Bitcoin versus the US Dollar

Will digital cash overtake traditional currencies?

One of the most heated debates in the Bitcoin community today is whether crypto coins such as Bitcoin will ever triumph over the mighty USD to become the world’s primary means of payment for cross-border transfers. Reading through numerous threads and blogs, our research shows that many Bitcoin enthusiasts believe this scenario is not only possible, but is bound to happen in the not-so-distant future.

Powerful currencies have fallen in the past

Powerful currencies can and do fall. Prior to the digital age, world-famous hedge fund manager George Soros brought down the British Pound almost single-handedly, and some believe that a similar feat will occur with Bitcoin bringing down the USD. While this is by no means the general consensus, most researchers and financial analysts do agree that digital cash is on the cusp of widespread adoption. This article analyzes the array of positions concerning the future of Bitcoin and other digital monies.

Predicting Bitcoin’s future

Most analysts do not address the question of whether Bitcoin will someday replace the USD. Instead, they ask the following more fundamental question: Can Bitcoin ever play an important role in the global economy? Venture capitalist Fred Wilson puts it squarely in the realm of the possible. The New York-based financier invests heavily in Web 2.0 companies. He has analyzed the price movement of Bitcoin within Gartner’s Hype Cycles model, arguing that Bitcoin has already passed the peak of inflated expectations and is currently in the trough of disillusionment. If this is the case, and if Bitcoin conforms to the path described by the model, then the future value of the crypto coin should only rise. To drive the point home, Wilson uses the Internet itself as an example. After the “dotcom bubble” in 2002 and 2003, some people thought the Internet was no longer a technology worth investing in. Obviously, this proved not to be the case. Wilson’s research shows that  the same thing is happening with Bitcoin. More and more people believe that digital cash rooted in peer-to-peer networks and publicly transparent general ledgers is an idea poised for exponential growth in the coming years [1].

A volatile dilemma

In its current state, however, Bitcoin is far too unpredictable to pose a serious threat to more stable, government-issued currencies.  The ups and downs of Bitcoin’s value since January alone have been unstable at best. At its worst, Bitcoin is unacceptably volatile.  According to John Delono, the Chief Business Development Officer at Bitcoin Reviewer, “The Bitcoin market really is unpredictable, and unstable compared to most government-issued currency markets” [2]. Bitcoin’s unpredictability is problematic for a number of reasons. If, for example, a store accepts Bitcoins from its customers but its suppliers do not accept digital cash, then the volatility of Bitcoin alone could send the store spiraling into bankruptcy. In another scenario, imagine consumer reaction if on one day a unit of Bitcoin can purchase three beers, but the very next day that same unit is only capable of buying one beer. That kind of volatility is simply unacceptable to consumers. Of course, there is also the chance that a unit of Bitcoin will purchase ten beers the day after that. This unpredictability, however, is something most people want to avoid, and something Bitcoin must solve in its quest for widespread adoption.

The Bitcoin advantage

Despite such issues, Bitcoin has several unique advantages that position it for broad acceptance as a medium of exchange and store of value. According to Emma Lawson, an analyst from Australia National Bank, Bitcoin compares favorably against other electronic payment methods. It is as durable as a credit card or PayPal, lacks the portability problems inherent to physical money, has excellent divisibility, and is scarcer than other fiat money. Lawson also points out that Bitcoin is already both widely recognized and accepted, despite what detractors may say to the contrary. She also readily admits that Bitcoin still has a long ways to go.

Famous and misunderstood

Many disagree with Emma Lawson’s argument that Bitcoin is already widely recognized or accepted. Admittedly, after intense exposure in the media, Bitcoin is now a household term. Truly understanding all the details and functions of Bitcoin, however, is far more complex than just knowing that it is digital cash. Even the US Treasury mistakenly calls Bitcoin a “virtual currency”. In reality, it is not legal tender. Using the term “currency” is therefore misleading. An early whitepaper by enigmatic inventor Satoshi Nakamoto more accurately defines it as a peer-to-peer electronic cash system rather than an actual “currency”. For Bitcoin to achieve true recognition, these misunderstandings must be addressed. After all, it’s important to know what is happening with your money. Unfortunately, even with all the information that is out there, most people still do not understand the complexities and potential of Bitcoin as a payment system. The result is a lack of knowledge about the properties of digital cash. This is a problem the world has never really had to face before when dealing with other forms of money such as gold or traditional currencies [3].

If digital cash steps up against the dollar’s dominance

Assuming that Bitcoin someday overcomes these issues, could it ever reach a position influential enough to challenge the mighty USD? The challenges faced by someone wanting to use digital cash to defeat the USD would be tremendous, much greater than speculating with legal tender against the British Pound. In 1992 George Soros brought the Bank of England to its knees, reportedly making over a billion dollars in the process. Bringing down an entire monetary system, especially one belonging to a prominent G7 nation, is a legendary feat still talked about by currency traders more than twenty years later. If a group of investors led by George Soros can wreak havoc on a country’s monetary system, could Bitcoin ever do the same?

Bitcoin attacking USD compared to George Soros attacking GBP

After World War II, European countries sought a higher level of economic integration with one another. They hoped that tighter relations would prevent catastrophic wars from breaking out every few decades and would usher in the creation of a large Pan-European market capable of competing with the United States. Before the introduction of the Euro, there was the European Exchange Rate mechanism (ERM) with its ECU (European Currency Unit). Under the ERM, countries agreed to fix their exchange rates with each other instead of “floating” their currencies and letting capital markets set the rates. Because Germany was the strongest economy in Europe, each country set their own currency’s value in Deutschemarks. In 1990, with high inflation and weak exports, Britain chose to enter the ERM to keep its monetary policy on course. Two years later, due to a massive global recession, unemployment in Britain skyrocketed to 12.7%. Under such circumstances, a country would normally cut interest rates and increase investment and government spending. However, because the UK had joined the ERM and agreed on a lower bound for the exchange rate between the Pound and Deutschemark, implementing those normal procedures would force the exchange rate to drop below the lower bound—an impossible situation. The Bank of England (BoE) was at a complete loss on what actions it should take.

The Bank of England surrenders

George Soros and his Quantum Fund team saw this as an opportunity and built up a 15 billion bet against the GBP. More importantly, everyone knew that the GBP was overpriced, and as currency traders became aware of Soros’s own position, more and more of them followed suit, betting that the GBP would depreciate. This created a phenomenal amount of pressure on the whole system. The BoE used its foreign reserves to buy up a billion GBP in a single morning to bolster the exchange rate. The fight between the BoE and speculators continued during the rest of that day but the Pound continued to plummet, even in spite of the BoE increasing interest rates from 10% to 15%. At 7:30 PM, Finance Minister Norman Lamont announced that Britain would quit the ERM and the GBP’s exchange rate would be converted back to the floating method. On September 16, 1992, a day that has ever since been called Black Wednesday, the pound dropped 15% relative to the Deutschemark and 25% relative to the US dollar. Meanwhile, the value of George Soros’s Quantum Fund increased from $15 to $19 billion. A few months later, it was worth nearly $22 billion [4].

Can Bitcoin repeat this phenomenon and drive the FED into a corner?

Could Bitcoin do the same to the US dollar? In the final analysis, it is extremely unlikely. There are a few key reasons that the USD will not see its dominant position challenged by Bitcoin or any other digital cash in the foreseeable future. First of all, even though US debt is more than its gross domestic product (GDP), the US Federal Reserve can literally print money at will to avoid federal bankruptcy, thereby prolonging the dollar’s top position in global finance. In fact, this is exactly what occurred during the recent global financial crisis.

Petrodollars enable the USA to print unlimited money

Another reason the dollar will not be toppled by Bitcoin is due to its strong ties to the oil industry.  As long as payments for oil flow through the USD clearing system, the Federal Reserve has an incredible amount of control over global finances. Because oil is mainly paid for in USD, the currency remains in high demand. This keeps the USD deeply rooted in the global economy and allows the United States to get away with actions such as printing as much money as it pleases.

China will not allow the US dollar to drop significantly

The actions needed to replicate Soros’s feat in a Bitcoin/USD scenario are practically impossible. In order to build a position capable of toppling the US dollar, one would have to own an incredible amount of Bitcoins first, and then be able to borrow an astronomical number of US dollars or Treasury Bills. But where could a speculator borrow such a large amount of money using Bitcoin as collateral for placing leveraged trades? There is no financial market enabling this kind of trading activity; but what if the entire Bitcoin community in China would assist with money? Even though their capacity outnumbers the trading volume on Western Bitcoin exchanges, it would be like a drop in the ocean. The supply of Bitcoin is nothing against the amount of dollars in circulation. Are there any other options? Let’s assume, one could borrow more than enough dollars from somewhere, sit back, and just wait for the USD to depreciate, and eventually benefit from its own risen Bitcoin positions. It sounds fanciful, to be sure, but the Peoples Bank of China (PBoC) would certainly intervene against it. China has the largest foreign reserves of US dollars in the world and potentially the power to overthrow the greenback. Theoretically, overturning the dollar is conceivable for China, but practically it is virtually impossible. Betting against the dollar is a purely hypothetical case for the Middle Kingdom.  Neither the USA nor China would ever allow this to happen.

The capacity to protect the dollar is gigantic

If China allowed the US dollar to drop significantly, its vast reserves of dollars would suddenly be worth much less, thereby exposing China to an unacceptable level of risk. The US would also stop such an effort by leveraging its relationships to China and the Organization of the Petroleum Exporting Countries (OPEC) that rely heavily on petrodollars. Simply put, the capacity to protect the USD is far greater than was the UK’s capacity to protect the GBP back in 1992. In addition, George Soros’s success in bringing down the GBP relied heavily on the supporting actions of many other speculators. It is highly unlikely that anyone could garner such widespread support in today’s financial environment.

When two currencies quarrel a third rejoices

Let’s think outside the box a little further. Are there any other ways besides the one mentioned that could lead to Bitcoin replacing the US dollar’s dominating position? Again, the answer is no. To explain, let’s look at a recent event that is probably as close as the USD will momentarily come to losing its dominance, one that still falls well short of toppling it. Recently, Russia and China linked a 30-year gas deal worth 40 billion, with the transaction to be settled with Chinese renminbi (CNY or RMB, Yuan is the basic unit of the currency) instead of the almighty US dollars [5]. This agreement poised a challenge to the US dollar’s status quo as the ordinarily used currency in energy deals. The fact is, however, that the deal between China and Russia is a rather rare event, the only reason it was able to go through in the first place being Russia’s limited options to sell gas and the increasing political influence of China. Without bringing in too much politics, it’s safe to say that neither China nor Russia will adopt Bitcoin as a means of payment for energy trading, hence another reason why Bitcoin has no change to topple the dollar.   

It’s virtually impossible for Bitcoin to replace the US dollar

The aforementioned arguments and scenarios show why it’s impossible for Bitcoin to replace the US dollar in the foreseeable future. This begs the following questions: Is there even a need for Bitcoin at all? What purpose does Bitcoin serve? Even though Bitcoin and other digital cash systems cannot meet all the requirements of becoming a dominant form of currency in the future, the Bitcoin does represent a cheaper, faster, and more secure way of transferring funds than any of the existing alternatives.

Bitcoin-like technology can be highly beneficial even to central banks

More specifically, a central bank can issue its own digital cash to improve the quality of its country’s financial services, thereby improving its competitive position in the overall global finance industry. At the same time, crypto coins represent a thread to some small and emerging economies. For example, a private initiative in Iceland recently created Auroracoin and distributed it freely to anyone with Icelandic identification. Auroracoin addresses the need for a suitable medium of exchange and circumvents the government’s restrictions on the cross-border movement of Iceland’s króna that have been in place since the country went bankrupt due to the financial crisis in 2008.

Money talks but money can’t buy the true potential of the Bitcoin protocol

Although the world may never see Bitcoin or any other digital cash system overthrowing a dominant currency such as the USD, Bitcoin’s true potential lies in its technological foundations.  The Bitcoin protocol is crucial to the success of a new collaborative economy. It enables a frictionless and transparent way of sharing all kinds of digital products and services between people without the interference of third-parties. These features make it an exciting and valuable tool for individuals, banks, and even governments around the world. Whether you love it or hate it, digital cash is undoubtedly on its way to becoming a key part of the global finance arena. 

About the author

Bernhard Kaufmann is the managing director of a Swiss-based payments technology company. He has contributed to the transatlantic crypto industry through his many years of expertise in ecommerce, payments processing, cross-border banking, regulatory compliance, copyright law, tri-medial publishing, and by developing pioneering use cases for financial service companies based on Bitcoin technology. Bernhard’s primary objective is empowering people by forging digital connections across developed and emerging markets. In the early days of the Internet, he was recognized as one of the first investors to take an active role in cross-media communication and multimedia production. Bernhard is an analytical and creative thinker with an influential voice in the community by hosting some of the most innovative business engineers and web architects at his company’s regular research boot camps in Switzerland. The firm is a financial service and software company powering state of the art platforms such as Payment21® and Benscha™ that connect users globally and provide alternative payment methods to consumers, businesses and financial institutions.

Links & sources:

[1] http://avc.com/2011/11/bitcoin/?utm_source=feedburner&utm_medium=feed&ut...

[2] http://letstalkbitcoin.com/bitcoin-simply-cannot-replace-fiat/

[3] http://letstalkbitcoin.com/bitcoin-simply-cannot-replace-fiat/

[4] http://priceonomics.com/the-trade-of-the-century-when-george-soros-broke/

[5] http://america.aljazeera.com/articles/2014/5/20/russia-china-bankdeal.html