Bitcoin
Bitcoin is a crypto asset created in 2009, by a person or group of people whose identity is unknown, under the pseudonym of Satoshi Nakamoto. The original goal was to create a new payment system with no financial intermediaries. However, it is currently used mainly as an investment instrument, as it lacks clear backing or economic fundamentals to justify its market value and does not have legal tender status in almost any country.
Bitcoin was the first creation of the so-called “criptocurrencies”, which emerged with the aim of replacing traditional money, eliminating the financial intermediation carried out by both commercial banks and central banks. However, cryptocurrencies do not meet the three defining characteristics for consideration as money: means of payment, store of value and unit of account.
Economic theory defines money not by its nature but by the functions it performs: “Money consists of the instruments that society uses as a unit of account, store of value and means of payment”. These three conditions must be met simultaneously. The instruments that can be considered money have varied throughout history (e.g., shells, salt, precious metals, etc.).
From the 19th century until 1971, money was, in various ways, backed by gold, in what was called the “gold standard monetary system”, whereby the value of money could, in principle, be converted into grams of gold if the citizens who owned it so demanded. Since 1971, this “gold standard” has been abandoned, so that since then money is no longer backed by a physical asset; this is known as “fiat money”.
Nowadays, money is considered to be both banknotes and coins issued by the central bank, and the money created by commercial banks through their activity of taking deposits and granting credit.
“Fiat money” is based on the trust that citizens have in the central banks of their country or monetary area. Therefore, the reputation of these institutions is key to ensuring that their banknotes and coins, which are recognised as legal tender, are accepted by other citizens or companies for the settlement of obligations. Neither bitcoin not any other crypto asset has the historical backing that money has had and continue to have.
Why can't cryptocurrencies be considered "money"?:
- Unit of account:
Due to their high volatility, cryptocurrencies cannot be considered a reliable instrument for measuring the market value of different products and services. - Store of value:
Similarly, due to their high volatility, cryptocurrencies cannot be considered a reliable instrument for maintaining their value over time. - Means of payment:
Cryptocurrencies are not accepted as a means of payment in any country except El Salvador, which has recognized bitcoin as legal tender in the country1.
When it was created, bitcoin was designed to:
- Assume the role of an "alternative currency" for financial transactions with no intermediaries.
- Offer an alternative for reducing the cost of financial transactions, using a peer-to-peer network.
- Functionally assimilate itself as a “decentralized currency” that would allow users to send and receive payments across geographical borders in less time than traditional transfers.
Why have Bitcoin and crypto assets in general been so successful since their emergence in 2009?
As we already know, crypto assets are based on a novel technology called blockchain2, que puede tener which can have multiple benefits in terms of automation and integration of processes and control of records. However, the use of this technology for the development of “cryptocurrencies”, which can replace legal tender, is limited.
Therefore, on this basis, we can define the positive and negative aspects of crypto assets.
Positive:
High potential of Distributed Ledger Technology. This allows for process automation and security guarantees, which in turn can bring about significant advances in the functioning of financial markets.
Programability of crypto assets. This means that some of these digital assets have the ability to include sets of instructions in the form of computer code through so-called “smart contracts”.
Negative:
High volatility: the value of Bitcoin is highly volatile and can fluctuate dramatically in a short period of time. This means that acquiring Bitcoin involves a very high risk and could result in the loss of all of the capital invested. This is because Bitcoin is not backed by assets, but rather its value is based on the trust of the community that relies on it.
Limited security: transactions involving crypto assets are irreversible, meaning that if a transaction is made to a wallet by error, there is no way to recover it. In addition, digital wallets can be hacked, which can result in the total loss of the funds invested, with no possibility of recourse to the competent institutions.
Limited acceptance: the acceptance of crypto assets as a means of payment is still very limited.
Risk of fraud: the still incipient regulation of these markets, as well as the limited experience of supervisors, professionals and users compared to the traditional financial market, brings with it a high risk of situations linked to scams or fraud. The recent cases of Terra-Luna and FTX are clear examples of this. The new European regulation that came into force on 30 December 2024 (MiCA regulation) establishes a regulatory framework that will mitigate some of these risks, although it is not as stringent as the regulations applicable to traditional financial instruments.
Limited scalability: for a Bitcoin transaction to reach another user, the network has to validate this transaction. Depending on network congestion, a transaction can take between 10 minutes to several hours, regardless of the time of day it is carried out. Additionally, the cost of conducting transactions on the Bitcoin network is very high. To mitigate this problem, technological solutions have been developed that rely on the Bitcoin system without having to record each transaction and that could allow for intensive use of Bitcoin (such as Lightning).
1 The Central African Republic also adopted Bitcoin as legal tender in 2022, but abandoned it a year later.
2 A blockchain is a specific type of Distributed Ledger Technology.