A recent crash raises questions about whether cryptocurrency is inflation-proof, as proponents claim. Some are still wondering, what exactly is cryptocurrency?
To answer what cryptocurrency is, it’s useful to understand what cryptocurrency is not. For instance, cryptocurrencies are not securities. A security evidences the holder’s ownership in a company (a stock) or claim to a company’s debt (a bond).
In short, these assets are linked to something of value. To illustrate the concept of value, let’s abandon Wall Street terminology and revert to an old-time market. Imagine you produce fleece circa 700 BC. Your family has needs, such as nutrition, which fleece does not fulfill. The market is a venue for you to trade with a grain producer. In this scenario, the advantage of the marketplace is clear to both participants. The fleece producer eats and the grain producer stays warm.
Enter monetary currency. Broadly, money lacks intrinsic value but stands in for something possessing intrinsic value. In the early marketplace, money has attractive features to market participants. For one, it tempers a transaction. Consider vendor A, who has a buffalo to trade and desires chicken. Vendor B has chickens to trade . . . but one buffalo equals a lot of chickens. Using money, vendor A can sell the buffalo and spend the proceeds on one chicken (an amount the chicken vendor is likely to have), and other items, such as corn and spices. For another, money facilitates trading over farther distances.
When bartering, market participants obtain goods from their surrounding environment. But maybe what the Alaskan fisherman wants is a lemon. With money, a transporter is compensated and lemons travel to the fisherman’s market. What’s more, the lemon grower must not want fish, as would be required in a direct trade. What this boils down to is an understanding among market participants: Each is willing to accept something without value because it can be used reliably to obtain something with value.
We can understand today’s financial assets using the simple market paradigm. Take a worker saving cash in a 401(k). Cash is invested in securities. After the worker retires, proceeds received from dividends, interest and gains are used for everyday necessities. Ultimately, the stock market participant obtains items of value, such as fleece, grain, chicken, buffalo, fish and lemons.
So, what is cryptocurrency? Miriam Webster offers some definitions.
Crypto: not openly avowed or declared.
Currency: something that is in circulation as a medium of exchange.
“Crypto” accurately describes Bitcoin, an early model of the most widely known cryptocurrency. It was started by someone having only an online moniker. Since Bitcoin, thousands of cryptocurrencies have emerged with varying levels of transparency as to their sponsorship.
“Currency” is debatable. Strictly speaking, any cryptocurrency can be in circulation by virtue of its creator giving it an online presence. Whether it is actively circulated is up to market participants. Cryptocurrency fits the description of monetary currency in that it lacks intrinsic value, but there is scarce proof that it can be exchanged reliably for something of value in the U.S. market. This is likely because market participants’ use for money has been satisfied by the dollar.
Unlike the dollar, crypto is neither sponsored by a government whose elected officials are accountable to their constituents nor overseen by a federal reserve. These aspects are lauded by supporters. Theoretically, a decentralized currency is difficult to counterfeit and, in turn, resistant to inflation. However, the fact that anyone can invent a cryptocurrency invalidates such claims of inflation resistance.
Hence, answering a question of why cryptocurrency lost value is a bit like addressing why the tooth fairy stopped visiting. The value of cryptocurrency – like the physical presence of the tooth fairy – never existed in the first place.
Lacey Donley is an assistant professor of accounting at Fort Lewis College and a Certified Public Accountant.
