Everyone uses money in order to obtain services and goods they need. Throughout history, a broad spectrum of objects (such as precious metals, livestock, seeds, etc.) have been used as money. In the relatively recent past, however, paper money emerged as the most prevalent and preferred form of money. With the rise of the internet and advancements made in cryptography, we may be witnessing a crucial period in time when Bitcoin and various other digital currencies will start presenting a challenge to paper money dominance.

The Functions of Money

Every form of money has to tick three important boxes before it can be widely used in a society. It has to function as a store of value, since it has to retain value long enough to be practical for its users. If you earn 50 dollars today, you have a certain expectation that in a week, or even in a year, its purchasing power remains more or less the same. However, sooner or later, inflation erodes the value of a single unit of money, thus making fiat money a bad option for long-term saving.

All forms of money act as a unit of account. Money serves a role of a measuring device of value in economic transactions. This enables direct and transparent comparisons between different goods, services, assets, etc., in an economy, by comparing their prices in a certain currency.

The third trait is quite self-evident, but all forms of money have to function as a medium of exchange. Basically, money has to be accepted by enough people as a valid form of payment, so it can be exchanged for goods and services among sufficient number of participants in an economy to make it practical for everyday life.

No matter what we were using as a medium of exchange in the past, there were certain properties, which fundamentally sound money had to have before it could hope to be widely accepted in society. These properties are: durability, portability, divisibility, uniformity, acceptability, and (preferably) limited supply.

Bitcoin's Potential as a Universal Medium of Exchange and a Store of Value

BTC has pretty much all of the hallmarks of sound money. It is incredibly divisible as any single BTC can be divided down to eight decimal points, durable (barring any catastrophic events), sufficiently portable, and its uniformity is guaranteed by its design. With time, its acceptability will only increase as more people start to use it. BTC's limited supply of 21 million coins sets it apart from various fiat currencies, whose value has to be guaranteed by governments as they posses no inherent value, or finite volume.

Its disinflationary characteristic in conjunction with artificially set cap in supply make BTC a very appealing option for money, at least on paper.

The current volatility of BTC unfortunately hinders its ability to become a widely used medium of exchange, at least in the near-term future. Nobody wants to get paid with an asset that can drop in value as quickly as BTC can. On the other hand, nobody wants to spend an asset that could potentially increase its value as much as BTC did in the past to pay for their daily expenses. It is difficult to see how this trend could change adequately in the foreseeable future for BTC to become a serious competitor to fiat money.

Still, BTC could become a legitimate option for people looking for an alternative store of value, in the not too distant future. But first, its price fluctuations have to become much less extreme than they have been up to now. Nevertheless, for people looking to diversify their investments, it could soon become a staple in various private and institutional portfolios, next to traditional assets like gold, bonds and stocks. To some degree, this process is already underway, especially in developing countries, where monetary policies can be changed on a whim and inflation rates severely undermine the store of value function of local currencies.