How the crisis makes crypto a better investment (3/3) - icoinic
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Imre Molnár
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How the crisis makes crypto a better investment (3/3)

In the last part of the series, Bitcoin will be introduced and explained as a form of digital money. There are a couple arguments that strenghten the position of the Bitcoin and make it more likely to survive. Nonetheless, there are some factors which can make it irrelevant. At the end of the blogpost we will conclude the series and try to answer the question ‘How the crisis makes crypto a better investment’.

Why Bitcoin is here to stay

Bitcoin is actually so little compared to gold (which is also a small market in the financial world), that one might ask: is it possible that crypto and Bitcoin will disappear in the future? It cannot be ruled out at this point but there are reasons which make it highly unlikely:

  • Bitcoin is a protocol, not an organization
  • There was a breaking point in Bitcoin’s history, and it survived it
  • Its eco-system is growing and highly decentralized
  • It is the most well-known alternative digital currency

Bitcoin is a protocol, not an organization

Bitcoin on a protocol level is just a set of rules on how to maintain the ledger of transactions, what a valid transaction is, how new bitcoins are emitted and who gets those. If one complies with the rules, then he or she can participate in the network without restrictions. The rules are fair and simple. They do not require to use any specific software or hardware. Thus, anybody can write a software to interact with the Bitcoin network or create a hardware which stores bitcoins. 1 Today bitcoins can be transacted by touching a plastic card to a sensor, or by using a wallet software on a PC or on a mobile device, or by sending an email or even on paper. 2 Due to the numerous ways to use the network and because of the fact that no permission is needed to open a Bitcoin address3 , there are already huge numbers of users distributed worldwide.

Since Bitcoin is just a standardized and open way to send money over the internet, it is very difficult to stop it. It is like stopping a custom or tradition that people voluntarily comply with. It is not practically feasible to go and check everybody nor is it easy to explain why it should be stopped. In addition to this, what needs to be stopped is the activity of a person keeping a secret passphrase and occasionally producing digital signatures, for transacting and sending that to the network. These actions can be done very easily and in so many ways, that’s what makes it a heroic effort to keep it from not happening. Furthermore, the users are distributed around a globe which would make it difficult to stop it effectively, even if one had legal authority to do so in a given jurisdiction.4

Bitcoin has been an open source project and developers built its codebase voluntarily, free of charge. There is no organization which owns Bitcoin or blockchain, nor is there a person who would be liable for its development or use. Therefore, there is no one in power who could be contacted to stop the network or to make changes that somebody would like to implement in the protocol. This is a unique feature compared to proprietary IT products, where the owner could be legally held liable for the operations of the product. One example is the story of the cryptocurrency project of Facebook, called Libra 5 which was forcefully halted by the US government as it raised concerns that it might diminish the global hegemony of the US dollar.

There was a breaking point in Bitcoin’s history and it survived it

In 2014, the biggest Bitcoin exchange of the world got hacked and all bitcoins got stolen. At that time the funds were worth around $450 million and the exchange was so big that it handled 70% of all bitcoin transactions worldwide. Back then, Bitcoin was more of a niche thing that was fun to try out for IT enthusiasts. An experience like this, when all funds are gone, due to the mismanagement of a start-up somewhere in Japan with whom most of the users had no contact, is exemplary. It could have easily been a point when the development of the Bitcoin eco-system stops, as a big part of the group who did the work had a terrible experience. Nevertheless, Bitcoin as a protocol survived, it was never hacked since its inception 6and there are dozens of new exchanges since then who have built their businesses around the protocol.

Its eco-system is growing and highly decentralized

Although the protocol is incredibly difficult to stop, the companies who use it and the software which builds on Bitcoin are subject to local laws. There are examples when a government tried to limit the use of crypto by prohibiting operating crypto exchanges, or made crypto mining illegal. However, these measures did not prove to be long-lived as Bitcoin lives on the internet, and it does not matter too much from which location those companies run their servers to provide their crypto services. Thus, crypto companies moved to other countries where the regulations were more friendly like Japan, Singapore or Malta. Apart from the businesses, there is still serious development going on in the open source communities, which are developing the Bitcoin Core software or the Lightning Network. These developers are working remotely around the world and sometimes even their identity is unknown.

It is the most well-known alternative digital currency

By today, Bitcoin is by far the most well-known alternative digital currency of the world. From its start when it was a technological solution to create digital cash, it went on to be a household name after its dark web scandals and its speculative bubbles. Currently, there is hardly any person in the world who has not heard of Bitcoin and surveys show that young generations like millennials and Gen Z have more faith in Bitcoin than in the financial system. For this reason, if money was about to be changed then Bitcoin has quite a good chance to come to mind.

It is clear in 2020 that the world loves digital currency. We prefer not to count change and carry coins in our pockets around or to do online shopping instead of queueing for long minutes in the store. However, at the moment we have no standard way to transact money online. For merchants and customers, there is MasterCard, Visa, Amex, JCB, PayPal, Apple Pay, online banking and many local payment processors for those which always raise questions of compatibility at payments. For banks there is SWIFT. These are all corporate solutions which make online payments possible, but they come with their costs too. 7 Also realize that there is no actual digital money in the systems. It is not possible to take your digital money out of the system to take it home and store it on a big memory stick. Therefore, a digital standard for peer-to-peer online transaction would help the situation and Bitcoin comes closest to that even in its infant form. 8

Bitcoin can become irrelevant

These are factors that almost guarantee that Bitcoin will survive. Nonetheless, there are some factors which can make it irrelevant. Firstly, governments might want to try to make it obsolete. This could be motivated with saying that cryptos are making their monetary policies less effective9 as it was the case with gold during the Great Depression.10 This could lead to banning the use of Bitcoin in physical and in online shops which would limit the use to international online payments or to peer-to-peer individual payments. 11 This sounds like something that would stop the adoption of cryptos, but if you think about online shopping, the jurisdiction where the products are sold is not crucial to the service. It sounds logical that some small countries would not resist to the tax revenues of an online store which ships to other countries.12

Furthermore, being one of the online currencies of the world, if nothing else, is already a big achievement. As daily life is becoming more and more digitalized, more people work online, more services are provided online so the need to have a digital currency which might be not even used for physical purchases is predicted to only increase in the future.

Secondly, it could happen that Bitcoin will stay around but will go out of business as there are other solutions which give a better user experience or will have quick successes at adoption maybe using government budgets for marketing campaigns13 . This sounds possible as its code is openly available and anybody could take it and modify somewhat the rules in it to create a digital currency that is desired. In this way a government could scrape off the deterministic emission feature, the permissionless participation in the network and give a very similar or even better experience to its users while keeping the option to print money and to censor transactions.

Central bank digital currencies (CBDCs) are more likely to occur than not. Currently many central banks are reported to have pilot projects on them such as China, Russia and probably the crisis will speed up the development and the process of approving experiments with them. On any given day, they might give a great competition to Bitcoin which will be about the governance of the monetary systems. This is because, it seems very unlikely that governments will create an alternative to Bitcoin which is also opened and fairly emitted. It is more reasonable to think that they will keep the right to inflate the money supply and permit licenses to participants to use their currency. However, if they do so, the different inflation rates in “crypto Rubel” and “crypto Yuan” will result in a non-static exchange rate between the two. This, and the possible technological differences will lead back to the problem of the non-standardized, fragmented global financial system.

Currently the global financial system does not work without frictions. Local digital transactions are convenient on the modern part of the world, but when it comes to international transfers using foreign currencies, costs jump high and hassles are usual with delays. Furthermore, the currency of global trade is the US dollar which requires to be wired through the FED every time a transaction is made in the world 14 . This requires sending the funds to an American bank who has an account at the FED which adds to the costs and to the transfer time, plus grants the possibility to the US to censor the transactions and enforce sanctions on countries. Recently, there was an alternative financial system developed by the EU to facilitate transfers to and from Iran. The INSTEX mechanism was successfully used for the first time in late March to bypass the US sanctions and continue trade with Iran.

This illustrates how money became a permissioned IOU which is also used for pursuing political agenda. Apart from the sanctions, money is also a political tool when it comes to financing unfeasible governmental projects. Printing money is extensively used in countries like Venezuela, Argentina or Turkey.

Another fact which is important to mention is that still 1.7 billion adults around the world remain unbanked. However, most of these people have internet access and a mobile phone, which makes them able to use permissionless digital currencies even though they are not allowed to open a bank account. This also provides a huge pool of possible users.

Conclusion on Bitcoin

For most of human history, money was separate from the state and it is only since the existence of central banks that the state manages the money supply. In the last century money became more and more political and global. After the widespread adaption of the internet, fiat money was also put onto the internet and used for online payments. It is clear by now that the standardization of a global native digital currency would be desirable, furthermore, its supply should not be changed to follow political agendas and it would be fairly distributed. Unfortunately, there is no sign that the world powers would converge to a solution like this, rather they use their currencies as economical weapons in global trade. Moreover, there is apparent need in the world from sanctioned nations, from countries with high inflation rates and from 1.7 billion unbanked, to have a permissionless digital currency.

Bitcoin provides a viable option to serve these needs. It has been running 24/7 for 11 years with 100% uptime without a single successful attack on it and settled more than 500 million transactions with low fees. The world knows about Bitcoin today and it is expected to become widespread by the younger generations. All these have been achieved without any corporate structure behind it or any budget spent on its marketing. It can be used merely with an internet connection without any third party and it can be stored online in several ways and also anywhere offline. Its supply has a deterministic trajectory and it is written in the consensus rules, meaning that it will not be changed.

As our life is becoming more and more digital and the internet is available on all devices around us, it seems logical to use a digital currency which was also born on the internet.

Back to the economic recovery

In section 1, it was discussed how the economies got to the point where they basically have no reserves and the monetary tools to fight the crisis. In the second part it was described how the provided solution fails to address the structural problems underlying this crisis and printing money takes value from those who hold their savings in the currency. In section 3, Bitcoin was depicted as a superior digital money with deterministic supply. This last section will show the possible role of crypto and Bitcoin in the recent crisis.

The possible role of Bitcoin in the recent crisis

Currency is the oil of the economy. Having the right to create currency out of thin air is a huge power. The creator can decide on how to spend big portions of the nation’s wealth.15 This leads to an enormous control over the economy. Central banks are aware of the responsibility of maintaining the ultimate price control: interest rates, which is, the price of money. This form of top down control is hard to practice since there are so many factors at the level of businesses and households, that are painfully difficult to measure and incorporate in their decisions. Furthermore, every action they take will have an impact in a few years making it especially hard to learn quickly from their mistakes and iterate.

Governors around the world are complaining about how hard their jobs are, and they are not doing well at it, as the recent crisis also illustrates. They have created boom and bust cycles in the last century and some severe crises which led to terrible political events. The FED is trying to solve the current crisis in the exact same way which led to the prevailing situation: create more credit.

Their solution will most likely fail soon, and inflation will kick in. The risk of a coming stagflation16  period is increasing rapidly and currencies around the world are under big pressure. The best hedge against stagflation, when companies are trying to survive and inflation eats up the purchasing power of cash, is going into scarce assets. Thus, traditional scarce assets like precious metals will perform well during stagflation. 17

Bitcoin is the first digital scarce asset of the world. It is native on the internet and the world knows its name by now. It provides an alternative to the current financial system; it was developed and works outside of that. It is a superior digital money and a fairer monetary system.18

We believe that it is going to perform exceptionally well in the coming years for the following 4 reasons:

  1. Better money: digital, permissionless, low fees, it is a protocol not an organization
  2. Better monetary system: global, native on the internet, no one has printing power
  3. Scarce asset: it is deterministically emitted and has low inflation
  4. Cheap: compared to its historical highs and to gold, it is a bargain now

Bitcoin could become the world’s reserve currency and whether this happens is to be seen in the coming decades. But just the fact that it could, makes it a brilliant hedge against the looming economic depression.

Footnotes

  1. It is similar to the TCP/IP protocol where it is required to package your data in a specific format to send it over the internet but it does not say anything what tools you have to use for packaging.
  2. It is even possible to mine bitcoin on paper, although it requires high accuracy and one would get pensioner sooner than paper mine a single bitcoin
  3. Nothing can stop anybody to do this as many times as he or she wants and open lots of addresses for any imaginable reason.
  4. One analogy is the existence of the BitTorrent file transfer protocol. It was created in 2001 to facilitate peer-to-peer file sharing over the internet and although its users repeatedly broke copyright laws around the world and law enforcements wanted to stop its usage for years, it was never effectively successful. BitTorrent is still around, however it has lost its popularity after the entertainment industry went from the CD and DVD distribution model to the streaming model.
  5. Reference to halting Libra
  6. Common misconceptions is that Bitcoin is not secure as there are many exchange hacks. This is analogous to giving the keys of a car to someone and saying that the car was not secure as it got stolen after the person let the doors open or even he ran away with it.
  7. Many small merchants do not accept credit cards since the cost of accepting them sometimes exceeds the margin they have on the sold product. Other implied cost of using credit cards online is the risk of credit card detail theft.
  8. Many claim that Bitcoin cannot be global medium of exchange since it allows only for 3 transactions per second while Visa can handle 45,000 transaction in a second. This is true if one means only the on-chain transactions of Bitcoin, however the second layer of Bitcoin, the Lightning Network, is designed to handle millions of transactions per second. The network is currently operational and growing, increasing the possible transaction rate as new peers join the network.
  9. Other arguments could be that Bitcoin fosters tax evasion and financing terrorism. Although these are common arguments around Bitcoin, they are not ones that would suggest that using Bitcoin would make things worse. Actually, if the government would register the Bitcoin addresses of its governed companies, the tax collection would be easier than currently, plus Amazon paid $0 tax in 2018 completely legally without using Bitcoin. Terrorists might use Bitcoin to transfer online which makes their fund sourcing much simpler as well as mobile phones make their communication simpler or cars make their transportation quicker.
  10. During the Great Depression, Roosevelt confiscated the gold reserves of the population by buying them at a fixed oppressed price. After all gold was collected, the dollar was devalued against gold.
  11. It sounds difficult to define what actually would be banned. Bitcoin or all cryptos? What is considered as Bitcoin or crypto? Again, banning a protocol is hard. If one took the code and ledger of Bitcoin and started a new identical crypto currency but called it “Not Bitcoin”, would that be in scope of the ban?
  12. Amazon can be mentioned as an example which has subsidiaries in many countries and actually it is permitted to buy products from Amazon Germany or from Amazon UK at the same time and get it delivered in a third country illustrating that international online shopping is already widespread.
  13. Similar story happened to BitTorrent which was made less commonly used after Spotify and Netflix started their services.
  14. Reference to Fedwire
  15. It is scary how well the causes section rhymes to the current situation
  16. It is scary how well the causes section rhymes to the current situation
  17. Gold’s performance during the great inflation crisis (1970-1980)
  18. Many times, it is depicted that one has to choose between BTC and the current financial system. This is not the case, it’s more like how WhatsApp and the other online messaging systems replaced SMS. Today you can still use SMS, even though it’s slow, limited and expensive. And there is WhatsApp too.
Luc Correia Cabrito