Why bitcoin won’t become like money

In the foreword to The Bitcoin Standard written by Saifedean Ammous, a book which has become the bible of bitcoin believers, Taleb had called bitcoin an excellent idea, primarily because “it has no owner, no authority that can decide on its fate". Nevertheless, that’s now changed. As he tweeted on 12 February: “I’ve been getting rid of my BTC [bitcoin]. Why? A currency is never supposed to be more volatile than what you buy and sell with it."

Why Taleb brought this up now and not in the past is something only he can clarify. But that does not take away the strength of his argument, which has often been made by others in the past. It’s this very point that basically makes bitcoin a speculative investment asset rather than a form of money that its founder(s) had hoped it would become.

Bitcoin is a cryptocurrency that has been around since 2009. It was supposedly invented by Satoshi Nakamoto, whose real identity or identities (given that it could even be a group of people), is/are not known.

In fact, the entire idea behind creating bitcoin was to give the world an option to the paper or fiat money system. The paper money system is run by central banks and governments; they can manipulate it at will. In the aftermath of the financial crisis of September 2008, the Western central banks printed trillions of units of paper money in the hope of getting their economies back on track.

Nakamoto looked at this as an abuse of the trust people had in paper money. And bitcoin was supposed to be a solution for this breach of trust; a cryptocurrency which did not use banks or any third party as a medium and the code for which has been written in such a way that only 21 million units can be created.

As of 16 February, the total number of bitcoin in existence stood at 18.63 million units. The rate of creation of new bitcoin keeps slowing down. Hence, unlike paper money, bitcoin cannot be created out of thin air. In fact, what is true about bitcoin now will be true about any other crypto which might displace bitcoin in future. Governments will continue to try and protect their monopoly over money.

Also, unlike the paper money system which is ultimately run by individuals, the bitcoin system is decentralised and has no owner. In fact, these are the main reasons offered by those who believe bitcoin is money or at least the future of money. But then, bitcoin’s dream of becoming a form of money has got many things going against it.

The issues

First and foremost, any form of money needs to have a relatively stable value. Between 21 January and 16 February, the price of a bitcoin went up 59.4% to $49,225. This made bitcoin investors more wealthy.

Nevertheless, the question that one needs to ask here is what does a huge increase in value of any form of money actually mean. It means that the price of goods and services that money can buy have fallen massively. Assuming bitcoin was a form of money, such a huge increase in its value would have led to a collapse in prices of goods and services, and played havoc with the economy already struggling with the covid pandemic.

Alternatively, let’s take the price of bitcoin between 8 January and 21 January, when it fell 23.8% to $30,873. What would this mean if bitcoin was actually money? The prices of goods and services would have gone through the roof. Hence, the world would move between inflation and deflation, in quick time, if bitcoin were money.

The believers offer two arguments against this. The first being that yes, bitcoin can fall massively, but every time it rallies back big time. This is an argument in favour of bitcoin as a speculative asset and not as something which expects to play the role of money.

Given the massive volatility in bitcoin price, a majority of bitcoin, at different points of time, have been held at a massive loss or at a profit (as has been the case in the recent past).

As Rebecca Patterson, Dina Tsarapkina, Ross Tan and Khia Kurtenbach of Bridgewater Associates, a globally renowned asset management firm, put it in a recent research note: “It is much more important for a storehold of wealth to confidently mitigate against downside risks than to possess speculative upside potential."

This is not to say that the value of paper money is stable all the time. But in the last four decades, the global consumer price inflation, which eats into the value of money, has largely seen a downward trajectory. Of course, there are always exceptions to the rule, and countries which see very high inflation at certain points of time.

For the second argument, the believers fall back upon The Bitcoin Standard, where Ammous writes: “Bitcoin’s volatility derives from the fact that its supply is utterly inflexible and not responsive to demand changes."

This is the point about new bitcoin growing at a very slow rate. Hence, whenever the demand for bitcoin goes up as fast it has in the last few weeks, the price goes up at a very fast pace because the supply barely goes up. When prices are falling and investors are selling out, there aren’t too many buyers going around, leading to very quick falls.

Nevertheless, as we shall see, this argument doesn’t really matter. Due to the overall limit of 21 million, bitcoin is often compared to gold, the argument being, like gold, bitcoin cannot be created out of thin air. This is true, but it comes with a corollary. While supply of bitcoin is limited, the same cannot be said about the supply of cryptocurrency on the whole.

Bitcoin is the most popular cryptocurrency, but it’s not the only game in town. Hence, the number of bitcoins may not go up, but the number of bitcoin-like assets will continue to go up in the years to come, as newer cryptocurrencies get launched.

As renowned investor Ray Dalio put it in a recent note on bitcoin: “Competition will play a role in determining bitcoin and other cryptocurrency prices. In fact, I assume that better ones will come along and displace this one because that is the way the evolution of everything works." Given this, in the years to come, gold will still be around, about bitcoin, we really don’t know.

In the future, the number of bitcoin-like assets will definitely grow. In the past, initial coin offerings (ICOs), which launch new cryptocurrencies have been very popular. An estimate made by Willian Quinn and John Turner in their book Boom and Bust–A Global History of Financial Bubbles suggests that these ICOs raised “$6.2 billion from investors in 2017 and a further $7.9 billion in 2018." A lot of this money never came back to investors.

The bitcoin and cryptocurrency believers are comfortable with this idea of a free market in money, where different forms of cryptocurrencies compete with one another and the best ones win. Nevertheless, it’s one thing to have competition in soaps and mobile phones, it’s another thing to have different forms of money compete.

Wildcat banking

In the mid-1800s, in the era of wildcat banking in the United States, there were many different forms of paper money going around. Almost any bank could print its own money and there were more than 8,000 different types of paper money.

Jacob Goldstein describes an interesting situation in his book Money—The True Story of a Made-Up Thing, regarding a customer walking into a shop, asking for a sack of flour and handing over paper money which the shopkeeper didn’t quite recognise.

What did the shopkeeper do? As Goldstein writes: “He pulls out his Thompson’s Bank Note Reporter—a handy periodical that lists every bank in America, what the banks’ bills [paper money] look like, and whether the bank is reliably redeeming its money for gold or silver." Back then, paper money could be exchanged for gold or silver.

In this environment, it was very easy for scamsters to issue fake notes. One estimate made by a Counterfeit Detector guide pointed out that in November 1854 around 825 different kind of forged notes were in circulation. Imagine the kind of anarchy that would have existed in the financial system, making it difficult to carry out even the most basic economic transactions.

Given this, it is hardly surprising that many bitcoin believers tend to believe in anarchy as well.

We’ll be watching you

Finally, as bitcoin and cryptocurrencies become popular, they are bound to attract the attention of governments. In fact, they already are.

In India, the government soon plans to introduce The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021. As finance minister Nirmala Sitharaman told the Rajya Sabha recently: “A high-level Inter-Ministerial Committee (IMC) … to study the issues related to virtual currencies… recommended in its report that all private cryptocurrencies, except any virtual currencies issued by the state, will be prohibited in India."

While the state issuing a cryptocurrency sounds like a good joke, it isn’t surprising that the Indian government is reacting the way it is. It is trying to protect its right to create money out of thin air. Further, the Indian rupee, like the dollar or the euro, is not a global reserve currency which is in demand all across the world.

Given this, if the Indian government, in time to come, decides to print a lot of money to pump up the economy, cryptocurrencies will make it very easy for individuals to move their money out of India. The spread of cryptos will also make it easier for individuals to move their ill-gotten wealth out of the country. It is worth remembering there is a limit to the amount of money that individuals can move out of the country every year.

Of course, India is not the only country worried about the spread of cryptocurrencies. As Christine Laggard, the President of the European Central Bank, recently remarked: “It’s a highly speculative asset, which has conducted some funny business… and totally reprehensible money laundering activity…There [have] to be regulations."

In fact, the American treasury secretary Janet Yellen, said something similar: “I see the promise of these new technologies, but I also see… cryptocurrencies have been used to launder the profits of online drug traffickers; they’ve been a tool to finance terrorism."

Interestingly, there are very few real uses of bitcoin going around, like should be the case with any form of money. Further, at some point of time in the near future, the governments of the world will start defending their right to create money out of thin air.

The prospect of government interference has got India’s cryptocurrency community highly concerned. As Sumit Gupta, CEO and co-founder of CoinDCX recently told moneycontrol.com: “We are talking about 75 lakh Indians who are invested into cryptocurrencies."

Of course, a bulk of investors in India and across large parts of the world have bought bitcoin and other cryptocurrencies through brokers. As the Bridgewater Associates points out: “Most bitcoin purchasers rely on wire transfers and bank debit to move money in and out of bitcoin exchanges." This goes against the very idea of bitcoin being decentralised and anonymous and being without the involvement of the banking system.

It also tells us that the philosophical undertones of the creation of bitcoin do not matter to the average bitcoin investor, who is just happy with the price rising. Also, the brokers don’t want their business to end. Gupta of CoinDCX told moneycontrol.com that “there is a lot of confusion in calling bitcoin as cryptocurrency and not calling it an asset." He further argued that bitcoin should be regulated as an investment asset in which people should be allowed to invest and not as money.

Satoshi Nakamoto, if he is alive and has heard this, must be wondering: where did it actually go all wrong.

Vivek Kaul is the author of the Easy Money trilogy