A threat to traditional currencies?
First of all, cryptocurrencies need market regulation. However, an independent cryptocurrency such as bitcoin is unlikely to threaten traditional currencies. Bitcoin, on the other hand, can continue to evolve as an alternative to traditional assets such as gold.
In 2020, cryptocurrencies, especially bitcoins, have yielded the biggest gains as risk appetite has increased and financial markets have recovered. While the price of bitcoin was below $5,000 in March 2020, it had already surpassed $63,000 in April of this year. In mid-May, the price fell just below $50,000.
Bitcoin has also benefited from growing fears that mass money printing will devalue traditional currencies, as well as news that a number of respected investors and companies have begun investing in cryptocurrencies.
Bitcoin now has access to financial instruments such as a functioning futures market, funds and other investment products. Thus, bitcoin's growth now can also be attributed to favorable market conditions and the growing acceptance of this cryptocurrency as a marketable asset.
Can a bitcoin bubble burst?
As with many other assets, there is a high risk of a bubble forming with bitcoin. However, analyzing the value of bitcoin is particularly difficult.
Traditional assets, such as stocks, bonds, or real estate, have a rate of return that can be used to calculate their value compared to other assets. For bitcoin and commodities, lacking this capability, it is not even possible to determine their true value.
For many commodities, you can get an idea of the change in their value by tracking changes in demand. For example, when forecasting the price of oil, one knows how much oil will be consumed given economic growth and other aspects.
The price of bitcoin is more difficult to determine, because all price forecasts must be based on the assumption of how widely and intensively this "currency" will be used in the future. And there are a number of radically different points of view: from those who believe that bitcoin will replace conventional currencies, to those who are sure that bitcoin will be banned and become useless. The truth is probably somewhere in the middle.
Headache for central banks
Bitcoin and other cryptocurrencies have taken significant steps in recent years to become a recognized investment asset. Last year Paul Tudor Jones, one of the most successful hedge fund managers in the world, announced that he had invested in bitcoin.
Earlier this year, the car company Tesla also announced that it had acquired $1.5 billion worth of bitcoins. Shares of Coinbase, the world's largest cryptocurrency exchange with a market value of more than $60 billion, went public on the Nasdaq exchange. There are other examples of companies and banks announcing that they will start offering different types of services with cryptocurrencies.
While the proliferation of cryptocurrencies is growing, they have many skeptics. Among the biggest detractors are central banks, which see cryptocurrencies as a growing threat to their currency monopolies.
They may not be worried about bitcoin and other independent cryptocurrencies. They are more concerned about plans by large technology companies to create stable coins (stablecoin) or private cryptocurrencies with a fixed exchange rate against traditional currencies.
The most prominent example of a stablecoin is Facebook Diem (formerly Libra), which could actually become a threat to conventional currencies if used by billions of people around the world.
Libra was originally scheduled to launch as early as 2020, but the project has raised much suspicion in the U.S. and the European Union, causing delays and concept changes. Now there are plans to launch a new version of Diem, but those plans are not carved in stone, so we should not be surprised if the project is delayed.
Avoiding Competition
The problems with cryptocurrencies Diem or Libra are good examples of how governments and central banks are unwilling to put up with competition. In particular, the United States has good reason to do everything in its power to maintain the dollar's status as the world's largest currency. Today the U.S. dollar is used in nearly 9 out of 10 world transactions.
The fact that the dollar is so dominant gives tremendous power to the United States because it controls the supply of currency. Those who want to use dollars electronically are totally dependent on the U.S. banking system, which increases the influence of the United States.
Neither the United States, nor the European Union, nor China, nor any other state with its own currency is interested in making bitcoin or any other cryptocurrency a means of payment.
The main weapon for states is the regulatory and supervisory systems at their disposal. By limiting the appropriateness or legitimacy of cryptocurrencies in various ways, states can limit these threats. The EU has already presented a draft of what legal regulation for cryptocurrencies might look like.
Regulations are not bad, rather they are even necessary. Regulation and better oversight are important to make it harder to use cryptocurrencies for all sorts of illegal activities, to increase consumer protection, and to increase predictability.
Will local e-currencies emerge?
Central banks know that the success of cryptocurrencies is partly due to the shortcomings of conventional currencies. Simply put, traditional currencies are not suited to meet future demands for services and payments.
That is why many central banks are planning to introduce their own electronic currencies, which will have more features than today's traditional currencies. The Bank of Sweden has ambitious plans to introduce the e-currency. In China, authorities have already begun testing the electronic yuan.
However, none of these currencies in the form of cash will be able to be used anonymously and most likely outside the respective state.
Big electric bill
Much of the criticism of bitcoin concerns the fact that its virtual mining or mining consumes large amounts of energy. In 2020, the bitcoin network consumed 77 TWh of electricity, the equivalent of Sweden's annual consumption.
The higher the price of bitcoin, the greater the interest in obtaining it. There is an opinion that such consumption is a waste of energy. However, it is the mining process that secures the bitcoin chain, ensuring that no one can sell their bitcoins multiple times.
Thus, the high electricity consumption can be seen as a cost to keep the network secure.
However, this does not change the fact that electricity consumption is a problem. Today, making one bitcoin transaction requires as much energy as it takes to make approximately 700,000 transactions with ordinary payment cards.
Growing interest in climate and sustainability issues will draw increasing attention to the bitcoin debate in the context of environmental, social and intra-corporate (ESG) issues, and huge energy consumption could be a growing problem for bitcoin's image.
At the same time, the technological innovations associated with cryptocurrencies should not be underestimated. There are reports of a move to more energy-efficient blockchain security methods that are not based on virtual mining.
When can bitcoin be used to pay in stores?
Another Achilles heel of bitcoin that is becoming increasingly obvious: bitcoin does not work well as a means of payment. An additional problem is the large price fluctuations that complicate pricing.
The blockchain technology on which bitcoin is based is slow. Thus, the Bitcoin network does not have the necessary capacity to process payments smoothly and operate as a global means of payment.
Currently, the Bitcoin blockchain processes no more than 7 transactions per second. In turn, it takes 10 minutes to confirm a transaction. By comparison, the 30-year-old VISA payment system can still process 1,700 transactions per second. While technological advances continue, the problem of capacity remains unresolved.
One area where bitcoin is being used as a means of payment is all sorts of criminal activity. For criminals, bitcoin's disadvantages are offset by its anonymity. Although such transactions can now be tracked, it is difficult and resource intensive. There are other cryptocurrencies designed specifically to provide untraceable transactions.
According to Chainalysis, a blockchain analytics company, only 0.34% (2.1% in 2019) of bitcoin flows in 2020 could be linked to illegal services.
That's not much, but it should be noted that Chainalysis is not able to identify flows related to money laundering or tax evasion.
Reducing the illegal use of cryptocurrencies will be an important area for further market regulation and oversight, which can be used to limit the ease of use of cryptocurrencies and therefore their popularity.
Modern Virtual Gold
Because bitcoin and most other cryptocurrencies are relatively little used as a means of payment, these currencies have become something that is bought and sold primarily as a financial investment.
As an investment asset, bitcoin poses no more risk to traditional currencies than does physical gold. Rather, bitcoin has become the equivalent and competitor to gold.
The value of bitcoin today exceeds $1 trillion. This amount is equal to 11% of the value of all the physical gold available in the world. Today, people use gold as an investment and a means of saving rather than as a means of payment. This is likely to be the future of bitcoin.
As long as bitcoin does not threaten traditional currencies as a means of payment, governments and central banks around the world will let it live on. But the dream of bitcoin enthusiasts that it will one day dominate the global currency market seems to be just a dream.
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