Bitcoin and cryptocurrencies have grown increasingly popular as the public – ranging from amateur investors to technology experts – try and profit from the potential of the digital applications that blockchain technology provides. At the time of writing, Bitcoin has reached new highs, rising above $4700, which is up 350% from roughly $1000 on 1st January, and even considerably more than its price of $0.08 in July 2010.
With a market cap of near $70bn (44.7%), Bitcoin is the leading cryptocurrency. Acting as a decentralised and public ledger, each bitcoin transaction is permanently, yet partially anonymously, recorded. This improves the transparency (through public key cryptography) and speed of transactions whilst simultaneously reducing costs.
The decentralised nature of bitcoin has, in part, roots in the financial crisis and resistance against traditional banks and government control. Despite a few scandals, such as that of Silk Road, its usage has increased widely and can now be used to buy goods online, while services like bitcoin ATMs and bitcoin debit cards exist.
Notably, on 1st August, bitcoin was made legal tender in with 300,000 retail stores accepting the digital currency. Bitcoin has moved from being confined to the field of technology to the heart of everyday life.
Innovation in Adversity
Its popularity and increasing usage has meant that the coin recently experienced a ‘fork’, resulting in the creation of a new currency- Bitcoin cash– to help facilitate transaction speed and improve the processing power of the network. Bitcoin started experiencing high transaction costs and lower speeds due to limited blocks, raising concerns about its future ability to cope with higher usage. The result of the fork is the increased processing power of Bitcoin, which increases the longevity of its use and can sends a signal to people about its ability to cope with increasing demands.
This ‘scaling’ of the currency was met with price rallies and optimism about the future of the coin and its potential role in society. As bitcoin innovates and responds to adversity, questions about its ability to truly displace conventional monetary systems are raised. So- will bitcoin replace traditional money?
The Future of Bitcoin
According to Saxo Bank analyst Kay Van-Petersen, Bitcoin could be responsible for 10% of the $5trn average daily volume in the foreign exchange market within 10 years. This assertion is supported by Adam Davies, a consultant at Altus, who states society could be about five years away from bitcoin becoming popular enough to be used alongside physical currencies.
It should come by no surprise, then, that more and more countries are asking regulators to look at bitcoin and are investing in blockchain, helping to legitimise the cryptocurrency with institutions. Further, large institutions such as Goldman Sachs have said that they can no longer go on ignoring cryptocurrencies.
However, some have likened this rally and rapid growth (the cryptocurrency market cap is up 800% this year alone) to the early 2000s and the technology boom, fearing a potential bubble, thus over-estimating the impact bitcoin might have.
For bitcoin to replace normal currencies, the plurality of society will need to understand it, regulate it, adopt it and then effectively manage it. Initially, people will need to be willing to adopt, and successfully switch, to digital currencies.
This will require improved infrastructure, information and security. Alongside this there will be an overhaul of regulation and a change to accounting, billing and payment systems. Eventually, if universally adopted, bitcoin will have to be managed; vexing issues such as rising transaction costs and slowing speeds will need to be resolved.
When cryptocurrencies can be used to pay taxes, acquire debt and manage an economy, they will begin to take over. In some countries like Japan, this has seen success, whilst China are also working positively towards developing a national cryptocurrency.
In the case of bitcoin, the ability of it to be used as widespread money is quite limited when one considers the adoption and regulation required. It’s also important to remember that the growth of the Bitcoin money supply is constrained by the increasing difficulty of verifying transactions, as mining becomes increasingly difficult.
The current reality is that Bitcoin’s market cap is still tiny compared to the value of dollars and pounds issued by central banks. The Federal Reserve alone issues amount summing to about $1.4trn, and we are therefore nowhere near the point yet where cryptocurrencies pose a credible threat of ‘supplanting central-bank-issued money’ according to former Bank of England Economist Tony Yates in the Financial Times.
Difficult Economy Management
One major issue is that there is a finite supply of bitcoin, with a limit of about 21 million coins. Fluctuations in demand for Bitcoin and its competitors, in the face of relatively fixed supply cause wild swings in the price. This makes Bitcoin impractical as a money. Businesses would need to constantly adjust prices to reflect changes, whilst economies across the world have differing structures and requirements, which makes managing economies simultaneously very difficult.
Currently, we have different currencies where the values adjust against each other, then allowing individual countries to provide stimulus or raise interest rates to control inflation. With a universal bitcoin currency, or even individual country cryptocurrencies, this would be a daunting challenge, without even considering the extensive regulation and re-shaping of the market and monetary infrastructure that would be required.
Without a state directing fiscal transfers to make up for the inability to adjust exchange rates within the area, the result is going to be a monetary policy consistently too tight and too loose for different groups, like that of the Eurozone. However, this central state goes against the initial motivations for a decentralised bitcoin.
As bitcoin and other currencies gain attention and momentum, regulation will only toughen. Japan’s legal tender included legislation to protect uses from being stung by a collapse of exchanges, whilst also making exchanges comply with anti-money laundering regulations, officially authorising it as a normal payment method.
This type of regulation is quite limited and varied however, with some countries treating it as a commodity and some as money, making it difficult to enforce a universal law. In Venezuela, it is seen as a safe haven as the country struggles to deal with the downturn of the oil industry, whilst in Ecuador the government has issued a ban on cryptocurrencies. In the UK, the BoE and policy makers are talking about digital currency which could help tax evasion, with a digital pound rivalling bitcoin. Clearly, there is no general consensus.
Different countries, people and business have different motivations for using the cryptocurrencies. The likelihood of one digital currency across the world seems far-fetched at present, especially when you consider the infrastructural improvements and subsequent transition required to move from money to digital currency.
What is more likely is the idea of different countries using cryptocurrencies how they see fit, some more than others. Some may use it as a central currency which will then need to be regulated against conventional currencies, and some may use it alongside conventional currencies.
What is more promising is the variety of decentralised applications of cryptocurrencies and blockchain technology, such as Ripple being used in banks, and Dash being used to ‘revolutionise digital money systems’, with people owning these coins to use its associated applications. Bitcoin appears to be on a clear upward trajectory and its progress is set to continue in the coming months.