Money – Collective Imagination, Fiat Currency and the Future of Bitcoinn’t Forget to Wear Your Seat-belts!
This is the monthly chart of Dogecoin. It has increased from 0.09 cents to 0.35 cents in the last one week. That’s almost ~4x in 7 days. Here is what the founders had in mind when they created Dogecoin – We started it as a joke. We wanted it to be a light-hearted cryptocurrency based on a popular dog meme.
Today, thanks to Reddit, Elon Musk and Twitter, the market cap of Dogecoin is $45 billion. To give you a perspective – its higher than the market cap of State Bank of India – the largest lender in our country.
Another fun fact – The market cap of Bitcoin is $ 1 trillion ($ 1000 bn). The market cap of all listed banks in India – private as well as public – is one-third of the market cap of Bitcoin. Is Bitcoin really worth 3 times the entire Indian banking sector?
Well, we cannot even say that this is absurd. We are at a stage where you only have to write “crypto” in the description and the prices will sky-rocket in no time. For such examples, read our previous blog on NFTs.
In this post, I try to explain what’s going on with crypto currencies. Only time will tell whether my views were right or wrong.
As always, let’s start with the basics.
1. What is Money?
Money is a store of value, a medium of exchange, blah blah.
We all know that already. The question is who decides that this particular paper/thing/code is an acceptable medium of exchange or store of value?
Us – the users! Whatever you and me are willing to accept as a currency can become a legit currency.
2. Really? Can anything be used as a currency?
There are many examples of people deciding amongst themselves about what they want to use as a currency.
What is the currency in a prison? – Cigarettes. Even thieves and murderers can devise a perfectly functional currency system.
From barley, shekels, cowry shells to playing cards, paper notes and Bitcoin – humans have designed & dismantled many currency systems.
3. But how does the currency system work?
It works on Trust. Trust is the cornerstone of any currency system.
Why do you accept some pieces of coloured paper for your products / services? Because you know that your neighbourhood kirana store will accept them in return for groceries. Your family doctor, your fruit vendor, your landlord and everyone else will accept it. Basically, you trust in the system because everyone else trusts in the system. Like Yual Noah Harari says “It’s a figment of our collective imagination.”
4. How was this Trust built?
This trust has been built over the years due to many political and economic events that have occurred. However, it wouldn’t be wrong to say that people believe in the currency because they believe in the State (Kings/Emperors/Countries) that issued the currency. For majority of known history, we have been using State-sponsored and State-controlled currencies.
This Trust in the Government is the primary reason that the entire world uses Fiat currency.
5. What is Fiat Currency?
Till a few centuries back, people used metals like Gold and Silver as currency.
Every-time someone paid you in Gold, you had to measure its weight and you would have no idea about its purity.
Coins solved this problem – Kings issued coins which guaranteed the weight and the purity of the Gold.
Then came Paper Notes. The State kept the Gold in a Vault and issued Notes that entitled the holder of the Note to collect a pre-defined quantum of Gold from the vault. These notes started being used in the economy as currency.
Then came Fiat currency. The State decided that we don’t have to limit the number of notes in circulation to the quantum of Gold we have in the Reserves. We can issue as many notes as we want.
Since 1971, all the major countries in the world, including India, use Fiat currencies, i.e., the currencies are not backed by any precious metal like Gold or Silver.
Now, the only reason we trust the Indian Rupee is because we have trust in the RBI and the GoI.
Ray Dalio, who is one of the biggest fund managers in the world, thinks that too much of Fiat currency can cause the system to fail and the economy can go back to Type 1 / Type 2 currency – metal coins / bank notes. IF, and it’s a big IF, that happens then it will be very painful for almost everyone.
(This image showing Types of Money is from his website – Principles.com).
The latest entrant is Digital Currency. China has recently launched Digital Yuan. Well, you might say that you too use digital banking. Yes, but there is a difference. When you do a UPI / IMPS / NEFT / RTGS, what you are doing is an electronic transfer of physical cash. Sounds weird but that’s what it is.
Whereas Digital Currency is a programmed currency. It can be tracked, and its uses can be controlled.
6. But Bitcoin is not State-backed or State-sponsored…
No, it’s not. In fact, the sole reason that Satoshi Nakamoto – the mysterious inventor of Bitcoin – created Bitcoin in 2009 was to have a currency which is free from Government control and manipulation.
The first argument – “there is no limit on the amount of Fiat currency that can be created and Governments have used this to pump obscene amounts of new money in the system. Whenever there is too much of anything its value decreases. The value of our savings is being eroded day by day due to infinite money creation by the Government”. This is a very valid argument and I agree that this is a major shortcoming of the Fiat currency regime.
The second argument – “First Governments issue too much currency, take on too much debt and once they are to unable repay the Governments devalue the currency.” Another valid point. Every single currency that the world has seen has either died or has been devalued or both. Back home, the Indian Rupee was devalued in the early 90s to protect the country from a dire situation.
Bitcoin records are maintained in a public ledger which is based on Blockchain technology. This intends to make it a peer-to-peer system which doesn’t need an intermediary. [This blog is not on the benefits and usage of Blockchain technology but on the future of Bitcoin. Its important to differentiate between the two.]
7. As you must have deduced by now, the basic tenets of the Bitcoin are-
Finite number of Bitcoins – Not more than 21 million Bitcoins can ever be mined/created. Currently a little more than 18 million bitcoins have been mined. Bitcoins are mined as per the code written by Satoshi Nakamoto and it becomes progressively more difficult to mine new Bitcoins. The last Bitcoin will be mined in 2140. None of us are likely to be around at that time.
Price discovery – Demand and supply will determine the price and nobody will be able to control the price. It will be free of any centralised control.
No intermediary – Transactions will be directly peer-to-peer.
Its aim was to become the first de-centralised and digital currency of the world. How is it going?
Bitcoin started off slowly and then suddenly burst on to the scene in 2017. Made a high of ~$ 20k in 2017 only to fall almost 80% from there in the next 2 years.
Then the pandemic happened. USA pumped trillions of $ in the financial system and a decent chunk of that money found its way to Bitcoin. Its price zoomed from $5k to $60k in 12 months.
8. What led to this meteoric rise in 2020-2021?
Trillions of dollars are floating in the financial system. Interest rates are low. Thus, money is cheaply available. When you have cheap money, a lot of people take a punt on risky assets.
Such historical creation of new money validated the original Bitcoin thesis that Governments will keep printing Fiat money and reduce its value.
The USA is the weakest it has been since the WW 2 and there are concerns that USD may lose its position as the reserve currency of the World. In absence of any worthy replacements, some people thought Bitcoin can become the new reserve currency of the world.
Most important of all – hedge funds which till now ignored Bitcoin started to buy Bitcoins. Bitcoin is thinly traded. So, when big money from hedge funds started chasing Bitcoin, the price started rising vertically.
9. Does that mean Bitcoin is the going to be currency of the future?
Let’s evaluate each argument…
10. There are larger issues at play here which we need to discuss.
11. What is the future of Bitcoins?
It’s tough to say because strange things happen all the time. However, in my opinion, Bitcoin doesn’t look a candidate for becoming a Medium of Exchange or Store of Value.
Maybe it can become an Inflation-hedge but that too is not yet proven as the developed world hasn’t seen inflation since Bitcoin was launched. I think this is the best Bitcoin can become – an Inflation hedge.
Many early adopters of Bitcoin have sold their Bitcoins as they now do not see it becoming a true currency. Recently, NNT – the author of Black Swan – sold his Bitcoins. Read the tweets to understand his rationale for selling his Bitcoins.
The early believers in Bitcoin must all be very rich people now. But as of now, their dream of seeing Bitcoin become the currency of the future looks all but dead.