Cryptocurrency volatility and the implications for emerging markets.

The cryptocurrency narrative has to date been dominated by tales of nefarious activity carried out on the dark web, and unpredictable price volatility, inevitably calling into question the sustainability of these alternative forms of money.

Comments made by JP Morgan CEO Jamie Dimon, amongst others, have further fuelled the fire, calling into question Bitcoin’s suitability as a currency. This has prompted an exploration of these assertions to determine whether they are indeed valid. Why? A cryptocurrency found to be unsuitable as money could not be utilised as regional or national money, which ought to be one of the most profound applications for cryptocurrencies in emerging markets. My investigations took me into the history of money and apart from revealing a general ignorance of what money is, it brought to the surface some interesting insights into the nature of Bitcoin and by association, the majority of cryptocurrencies in circulation today.

Where money comes from

Nineteenth-century authors like Karl Menger (1892), produced the seminal works surrounding the origins of money in which they argue that money has three functions, namely as a means of exchange, store of value and unit of account. My first stop along this journey was, therefore, to define these functions and then test whether Bitcoin fulfils these requirements.

...evidence from Zimbabwe and Venezuela has revealed a preference for Bitcoin in daily transactions...

I then tested for the currency’s relevance as commodity and fiat money.

Menger looks back to the days of bartering within a village for the utilisation of commodities as a means of exchange, arguing that goods most favoured in exchange, such as rice and corn, became socially accepted as money. It could be argued therefore that Bitcoin has been adopted by the Internet community in much the same way. Overlaying Google search trends for Bitcoin over the Bitcoin price graph seems to offer fairly conclusive evidence of the social construct upon which Bitcoin has been built, supporting the view that Bitcoin’s value is derived from our collective inter-subjective view of what its value should be. I know that I can accept Bitcoin as payment because I believe that I will be able to exchange the Bitcoin for something of equal value at a future time. Excessive payment delays and transaction fees have however recently undermined Bitcoin’s suitability as a means of exchange, but the same cannot be said of all cryptocurrencies. I would therefore argue that Bitcoin serves as a questionable means of exchange.

Returning to Menger’s tale, once the local market had been saturated, merchants needed to travel between villages in order to extend their markets. The time delays inherent in this form of trade meant that a merchant returning to his village with bushels of corn, would not want a local villager to have planted several hectares of corn, thereby undermining the value of his stock. Merchants would therefore seek out commodities with a greater ability to preserve value over time. This function of money became known as the store of value. Supporters of Bitcoin, claiming that the coins possess a store of value are misguided in this regard, as the risk associated with the coins losing value over time is substantial.

The third function of money, outlined by Menger, is known as the unit of account. This characteristic, which many economists argue to be the most fundamental feature of money; is the money of business. It is the money in which proposals and quotations are drafted and in which invoices are issued and payments received. It is the money in which stock is valued and accounts are drafted. Bitcoin, as a result of its volatility, could not be said to have use as a unit of account, as businesses would be unlikely to quote in a currency, the future value of which is highly uncertain. The lack of willingness to conduct business in Bitcoin has been evidenced by merchants such as Overstock, accepting Bitcoin as payment but that exchange the majority of these coins for local currency instantaneously, keeping only a small amount of Bitcoin in stock.

Other than for the fact that Bitcoin, much like many other forms of money, has been constructed and derives its value from social interactions and conventions, the story so far does not seem to be in support of Bitcoin as currency. The search for clarity was therefore extended to include the most prominent forms of money in use for the last two hundred years, namely commodity and fiat money and to ascertain whether any of the features of these currencies could be transferred to Bitcoin.

Gold and fiat

Commodity currencies were most evident during the gold standard era, which lasted until 1971. Although notes were utilised during this period, they were supported by the promise of redemption, in that they could be exchanged for the commodity used to back their value, e.g. gold or silver; and that the commodity itself had a use other than as a means of exchange, e.g. gold jewellery. A feature of commodity money is that the price in equilibrium, assuming competition exists in the supply of the commodity, will have a positive price equal to the marginal cost of production (Selgin, 2015), which had the effect of stabilising the price of the money. Comparing Bitcoin to this form of money is problematic. Bitcoin does not have an alternate utility other than as a means of exchange and the cost associated with the production of Bitcoin is far exceeded by the value of coins created during the same period.

Fiat money, unlike commodity money, has a price in equilibrium that is substantially greater than the marginal cost of production, as the cost associated with producing a note is significantly lower than its face value. The variance between the two is known as seigniorage and is cited by many as a drawback to the fiat monetary system, as issuers of currency are incentivised to issue currency so long as the face value is in excess of the cost of its production, which calls for monopoly over money issue, as well as high degrees of monetary and fiscal discipline on the part of governments and central banks. This is where central banks can take a feather out of the cap of Bitcoin, which embeds these rules in the construct of the system and in so doing replaces institutional trust with trust in the immutable algorithms built into the system.

Rules such as capping the issue of Bitcoin at 21 million coins, as well as the rate of coin issue as incentives to miners for block authentication, are maintained within the system’s code and, it may be argued, are reminiscent of Nobel Laureate and economist Douglass North’s institutional ‘rules of the game’. Any attempt to alter these rules would either require the consensus of the network or result in a technology ‘fork’, which results in the creation of a new coin, while the incumbent continues to operate, as highlighted by the recent creation of Bitcoin Cash.

The idea of embedding the monetary and institutional ‘rules of the game’ in the construct of a money system is an appealing notion and could have implications for nations where there has been a breakdown in political and financial institutional trust. The practicalities of achieving this aside, evidence from Zimbabwe and Venezuela has revealed a preference for Bitcoin in daily transactions, as the currency is seen as more stable. While these preferences are evident in the short run, it is unlikely that a cryptocurrency would be effective as a national currency in the long run without some degree of price stability. The question that remains: what factors can we attribute to the price of Bitcoin and how could they be stabilised?


Bitcoin’s scarcity is one of, if not the most, important drivers of Bitcoin price volatility. Think of the supply of Bitcoin as a ‘liquidity lake’. The rainfall in the area is low, but consistent, so the lake is increasing in volume at a constant rate, although this rate is far exceeded by the demand for the water, or Bitcoin. The top 1 000 holders of Bitcoin own half the lake and are not willing to give up their share in a hurry. Passive miners and other enthusiasts hold a significant portion in addition to this. A recent study showed that 73% of all Bitcoin accounts were dormant or had not transacted in the last year. This has the impact of reducing the supply of Bitcoin to little more than a ‘liquidity puddle’ over which buyers seeking to purchase the coins must contest.

Demand for cryptocurrencies, on the other hand, is driven by a multitude of factors including but not limited to technology changes, political turmoil, regulation and media attention. It must be noted that changes in these factors would typically impact any currency’s value, whether digital, commodity or fiat, however, the extent to which this seems to impact the relative exchange rate of Bitcoin is exponential. Therefore the scarcity of the currency appears to be largely responsible for the non-linear behaviour.

Nobel Laureate and political economist F.A. Hayek in his Denationalisation of Money: The argument refined (1976), provides some clues as to how this could be achieved, arguing that the competitive issue of currencies within a single economy, much like during the free banking era, would result in improved price stability and quality of money issue, as a result of competition. Issuers of currencies who failed to preserve the stability of their price would lose customers to issuers who succeeded in doing so. Hayek, however, argues that, in order for a first-mover advantage to be eliminated, that it will be necessary to introduce competing currencies simultaneously. While the horse has already bolted in the case of Bitcoin, it is not necessarily too late when considering the introduction of national currencies, particularly in emerging markets.

Many would argue that the current trend towards pegging cryptocurrencies to fiat currencies such as the US dollar will provide a more stable coin. I would argue though that these coins are acting in a manner that is contrary to the philosophy underlying the cryptocurrency ethos, by instead placing these currencies under the control of human-directed institutions.

It's about blockchain

In returning to the question posed at the beginning of this article which asked whether Bitcoin could be viewed as a currency, it could be argued that Bitcoin finds itself in a ‘Catch-22 situation’.

These technologies offer a glimpse of what future monetary regimes will look like...

Price stability seems unlikely without mass adoption, which in turn is unlikely to be achieved without the price stability merchants require in order to utilise Bitcoin as a unit of account. While I am not able to find much support for the hypothesis that Bitcoin is money, it does not mean that I am not hopeful that Bitcoin 2.0 and the blockchain technology upon which cryptocurrencies are built will succeed. These technologies offer a glimpse of what future monetary regimes will look like and at the very least have given us cause to reflect on our understanding of what money is.

In much the same way as Bitcoin emerged from the turmoil of the 2008 Global Financial Crisis and the proliferation of high-risk financial instruments and monetary policy decisions leading up to that point, the current complexity and volatility surrounding Bitcoin will give rise to the emergence of new, higher-level structures and behaviours that would be called money. Cryptocurrencies such as Bitcoin are currently being utilised in emerging markets to facilitate cross-border remittances at greatly reduced costs, while other coins look to provide digital wallets and payment mechanisms with a view towards stimulating financial inclusion in these markets. These social experiments will no doubt offer fertile ground for future academic research and offer new insights into the future of money.


Hayek, F.A. (1976), Denationalisation of money, London: Institute of Economic Affairs, pp. 20-35.

Menger, K. (1892), On the origin of money, The Economic Journal, 2(6), pp. 239-255.

Selgin, G. (2015), Synthetic commodity money, Journal of Financial Stability, 17, pp. 92-99.


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