Bitcoin – Turning money from a legal agreement back to a commodity

Is bitcoin a currency, commodity, or something else? There are a lot of arguments either and every which way. Like a commodity, bitcoin’s value frequently fluctuates, in contrast to the general stability of currencies. Yet unlike traditional commodities, bitcoin can and does facilitate purchasing. One could argue then that bitcoin is a commodity-based currency.

Could this unique nature shift money from being strictly a legal agreement back to being commodity based? Most forms of currency are little more than figments of our imagination. Money has no intrinsic value outside of the paper it’s printed on and the ink used. Despite this, human civilization is primarily organized around the exchange of money. By and large, it seems that imagination itself may be enough to make the world go round.

Still, by examining extreme cases, we can see what happens when people lose faith in money. In 2008, inflation in Zimbabwe hit nearly 100% per day, meaning money would lose half of its value in a single day! Because of this, people refused to keep their money in banks. If they had money, most would spend it immediately as holding onto it meant losing wealth.

Money’s value changes as our views on its value change. Indeed, the values of currencies change every day as exchange rates fluctuate in the massive global foreign exchange (FOREX) market. Currencies that are allowed to trade freely with one another and that don’t derive their value from anything else are called “fiat” currencies.

Yet currencies weren’t always fiat. In fact, through much of human history, currencies derived their value from commodities, such as gold and other metals. Once upon a time, the metal that made up coins was what the money itself derived its value from.

Even paper money was once tied to commodities. From 1944 to 1973, the American dollar’s value was pegged to gold. In theory, you could take your dollars and exchange them for a specified amount of gold (in practice, this was limited). Many other currencies were, in turn, pegged to the value of the dollar. However, the dollar’s strong value and other conditions lead to the collapse of the gold standard.

These days,  no country is using a currency that is directly tied to a commodity. Instead, fiat currencies are legal agreements that derive their value from our imagination. Which brings us back to bitcoin and other cryptocurrencies. Do they count as a “commodity” based currency? Is bitcoin even a currency? Or is it perhaps a commodity?

Views on this are mixed, but  U.S. federal district judge Jack Weinstein recently ruled that “virtual currencies” are, in fact, a commodity. Judge Weinstein was less concerned with jumping into the theory behind money and instead the application of the law. By ruling that bitcoin was a commodity, the judge signified that the Commodity Futures Trading Commission had oversight and could pursue a lawsuit against Coin Drop Markets.

According to judge Weinstein, bitcoin met the “plain” definition of a commodity. What does this mean? One of the defining elements of a commodity is that it’s interchangeable for other commodities of the same type and grade. One barrel of sweet crude oil, for example, is the same as another barrel of the same type. These products are traded in mass on markets.

Sound familiar? This is similar to both bitcoin and traditional currencies. Outside of collector bills and coins, one traditional coin or bill is worth the same as another coin or bill of the same type. Yet currencies are different in that their worth is derived not from any intrinsic use or value but instead to facilitate business and trade.

Bitcoin seems to fall somewhere in-between. While bitcoin was established as a currency, thus far it has primarily been used as an investment asset. Like commodities, one bitcoin is valued the same as any other bitcoin and prices fluctuate dramatically. Like a currency, however, bitcoin’s primary use value is derived from facilitating exchange.

Moreover, like many commodities, bitcoin is “mined” or extracted. A distinct and expensive process, in this case solving algorithms, is used to create cryptocurrencies.  Bitcoin mining powers the entire bitcoin system by maintaining and expanding the public ledger. Mining costs money, principally in the form of electricity. Traditional money supplies, on the other hand, can be expanded at the whims of governments.

Both custom mining rigs (which cost money themselves) and consumer equipment (i.e. your home PC) require electricity to run. Someone has to pay for that electricity bill. This means that bitcoins themselves have an intrinsic and unavoidable cost.  Some argue that this cost gives rise to value.

While this angle is debatable, at the very least, mining costs create a minimal value at which bitcoin is viable. Commodities likewise have de facto viability floors. If the value of a commodity drops too much, people will stop extracting that commodity. For example, a few years ago plummeting oil prices pushed many oil producers out of business.

Commodities are traded through commodity markets. Most of the traders who buy commodity contracts have no intention of actually receiving the underlying commodity, say corn. Instead, they seek to profit off of rising and falling commodity prices.

Many bitcoin traders likewise hope to profit off of changing bitcoin prices. Some traders may go their entire trading career without using bitcoin to make a purchase. This likewise makes bitcoin similar to a commodity. Yet you can use bitcoin to make purchases. Indeed, countless businesses now accept bitcoin as payment. This makes bitcoin similar to a currency. On the other hand, you can’t make payments with bushels of corn or barrels of oil.

This in-between nature makes bitcoin a unique asset. Already, bitcoin is emerging as the next “recession” commodity. Akin to gold, economic and/or turbulence tends to increase bitcoin prices even as stock markets tumble. Bitcoin’s limited supply in combination with the costs of creating it and use-value as an exchange currency has made it attractive for people worried about economic downturns.

Meanwhile, as inflation marches on, reducing wealth where it stands, more people are beginning to question money itself. What’s the point of storing wealth in something that loses money? When currencies were based on commodities, one could hope that the value of the money itself would actually rise, rather than decrease. With governments capriciously increasing the money supply, there’s no real hope for that anymore.

Some have called for the return to the gold standard. Whether this is a wise idea or even feasible is beyond the scope of this article. Yet there might be a more readily available alternative anyways: using bitcoin and other cryptocurrencies. In the marketplace, bitcoin already behaves like a commodity. Yet when it comes time to make a purchase, bitcoin can be used like a traditional currency.

One could argue that bitcoin combines the best attributes of fiat currencies and commodities, thus making it a commodity-based currency. As more people trade and use bitcoin, it could slowly change the way we interact with money. This could portend the move for at least some currencies back to a commodity-like system.

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