Bitcoins rise back above the $1,000 mark for the first time in three years, amid continuing global economic uncertainty, signposts its emerging niche as a long-term store of value – with other blockchain platforms emerging to provide facilities as transactional currencies.
Markets move in cycles and it is not surprising that, three years after the speculative bubble at the end of 2013, bitcoin is enjoying a resurgence of interest. The virtual currency has been declared dead by experts and the mainstream media more times than it’s worth counting, but it appears to be stubbornly resistant to demise.
This time around, bitcoin’s move above $1,000 takes place in very different circumstances. The bitcoin and wider blockchain ecosystem is significantly more mature, with multiple large exchanges rather than one huge, poorly-run and insecure exchange (the ill-fated MtGox) providing a hub for trading and a catastrophic single point of failure.
Awareness is far greater, liquidity is higher. The rise in price has been rapid (and somewhat choppy, to say the least) but does not, at the time of writing, have the character of a bubble – that irrational exuberance that sees a period of multiple double-digit daily increases, culminating with a final sharp spike upwards and an inevitable and brutal crash.
The Global Economic Picture
Moreover, there are reasons for bitcoin’s rise beyond mere speculative interest. Like the bitcoin ecosystem, the global economic crisis has also matured over the past three years. We now have a better picture of the problems facing us – and how bitcoin fits into that.
China has always been a big player in the bitcoin space, accounting for around 70 percent of bitcoin mining (the process by which new bitcoins are created, and transactions on the bitcoin network approved) and up to 90 percent of trading. The Chinese government’s move to devalue the Yuan to make its state-run economy more competitive, and the strengthening US dollar, have made bitcoin even more interesting to Chinese speculators. Moreover, bitcoin has become a popular and proven means of circumventing the capital controls imposed by the authorities. If you want to move money out of China, there are various options – and bitcoin is one of them. No wonder it has seen increased demand as wealthy Chinese seek to store value in assets and currencies other than Yuan.
China also forms a large piece of the global economic puzzle. What happens in the next year will shape the rest of the world. How much further their economy will slow; the problems of China’s vast and opaque shadow banking sector; their interaction with the US and the Trump presidency, which is notably more hostile towards Chinese imports and labour than the previous administration; what they do with their very significant dollar reserves in response – all of these have yet to be answered.
Later this year will see the 19th National Congress of the Communist Party of China, at which new leadership will be elected, including five out of the seven members of the Politburo Standing Committee – the highest decision-making body in the country. This is closely watched due to the significant scope for uncertainty and its economic impacts as potential candidates jockey for power.
Bitcoin offers something here for the scared Chinese middle classes. In fact, any form of uncertainty increasingly favors bitcoin as a ‘safe haven’ asset, either as a means of moving money across borders, or as a means of protecting it from bail-ins and erosion by inflation. Bitcoin has not previously proven a good store of value, but with growing market cap and awareness, volatility is far lower than it was. On the long-term timescale, it has posted attractive gains, where the Yuan has only slid one way.
China provides uncertainty in spades, but there’s plenty more of it to go around. The Eurozone is experiencing what is looking more and more like secular stagnation, and only successive rounds of QE have prevented full-blown deflation and depression. The currency bloc is running to stay still. The rise of right-wing and populist parties across Europe indicates that dissatisfaction with the political-economic status quo has now reached a tipping point. Anti-establishment candidates are achieving what was once thought impossible. The French presidential election in May will be a further bellwether of popular sentiment.
In Italy, which recently saw the resignation of Prime Minister Renzi after the referendum on constitutional reform went against him, there is continuing uncertainty about the country’s oldest and most dysfunctional bank, Monte dei Paschi.
The state has fudged a bailout and managed to protect retail investors (who, under EU rules, were due a haircut on their holdings), but it’s unclear whether this will be enough – and there are plenty of other banks in similar positions. Even Germany, bastion of fiscal credibility, has its problems in the form of Deutsche Bank. Its issues with US regulators may be nearing a close, but the underlying picture is still not pretty for the over-leveraged bank’s finances. Throw in the messy Brexit negotiations and what becomes crystal clear is that nothing is crystal clear.
Bitcoin’s Role and Limitations
This is the broader economic context within which bitcoin sits. Like gold, it has limited supply that cannot be tampered with. Unlike gold, it can be purchased easily and in any quantity, and moved around the world almost frictionlessly. It has, perhaps rather inaccurately, gained a reputation as a ‘safe haven’ asset. It is true that bitcoin’s price tends to correlate negatively with conventional assets, and economic shocks in the wider world tend to give it a boost.
But it has not, in the past, proven a good store of value due to its signature volatility. That volatility, whilst still marked, has attenuated over the past three years as awareness of bitcoin and blockchain grows, and new exchanges open. It is no longer so thinly traded. There is regulation, institutional interest, even an ETF on the way. Thus it appears that some mainstream investors now genuinely are considering using it as an alternative to traditional stores of value such as gold – especially those prepared to hold for years, riding out the day-to-day ups and downs.
There is one other aspect of bitcoin that makes it a superb store of value. It cannot be taken from you. Used properly, bitcoin truly belongs to you in a way that funds held in a bank do not. Bank-held money can be taken unilaterally, upon action by the bank or a demand by the government – this is the nature of some forms of bail-in or ‘haircut’.
But if you keep bitcoins in an address to which you alone hold the private key (not on an exchange), then they are protected with all the security of the laws of maths and physics that underpin the universe. So while bitcoin’s value against the dollar may fluctuate, it has the quantitative benefit that it cannot be appropriated by a government or third party. That is becoming more and more attractive in this age of both bail-outs and bail-ins.
This emerging picture is reinforced by bitcoin’s own governance issues. It is not currently suited for use as a transactional currency. The bitcoin protocol simply cannot handle the necessary throughput. Numerous scalability improvements are actively being worked on, including the exciting-sounding Segregated Witness, or SegWit.
SegWit would allow a greater number of transactions to be squeezed into the same parcel or ‘block’, thus raising capacity without making major changes to the core bitcoin software. But both development and adoption are slow, and the decentralised nature of bitcoin means that achieving consensus amongst the different stakeholders is often difficult. Whilst these issues are worked through, bitcoin’s transaction capacity is not large enough for it to be used as a popular means of remittance or e-commerce. Blocks are often full, such that higher fees must be paid to guarantee that a transaction is accepted.
This, of course, makes bitcoin more lucrative for miners and actually contributes to its rising value.
In some ways, it doesn’t matter whether bitcoin’s capacity is raised by a factor of two or ten or even a hundred. It is still not enough to support a role as a popular transactional currency – the amount of money moving around the world is simply too great for that. One way or another, bitcoin’s current role appears to be as a haven for value.
Blockchain and Transactional Currencies
This leaves an opening for other blockchain-based currencies. The past three years have been a time of rapid advances in the broader cryptocurrency scene, and numerous use-cases are now emerging. Bitcoin is becoming a store of value and a currency of settlement between these, since all of them trade against bitcoin (and often other currencies). But the job of actually interacting with different marketplaces appears to be moving in the direction of not one but many different blockchain tokens.
This is only reasonable, with the benefit of hindsight. No one protocol would support the weight of so many transactions, and it makes sense to specialize. Austrian economist Friedrich Hayek foresaw something similar, a marketplace of competing currencies rather than state-backed money. The best currencies – those that served businesses and consumers best – would naturally rise to the top. There would ultimately be a handful of winners.
We’re too early in the history of blockchain to know who the winners are, but we are now well into the early stages of that primordial soup of monetary competition. Businesses are launching and marketing new cryptocurrencies, and gaining traction in their chosen niches. Gamecredits is positioning to become a major means of payment for the $100 billion gaming industry, circumventing the considerable costs and frictions of moving money into and between in-game economies.
Incent is launching as a currency of reward. There are currencies designed to facilitate anonymity, partly for use on the drug markets of the darkweb (the free market has no respect for legalities). Those like Dogecoin that foster a culture of tipping and fun are naturally suited to social media users. Crypto-coins are being created to act as local currencies for specific geographic areas, in the same way that the Bristol Pound or Berkshares operate. There are currencies that target the recruitment sector or operate on the principle of timebanking.
It’s a gold rush to bring these applications to market, since blockchain is in its infancy and there are wide open doors. Every gold rush has its shovel sellers – those who see business regardless of the success or failure of each individual initiative – and it’s a fair bet that software platforms that allow users to create and launch their own custom digital tokens with a minimum of fuss or technical know-how will do well out of it.
It’s a fast-moving world, and the picture will doubtless change. Individual currencies will rise and fall, until out of the churn come a handful of favorites. But bitcoin itself appears to be cementing its position in a unique space – not primarily as a means of transacting, but as a digital safe space for funds under threat from currency devaluation, inflation, bail-ins and other hazards of the current global economic malaise.