By Rhian Lewis, author of The Cryptocurrency Revolution
There are now many different digital currencies, from small-circulation cryptocurrencies to government-issued electronic cash – but there is only one Bitcoin
Paying for goods and services with a debit card or phone app is not new: these forms of digital payment have been around for decades. This is why people get confused when they hear people like Christine Lagarde, head of the IMF, talking about the digital euro or Rishi Sunak, Chancellor of the Exchequer in the UK, talking about stablecoins and a digital pound issued by the Bank of England.
In simple terms, while these new forms of electronic money have some things in common with the money system we use now – the digital euro will still be called the euro, for example – they have more in common with payment systems like Bitcoin than they have with physical cash in the form of notes and coins. This is because the technology that underpins these novel currencies is often based on distributed ledger technology, which is similar to the blockchain architecture on which Bitcoin is built.
Why are governments launching digital currencies?
At the moment, if someone goes shopping, a payment is made from their bank into the bank account of the store where the goods are bought. While this payment appears to be instantaneous, in reality, there are complicated processes of settlement happening behind the scenes that add costs and friction to transactions. In the case of central bank-issued digital currencies (or CBDCs, as they are known), payments flow seamlessly from the end user’s mobile wallet to a nation’s central bank, with the transactions recorded on different computers that reach agreement automatically.
China has already rolled out its own CBDC (called DCEP) in a pilot program in several areas of the country, and early indications are that it has been successful, so many people expect other large countries and central banks to follow. These government currencies were inspired by Bitcoin – so the question is, once we have an easy and convenient electronic payment system, why do we need Bitcoin?
Bitcoin, more than any other cryptocurrency, is a store of value
Bitcoin sceptics point to the fact that the main network itself is slow and limited in capacity. This is true, although technical developments are in progress that will change this, particularly when we talk about secondary layers such as the Lightning network. But the main answer is that Bitcoin is far more than a payment system: it is increasingly being used as a store of value.
The Covid-19 pandemic has brought about profound changes in the way societies are organised around the world, and among these has been the necessity for governments to spend eye-watering sums of money to support those citizens who have been unable to work either because Covid restrictions have prevented them from doing so, or whose markets have been disrupted so that demand for their product or service has disappeared. In general, governments have fulfilled these financial obligations by expanding the supply of money within their economies – commonly known as “printing money”.
While this money supply expansion might not be as simple or visible as printing greater quantities of notes or coins, an imbalance of money within a system when compared with the real assets and work that circulate in that system can result in inflation. This means that prices rise as more cash chases the same amount of products, and the currency falls against other countries’ currencies, sometimes dramatically.
When we think of hyperinflation, we think of Germany in the Thirties, where a wheelbarrow of banknotes was insufficient to buy a loaf of bread. But in more recent times, many other countries have also suffered the curse of hyperinflation, with Zimbabwe being a notable example. In historic terms, when people saw the value of their national currency being eroded, they would move their savings into gold, or perhaps even buy commodities such as grain or oil.
Where will the Bitcoin price go next?
In recent weeks, we have once again seen an upward movement in the price of Bitcoin. Will it stay above $19k? Price predictions are notorious for being wrong, so it’s entirely likely there may be more dips and volatility in future, but there is something different about the market cycle this time. For example, the current price increase is partly driven by a wave of interest from institutions – it seems that barely a day goes past when we don’t read a headline about a mainstream fund or company expressing an intention to put some of their holdings into Bitcoin. The news that Guggenheim Partners is reserving the right to invest 10 per cent of its assets into Bitcoin investment trust Grayscale was just one example, while companies like Microstrategy and Square had already taken the plunge.
“Every asset that represented the value of an entity was going up in value, while the actual value of the entity was going down,” explains Microstrategy CEO Michael Saylor. “The nominal inflation rate is zero, but the asset inflation rate is 15 per cent.”
While there are no guarantees that the Bitcoin price will increase or maintain its current level, many companies and retail investors are increasingly betting that this will be the case and help them ward off the worst effects of inflation. Headlines like the ones I mention above are a powerful drawcard for retail investors, as is their ability to buy it more easily through apps such as Coinbase, Revolut and even Paypal.
This explains why Bitcoin might be a better bet than government currencies – but what about other cryptocurrencies, or even corporate digital cash such as Facebook’s Libra, recently rebranded as Diem?
While the token economy has much exciting potential, there is no decentralized cryptocurrency that comes close to the network effect that Bitcoin has achieved, or that does one thing so well. Bitcoin’s established network of miners gives it an unassailable position that makes it a much better bet for the long term than lesser blockchains.
And while Diem is undoubtedly an interesting development which will be followed by many other coins issued by corporations, it will be issued as a stablecoin which tracks the exchange rate of the user’s country. As long as this remains the plan, this means that the token’s value will be inextricably linked to the fortune of the dollar, euro or pound sterling and will provide no protection against inflation, however useful it may be for payments.
Having said all this, whatever happens to the price of Bitcoin, this is not in itself the most important thing about it. At the moment, we underestimate the profound economic and social changes that will happen as programmable digital currencies become more widespread.