15th June

Virtual Currencies: Are They Money?

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15th June

Virtual Currencies: Are They Money?

Money has formed an integral part of human economic interaction for millennia. It has appeared in many forms – barley, metallic currency, paper notes, cowry shells, cigarettes and even the great Rai stones of Yap. The question that everybody asks is, are Virtual Currencies (VCs) the latest incarnation of money?

To answer the question, we need to pose another one first; what is money?

What is money?

In The Wealth of Nations, Adam Smith defines money by the roles it plays in society, in particular, how well it serves as:

  • a medium of exchange with which to make payments for goods and services;
  • a unit of account with which to measure the value of a particular good, service, saving or loan; and,
  • a store of value with which to transfer purchasing power from today to some future time.

These functions of money operate in a hierarchy. There are many assets that people view as stores of value such as houses, that are not used as media of exchange. By comparison, an asset can only act as a medium of exchange if at least two people are prepared to treat it as a store of value, at least temporarily. And for an asset to be considered a unit of account, it must be able to be used as a medium of exchange across a variety of transactions over time between several people.

The hierarchy points to the reality that money is a social convention. We accept that a token has value whether made of metal, polymer or code because we expect that others will also do so readily and easily. Therefore, to analyse whether virtual currencies should be considered as money, we would have to submit them to the test of the three main roles of money.

Medium of exchange

Some VCs have attained limited acceptance as a medium of exchange. The current largest, Bitcoin, is accepted by some retail outlets, but on a global scale these outlets remain small in number. On a daily basis, there are around 284,000 Bitcoin transactions globally, compared to 330 million retail payments in the euro area. Bitcoin is far inferior to existing payment options. Bitcoin transactions generally require confirmation from six miners. With each block taking around ten minutes to mine, you would expect transactions to take an hour to process. Bitcoin payments are also expensive. The recent cost of a Bitcoin transaction is €25, the same cost as carrying out 12,500 transactions on the incoming TARGET Instant Payment Settlement (TIPS). Bitcoin is heavily resource intensive, and certainly not a green technology. Bitcoin mining is estimated to currently consume energy at an annual rate of 46 TWh. In comparison, traditional payment services have made large strides in innovation. The instant payments scheme SCT-Inst was launched in November 2017 and the Eurosystem will implement the TIPS service in November 2018. A key characteristic of the instant payments scheme is that funds are made available to the beneficiary in, at most, 10 seconds for 0.2 euro cents.

Unit of account

The second function of money is acting as a unit of account, without which buyers and sellers would have to know how many kilos of barley an iPhone would be worth, how many iPads would buy a house, and so forth. Such a system quickly becomes complex: just ten products already have 45 bilateral pairs of prices. Money simplifies the comparisons of value between products. VCs fail this test – none of them are generally accepted as a unit of account. A unit of account is a representation of commonness backed by assets and values which is even accepted beyond the territory of legal tender. The lack of acceptance as a unit of account is also down to the final function of money – being a store of value.

Store of value

Everyone is aware that the price of Bitcoin has fluctuated during the past few months. Strong rallies were soon followed by fast declines in the price of Bitcoin. Such wild fluctuations in the value of VCs mean that businesses pricing in VCs could find themselves with a large and detrimental gap between their actual price and their optimal price. A stable value is required to underpin effective pricing. Similarly, households benefit from being able to optimise their spending over time by saving. To do so, they need an effective store of value that they can be sure will enable them to buy goods and services in the future. When there is considerable uncertainty around how many goods and services an asset can buy in the future, or indeed whether it can be used to purchase anything at all, it is a poor store of value.

Traditional currencies have a trusted issuing authority that acts as a guarantor of the stability of the currency, and a legal framework that punishes counterfeiters. There are no equivalent structures in place for VCs. They have neither intrinsic value, such as the commodity content of gold coins, nor extrinsic value, such as the value assigned to traditional fiat currencies by the trusted public issuing authority. VCs do not even provide the dividend or coupon payments that tie down the prices of equities and bonds. They are in fact a classic Keynesian beauty contest, where investors buy what they perceive others view as the most attractive investment.


Although VCs do not fulfill the three benchmarks that economists have tied to defining money they are definitely something not to be dismissed. The technology underpinning them is revolutionary to say the least and the advent of VCs can also positively contribute to the economy. Just like money, they are evolutionary and here to stay.

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