by Joanne Masters

One key issue being hotly debated in many circles is how to categorise the bitcoin. Is it a currency? Is it a commodity? Is it a unique, new financial instrument? For some, this is an economic debate, for many the outcome is a critical component for assessing the bitcoin in terms of taxation, regulation, and for trading and holding the asset.

From an economic perspective, there are three traits that a currency must exhibit: store of value; medium of exchange; and unit of account.

There is a consensus that bitcoins satisfy both medium of exchange and unit of account. Whilst bitcoin acceptability is still narrow compared to traditional currencies, it is broadening at a rapid pace and arguably will become more widely acceptable in time. In Australia alone, bitcoin usage was up 480% in the first four months of this year. In early June, eBay Chief John Danohoe said he sees bitcoin playing an “important role” in PayPal – a move that would be defining for the future of the bitcoin.

Defining bitcoin as a currency, however, stumbles when we consider whether it is a store of value.

Store of value is the part of a financial asset that has value that can be stored and retrieved in the future. In terms of currencies (or gold) the store of value reflects the base level of demand and the backing of the relevant central bank. Bitcoin has neither. Moreover, for many, one of the advantages of the bitcoin is lack of regulation and central bank oversight.

In a paper titled ‘Is Bitcoin a Real Currency?’, the US National Bureau of Economic Research agued:
A bona fide currency functions as a medium of exchange, a store of value, and a unit of account, but bitcoin largely fails to satisfy these criteria. Bitcoin has achieved only scant consumer transaction volume, with an average well below one daily transaction for the few merchants who accept it. Its volatility is greatly higher than the volatilities of widely used currencies, imposing large short-term risk upon users. Bitcoin’s daily exchange rates exhibit virtually zero correlation with widely used currencies and with gold, making bitcoin useless for risk management and exceedingly difficult for its owners to hedge. Bitcoin prices of consumer goods require many decimal places with leading zeros, which is disconcerting to retail market participants. Bitcoin faces daily hacking and theft risks, lacks access to a banking system with deposit insurance, and it is not used to denominate consumer credit or loan contracts. Bitcoin appears to behave more like a speculative investment than a currency.
Goldman Sachs have described the bitcoin as a ‘speculative financial asset that can be used as a medium of exchange’, but argue it is more like a commodity than a currency.

Australia’s bitcoin advocacy association, Bitcoin Australia, argues that the bitcoin is ‘money’ as it is a generally accepted medium of exchange for goods and services and the repayment of debt.

Describing bitcoin as generally accepted is a big call today, but that may not remain the case. Indeed, the lack of ‘store of value’ may reflect the infancy of the bitcoin market.

Certainly the lack of liquidity and high volatility is a hurdle for the bitcoin to be considered a store of value. However, does the volatility reflect the lack of liquidity? Does it reflect uncertainty about the sustainability of the bitcoin, or concerns about theft of bitcoins? Or that there is no reserve backing? And no regulatory structure?

I wonder whether the landscape will look different in the future? To develop a store of value, the bitcoin needs to be more widely acceptable within the commercial world. There needs to be some way to hedge exposure, to help reduce volatility. There needs to be some level regulation to safeguard users and investors.

But isn’t this starting to develop? Bitcoin is becoming more widely used and accepted, regulation is under development as are hedging products. Indeed, Coinarch is now offering a derivative trading platform, starting with contracts for difference (CFDs). Whilst this may have regulators nervous, it is a critical step in the coming of age of bitcoins.

Indeed, one of the problems for regulators and legislators is that the global stage for bitcoins is moving, developing and shifting so quickly. The regulatory and taxation structure is under review but needs to be developed with the future in mind.

From an economic point of view, perhaps it doesn’t matter whether we call the bitcoin a currency, a commodity or a financial asset. However, the same cannot be said for regulators and policymakers.

And this is exactly what is being grappled with globally as policymakers try to work out how to regulate and how to tax bitcoins in a manner that is equitable, consistent and without strangling the very concept.