Bitcoin cannot replace fiat currencies, it will gain more institutional favor as a risky asset

Bitcoin and other cryptocurrencies have zero chance of replacing sovereign fiat currencies, and their cross-border payments will face an increasingly tough regulatory and enforcement environment.

Bitcoin cannot replace fiat currencies, it will gain more institutional favor as a risky asset

The likelihood of bitcoin and other cryptocurrencies replacing sovereign fiat currencies is nil, and their cross-border payments will face an increasingly tough regulatory and enforcement environment. …bitcoin,mining,policy and regulation,CFTC,cryptocurrency,market Bitcoin Mining Policy and Regulation CFTC Cryptocurrency Market
Bitcoin and other cryptocurrencies have zero chance of replacing sovereign fiat currencies, and their cross-border payments will face an increasingly tough regulatory and enforcement environment.

Original Article Title: “Ding Anhua | Paradise Lost: The Future of Bitcoin
By Anhua Ding, Chief Economist, China Merchants Bank

May’s Cryptocurrency Circle
On May 11, Tesla boss Elon Musk announced that he was suspending his plan to accept bitcoin payments for cars, which caused the price of bitcoin and other cryptocurrencies to plummet by 30% in a week’s time. On May 21, the Golden Stability Committee of the State Council held its fifty-first meeting to further clarify “the crackdown on bitcoin mining and trading”. The cryptocurrency world has since changed, with the price of bitcoin falling by up to 50% from its all-time high in April.

In May, the cryptocurrency world once again brought us back to a few classic questions about cryptocurrencies: Is Bitcoin a real currency or not? Is Bitcoin, as a virtual asset, a risky asset or a safe-haven asset? Where will the cryptocurrencies represented by Bitcoin go from here? These are all questions we should ponder.

Bitcoin as Currency: Utopia
According to the cryptocurrency community, the original intention behind the creation of Bitcoin was to provide a cryptographic digital currency that does not require central bank endorsement or bank intermediation, and to completely solve the trust problem of money through blockchain technology. This ambitious design has generated widespread and intense curiosity. So, what is cryptocurrency? Why do we need cryptocurrencies?

Money exists because it serves a fundamental economic purpose: to facilitate the exchange of goods and services. Without money, people would have to engage in barter, exchanging goods and services for other goods and services. In a barter economy, each exchange requires an exact match of needs between the two parties. A butcher in need of rice and a farmer in need of pork must seek exact agreement in time, space, quantity, and consideration to reach a deal, which greatly constrains economic development. To solve this dilemma, money emerged. If all members of society agree to accept some commonly accepted representation of value (money) as a medium of exchange, payments can be made quickly, people’s needs can be met effectively, and economic efficiency is enhanced. Therefore, the primary function of money is to serve as a medium of exchange. What can be used as a medium of exchange? This leads to two other subtleties of money: first, money is used as a unit of account to express prices, which requires money to have relatively stable price characteristics; second, in order to express prices, money needs to reflect the function of value storage, that is, money needs to carry the trust of value, gold is In Gold We Trust, the U.S. currency written In God We In God We Trust is also this meaning.

Bitcoin is named as “coin”, does it really have the characteristics of a currency? A decade of practice has provided a clear answer: no. On the surface, Bitcoin seems to fit the bill as a medium of exchange, otherwise Musk wouldn’t have announced in March that he was considering accepting Bitcoin payments. However, the reality of bitcoin as a medium of exchange presents many insurmountable challenges, most notably a lack of liquidity. We know that cash is fully liquid and can be used for payments at any time; treasury bonds are the next most liquid; and stocks again. Bitcoin, as a virtual digital currency, is constrained by the system’s storage space and security confirmation requirements, which limit the size of the blocks used to store transaction records and the speed of generation, which fundamentally limits the speed at which Bitcoin can process transactions. Currently, the number of transactions processed by the Bitcoin network is around 300,000 per day, which is a drop in the ocean compared to other electronic payment systems (e.g., credit cards, WeChat Pay, and Alipay). The user experience of Bitcoin as a medium of exchange is extremely poor, and the capacity and depth of the entire cryptocurrency market is still very limited.

Similarly, Bitcoin cannot meet the requirements of being a unit of account and a store of value. Its price fluctuates too much to be a useful unit of account; nor is it a credible store of value, as it has no real value and is not backed by the credit of governments or central banks. However, the view in the cryptocurrency community is that governments and central banks are not credible, with governments running the money printing presses to deflate money in a big way and inflation constantly eroding the purchasing power of legal tender. The debate continues, and from an official perspective, challenging the dictatorial power of a sovereign state to issue currency does not stand a good chance of winning. So, to date, no country has endorsed bitcoin as a true currency.

Nonetheless, as a medium of exchange, Bitcoin and other cryptocurrencies demonstrate unique possibilities in the cross-border payments space. Due to its decentralized, anonymous, borderless and portable nature, coupled with the capital controls and anti-money laundering compliance review requirements faced by cross-border payments, Bitcoin is widely used for blackmail, drug trafficking, gambling, pornography, money laundering, tax evasion and other illegal cross-border transactions. One study estimates that approximately one quarter of Bitcoin users engage in illegal activities and 46% of Bitcoin transactions are related to illegal activities. It is foreseeable that cross-border payments of Bitcoin will face an increasingly stringent regulatory and enforcement environment.

Bitcoin as an Asset: High Risk
Unlike as a currency, bitcoin is still gaining wider market acceptance as a tradable asset class. The U.S. Commodity Futures Commission (CFTC) treats bitcoin as a commodity (commodity), and our country defines bitcoin as a “virtual commodity,” as distinguished from a physical commodity. As with all financial assets, the trading price of bitcoin is ultimately determined by supply and demand.

The cryptocurrency community believes that there is a clear upper limit to the supply of bitcoin. This is different from all fiat currencies and is therefore inflation-proof. The supply of bitcoins is generated by what is often referred to as the “mining” process. Mining provides the incentive upon which the entire bitcoin system is based, and the “miner” is at the heart of the entire bitcoin system in issuing, maintaining, verifying, and recording transactions throughout the network. Mining is the process of solving mathematical puzzles through computer operations, with successful solutions resulting in the mining of a certain number of bitcoins. The reward for mining starts at 50 bitcoins per block and is halved every 4 years to the current 6.25 bitcoins per block. The mechanism of halving the mining reward (bitcoin halving) has resulted in a fixed supply rhythm and a gradual decay of incremental bitcoin supply. The final number of bitcoins is limited to 21 million, which is expected to be mined out by 2040, with about 18.7 million bitcoins already mined so far. In fact, given the number of “lost” bitcoins, the number of bitcoins in circulation is significantly smaller than the theoretical value, meaning that bitcoin is even a deflationary system in terms of supply.

This reminds us of gold. A few years ago, archaeologists found a large amount of gold, over 120 kilograms, in the tomb of Liu He, the Marquis of Haihang. More than 2,000 years ago, the Marquis of Haihang took this gold underground, which at the time may have caused severe deflation in the Western Han economy. Today, many investors in the cryptocurrency world see bitcoin as a potential ‘digital gold’ alternative to gold. Between March of last year and April of this year, the price of bitcoin skyrocketed 12-fold. And so far this year, bitcoin is seen by many investors as an effective hedge against inflation in the context of a recovering vaccine economy and rising inflation expectations. Millennial investors, in particular, seem to prefer bitcoin to gold.

Bitcoin has attracted the attention and favor of an increasing number of institutional investors over the past year, a significant departure from the retail-led bitcoin bull market of 2017. Some institutions believe that bitcoin can serve as a store of value/wealth and an inflation hedge in their portfolios, and expect that ‘digital gold’ could eventually replace traditional gold. Gold currently holds about $2.7 trillion worth of private wealth, more than three times the total market value of bitcoin. Some foreign research reports suggest that if Bitcoin’s market capitalization reaches the level of gold, its price will exceed $140,000 per coin.

The phrase “digital gold” seems to me to be more of a marketing term and deserves some consideration. While gold has practical uses as a precious metal, such as making jewelry and chips, bitcoin has no intrinsic value. Even as an investment asset, gold has proven to be a safe-haven asset in times of high uncertainty due to its high market value, good liquidity, low volatility, and lack of correlation with stock movements. Bitcoin, on the other hand, has behaved more like a risk asset, and the market volatility in May is ample evidence that Bitcoin is really no risk to avoid. Over a longer time series, bitcoin price action is highly similar to that of fellow risky assets (especially small-cap stocks).

Even as a hedge against inflation, bitcoin’s role may be overstated, or at least not empirically tested. Cryptocurrency enthusiasts often emphasize that the supply of bitcoins will not exceed 21 million at most, thereby proving that bitcoins will not keep depreciating in value as inflation goes up, like fiat currencies do. This argument is still flawed. Because cryptocurrencies like Bitcoin are springing up all over the place. A small team of ten programmers can develop some sort of cryptocurrency, with professional requirements no higher than a master’s level. In fact, we are seeing all types of ‘coins’ popping up and more novel in their technical design. So there is no upper limit to the number of cryptocurrencies available, just as there is no upper limit to the number of legal tender. An accurate count of how many cryptocurrencies there are is difficult; a less outrageous estimate is more than 6,000, of which at least 1,600 are dead. With the emergence of various cryptocurrencies, Bitcoin’s market share has dropped from 90% before 2017 to around 50% today.

My conclusion is that Bitcoin, as a tradable virtual asset, is characterized by high risk. It is similar to gold in that it is a hedge against inflation, although that conclusion remains dubious; the difference is that it is not a safe-haven asset, but a high-risk asset. So the argument for replacing gold is not necessarily valid, at least in times of high uncertainty. the divergence in trends between bitcoin and gold since late May illustrates this point.

Bitcoin and China: Bigger than Half the Sky
When I visited the U.S. in 2015, I heard a professor at a prestigious university say that bitcoin was on fire thanks to the enthusiasm of the Chinese people. He wasn’t kidding. In fact, Chinese miners and investors have, for more than a decade of Bitcoin’s development, and especially in its early stages, supported a large part of the Bitcoin world. According to estimates from the University of Cambridge Centre for Alternative Finance, China controls 65% of the world’s bitcoin mining capacity (in terms of computing power) (2 out of every 3 bitcoins are mined in China), up from 75% five years ago (75% of every 4 bitcoins are mined in China). Between 2013 and 2017, RMB-denominated bitcoin accounted for over 80% of trading volume, and at one point accounted for 95% of transactions, so it’s not too much to say that it was all Chinese speculation in bitcoin. The number of nodes in the mainland accounted for more than half of the global share of the Bitcoin network at the time, and has dropped to 3% since the government cracked down on Bitcoin trading in 2017. Most investors either open accounts to trade offshore or trade peer-to-peer OTC domestically. Four of the world’s five largest cryptocurrency exchanges now have Chinese investors as their primary users.

As a result of this development, Bitcoin has had a degree of ‘negative externality’ on China’s social welfare. First, Bitcoin as a financial innovation has not improved financial efficiency, and decentralized payment systems are nowhere to be found in China’s mobile payment sector. It is estimated that carbon emissions due to bitcoin mining in China can rank ninth among all cities in the country. Without regulation, carbon emissions from bitcoin mining will peak at 130 million tons in 2024, surpassing the carbon emissions of the Czech Republic (which ranks 39th globally). This is contrary to our policy goal of “carbon peaking and carbon neutrality”. Bitcoin’s negative externalities may also be the very reason why Elon Musk has gone back on his word – after all, Tesla Electric Vehicles is an innovative company that boasts environmental protection.

At the same time, the expansion of bitcoin trading poses a certain threat to our financial stability and investor protection. As the price of bitcoin continues to reach new highs, the level of leverage in the bitcoin market continues to climb. More and more individuals and investors are becoming involved in unregulated bitcoin trading, expanding the correlation between bitcoin prices and other financial markets and further escalating the strength and scope of the impact on financial stability. It is said that there were not a few investors who lost their positions in the cryptocurrency world in May, and while these people rarely petition for trouble, the opaque, irrevocable (irreversible) nature of bitcoin trading makes it more difficult for investors to claim their legitimate rights.

The Future of Bitcoin: Capital Never Sleeps
The understanding of Bitcoin has evolved since its introduction. While we still have doubts about Bitcoin, the future is showing a clearer picture. In my opinion, at least the following three points are now conclusive.

There is zero chance that Bitcoin and other cryptocurrencies will replace sovereign fiat currencies, while the process of launching digital currencies by central banks accelerates. The decentralized payment mechanism built by Bitcoin is not necessarily more efficient than existing mobile payments, even in technical terms. However, the anonymous and trusted mechanism of Bitcoin payments is likely to become an alternative tool for cross-border payments that is evolving towards dark web transactions and underground economic activities. Against this backdrop, governments are bound to start cracking down on the illegal transactions that Bitcoin may be involved in.

Bitcoin, as a new risk asset, will gain more institutional investors and take a place in the market portfolio. The trend is to clarify Bitcoin’s characteristics as a risk asset, and thus to properly regulate Bitcoin investments and transactions. In fact, increased regulation is beneficial to the health of the market for trading Bitcoin and other cryptocurrency assets. Regulation is not the biggest risk facing Bitcoin, but rather the opportunity for Bitcoin to survive in the long run. Bitcoin itself is not a demon. Two big bubbles in history burst and Bitcoin’s price had dropped 90%, but it survived and lived a wonderful, heart-wrenching life.

The blockchain technology on which Bitcoin relies has a broad development prospect. However, the key to recognize this is to “get rid of the charm”, remove the mystery, sanctity and charm on blockchain, and give up the illusion of anarchy and decentralization. Decentralization can only be a utopian imagination if the objects of decentralization are governments and financial intermediaries. Moreover, in terms of economic logic, financial intermediaries emerge precisely to solve the trust problem and reduce transaction costs, and while blockchain technology has proven that decentralization can solve the trust problem, it cannot reduce transaction costs.

Looking to the future of Bitcoin is like a youthful paradise lost. Come on, welcome to the real world.

Posted by:CoinYuppie,Reprinted with attribution to:
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