It’s still up for debate whether digital currencies are in fact currencies, commodities, or a different asset class currently unknown. Digital currencies do solve many currency issues such as counterfeiting, double spending, and over-issuing, but there is debate as to whether they meet the three core functions to be termed a currency.

Does digital currency fit the definition of a currency?

A currency is meant to accomplish three functions:

  1. Store of value: Able to maintain its value over time. You won’t suffer greatly if you wait to spend or trade it.  
  2. Medium of exchange: Accepted by buyers and sellers to facilitate trading of goods and services without needing to barter.
  3. Unit of account: A unit of measurement to value goods, services, and assets. It allows us to ‘put a number’ on things and compare things that are not perfectly comparable. Currency should be countable, divisible, and fungible (each unit is the same as all others).

The “currency-ness” of something is not binary, but a continuum. How well an object (or code?) performs all three of these functions is a fluid exercise. We can see today that some tokens succeed on one or two of these functions, but not all.

Bitcoin, for example, is a good unit of account as you can measure different goods’ worth, and its countable, divisible and fungible.

Some people believe it will be a good store of value, like a virtual gold, but at the moment that is not the case given its volatility.

Bitcoin’s mark as a medium of exchange is weak as not many merchants accept bitcoins in exchange for their goods. This is because the technology is still early, but also because it’s risky and difficult to transact using a medium that has constantly changing value. There are also technical limits to how many transactions the Bitcoin network can process per minute.

Given these known issues, some protocol enhancements such as Lightning are trying to better accomplish currency functionality by focusing on price stability, high transaction capacity, and promoting merchant participation.

New Assets?

The argument can be made that these tokens are not great currencies just yet, but are assets like a stock, bond, or building.

The commonality of assets like stocks or real estate is that they produce future earnings – dividends (or retained earnings), interest, and rent – that are all a claim on an asset’s hopeful cash flows. We can look at an asset’s ability to generate future earnings and estimate how likely they are to last, or if they will grow or shrink.

Digital currencies do not produce any future cash flows in this way, so are dissimilar to traditional cash-generating assets. In this regard, digital currencies resemble gold, which we value not for its earning ability but for its durability, scarcity, and universality. With these characteristics, gold has functioned as a currency for millennia.

With no cash flows, we don’t so much value digital currencies as we do price them relative to other currencies, observing market dynamics and closely analyzing supply and demand. If demand for one currency increases relative to another, perhaps due to it becoming more widely accepted, its price should increase relative to the other.

Increasingly, tokens are being used to turn traditional assets into blockchain based assets. In this case, the token is a representation of the asset, like a share or claim, and not a new asset altogether. The ‘tokenization’ of traditional assets can bring benefits of increased liquidity, security, and a global reach.

Fundamentally, different tokens are aiming to accomplish different goals, and to offer different types of value. Widespread acceptance as a ‘currency’ is in the crosshairs of some digital currency projects, but others aim for a different target entirely.

 

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