Saturday, November 11, 2017

Bitcoin can't compete with fiat currency

Bitcoin's most important achievement is that it solves the double-spending problem. This allows, on a distributed and decentralized platform with no single authority, for digital credits to be spent in a verifiable and reliable manner. This means that if a transaction occurs using Bitcoin, you can verify that the credits spent only went to the address you specified.

The ability to avoid double-spending without a central authority means that trust is no longer needed to make transactions and assert identity. This allows you to do things such as sending digital credits to someone on the other side of the world without any concern over multiple banks communicating to transfer from one bank account to another and making sure it all occurs successfully. Additionally, blockchains inherently enforce identity by requiring a near impossible-to-break private key that only the owner of the credits has. This key allows the owner to publish transactions on behalf of the address they represent, asserting that they are who they say they are. This means that fraud cannot occur as long as your private key is secure.

While a powerful tool, blockchains suffers drawbacks that prevent it from being used as a mainstream currency. First and most importantly, is that it completely nullifies a country's ability to use monetary policy. This is dangerous as it prevents a government from working to prevent an economy from entering a recession or from overheating. To add to this, bitcoin is deflationary. The supply of Bitcoin is limited and by 2036, 99% of bitcoins that will ever exist will have already been mined. This results in hoarding (and less spending), real debt increasing over time, and a possible deflationary spiral.

Another vulnerability to bitcoin is that it is susceptible to a panic. All it takes is one time, and if bitcoin's price were to ever sharply dip (due to other reasons like adoption of other coins, government sanctions,  etc), it could create a panic where people start to sell en masse to avoid losses until the price went back up. This feedback loop would cause even more to sell until bitcoin were to eventually lose all value. If an economy relied on bitcoin for everyday business, this would cause an economic crisis.

Finally, Bitcoin has the problem of early adopters having a disproportionate amount of bitcoins. The original adopters were earning as much as 50 bitcoins every 10 minutes (worth roughly $360,000 now @ $7200/bitcoin). Large amounts of these bitcoins are tied up in addresses and have not been touched in years, causing uncertainty over the true money supply of bitcoins. The uncertainty of hundreds of thousands of bitcoins possibly flooding the market at any time could create a large disruption in the economy. The founder of bitcoin alone is estimated to have access to roughly 1 million bitcoins, or 5% of the entire bitcoin supply.

While bitcoin has value in being used as a currency, its inflexibility and inability to be controlled by governments will likely prevent it from ever reaching a scale that can compete with fiat currencies. In the same way that gold was banned from ownership and money moved to fiat in the 30s, so too will governments ban blockchains that threaten fiat currency and the government's ability to control the money supply. It is possible however, that governments will adopt a form of blockchain that uses a central authority (similar to IOTA for example) to both allow for a more efficient form of currency while still retaining control over it. Additionally, blockchains will continue to have value outside of monetary uses.

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