The Cryptocurrency Volatility Conundrum

September 3, 2017

A common criticism leveled at cryptocurrencies—such as Bitcoin or Ethereum—is that they are very volatile. I think that this critique carries less bite than may seem at first sight.

 

For example, John Lewis at the Bank of England has recently compared the purchasing power of the US dollar (in the US) to that of the major cryptocurrencies:

The purchasing power of these cryptocurrencies jumps up and down a lot. The purchasing power of the US dollar, in contrast, is very stable.

 

But wait. The purchasing power of the US dollar is so stable in part because prices in the US are quoted in US dollars (“that will be 3 dollars”). If prices were quoted in Bitcoin (“your coffee is 0.00065 BTC”), the purchasing value of Bitcoin would be far, far more stable. In econ-speak, the US dollar, not Bitcoin, is the unit of account in the US.

 

If that seems confusing, consider a different question: Is the UK pound a good store of value? If you live in London, UK, the answer is clearly yes. (Thanks, in no small part, to the Bank of England for keeping inflation low and stable.) But if you find yourself in New York City, US, putting all of your wealth in pounds may prove risky when it is time to pay your rent, and your landlady asks for dollars.

 

Cryptocurrencies clearly have their issues. For example, it is not easy to create more Bitcoins in a financial crisis. Some see this as a feature, not a bug. The long history of financial crises suggests otherwise. But in any case, the purchasing power of cryptocurrencies would be much more stable if they became the unit of account.

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