Cryptocurrencies, or "digital coins" are terrible at being currencies and do not deserve to bear this name. Clams did much better with no other technology needed than bending over to pick them up from beaches in the XVIIth century. Making the case for clams being better currencies than digital coins hopefully also establishes that today's currencies such as Euro, Dollar, and Yen are much better currencies than digital coins.
What are digital coins?
Most of the self-designated "cryptocurrencies" rely on distributed ledger technologies (DLTs). It is the case with the largest of them (by market capitalization), with Bitcoin, Ethereum, Ripple, Bitcoin Cash and Litecoin leading the way.
DLTs are technologies implementing secured distributed ledgers within a network of participants. The transactions or events happening in the network are first of all encrypted and then inscribed into a ledger that is maintained and duplicated throughout the whole network. To be added, a block of transactions or events need to be validated by the network. This may take several forms, but the most common, which is also used by the Blockchain, is to have the network find the solution to a computation-heavy cryptographic problem. When someone solves the problem and hence validates a transaction, he is rewarded with a few new coins. This is typically the only money creation that occurs within the network.
The proponents of digital coins propose them as an alternative to fiat currencies, that is the traditional currencies such as Euro, Dollar or Yen. In particular, they find digital coins to bring several benefits, the largest probably being that they do not require a trusted third party, hence removing the need for intermediaries to make transactions. Let’s dive in the opposite direction: one of the most basic an un-technologic money : clam shells.
Did you say clam shells?
American Indians used clam shells as a currency for a very long time to settle transaction between and within tribes 1. Iroquois tribes gathered a treasure of clam shells necklaces, even though there territory was nowhere near the seaside where such clams could be found.
Clam shells were an efficient enough money to be adopted by the first colonists in the XVIIth century. In fact, clam shells even became legal tender in the then New England for 25 years in the middle of the century, and subsisted as a medium of exchange after that.
Digital coins versus clam shells
Let's review how good digital coins and clam shells are doing through the various criteria that make a money 'good'.
Money is a medium of exchange
Money is supposed to be a medium of exchange. That is, you should be able to make transactions using the money in question.
Digital coins today are quite bad at this. The adoption rate is terrible and only slowly increasing. The transaction costs are very high, in particular in the case of Bitcoin, for which each transaction costs about $2.5 in fees.2. But the real cost is significantly larger, as new bitcoins are issued to reward the person (the computer) having solved the cryptographic problem and validated the transaction. Accounting for the dilution (the nominal money supply increases without real increase in value), the cost of each transaction is above $1003. The time needed to validate the transaction is long, more than an hour on average over the last 6 months4. In addition, it is not easy to use digital coins to make peer-to-peer transactions, which is why huge platforms have developed and serve as intermediaries - trusted third parties - to help users make transactions in digital coins.
Clam shells were quite good at this, and were better than the limited number of english coins that were available to the colonists in the XVIIth century in the Americas. They were widely used among the locals for a long time, and subsisted as a medium of exchange even after the Crown allowed official coins to be distributed to the colonists as payment for the goods they exported to Europe. Clam shells were gathered into necklaces and wampum, making them transportable and easier to count and physically exchange.
Money is a unit of account
Money is a unit of account, meaning it can be used to measure the value of the good (the price) and compare easily the value of that good with the value of other goods.
Digital coins vary very much on this issue. On one hand, the bitcoin is terrible at this because a single bitcoin has a large value, that is to buy a regular coffee you would use 0.0002BTC. Not quite easy to read with all those decimals, but we could definitively get over it, or simply use other notations to have that look like "2". A “satoshi” is the smallest division of a Bitcoin, and represents 0.00000001 Bitcoins. Now your coffee is worth 20,000 satoshis. A bigger issue is that a coffee of a similar value was worth 20% more a week ago. It was worth 30% less a month ago. It was worth 350% more last July. So, how much exactly is worth a coffee, or any good, as measured in Bitcoin? your answer will only be valid on the moment you look up its price.
Clam shells were doing OK on this side. There were no decimals, but prices could be expressed in a certain number of clam shells, and these prices could be compared easily, using understandable numbers (though probably large ones).
Money is a store of value
Money is a store of value, that is it has value in itself, and its value remains somewhat constant. This doesn't mean that the money has an intrinsic value, it means that society puts trust in the money, and will continue to trust that money tomorrow, so that the value of the money still exists tomorrow.
Once again, digital coins are awful in this respect. They display a crazy volatility basically unseen in financial markets. A single picture says it all:
Data from Sifr Data
What this means is that the standard deviation (or "volatility") of all the major digital coins is above 100% per year. In the case of Bitcoin, the volatility is tenfold that of the S&P500, an index tracking the value of the shares of the largest US companies. Equities are considered to be a risky asset (ie. volatile), so that says a lot about digital coins. They are not reserve of values, they are highly volatile and risky instruments.
Clam shells were good reserves of value. They are easy to store in the form of necklaces and other arrangements. They do not break easily and basically don’t age. It is likely that the total stock of clam shells has been relatively stable without dramatic increases, at least up until the arrival of the British colonists.
Which is the best money?
Obviously, with digital coins failing all three tests5, we should not expect it to be the winner in this contest. Clam shells were a much better money than digital coins. For one, they were actually used as a money. The colonists adopted it because it was more suitable than the other currencies available. It is very notable that the people, without pressure from a State or other authority, did adopt the most suitable money, when several opportunities were available. It might very well be the case that if Bitcoin or Ethereum or whichever other would-be currency was as good a currency as its proponents claim, then the people would adopt it.
A special note on the centralization.
The claim is often made that digital coins are decentralized systems and that they remove the need for third parties. But then, why are there third parties in the market? Coindesk, Kraken, Circle, Bitpay, and so many others... What are they? Who actually uses a wallet over which they alone actually exercise control and ownership, instead of having their bitcoins under custody at a third party? Who actually exchanges Bitcoin peer-to-peer and not through an intermediary, being a Broker or an exchange of some sort? The answer to all the previous question is: a marginal number of users of digital coins. Only technologists with a deep understanding of the technical aspects of digital coins and a strong philosophical belief that decentralization is good may do so.
To add insult to injury, it is not only the access to the use of the network that is intermediated: the contribution to the network and the composition of the network is itself strongly intermediated, with large pools of miners controlling inappropriate proportions of the computing power (hashrate) of the network. That is, miners, who try to solve the cryptographic problems in order to validate transactions can put their efforts together and gather in a "pool", who has a much larger chance of finding the solution than a single miner all by himself. The pool then retributes all of its miner, insuring a more stable level of income to them than if they were all by themselves. Once again, a picture is worth a thousand word to show the concentration of the hashrate:
Three pools of miners do control more than 51% of the computing power of the network, therefore opening the possibility of maliciously altering the blockchain by corrupting only three players of the network6. Some other digital coins have been hit by such attacks, for example feathercoin7. In addition, large players can do damage and acquire a significant nuisance power even without controlling 51% of the hashrate by denying the validation of transactions8. I hope you trust these third parties not to collude or abuse of their dominance position9.
I don't mind that third parties exist. I simply refute strongly the argument according to which digital coins are "decentralized" or "peer-to-peer" or any other such concepts. The ledger is distributed. Its setup was the doing of a small group, its management and access to it are today intermediated, and controlled by a handful of firms growing larger and larger. Satoshi Nakamoto did create the Bitcoin as a decentralized protocol10, however its use has been re-appropriated by service providers who act as third parties and intermediaries. You may think that it is good or bad, but the fact remains: all the digital coins are today used through intermediaries.
I agree that the current frequency of transaction, the distance between buyers and sellers and such other features of modern transactions do not allow Clam shells to be an appropriate currency today. However, they seem so ridiculous that nobody would argue that they were a better currency than the Pound and the then gold & silver coins, whereas they were actually working well as a currency. Today's argument about digital coins being currencies is wrong and fallacious.
- Nick Szabo, Shelling Out: The Origins of Money, 2002
- Data from https://bitcoinfees.info/
- See Matt Hurd, Curious Bitcoin Curiosities for a detailed analysis, or blockchain.info for statistics on the transaction costs.
- The median over the last 180 days is 71.5 minutes, according to data from Blockchain.info
- Economists such as Jon Danielsson seem to agree: Jon Danielsson, Cryptocurrencies don’t make sense
- For more details on 51% attacks, see this Stackexchange post or this wiki article from Ripple (a Bitcoin competitor).
- Coindesk, Feathercoin hit by massive attack
- Bitzuma, Bitcoin's End Game: The Benevolent Mining Monopoly?
- Which they could do to their benefit, as shown in this paper: Ittay Eyal and Emin Gün Sirer, Majority is not Enough: Bitcoin Mining is Vulnerable
- Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System