Will Digital Currencies Like Bitcoin, Ethereum or Even CBDC Replace Fiat Money?
What are our Future FinTech Champions learning at the moment? And what are their thoughts on the current development of FinTech? Read through this submission from one of our FFCs, Luqman Sookia, currently studying Banking and Finance @ Curtin Mauritius.
With the advent of technology and internet, a new digital era was born. Certainly, one of the most innovative technology that is gradually paving its way into our lives is blockchain technology. Its adoption in the financial world has bitcoin as its epicentre.
Bitcoin has been in the limelight for quite a few years now. It has encountered several crashes and somehow happened to have survived and become even stronger. With now hitting a record high of $60,000, one of the most notable events demonstrating bitcoin’s surreal gain in value has been the “Bitcoin Pizza Day”. On 22 May 2010, Laszlo Hanyecz bought two large pizzas with 10,000 Bitcoins as a payment worth at the time around $41. If he would have held all his Bitcoins till now, it would have been worth around $550 million in just 11 years, or 27 million pizzas.
Over the recent years, we saw the creation of other cryptocurrencies with their own target markets including the new central bank digital currency most commonly referred to as CBDC, all predestined to become as mainstream and versatile as fiat currency. Therefore, are bitcoin or other digital currencies the future of money and what do they need to succeed as a currency?
Evolution of money
From bartering to early commodity money and to now using paper money and credit cards, money procures its value by account of its function. Money primarily acts as a medium of exchange. Money itself has no value, where it is only an estimate of its perceived value viewed by the public. Up to now, only governments could confer the legitimacy of their currencies which had to be constituted by law. Central banks can also control the amount of money being printed and distributed. However, after the 2008 financial crisis, people started questioning their trust towards governments and banks which brought the impetus for a new decentralized ecosystem.
The bitcoin protocol was first introduced to the world on 31 October 2008, where the creator or creators of the coin appeared as the pseudonym of “Satoshi Nakamoto” and has since then remained unknown. The concept of bitcoin was projected as a decentralized digital currency. The goal was to erase any third parties and instead use a public ledger of transactions that anybody could store on their computers, known as the blockchain. Blockchain technology allows many different entities to store a copy of the history’s transactions which is then distributed amongst other users, it is not controlled by a single entity.
Since its creation, there has been numerous cryptocurrencies in the market, known as altcoins. There are 3 specific cryptocurrency categories – transactional, platform and utility cryptos.
To date, there are more than 4000 cryptocurrencies in the market with a total market capitalization of around $1.8 Trillion, yes Trillion. Bitcoin now has the largest market capitalization of more than 1 Trillion but it fluctuates rather frequently due to its high volatility. The second largest is Ethereum at around $200 Billion. Contrarily, many of these cryptos in the market have limited to none trading volumes.
Consequently, the ramification of such disruption in the financial system posits both a practical defiance to current monetary regimes and a theoretical one whereby the legislation of currency and the requisite foundation of money should be controlled by governments only.
Bitcoin – A dent in the financial world
The tipping point of bitcoin’s innovation revolves around a peer to peer trusted system. Bitcoin is often compared to gold since they are both scarce and are used as a store of value. In fact, its price is driven solely by demand and supply. Most people invest in Bitcoin hoping that it will gain more value in the future. Nonetheless from a recent article by CNBC, it was found that more than 1 to 3 cryptocurrency investors had little to no knowledge about the digital currency and its main function.
Bitcoin is often viewed as an instrument of quick investment or “make quick money” rather than its main purpose being an alternative to fiat money. Ultimately, this effect provokes high volatility in the market which makes it harder for the digital currency to be adopted as a mainstream form of currency.
Source: CoinMarketCap, Bitcoin’s price from 2016 to 2021.
Subsequently, there has been a lot of hype around the cryptocurrency space lately with payment companies like Stripe and PayPal now accepting Bitcoin and other cryptocurrencies. Its adoption in the financial world is gaining more significance with Square announcing in 2020 the buying of 4709 Bitcoins for $50 million. This means that you will be able to transfer money from one country to another with far less fees and transfer time than the traditional banking method which would use the exchange rate system. Likewise, many financial institutions like J.P. Morgan and Goldman Sachs are now seeing the true potential of Bitcoin, with future plans of accepting Bitcoin as payment. VISA also has recently revealed that it will offer credit cards with Bitcoin rewards. Even Elon Musk recently said that Tesla will start accepting bitcoin as payment for cars.
The flaws of Bitcoin
Firstly, bitcoin has been viewed as a money laundering vehicle. Although bitcoin may be used for black market transactions and for other illicit activities, the overall impact of bitcoin and other cryptocurrencies financial crimes is insignificant in comparison to cash transactions. In 2019, only 0.5% of all bitcoin transactions were spent on the dark web. Actually, Bitcoin’s adoption to the financial world is real and is already happening, even if it is still volatile. However, can Bitcoin supersede fiat currency as the ultimate store of value since it necessitates no political or governmental regulations?
Only 21 million bitcoins can ever be mined, meaning it is impossible for any entities to create new bitcoins that would devaluate or inflate it. In a purely theoretical standpoint, bitcoin is inherently deflationary in the long term due to its limited supply and its increasing purchasing power. Alternatively, there has been many arguments from the bitcoin community refuting this idea. For once, a growing population will lead to more demand, hence leading to a deflationary pressure. Adversely, they argue that the definition of deflation is formally a decrease in supply of money and not in prices itself. Bitcoin’s supply will not decrease but will rather stay relatively constant. Also, the bitcoin protocol is designed to sustain both inflation and deflation.
In addition, Bitcoin’s underlying technology is blockchain, whose nature is considered as decentralized and is claimed to be unhackable. An article published in 2019 by MIT Technology Review indicated that blockchain could perhaps be hacked, since hackers previously saw a loophole in the system. Bitcoin alongside other cryptocurrencies can be bought on exchanges just like Coinbase and Binance to name a few. These exchanges provide you with your own wallet and give you total rights of your own cryptos but then comes the question of whether it is totally decentralized. Some argue that since these exchanges add fees and security concerns, Bitcoin itself has been “recentralized” but this argument is somehow subjective.
Another argument that makes people skeptical in using Bitcoin as a replacement for fiat money can be due to its energy consumption. According to an article from BBC in 2019, Bitcoin uses as much electrical energy as Switzerland, around 58.93 TWh per year to 58.46 TWh per year respectively disregarding other energy usage from the country like heat energy from coal, oil, gas and so on. Bitcoin’s carbon footprint is due to its mining process of not only creating new Bitcoin, but also the critical component for the maintenance and development of the network. Miners can be considered as auditors and this task can be very costly and sporadically rewarding.
Ethereum – The open-sourced blockchain
Ethereum is a platform cryptocurrency which operates on its own separate blockchain system and protocol. A platform cryptocurrency is primarily designed to eliminate middlemen, create new markets and even kickstart and launch other cryptocurrencies. In fact, Ethereum fosters mainly on decentralized applications rather than as a digital currency. Created in 2015, Ethereum allows developers to create and run their applications with added decentralized security. Its token “Ether” can also be used and traded as a digital currency like any other cryptocurrencies. As a result, Ethereum’s main purpose is not necessarily to replace fiat money but rather help promote a decentralized space for developers and their application and monetize their work.
Ripple – A non-blockchain cryptocurrency
Ripple on the other hand does not use blockchain but is instead utilized for larger companies and corporations to move large amount of money. The utility cryptocurrency uses a common ledger that is managed by independent networks, with the ability to move assets instantly with less fees. “XRP”, Ripple’s token, cannot be mined but has been issued by the company at 100 billion. Subsequently, Ripple’s ultimate goal is to connect banks and other financial institutions with instantaneous payment settlements for frictionless transfer of value. However, many people view Ripple being able to supersede fiat money as highly improbable, if not impossible.
Central Bank Digital Currency (CBDC) – The controversial new digital currency
Issued by the central bank, CBDC can be represented as the closest digital form of a country’s fiat currency. For several years now, central banks have begun to acknowledge the threat of cryptocurrencies and are therefore experimenting with new digital currencies of their own. These digital currencies are issued by the central bank, hence backed by the country’s government. 60% of the world’s central banks including Europe and the US are already in the research and development phase. However, it will take around 3 to 5 years before we start seeing these digital currencies circulating in the market. China on the other hand has already launched its own CBDC known as the digital yuan.
Contrarily, one of the main concerns CBDC raises is privacy issues. The digital yuan for example, can be traced by China’s central bank, the People’s Bank of China (PBoC), therefore, they can track everything from transactions to spending patterns. This could usher in privacy concerns which would never have been possible with the current monetary system. CBDC seems less about money and more about data. Users’ information are kept anonymous on the surface from other users but beneath it is where the central banks collect and store all the data. It is unlikely that we would be willing to give such control to governments which defeats the whole purpose of why bitcoin was initially created. Adversely, this digital currency can create more efficient monetary policies and counter criminal activities but the opportunity cost of giving out our data and privacy is too risky.
Which digital currencies will supersede fiat money?
Cryptocurrency is on the cutting edge of the split between a centralized incumbent order and a decentralized voluntary one, and that separation depicts the philosophy and the purpose of money itself. Perhaps, it is inevitable that quantitative easing will trigger uncontrollable hyperinflation of all major fiat currencies in the near future which will force us to seek for alternative digital currencies as the new form of transaction.
The future of money is optimistic, but who will win the race and dominate the market as the next currency? Well, it will not be bitcoin or altcoins or even CBDC to that matter. It might be a culmination of many cryptocurrencies complementing each other for a decentralized future. Otherwise, blockchain technology will keep improving and push developers to venture new innovative pathways that shall tackle existing cryptocurrency limitations. This will enhance current cryptocurrencies or bring forward better digital currencies which might make its adoption easier. The COVID-19 pandemic has proven to accelerate the dispersion of digitalization in both the economic and financial system. In a future contactless world, the vast majority of interactions must take place virtually. Consequently, it is only a matter of time before we start using cryptocurrencies for our daily transactions.
REFERENCES - PART 1
REFERENCES - PART 2
https://medium.com/@xaurumofficial/the-difference-between-cryptocurrency-and-digital-assets and-why-should-holders-care33e00c62a3b9#:~:text=Cryptocurrency%20is%20a%20dig,the%20right%20to%20use%20it. https://www.economicsobservatory.com/are-bitcoin-and-other-digital-currencies-future-money https://www.bbc.com/news/technology-48853230
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