The big financial institutions have been pretty hostile to the crypto-currency craze, but Goldman Sachs (GS - Get Report) put out a note Wednesday where it outlines the pros and cons of the potential adoption of bitcoin as a widely accepted currency.
Goldman's note suggests that there is some confusion at the center of the bitcoin debate about what the purpose of money is. Money is "simply a device that facilitates transactions in a market economy. The confusion arises because the physical properties of money are practically arbitrary. Instead, the value of money derives from its usefulness. Therefore, digital currencies like Bitcoin could prove to have value, if they can demonstrate their usefulness relative to existing forms of money."
An argument against cryptocurrencies outlined in the note is that the digital currency can seem like a solution in search of a problem. Consumer price inflation has averaged 2.1% over the past 30 years, and while there have been hiccups, most notably the financial crisis of 2008, the currency itself wasn't the underlying cause of the near meltdown.
An argument for the digital currency laid out by Goldman is that new currencies have been introduced on an international scale and have succeeded. A recent example is the euro, which was introduced in 1999 as a unit of transaction between the 14 members of the European Union. Since then the currency has spread to 19 countries and is currently the second most common currency held in foreign exchange reserves.
The motivations for increased demand of crypto adoption can be traced to dissatisfaction with current monetary systems. Goldman sees demand for bitcoin being especially high in countries whose monetary systems are faltering or who have tight capital controls.
The attributes that make cryptocurrencies attractive as alternative stores of value also make them subject to increased government scrutiny. "In particular, the anonymity of many cryptocurrencies makes them a useful medium of exchange for criminal activities, including tax avoidance and the circumvention of capital controls," Goldman's note said.
The note points out that while cryptos currently have high returns, they should have low expected returns over the long-term as returns should be pegged to growth in global real output -- a number that is expected to be in the low single digits.
"So could Bitcoin succeed as a form of money? In theory, yes, if it proves to be more useful than the alternatives-in terms of facilitating transactions at a lower cost and/or providing better risk-adjusted returns for portfolios. In practice, however, these gains look small, at least in developed market economies," Goldman concluded.
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