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Bitcoin would be a disaster, not an economy

In a Bitcoin powered economy, these things would be impossible for a central bank to accomplish. An important aspect of the Bitcoin protocol is that the total number of Bitcoins is limited to 21 million and will never be spent afterwards. This makes Bitcoin attractive to many people, as something that is never in supply is more likely to retain its value. The problem is that in the event of a crisis there would be no way of adding liquidity to the system, since you can no longer “print” bitcoins. The central bank could build a supply of bitcoins that it could then inject into the system, but that would be of little use because people would know the supply is limited. And in any case, central bank demand for bitcoin would drive the price up, which would make people more clingy to it and less willing to spend it – the opposite of what you want in a financial crisis.

Bitcoin would also make it difficult for governments to fight recessions, which they normally do, using what economists refer to as countercyclical monetary and fiscal policies. Central banks cut interest rates and, as the Federal Reserve did after the 2008 financial crisis, pump money into the system by buying assets (known as quantitative easing). And governments are trying to get the economy going again by cutting taxes and increasing spending, usually paying for it by borrowing like the Obama-era stimulus package.

Here, too, a Bitcoin economy would limit the government’s options. Since the central bank had no control over the currency, it would have no control over interest rates and only a limited ability (depending on the size of its Bitcoin supply) to pour money into the economy. Fiscal policy would also be on the verge of impotence. If the government runs a deficit today, it can have the Fed print money and then borrow that money from the Fed. That adds liquidity to the system. In the bitcoin world, the government would have to borrow bitcoins to spend. And again, this would make bitcoins more valuable and make people less willing to spend – the opposite of what it takes to battle a recession.

But do not worry

The good news is that it is an incredibly unlikely future. While the idea of ​​making Bitcoin a universal currency may have impeccable logic for utopians of the digital age, it makes little sense in practice. And the design of Bitcoin also makes it difficult to imagine. Since the supply of bitcoins is limited, their value increases as demand increases. But that means if you own bitcoins and you think they will become more popular then it makes sense to keep them as they will be more valuable tomorrow. That leaves people less interested in using bitcoins to actually buy things and more interested in treating them as speculative investments – the opposite of what you’d expect in a medium of exchange.

This does not mean that cryptocurrencies are useless. Buying drugs, laundering money: these are situations in which they can come in handy.

One might think that the same restrictions on the supply of gold applied when economies were run on the gold standard. But the gold supply was not fixed. It expanded as people extracted more of it. There was actually such a thing as an equilibrium – as economic growth increased the demand for gold and made it more valuable, the rising price encouraged people to mine it, which brought more gold into the system and ultimately kept the dollar value of gold relatively stable. Between 1800 and 1900, the dollar value of gold gradually increased by small percentages. Bitcoin, on the other hand, regularly rises and falls by 5 or 10 percent in a single day, solely due to shifts in speculative sentiment. This volatility weakens its usefulness as a store of value (one of the other functions of a currency) and makes it unsuitable for everyday use as no one wants to accept a currency when it has a value 10 percent less in a couple of hours. In other words, a financial system powered by Bitcoin would have all of the bad properties of the gold standard and few of the redeeming ones.

There are also practical hurdles to making Bitcoin a currency that people can easily use. When the demand for Bitcoin is high, transaction fees go up as miners raise the price of processing these transactions. At the height of the Bitcoin mania last fall, a transaction could cost as much as $ 55. That was fine when people thought the value of their bitcoin supply was going to double overnight. But it doesn’t work when people use Bitcoin to buy pizza or a new TV. More importantly, Bitcoin cannot scale to handle the number of transactions a modern economy requires. The system is limited to processing only 420 transactions per minute. Finally, there’s the fact that a remarkably small number of people control a remarkably large percentage of all of the bitcoins in the world. That gives them the leverage to manipulate prices and makes it harder for Bitcoin to have the reach it needs to become a real currency.

Choose your own currency!

Of course, Bitcoin is far from the only cryptocurrency. Depending on how you count, there are now hundreds, if not thousands. And although they are all built on the blockchain like Bitcoin, some have features that make them appear more attractive as a potential global currency. Litecoin, for example, can process more transactions per minute. Monero and Zcash offer true anonymity (unlike Bitcoin, where every transaction is linked to a specific key that can be tracked). And not all cryptocurrencies have a fixed upper limit for the total number of coins. So maybe another cryptocurrency could replace the dollar or the euro or the yuan – or, what is more plausible, we could end up with a system of many different private currencies instead of just relying on a single medium of exchange.

There is something appealing about the idea that everyone chooses the currency that suits them best and that cryptocurrencies compete against each other to win the loyalty of consumers and businesses. But in fact, the proliferation of cryptocurrencies that we’ve seen over the past few years makes it less likely, no longer, that they will eventually replace fiat money.

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