*
For helpful comments I thank audience members at the 2013 annual meeting of the Southern Finance
Association and my colleague Roy Smith.
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Is Bitcoin a Real Currency?
David Yermack
*
Department of Finance
New York University Stern School of Business
December 1, 2013
Abstract: Motivated by Bitcoin’s rapid appreciation in recent weeks, I examine its
historical trading behavior to see whether it behaves like a traditional sovereign currency.
Bitcoin has exchange rate volatility an order of magnitude higher than the volatilities of
widely used currencies, undermining Bitcoin’s usefulness as a unit of account or a store
of value. Bitcoin’s daily exchange rates exhibit virtually zero correlation with bona fide
currencies, making Bitcoin useless for risk management purposes and exceedingly
difficult for its owners to hedge. Bitcoin also lacks access to a banking system with
deposit insurance, and it is not used to denominate consumer credit or loan contracts.
Bitcoin appears to behave more like a speculative investment than like a currency.
Late 2013 became an auspicious time for Bitcoin, a “virtual currency” launched five
years earlier by computer hobbyists. During the month of November 2013, the U.S. Dollar
exchange rate for one Bitcoin rose more than fivefold, and the value of one Bitcoin, which had
begun trading at less than five cents in 2010, exceeded $1,200.00. Two days of hearings were
held by the U.S. Senate Commitee on Homeland Security and Governmental Affairs, at which
government regulators testified that virtual, stateless currencies like Bitcoin had the potential to
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play useful roles in the commercial payment system. Stories appeared in the media about
travelers subsisting for lengthy periods by spending only Bitcoin, and various businesses –
including Richard Branson’s Virgin Galactic space travel startup – attracted publicity by
agreeing to accept Bitcoin as payment. With approximately 12 million Bitcoins circulating, the
worldwide value of the currency exceeded $14 billion, equal to the market capitalization of a
mid-range S&P500 company. Figure 1 shows the daily closing Dollar-Bitcoin exchange rate on
the Mt. Gox exchange, with the data plotted on a log scale necessitated by the meteoric rise in
Bitcoin’s value.
In this research note, I argue that Bitcoin does not behave like a currency at all. Instead it
resembles a speculative investment similar to the Internet stocks of the late 1990s.
Money is typically defined by economists as having three characteristics: it functions as a
medium of exchange, a unit of account, and a store of value. Bitcoin increasingly satisfies the
first of these three criteria, because a growing number of merchants, especially in online
markets, appear willing to accept it as a form of payment. However, I argue in the sections
below that Bitcoin performs poorly as a unit of account and as a store of value. The currency
exhibits very high time series volatility, which tends to undermine any useful role for Bitcoin as
a unit of account. A currency should have only negligible volatility in order to be a reliable store
of value. Bitcoin’s daily exchange rate with the U.S. Dollar has virtually zero correlation with
the Dollar’s exchange rates against other prominent currencies such as the Euro, Yen, Swiss
Franc, or British Pound. Therefore Bitcoin’s value is almost completely untethered to that of
other currencies, which makes its risk nearly impossible to hedge for businesses and customers
and renders it more or less useless as a tool for risk management.
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Bitcoin lacks additional characteristics that are usually associated with currencies in
modern economies. Bitcoin cannot be deposited in a bank, and instead it must be possessed
through a system of “digital wallets” that have proved vulnerable to hackers. No form of
insurance has been developed for owners of Bitcoin comparable to the deposit insurance relied
on consumers in most economies. No lenders use Bitcoin as the unit of account for standard
consumer finance credit, auto loans, and mortgages, and no credit or debit cards have been
denominated in Bitcoin. Bitcoin cannot be sold short, and financial derivatives such as forward
contracts and swaps that are routine for other currencies do not exist for Bitcoin. The absence of
these types of contracts seems to be the most straightforward explanation for the astronomical
rise in Bitcoin’s value in November 2013. Since currency investors have no easy way to bet
against Bitcoin’s appreciation, skeptics can only watch as optimists trade the currency among
themselves at ever-rising prices.
History and background of Bitcoin
Until the 20
th
century, most of the world’s successful currencies were convertible into
fixed amounts of gold or other precious metals. This promise of convertibility, secured by
sovereign inventories of gold such as the Fort Knox depository in the U.S., created public
confidence in a currency’s value. The gold standard collapsed in most economies between the
1920s and 1970s, partly due to the pressures of financing two World Wars, but also because
worldwide production of gold did not keep pace with economic growth. Since then, nearly every
major economy has issued paper fiat currency, the value of which relies on public belief that a
nation’s government or central bank will not increase the supply of new notes too rapidly.
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Multinational consortia have issued fiat currency like the Euro on similar terms. Fiat currencies
have circulated for thousands of years, and sooner or later nearly all of them have been inflated
down to worthlessness by governments confronted by strained public finances. Bitcoin attempts
to overcome the weaknesses of gold-based and fiat currencies, presenting itself as an
“algorithmic currency” with a deterministic supply and growth rate that are tied to the rigor of
mathematics. No government or other central authority can manipulate the supply of Bitcoin.
Instead the currency is governed by cryptographic rules that are enforced by transparent
computer code in a decentralized manner.
Bitcoin originated using a scheme oulined in Nakamoto (2008), a nine page proposal for
a “peer-to-peer electronic cash system.” The author or authors of this document have not been
identified, but their system was designed in a way that gave them no royalties or residual
property rights to benefit from Bitcoin’s adoption. According to the algorithms proposed by
“Nakamoto,” new Bitcoins are created and awarded to computer users who solve pre-specified
mathematical problems. A transparent, decentralized registry tracks the ownership and
subsequent transfers of every Bitcoin after it is “mined” by its initial owners. The algorithm
limits the rate at which new Bitcoins can be created, and it fixes an ultimate limit of 21 million
Bitcoins that will be reached in the year 2140. All of these quantities and growth rates are
known with certainty by the public, so Bitcoin’s circulation cannot be affected by monetary
policy in the way that the Federal Reserve controls the public supply of U.S. Dollars.
Wallace (2011) reviews the early history of Bitcoin and states that “Nakamoto”
introduced the first 50 Bitcoins into circulation in 2009, essentially to demonstrate the mining
method to online enthusiasts who were attracted to the concept of an algorithmic currency.
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Bitcoin’s circulation at first took place among online volunteers and enthusiasts, and interest
grew to the point that Bitcoin began to trade on a Japanese-based online exchange, Mt. Gox, in
July 2010. On the first day of trading, 20 Bitcoins changed hands at a price of 4.951 cents, for
total volume of slightly less than one U.S. Dollar.
The first purchase of goods and services using Bitcoin is said by Wells (2011) and other
sources to have been a pizza procured at a cost of 10,000 Bitcoin in 2009. The pizza parlor did
not accept Bitcoin directly, and instead a third-party broker was enlisted who agree to procure
the pizza using a credit card (based on a real currency) and accept Bitcoin as consideration.
Much of the commerce involving Bitcoin continues to take place using middlemen who facilitate
immediate exchanges of Bitcoin into more widely used currencies.
The Silk Road marketplace, an Internet portal for the sale of illegal narcotics which
accepted only Bitcoin for payment, was sometimes reported to account for as much as half of the
early Bitcoin transaction volume. This association helped give Bitcoin an early reputation for
lawlessness. The cachet as an outlaw currency may not have harmed the appeal of Bitcoin at all,
and its usage spread into the bricks-and-mortar economy. Silk Road was shuttered by U.S.
authorities after they arrested its operator in San Francisco in October 2013, but the event
generated publicity for Bitcoin and seemed to have little impact on Bitcoin’s value or trading
volume. Later that month, the first Bitcoin ATM was installed in a Vancouver coffee shop.
Trading of Bitcoin grew rapidly on the Mt. Gox exchange, and Figure 2 shows the daily
volume in U.S. Dollars, calculated by multiplying each day’s midnight exchange rate by the unit
volume over the prior 24 hours. Other online exchanges have opened to trade Bitcoin and
additional virtual currencies that sprang up as rivals. These exchanges generally operate around-
