Bitcoin has been having quite the wild ride over the last several months, and especially the last several weeks. During 2020, the price of a single bitcoin dipped below $5,000, then soared past $20,000 in December. It is currently bouncing in the range of $30,000 to $40,000.
So what is the attraction of the digital currency Bitcoin? Why is the value of a bitcoin so high and what are people doing with it?
To begin with, keep in mind that a “single bitcoin” is a bit of a misnomer. While a single bitcoin is indeed expensive, coins can be split. The smallest unit in Bitcoin is known as a satoshi, which is 0.00000001 bitcoin. While the quoted price is always given for full coins, one doesn’t have to have the cash for a full coin in order to use the system.
So why did bitcoins soar in value?
There are many reasons but ultimately, the bitcoin’s price depends on how likely the market thinks it is to become an established currency. To understand this, let’s look a little bit about the mechanics of Bitcoin and the monetary system.
First of all, Bitcoin was designed to be anti-inflationary. There are roughly 18 million total bitcoins in circulation. The maximum number of bitcoins allowed by the Bitcoin system is roughly 21 million. So, imagine if Bitcoin replaced the US dollar.
Depending on how Bitcoin would be integrated into the monetary system, it might represent basic currency (known as M1), currency plus deposits ( M2 ), or any directly spendable asset (MZM).
M1 currently represents $6.7 trillion. If Bitcoin were to replace M1, it would be replacing $6.7 trillion worth of money. That means that each coin would be worth over $300,000. Likewise, replacing M2 would make coins worth over $900,000, and replacing MZM would make coins worth over a million dollars each.
So the question becomes, is Bitcoin likely to become the next major currency? Its current usage right now makes me question it. A tiny number of merchants take Bitcoin, and even then it is usually more as a novelty and an advertising strategy than a serious move towards cryptocurrency. There are about 350,000 Bitcoin transactions each day. However, most Bitcoin transactions are speculation and trading, not actual economic transactions.
In comparison, Visa processes the same number of transactions every six seconds, and all of those transactions are economic in nature.
In fact, Bitcoin’s seeming main purpose at present is underworld transactions. Bitcoin is being used as the payment system of choice for hackers holding computers hostage. On the more extreme end, Bitcoin is being used as the payment processing system for assassinations. In a more morally grey area, Bitcoin is being used to subvert governmental policies and controls on commerce, or even being used by governments to subvert what they consider to be oppressive trade policies or sanctions of other nations. Likewise, many who are opposed to the US lockdowns are considering it in the US for the same reasons.
In any case, the extended lockdowns have probably sparked increased usage of Bitcoin for business owners opposed to the lockdown, which may have contributed to its recent rise. Additionally, the waves of anti-government sentiment have probably caused additional increases in Bitcoin values, as well as an increasing distrust of the way that the US government is handling the economy.
Given all these considerations, I think the chance of Bitcoin replacing a significant fraction of legitimate economic activity is unlikely. In addition to the reasons I’ve outlined before, I think that the non-inflationary nature of Bitcoin is just as much of a problem as a solution. Because most of the Bitcoin that will ever exist is already on the network, this means that it will generate a huge disparity between early and late adopters, essentially driving an economic wedge in the economy that serves no economic purpose. With a gold standard, if the price of money gets too high, people can invest in mining. With a fiat standard, if the purchasing power of money gets too high, the government can inflate the currency. With Bitcoin, there is no available offsetting process. An increase in the need for money simply establishes and fortifies the power of those who simply already hold cash. It doesn’t go to those who build, invent, and maintain society, but merely to the cash hoarders.
Because of this, I don’t think Bitcoin will ever make the transition to a primary currency.
However, I do think that, as government regulations of commerce become more odious to the populations at large, a variety of crypto alternatives will be developed to meet those needs.
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