Earth provides enough to satisfy every man's needs, but not every man's greed. Mahatma GANDİ

Analysis and Synthesis -21st Century

Is Bitcoin the Currency of the Future

SATURDAY, JANUARY 13, 2018

 

      BITCOIN : a CURRENCY for the FUTURE ?

                                   By

                    Dr. Michael Sakbani

 

In the past few years after the 2008 financial crisis, Bitcoins were mined, i.e. created, by using Blockchain technology. Twenty  million Bitcoins were created by unknown digital technology master, rumoured to be from Japan. The creation of Bitcoin involves elaborate and advanced computer use which assures its safety. According to digital experts, the amount of computing power involves the use of a great deal of electricity, which implies a big energy foot- print which is both economically costly and environmentally harmful.

After the invention of Bitcoin, many speculators bought into this invention in the expectation that it will be the future currency of the World. A speculative bubble similar to the Tulip bubble and other such bubbles was seen in 2016 and 2017. The value of the Bitcoin reached astronomical heights $17,000 in the fall of 2017 and then recoiled to $12,000 by the end of the year.

The great fluctuation in the market value of the Bitcoin reflects two factors: its speculative nature and its lack of an intrinsic value. Fiat money shares the latter attribute of the Bitcoin. But because it is issued by the Government as a legal tender, it does not have the speculative nature of the Bitcoin.

Like gold, Bitcoin has a costly and limited supply. So, scarcity, a necessary attribute of money, is satisfied. Like gold also, its stock is non- destructible and is cumulatively considerably larger than its flow mining. It is portable, divisible without losing value and is durable. Thus, important characteristics of money are in evidence in Bitcoin. However, all of these desirable attribu tes are balanced off by the inflexibility of its supply.

Currency of the Future?

The question arises whether the Bitcoin will be the currency of the future. The answer to that is at present, affirmatively negative.

The supply of Bitcoin is asymptotically fixed. Hence, if it must keep with the growth of the world economy, or any economy, its value in terms of goods and services should increase. That leads to deflation as a permanent state of economic being. Deflationary economies are harmful to the spirit of capitalism. Entrepreneurs will not take risk and capital investments by corporations will be postponed and interrupted in a deflationary economy. If monetary authorities decide to have somehow a steady supply of Bitcoins, that would not solve the problem because the market value of the Bitcoin depends on excess supply or excess demand in the marketplace. Thus, a steady supply of money a la Friedman would not foreclose ups and downs in the market values and in the cyclical macroeconomic conditions. During such cyclical ups and downs, if there is no bank of last resort for Bitcoins, there would be a flight to fiat liquidity supported by the Central Banks.

While Bitcoin can be theoretically capable of being a medium of exchange in normal times, there general acceptance, would not be there in time of crisis  if there is no bank of last resort behind them.

There are more grave problems in so far as the function of money as an asset. Because Bitcoins have no intrinsic value, their own rate of return can only obtain from their increase in value. But this is practically impossible to be stable given the relationship between changes in the stock of Bitcoins and their flow quantum. Like gold, the relationship between the stock and the flow is volatile and essentially unpredictable. Moreover, the financial markets would not assign a rate of return unless financial instruments are denominated in Bitcoin. That would imply generalized international acceptance and functioning secondary markets. Without that the Bitcoin would lack liquidity and very fast becomes non- negotiable.

These same factors cause ebbs and tides in the value of Bitcoin over time. Consequently, the unit of account and instrument of deferred payment function of money would be nearly missing in Bitcoins. 

Is Bitcoin a Protection Against Inflationary Monetary Policies?

The cheering for Bitcoin comes from quarters who objects to the misbehaviour of states in issuing fiat money. That economic issue has not found a satisfactory answer yet. It is obvious that we do not face the simple quantity theory of money in reality and thus, the money supply function is not empirically predictable and steady. Changes in velocity and interest rates as well as financial innovations affect the money supply function. The experience of the US federal reserve from 1981 till 1985 when it sought to target monetary aggregates is a case in point. The money supply function has the same problems if Bitcoin is involved.

International Poltical Economy Issues

Bitcoin holding seems to be highly concentrated in South Korea and Japan. Its acceptance elsewhere is yet not wide-spread. It is very attractive instrument to have for holding illegal money and for terrorist financing. Thus, Governments and their Central Banks will not be among the willing backers of Bitcoin.   The rise in the economic power and trading ability of China as well as the importance of the European Union economically and commercially is bound to challenge the position of the US dollar as the dominant international reserve currency. China is on record seeking an acceptable replacement of the US dollar in the international monetary system. China holds several trillion US dollars whose track record is becoming suspect. This will recieve greater impetus as the Current US Administration withdraws from many international fora. The subject of replacing the US dollar with an international reserve currency goes back to the time of the C.20 in the early 1972-74. But it has been on the back-burner eversince. Neither the SDR nor the advent of the Euro have dethroned the US dollar from its position as the key world currency. The advocates of the Bitcoin have intimated that it might be the black horse in the waiting. The above discussion clearly demonstrates how misplaced are such

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