Cryptocurrencies – Problems and Solutions

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Bitcoin has resurfaced in the press. Some bitcoin proponents argue that the cryptocurrency’s price is rising because it is challenging gold’s status as the one supra-currency, the commodity to own when fiat currencies are debased. Is bitcoin a one-of-a-kind new store of value that combines some of the advantages of both technology and gold? Here’s the breakdown.

Cryptocurrencies - Problems and Solutions

There is a difference between Bitcoins and Money

Despite what some people believe, cryptocurrencies such as bitcoin are not money, both theoretically and legally, these are related to mining digital currencies. Money is a medium of trade, a unit of account, and a store of value.

Bitcoin is used to price and settle a limited number of products and services (or other cryptocurrencies). As a unit of account and a means of payment, Bitcoin is not widely recognized. To be sure, several cryptocurrency payment applications have been developed in recent years to encourage the use of cryptocurrency. Except for certain underworld transactions, none of them have made it to the heart of the world’s everyday transactions and payments.

Importantly, cryptos are valued in US dollars (or other fiat currencies). As a result, they’re no different from any other item priced in USD on the other side of a deal.

A means of payment must be given official monetary unit status by a country’s laws in order to be legally classified as income. This legal tender status enables debtors to pay their obligations/liabilities by passing them to creditors in a legal manner.

According to a recent study, 80 percent of the world’s central banks are either prohibited from issuing digital currency under current laws or their legal structures are vague and do not explicitly allow them to do so. However, in 2020, China passed legislation enabling its central bank to issue a digital currency, resulting in the development of the world’s first official digital currency, the Digital Currency Electronic Payment System (DCEP). Despite its digital nature, DCEP is not a cryptocurrency in the traditional sense.

Legal tender status is normally granted to forms of payment that are simple to pass and use by the general public. To use bitcoin or other cryptocurrencies, a digital infrastructure must be in place, which includes computers, smartphones, internet networks, and communication. Because of this, it is unlikely that cryptocurrencies will ever become money. It’s similar to Mark Cuban’s case against bitcoin as a medium of exchange.

Bitcoins – A Store of Value?

Something must be liquid, widely recognized, and have a stable value in order to function as a store of value. Bitcoin and other cryptocurrencies do not share any of these features.

Because of the presence of “whale wallets,” Bitcoin trading suffers from illiquidity and manipulation (wallets holding disproportionately large amounts of bitcoins).

The top 100 wallets are projected to own 13% of the total bitcoin supply in late 2020 (6), with most of the owners’ identities unknown. As a result, it would only take a few whale wallets to exploit the bitcoin market and cause wild price swings. Bitcoin and cryptocurrencies are unsuitable as a store of value due to their extreme price instability.

Is Fixed supply a problem?

Contrary to popular belief, the finite supply of bitcoins and other cryptos is not an advantage and does not preserve value; it is, in effect, a major obstacle to their acceptance as a currency.

There are a total of 21 million bitcoins that can ever be mined. There are currently 18.6 million bitcoins in circulation as of this writing. In 2040, the last bitcoin will be mined. Any cryptocurrency has a limited supply, and the rate at which it can be increased is unpredictable and uncontrollable.

Since the static money supply’ in the finance would deprive central banks of the opportunity to pursue countercyclical policy, cryptocurrencies are unsuitable as legal tender.

Crypto proponents, on the other hand, have profited from widespread fear and mistrust of fiat money as a result of post-Global-Financial-Crisis (GFC) monetization. They’ve cleverly twisted this supply issue into a case for cryptocurrency as a safeguard against doomsday scenarios.

What’s Next?

China, which used to be the world’s largest crypto mining nation, has seen through the smoke and mirrors and has slammed the brakes on cryptocurrency trading and mining. This demonstrates how easily regulators could destabilize the decentralized, free-wheeling crypto sector. Instead, China has formed an official DCEP with centralized power.

What crypto enthusiasts don’t seem to realize is that countries will take measures to safeguard their monetary systems and currencies, as well as their ability to tax and regulate the economy. The greater the number of people who believe cryptocurrencies are money, the greater the possibility of government interference in the sector. The rise of official digital currencies is a warning that central banks are retaliating.

Concerns about central bank quantitative easing and what these QE programs could mean for fiat money can be exacerbated by the common narrative that bitcoin’s finite supply guarantees its value. As a result, the rise of cryptocurrencies can be seen as a reflection of anti-establishment movements that have occurred in many countries since the 2008 global financial crisis.

If viewed favorably, this ‘crypto revolt’ could force governments to reform their economic management in order to regain confidence and reputation. We’ll have to wait and see.

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