Is Bitcoin the Currency of the Future

      BITCOIN : a CURRENCY for the FUTURE ?                                                                                             By                   

                         Dr. Michael Sakbani

In the past few years since the 2008 financial crisis, Bitcoins have been mined, i.e. created, by using Blockchain technology. Twenty-one million Bitcoins were created by unverifiable digital technology master or masters. We know of a pamphlet authored by Satoshi Nakamoto from Japan entitled "Bitcoin: a Peer to Peer Electronic Cash System". but we have no definite knowledge about the original creator. The creation of Bitcoin involves elaborate and advanced computer use known as "mining" to assure its safety and to avoid double payment. It should be added that Bitcoins are only one of the numerous potential applications of Blockchain technology. 
This technology programs and disseminates programmable data on the internet to all relevant users.

The Process of Bitcoins.

The process has two phases. In the first phase, the initial purchaser has to validate his offering on the internet. This is called encryption. It starts by the account holder, i.e. the initial purchaser, who has his own digital key, making his validation. This verified entry on the ledger must now be validated by those who run the computers, which are called the miners The miners in this second phase must now validate the entry by trying to guess the algorithmically generated number between zero and 4,294,967,296 (with the correct number of zeros preceding it), which was assigned to the initial offer. This validation, called "proof of work", involves a lot of iterations reaching into millions of guesses.  Once the number is guessed, the transaction is entered into the Blockchain ledger. Up to six such validations are required by the Nakamoto software. This in effect, establishes several blocks deep. confirmed ledger for all the transactions between the parties. The approval process takes time and because of its digital requirements is slow. The more is the approval depth, i.e., the number of approvals, and the larger is the number of participants, the slower and more computing time is required by the process. According to digital experts, the amount of computing power in the case of Bitcoins involves the use of a great deal of electricity by scores of computers running 24 hours a day, which implies a big energy footprint.  Some experts place the consumed electricity at more than a country like Denmark uses over the same period.  This is naturally, both economically costly and environmentally harmful.

It is clear from the above that the process is not a simple exchange between transactors. Parties to transactions often resort to using facilitators. However, facilitators and companies involved in the Blockchain processing in effect intermediate and charge fees for their services,. So, Bitcoins according to traders, run on the average $400 of such costs. The deeper is the level of approval, the costlier are Bitcoins and the more electric power they run. That is why the mining of Bitcoins is asymptotically fixed.

After the invention of Bitcoin, many speculators bought into this invention in the expectation that it will be the future currency of the World. A speculative bubble similar to the Tulip bubble and other such bubbles was seen in 2016 and 2017. The value of the Bitcoin was initially zero but reached the  astronomical height $20,000 in the fall of 2017 and then recoiled to $7,000 by the time of writing. Market traders expect it to go down considerably further.  The great fluctuation in the market value of the Bitcoin reflects two factors: its speculative nature and its lack of intrinsic value. Fiat money shares the latter attribute of the Bitcoin. But because it is issued by the Government as a legal tender, and backed up by the Central Bank as a lender of last resort, it does not have the speculative nature of the Bitcoin.

Like gold, Bitcoin has a costly and limited supply. So, scarcity, a necessary attribute of money, is satisfied. Like gold also, its stock is not- destructible and is cumulatively considerably larger than its flow mining thus its monetization generates large market swings. It is portable, divisible without losing value and is durable. Thus, the important characteristics of money are in evidence in Bitcoin. However, all of these desirable attributes are balanced off by the inflexibility of its supply and its costly mining in energy..

The currency of the Future?

The question arises whether Bitcoin will be the currency of the future nationally and internationally. The answer is at present, affirmatively negative for economically well run countries. But as bankers like Jamie Dimon, the CEO of Morgan -Chase acknowledged that in countries whose inflation is high and thus credibility is low, such as Venezuela now, or in places where there are no banks, Bitcoins are very good invention.

The supply of Bitcoin is asymptotically fixed. Hence, if it must keep up with the growth of the world economy, or any economy for that matter, its value in terms of goods and services should increase. That leads to deflation as a permanent state of economic being. Deflationary economies are harmful to the spirit of risk-taking in capitalism. Entrepreneurs will postpone taking risk and capital investments by corporations will be postponed and interrupted in a deflationary economy. If monetary authorities decide to have somehow a steady supply of Bitcoins, that would not solve the problem because the market value of the Bitcoin depends on excess supply or excess demand in the marketplace and not on supply alone. Thus, a steady supply of money a la Friedman would not foreclose ups and downs in the market values and in the cyclical macroeconomic conditions. During such cyclical ups and downs, if there is no bank of last resort for Bitcoins, there would be a flight to liquidity, i.e. to fiat money supported by the Central Banks. Thus, while Bitcoin can be theoretically capable of being a medium of exchange in normal times, their general acceptance, would not be there in times of crisis if there is no bank of last resort behind them.

There are more grave problems in so far as the function of money as an asset is concerned. Because Bitcoins have no intrinsic value, their own rate of return can only obtain from their increase in value. But this is practically impossible to be stable given the relationship between changes in the stock of Bitcoins and their flow quanta. Like gold, the relationship between the stock and the flow is volatile and essentially unpredictable. Moreover, the financial markets would not assign a rate of return unless financial instruments are denominated in Bitcoin. That would imply generalized international acceptance and functioning secondary markets. Without that, the Bitcoin would lack liquidity and very fast becomes non- negotiable.

These same factors cause ebbs and tides in the value of Bitcoin over time. Consequently, the unit of account and instrument of deferred payment function of money would be nearly missing in Bitcoins. In this respect, if banks were to lend in Bitcoins, their risk of asset default would be so large that they would have to be deeply capitalized as their capital- asset ratios would be multiplied by a large standard deviation. That obviously renders banks' profitability and commercial viability very much in question.

Is Bitcoin a Protection Against Inflationary Monetary Policies?

The cheering for Bitcoin comes from quarters who object to the observed misbehavior of states in issuing fiat money. That economic issue has not found a satisfactory answer yet. It is obvious that we do not face the simple quantity theory of money in reality and thus, the money supply function is not steady, and empirically predictable  Changes in velocity and interest rates as well as financial innovations affect the money supply function. And, it is its relationship to demand that determines inflation. The experience of the US federal reserve from 1981 till 1985 when it sought to target monetary aggregates is a case in point. The money supply function has the same problems if Bitcoins were involved.

International Political Economy Issues

Bitcoin holding seems to be highly concentrated in South Korea and Japan. Its acceptance elsewhere is yet not wide-spread. It is a very attractive instrument to have for holding illegal money, for terrorist financing and for tax evasion. Moreover, it results in loss of seignorage for states. Thus, Governments and their Central Banks will not be among the willing backers of Bitcoin.  
The rise in the economic power and trading ability of China as well as the importance of the European Union economically and commercially is bound to challenge the position of the US dollar as the dominant international reserve currency. China is on record seeking an acceptable replacement of the US dollar in the international monetary system. China holds several trillion US dollars whose track record is becoming suspect. This will receive greater impetus as the Current US Administration withdraws from many international fora. 
The subject of replacing the US dollar with an international reserve currency goes back to the time of the C.20 in early 1972-74. But it has been on the back-burner ever since. Neither the SDR nor the advent of the Euro has dethroned the US dollar from its position as the key world currency. Today, 75% of international reserves are in US dollars while the US economy is only 19% of the global economy. To move on making the Bitcoin an international key currency would require finding a way of controlling theirs and the dollar quanta, establishing an agreed substitution account and securing rules for unlimited acceptability by surplus countries. Neither the US nor the holders of the surplus will agree to have a doubtful, speculative asset as an international reserve currency in the foreseeable future. The advocates of the Bitcoin have intimated that it might be the black horse in the waiting. The above discussion clearly demonstrates how misplaced are such hopes.