CAN BITCOIN ACT AS MONEY? / MACLEOD FINANCE

Can bitcoin act as money?

An analysis of bitcoin's ultimate credibility

MACLEODFINANCE

Since 24 January, bitcoin has risen 65% and gold rose about 7% priced in US dollars. 

Before gold began its current successful but relatively modest leap into new high ground, there is little doubt that hedge funds and others sold down their Comex gold contracts and bought some bitcoin ETFs instead. 

The listing permissions for bitcoin ETFs made regulated investment possible. 

And attracted by the limitations of supply, an investment cohort moved in for the kill.

This raises the often debated question yet again as to whether BTC will become money, which is the long-stop argument of its supporters. 

For the avoidance of doubt, I approach this topic not as a goldbug insisting on an old-school argument. 

Defending bitcoin, Colonel Macgregor put it in a recent interview that Macleod has a vested interest as a gold bug. 

I maybe a gold bug, but that does not mean that I am one through bias. 

I try to look at all matters objectively, which is how I approach an examination of bitcoin without any bias against or in favour. 

But there are some factors that investors should bear in mind and that is what this posting is about.

I draw your attention to the correlation between BTC and US tech stocks, illustrated in the chart below.

I constructed the tech index by taking the weekly close of seven large-cap stocks, rebasing them all to 100 on 24 February 2020 and then taking the arithmetic average of all of them to construct an index. 

It is therefore a pure price index instead of the weighted by capitalisation approach. 

This is then compared with bitcoin’s (BTC) weekly closing price, similarly rebased. 

Since bitcoin has far higher volatility than even the tech stocks, I put them on different axes to facilitate visual comparison. 

The current bull markets in both tech stocks and bitcoin commenced at that same time.

The result is striking. 

Until early November 2021, the correlation was loose, though both were in bull phases. 

But remarkably, bull phases ended at the same time, and a bear phase ensued until both markets bottomed a year later in November 2022. 

The correlation in that correction was then much tighter, as it has been in the subsequent bull phase, particularly in recent months.

This begs the question: is bitcoin to be regarded as a new form of money, escaping from government currency debasement, or does it merely act as an investment or speculative substitute for tech stocks? 

This is important, because many hodlers[i] argue that the tech bubble is being fuelled by “money printing”, the very evil that justifies their hodling. 

But the reality is that by their actions they appear to be chasing profits as if they were punting in momentum-driven tech stocks, instead of genuinely hedging out of fiat currencies.

Is bitcoin money?

To answer this question requires an understanding of both money and credit and how they differ, something which is generally lacking even among economists. 

If bitcoin is to be the “new money”, replacing gold, then it must satisfy all the functions of money: a medium of exchange, a unit of account, and a store of value. 

To this which was Aristotle’s definition, my colleague James Turk added a fourth to take account of modern credit conditions: to act as the final payment for transactions.[ii]

This last function links money, properly describing physical gold in international law whose possession has no counterparty risk, with credit where there is always counterparty risk. 

Credit encompasses currency, bank deposits, bonds, bills, equities, and personal commitments to pay for something already received. 

It is always matched with an obligation, or debt. 

Ownership of an equity, for example, is matched by a promise to pay an income stream. 

Credit is not only matched by debtor’s obligations, but it also represents wealth.

It is not that true money circulates. 

As long as credit can be exchanged for it, credit can happily continue to circulate in its various forms, because money guarantees credit’s value other than its counterparty risk. 

This was why gold standards always worked until they became abused by the currency issuers.

Since 1971, this final function of true money has been removed from the global financial system, creating the conditions of fiat currencies without the guarantee of convertibility into money as the final payment available for transactions.

Any goldbug or hodler who mistakenly believes that money circulates and in a financial Armageddon will replace credit, fails to understand money’s true function and its distinction from ubiquitous credit. 

Money can be used for direct exchange, but that is always a last resort. 

If in a financial anarchist’s imagination credit and all its evils somehow disappear, we would quickly return to the dark ages.

Presumably, hodlers think that bitcoin will be used as payment for transactions by electronic means. 

That is undoubtedly true between consenting parties. 

But in the absence of credit, it is hard to envisage any trade taking place, except on a very limited basis because of the intensely deflationary conditions that would be the result.

It is a vital function of any form of money to introduce monetary stability, upon which credit can be based. 

No one will enter into a contract involving credit without some certainty of final value. 

This is why money is objective in its value, which means that parties to a transaction can agree that all subjectivity, or variation in a transaction’s value is in the goods or services subject to the transaction.

But find me a hodler who expects BTC to provide objective value: they are all enthusiastic supporters because they expect BTC’s value, measured in fiat credit, to rise ad infinitum. 

And here we hit a real problem: without fiat currencies to value it, would bitcoin and other cryptocurrencies have any value themselves? 

To have that value it must be freely exchangeable for goods and services and must have the agreed objectivity, which with bitcoin’s disruptive volatility is a problem.

Bitcoin is equally unsuited for valuing capital. 

Capital is required for financing businesses and comes in the form of credit. 

In any business, this credit is required to finance production, which means that a significant period of time must elapse between acquiring or providing finance and being able to pay it down through profitable sales. 

Without stability of value in the medium of exchange, it is impossible to make business calculations. 

Admittedly, this stability is absent with a fiat currency, but through its mild devaluation a business benefits, so long as the interest cost is reasonable. 

It is this feature promoted by Keynesian economists as a virtue, which eventually destroys a fiat currency.

Bitcoin has as its enthusiasts who recognise the damage done by governments to the purchasing power of their currencies. 

But they are a generally tech-savvy investors. 

The extent of bitcoin and other cryptocurrencies would be unlikely to find wider support in the seven billion transacting humans with a different concept of money, even if its volatility could become tamed.

The blockchain is both good and bad

There is little doubt that the blockchain, which is bitcoin’s self-auditing and identification feature, is a remarkable innovation. 

It identifies ownership, giving hodlers complete confidence that they do own bitcoin or a defined fraction of one. 

It gives integrity to the entire network. 

And it has sparked an entirely new industry for the recording of asset ownership on blockchains.

It is this identity which ensures that ownership is entirely free of counterparty risk, just like physical gold with the convenience of electronic transferability across national boundaries. 

In this sense, bitcoin is obviously superior to gold as many hodlers tell us.

While these benefits cannot be denied, there is a problem in law with the blockchain. 

By giving clear ownership identity for each bitcoin in existence, technically they are no longer fungible. 

This means that their ownership is not only specific, but also so is that of previous owners. 

This is not the same as fungible money and credit. 

Where this matters is in the legal treatment of theft and fraud.

If someone steals your wallet and spends the contents in a shop, you only have a right of action against the thief and no right of recovery of your money from the shopkeeper. 

And if someone hacks into your bank account and transfers your deposit to another bank, this is also true. 

You may have a right of action against your bank which could result in the restitution of your deposit if you can establish that the fraud was due to the bank’s negligence. 

But your bank cannot recover the funds, unless, perhaps, your bank can establish that the fraudster’s bank might be deemed to be in on the act, deliberately or by omission: in other words, a party to the fraud. 

It is the fungible quality of money and credit that makes it impossible to isolate the identity of your property.

Bitcoin appears to be in a different asset class because of the blockchain identity. 

For non-fungible assets, there is a right of repossession, which is why paintings looted by the Nazis are recovered by the inheritors of those from whom the art was stolen. 

A subsequent owner has no right to compensation, even if the stolen property was acquired through an auction house in good faith.

The distinction between fungible assets, including money and credit, and non-fungible durable assets was laid down in Roman law, which formed the basis of common law in all subsequent European colonies — including the United States. 

The problem posed by bitcoin is that it has been widely used for money-laundering and alleged tax evasion. 

It gives the authorities free rein to confiscate bitcoin without compensation from current owners if they can establish, or even suspect that under previous ownership they were the proceeds of crime.

Publicly, there is not much evidence that the authorities have been prepared to follow this course, probably for fear of collapsing an entire industry triggering a wider financial crisis. 

But in a financial crisis, the authorities are probably more likely to undermine the credibility of cryptocurrencies in an attempt to protect their own currencies than to confiscate gold. 

Confiscation of gold will almost certainly lead to an unnecessary headwind for fiat currencies, while an attack on crypto will not.

Conclusion

In this post I have established that there is a worrying correlation between the performance of bitcoin and that of high-flying technology stocks on Wall Street. 

It suggests that the investment cohort driving values is the same, or remarkably similar. 

If we can agree that technology stocks are the subject of an investment bubble, then in all logic so is bitcoin.

Bitcoin and the entire crypto industry are thus aligned with credit, the very evil that hodlers are hedging against. 

If credit is destroyed, speculative counters without physical form almost certainly will be as well.

As a money substitute, global acceptability will have to spread beyond its fanbase, which seems unlikely. 

Furthermore, as the basis of a future form of credit, its volatility in value renders it entirely unsuitable as a medium of exchange, and it lacks the necessary basis in law with respect to fungibility.

It gives me no pleasure to come to this conclusion. 

If my analysis is correct in these respects, ordinary people will be sucked into a bubble from which they will emerge with nothing. 

It will become a posthumous chapter to Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds.

________________________________________

[i] To those unfamiliar with the term, a hodler is an owner of bitcoin. It originated from a misspelling and has stuck ever since.

[ii] Money and Liberty, by James Turk, Woodlane Books