Summary
There are no features of the current monetary system that necessarily make it the final stop in the evolution of money. In that regard, cryptocurrencies, which exist in electronic form only, have come into use as a medium of exchange in recent years.
Moreover, the explosive growth in digital currencies, which did not even exist prior to 2009, is a testament to some of their qualities that make them a better medium of exchange than paper money. But one of the most notable drawbacks to some cryptocurrencies is their extreme price volatility. For example, the price of Bitcoin has dropped roughly 35% on balance since its peak in November, and daily changes of 10% are not uncommon. This volatility derives from the limited supply of many cryptocurrencies. Prices can fluctuate widely as demand shifts back and forth along an inelastic supply curve. Due to this high degree of price volatility, many cryptocurrencies are not good "stores of value," at least not over short periods of time. Furthermore, the limited supply of these digital currencies could potentially lead to price deflation of goods and services.
So, what does the future hold? For starters, digital currencies have established a firm foothold in the global financial system, and they are simply not going away, in our view. But we believe that cryptocurrencies with inelastic supplies and significant price volatility(e.g., Bitcoin and Ether) will play a limited role as a form of money. Money has three functions: it is a medium of exchange, a unit of account and a store of value. Digital currencies such as Bitcoin and Ether are currently being used as a medium of exchange, but only to a limited extent. Rather, the vast majority of transactions today continue to be made in national currencies (e.g., U.S. dollars, euros, etc.) Their use as a unit of account is also quite limited at present. That is, prices of most goods and services continue to be denominated in national currencies, not in terms of specific cryptocurrencies. We recently finished an 4-part series of reports on digital currencies, both public and private, and the future potential of Central Bank Digital Currencies (CBDCs). We gather all of the individual reports together in this compendium piece.
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