By Robert MacGregor

“So, is Bitcoin actually money?”

It’s a fair question and, with the intense scrutiny directed at the “crypto-currency” of late, an increasingly common one. But the real question is not whether Bitcoin functions as money today, nor whether Bitcoins themselves are a good speculative investment. The real question – and the only important question when considering whether Bitcoin could be a viable alternative currency – is, “can Bitcoin ever function well enough as money to matter?”

And that answer, I fear, is no.

Whether something is “money” has nothing to do with the source of production, whether it’s issued by a government or a private company or spontaneously generated by a community, whether it’s minted or mined or printed or issued electronically.

Money is … well, money … to the degree to which it enables transactions, to the degree that you can use it to purchase things. No matter how efficient or liquid a market is, unless it can be used to purchase things, it’s not money; it’s a commodity.

By that measure, Bitcoin is unquestionably money.

It just happens to be terrible at it.

Where's the marketplace?

Even the most vocal supporter of the system acknowledges that the number of merchants accepting Bitcoins is miniscule and the number of large merchants embracing it is almost nil.

But is that unfair, or at least premature?

Perhaps it’s just a question of time, business development, marketing … of scale. One hears the term “critical mass” a great deal when this question is posed, the implication being that the ecosystem just needs enough merchants to buy in for Bitcoin to become useful as money and to become self-sustaining.

But it is not quite so simple.

To understand why, the system must first be viewed as a product: look to the value proposition versus existing payment options and then at the barriers to adoption. If the problems with Bitcoin as money are a lack of participants, Bitcoin must be viewed form the perspective of a merchant.

Consider the debate from the perspective of Tom Szkutak, Amazon.com’s CFO.

To accept credit cards, Amazon pays hundreds of millions of dollars in transaction fees and credit card fraud, in addition to the costs of related systems and personnel. While processing costs vary, typical rates for online merchants hover in the 2-3% range. At first blush, implementing Bitcoins as a payment option seems compelling – potentially eliminating entire categories of fraud and risk. From a payments risk perspective, it’s relatable to being paid cash over the counter on a worldwide scale.

So why aren’t large merchants like Amazon flocking to Bitcoin’s banner?

Liquidity

Companies like Amazon (AMZN) don’t pay staff or operational expenses in Bitcoin, so to accept them as payment they must be assured of the ability to convert Bitcoins to “real” currencies at will, in any amount, and at a predictable price.

However, Bitcoin liquidity is limited, the system itself guaranteeing that at some point total supply of Bitcoins will be capped at around 21 million.

Like a commodity, Bitcoin trades on exchanges and limited liquidity means that merchants cannot be comfortable that their large sell orders will be executed at a known or predictable price, or filled at all. Worse, in a transparent market with constrained liquidity, a sizable sell order has the potential to itself drive the Bitcoin price sharply downwards.

The very act of disposing of them may, in effect, devalue them.

And, if they cannot be sold at will, Amazon will be forced to sit on a large and unpredictable FX exposure until they can be flushed from the system. And that’s bad.

Legal Risk

I often hear that because the Bitcoin network is technically distributed and that there is no centralized authority to be targeted, it is beyond the effective reach of existing law enforcement and regulatory structures.

Of course, this is utter nonsense and deeply, dangerously naïve.

If a virtual currency is to grow beyond a technical curio and function as money, an infrastructure must exist to enable interaction between the existing banking and financial system and the virtual ecosystem. Participants in the virtual system must integrate with banks, payment processors, digital wallets and card networks, all of which are highly regulated. Banks are risk adverse - they are creatures of regulation and compliance and, ultimately, risk mitigation.

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