The timing of Bitcoin could not have been better. This cryptocurrency came into existence in early 2009 the period just after the start of the global financial crisis, when trust in national governments and commercial banks in the US and other Western countries was at an all-time low.
Immediate appeal was the notion of being able to transact without the use of central bank money and without the intervention of a financial institution.
Bitcoin is a medium of exchange that can facilitate transactions using only the digital identities of the transacting parties (referred to as pseudonyms).
Bitcoin initially fueled the dark web, where illegal businesses such as drug and sex trafficking take place. As it gained popularity, it became clear that the anonymity of its users could not be guaranteed.
Transactions using bitcoin or the purchase (and delivery of) genuine goods and services using cryptocurrency make it possible to reveal the true identities of users. Hackers receiving ransomware payments in bitcoin have to do a lot of brainstorming to hide their digital trails.
Furthermore, bitcoin is volatile and transactions using it are slow and expensive. The network also cannot process large transaction volumes in a timely manner.
Bitcoin, under a pseudonym, has failed in its stated purpose as a medium of exchange. But still bitcoin has turned into a financial asset to some extent. Bitcoin lacks intrinsic value and its followers believe that its lack is the basis for bitcoin’s high price.
The algorithm governing the process of creating cryptocurrency places a hard cap of 21 million bitcoins (about 18.5 million bitcoins have been created so far).
But scarcity may not in itself be a sustainable source of value, and the skyrocketing prices of bitcoin and similar cryptocurrencies at this stage reflect pure speculation. Their value completely depends on the confidence of the investors.
Over the years, various cryptocurrencies have emerged that attempt to address the flaws of bitcoin. Cryptocurrencies like Monero and Zcash have sophisticated encryption algorithms that hide users’ identities more effectively but they are cumbersome to use.
A new breed of cryptocurrency called stablecoins attempts to fix the problem of volatile prices, but they require specified intermediaries to validate transactions. Somewhat ironically, stablecoins derive their stable value from their backing by stores of fiat currencies or government bonds.
The business case for stablecoins is that they provide low-cost and easily accessible digital payments within and across national borders. Sensing the opportunity, even Facebook has proposed its own stablecoins Diem, which will initially be backed by reserves of hard currency such as the
US dollar and US government bonds. Given the wide reach and financial clout of corporations like Facebook and Amazon, it’s not hard to imagine their cryptocurrency gaining widespread acceptance.
Some governments consider danger
China’s ban on bitcoin and other cryptocurrencies highlights how some governments see them as a threat.
Other governments are also working hard to regulate cryptocurrencies and related speculative financial products. Cryptocurrencies also have financial risks, but that doesn’t mean that cryptocurrencies haven’t provided any real benefits.
The technology underlying bitcoin, called blockchain, is being explored for use in other areas of finance. Soon broad range transactions like buying a house or a car will be possible without the traditional middlemen like lawyers and real estate brokers.
It is also worth noting that central banks have begun to design their own digital currency. Countries like Japan and Sweden have started testing and many other countries including India plan to do the same. Thus cryptocurrencies are indirectly accelerating the demise of physical currency.
While the future of cryptocurrencies as a financial asset is unclear, they have clearly heralded a revolution that will make low-cost digital payments widely accessible.
These new technologies will help democratize finance by making a range of basic financial products and services easily and widely available to the public. This may be the true legacy of bitcoin that we should be thankful for.