Chapter 26's Case Study 2 applied the three-functions test to Bitcoin and found it a poor medium of exchange, a poor unit of account, and a volatile (though historically appreciating) store of value. This chapter goes deeper: what is crypto actually...
Learning Objectives
- Apply the three-functions-of-money test to Bitcoin and evaluate whether it qualifies as money.
- Distinguish Bitcoin from stablecoins from CBDCs and the design choices each makes.
- Explain the monetary theory implications of private money with historical examples.
- Evaluate two extreme claims about crypto (revolutionary vs. Ponzi) and articulate the nuanced reality.
In This Chapter
Chapter 37 — Cryptocurrency, Digital Currency, and the Future of Money
Chapter 26's Case Study 2 applied the three-functions test to Bitcoin and found it a poor medium of exchange, a poor unit of account, and a volatile (though historically appreciating) store of value. This chapter goes deeper: what is crypto actually for, what are the different varieties (Bitcoin, stablecoins, CBDCs), what can we learn from the history of private money, and what is the honest economic assessment?
37.1 Bitcoin as a monetary experiment
Bitcoin (2008/2009) was designed to be "peer-to-peer electronic cash" — a payment system that doesn't require banks or governments. It introduced the blockchain: a decentralized, public ledger that records every transaction without a central authority.
What Bitcoin does well: censorship-resistant payments (no government can block a Bitcoin transaction), pseudonymous transactions, cross-border transfers without intermediaries, and a fixed supply (21 million coins maximum — no central bank can inflate it).
What Bitcoin does poorly: medium of exchange (slow, expensive, volatile), unit of account (almost no one prices goods in BTC), and environmental cost (Bitcoin mining consumes as much electricity as a small country).
The honest assessment: Bitcoin is a speculative digital asset, not functional money. It has real uses (international remittances, censorship-resistant payments, speculative investment) but it has not replaced — and is unlikely to replace — fiat money for everyday transactions.
37.2 Stablecoins
Stablecoins are cryptocurrencies designed to maintain a stable value, usually pegged to the U.S. dollar. Two types:
Fiat-backed stablecoins (Tether/USDT, Circle/USDC): backed by reserves of actual dollars (or dollar-denominated assets). 1 USDT is supposed to be redeemable for $1. These function much better as money than Bitcoin (stable value, fast transfers, low cost) and are used heavily in crypto trading and in countries with failed banking systems.
Algorithmic stablecoins (TerraUSD/UST): maintained their peg through algorithms and arbitrage rather than reserves. TerraUSD collapsed in May 2022, losing its peg and wiping out $40 billion in value. The lesson: algorithmic stability is fragile.
37.3 Central Bank Digital Currencies (CBDCs)
Several central banks are developing or piloting digital currencies: China's e-CNY (digital yuan), the ECB's digital euro project, and smaller pilots in the Bahamas, Nigeria, and Jamaica.
What a CBDC is: digital money issued directly by the central bank, available to the public (not just to banks). Like cash, but digital. Like a bank deposit, but at the central bank.
Potential benefits: financial inclusion (unbanked people can access digital payments), faster/cheaper payments, better monetary-policy transmission, reduced reliance on private payment systems.
Potential risks: privacy concerns (the central bank can see every transaction), disintermediation of banks (if everyone holds CBDC instead of bank deposits, banks lose funding and lending capacity), and cybersecurity.
37.4 The history of private money
Crypto is not the first experiment with private money. The U.S. "free banking era" (1837–1864) saw hundreds of private banks issuing their own paper notes. Some notes were good (backed by adequate reserves); many were bad (backed by nothing, issued by fly-by-night "wildcat banks"). The notes traded at discounts that varied with the issuing bank's reputation and distance. The era was chaotic, prone to fraud, and was eventually replaced by a uniform national currency (the National Bank Act of 1863).
Friedrich Hayek (Denationalization of Money, 1976) proposed returning to private money competition, arguing that competition among currency issuers would produce better money than government monopoly. Crypto is, in some ways, the realization of Hayek's vision — though the outcome (extreme volatility, frequent fraud, speculative mania) is not quite what he envisioned.
37.5 The honest economic assessment
Crypto has demonstrated real innovations: programmable money (smart contracts), censorship-resistant payments, tokenization of assets, and decentralized finance (DeFi). These have genuine applications.
Crypto has also demonstrated real failures: extreme volatility, persistent association with fraud and criminal use, environmental cost (Bitcoin mining), multiple exchange collapses (FTX, 2022), and the Terra/Luna stablecoin collapse. The industry's track record of self-governance is poor.
The middle ground: crypto is a new asset class and a set of technologies, some of which will find lasting applications. It is not replacing fiat money. It is not a Ponzi scheme (the underlying technology is real). The regulatory framework is still being built, and the industry's long-run shape is uncertain.
Key terms recap: Bitcoin — the first cryptocurrency; decentralized, blockchain-based, limited supply, volatile stablecoin — crypto designed to maintain a $1 peg (fiat-backed or algorithmic) CBDC — central bank digital currency; digital money issued by the government free banking era — 1837–1864 U.S. period of private bank-issued money; chaotic Hayek — proposed competition among private currency issuers in 1976