Throughout history, money has come in different forms, from copper, silver, and gold to salt and even seashells. Eventually, modern society settled on government-issued money in the form of notes and coins, which exist largely in digital form on bank accounts and credit cards today. But with the emergence of Bitcoin in 2009, money is changing again. Read on to learn more about Bitcoin and how this technical innovation is on the path to becoming what economists called “sound money.”
What is Sound Money?
Sound money is money that is not prone to a sudden depreciation or appreciation in value and typically backed by a hard commodity, such as gold or silver.
More specifically, sound money should be durable, divisible, portable, uniform, acceptable, scarce, and fungible.
To further understand what counts as sound money, you have to look at each characteristic.
Money obtains durability when it can endure continuous use by a large population, while portability means that it’s easy to transfer. Divisibility means that it can be broken down into smaller units, and uniformity means that it has the same value, size, and shape. For instance, all EUR 100 notes look the same and have the same value. Acceptability refers to merchants and retailers widely accepting it as money.
Scarcity is a characteristic we can find in gold, for example, but not in fiat currency because the latter can be printed at will and (theoretically) to infinity by central banks.
Fungibility means that money has to be interchangeable so that one unit is always worth one unit. For example, a EUR 100 note is acceptable anywhere regardless of whether it was used to facilitate criminal activities prior or not.
Now that we’ve defined what sound money is and what characteristics money needs to have to be considered sound, let’s look at whether Bitcoin is sound money.
Is Bitcoin Sound Money?
Bitcoin is arguably the soundest money we have right now, but that doesn’t mean that it’s in a place in its development yet where it qualifies fully as sound money.
The reasons for that are that the digital currency isn’t widely accepted as a currency yet and that it isn’t fungible yet.
While Bitcoin has experienced a tremendous adoption rate in the last decade, the reality is that it remains largely unsupported by merchants and retailers as a payment method. A handful of very pro-Bitcoin countries aside, you will be hard-pressed to find a shop where you can pay with bitcoin in most major cities across the globe.
For Bitcoin to become sound money, its adoption rate as a medium exchange (as opposed to as a speculative investment asset and store of value) would have to continue to grow substantially from current levels.
However, the digital currency’s reputation, which is regularly damaged by falsehoods spread about it, is still preventing it from being adopted at scale as the broader public still has too many misconceptions about Bitcoin. The cryptocurrency’s volatility is another factor that is deterring many from using it as a currency as opposed to just an investment.
Additionally, on-chain transactions are too expensive for the Bitcoin network to be used for day-to-day spending. Even though on-chain fees have dropped significantly since the introduction of SegWit, it doesn’t make sense to pay a USD 2 transaction fee when you are buying a USD 5 coffee.
Fortunately, the Lightning Network (and other second-layer solutions) that enable high-speed, low-cost, off-chain transactions are experiencing substantial uptake. But for second-layer solutions to be implemented at a global scale will still take time.
Aside from its lack of acceptance as a transactional currency, Bitcoin also suffers from the fact that it isn’t actually fungible.
Despite what some Bitcoin advocates may claim, one BTC is not always one BTC. For example, freshly mined “virgin” coins are sold at a premium because there is no chance that they could be “tainted.”
“Tainted coins” refers to Bitcoin that have been identified as having been used in illegal activities, making them a target for potential blacklisting by exchanges and other crypto services providers. Once coins are blacklisted, they become difficult to move and convert into fiat currency. As a result, tainted coins are worth less than non-tainted coins and substantially less than virgin coins.
Because of the existence of tainted coins and virgin coins, one BTC is not always worth one BTC, which means that Bitcoin is currently not fully fungible.
While it may seem like splitting hairs here, the distinction is significant if Bitcoin is to become sound money for the Internet age.
The good news is – aside from a lack of global acceptance and full fungibility – Bitcoin is on track to becoming sound money.
The world’s first cryptocurrency has five out of seven characteristics of sound money and, since it’s in continuous development, is poised to tackle the remaining two.
What’s more, Bitcoin has features that arguably make it superior to other forms of money, such as gold-backed currency. For example, Bitcoin is censorship-resistant, thus allowing anyone to have complete sovereignty over their finances. Additionally, the value of the digital currency can’t be easily swayed by government or central banks, and its monetary policy is hardcoded, making it essentially impossible for anyone to manipulate.
Finally, Bitcoin is well-positioned to become the currency of the internet by allowing anyone with an internet connection to create a wallet and start using it. It’s the first open, borderless monetary network that has the ability to enable anyone to be their own bank.
What Needs to Happen for Bitcoin to Become Sound Money
While Bitcoin is arguably the closest thing we have to sound money today, it still isn’t 100% there yet.
Bitcoin’s lack of global acceptance and fungibility need to be addressed for Bitcoin to become sound money.
Fortunately, the Bitcoin community is working tirelessly to make that happen.
Bitcoiners around the world are holding meetups, organizing events, and talking to their friends and families about the benefits of Bitcoin to spur Bitcoin adoption. Moreover, there are hundreds of startups working on making access to and use of Bitcoin as easy as possible.
The Bitcoin community’s combined effort to boost adoption has been incredibly successful over the last decade, which will continue to be the case in the decades to come. In light of Bitcoin’s brand recognition in the mainstream, getting to a place where merchants and retailers become comfortable accepting the digital currency shouldn’t be too far off (provided lawmakers play ball).
Arguably the bigger challenge for Bitcoin to become sound money is the cryptocurrency’s fungibility issue. Fortunately, the implementation of Confidential Transactions (CT) could resolve the issue by adding a layer of privacy on Bitcoin transactions.
Confidential Transactions are “a cryptographic tool to improve the privacy and security of Bitcoin [that] keeps the amounts transferred visible only to participants in the transaction [and those they designate],” according to Bitcoin Core developer Greg Maxwell.
By implementing Confidential Transactions (or other privacy-enhancing technologies) for Bitcoin transactions, Bitcoin could reach a level of fungibility that would allow the world’s first cryptocurrency to become truly sound money.
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