Can Bitcoin Become The New Global Reserve Currency?

February 7, 2014Marketsby QFinance

Can Bitcoin Become The New Global Reserve Currency?

The lack of trust in the custodians of fiat money has provided a fertile context for the rise of Bitcoin, the ultimate digital alternative store of value as against mainstream, central bank managed currencies like the US dollar, sterling and the euro.

Ever since advanced market central banks began rolling the printing presses, the warnings from various quarters foretelling the implosion of fiat currencies have been getting louder and louder.

For International Monetary Fund (IMF) CEO Christine Lagarde, the unconventional measures taken by central bankers – such as the Fed’s quantitative easing (QE) and zero interest rate policy (ZIRP) and the ECB’s Long Term Refinancing Operation – have been key to preventing a re-run of the Great Depression.

However, polls taking the pulse of public trust in politicians and bankers are flagging up the fact that trust in both is at an all time low.

This lack of trust in the custodians of fiat money has provided a fertile context for the rise of Bitcoin, the ultimate digital alternative store of value as against mainstream, central bank managed currencies like the US dollar, sterling and the euro.

The idea of creating an alternative currency that could not be manipulated by politicians or bankers, but was grounded solidly on a "real world" factor, namely the price of a basket of commodities, was first put forward by Thomas Edison and Henry Ford.

In 1921, worried by what he (correctly) saw as the US Federal Reserve's manipulation of the dollar, Edison put forward a plan for a new dollar founded on the price of a basket of commodities, with the commodities being held at a specified collection of warehouses around the US. (The PDF file of the original New York Times 1922 presentation of Edison's idea can be found here). This plan would take politicians and central bankers entirely out of the loop and let the market determine the value of the dollar. 

Ford's plan was a proposal to have the government fund a hydro power project by issuing $30 million in new currency against the future value of the project down the generations. His goal was to enable the government to avoid the interest payments associated with issuing a $30 million bond.

Milton Friedman took the idea into the digital age by pointing out that there was actually no need for a Federal Reserve or for money to actually be printed. In an electronic era, it was perfectly feasible for a currency to be purely digital.

What made a currency real, he argued, was that a nation's people were prepared to trust it. Provided the form of that money was seen as convenient, it did not matter if the currency was paper based or purely digital.

Key to Friedman's proposal to get rid of the Fed was the idea of an automated computer that simply generated a set amount of money at regular intervals, no more and no less.

This basic idea is paralleled to a great extent by Bitcoin and appears to have been deliberately followed (or reinvented, perhaps) by Bitcoin's inventor, a person known only by the pseudonym, Satoshi Nakamoto.

The original Bitcoin protocol, based on public and private key cryptography, appeared as a paper in 2008 and Bitcoin itself was launched in 2009. Space precludes giving an account of how Bitcoin works or how Bitcoin transactions are validated. The Economist has a good article on this (see the Friedman link above) for those who are interested. The key points from the perspective of this blog are:

  • Bitcoin usage around the world is growing like Topsy
  • It is immune from central bank interference
  • It is an alternative store of value
  • It is essentially deflationary if demand grows, because its creator has decreed that only set amounts of bitcoins will be produced and that the maximum number that will be generated is 20 million.

Given extremely tight supply and extremely large demand, the value of individual bitcoins can only skyrocket.  Speculators have jumped onto this fact and a large proportion of bitcoins now represent speculative investment rather than enabling trade.

Some very interesting ideas follow from all this, and their implications – which all boil down to the idea that Bitcoin might end up being a more attractive global currency than the US dollar, the euro or the yuan.

recent blog in the Wall Street Journal sets out the case for and against this happening any time soon, taking into account the extraordinary volatility in the price of Bitcoin over the last two months of 2013. On 4 November, Bitcoin was valued at just over $200. On 3 December, it peaked at just over $1200, then slid to a low of around $460 before finishing December at over $800. That volatility might be attractive to speculators, but one imagines it would be hugely off-putting for business to business transactions.

However, more and more organizations around the world, including public sector and municipal bodies, are accepting bitcoins as payment. The state-owned China Telecom recently accepted some payment in digital currency, and some 36 US municipalities have moved to accept payments from citizens in bitcoins. The list is large and growing.

Related: Infographic: The History Of Bitcoins

Related: Infographic: Bitcoins Vs Gold

Related: Bitcoins: The Politics of A Virtual Currency

The WSJ argues that the near zero transaction costs associated with Bitcoin, the powerful encryption protections and the promised finite number of bitcoins that will be produced – as against potentially unlimited money printing by central banks – may well continue to make Bitcoin attractive to investors seeking an alternative to both fiat money and gold.

These same characteristics might also make it attractive to central bank reserve managers, but that day still lies some way off, if it ever comes.

By Anthony Harrington

Anthony Harrington is an award-winning business and energy journalist, writing regularly for the Scotsman newspaper, the Glasgow Herald newspaper, Financial Director magazine, Pensions Insight magazine, CA Magazine, and a number of other publications. He won Business Finance Journalist of the Year 2006, Institute of Financial Accountants, and Journalist of the Year, State Street 2006 Institutional Press Awards, and was runner up in 2007 and 2008.

Will Bitcoin become the new global reserve currency? is republished with permission from the QFinance Blog.

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