In less than a decade, bitcoin has gone from being an obscure curiosity to a household name. Its value has risen — with ups and downs — from almost nothing to $16,000 at the time of writing.
Bitcoin’s rise is spectacular. Its price is up almost thirtyfold in the past two years. Currently, the value of Bitcoin in circulation is more than US$170 billion, greater than the market capitalization of McDonald’s. This is remarkable because unlike McDonald’s, which has stores in almost every corner of the world, Bitcoin as a virtual currency is hardly even transacted in the real world.
Bitcoin is a mirage
The rise in Bitcoin’s value reflects speculation about its future value: This digital currency will have long-term value as long as it is accepted as a medium of exchange and a store of value.
The greater its acceptance, the more it will be worth. However, it is difficult for Bitcoin to be accepted as real money. Therefore, the high volatility of its value largely reflects changes in the perceived degree of acceptance.
By design, there are inherent weaknesses that prevent Bitcoin from becoming real money.
For it to be real money, Bitcoin must be a viable and stable store of value. It is a poor store of value because of its extreme volatility. Bitcoin’s price is characterized by wild swings, both up and down, with the potential to move more than 20% in a single day. This volatility is almost by construction because Bitcoin’s supply is relatively fixed but demand can change dramatically.
While the supply of individual cryptocurrencies may be limited, the supply of cryptocurrencies in aggregate is unlimited. They have low barriers to entry. Anyone can create a new cryptocurrency. For example, a digital cryptocurrency, Potcoin, was created to facilitate transactions within the cannabis industry.
Bitcoin’s utility as a medium of exchange is still very limited. While there might be more usage of cryptocurrencies in the future, it is inconceivable for governments to allow the widespread adoption of them. Governments will want to keep government-backed currencies as they do not want to give up their ability to control policy levers such as money supply and fiscal policy. At the same time, banks and financial institutions are creating their own private cryptocurrencies to rival public cryptocurrencies like Bitcoin.
Blockchain holds promise
While Bitcoin’s future is still highly speculative, there is a need to differentiate between Bitcoin and Blockchain, the technology behind Bitcoin.
A blockchain is essentially a distributed database of records or public ledger of all transactions that have been executed and shared among participating parties. Each transaction in the public ledger is verified by consensus — a majority of the participants in the system.