IS BITCOIN A THREAT TO THE ESTABLISHED FINANCIAL SYSTEM?

The idea of Bitcoin endangering the FED has its latest reappearance in the statement of the US Congressman Brad Sherman saying that cryptocurrencies should be nipped the bud. Adding that the US financial power stems from the fact that the US dollar is a standard unit of international finance and transactions, he called for Bitcoin to be banned, since the announced purpose of Bitcoin is to take this power out of US hands.

 

TIME FOR A TRUSTLESS CURRENCY TO STEP IN?

The possibility of using cryptocurrencies instead of US dollar should be viewed together with the trend of deglobalization. As China and Russia are making clear their intention to reduce the role of US dollar in international trade, and the US president threatens with trade war measures on a regular basis, the issue of trust comes into the foreground.

Even with rising tensions, would China really dump a huge amount of their US Treasuries to defend their currency, with crippling consequences for both countries? Should we start hoarding gold and Bitcoins when countries’ trust in each other decline?

Is deglobalization gaining speed and strength or is it just a passing headwind to the global economy? The Chinese certainly do not see it as a large drawback while they are preparing new foundations for the global trade routes. And the recent Iranian example shows that US is still quite capable of exerting pressure on disruptive technologies that could bypass their sanctions.

 

BITCOIN AS A FINTECH REPLACEMENT OF FIAT?

Some commentators have named Bitcoin digital gold since it is apolitical, tied to an algorithm, just like money used to be tied to gold. But should Bitcoin be considered a currency or a commodity? Money is a triangular relationship involving a seller, a buyer and a trusted third party – the banking sector, while Bitcoin dispenses with the latter.

Could the trusted third party be replaced by the Bitcoin algorithm? One can object, that the majority of security issues and scams take place on the Ethereum network, but that can be explained by the fact that the majority of new tokens have been issued there. Bitcoin itself has a history of hacks (beginning with Mt. Gox) and technical issues that required forking.

Another big issue with Bitcoin is the energy cost of its production. The problem of rising global energy consumption is a serious hurdle to the mass adoption of Bitcoin, as its transaction rate would have to scale from 7 to at least 1700 per second to meet the global transaction demand. How much of a country’s GDP would be swallowed up by transaction costs?

The Bitcoin enthusiasts are working on possible solutions for this problem, the most promising of which seems to be the Lightning Network where transactions can take place off the blockchain. This allows substantial scalability, but the problem is that currently this solution is a bit too complex to be retail friendly. Also, it may require some centralization for handling large transactions which is contrary to the concept of Bitcoin.

Bitcoin’s deflationary nature is another drawback. Only 21 million units will ever be created. No economy can grow with a shrinking money supply, especially in a system based on credit and debt. Central banks aim at mild inflation to encourage rapid turnover of money, quite the opposite of HODL which discourages consumption.

On the more positive side, Bitcoin could challenge the existing financial system on other grounds. There is a need for transactions that are not based on credit in an economy when the level of debt becomes prohibitive. Transparency is another area where traditional finance sometimes fails. To take one recent example, the Commonwealth Bank of Australia actually somehow lost the data of 20 million accounts. Blockchain would be a most welcome solution here.  Visa experienced its own difficulties when the network crashed last year, allegedly due to the hardware failure.

 

SUMMARY

The news about rapid deglobalization might be exaggerated and the major economies are too interdependent to risk moves like dumping US Treasury securities on an unprecedented scale. Bitcoin in its present state does not meet the criteria for a successful replacement of the fiat currencies, but is and will be very useful on the fringes of the economies that are excluded from the full spectrum of the financial services available to the developed world.

Bitcoin, with all its shortcomings, was still the first cryptocurrency and has been riding on this momentum ever since, with the world still waiting for a rival to overtake it in terms of market capitalization.

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David Prezelj
David Prezelj

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