In a prior post I noted one major obstacle to cryptocurrencies being widely accepted as a “medium of exchange,” which is a key characteristic of “money.” The “price” of most cryptocurrencies relative to the U.S. dollar continues to fluctuate more widely on a daily and weekly basis that most traditional “risky” investments. This is a problem handled for millennia by the historically-reviled profession of the “money-changers,” as we will later see, complete with a Bible story.
But it gets more complicated than that, which I again confronted while trying to book a European vacation after two Covid-isolated years. Twenty years after leaving the U.K, I still have a bank account denominated in British Pounds Sterling (“GBP” in a later chart). In some circumstances, whether you choose to pay with pounds or dollars for hotels, airfare, and other trip essentials, the difference in price is often noticeably more than a simple exchange rate conversion. The “real price” in one currency may be significantly more than the other, and that difference can easily flip in either direction.
And this issue is not just for British pounds versus U.S. dollars. If any cryptocurrency wants to be seen as, well, currency, it is helpful to think of it as “a different country,” like Britain or Canada. Money is a choice-counting system, with a different number base for every nation with a sovereign currency. And Bitcoin seeks to be its own choice-counting system.
Pricing in Bitcoin, or any other cryptocurrency, has more complexity to it than the typical crypto owner can see from the surface. As cryptocurrencies become more common, then these pricing issues will also become much more apparent. Because we have been here before with another “new” currency.
The model: Introducing the Euro as a business-to-business currency
One of the key tasks handed to me in 2000, when I moved into my employer’s British group of publishing companies, was to coordinate the expansion of all critical accounting and business systems to work transparently in the then-new Euro currency. While it was not yet in consumer hands, and even though the U.K. did not intend to adopt the Euro as a primary currency, companies throughout the European Union could open accounts denominated in Euros in 2000 and “do business” with other firms set up to accept the currency. Many British firms were eager to do so, as it simplified greatly doing business with the Continent.
Fortunately, most of our British information systems, unlike the U.S. systems that I had dealt with for many years, were already capable of trading in French Francs or German Deutschmarks (as well as U.S. Dollars), and those old European Union currencies were now on their way out of circulation within a couple of years, to be replaced by the Euro. It turns out, however, that the systems issue goes far beyond simply looking up the exchange rate of the day for a particular currency. Companies in negotiation with each other for large purchases want to know the price at the point of delivery or the point of payment, which may be well down the road, when exchange rates could be significantly different.
And so, any multinational computer system worth its salt needs to handle at least four different pricing “schemes” (as the Brits would say) depending on the type of goods and the nature of the customer relationship. The (expensive) German software product SAP rose to the top of the international heap for many major multinational companies because it was designed from the ground up to flexibly accommodate the many currencies of a pre-Euro world. Most American software has yet to catch up, and my British company had its own patchwork of proprietary systems.
My point is that Bitcoin, Ethereum, and the other cryptos are like the Euro here, but more so, because of their higher “exchange rate risk.” Every company that seeks to trade in one or more cryptocurrencies will be forced to make some critical pricing decisions, just like the Euro countries do daily in dealing with the U.S. or Britain. Mistakes on the monetary exchange part of the deal can be very costly. Here are the four pricing schemes I had to work with:
Model #1 – “The American Way”
When I was teaching international finance in Iowa, an Argentine student summed up the exchange rate problem in a very insightful way:
“When Americans purchase oil anywhere around the world, they pay in U.S. dollars. When my country wants to buy oil, we first must buy dollars, and then we can buy oil.”
Americans are so used to being the world’s reserve currency that most U.S. business accounting systems can only accept payment directly in dollars. In America the purchaser almost always assumes the exchange rate risk. If you made a deal in rubles in January and need to pay in dollars this month after the Ukrainian invasion, too bad, so sad. Your cost just went up a lot.
In short, most American companies deal with the exchange rate problem by simply pricing in U.S. dollars only. Like my Argentine student, if you want to buy a U.S. product, you, the customer, take on all of the exchange rate risk; you purchase the dollars, and then pay the American company for the product. You may pay through an international money exchange, and you pay their often-high extra fee, just as you do when you hit an international airport with no local cash.
Smaller British firms might also apply this technique, accepting payment only in pounds, but quickly this becomes impractical as your company grows. The big cryptocurrency problem in becoming a medium for daily exchange is that, especially in America, most companies will load the exchange rate risk completely on the crypto holder. You first convert your bitcoins to dollars, then pay me. You well may be the “ruble holder” and take a bit hit, or the next week you might score a great bargain if the exchange rate continues to swing wildly, but you, the purchaser, hold the risk alone.
Model #2 – The floating exchange rate
The internet is great for this. I can get the spot exchange rate for just about any worldwide currency at least for the close of business yesterday, and maybe even by the minute. If my company holds bank accounts in multiple currencies, I can simply apply the math in either direction in my computer system and we are done. Note that the two columns in the chart below are reciprocals of each other; the exchange can go in either direction.
Seems simple enough. But what if we are negotiating for a future purchase or delivery? Does today’s rate apply, or instead the date of the delivery, or the date of the movement of the money? For big international purchases, this timing can be a big deal, and it needs to be carefully spelled out in purchase contracts. And for cryptocurrencies, as that first chart demonstrates, the value over time can be radically different. Which party will bear that risk? It depends on the terms and timing of the deal.
Model #3 – Pegged exchange rates
For trading partners on fairly equal footing, a common answer to this dilemma is to “peg” an exchange rate as part of the contract or a long-term customer relationship agreement. Our contract might state something like “For all deliveries in March of 2022, the exchange rate shall be fixed for accounting purposes at 1.094 dollars per euro.”
Pretty simple. Except that all accounting systems need to be adapted for someone plugging in the correct rate at the correct time. This pricing would only work for major cryptocurrency purchases because it requires a risk-sharing agreement ahead of time, and it requires the information systems to support it.
A common way for that pegged price to be set, especially on deals out several months, is to peg to the current “futures” price. Futures (and options on futures) are basically broad market “hedge bets” on the direction of, in this case, future exchange rates. I can easily get a rate from the internet for locking in a September price in Euros, for instance, for a purchase with a September delivery. The odds of the actual rate being either higher or lower, come September, than the price of the bet come out to be very close to 50-50 odds in an efficient futures market. Therefore, this is about as close to a “shared risk” between the two parties of the transaction as you could get.
There is a growing futures market for Bitcoin and other cryptocurrencies, so this approach increasingly becomes an option. It is a very risky market, however, and can be riskier than Bitcoin pricing itself. My British company made large funds transfers to their Canadian parent company on a regularly-scheduled basis, and we always bought some Canadian dollar futures contracts for those dates in order to better budget cash outflows and to sleep more soundly at night.
Model #4 – Local pricing
You may have noticed on the back covers of some books two printed prices, one in U.S. dollars and one in Canadian dollars. This is an example of local pricing, and it happens when the seller is required by market forces to bear nearly all of the exchange rate risk.
Especially when exported products must compete on the shelf with local products for market share, the “exchange rate price” becomes irrelevant. Local distributors find that they have to set and adjust prices to local conditions regardless of changes in exchange rates if they are to sell any products at all. They either eat the losses or reap the gains of exchange rate movements.
This also, by the way, is the source of the vacationer’s conundrum, if you can select from two currencies in which to pay. Hotel prices, for instance, often have a local factor, where it might be advantageous to pay with, say, a Barclays Bank debit card instead of your dollar-denominated Visa card. At the minimum you likely escape an extra card fee charged for moving the money.
We have yet to see many tangible products being “locally priced” in Bitcoin exchanges, except maybe for illegal drugs where there are multiple competing vendors on the “Dark Web. Ethereum and Dogecoin have gained popularity in game purchases. For any product that has an alternative purchase medium in the conventional currency world, however, the wide value swings of cryptocurrencies are not conducive to “local” crypto pricing.
The myth of the first crypto commercial transaction
In his excellent new book Money: the True Story of a Made-up Thing (Hachette, 2022), Jacob Goldstein passes on the “founding myth” of the first commercial Bitcoin transaction in 2010. Laszlo Hanyecz, an early crypto proponent living in Florida, proposed “to the internet” to purchase two pizzas for 10,000 bitcoins (worth about a third of a cent each at that time, but today worth in total around $400 million). A nineteen-year-old in California called a pizza place near Lazlo’s home and put two pizzas on his personal charge card, for delivery to Laslo.
The reason I call this a myth is because the kid in California was acting not really as a vendor, but in the classic role of the money exchange desk at the airport. He took in one currency (Bitcoin), dispensed another (dollars) at some implied “conversion rate,” and personally bore the exchange rate risk, hopefully reaping the benefits if he had hung onto the Bitcoin.
If you exchange a foreign currency with a good credit card, say buying something in Euros while you are visiting Europe, you will likely pay at least a 3% currency exchange fee, with your bank acting as the money-changer. At the airport, you can easily pay 8% or more in fees, and on the street in London, expect up to a 15% hit on your money.
Crypto money-changing is a growth business. The language of money conversion in the crypto world can be confusing, with terms such as “gas” in the Ethereum world, “maker fees, “taker fees” and differing charges based on volume. ATM and debit card fees can be large relative to the amount of the withdrawal. Somebody needs to earn money to cover the transaction costs, and you are the likely fee-payer in either direction. Coinbase, one of the biggest Bitcoin ATM machine operators and wallet holders, has recently seen their stock price roll down a severe downward slide. At any rate, assume that any conversions will cost at least what you would pay to go into a different conventional currency.
Note that the role and reputation of the “money changers” are largely unchanged since the time of Jesus. It was a dangerous business then, even pissing off Jesus, and it still is in the cryptocurrency world, where exchanges have been major sources of fraud and theft.
“The Passover of the Jews was near, and Jesus went up to Jerusalem. In the temple he found people selling cattle, sheep, and doves, and the money changers seated at their tables. Making a whip of cords, he drove all of them out of the temple, both the sheep and the cattle. He also poured out the coins of the money changers and overturned their tables. He told those who were selling the doves, ‘Take these things out of here! Stop making my Father’s house a marketplace!'” — (John 2:13-16 NRSV)
Note that this post has been updated to reflect current cryptocurrency conversion conditions as of May, 2022.