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The word ‘currency’ can be used to define the money that is accepted in a particular country as a medium of exchange at a particular time. Currently, the most common form it takes is of ‘fiat currency’ that is the currency that has been verified by the Government and is legal tender. This article aims at understanding the future of bitcoin as money and what holds it back.

There are some features that a currency needs to possess for it to be functional and thus, it is important to examine this cryptocurrency on these parameters. One of the features that are in-built in bitcoin’s design is scarcity. While the central bank controls the supply of fiat currency, the supply of bitcoin has already been limited to 21 million and this number could easily be reached by 2140 if the power of mining remains constant. But a functional currency must also be convenient to use and that is where bitcoin’s design fails it. The use of blockchain technology makes bitcoin transactions secure and private but this also makes the process slow and inconvenient. Another critical feature is verifiability, which is granted to fiat currency by the central and commercial banks. The bitcoin network uses public and private keys in the network where the private key can be used by individuals to verify a transaction but everyone with the public key can access the ledger listing all the transactions. While a currency should be limited, it must be accessible and available to everyone like coins or paper notes but bitcoin’s secure network makes sure that it is accessible to only those who perform the cryptographic calculations. Incidentally, this has also given rise to a number of business ventures set up to mine cryptocurrencies.[1]

Given the above, what is in the store of bitcoin’s journey to become legal tender?

This new digital currency would find it difficult to compete with the already established incumbent money, a phenomenon which the economist William Luther calls the ‘incumbent monies’ problem.[2] He goes on to explain that the incumbent currency is already conveniently available and hence the cost of switching to bitcoins is high. The network effects that results in an increase in the value of service as more and more people use it are hence not in favor of bitcoin. In such a scenario, this cryptocurrency would have to prove to be revolutionary enough for any economy to even think of incurring the costs of changing its whole mechanism to incorporate digital payments through bitcoin. Not just incumbent money, bitcoin also faces competition from altcoins such as neo, ox, ripple, etc. In this case, though bitcoin has the first mover advantage as these altcoins came into existence after the unexpected rise of bitcoins. We still cannot ignore this competition as they might be able to defeat bitcoin in its own game in the long run once its bubble bursts.

We cannot discuss the future of bitcoin as money without addressing the issue of legality. For it to become common currency, governments need to declare it as legal tender, something that the majority of countries have refrained from doing. The Government backed fiat currency is used by central banks to regulate the economy through tools like monetary policy especially during a crisis such as high inflation or deflation. Bitcoin might not be able to serve such objectives of the government as long as it runs on the current blockchain technology which removes the need for a third party such as commercial banks or clearing agencies.  Another disadvantage is the use of electricity in the bitcoin mining process. According to a controversial estimate, the amount of energy needed to keep the bitcoin economy running now exceeds the energy use of 159 individual countries.[3]

Money needs to serve three primary purposes - the medium of exchange, store of value and unit of account. As a medium of exchange, the Governments need to recognize bitcoin as a legal tender which has a lot of problems, as discussed above. Not just that, its efficiency as a store of value is also questionable and that is because of its volatile price. Bitcoin was valued at $1 in February 2011, rose to $290 by 2015, reached around $775 last year and more than $17000 in December 2017 but it has recently dropped down to $10,650. Such high volatility makes it an extremely risky investment and hence an unstable store of value. The fact that bitcoin transactions have only gone up by 33% in the last year stems from such instability.[4]

Adding to this, in an interesting article published in Forbes, economist Jeffrey Dorfman argues that bitcoin would rather be used for speculating on its asset value because of the drawbacks mentioned above of bitcoin as money and currency. According to this view, the only purpose it can serve is that of an asset that is traded to earn profits because of its changing prices.[5]

Another important aspect we need to analyze while commenting on bitcoin are the reasons for such price volatility and why has it been called a bubble?

Bitcoin has shown similar movements in price as that of an asset trapped in a speculative bubble which is essentially defined as a phenomenon which occurs when an asset’s price exceeds its intrinsic value. Experts have compared the massive rise in the value of bitcoins with the tulip mania of the late 17th century which is widely regarded as the first ever speculation bubble. During the tulip mania, the prices of some fashionable bulbs increased dramatically in the Dutch Republic but plummeted down within months. Another phenomenon often quoted is the dot-com bubble of 1999 when the demand for companies claiming to be internet ventures skyrocketed many of which could not survive for a long time. To quote economist Chris Roberts, ‘Today, Bitcoin is mostly just a matter of media speculation arising from the continuing financial turmoil and growing distrust in the global financial system.’[6]

Broadly speaking, the limited amount of bitcoins, too much hype around cryptocurrencies and the way it removes the need for a third party like a bank or a clearing agency has made the demand go soaring up in recent times. Thus, increasing price and the rise in fluctuations is a sign of bitcoin bubble which makes it a risky investment. Concerns have also been raised that the rising popularity is a part of the capitalist tendency to go after anything that promises wealth in short time without thinking about what the real economy could face once the bubble bursts.

In conclusion, although it is difficult to predict the future, from where we are standing right now, bitcoin’s future as money seems pretty bleak and it is unlikely to be adopted as a global medium of exchange anytime soon.

 

[1] EPW, The Bitcoin-Blockchain mania, 2018, accessed on 19th January, 2018.

http://www.epw.in/journal/2018/2/editorials/bitcoin%E2%80%93blockchain-mania.html

[2] William J. Luther, Bitcoin and the future of digital payments, 2016, accessed on January 19th, 2018.

http://www.jstor.org/stable/24562161?seq=1#page_scan_tab_contents

[3] Umair Irfan, Bitcoin’s price spike is driving an extraordinary surge in energy use, 2017, accessed on January 22nd 2018. https://www.vox.com/energy-and-environment/2017/12/2/16724786/bitcoin-mining-energy-electricity

[4] Matt o’Brien, The Simple reason bitcoin will never be a currency, 2017. Accessed on January 20th, 2018.

https://www.washingtonpost.com/amphtml/news/wonk/wp/2017/12/18/the-simple-reason-bitcoin-will-never-be-a-currency/

[5] Jeffrey Dorfman, Bitcoin is an asset, not a currency, 2017, accessed on January 20th,2018.

https://www.forbes.com/sites/jeffreydorfman/2017/05/17/bitcoin-is-an-asset-not-a-currency

[6] Semil Shah, Iterations: How five real economists think about bitcoin’s future,2013, accessed on January 20th, 2018. https://techcrunch.com/2013/04/14/iterations-how-five-real-economists-think-about-bitcoins-future/

Image source-https://www.bitcoin.com/wp-content/uploads/2017/03/what-is-bitcoin-story.jpg

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Written By Pragya Mishra

Economics Graduate

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