Introduction
I often hear people praise Bitcoin as the non-plus-ultra when it comes to being a "medium of exchange", "store of value" and "unit of account", and thus, the best money ever- only that it isn't, yet.
While there is some truth to the above, I still think that many people shout (and claim) the above too fast- and furious, without even knowing what Bitcoin has to comply with to be able to "claim" said attributes- just as many people like to shout "BITCOIN FIXES THIS" at each- and every possible nuisance that cross their sights.
I'd like to try and explain some things in this regard, in hopes of having people leave with a better idea of this topic.
** I've written this to the best of my knowledge (and in accordance to the Bitcoin Standard), if I've got it wrong, feel free to correct me.
*** English isn't my native language, which means that I might have worded a given part poorly, sorry for that.
A medium of exchange and the problem of matching needs.
Any person who chooses to buy something, not to own it, but with the aim of exchanging it for something else, effectively turns it into a medium of exchange.
A small market (think tribes and other small communities) doesn't have much room for specialization and trade; everyone participates in the production of essential goods and services, and directly exchanges them with each other.
The larger the market, the more opportunities for specialization and exchange, but the greater the problem of matching needs - what someone wants to acquire is produced by someone who does not need one's own offer.
This problem is characterized by three different dimensions:
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The scales do not sufficiently match: what someone needs may not be equivalent to what someone possesses, and dividing into smaller units may not be practical.
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Matching time-frames: what someone wants to sell may be perishable, but what someone wants to buy is durable and more valuable, making it difficult to accumulate enough of one's perishable goods to exchange for a durable one at a specific time.
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Lack of matching locations: one may want to sell a house in one place to buy a house in another place, but (most) houses cannot be moved.
Direct and indirect exchange
These "dimensions" make direct exchange very difficult and often require multiple levels of indirect exchange to satisfy one's economic needs; with indirect exchange, someone exchanges their good until one owns the good that the counterparty currently needs:
- Someone might exchange their apples for shoes, and said shoes for wood, only to ultimately exchange said wood for the good one initially needed.
These goods are called mediums of exchange, and since any good can serve as a "medium of exchange", indirect exchange can become impractical the bigger the economy gets, as one has to constantly look for different goods needed by the counterparty.
The problem of matching needs and the impractical handling of indirect exchange can be solved by people agreeing on one single good that can be exchanged by everyone, for everything; a good that's a widely accepted medium of exchange is referred to as money.
A money's central function
The central function of money is to be the dominant medium of exchange; money is a good that wasn't purchased to be consumed- nor to be used in the production of other goods, but to be exchanged wherever, whenever and for whatever the owner wants.
A MoE can only be money when it fulfills a money's functions
Whether a given good can be used as money or not, is dependent on it's ability to fulfill the three functions of money: it's saleability, ability to act as a store-of-value, and usability as a unit-of-account.
Saleability
The saleability refers to the easiness of exchanging a given good on the market whenever its owner wishes, and with minimal loss of value.
The relative saleability of goods can be measured by looking at whether or not a given good "covers" each of the three dimensions of the problem of matching needs: their saleability across scales, space, and time.
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Saleability across scales refers to a given good's ability of being divided into smaller units, or combined into larger units, enabling the owner to exchange said good in any desired quantity.
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Saleability across space refers to a given good's place-independent saleability: is said good easy to exchange on a national- and international level, is it easy to take with you and transport?
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Saleability across time refers to a given good's ability of preserving value for the future, thereby also enabling the owner to retain wealth.
Storage of Value
For a good to remain saleable over time, it must be immune to decay, corrosion, and other forms of deterioration- In addition, the supply of a good should be resistant to sudden artificial expansion.
To prevent the supply of a good from artificial expansion or general significant expansion of the supply, a natural or artificial mechanism is needed to restrict the entry of the good into the market and maintain its value over time.
To fulfill a monetary role, a good must be expensive to produce because the temptation of cheap money production destroys the wealth of savers and the incentive to save in that medium.
The relative difficulty of producing new units of money determines the hardness of money. Money whose supply is difficult to increase is called hard money, while soft money is a type of money whose supply can be easily increased.
The "hardness" of money is derived from the relationship between the stock and flow of a good used as money.
The "stock" represents the existing supply of the good, and the "flow" is the additional production that occurs in the coming period.
A good with a low stock-to-flow ratio is a good whose supply can be significantly increased artificially; these goods would hardly be able to maintain their value, because the supply can increase faster than the demand; on the contrary, the higher the stock-to-flow ratio, the more likely it is that a good will maintain its value over time, as its supply increases slowly, it enables the good to keep-up with demand without outrunning it, rendering the respective good to stay saleable over time.
Unit of Account
The broad acceptance of a good allows it to express all prices within its terms. In an economy without a recognized medium of exchange, every good must be valued in relation to every other good, resulting in a large number of prices and making economic calculations extremely difficult.
In an economy with a recognized medium of exchange (money), the prices of all goods are expressed in relation to said medium of exchange, rendering it the unit of account.
In such a society, money serves as a "ruler" for the measurement of interpersonal values; it rewards producers in proportion to the value they provide to others and tells consumers how much they have to pay in order to acquire their desired goods and services.
Only with a unified medium of exchange as a unit of account is complex economic calculation possible, which enables the possibility of specialization in complex tasks, wealth formation, and large, internationally-intertwined markets.
The functioning of a market economy depends on prices, and prices are, strictly speaking, dependent on a common medium of exchange that reflects the relative scarcity of different goods in relation to said medium of exchange.
How does Bitcoin fit the bill?
Bitcoin covers the three "dimensions" of the problem of "matching needs" as follows:
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Divisibility: Bitcoin's native token can be divided up to eight places after the decimal point, the smallest unit being a satoshi, and combined into large units of up to one-hundred-million satoshis known as a bitcoin, allowing users to exchange any desired quantity. This divisibility provides immense flexibility in conducting transactions, whether it involves microtransactions or substantial transfers.
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Portability: Being a digital asset, Bitcoin is inherently place-independent. It can be transmitted swiftly and securely over the internet, making it a versatile medium of exchange that can be seamlessly transported- even across borders.
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Scarcity: Bitcoin's supply is strictly enforced and capped at ~ twenty-one million coins. This predetermined scarcity ensures its saleability over time. Unlike traditional fiat currencies subject to a low stock-to-flow, Bitcoin's fixed supply gives it the highest stock-to-flow available today, rendering it a reliable store of value, and thus, an attractive medium of exchange.
Bitcoin is a promising medium of exchange, and a viable option to be used as money- but it isn't, yet...
See, what Bitcoin lacks is it's broad acceptance, which is in part because Bitcoin's transaction fees are volatile, varying from very low to very high, rendering transacting with it's native token quite expensive at times, and since a transaction's only "final" after a given amount of confirmations, a transaction isn't instantly "valid"- at least in theory.
Although there's being worked on L2's that try to minimize- or remove the above completely - rendering Bitcoin more suitable to transact with - these also come with their own share of problems and / or compromises.
Bitcoin can easily be the best "store of value" we've ever had, but in order to be a global monetary medium, Bitcoin also has to prove itself as a "unit of account"- something that's only possible after claiming the status of being a widely accepted and reliable "medium of exchange".
I'll end it here, but feel free to comment suggestions in regards to expanding, correcting or improving the post!