Bitcoin - A Possible New Reserve Currency?

“The future of money”, “a drug-dealer’s dream”, “a bubble wrapped in techno-mysticism inside a cocoon of libertarian ideology” – Bitcoin has been called many things. However, could it possibly change the world?

By Chris Campbell.

10 January 2021 (2 months ago)

The future of money”, “a drug-dealer’s dream”, “a bubble wrapped in techno-mysticism inside a cocoon of libertarian ideology” – Bitcoin has been called many things. Beyond its anonymous nature, Bitcoin has the potential to transform the world.

Bitcoin is a cryptocurrency invented in 2008 by an unknown group under the name Satoshi Nakamoto. It is a decentralized digital currency that can be sent from user to user on the peer-to- peer bitcoin network without the need for intermediaries such as a central bank or single administrator. Transactions are verified by network nodes through cryptography and recorded in a public distributed ledger called a blockchain.

Amidst a world crisis like COVID-19, countries are holding onto their U.S. dollars as their currencies have depreciated rapidly. However, some have turned to digital currencies: Singapore, China, Ecuador, Tunisia, and possibly more in the future. The U.S. dollar has remained the world’s reserve currency for many decades partly due to stability amid global crashes. Yet, this is but an oversimplified and misguided way of understanding the true value and necessity of a reserve currency. Just as many civilizations have come and gone, every reserve currency in post-Renaissance history has had a lifespan of only a century, leading many to believe the American dollar is in decline and will give way to a new contender for reserve currency. If there were to be a new player in the game, it would need to be more stable and more accessible than the current ones.

The value of cryptocurrency is on full display for emerging markets, because a cryptocurrency can be both fully accessible and received freely through network participation. This is true financial inclusion where transactions are not merely simple exchanges of fiat currencies to crypto ones, but of a new type of production that includes the previously financially excluded.

Since the inception of Bitcoin 12 years ago, cryptocurrency has become the pinnacle of international economic cooperation in the modern era. Its value transcends political affiliation and sovereignty is instead derived from algorithmic and calculable value. Given its potential to completely reconstruct the role of government in the financial arena, and its mission to revolutionize and expand access to markets, cryptocurrency could be a prime and viable candidate to be the next global currency. However, it does not come without its sceptics.

A global currency requires a flexible supply. The gold standard failed due to limits on the amount of gold that banks could hold. Economic growth eventually outstripped the supply of gold-backed money, and the inevitable scramble to overcome this limitation led to destabilization. This is an issue Bitcoin will eventually face, with 18.54 million Bitcoins currently in existence and a fixed supply of only 21 million. Along with the issue of supply limit, the price of cryptocurrencies notoriously fluctuate. The 2018 cryptocurrency crash (also known as the Bitcoin crash), after an unprecedented boom in 2017, occurred early that year where the price of Bitcoin fell by 65%. Subsequently, other cryptocurrencies also collapsed by 80% from their peak value. In the past, reserve currencies arose from powerful sovereign governments whose trade and economic value were stable. The price fluctuation of Bitcoin and other cryptocurrencies may indicate that it would not be able to handle the weight of global trade upon their shoulders.

Ultimately, it would seem unlikely that the American dollar will be dethroned any time soon, given the depth of capital markets and the overwhelming volume of U.S. dollar -denominated global transactions. However, the age of digital currencies is inevitable. With the advances in online banking, contactless payments, and the recent concerns of using physical currency in the days of COVID-19, demand for digital currencies will continue to surge. The existence of Bitcoin has pushed some central banks to explore digital currencies and others to release their own national digital currency. The world is undeniably recognizing the value and potential of this new form of currency.

While Bitcoin may never become a global reserve currency, it has certainly paved the way for the next generation of digital currencies to transcend its predecessors and transform the world.

We make no apologies for any and all puns used. Find them all and win a prize! Note: Prize is the feeling of pride, or shame, that you tried and not a tangible object.

© Heriot-Watt Students' Actuarial Society