The primary role of money is to abstract the value from our goods and services to a form that is easier to store and transact with. As such, the most important function of money is its ability act to as store of value. Early forms of money like cattle and grain grew ineffective as civilisation evolved due to its lack of durability. Its perishability meant that the value erodes over time. Similarly, the value of fiat currency decreases over time due to inflation.
The Dangers of Hyperinflation
Like everything else, the value (or price) of currency is determined by its supply and demand. Demand is controlled by the economy, made up the need for financial agents to engage in trade, pay taxes, and store value. On the other hand, supply is controlled and closely monitored by the central bank, whom can print currency to increase the supply – known as quantitative easing (QE)(https://www.investopedia.com/terms/q/quantitative-easing.asp). This puts the average participant of an economy at a disadvantage as supply increases each year, diminishing the buying power of each person’s savings. This concept is called inflation.
While it’s easy to overlook the effects of inflation during times when the economy is strong, inflation can spiral out of control. When a central bank prints too much money, its citizens notice the erosion of purchasing power and lose confidence in their currency. This rapid diminishment in the value of a currency is known as hyperinflation.
Subsequently, a situation arises where individuals rush to purchase goods and other assets today for fear of their currency being worth less tomorrow. Amongst other major issues, this increased demand for goods results in price surges throughout the economy, creating a scarcity of necessities like food and fuel. These issues would be exacerbated further if Central Banks were to resort to QE to solve the problem. The fear surrounding hyperinflation is that it is difficult to detect early and to fully grasp the potential for damage.
Hyperinflation is not rare.
There have been 55 cases of hyperinflation in the 20th century, including Germany, China and Russia. Currently, there are 13 hyperinflationary economies in the world, with Venezuela leading the race to the bottom with an almost meaningless figure of a 10 million percent inflation rate projected in 2019 by the IMF. In other words, the price of Bitcoin (as well as everything else) in Venezuela is breaking new all-time-highs every single day.
Historically, gold has served as the most effective store of value due to its natural properties ensuring durability, fungibility, divisibility, transferability and most importantly, a finite supply. Bitcoin aims to be a digital gold, demonstrating all the same properties, with the additional benefit of better transferability and divisibility.
While it may seem obvious now, the creation of a digitally sovereign form of money was road blocked for many years. Files were treated as data that could easily be duplicated, and thus were not scarce. At the time, this meant all transactions would be tracked on a single ledger controlled by a single entity was – clearly in contradiction to the concept of Bitcoin acting as a replacement for gold.
The invention of a digital gold required a computer science breakthrough known as Byzantine Fault Tolerance, or Byzantine Generals Problem which enabled digital scarcity in the form of blockchains. Bitcoin became the first digitally sovereign form of money that was not issued or controlled by a centralised entity.
It is difficult to argue that Bitcoin will completely replace gold after only 10 years in circulation, particularly when compared to how gold has functioned for society over thousands of years. But, the likelihood of it taking up a portion of its market share is certainly likely.
A valid critique of Bitcoin’s ability to be a store of value is its volatility. Bitcoin is still an asset class in its infancy with a relatively small market cap. As the market cap grows and institutional infrastructure develops in the space, volatility is highly likely to decrease.
The effects of having circulating supply split over hundreds of exchanges around the world across multiple currencies also has the effect of limiting liquidity and increasing volatility – explained by my exploration of Bitcoin’s ability to function as a Unit of Account. This is now largely solved thanks to the emergence of a market-makers across the world bridging the price disparities across currencies and exchanges.
Another attribute that makes bitcoin a better store of value than a bank savings is its resistance against seizure. There’s a possibility that Bitcoin could take up a portion of the offshore banking market share once the asset class gains stability.
A fascinating point can be made about how governments act in times of hyperinflation. In the past, governments have often banned the purchase of foreign currencies and gold during hyperinflation, to force citizens to use their failing currency. The invention of an asset that can’t be seized (with proper private key management), makes it extraordinarily difficult for governments to prevent people from exiting a currency. This may cause the speed at which hyperinflation takes place to be much more rapid in the future.
Knowing that there’s a significant chance that at some point over your lifetime, all your savings in central bank issued currencies could become worthless, would you consider buying bitcoin as a store of value?