Bitcoin, monetary systems, and legal tender: How they interact

Bitcoin, monetary systems, and legal tender: How they interact

A question frequently heard from Bitcoin newbies is whether the cryptocurrency is legal or not. It is an ambiguous question to begin with, but answering it is nearly impossible without getting into a lot of additional information. There is more to Bitcoin then its legal status. You have to consider monetary systems, what governments consider legal tender, and how cryptocurrency interacts with the larger financial system as a whole.

If you are new to the whole Bitcoin thing, you might be confused over what it is and how it works. This post will try to explain it in terms that are easy to understand. By the time you finish you should have a handle on the basics of Bitcoin, monetary systems, and legal tender. You should also understand how all three interact.

Bitcoin (and other cryptocurrencies)

As you read our basic description of Bitcoin, bear in mind that it applies to most other cryptocurrencies that have been designed as monetary systems. Bitcoin is not all that unique. In fact, there have been plenty of coins built on the Bitcoin code. Bitcoin Cash is a good example.

At any rate, Bitcoin is a combination of computer code and monetary policy. The easiest way to think of it is to look at Bitcoin as a software application designed to help people buy and sell things without having to use fiat. The software portion constitutes the computer code while the goal of facilitating financial transactions is the monetary policy.

What makes Bitcoin different in a practical sense is that there are no tangible bills or coins involved. What we call 'coins' are really just digital tokens represented by numbers in Bitcoin's blockchain ledger. Each coin is given a unique identifier when first released into the ecosystem. It is then tracked throughout the ecosystem whenever it changes hands.

Bitcoins work a lot like the fictitious coins you might spend in a video role-playing game. You can purchase them on an exchange or from a private seller, then spend them just like you would fiat. Or you can hold onto them as an investment.

Monetary systems

A monetary system is an established system of doing business by exchanging something of value for some form of money. You might sell a pair of shoes for US $25. In so doing, your shoes represent something of value that you are trading for tangible money. Thus, you have a monetary system.

The thing to understand is that monetary systems do not have to be fueled by minted coins and printed bills. Money can be anything that two parties agree on. If your entire town suddenly decided that kernels of corn would become the new local currency, you could make it work. The key is that you all agree to use corn kernels as money.

It should be easy with this definition to see how Bitcoin can function as a monetary system. Within the Bitcoin ecosystem, buyers and sellers agree to use their digital tokens as money. Now they can buy and sell by exchanging tokens just as if they were exchanging minted coins.

Legal tender

Thus far we have discussed the basics of Bitcoin and monetary systems. So far, so good. Now let us talk about legal tender. This is where the whole Bitcoin-as-money paradigm gets a bit fuzzy. For the record, there is no global jurisdiction we know of that recognizes Bitcoin as legal tender.

Legal tender is some form of money that a government recognizes as a tool for settling debts. UK residents know that the pound is legal tender within their countries. U.S. residents understand that the dollar is legal tender. In both cases, paying a debt with legal tender would settle it once and for all.

Let's say you live in the UK and you pay £500 to purchase a new laptop computer. You and the seller agree on that price, the transaction is completed, and you go your separate ways. The law now establishes that the laptop computer is yours. You own it free and clear. The pounds you gave to the seller legally transferred ownership of the laptop to you. The transaction cannot be undone unless both you and the seller agree to it.

You should know that in all but a small number of countries, only fiat is considered legal tender. There may be other legally allowed monetary systems for buying and selling, but those systems do not carry the weight of finality afforded by legal tender.

Buy that same laptop computer with points you earned on your credit card, and it may turn out that you don't own it after all. The buyer might seek to reclaim it if there is any problem with your credit card or the points attached to it. Indeed, the transaction doesn't become legally final until settlement is completed. That is when your credit card company actually pays for the company with fiat.

Bitcoin not legal tender

As you have probably figured out by now, Bitcoin is not legal tender. That is one of its downfalls in the eyes of fiat proponents. From their perspective, only fiat can be legal tender. Furthermore, only legal tender is valid for doing business. This explains why there is so much resistance to Bitcoin among central banks, payment processors, settlement networks, and so forth.

Their resistance is legitimate. It would be bad news for a settlement network to transact large sums in Bitcoin only to find out said coins have no value. Such a transaction would open the service up to a ton of liability. The same goes for central banks, payment processors, etc.

So, does this mean you cannot use Bitcoin to buy things? Absolutely not. While Bitcoin might not be legal tender, it is a monetary system. It is a monetary system that is legally allowed in many, many countries. Using it to buy things is no different than paying with a credit or debit card.

Bitcoin as a monetary system

You might not know that Bitcoin was originally developed as a monetary system a decade ago. Its creator never intended for it to be a security or store of value. Instead, he or she wanted a system that would allow for easy payments among people who are either underbanked or altogether unbanked.

It turns out that Bitcoin works very well as a monetary system. Anyone can buy bitcoins on the open market. Once bought, these can be used to buy things from any individual or merchant who agrees to accept them. Purchases can be made via payment processors or by directly transferring coins from the buyer's wallet to the seller's.

The system works by executing the computer code that defines Bitcoin as a piece of computer software. Again, let us say you purchase a pair of shoes in the UK from a seller in Germany. You would complete the checkout process as normal, selecting Bitcoin as your payment method.

Completing the checkout process would initiate a transfer of coins from your wallet to the seller's wallet. If the seller uses a payment processor rather than accepting Bitcoin directly, the payment processor's wallet would receive your coins. Your coins would be sent along with a private key.

The seller's wallet would also provide a private key to complete the transaction. Both wallets would have access to a public key as well. In the meantime, a record of the transaction would be sent across the Bitcoin network. All the computers on the network, known as nodes, would record the transaction and add it to the ledger. The nodes would be building blocks at the same time.

Once the transaction has been verified and added to the next block in the chain, it becomes immutable. In other words, it cannot be reversed. It becomes a permanent part of the blockchain for all time and eternity. You get your shoes, the merchant gets his money, and everyone is happy.

The best of both worlds

Knowing what we know about legal tender and monetary systems, it is easy to make the case that Bitcoin represents the best of both worlds. Perhaps that's one of the reasons it remains the dominant cryptocurrency. Buyers and sellers looking to get into the crypto game almost always start with Bitcoin and go from there.

Bitcoin offers the confidence and reliability that come with legal tender despite not actually being the same. That is good in the sense that you do not really need legal tender if two parties in the transaction agree to the value of Bitcoin as a means of exchange. Legal tender only has considerations in rare circumstances.

As a monetary system, Bitcoin shines brightly. It is a secure monetary system inasmuch as encryption and proof-of-work pretty much eliminate any risk of data breaches. It is safe in the sense that Bitcoin's built-in redundancy keeps the network alive even if a node fails or a corrupt copy of the blockchain is passed off as legitimate.

Now you know about Bitcoin, monetary systems, legal tender, and how they all interact. Hopefully you also have a new appreciation for what Bitcoin actually is. It is not fiat, but it is the next best thing.

Byline: This article was published by Henry.
About: I'm a bitcoin advocate and admin of Coinbet.com.