Bitcoin lacks the properties of a real currency says NYU's David Yermack
Bitcoin lacks the properties of a real currency says NYU's David Yermack.Reuters

Economists doubt bitcoin's effectiveness as a currency because the cryptocurrency lacks most of the features they value in a currency, according to New York University professor David Yermack.

Yermack, a professor at NYU Stern School of Business and director of the NYU Pollack Center for Law and Business, says money is supposed to serve as a medium of exchange, a unit of account, and as a store of value.

While bitcoin satisfies the first condition, given the growing number of merchants who accept it as payment, it performs poorly as a unit of account and as a store of value, Yermack writes in the MIT Technology Review.

"Bitcoin's extreme fluctuations undermine any useful function for it in these roles. During 2013 its volatility was three to four times higher than that of a typical stock, and its exchange rate with the dollar was about 10 times more volatile than those of the Euro, [the Japanese] yen, and other major currencies. Bitcoin's [US] dollar price exhibits no correlation with the dollar's exchange rates against other currencies. Nor does it correlate with the value of gold. With a currency whose value is so untethered, it is nearly impossible to hedge against risk."

"Bitcoin also lacks additional characteristics usually associated with currencies. It cannot be deposited in a bank; instead it must be held in "digital wallets" that have proved vulnerable to thieves and hackers. There is nothing comparable to the deposit insurance relied on by banking consumers. No lenders use bitcoins as the unit of account for consumer credit, auto loans, or mortgages, and no credit or debit cards are denominated in bitcoins," says Yermack.

"Even if volatility subsides and the currency finds a place in the world payments system, it has another fatal economic flaw. Only 21 million units can ever be issued, and a fixed money supply is incompatible with a growing economy. In a bitcoin-dominated economy, workers would have to accept pay cuts every year, and prices for goods would gradually fall. Such conditions might lead to public unrest reminiscent of the late 19th century's free-silver and populist movements—an ironic consequence of a currency known for its futuristic cachet," Yermack adds.

Bitcoin Round-Up

The cryptocurrency markets experienced a third day of relative calm on 19 February, while protests outside troubled bitcoin exchange Mt Gox struggled to gain momentum.

While users waited anxiously for Mt Gox to resume its bitcoin withdrawal service, the cryptocurrency saw a small 24-hour dip of 0.83% taking its value to $624 (£374) per coin.

Contrary to its volatile past, bitcoin is showing remarkable resilience during a difficult time for the currency, as Mt Gox fights to convince customers it holds all the coins it claims to have. The exchange would open its withdrawal service again soon - possibly later this week - but a run on its reserves is widely expected, as users scramble to get their bitcoins out of Gox, for fear of losing access to them again.

How Does The Bitcoin Economy Work?

Bitcoin Economy
Graphic explaining how the bitcoin economy works.Reuters