Is cryptocurrency or crypto considered money? Despite its trillion-dollar market capitalisation, they are not widely accepted yet, says DBS Group Research analyst Chang Wei Liang.
At its peak, there were 1.36 million active Bitcoin addresses, and 46 million wallets containing more than US$1 ($1.29), Chang, a foreign exchange (FX) and credit strategist, points out. However, this pales in comparison to our global population of 8.2 billion people, with a vast majority of these individuals having never used crypto before, he adds.
In his Sept 30 report, Chang dives deeper into crypto, how it came about, the challenges it faces and its future
The rise of crypto
Technological change and forces of digitisation have transformed the world of currencies, birthing a new kind of digital currency, known as cryptocurrencies.
Chang notes that while the computational features of cryptos are interesting, they have a much richer impact on social sciences as their nature evolves alongside society’s perceptions and acceptance of the use of digital currencies for payment, or as a digital representation of assets used in applications.
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The most famous example of crypto is Bitcoin, which was invented as an “electronic cash system” by its developer Satoshi Nakamoto in 2008.
Since then, other cryptocurrencies such as Ethereum and Tether have come about with the same idea of having a decentralised network and distributed database, although their operational modalities differ, says Chang.
“The computational features of cryptos are a fascinating subject, but cryptos have a far richer social science dimension,” he writes.
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“Their nature co-evolves with society’s perception and acceptance of them as digital money for payments, or as a digital representation of an asset used in applications,” he adds. “They are not mere abstract data entries on an immutable database (also known as the blockchain).”
Challenges to the adoption of crypto
That said, Chang expresses that cryptos face a unique challenge, beyond the difficulties in adopting new technology, as crypto does not fit the two traditional paradigms of money.
Firstly, metallism, which states that money must have intrinsic value. Secondly, chartalism, the idea that money is a creature of law used to satisfy tax obligations. “Cryptos are neither backed by physical commodities nor the taxation power of governments,” Chang notes.
Therefore, the analyst states that a paradigm for crypto must rely on a more foundational understanding of money as proposed by Aristotle: a social invention that addresses the challenges of direct barter and provides a means for facilitating trade and establishing value in the market.
“Money is then a co-ordination device of society that plays the roles of a medium of exchange and a measure of value,” Chang adds.
The relationship between money and institutions
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Money has continuously evolved from the ancient era to the present day, alongside the institutions that are created to manage it, Chang notes. Chang cites the shift from the use of money as a commodity in primitive societies to today’s currencies which are fiat in nature and supported by the authority and credibility of institutions.
Chang notes that throughout history, there are two clear trends. Firstly, money has progressively evolved to be increasingly abstract. Secondly, the level of trust required has increased in tandem with institutions that co-evolve with money.
“Trust is an unspoken but key tenet of modern monetary systems,” Chang notes.
According to Chang, crypto seeks to challenge this trend.
Cryptocurrency and trust
Chang notes that Bitcoin was designed as a digital currency without trust. Chang adds that not a single actor is trusted in the decentralised network, but by virtue of each actor’s pursuit of self-interest, their actions give rise to a trusted outcome – a digital ledger of ownership and transactions.
“The path for money without trust lies in the use of abstract mathematical logic,” Chang states. Bitcoin relies on mathematical logic for entries into its ledgers or blockchain, and if these entries are taken to imply ownership, they can be used as money as it is a medium of exchange and measure of value, Chang notes.
Chang says that while money based on gold relies on the consistent appeal of gold in current and future generations and money based on fiat relies on governmental authority, money secured on mathematical logic, such as Bitcoin, are pure abstractions that rely on nothing.
Chang notes that Bitcoin has become the standard of crypto for both developers and users. This brings about significant advantages via network effects and the widespread media coverage on Bitcoin has allowed it to attract developers as voluntary contributors, Chang adds.
According to Chang, the digital abstraction of Bitcoin and other cryptos have enabled the creation and development of new applications. Chang identifies cross-border money transfers, decentralised applications including smart contracts to gaming and non fungible tokens (NFTs), as some examples.
The volatility of Bitcoin
Despite the positives of Bitcoin, Chang recognises that the volatility of Bitcoin is high, even in comparison to other financial assets. Chang attributes this volatility to Bitcoin’s inelastic supply and uncertain prospects of adoption that depend on macroeconomic, political, regulatory and technological changes.
However, Chang notes that volatility is not an insurmountable challenge. Using fiat money as an example, Chang says that inflation can be volatile short term too, but there are strong expectations for it to converge towards a long-term value, supported by an inflation targeting policy regime.
Applying this to Bitcoin, Chang assesses the long-term predictability of Bitcoin by applying a variance ratio test, with the null hypothesis being the absence of a stationary component.
Following Lo and MacKinlay's paper in 1988, Chang tested the variance ratio of daily, weekly and monthly bitcoin returns aggregated over two, four and eight time periods from January 2012 to August 2024. Chang also compared the results with that of monthly returns for gold and monthly US personal consumption expenditure inflation.
The test results cannot reject the null hypothesis that Bitcoin follows a random walk, and the random walk hypothesis also applies to gold. Thus, Chang found that neither gold nor Bitcoin are a suitable replacement of the US dollar (USD) in being a unit of account or or numéraire for longer-term investment.
On the other hand, the test statistics for US personal consumption expenditures (PCE) inflation uniformly reject the random walk hypothesis at the 1% significance level. According to Chang, this shows that “a predictable component clearly exists in the value of the USD,” and “stablecoins, which are linked to the USD, thus have an important place in crypto-based transactions, even if they reify several issues of trust.”
The future of crypto
Chang notes that crypto has brought a fresh perspective to the concept of money, showing promise of a currency that operates without trust and based on logic and free market principles.
Chang admits that while they may not be perfectly suited for use as money presently, they have introduced decentralised digital payments and have the potential to deliver new applications given their abstract nature.
While crypto adoption has grown, it has not reached critical mass yet and its value as a digital asset could remain volatile given the uncertainty of adoption, Chang adds.
Ultimately, “the crypto story is one that is still being written and is one that is worth following.”
