Throughout much of human history, physical money has evolved from tokens connected to goods at warehouses to precious metals to promissory notes and now into paper and plastic notes backed by central banks.
In a nutshell, any “legal tender” backed by faith can be labelled and used as ‘money’.
Ray Dalio, the co-CIO and founder of the world’s largest hedge fund Bridgewater Associates recently tweeted his thoughts on Bitcoin and as to why it may not be the “future of currency”.
Any “legal tender” that can be used to purchase or sell other goods is essentially what people can label as a currency but there are a few other things that constitute what money is.
According to textbook definitions, “ money needs to be divisible, represent a store of value as well as be a medium of exchange”.
The version of money being used nowadays is “electronic money” whereby you swipe your credit/ debit card and the person upfront gives you the good/service that you swiped your card for.
When you swipe your credit/debit card, your information is immediately sent for processing to a merchant bank, which in return sends this signal to the servers of Visa/Mastercard to check for any kind of fraudulent transaction and if the signal reciprocates in a positive manner, the customer’s query is then sent to the ‘customer’s bank’ which sets aside the funds from the customer’s account and sends this information back to Visa/Mastercard and then eventually to the merchant bank again, before the customer gets the chance to finally walk out of the store with the required items.
This entire process makes use of several intermediaries that cryptocurrencies don’t.
In essence, most cryptocurrencies like Bitcoin and Ethereum are decentralized. Monetary transactions are governed through government-controlled currencies, which cryptocurrencies don’t fall under.
Crypto transactions are dealt with through a digital ledger called a blockchain and is monitored through peer-to-peer transactions. There is technically no central authority that processes these transactions when it comes to cryptocurrencies.
Blockchain, bundles transactions into blocks which are then chained together and broadcasted to the nodes in the central network. This central network is better known as Distributed Ledger Technology (DLT).
The public aspect of blockchains generally implies that anyone can use blockchain while serving as a validating node to the system. Anyone assigned as a node can in return, act as part of that blockchain’s governance mechanism. Thus theoretically, blockchains are decentralized and resistant to undue control or influence from any single party.
In contrast, a distributed ledger generally doesn’t enable most of these public features. It can impose restrictions on its users which is why it is often referred to as a “permissioned network”. It restricts who can operate as a node and in most cases, governance decisions are left to a single centralized party.
The conflict of interest between banks, big businesses, and the government should now appear to be crystal clear. If any particular government, wants to impose a “centralized digital banknote” system combining the permissioned network feature of DLT’s and the payment mechanism of blockchain, it would mean that there would be no need for banks to act as intermediaries!
If they fail to obtain deposits, they simply cannot issue any form of loans.
People would simply utilize blockchain for transaction purposes, without having to deposit their savings with commercial banks. Only the central issuer of the “digital banknote” monitoring the system, would have all the required data to facilitate for such transactions. In most cases, this would imply one large state-owned entity.
Thus, the need for banks as intermediaries would be eliminated, driving them out of business.
Thus, in essence, cryptocurrencies can be deemed to be safe, but unless it’s regulated most governments and corporations would not accept them as a “store of value”.
Ray Dalio’s recent tweet addresses this issue precisely:
“I might be missing something about Bitcoin so I’d love to be corrected. My problems with Bitcoin being an effective currency are simple. They are that
1) Bitcoin is not very good as a medium of exchange because you can buy much with it (I presume that’s because it’s too volatile for most merchants to use, but correct me if I’m wrong)
2) it’s not very good as a store-hold of wealth because it’s volatility is great and has little correlation with the prices of what I need to buy so owning it doesn’t protect my buying power, and
3) if it becomes successful enough to compete and be threatening enough to currencies that governments control, the governments will outlaw it and make it too dangerous to use
Also, unlike gold which is the third highest reserve assets that central banks own, I can’t imagine central banks, big Institutional investors, businesses or multinational companies using it. If I’m wrong about these things I would love to be corrected. Thank you”
Over the past five years, the price of bitcoin went up 20 times and subsequently went down 83 percent and it rallied over $25000 recently!
The technology behind cryptocurrencies might have a future, but the economics of cryptocurrencies themselves don’t enable them to be deemed as a store of value or a stable medium of exchange. It can be used for investing or speculative purposes, but it cannot be used as an “everyday currency”.
Bitcoin or Ethereum doesn’t protect your buying power and if it enters a hypersensitive area governments will ban the cryptocurrencies simply because it threatens their own currency, which they can control or print at will.
During November 2016, all the television sets across India flickered in unison with images of Prime Minister Narendra Modi. In an unscheduled surprise address, he announced that the Rs 500 and 1000 notes would lose their status as legal tender effective immediately.
The two notes accounted for 86 percent of India’s currency as the country paid 80 percent of its workforce salaries in cash. The sudden decision wreaked havoc among the masses.
The next few months were nothing but a disastrous experiment. To track the underground economy, policymakers turned the life of 1.3 billion people into a nightmare.
India’s demonetisation scheme did add 9 million taxpayers but the mass disruption it caused resulted in 8.8 million taxpayers to completely exit the banking channel.
Despite its sole purpose to curb corruption and reduce terrorist financing, demonetisation did not necessarily force the ultra-rich to pay their fair share in taxes. Instead it created hours wasted at the bank, financial uncertainty for the most vulnerable, lost wages, and cost at least several innocent lives.
But why is the policy still very popular in India among those who personally paid its costs? Similar to Xi Jinping’s consolidation of power in China, Modi successfully solved a part of the riddle that dealt primarily with monetary unfairness in India to ultimately gain political support.
Thanks in part to the popular belief that demonetisation was a collective sacrifice to force the rich to pay their dues to support the underprivileged, it was all disguised under the false umbrella of patriotism.
Given how countries like China are introducing a “national digital banknote” that makes use of blockchain technology we may see the widespread implementation of blockchain during the next decade or so, but then again, the governments around the world are still in control of their own currencies. Decentralized currencies like Bitcoin or Ethereum won’t necessarily be used as a “medium of exchange”.
Thus, cryptocurrencies might be a great investment but it is not exactly backed by faith. If it fails to acknowledge itself as a proper “medium of exchange” its future in terms of being labeled as “money” will still be questionable.
For more interesting articles on technology, startups, or the stock market, feel free to check out some of my other articles below:
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Disclaimer: This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.