Ethereum as a Means of Trade

The Need for Financial Intermediaries

Whenever you make a digital payment, there needs to be other parties involved, called financial intermediaries. Both parties need to be represented here, even though they may share the same institution. If you make a payment, you are instructing your bank essentially to send money to the other party’s bank, and while the payment doesn’t clear for a couple of business days, the fact that it is already verified allows the transaction to proceed as if cash were exchanged.

This allows for the same efficiency for non-face to face exchanges of money as for face to face, like we would see with cash, and with digital payments, they actually happen faster, as there is no need to count money or make change.

Cybercurrencies like Ethereum claim to eliminate the need for financial intermediaries, and there are some people who may have a preference towards avoidance for various reasons, whether they be practical ones or just based upon a general distaste of large financial institutions.

Ethereum does allow for payments to be confirmed without the need of financial institutions, but it’s not that they don’t use third party verification, because it is necessary to verify transactions anytime a digital payment is made and someone has to do it.

What Ethereum and other digital currencies do is verify the transactions in the public ledger that is held in what is called the blockchain, which is a peer to peer network of computers around the world. Ethereum is essentially digitally coded and a public record of all transactions involving it is kept, which serves to verify that the transaction is a legitimate exchange of the currency.

How Ethereum Functions as Money

The actual currency that is involved with Ethereum is called Ether, where Ethereum itself refers to the platform and programming language that is behind the project.

Unlike other popular forms of cryptocurrency, Ether was never designed to be a common currency, to replace traditional currencies generally, it was designed to allow for a digital form of money to be exchanged in transactions involving the use of the Ethereum software.

Ether can be used to make payments like one would use Bitcoin for though, and it actually does so more efficiently, but not so efficiently that it will ever serve as a general replacement for national currency, at least with current technology.

Even though Ethereum’s superior platform does allow for transactions to be verified more quickly than Bitcoin for instance, which is already infamous for its long transaction times, sometimes taking an hour or two to verify by the blockchain, the nature of the blockchain requires much longer verification periods than is often practical.

Imagine being at a store and using a cybercurrency to purchase something and then be told that it will take even a few minutes for your payment to go through. This just isn’t going to work in that setting. In some settings, that might be more practical, for instance with some online purchases, where there is no queue that is going to develop and neither you nor the merchant may not be in any particular hurry to verify the transaction, but people still may want to avoid this inconvenience by using an immediate method such as a credit card.

The best that cybercurrencies like Ethereum can aspire to as far as being an alternative currency is to serve as a niche for certain transactions that parties deem it suitable for and where the preference for the cybercurrency in some sense exceeds any inconvenience.

Ironically, Cybercurrencies Involve Even More Third Party Involvement

With this all being the case, what ends up happening with Ethereum and other cybercurrencies is that in their effort to circumvent third party institutions, and perhaps third party transaction fees, the practical use of these digital currencies end up requiring even more third party involvement and even higher fees paid as a general rule.

In order for blockchain based currency to function efficiently, or any currency to, transactions must be kept within the blockchain, meaning that one needs to be able to shift or substantially shift their money over to it, without having to go back and forth between currencies.

For instance, you would get paid in Ethereum we’ll say, and then spend your Ethereum, the same way we do with non-digital currencies. This way, your money would stay in the blockchain and avoid transactional costs outside of it.

It’s not that there aren’t any costs involved in this, or the need for others to verify your transactions, but at least this way you wouldn’t be paying conversion costs or requiring exchanges to convert your money from Ethereum or whatever to dollars or whatever.

Instead, what people end up doing, out of necessity, is converting their cybercurrency, to other cybercurrencies or to other currencies, and this is necessary to both acquire the cybercurrency like Ether and for the most part to spend it as well, as hardly anyone accepts Ether for payment.

Each time you do this, you end up paying a spread, and this really isn’t any different than converting dollars to another country’s currency, where the intermediary performing the exchange will charge a spread, buying it for one price and selling it at a higher price.

They have to do this in order to profit from the transaction, otherwise they wouldn’t be in business, and you can’t convert any currency without paying a spread. The huge foreign exchange market allows people to exchange popular currencies with tight spreads, and therefore you may think that digital currencies would have similar efficiency, providing spreads more like forex rates than retail bank rates, who have much larger spreads, but the spreads involved with digital currencies aren’t really that narrow.

This has only been made worse by the rash of speculation in Ethereum and other currencies, which has widened the gap between the buy and sell rates, due to speculators being more willing to pay bigger spreads. The percent or two that you pay with these spreads may not seem to be that much, but each time you convert, you pay it, and this does represent a meaningful cost of transacting.

Keeping your money in a single currency will only involve conversion fees if you are doing a transaction in another currency, which means international transactions essentially, but when you’re moving money from your currency to a digital currency, to another currency, back to your own currency, and so on, this can involve some serious costs.

The Real Reason Ethereum Has Become So Popular

In theory at least, digital currencies can provide more efficiency than traditional currencies, but this is going to require, at a minimum, that digital currencies be more useful, so that less conversion is needed. The sheer nature of Ethereum and other cybercurrencies are not such that this would be even practical at present, and may never be.

In spite of this, Ethereum has seen phenomenal growth in its market capitalization since its inception, but very little of this has been driven by its popularity or usefulness as a currency, or even its usefulness as a platform for the smart contracts that it was designed for.

Ethereum has attracted a lot of interest as a commodity though, and functions a lot like digital gold, where people have bought it in order to speculate on its future value, just like many people have done with gold and other precious metals, and just about every financial instrument as well.

As the value of Ethereum simply exploded under this speculative pressure, this created a lot of momentum, as well as a huge amount of volatility. This volatility may be the delight of many speculators, but this is the worst quality a currency can have, as far as how this impacts its role as a currency anyway.

Aside from any other concerns about the viability of Ether as a currency, its current instability, and massive instability compared to traditional currencies, will need to be resolved. Speculators may be willing to tolerate the large fluctuations in its value that we have seen lately, but events such as a currency losing a large percentage of its value in a couple of days, as we recently saw, does not serve to make a lot of people comfortable with holding it.

In a nutshell, currencies require stability to function well, the opposite of what we are seeing these days with Ether and other cybercurrencies. This is just one of the challenges facing Ethereum, although given that it was never designed to serve as a general purpose currency anyway, this might not matter much.