Will Bitcoin Ever be Used as a Medium of Exchange?

The original Bitcoin whitepaper envisions the digital currency as a "peer to peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution".

Bitcoin is no longer the “new kid on the block” of money. In 2019 we saw the digital asset garner increasing support from governments, the general public and esteemed financial institutions. For many people, investing in Bitcoin is no longer a crazy gamble but a legitimate and lucrative use of money.

Bitcoin’s period of heavy accumulation is no doubt positioning the digital asset as a store of value, but critics argue that this deviates from its intended purpose as a functional medium of exchange.

Will Bitcoin ever be used as a medium of exchange?

Presently, most people who hold bitcoin or accept it as a cash balance only do so because they expect it to appreciate over time. Bitcoin’s attractive properties as a store of value mean that when merchants immediately sell their bitcoin, they decrease demand and contribute to market volatility and lack of liquidity. The more Bitcoin’s value appreciates, the deeper this circular trap becomes.

Bitcoin’s property as a medium of exchange heavily relies on three things:

1. Scalability
2. Liquidity
3. Adoption

Scalability

Visa is the largest international payment system, facilitating about 150 million transactions a day or 1,700 transactions per second. Bitcoin, on the other hand, has a transaction rate of about 4 transactions per second.

The Lightning Network is a second layer on the Bitcoin blockchain that may solve the scalability issue as it promises to conduct potentially millions of transactions per second. However, Lightning is still in its early stages of development. Until Bitcoin can compete on the scale of existing payment systems, its function as a medium of exchange will be severely limited.

Liquidity

Liquidity is the ability to buy or sell bitcoin at the fair market price. It requires easy convertibility to other asset classes and a sufficient number of buyers and sellers in the market.

Bitcoin’s price volatility is often attributed to a lack of liquidity. Financial Institutions like Bakkt and Fidelity may increase the number of investors who are exposed to the bitcoin market.

Over time, as more of these institutional investors come on board, Bitcoin should suffer fewer wild price swings and start to look like a more stable market.

Adoption

The number of Bitcoin users worldwide is on a steady rise. There are currently around 700,000 bitcoin wallets, although not all of them are unique. Adoption is being driven by increased public awareness as well as more user-friendly financial services aimed at crypto adoption.

The United States has the highest number of bitcoin ATMs (2616) while countries like South Korea allow people to top up their bitcoin wallets at convenience stores. These efforts increase the number of facilities that enable people to convert their fiat to bitcoin and back again.

Coinmap shows which merchants around the world accept Bitcoin:

Evolving as a store of value

Scalability, liquidity and adoption are all interlinked. While bitcoin has become a household name, it still faces some glaring limitations such as the inability to support chargeback, a term which refers to the demand by credit-card providers for retailers to reverse a transaction when it is fraudulent or disputed.

It is clear that Bitcoin first needs to establish itself as a solid store of value before it can become a functional medium of exchange. In other words, before people will want to use bitcoin for their everyday transactions, they need to want to be paid in Bitcoin and to hold bitcoin balances.

Bitcoin price action today is less driven by speculation than it was in 2017. As we move into a period of heavy accumulation, the factors necessary to turn Bitcoin into a functional medium of exchange may be a byproduct of market maturity. For now, it’s safe to say that buying your first bitcoin is a good place to start.