Why Bitcoin is booming but can't replace the US dollar?

Bitcoin is the bellwether of the crypto space. It has recovered from its catastrophic crash in 2018 and is barreling toward its December 2017 highs. So what does the future hold for Bitcoin? Will it eventually replace the dollar as the world’s reserve currency, as its loyal supporters claim? Or will it collapse and die, as Nouriel Roubini predicts? Or is it destined to remain a speculative asset that adds pizzazz to portfolios but is never used as a primary medium of exchange?

More than a decade after it emerged from the ashes of the financial crisis, Bitcoin remains a minority movement. Predictions of it reaching $1 million or more seem overly optimistic, and there is no sign that it will become a major medium of exchange. In contrast, the dollar has become increasingly secure as the world's primary settlement currency over the past decade. Bitcoin is no closer to universal acceptance than it was when it first began.

However, Bitcoin has survived two major crashes and countless smaller ones, and is now rising again. Unlike many smaller cryptocurrencies, its value has never fallen to zero - in fact, in its 12 years of existence, its value has risen significantly. Despite its volatility, it has proved its long-term value retention. Bitcoin has reached a certain level of maturity as a store of value, although it is not yet a (mainstream) medium of exchange.

It would be tempting to predict the future of Bitcoin based on its current performance. It is undoubtedly a speculative high-yield asset, and perhaps a long-term store of value. But it would not be a very good medium of exchange. As any investor knows, past performance is not always indicative of the future. So let's look at whether, despite its apparent resilience, Bitcoin's value could still fall to zero, and conversely, what it would take for Bitcoin to replace the dollar as the global reserve currency.

In order to understand how these two situations occur, it is necessary to study the operation of fiat currencies. For example, what gives fiat currencies value? How do they lose this value?

There are two main competing theories for assigning value to fiat currencies: one we call the “metallist” theory, which assigns value to fiat currencies tied to gold, and the other is the “chartalist” theory, which holds that fiat currencies have value because of the taxes people pay. Of course, neither of these situations applies to Bitcoin, which has never been pegged to gold and no government accepts Bitcoin taxes. So, are there other ways for money to gain and hold value over the long term?

Both the Metallist and Chartalist view of the value of fiat money share a deeper underlying idea: that what backs the money is itself trustworthy. In the Metallist mindset, gold will always be valuable. This idea has been tested for thousands of years and has never failed, so it may be reasonable. The less reasonable view is that the money that is not currently pegged to gold is valuable because it was once pegged to gold. However, many Metallists believe that fiat will eventually re-peg to gold (more on this later).

For chartalists, the fundamental idea is that governments should be able to impose tax obligations. The ability to tax does not necessarily imply authoritarianism: a government that is seen as fair and benevolent and that imposes reasonable taxes is actually more likely to bring about monetary stability than one that heavily enforces punitive and unfair taxes.

Therefore, what gives currency its value is actually the trust in whatever is backing it. So, what backs Bitcoin? In response to criticism that "Bitcoin is not backed by anything," investment website Fidelity Digital Assets said, "Bitcoin is backed by code and consensus among major stakeholders."

It’s a declaration of faith. That is, “the code is perfect, and key stakeholders will never do anything less than perfect.” While neither of these statements may be entirely true, they are necessary to convince enough people of the value of Bitcoin.

To be sure, the code isn’t perfect. If it were, it wouldn’t have hard forked. However, Fidelity Digital Assets has its own answer to this. Bitcoin may not be immutable, but its community can be: “While Bitcoin’s open source software may be forked, its community and network effects cannot.”

Many have commented on the "cult" nature of Bitcoin, but this appears to be a design feature, including the disappearance of the anonymous leader after three years, the refusal of those who knew who Satoshi was to reveal his identity, and the reverence of followers for the words of Satoshi and his close associates. Network effects are particularly strong in "cults," and the motivations of their members are not necessarily monetary. True Bitcoin believers will always invest in Bitcoin and actively trade it even if the price of Bitcoin drops catastrophically because they believe that Bitcoin will eventually become the core of the new world order. And as long as they exist, there will always be an incentive to mine Bitcoin, and the price of Bitcoin cannot drop to zero.

Therefore, the confidence of Bitcoin investors is the source of Bitcoin's value. If they lose this confidence, its value will fall to zero. But is investor confidence alone enough for Bitcoin to eventually replace the US dollar as the global reserve currency?

For now, there is nothing to suggest that the world is likely to abandon the dollar anytime soon. If anything, the current pandemic has increased reliance on the dollar, forcing the Federal Reserve to provide more liquidity to financial markets. Even in the crypto market, demand for the dollar is growing — after all, aren’t stablecoins just a means of tying cryptocurrencies more closely to the dollar?

A global shift to Bitcoin would bring about the root of all financial crises, devastating not only traditional markets but also crypto markets. However, a significant number of people, including but not limited to Bitcoin enthusiasts, believe that this is not only possible but inevitable. They believe that quantitative easing will eventually trigger uncontrollable hyperinflation in all major fiat currencies. This belief will persist despite the fact that quantitative easing has failed to trigger significant price inflation anywhere in the world.

Those who believed in this hyperinflationary Armageddon in the early 2010s, and some of them still believe that today, believed that the inevitable outcome would be a return to a global gold standard. Conversely, Bitcoin’s true believers insist that when fiat currencies crash and burn, the world will turn to Bitcoin, not gold.

Why Bitcoin? Because it has the advantages of gold with the convenience of digital currency. It is not issued or controlled by a government, and unlike gold, its supply increases predictably and is ultimately fixed forever. It can be divided into infinitesimal amounts, making it more useful as a medium of exchange than gold. And as its value increases, the price of real goods and services purchased with it decreases. After the hyperinflationary collapse of the U.S. dollar, a digital currency that is independent of the government and naturally deflationary is exactly what people need to restore trust in money.

However, high inflation is also strongly associated with social, political, and economic collapse. So those who invest in Bitcoin, believing that it is destined to replace the dollar as the premier international reserve and settlement currency, are essentially betting on the collapse of the United States and the disintegration of the current international order. And such a sudden, catastrophic collapse of hegemony can only be the stuff of apocalyptic fiction, not reality. It took more than half a century and two world wars for hegemony to shift from Britain to the United States, and even then, the shift was slow but not particularly disorderly. The kind of social and political collapse that destroyed the dollar would surely destroy global civilization as well.

After such a catastrophe, will people still have and use the equipment, bandwidth, and electricity needed to mine Bitcoin? In the apocalyptic novels of the Cold War, when nuclear war became a real threat, people would unanimously say "no." Not only will these equipment and electricity not survive, but in their struggle to survive, people will quickly forget they exist. After all, you can't eat Bitcoin.

It’s possible that the world could avoid a deflationary collapse by agreeing to make Bitcoin the basis of a global digital fiat currency system, just as gold underpinned the “Bretton Woods system” after World War II. However, Bretton Woods lasted only 20 years before global economic imbalances and conflicts fatally destabilized it. So why will “Bitcoin Woods” last even longer?

When belief rules, people will believe all sorts of incredible things. It would be incredible for Bitcoin to replace the dollar as the world's reserve currency, and the chances of that happening seem slim. But as long as Bitcoin supporters continue to believe that it is destined to rule the world, Bitcoin will continue to have value; others will benefit from that value even if they don't share that belief. Bitcoin will continue to be a good choice for investors because of the faith of its true believers.

Original author: Frances Coppola

Original link: https://www.coindesk.com/why-bitcoin-thrives-wont-replace-dollar