I have received a lot of questions about Bitcoin, and I'd like to paint a more balanced and accurate picture between people who are completely sold on the merit of Bitcoin, but who may not be realistic, and people who reject the very notion of Bitcoin without much logical reasoning. While there are risks that investors in Bitcoin may not see, and there are also reasons that explain why people buy Bitcoin, Therefore, I start by discussing strongly-held convictions about Bitcoin, which is capped at 21 million, by saying that it is a decentralized digital system unlike all other digital currencies, and on the other hand I present what I think are the the reasons for investing in this digital asset.
First, let's start with the pro-Bitcoin cmp. Some Bitcoin investors believe it is a safe haven parallel to the (central) banking system, which experienced a major crisis in 2008, and a significant injection of currencies, which can lead to inflation and is also subject to corruption and manipulation. Second, the concept of scarcity and lack of supply has been established, which gives Bitcoin the ability to preserve value.
As for the first point, I would like to mention that these major central banks are in countries with well-established institutions in their cities, which has earned them confidence and stability. These include the United States, the Euro countries, Britain, Japan and others, which make up the community of developed countries and with deeply rooted institutions. Their central banks have a relatively high degree of independence, decisions made within them are not done so by an individual, but rather through a vote, similar to a parliament. The governor of the central bank also has to present an opinion to the government’s parliament and answer the questions of members. This does not mean that no mistakes occur, but what is important is the possibility of offering solutions and saving institutions as happened in 2008. This has achieved growth that continued for years, it reduced the value of the issued currency in relation to the US GDP, and inflation did not rise much despite the record drop in unemployment.
And if we look back at history, this monetary system that was liberated from gold - of limited quantity like Bitcoin - in 1974 was largely responsible for the growth of developing economies at that time such as Japan and Germany and the wave of Asian developing countries later on. This is thanks to the flexibility of this system that gives a group of people, akin to a Parliament without absolute power, the ability to innovate and address issues. Secondly, monetary policy is one of the tools of the treasury system, to intervene, motivate and save productive institutions, and most importantly, create confidence in society, with the state intervening in exceptionally critical historical times. Therefore, central banks are linked to more stable institutional countries. Finally, there is a great digital development in China and concerns about creating a digital system centered around the dollar and other sovereign currencies. This was discussed recently in the Nixon Legacy Forum by Peter Thiel, who is one of the major Bitcoin investors, and who sees this a weapon that can be used against institutional countries. Meaning that the major investors and technology experts are aware of the necessity of the survival of the sovereign currencies for fear of China from a moral perspective, in defense of freedoms and rights.
What is clear is that digital currencies can affect the banking system while not replacing the currencies of countries, in a research paper presented by Fabian Sacher from Federal Louisiana that blockchain technology is very likely to change the banking system, and to establish a decentralized financial system (DeFi) that helps increase the level of security for transfers, accounts, and transparency, lower costs, and spark the emergence of automated services, including insurance products and financial derivatives, but under a specific and clear framework. This will require choosing a stable cryptocurrency with a fiat-backed stablecoin and not a fluctuating bitcoin, such as what Visa decided recently to issue a digital currency pegged to the US dollar. And also under the supervision of the FinCEN office, which proposes imposing stricter laws on digital currencies, including Bitcoin, to raise transparency and informatics for acceptance into the monetary system. In Bitcoin budgets, you can see money transfers but cannot know who the senders are, and the impact of the requirements of the Financial Supervision Office is unknown. But it could hinder the increased use of Bitcoin in daily life. So far the volume of Bitcoin transactions per second is matched by 4800 Visa transactions, which is an indication of the limited use of Bitcoin.
For the second proposition, is Bitcoin a means of value preservation? If we use the supply and demand rule, we see that the demand for it for use is limited, but the demand for investment is divided into two parts: buying from institutions, there is a high probability that it will not be promising in light of its low use, and the high volatility of Bitcoin, which does not make it comparable to gold according to the governance policies that many of these funds adhere to them. The maximum fluctuation of gold was 30% in 2013, which is a correction after a significant increase after the financial crisis, while Bitcoin fell 80% in 2014 and 2017. With the pandemic, the value of Bitcoin decreased 29%, as compared to 12% for gold, so the JP Morgan report explained that funds entering into Bitcoin are temporary and opportunistic. The second problem is the carbon emission of mining in light of a well-known algorithm and technology equation that consumes a high amount of electricity estimated to be equivalent as the amount consumed by New Zealand, as it requires cheap electricity sources that are produced from fossil fuels. The largest mining countries, which are China 65%, Russia 6.9%, and Iran 3.8% (according to Cambridge Bitcoin data), can impose laws that prevent funds from investing in Bitcoin for environmental reasons, such as those imposed on companies with a high carbon footprint. The energy that Bitcoin consumes in a single transaction creates a carbon emission equivalent to 700,000 for Visa, according to Digiconomist estimates, and this could force funds to impose on their government not to invest in Bitcoin and thus lose an investor that gives them stability, unlike the individual investor who is by nature more volatile with a shorter investment period. Only 1000 people own 40% of all Bitcoin, which are assets that do not generate returns, so these people have great influence, especially if one of them goes bankrupt for personal reasons or uses financial leverage against these assets or feels that Bitcoin has reached its maximum potential.
But what are the reasons for buying Bitcoin if we assume that it will not replace the monetary and banking system and does not preserve the value in a less volatile manner? I think that this digital object has an important use that we have not understood, and I will call it a high risk alternative investment for all types of investors, meaning that despite its high volatility, it is a saving and investment that is acceptable for a person who lives in a country suffering from turmoil and hyperinflation, such as Venezuela or Nigeria, which lacks security, and whose people are afraid of hoarding gold, unlike the Bitcoin code, or in countries outside the banking system that impose sanctions on them, such as Iran, and in rich countries if class differences are very pronounced and they no longer believe in financial markets. Bitcoin is an acceptable risk for these categories (better than buying a lottery ticket), and recently, with the high yield on bonds, institutional investors can see it as an alternative to high-repeat stocks. The market is expected to undergo a major correction, for example, since the beginning of the volatility, a high-repeat stock like Tesla has declined by 14% and Bitcoin rose 5%. The technology sector had the lowest returns during the same period due to the high-repeat rate. To date, Bitcoin represents 1.2% of the size of the global economy for the past year, for that Bitcoin is a good high risk alternative investment that is affected by geopolitical risks, economic crises and market movement, this is my observation and not a conclusive opinion.
In conclusion about Bitcoin, this modern digital object, while its economic role has been largely exaggerated, there has also been an exaggeration in canceling its importance and ignoring its addition. So far, I see it as an alternative investment with high risks that will continue to be highly volatile, but how knows about the future? There could be many new variables, which I may cover in years to come.
This article was originally published in, and translated from Saudi outlet Al Riyadh.