There’s an ongoing discussion about the role of Bitcoin that divides people into two camps: those who consider Bitcoin to be a currency and those who consider it to be an asset. The outcome of the discussion has an impact on its price, its correlation to the stock market (where other assets are traded) and government regulations. It is my view that although Bitcoin exhibits all the characteristics of a currency, it is mostly used like an asset (a risky one). But this role might change over time as Bitcoin will likely transition from being treated like an asset to being used like a currency. How do I know that? Because I witnessed the same transition of the US dollar in Venezuela.
The role of the US dollar in Venezuela
Venezuela has suffered from high inflation for many decades. In the “good old times” the inflation rate was around 30% per year and this was considered “normal”. People earned their salaries and bought everything they needed for their daily life using bolívares, the local currency. Even for expensive items like cars and real estate, sellers would accept bolívares.
Of course, with an inflation rate of 30% and similar depreciation of the currency compared to the US dollar, saving long term using local currency was a bad idea. For this purpose people resorted to exchanging their savings into US dollars and holding that currency instead. If you wanted to buy a car for example, you would put aside a percentage of your salary to exchange into US dollars every month. At some point you would have enough money saved in a “hard” currency that was immune to inflation (at least compared to Venezuela’s inflation level). At that point you might exchange your US dollars back to bolívares and purchase the vehicle. You save in US dollars but you transact in bolívares.
There was never doubt that the US dollar was a currency but people back then never really used it for purchasing goods and services as they didn’t want to depart from a hard asset that could appreciate over time. Sellers were also hesitant to receive payments in US dollar as it was illegal, people mostly had bigger bills ($20, $100) and they had no “change”, and in case of being fooled into accepting counterfeit money there was no one to complain about it as it was not the legal currency in circulation. The US dollar, a currency in its own right, was treated more like an asset than a currency. A hedge against inflation.
The analogy here is that in advanced economies like the US or Canada, Bitcoin is starting to assume the role that the US dollar had (and still has) in Venezuela, a hedge against inflation. If you live in the US or Canada you might think that this analogy doesn’t make sense as there’s no inflation (or very low) in either economy. In another article I proposed that there is in fact high inflation already in the economy that is impacting the stock market and real estate. This inflation has not yet affected the Consumer Price Index (CPI), the official measure of inflation.
But fair enough, if the average person is not suffering from inflation as measured by the CPI, the analogy doesn’t yet apply. My guess is that we are in phase previous to inflation and that the role of Bitcoin might soon change from “risky speculative asset” to “store of value” and the trigger for this transition could be either the rise in the CPI (inflation) or, more likely, a crash of the stock market.
The disconnection of the stock market from “reality”
If you have been following the news about the stock market recently, you’re probably aware of the GME saga where the stock price is reaching incredible heights, not because significant changes of the fundamentals of the company, but because of a massive short position that opened up the opportunity of a “gamma squeeze” from retails investors coming from the subreddit /wallstreetbets.
It’s not my goal to analyze who’s right and who’s wrong in this battle for the stock price but the fact is that the discussion around it is helping to uncover structural problems of the stock market caused by lack of regulation and overheating due excessive money printing from the FED. What seemed to be a contained problem to a single stock is causing a ripple effect in the whole stock market that might bring it down and this could usher the transition of Bitcoin from being a risky speculative asset to a store of value.
The correlation of Bitcoin with the stock market
Contrary to what the supporters of Bitcoin as a currency believe, Bitcoin has shown in recent times a correlation with the stock market as if it were an asset. The most recent example of this behaviour was seen in March 2020 when Bitcoin’s price collapsed as a consequence of the stock market crashing due to covid-19 lockdowns. Another example of Bitcoin behaving like a risky asset and not as a currency is its high volatility. You don’t often see the euro, the yuan or the canadian dollar exhibiting massive changes in reference to the US dollar.
This started to change in late 2020 when companies started to buy Bitcoin as a store of value with a long term vision. The arrival of these “institutional investors” brought not only a lot of cash pushing the price up but also more stability to the price as they tend to have a long term vision for their investments and are not easily scared with price fluctuations. Retail investors on the other hand are mostly treating Bitcoin as a speculative asset to make quick gains when the price raises.
This dichotomy of Bitcoin’s role might come to an end when the stock market crashes. As Bitcoin still shows correlation with the stock market, it is expected that it’s price will be affected as a result of a crash. Retail investors in Bitcoin that are more susceptible to these swings in price might sell most of their holdings in an effort to cut their losses. Institutional investors on the other hand might see this as an opportunity to buy more Bitcoin “at a discount”, completing the transformation of Bitcoin as a store of value.
Bitcoin’s transition to becoming a real currency
At this point in the story we can go back to the Venezuelan analogy as Bitcoin will have the status of a “store of value” similar to what the US dollar had in the venezuelan economy. From this point on we can try to predict Bitcoin’s evolution by looking at how the role of the US dollar changed over time in Venezuela.
To make a quick recap, in the good old days, people mostly saved in US dollars but transacted in bolívares. The US dollar was used as a store of value but not as a currency. After the price of oil collapsed and after years of corruption and mismanagement from politicians in power, the inflation rate started to climb even higher than before. Instead of the “normal” 30% inflation per year, we started to see 100% inflation. The most commonly used currency was still the bolívar as it was the currency by which people got paid and made most of their purchases like groceries. This time however, sellers of more expensive items like second hand cars or real estate started to “peg” the value of whatever they were selling to the US dollar. Even though it was illegal to transact in a currency different from the bolívar, it started to become the norm to require wire transfers in US dollars for such payments. This was the first step of the US dollar to start behaving like a currency in Venezuela.
Even with an extremely high inflation, most items could be still purchased with bolívares as it was inconvenient (lack of change, counterfeit) and risky (illegal) to make small payments with US dollars. This all changed when Venezuela moved from high inflation to hyperinflation. At this point most sellers, even the one selling cheap items, started to require people to pay with US dollars. Even the government was forced to ease the restrictions on transacting with a foreign currency given how quickly the bolívar was losing value, making it impractical to use it in the economy (high volatility).
In my opinion, this is the fate of Bitcoin. After a market crash the normal recipe for governments is to flood the market with new money in an attempt to stimulate the economy. This will lead to an increase of CPI and perceived inflation. Depending on how bad this inflation becomes it might force sellers to require a “harder” currency for payments like Bitcoin. As in Venezuela with the US dollar, paying with Bitcoin is still inconvenient due to the low throughput of the network and the high fees of transaction, but the need to use a hard currency will make layer 2 solutions like the Lightning Network the norm.
At that point, the transition of Bitcoin from a speculative asset, to a store of value and finally to a currency will be completed. History doesn’t repeat itself but it certainly rhymes.