Did you invest in Bitcoin? I get asked the question on an almost daily basis. And the answer has always been - and always will be - “no”.
Afterwards, we get into debating the rise of Bitcoin in specific, or cryptocurrencies in general, trying to understand if this is a bubble, a Ponzi scheme, or a safe haven that could one day compete with gold. Every time such a discussion takes place, there is a general consensus that this is a bubble, followed by a general perception that as long as you time the market right, you should be fine. Well...
Isn’t timing the market what people get by sheer luck? In such a case, high risk will yield high returns. But what happens when it’s the perfect time to sell, and there are no buyers?
Bubbles must pop, causing prices to crash and wiping out, in many cases, your investments. History tells us not to be the last person with the most expensive tulip. So, what’s behind the rise of Bitcoin and other cryptocurrencies?
What are the implications for gold as a safe haven? And what implications could the rise of Bitcoin and other cryptocurrencies have on the role of the dollar in international trade and transactions?
I must firstly point out that I am not your expert on the technology - Blockchain - that Bitcoin is a byproduct of, however, I will attempt to somehow explain it. Blockchain could be broadly defined as blocks of transactions that get processed and verified by multiple users connected to the network, after which they are stored in a shared ledger that is visible to individuals involved in processing the transactions – it basically is extremely transparent.
Bitcoin is what you get paid for processing the transaction, where “miners” - individuals processing the transactions - use their excess PC capacities to process those transactions. Do forgive me please if this comes across as confusing since I am still trying to get my head around the concept – which, by the way, is another warning not to invest in what you don’t understand. Not yet at least.
Now to answer the first question; Bitcoin’s price increase, and that of other cryptocurrencies could be attributed to a couple of factors. One, which is quite straightforward, is that a group of individuals decided that Bitcoin’s price can be speculated upwards given the tightly controlled supply. However, do bear in mind that no additional Bitcoins can supposedly be mined beyond 21 million.
And the right question to ask is when will there be 21 million Bitcoins in circulation? What will happen then? So, for now, good luck timing your entry into the market and exit from it, hopefully making money in the process.
The true fortunate, though, are those who got out on Bitcoin’s rise and not the ones who will try getting out on its way down, adding to the downwards spiral of its price. A second factor that could be driving price speculation is the desire to establish a parallel monetary system to that of the dollar. I will get to that before concluding.
Can Bitcoin ever be the future gold? I don’t believe so. When one examines gold’s history, you may notice specific purchasing patterns whether by individuals, funds, or even government. Those patterns allude all kinds of reasons behind buying gold, including but not limited to, investors guarding their wealth in times of turbulence, and governments diversifying their reserves.
As more investors pile their investments into gold, the price of gold surges and hence accumulated wealth, after which you still need to time your exit from gold whenever other investment options become more appealing. The difference here between gold and Bitcoin is that the former’s price can only be significantly moved upwards or downwards by bulk investments or gold purchases by governments and large investment funds.
The same cannot be said for Bitcoin. Now if you go back to the financial crisis of 2007-08, you would notice that the hike in gold’s price was because of the general down cycle in global markets, thus limiting available investment options. And even though investors could have taken out their investments and kept them in cash until markets recovered, parking money in gold could be more rewarding as it guards monetary value from inflation.
Bitcoin, on the contrary, is already facing a selling spree as investors seek to cash out their investments. As of the time of writing, it didn’t recover its all-time high. To wrap this section up, Blockchain technology is here to stay.
As for Bitcoin, you will find your answer by observing what’s happening with other cryptocurrencies’ prices.
Finally, the case for the dollar is going to be the most interesting one to observe in the future. Consider this. Post-gold, there has been no disagreement on the dollar’s important role in stabilizing the international monetary system.
Though there are today less countries than ever with their currencies pegged to the dollar, that did not diminish the currency’s role as it still dominates about 80 per cent of international transactions. Will that change?
Not soon, but there are a few signs to take into account - 1. Unpegging from the dollar by oil exporters, encouraged by Fed hikes, 2. Issuance of debt in local currencies and currencies other than the dollar, such as yuan, and 3. The drive to adopt cryptocurrencies by countries that faced and survived sanctions’ wrath.
This brings me to the main point of discussing the dollar’s role today, and the future role it will have tomorrow. The first two signs mark the start of a trend and not its climax. Also, note that the third sign may further contribute to possible decline in the dollar’s role in international transactions, and hence reduce the effectiveness of future sanctions as a result.
And so, the two will feed into each other’s further decline. Cryptocurrencies not only threaten the dollar’s international role, but they also undermine other currencies that are trying to increase their international role. China’s perceived push to internationalize the yuan is a case in point, and that cannot happen if cryptocurrencies realize international recognition and acceptance in settling trade balances and transactions.
In conclusion, the Blockchain technology will endure cryptocurrencies’ bubbles, with the future of cryptocurrencies being bleak and subject to governments adoption and international acceptance. The main, and most visible, implication of the rise of cryptocurrencies will be the uprooting of the international order since Bretton Woods, which will not be tolerated.
Not only that, but adding another layer of transactions, where you have to convert cryptocurrencies into traditional ones and vice versa, will further add to a much slower global adoption, if that is ever the case.
So, which currency will dominate the global scene? Are we going to have a currency per country with new exchange rates for countries’ cryptocurrencies?
So far, cryptocurrencies have been associated with the prospects of funding illegal and illicit activities, as well as the prospect of evading sanctions without having to move gold across borders. Cryptocurrencies are being driven not by fundamentals but by excessive speculation.
The last question that I want to leave you with: will the US ever allow a cryptocurrency or any other medium of exchange to replace the dollar’s role in international trade and in settling transactions?
The writer is a UAE based economist.