Everybody has heard of it before, but what does Bitcoin actually aim to do?
Bitcoin wants to be the money of the future, but can it achieve this?
Well, Bitcoin is a cryptocurrency designed to become both a store of value and a form of money. Some believe that Bitcoin is a better form of money than our current dollar due to a few reasons. One reason is the fact that all transactions are made public on the Bitcoin network, making Bitcoin highly transparent. Another reason is the fact that nobody can control or prevent which transactions are made. This is due to the fact that Bitcoin is decentralized, meaning that there is not one singular agent that controls the network; but rather, thousands of computers from different parts of the world are controlling Bitcoin.
In fact, Bitcoin was even adopted as a legal tender in the country of El Salvador on September the 7th 2021. Nayebe Bukele, the president of El Salvador, made a large shift toward Bitcoin when he was elected as president of the country. Not only did he make Bitcoin one of the country's few legal currencies, but he also added US$375 million worth of Bitcoin to El Salvador’s balance sheet, representing a rather large sum of money for the country. In order to ensure that Bitcoin functions as money, the government rolled out the Chivo wallet which allowed millions in El Salvador to use Bitcoin. This is essentially a digital wallet where individuals can hold their Bitcoin and the incentive to use this wallet was the fact that the government was providing people with free Bitcoin if they claimed the wallet. Moreover, by making Bitcoin a legal tender, every business in El Salvador was forced to accept the currency and Bitcoin was now tax free in the country.
As such, this represents the largest push toward Bitcoin by a single country in history.
However, would you be surprised to learn that Bitcoin has essentially failed in El Salvador?
Despite such a massive push towards Bitcoin, it has still failed. This is due to the fact that it takes more than just a government establishing something as a currency for it to work as a currency. Bitcoin lacks one core component in becoming money in the long term and multiple components in the short term. Over the short term, Bitcoin needs to become more accessible and less volatile. However, these problems will be resolved. Its main long-term issue is the fact that it is a deflationary currency, being completely different to modern inflationary currencies.
We can first discuss how Bitcoin works as a currency and how it is deflationary. The reason Bitcoin is deflationary is because the maximum amount of Bitcoin that will ever exist is 21 million, something that is stated in Bitcoin’s code and defended by proponents of Bitcoin. Of course, the price of Bitcoin will vary, but the actual number of Bitcoins remains the same. Essentially, the reason Bitcoin is created this way is in order to ensure that the value of the currency cannot be inflated away and to ensure that Bitcoin is stable and reliable. Of course, this is a large concern given the rapid money printing that occurred during the pandemic, causing rather high inflation levels in every country. Hence, Bitcoin was created to resolve this issue and perpetuate a more stable financial system.
So why is a deflationary currency a bad thing?
Well, the problem with a deflationary currency is that individuals will not be incentivised to spend their money. If the value of the money is slowly increasing, then people will simply seek to hold money in order to slowly grow their portfolio. All else being equal, if the amount of Bitcoin remains the same and some Bitcoin is slowly lost from circulation due to individuals forgetting passwords, the number of coins circulating will decrease slowly and Bitcoin’s price will go up. Such deflation is known to cause recessions and large economic slowdowns. On the other hand, an inflationary currency will incentivize individuals to spend their money, perpetuating economic growth and keeping the economy moving. Too much inflation will of course cause disaster, but the RBA aims for 2% to 3% per year which is an optimal amount of inflation.
The fact that El Salvadorians saw Bitcoin as an investment asset and not as a spending asset is likely one of the reasons as to why very few El Salvadorians ever used Bitcoin in their transfers. In fact, most large proponents of Bitcoin do not actually spend their Bitcoin, but rather they seek to hold as much of it as possible to take advantage of price increases, reducing its chance of ever functioning as money. Thus, Bitcoin’s deflationary nature will prevent it from becoming a currency.
Of course, Bitcoin also has a few short-term problems. Currently, Bitcoin is very difficult to use. This is especially the case for citizens who do not have access to technology. In El Salvador, the Chivo application yielded an extremely unsuccessful result with most people being unable to use the application and eventually dropping it. Despite all of El Salvador’s efforts to bring this technology to the people, very few actually went through the hassle of attempting to use Bitcoin to buy their everyday goods.
Moreover, Bitcoins rapid fluctuations in price also call into question its usability as a currency. Of course, other currencies often fluctuate more than Bitcoin, such as Sri Lanka and Venezuela’s dollar. However, this is because these currencies are in nature failing currencies. A truly good currency should remain relatively stable so that individuals will not have huge fluctuations in their purchasing power. Proponents of Bitcoin will argue that in time Bitcoin will become far more stable. This may eventually be the case; however, these short-term problems will be difficult to overcome.
Of course, the fact that Bitcoin is currently difficult to use and the fact that Bitcoin is rapidly fluctuating in price are minor issues. These issues do have the potential to be solved in the future. However, Bitcoin’s core design as a currency is flawed. It is impossible to have a functioning economy under a deflationary currency. People will be incentivised to hold their Bitcoin rather than spend their Bitcoin and the consequences for this will be far larger than any Bitcoin proponent could argue.
I believe the most likely scenario is that a Central Banking Digital Currency will become the currency of the future. This will be a currency that is pegged to the value of the Australian dollar but utilizes the benefits of blockchain technology. Most countries are already heading toward this future!