So could Bitcoin one day become a major mainstream currency alongside the Dollar, Euro and Pound and the other existing national paper currencies?
Will Bitcoin Become a Major Currency in the Future?
Bitcoin has been receiving more and more media attention in recent months. As a result more and more people are becoming interested in the digital currency and are entering the Bitcoin market to use, invest and trade in Bitcoin.
This also means there will be more incentive for businesses to expand into the Bitcoin market. At the moment the situation with what you might call the Bitcoin infrastructure is unsatisfactory.
Pretty well all the Bitcoin trading exchanges are amateur to one degree or another. Continual ddos attacks, support issues, security problems, as well as poorly designed interfaces which lack the features of mainstream Forex trading systems. Many of these exchanges don’t even offer proper statistical data or index charts.
But this will change with time as Bitcoin take up amongst the public increases and the currency becomes more widely popular.
It remains to be seen what will happen with Bitcoin on the side of the established banks. Bitcoin is basically a threat to their market position.
Paradoxically, my feeling is that rather than embrace Bitcoin they will aim to ignore, marginalise it and freeze it out. Much as the record companies did with the music file sharing site Napster.
Paradoxically, it’s the non-financial sector that is more open to new ideas in financial services.
This isn’t really surprising. After all it was a computer company and not a record company that created iTunes. It was also Apple and not a mobile phone company that created the iPhone. And it was a software company and not a telecoms company that came up with Skype.
The innovators in an industry or service tend to be people from outside the sector. The existing players are too stuck in their established ways.
There are rumours that some high profile companies such as Facebook or Google may get involved in Bitcoin. These companies have the financial resources to invest in Bitcoin infrastructure big time and propel the sector forward into more professional levels.
It’s also possible that big Forex trading institutions will eventually enter the Bitcoin market.
Bitcoin has a lot going for it technologically. But it also has a number of disadvantages.
Bitcoin’s big problem is it’s tendency to rise fast in value. This is caused by the deliberate
upper limit on the number of Bitcoins that can be mined.
Many of Bitcoin’s enthusiasts see this as an advantage. But I see it much more as a disadvantage.
The supply of a currency needs to slowly increase as the economy grows. Putting an absolute ceiling on the maximum number of Bitcoins that can ever be mined is not in the interests of a growing economy.
We’ve already reached the half way point of the maximum amount of Bitcoin that can be created and the currency is still only on the margins in terms of public interest, take up and usage. So how will it cope when/if Bitcoin were to see widespread take up throughout the economy?
It’s important for an economy to be able to expand it’s money supply according to demand. In 2008/9 we had the credit crunch and the global banking crisis. To ease the situation and prevent the economy from going into a crash and causing mass unemployment governments permitted their central banks to drastically increase the money supply (the so called “quantitative easing”).
Bitcoin does not allow you do do this. The amount of Bitcoin available is pre-set and pre-programmed into the system.
Sound money is certainly a good thing, but tight miserly money that no one wants to spend is not.
This inherent tendency of Bitcoin to deflate, in other words, to increase in value, hinders Bitcoin’s ability to serve as a useful standalone transaction medium for purchases.
In my opinion, this restriction is not just intended to ensure that the currency cannot inflate over time, it also suits the interests of the Bitcoin promoters. After all they will have no doubt made sure that they started out with a nice seed fund of Bitcoins when they launched the system.
Bitcoin’s Heavy Price Fluctuations Discourage Transactions
Another problem is that Bitcoin can’t even be used as a reliable form of money transfer either because of it’s fluctuations in value, despite the technical advantages offered by the peer to peer node system it uses.
Bitcoin has some major advantages for transaction purposes, low or near zero cost, speed, no bank, etc.
But this volatility in value means Bitcoin can only be used for purchases if it is converted using a real-time currency check executed at the point of purchase.
You can’t just price goods directly in Bitcoin because you don’t know what they will cost in Euro or Dollar terms from one day to the next.
Imagine you have a pizza priced at 0.1 BTC when the Bitcoin is at 100 Dollars. That pizza effectively costs 10 Dollars. If then a week or two later Bitcoin rises to 200 Dollars, then that pizza will be costing 20 Dollars. Any pizzeria operating on that basis would quickly find itself going out of business.
No one is going to want to conduct transactions with a currency whose value fluctuates by several Dollars or more over the course of 24 hours. A currency that can’t safely be used for transaction purposes is not really a currency. The only way is to use Euro or Dollar as a reference currency when making Bitcoin payments.
A big plus Bitcoin has going for it is it’s peer to peer transfer system. Free transfers which go through practically immediately (though it can sometimes take 30-60 mins or more), and no bank bureaucracy to deal with or have to pay fees to.
But you have to separate out the digital peer to peer transaction function of Bitcoin from the speculation and store of value aspect.
I would be willing to wager that the peer to peer advantages of the Bitcoin system could probably be reproduced to operate without Bitcoin. The two things don’t have to go together. In theory couldn’t we even have a digital peer to peer Euro or Dollar?
In fact, there’s a project called Ripple in progress right now which aims to create a peer to peer transfer system for payments, regardless of currency. It will be interesting to see how this develops.
Bitcoin as it’s constituted right now can only be really used as a long term store of value like gold. For that purpose it’s probably fine – in the long run. In the short run, even treating Bitcoin as digital gold could turn out to be a far riskier move than buying gold.
And even in the long run, no one can be sure what will happen.
Bitcoin Conflicts with Government Monetary Policy
Governments depend upon being able to control the currency in their territory in order to finance their public spending debt. Take this away and this will have huge consequences for government spending and taxation.
Governments and central banks have a great deal to lose if an independent currency comes along and tries to take over from their currency amongst the mainstream in the economy.
They just can’t afford to lose control over the currency used in their jurisdiction without any recompense. We are already seeing the strains the Euro is causing for the southern European countries who no longer have control over their own currency.
So national banks and governments will not meekly accept Bitcoin going mainstream without putting up a fight.
Bitcoin – the Ideal Money Laundromat?
There’s also another reason for governments to object to Bitcoin.
Over the last few decades, and especially since the 9/11 terrorist attacks of 2001, government authorities have been tightening up the regulations and procedures in the banking sector to try and counter money laundering and the flow of funds to terrorists.
Governments have created an entire infrastructure of financial control and monitoring of the banking system. You only have to try and open a bank account as a new small business start-up to discover at first hand how involved and complicated this basically very simple process has now become.
Bitcoin, with it’s non-traceable transaction system blows a hole right through that. The system as it is constituted at present serves as an ideal washing machine for dirty money and illicit transactions. This fact alone makes Bitcoin an immediate outcast in banking and government circles.
Of course, Bitcoin isn’t the only currency that is used for money laundering or criminal purposes. The Dollar, Euro and other national currencies have long been – and still are, the favoured currencies for this purpose. But Bitcoin, with it’s anonymous, can’t be traced transaction system, serves as an ideal laundering machine for getting those illicitly obtained Dollars and Euros clean again.
The commercial banking sector too has a great deal to lose if Bitcoin were to become widely used and accepted. Banks live from lending money and the so-called credit multiplier effect of receiving deposits and creating credit. If Bitcoin encroaches on that then they stand to lose business.
So all in all I see big problems with this currency ever trying to go mainstream at least given the way it’s currently constituted.
Bitcoin might suit promoters such as Max Keiser, but I don’t think it’s fit to serve as the currency of choice for the general public and the economy.
What are the options for Bitcoin in the future?
I see five basic possibilities for how things might turn out for Bitcoin:
1. Bitcoin takes off and becomes widely used. Bitcoin could gain general acceptance and become widely used alongside the national currencies and the Euro. The widespread use of smartphones will make it possible to easily conduct everyday transactions in Bitcoin.
2. Bitcoin rises, crashes and then dies. Bitcoin could rise heavily in value into the thousands of Dollars – and then crash heavily, leading most people to lose all appetite for it and give up for good on having anything to do with Bitcoin.
3. A better digital currency with more features pushes Bitcoin aside. Right now there are a number of other digital currencies in development and circulation.
Second in popularity right now is Litecoin, referred to by some as “Bitcoin’s silver”. If one of these other competing digital currencies can offer greater advantages than Bitcoin, then it may gain ascendancy and push Bitcoin aside. It could potentially be a digital currency sponsored and run by a consortium of banks or other financial institutions.
4. The authorities take measures to close Bitcoin. The authorities ie principally the EU/European Central Bank and USA could take joint action to outlaw and close Bitcoin down one way or another. For example, through tighter financial regulations, such as a prohibition on transferring money into and out of the Bitcoin system. This would not be that difficult to achieve, for example on grounds of “digital cryptocurrencies being used for money laundering, terrorism, drug dealing” and so on.
Or through more underhanded computer technical measures (hacking, ddos attacks, firewalling).
Or through ruining the market through “pump and dump” actions. This is when a single buyer or group of buyers acting together purchase large volumes of the currency or asset in question,. This causes the price to rise very fast very quickly (the pump). They then later on sell all their currency on the market all at once (the dump).
Alternatively the authorities may just be content with taking such limited measures as are needed to confine Bitcoin to the sidelines as a toy for the computer geeks and the libertarian activists to play with.
They may be willing to continue to allow Bitcoin to operate as long as it doesn’t encroach upon the economy or their own national currency to any major extent.
5. Governments embrace the Bitcoin idea and “go digital” with their national currencies. The authorities actively embrace the digital currency concept themselves and start switching their own currencies over to a digital peer to peer system or some kind.
This then marginalises Bitcoin and reduces the need and incentive to use Bitcoin for business and transfers.
Smartphones and the Internet now make it possible to use digital money for everyday transactions. In theory, there’s no longer any real need for paper banknotes, coins, nor plastic debit or credit cards.
What do you think will most likely happen with Bitcoin in future?
As for my opinion, I think I’d put my money on the last option.
That is, the national financial authorities eventually adapting the Bitcoin idea and implementing it for their own currencies. I think this will in time be the most likely turn out in the long run.
But I think it’s unlikely to happen for perhaps a good few decades or more yet. At present, we still use the old system of banknotes, coins and plastic cards. Governments are notoriously conservative and cautious when it comes to new ways of doing things. So it will take time for these new concepts to gain full acceptance.
I think Bitcoin is ideally suited to serving as a store of value, rather than as a means of transaction. As a form of digital gold and as a medium to long term investment, Bitcoin is ideal.
Beyond that function, I see Bitcoin at present as more like an experimental laboratory. It’s rather like a financial Napster. Napster eventually disappeared, but it paved the way for iTunes, YouTube, Soundcloud and podcasting.
We’re seeing the birth of our financial future in the making. We dont know yet how it will grow up and mature, but things definitely won’t stay the way they are.
One thing’s for sure: we certainly live in interesting times.
Disclaimer and Disclosure
WARNING: The value of all investments can go down well as up. Always seek independent professional advice before making any investment decision. Never invest in any asset or scheme that you do not understand. Never invest more money than you can afford to lose.
DISCLOSURE: The author holds investments in currency and the stock market at the time of writing this article.
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