The scope of this paper shall be limited to the analysis of the position of Bitcoin in our current and future financial economy. The blockchain technology on which the digital currency is based is truly revolutionary and will bring disruptive change to multiple industries in the years to come. However, for the purposes of this discussion the reader needs to only be aware of only one and possibly the most important use of this technology: The ability to make completely anonymous, encrypted and safe transactions amongst two users without the involvement of any third party. This makes the currency free from any government control, tracking and regulation and thus sets forth the possibility of it being able to change the current order of the financial world.
Bitcoin is currently the world’s largest digital currency, or ‘cryptocurrency’, with a market capitalisation over 350 billion US dollars and with one unit (BTC) of the currency trading at around 19000 US dollars as of the 14th of December, 2020. Besides bitcoin there exist a number of alternative coins, or ‘altcoins’, such as Ethereum, Ripple XRP, Litecoin and so on which utilise a form of the blockchain technology in their own way. Bitcoin is by far the most popular cryptocurrency and can thus serve as a viable proxy for the future of this new asset class.
It would be disastrously wrong to compare bitcoin as an asset to something like equities, bonds and real estate. Although, the currency serves as every speculator’s day dream with volatile prices and astronomical returns the norm rather than the exception, the very fact that bitcoin, unlike a stock or bond can be used as a global means of exchange to conduct transactions, significantly differentiates it from these asset classes. Essentially, bitcoin is not just another investment vehicle but rather a hybrid asset which has intrinsic value while also serving as a means of conducting payments for goods, services and even other assets. The intrinsic value of bitcoin is derived from the underlying blockchain technology upon which it is based and the market value is a bet on the future of how the currency will be treated by various governments, banks and institutions, and whether if crypto will be the future of payments. Therefore, the only feasible comparisons that can be made with bitcoin are those of Gold and the US Dollar.
The US dollar’s intrinsic value stems from the fact that is the reserve currency of the world. All global trade, commerce and finance are conducted using the greenback and just like any other fiat currency it serves as a means of exchange, its supply being regulated and controlled by the Federal Reserve. Similarly, gold is a precious metal or a commodity and has served as an acceptable means of exchange throughout the course of human history.
In this paper we shall aim to formalise the discussion of whether bitcoin can take on the heavyweight status of Gold and the U.S Dollar by trying to understand the answer to two questions:
- What are some of the defining characteristics that separate bitcoin from gold and the dollar?
- Is it feasible to assume that bitcoin maybe accepted by Central Banks, Governments and major financial institutions who currently enjoy a monopoly over the issuance, control, regulation and distribution of our current money supply?
A comparative analysis of Bitcoin, Gold and the US Dollar:
The US Dollar is the most important currency of any sovereign nation on the planet. Debt denominated in dollars, or US Government securities, are generally considered to be a ‘risk-free’ asset, with the market pricing in the possibility of a US government bankruptcy to be nearly impossible. This makes the currency the most liquid asset on the planet. To understand why the dollar is so important to world finance and how bitcoin can threaten its status, it is pertinent to broaden our understanding of the concept of money itself.
The textbook definition of money is as follows: “Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context.”
Money, fundamentally, is nothing but a piece of technology and a depreciating asset. Money has no technical intrinsic value as it cannot be used to produce anything productive and cannot alone generate future income even if it is hoarded due to the forces of inflation in an economy. The cash or fiat currency system which is the bedrock of our current global economy is nothing but a simple commonsense evolution of various economic agents and institutions trying to find better ways to conduct and finance trade and commerce and for governments to collect taxes from its citizens over the course of time. The evolution dates back to the ancient barter system and the use of precious metals for trade all the way to the final form of the fiat currency which became the norm after the 1971 collapse of the gold standard or the representative money system. Representative money being the system under which the cash in your pocket is exchangeable for an asset such as gold or silver.
The sole reason as to why the only way for us to purchase goods and services or to conduct any kind of business transactions is through money “printed” by the Central Bank of our country is simply because the Government demands it to be that way. The Government cements this demand by ensuring that the only way for any citizen to pay taxes in a country is through the domestic currency of the nation, failure to do so resulting in some quality time spent in jail. The government can enforce such demands because it has an army and a police force with guns, while the citizens do not. This system may sound draconian and dreadful to live in but is evidently the best economic innovation of the past 100 years and has fueled the massive growth and development of our modern economy.
These characteristics of traditional currencies, or US dollars which we are analyzing for this discussion, highlights the all-important fact that the value of a currency is dictated by first and foremost the stability of the government regulating that currency and of the ability of the central bank to curb inflation, prevent deflation and maintain price stability. Since the United States is the largest and the most dominant economy of our world today, it enjoys the status of being the reserve currency of the World. Post World War Two, it was the United States which took charge as the global military and economic superpower. The stability of its government coupled with its dominant industry and economy made the dollar the most sought-after currency—with more than half of the dollars being used outside the country and with a staggering 65 countries pegging their own domestic currency to the dollar to maintain the stability of their currencies.
The inherent flaws of the fiat currency system are quite simple to identify and analyze:
- If the government of a country fails or is destabilized due to any socio-political reasons, the currency suffers.
- If the economy becomes unproductive and the country slips into economic recession/depression, the currency suffers.
- If the country fails to pay back its foreign debt obligations, or worse defaults on its domestic debt, the currency suffers.
- Finally, and perhaps the most common reason as to why currencies tend to lose their value is the scale at which their supply is increased by the central bank through printing, excess of which causes inflation or in some cases even hyperinflation.
The reason for the surge of the value of bitcoin to record levels over the course of this year can be largely attributed to gloomy possibility that the trillions of dollars that were printed to stimulate the economy due to the Corona Virus lockdowns will eventually lead to massive inflation. The federal reserve has been on a spending spree ever since the great recession of 2008. Massive amounts of Quantitative Easing— Quantitative easing is a monetary policy whereby a central bank purchases at scale government bonds or other financial assets, largely from banks, in order to inject money into the economy to expand economic activity—operations along with regular interest cuts were conducted to restore faith back into the financial markets. This set the US debt to a staggering 22 trillion dollars pre covid-19. With interest rates already at very low levels across the world and QE operations becoming a regular tactic, the only option left in the Fed’s arsenal was to adopt direct debt monetization to fund the fiscal spending necessary to stimulate the economy. This printing has now further caused the debt to expand to 27 trillion dollars as of October, 2020.
The solution to the inflation conundrum has usually been to divest from cash to gold in times of crises. Gold has largely been considered to be a classic ‘inflation hedge’ and is the go-to asset class for investors in times of economic recessions such as the financial crisis of 2008. However, gold is extremely expensive to store and is not portable enough to be a viable means of exchange and payments for our modern economy. The supply of gold is actually unknown. With new innovations in mining technology and the possibility of further gold exploration in ocean floors and space (yes, it is actually quite plausible that gold and other precious metals maybe mined from asteroids and other planets in the future), the precious metal may not be as scarce as they seem to be. But since it cannot be printed in the trillions, it wins out in this aspect when compared to the greenback. Even the trade and circulation of gold is largely opaque and most governments place restrictions on its citizens and disallow them from hoarding gold. The price of the glittering metal is also dependent on the moves made by the large institutional market participants such as central banks, large commercial banks and traders.
As was mentioned before money is a form of technology. The fiat currency, which is essentially papers in your wallet or digits on a bank’s computer screen backed by a complex web of interdependent economic institutions is an iteration of that technological development with Bitcoin being the latest and by far the most advanced development of the same. Bitcoin, being based on the blockchain technology is extremely portable. Sending bitcoin is as easy as sending an email. Cryptocurrencies are borderless and their liquidity depends on nothing other than the number of people who are using the network. To top it all off, the supply of bitcoin has been fixed by design at 21 million units of which 3 million are yet to be mined. However, being a digital asset allows it to be divisible up to 0.00000001 units of BTC.
The most important distinction and the one that will most certainly threaten the legality of the future of cryptos is that it is impossible for any third party to control its supply and distribution. The technology makes the prospect of it inconceivable to begin with, threatening the positions of central banks and governments around the world. This is most likely the reason why the individual with the pseudonym ‘Satoshi Nakamoto’ created the currency and could also be the reason why he has chosen to stay anonymous to this date.
The future of Bitcoin will be decided by Politicians and not the People.
As mentioned before the money in your pocket is useful and valuable only as long as the government of your nation is stable. As an example, consider Switzerland: The Swiss economy, its banks and currency are considered to be the safest and most prosperous of the world because of the efficiency of its government and not because of the beauty of its mountains and watches. Therefore, all assets that citizens value in terms of currencies—equities, bonds, real estate, commodities and the like, in turn also depend on the value of the underlying currency and stability of the government. An extreme example of this is the recent surge in equities markets across the globe which most economists and investors attribute to inflation caused by excess money printing and open market operations of central banks.
Similarly, if you need credit in any form you will need to approach a commercial bank which is under the heavy control and regulation of the central bank of the country. Printing money also disproportionately benefits borrowers rather than lenders–—inflation reduces the value of money while the amount of debt owed remains fixed, in essence enabling you to pay back less than what is actually owed in real terms.
Put yourself in the shoes of any politician or central banker for a moment. You have just been elected/nominated to office and have a complete monopoly over the basic functioning of the economy of a sovereign nation and the ability to affect the lives and livelihood of all its citizens. Now, an unelected person (or maybe group of persons), some anonymous computer nerd comes along and makes a revolutionary innovation that gives complete economic freedom to anyone with a computer. Essentially, allowing them to buy, sell or transact in whatever way they feel like, all while remaining completely anonymous and therefore impossible to regulate and tax. Would you willfully give up all this power that you have worked so hard to acquire just so that your citizens can have more freedom? The answer to this question is probably a resounding NO.
Many politicians have already begun to pushback on the threat of cryptocurrencies. The reasons cited by them are the fact that cryptos threaten the monetary stability of a country and that they are often used to conduct criminal activities such as selling narcotics, weapons and money laundering. A recent example of this is Facebook’s attempt to launch its own digital currency ‘Libra’ and the large scale pushback that it received for the same by regulators in the US and the EU. While most nations have expressed ambivalence in their approach to tackling cryptos, China has taken a bolder stance. The nation recently announced a blanket ban on all cryptocurrencies, blocking access to all domestic and foreign exchanges trading in cryptocurrencies. However, it does plan to roll out a digital version of the RMB which will be based on the blockchain technology, but will simultaneously be regulated and controlled by the People’s Bank of China. The Chinese state clearly wants the best of both worlds and only time will tell whether this approach will be effective and fulfill the state’s ambition of becoming the next global monetary authority.
With the economic battle between the US and China at its infancy, the possibility of a threat to the dollar’s status as the reserve currency will be clearly unacceptable for Washington to even begin to consider. If the after effects of the economic turmoil caused by the pandemic result in inflation and an eventual run on the US Dollar, the value of bitcoin will certainly rise. However, it is highly probable that the prospect of such a situation will not be embraced by the politicians, who like China could also announce an outright ban on cryptocurrencies.
Hence, the most likely outcome and my personal opinion is that bitcoin, rather than disrupting the position of sovereign currencies, will most likely coexist as an alternative asset class such as precious metals.
The Luddites were a secret oath-based organization of English textile workers in the 19th century, a radical faction which destroyed textile machinery as a form of protest. They vehemently opposed the early technological innovations of the industrial revolution, fearing that these developments would displace their livelihoods. Their protests have now earned them a place in the dictionary as anyone who is generally fearful of or opposes technological change. Jump forward two centuries, their existence is all but forgotten but we as a society continue to benefit off of the fruits of the Industrial revolution. The similarity of our current situation with that of the early stages of the Industrial revolution makes it all but impossible to not draw a parallel between us and the Luddites.
Technology is always disruptive, innovative, and game changing while human behavior and emotions are monotonous, repetitive and mostly irrational. The past few decades have made it evident that a technological revolution driven by computers and artificial intelligence is forthcoming. Bitcoin is one such disruptive innovation and affecting one of the most politically sensitive industries of our modern economy—Finance. There are many factors which work against the currency’s mainstream adoption and it may just be truly ahead of its time, but change is inevitable and the future of money certainly will be digital with the citizens surely being able to exercise greater economic freedoms and benefits.