What is the Purpose of Bitcoin: Speculation or Dollarization?
What is the Purpose of Bitcoin: Speculation or Dollarization?
The US dollar has made its mark around the world, and several countries have integrated the US currency alongside their own. What is dollarization? The definition of dollarization incorporates the US dollar alongside a local fiat currency and typically occurs when the prevailing currency has lost its value.
But technology has advanced and, with Bitcoin and other cryptocurrencies, we find a more futuristic form of money. Experts debate whether the purpose of Bitcoin is that of a speculative asset, which means that Bitcoin is riskier than most other investments.
However, a speculative investment is not what the creator of Bitcoin, Satoshi Nakamoto, had in mind when he introduced the Bitcoin project. Nakamoto envisioned Bitcoin as an alternative to traditional fiat currencies.
Twelve years after its inception, the world is still deciding what Bitcoin does and how it should be classified. What is the purpose and function of Bitcoin? Could the world’s first cryptocurrency be considered a speculative asset due to its volatility, or will Bitcoin be a new form of dollarization?
Also, why do people think that Bitcoin is just speculation? Will cryptocurrencies start to coexist with traditional fiat money or will they completely replace certain currencies?
This article will explore the current state of Bitcoin and whether the cryptocurrency has what it takes to replace the dollar or should simply remain in the background as a more speculative investment.
The Original Purpose of Bitcoin
As all crypto enthusiasts know, the Bitcoin white paper was published in 2009 by the pseudonym Satoshi Nakamoto. What does Bitcoin do? According to the document, Nakamoto intended Bitcoin to be a “purely peer-to-peer” version of electronic money. The document detailed that Bitcoin was to be an anonymous alternative payment system, eliminating the need for third-party participation.
However, more than a decade after the creation of Bitcoin, it is debatable whether Bitcoin achieved Nakamoto’s initial bold vision. After all, the Bitcoin network suffers from scalability issues and high transaction fees, leading many to believe that Bitcoin is more of a store of value than an alternative form of cash.
Bitcoin has certainly risen in value to successful competitors such as gold (a commodity) in terms of price. But when it comes to using Bitcoin as alternative cash, Satoshi’s vision might not have been fulfilled. Bitcoin struggles to process more than seven transactions per second (TPS) and continues to suffer high fees in times of network congestion.
In March 2021, Visa processed an average of 84 million transactions per day. In that same period of time, Bitcoin had only processed an average of 350,000. In an attempt to create a global alternative to fiat money, 350,000 daily transactions are a significantly low threshold.
With more than 12 years of existence, the lack of a substantial daily transaction value of Bitcoin leads many to argue that the world’s first cryptocurrency is intended to be a store of value rather than an alternative currency. Although Bitcoin contains some characteristics relevant to a currency status – such as its use as a medium of exchange – scalability issues, among others, seem to prevent Bitcoin from reaching new heights as a global alternative currency.
How Useful can Bitcoin be in the Long Run?
A trusted store of value is an asset that appreciates slowly over time. Gold, for example, is probably the most popular store of value. Bitcoin is considered by many to be a form of “digital gold.” But what is the purpose of Bitcoin, or what is it used for?
Looking at the price history of Bitcoin, it could be argued that the world’s first cryptocurrency is a fairly reliable store of value. Bitcoin started at less than a dollar and has been slowly rising in value every year since its inception. In 2010, Bitcoin could not even reach a dollar. In 2013, Bitcoin spiked to $ 220 before falling back below $ 100. In 2017, Nakamoto’s assets surpassed $ 20,000 before skyrocketing above $ 64,000 in 2021.
Part of the success of Bitcoin’s price is due to long-term holders, or HODLers. These are Bitcoin investors who have no intention of trading with them. HODLers who have millions in Bitcoin are called whales and they can change the asset’s market with a single sale. However, the dedicated whales understand that they keep the price of Bitcoin high and seem to have no intention of selling for a long time. Like gold investors and others who invest in assets of value, HODLers view Bitcoin as a form of money that is constantly appreciated.
When the COVID-19 pandemic hit the world in early 2020, almost all financial assets suffered a price crash, as investors withdrew their money out of fear. That said, over the years, investors poured money into Bitcoin and gold at an alarmingly similar rate.
While a positive correlation between Bitcoin and gold could lead to belief in the cryptocurrency as a store of value and a safe haven asset, the two assets saw an inverse correlation the following year.
There is a positive correlation when two variables move in parallel, that is, in the same direction. A safe haven asset is a financial instrument that is expected to maintain or even increase in value during an economic crisis. Since these assets are uncorrelated or negatively related to the overall economy, they can appreciate in the event of a market crash.
From an institutional point of view, a good number of companies believe that the purpose of Bitcoin is to be the next potential reserve asset globally. Both the financial group JPMorgan Chase and Blackrock believe that the former cryptocurrency is digging into the market share of gold, for example.
In contrast, Europac’s chief economist and global strategist Peter Schiff claims that Bitcoin is just a “giant pump and dump .” In mid-2021, Schiff publicly debated with Anthony Scaramucci, the founder of the investment firm SkyBridge. The former claimed that gold will have a use case even 1,000 years from now, due to its physical nature, which implies that another asset could easily replace Bitcoin in the short term.
Scaramucci defended Bitcoin, arguing that the scarcity of the digital asset is reason enough for it to hold its value over the long term. Unfortunately for Bitcoin, Schiff tipped the audience towards a 51% belief in gold, with only 32% in favor of Bitcoin.
Schiff’s argument has a fair point. Historically, all stores of value, such as property, gemstones, and art, have been physical items that stand the test of time. The digital nature of Bitcoin could mean that if everyone walks away from the first cryptocurrency, it is practically useless and could cease to exist. Meanwhile, physical assets have other uses, which are part of their value.
However, as the world moves towards a more digital future, Bitcoin believers argue that a digital store of value is a progression from what came before. After all, Bitcoin is a globally accessible asset with more than $ 1 trillion of liquidity. Bitcoin cannot erode over time, and the scarcity of the asset could be positive for Bitcoin price speculation or Bitcoin investment speculation as long as users invest in the cryptocurrency.
The Case for Bitcoin as a Currency
Despite the constant volatility of Bitcoin, it could be argued that Bitcoin exists as a currency in the form that it was originally presented by Nakamoto.
After all, on paper, Bitcoin is a relatively easy asset to acquire. Potential Bitcoin holders do not need a bank account or deal with a third-party controller to work with Bitcoin. Globally, the financial infrastructure of Bitcoin is already in place. Traders can simply choose to start accepting Bitcoin, assuming their local regulators respect the cryptocurrency, and anyone in the world can easily come and spend it.
But the case for a coin is based on more than just the ability to spend it. When compared to the three elements of traditional currency – storage of value, medium of exchange, and unit of account – Bitcoin is not viewed by its opponents as an alternative form of cash.
1. Bitcoin as a Medium of Exchange
Bitcoin fits the description of a medium of exchange quite well. The world’s first cryptocurrency is already accepted for goods and services on various websites and even some local businesses in a strip of countries.
Unfortunately, much of the history of Bitcoin as a medium of exchange lies in its use on the dark web. In particular, Bitcoin was the currency of choice for users purchasing illegal narcotics and conducting dangerous activities on a website called Silk Road.
That said, the bad actors’ beliefs as to the purpose of Bitcoin as an anonymous currency were wrong. Governments ended up withdrawing Silk Road after using various tracking methods within the public Bitcoin ecosystem. Due to the lack of anonymity of Bitcoin, it could be argued that Bitcoin was used as a medium of exchange on Silk Road, as goods and services had a certain value within the platform, and Bitcoin was used to pay for said goods and services.
Furthermore, Bitcoin is fungible, which means that each Bitcoin is interchangeable with another, similar to the US dollar and other fiat currencies. Some countries are even beginning to adopt Bitcoin as a medium of exchange. In September 2021, El Salvador became the first country to adopt Bitcoin as legal tender. President Nayib Bukele believes that Bitcoin will help 70% of Salvadorans who do not have access to adequate banking.
But if the government of El Salvador believes that Bitcoin is a great complement to its use of United States fiat, 70% of its citizens are against bidding for Bitcoin. Many Salvadoran citizens do not even know how to use Bitcoin, so the government of El Salvador must educate the people to see if Bitcoin as legal tender alleviates their distress.
One roadblock to Bitcoin adoption is network scalability issues. Currently, the Bitcoin network can only process seven transactions per second (TPS), compared to 24,000 for Visa. Some second-layer solutions, such as the Lightning Network, are working to solve Bitcoin’s scalability problems.
Although the Lightning Network is experiencing some level of adoption, it remains to be seen if the project can function at scale, as the Bitcoin network cannot be considered a medium of exchange if Bitcoin cannot increase its average TPS.
On the other hand, it should be noted that Bitcoin is a deflationary asset due to its hard cap of 21 million coins. Considering that Bitcoin is believed to rise in value as the asset becomes rarer, the cryptocurrency could very well be used as a medium of exchange similar to the gold standard when it was in effect.
But again, if businesses don’t embrace Bitcoin as a form of daily payment, the deflationary attribute of Bitcoin would lend itself more to a store of value than an alternative currency.
2. Bitcoin as a Unit of Account
Bitcoin’s volatility makes it difficult to exist as a unit of account. After all, an asset that can fluctuate tens of thousands of dollars in a day can hardly be issued in a local economy, much less be considered a reliable way to transact value.
A product can be worth $ 0.00034 in Bitcoin one day, only for the value of the product to completely change in the next hour due to the constant price swings of Bitcoin.
It is also difficult to determine the true value of Bitcoin at any given time. Crypto exchanges show different prices for Bitcoin at any given time, with price disparities of up to hundreds of dollars each time. Retailers cannot be expected to keep up with Bitcoin price changes if the world cannot even agree on a price point.
Also, we have the average denomination of Bitcoin. Considering that the price of a Bitcoin is well above $ 10,000, not to mention a dollar, how can retailers set the price of their products? If the price of a coffee is $ 0.00034 Bitcoin on Tuesday and $ 0.000012 on Thursday, both customers and retailers would have a difficult time analyzing the true value of the coffee.
For both accounting and convenience reasons, today’s financial systems around the world are presented as simply as possible. Asking traders to adopt another form of fluctuating and confusing accounting in Bitcoin is unlikely to go well.
3. Bitcoin as a Store of Value
As mentioned above, Bitcoin could best be viewed as a store of value, even if there are some issues with this moniker. On the one hand, speculation about Bitcoin points to its volatility, which makes citizens doubt to see Bitcoin as a reliable long-term storage method.
When people invest in gold, they do so expecting the precious metal to slowly increase in value from the moment of purchase. At the very least, investors in gold expect to be able to resell the metal at a relatively similar starting price.
Bitcoin, on the other hand, can go down in price by more than 100% from the moment of its purchase. Although the volatility of Bitcoin may also lean towards the positive, such a high level of risk does not bode well for the future of Bitcoin as a store of value.
We must also consider the lack of physical representation of Bitcoin. Gold, art, and other stores of value can be hidden or safely stored for as long as they are kept. Bitcoin can be safely stored in a few ways, like a hardware wallet, but most investors keep their Bitcoins on a cryptocurrency exchange or other internet-connected wallet. The constant connectivity of online wallets leaves Bitcoin at a constant risk of theft that is completely out of the holder’s control.
Bitcoin insurance exists to some extent, but the level of accessible insurance totally depends on where the user has their cryptocurrency. Even if an investor finds the safest way to store their Bitcoin, traders are still at the mercy of the drastic volatility of Bitcoin. All this assumes that Bitcoin continues to be in demand. While the limited supply of the cryptocurrency is expected to create steady demand if a better crypto project comes into play, what is everyone doing with their now useless Bitcoin?
The Case for Bitcoin as a Speculative Asset
Looking at the first 12 years of Bitcoin’s existence, the asset can be considered speculative. Although that classification of Bitcoin may certainly change in the future, the unpredictable nature of the cryptocurrency makes it difficult to describe it as anything other than speculative.
Rosa Ríos, former Treasurer of the United States, has argued that most cryptocurrencies, including Bitcoin, are entirely speculative, as most have no primary purpose. Rios cited Ripple as less than speculative, considering that the asset is intended to facilitate cross-border payments around the world.
Interestingly, the president of the United States Securities Commission, Gary Gensler, has claimed that Bitcoin is primarily a speculative store of value. Gensler stated that Bitcoin and other cryptocurrencies do not serve citizens in the same way as the dollar. Still, we should consider Bitcoin as a single asset class and not as an asset that can enact widespread dollarization.
Bitcoin Against the Dollar
The promise of a digital alternative to traditional currency, not controlled by a central government or party, is polarizing for several reasons. On the one hand, it is easy to understand why a merchant may not want to accept Bitcoin against their local currency. If a merchant accepts Bitcoin for a good or service, Bitcoin can lose its value the next day. If a business is in trouble, it likely wants the steady income that the established dollar provides.
But Bitcoin advocates could argue that not accepting Bitcoin implies that the coin will only rise in value as it becomes rarer, claiming that Nakamoto’s cryptocurrency is a deflationary asset. In contrast, the US dollar is inflationary and will lose value over time. In the long term, assuming the demand for Bitcoin continues to grow, Bitcoin may very well be the asset to hold for the long term.
Let’s understand the differences between the dollar-based monetary system and a Bitcoin-based global monetary system.
Of course, if Bitcoin were to become the replacement asset for the US dollar in other countries, there would have to be a regulatory review. After all, Bitcoin is a global cryptocurrency and monetary policy would have to change to respect Bitcoin’s global reach. There would have to be tax changes, value adjustments based on the different fiat currencies, and a unification of the current global financial system.
This is not to mention that a government cannot print more Bitcoin than it can with a dollar. The limited amount of Bitcoin could mean that millions of people cannot have even a single BTC. Could Bitcoin’s limitations cause financial strain similar to that of the gold standard? We can expect the same problems that applied to the gold standard to apply to Bitcoin. It is for these reasons, coupled with Bitcoin’s scalability issues and the asset’s lack of convenience, that Bitcoin may never experience dollarization in the way that the United States dollar has.