eliminating your bank from the transaction. It may be possible to coerce sellers into accepting a currency via government action. Last year El Salvador became the first country to declare Bitcoin as a legal tender, which means its citizens are required to accept it as payment. The Salvadoran government developed a cell phone app called Chivo where Bitcoin can be traded, though many still prefer the country’s other legal tender, the U.S. dollar.

Even if Bitcoin were widely accepted by sellers, the wild fluctuation in its price deadens the incentive to use it for routine transactions. The value of a Bitcoin has grown roughly four-fold since the pandemic began, so why would a consumer forgo that potential by spending it on, say, lunch? From the seller’s perspective, the high daily price fluctuation means that it is possible that revenue you earned in the morning could be worth significantly less by the end of the day. While there will be times when the sellers benefit from an uptick in Bitcoin prices, people tend to be risk averse with short-term purchasing power. The volatility of cryptocurrency value is striking. Today the market capitalization of major cryptocurrencies sits at nearly $2 trillion, which seems impressive until you realize that it was almost $3 trillion four months ago. Americans are rightfully concerned about near double-digit inflation of the U.S. dollar, but the daily value of Bitcoin changed by more than ten percent twice in February 2021 alone.

For many investors, the price volatility of cryptocurrencies is a feature and not a bug. Many financial planners recommend devoting a small amount, typically between one and five percent, to cryptocurrency. This can help diversify a portfolio because the value of cryptocurrencies does not typically move in the same direction as more traditional investment properties. Such was the case at the onset of the pandemic when the Dow Jones Industrial Average fell by about one-third while the price of Bitcoin rose. This fluctuation also explains why cryptocurrency traders tend to be young, which is the right time to absorb larger financial risks. Advertisers seem to be aware of this audience. Recently cryptocurrency exchange companies have been promoted by highly paid athletes and entertainers like Tom Brady, Kim Kardashian West, and Matt Damon. The websites and cell phone apps where you can trade cryptocurrencies have the same general appearance and functionality as apps where you can trade stocks. But there is an important difference between these investments: stock prices are a signal of the company’s profitability, while cryptocurrency prices are determined by … no one knows.

The acceptance of cryptocurrencies by the investment community marks a significant evolution in the technology. At first Bitcoin earned the name “cryptocurrency” because many early adopters used it for illicit purposes since there are no restrictions over what can be bought and sold. During these times, it was primarily a medium of exchange (the currency part) with anonymous buyers and sellers (crypto). But as long as the price of cryptocurrencies remains volatile, it is hard to imagine Bitcoin or any of its imitators becoming a reliable medium of exchange. In addition, anonymity isn’t as important since many cryptocurrency investors are happy to share that they are part of its marketplace. For these reasons, cryptocurrency needs a new name … it should invoke dizzying ups and downs that seemingly occur at random … how about rollercoasters?