Cryptocurrencies are digital alternatives to traditional government-issued paper monies. Given the current state of technology and skepticism regarding the future purchasing power of existing monies, why have they failed to gain widespread acceptance?

The author of this paper offers an explanation based on network effects and switching costs. In order to articulate the problem that agents considering cryptocurrencies face, the author employs a simple model developed by Dowd and Greenaway (1993). The model demonstrates that agents may fail to adopt an alternative currency when network effects and switching costs are present, even when all agents agree that the prevailing currency is inferior. The limited success of Bitcoin serves to illustrate.

After briefly surveying episodes of successful monetary transition, the writer concludes that cryptocurrencies like Bitcoin are unlikely to generate widespread acceptance in the absence of either significant monetary instability or government support.

The lesson to be drawn from this study is not necessarily that proponents of cryptocurrencies should give up—though they may be fighting a losing battle. Rather, it is an understanding of the fundamental problem with replacing an existing money. A successful
transition requires widespread coordination to overcome the network effects at play. Moreover, the costs of coordination are likely to increase as the pool of early adopters is exhausted. Whether their efforts will be successful in the long run remains to be seen—but there is certainly room for doubt.