In Virginia, the money system was based on tobacco for centuries. The intrinsic value of metal coins depends on which metal is used to mint it, like copper, iron, silver, and gold. But most money has no practical application other than fulfilling the role of money.
One very old money standard was based on massive stones Rai , while the longest functioning money standard throughout a large geographical area was based on Cowry shells. Besides dental crowns and jewels, gold has few practical applications and paper money is completely worthless the minute that no-one will accept it.
Traditional fiat money has no physical form. The same is true for Bitcoin. As long as enough people believe in Bitcoin and are prepared to pay regular money for it, Bitcoin has value. If people stop believing in it, Bitcoin becomes worthless.
As noted, Bitcoin shares this characteristic with other types of fiduciary money, like the aforementioned Rai, shells, or currency and fiat money. However, that trust in money can be revoked if, during times of hyperinflation, trust in the government is utterly destroyed, as in Zimbabwe in see Figure 1 or, more recently, in Venezuela.
Some people anticipate that the value of Bitcoin can rise much, much higher, to a million dollars even. If asked whether this is possible, I can only say: yes, it could. The value of Bitcoin could even rise to as much as two million dollars, or more. But it might not, because the chance that the value of Bitcoin could suddenly crash, even to zero, is arguably just as likely.
As I have explained, the value of Bitcoin is completely determined by the value its enthusiasts attach to it. Hypes can go very far, though. Back in the 17 th century when Tulip Mania was sweeping the Netherlands, there was one type of tulip bulb that was worth so much you could trade it for a fine canal house in Amsterdam.
Relatively speaking, the hype surrounding Bitcoin is not so bad, although with a much larger international reach. Bitcoin advocates regularly point out that Bitcoin is not affected by inflation. They draw attention to the fact that there is a limited amount of Bitcoin, a situation they compare to the regular money circuit, where in principle central banks can introduce an infinite amount of money to the market.
While it is true that this tells us something about the amount of Bitcoin, it tells us nothing about the rate of inflation, which is measured in terms of price development rather than the development of the amount of money. So the example tells us nothing about inflation. In order to make any claims about inflation in the world of Bitcoin, you would need to identify exactly which goods and services were being traded in Bitcoin globally, how large a share each individual product has of purchases in Bitcoin, and what the price development of every product in Bitcoin is over time.
Only then can a price index be constructed for Bitcoin to measure its progression over time. But that information does not exist and will not be made available. Because that would require far-reaching transparency throughout the Bitcoin world, to an extent that would undermine the core philosophy of Bitcoin, which privileges privacy and pseudonymity over transparency. The claim that Bitcoin is not affected by inflation, therefore, is unfounded. A related factor is that Bitcoin is not suited to functioning like money in a normal economy.
In this respect, the predetermined, fixed amount of Bitcoin is a great handicap. To maintain a stable price level, it is important for the amount of money to be able to grow more or less in line with economic activity. If the amount of money cannot grow in relation to economic activity, it can only be accommodated by either an ever-increasing velocity of money or a structural decline in prices.
A problem arises when people begin to expect structural price decline, in that the velocity of money is more likely to decrease instead of go up. This could land the economy in a serious depression. The same problem, among others, affected the gold standard, eventually leading to its being given up.
As a result, fiduciary money became far more common during the last few decades of the gold standard, for example, debased currency, bank notes, and fiat money. The artificial scarcity of Bitcoin is an advantage for Bitcoin investors as long as enthusiasm for Bitcoin continues to grow: rising demand with inelastic supply by definition leads to a higher price. In this sense, Bitcoin resembles gold.
Price stability requires the amount of money to retain some elasticity so that it can grow in line with the economy. The gold standard proved untenable for a reason. The same thing could happen to cryptocurrency, too. Since the introduction of Bitcoin, a great many new cryptocurrencies have been created. As the deflationary character of Bitcoin becomes a bigger handicap to its successfully fulfilling the payment function of money, other cryptos may well step in to play that role.
In this scenario, it is imaginable that Bitcoin would increasingly become an investment category. History provides an analogy with precious metals here, as well. Considering the fact that the amount of some newer cryptocurrencies is not limited in advance, unlike Bitcoin, the crypto world is neither more nor less inflationary than the regular money market. It is well known that the "mining" of Bitcoins is a very energy-intensive process. A recent publication by PWC calculated that one transaction in the Bitcoin network consumes kilowatts of energy.
By comparison, , Visa transactions can be carried out for the same amount of energy. It is equivalent to approximately the electricity consumption of a Dutch family in about 75 days. Not exactly what you call an attractive sustainability track record. The total usage, according to another article , is around terawatt hours per year. That is more than the energy consumption of the whole of the Netherlands and is about thirty times the annual energy production of the Dutch nuclear power plant in Borssele.
The authors of the latter article point out that the annual costs of gold mining are even higher. But whether that is true depends entirely on the Bitcoin price. The comparison used in that study is based on the amount of energy per value unit. Relative to other payment methods, like cash or fiat money, Bitcoin is extremely energy intensive. There are also newer cryptos that consume far less energy.
Here the crypto devotees seem to be confusing the Bitcoin blockchain with the "currency. On the other hand, the distributed ledger technology it uses is a distinct innovation compared to the regular system. According to the PWC report mentioned above, the blockchain, the distributed ledger technology DLT behind Bitcoin, can handle approximately , transactions per day.
That seems like a lot, but the Dutch giro-based payment system can handle that volume in a few minutes. The existing Chinese giro payment system can handle it in two seconds; the new Digital Currency Electronic Payment DCEP system is even designed for , transactions per second. Compared to regular currencies, then, Bitcoin is clearly lagging behind as a means of payment.
To put it bluntly, for the time being, the speed of the blockchain is to regular payments what a handcar is to an F16 at top speed. That could all change, of course. A so-called lightning network has been under construction since , but it is still in an experimental stage of development. It can even make the Bitcoin market more opaque.
The tragedy of Bitcoin can be boiled down to the fact that it came with a completely new, revolutionary technology, the DLT. Now there are other cryptocurrencies that have their own networks; some are much faster than the blockchain, with a number of them almost capable of matching the processing speed of the regular payment system.
DLT is a technology that is rapidly gaining a foothold in the mainstream financial system. But the same is not automatically true for Bitcoin. It can be compared to the impact of the internet on banking. Twenty years ago, many trend watchers predicted that new internet banks, i. In almost every bank also offers its services via internet banking. Many a pure internet bank, however, has ingloriously been absorbed into an old-fashioned bank.
Egg Bank, the first real internet bank, is now part of the Yorkshire Building Society. Anyone searching the internet for "Egg Bank" today has a good chance of ending up on the websites of companies offering women the opportunity to have their eggs frozen. People who are deeply enthusiastic about Bitcoin like to draw attention to the network's transparency.
After all, every individual transaction is visible on the blockchain. But this is not the whole story. It is true that every web address is visible, but it is often not known who is behind it. This is because of pseudonymity. The creators of Bitcoin and similar crypto currencies and their supporters are mostly strongly committed to privacy.
There is nothing wrong with that in itself, but it also makes cryptos very attractive for the financial settlement of criminal transactions. Even in the case of computer hacks, as was the case recently at Maastricht University, the hackers often have to be paid off in Bitcoins. If such a transaction were concluded through an ordinary bank account, the police would probably be on the criminals' doorstep within minutes.
But when criminal transactions are conducted via the blockchain, tracking down the criminals requires much more law enforcement effort, although gradually the police are becoming more effective in tracing Bitcoin transactions Incidentally, the number of criminal transactions completed in Bitcoin accounts for less than 1 percent of the total number of Bitcoin transactions, I recently heard on a radio interview. Nevertheless, that says nothing about the amounts of money that could supposedly be involved.
It was also announced at the same time that Tesla had purchased USD 1. On March 23, Musk reiterated his commitment and made it more concrete. It will not be long before a Tesla in the U. Unlike the Swiss canton of Zug, Tesla does not use a crypto company as an intermediary. You can pay directly in Bitcoin. At first glance, this is a big step forward in the general acceptance of Bitcoin.
But a lot is still unclear. The key question is which currency will be used to set the price of a Tesla. Currently, in the U. If customers can then pay in Bitcoin, the daily price of a Tesla expressed in Bitcoin will constantly fluctuate with the USD-Bitcoin exchange rate. Then, as with the Swiss canton of Zug, it's a nice publicity stunt, but it's not really material.
On its own, this would be a logical choice for Tesla, especially since the cost side of the business is in regular currency. If Tesla were to lock in the Bitcoin price of a car for an extended period of time, the company would run the risk of making its dollar-denominated operating income increasingly dependent on fluctuations in the price of Bitcoin.
That would be a risky gamble. Only if Tesla started paying its suppliers and employees in Bitcoin could it afford to receive a large portion of its revenues in Bitcoin, because that would shift the risks to employees and suppliers. In practice, it is likely that Tesla will invoice a portion of its automobiles in Bitcoin and a portion in regular money.
This is like treating Bitcoin as a foreign currency, which is difficult to hedge against. The impact on the operating result would be limited, but would still depend mainly on whether the prevailing price is the dollar price or the Bitcoin price. The former is the most likely, and would be in Tesla's own favor, according to a recent article on CoinDesk, which also reveals that Tesla has another surprise in store for buyers. In the United States, when people buy a car, if the product is defective they are entitled to return the car to the factory and get a refund of the purchase price.
The legislation on this is known as lemon law. If someone buys a Tesla worth USD 50, and pays in Bitcoin, doesn't like the product, and is entitled to a refund, Tesla will refund the purchase price. But it will only do this in Bitcoin if it has fallen in value. If Bitcoin has continued to rise since the vehicle was purchased, however, Tesla will refund the amount owed in dollars. The terms and conditions show this. Thus considered, it is better to pay for a Tesla in dollars or, should people want to monetize their holdings of Bitcoins to buy a Tesla, they should simply do so through a crypto exchange and pay for the new car with the dollar amount released in the process.
A second important question is what Tesla will do with the Bitcoin it obtains. The company could add it to the Bitcoins it already holds, or it could choose to dispose of them directly. Some analysts point out that if Tesla keeps a large amount of Bitcoin in its portfolio, there is a chance that its share price could become increasingly correlated with the price of Bitcoin. Considering the small share of the balance sheet that Tesla currently holds in Bitcoin around 3 percent , this seems to be a non-issue for the time being.
Remarkably, since Musk's first announcement, the price of Bitcoin has risen by about 50 percent, but Tesla's share price has fallen by about 20 percent. This has evaporated about USD billion worth of stock market value.
But it is still too early to conclude whether the drop in Tesla's share price has anything to do with Musk's announcement. Some skeptics say that not only Bitcoin, but also Tesla shares still with a price-to-earnings ratio of around are a bubble. Time will tell. The absence of a central regulator for the blockchain is good for privacy, as explained above, but it also means that if anything goes wrong, no central authority can be called upon to fix it.
Human error is responsible for almost all payment transactions gone wrong. People occasionally mistakenly transfer money to the wrong account. They can be tricked into transferring money to a fake account spoofing. A third example: people sometimes pay the incorrect amount. In many if not most cases like these, banks can resolve payment errors. Not so in the blockchain. Another vulnerability is that losing the password for a Bitcoin wallet is just as bad as losing an actual wallet see below.
Given the current price spike, losing your Bitcoin wallet password is very similar to losing a winning lottery ticket. The solution? Cry your eyes out and try again. Some difficult to verify accounts maintain that roughly 20 percent of all wallets can no longer be accessed by their owners.
The contents of these wallets can be huge sums, especially those belonging to people who bought a few hundred dollars in Bitcoin for just a few cents per Bitcoin. The internet has stories to tell about lost passwords, people who deleted passwords while reformatting their hard drives, and people who discarded old computers only to realize their wallet had literally ended up on the garbage belt with it. The lesson is simple: pay better attention. Because there is no central regulator protecting Bitcoin users.
But, of course, you could also argue that the people who choose to hold part of their assets in Bitcoin are aware of this. It is the risk you inevitably run in exchange for far-reaching privacy and the absence of central supervision. Whether every enthusiastic Bitcoin follower who has recently jumped in realizes this is an open question.
By now, the reader can surely recognize some convergence between existing financial institutions and the world of cryptos. Among other things, banks provide custodian services to Bitcoin investors, which may actually help to solve some of the problems mentioned above. There are now also numerous other financial service providers offering investment products in Bitcoin and other cryptocurrencies.
In many cases, these parties do not include Bitcoins on their own balance sheets. Unfortunately, it is generally difficult to obtain precise insight into which services they are actually offering. Often, they do not have an annual report with core data, balance sheet data, and a profit and loss statement. In the Netherlands, if crypto companies want to have a banking relationship with a regular bank, they must provide comprehensive disclosure to their bank.
Banks must require this under supervisory legislation, which demands that they know their customers. Some crypto companies believe that the regulator is too strict and have even filed a lawsuit on this issue. It illustrates the inherent tension between, on the one hand, the high degree of privacy that many Bitcoin users see as a huge advantage and, on the other hand, the fear on the part of the regulator that this degree of privacy makes it all too easy for criminals to conduct illegal transactions through Bitcoin.
Distributed ledger technology is finding more and more applications away from Bitcoin in existing institutions, for example in transnational payments or expediting international letters of credit. In these places, DLT is adding significant value. Some central banks are considering introducing a central bank digital currency CBDC which will be based on DLT, although DLT appears to be more feasible for wholesale central bank applications rather than retail.
Terpstra et al. The Chinese central bank is also considering using DLT for the central settlement of DCBC, but as far as we know there is not yet a definitive decision. Paying with Bitcoin is in many ways similar to paying with cash. Law-abiding citizens use cash without any bad intentions, but it too, unfortunately, is also highly attractive to people with more questionable intentions. There is strong evidence that cash payments, especially banknotes in large denominations, play a significant role in the criminal world.
For that reason, some economists advocate a reduction in the use of cash money Rogoff, Over the past few decades, the central bank in Sweden conducted a large-scale cash purge, which has lessened the importance of large banknotes considerably. This article describes the process. In some countries, like Germany and Austria, people place a lot of value on cash. Synchronisation can also be seen with markets for other commodities such as oil, copper and gold. Marcin Watorek Cracow University of Technology , co-author of the publication.
Among the analysed correlations, the correlation of bitcoin to the yen attracted attention. It was very clear but negative: rises in one currency were accompanied by falls in the other, and vice versa. However, this phenomenon is a simple consequence of the well-known fact of the negative correlation of the Japanese currency to the oil market. The work of the Cracow physicists shows that the cryptocurrency market is becoming similar not to the currency market, but to the commodity market.
This process is in line with the original idea behind the introduction of bitcoin as money with measurable value, under the control of all players in the market and resistant to manipulation by central banks. However, at the current stage of market development, the assessment of the observed trend should be approached with great caution.
Cryptocurrencies, including bitcoin, are today subject to violent speculation that undermines confidence in their stability and makes them hard to use for valuation of various goods. Consequently, they are still different from, for example, gold or silver, which are the basis for the valuation of goods and are therefore not a speculative instrument. Bitcoin and other cryptocurrencies are increasingly seriously beginning to be seen as fulfilling their original intention of protecting fiat currencies from loss of value during a period of increasing monetary base by central banks.
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The cryptocurrency market is starting to consolidate and is becoming more and more like a commodity market, according to research by the Institute of Nuclear Physics of the Polish Academy of Sciences in Cracow. Journal Entropy. DOI
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