May 03 2021 Othman Zidane
Economics,Technology & Telecommunication

Bitcoin: Modern-Day Gold

Bitcoin has become the biggest trending topic for quite some time now, and rightfully so. The cryptocurrency keeps making headlines due to what seems like an everyday market all-time high, countless success stories of early investors becoming wealthy overnight, and its day-by-day adoption by large institutions. But is this new technology worth the hype or is it a bubble waiting to burst and most importantly is it here to stay?

 

What is Bitcoin?

To understand this new concept, it is important to start from the beginning. Bitcoin is considered as the first widely adopted Cryptocurrency, created in 2009 by an unknown person or persons whose pseudonym is Satoshi Nakamoto.

One of the main characteristics of Bitcoin is the ability to directly send money and receive money without the involvement of a third party such as a bank or a payment processor like PayPal using a system called “peer-to-peer”. 

In simple terms, the peer-to-peer system works as a web of users that simultaneously validates each bitcoin transaction. This system is also referred to as “the blockchain” which functions as a ledger of all transactions in the bitcoin network.

The blockchain is made up of nodes. These nodes are physical computers ran by individuals that make up the Bitcoin system. When these nodes process a transaction, which requires a great deal of computer processing power, they are rewarded with a small fee. The processing of these transactions is called “Bitcoin mining” and is the very process that generates new Bitcoin.

 

Why does Bitcoin hold value?

The reason Bitcoin holds value is the same reason regular currencies hold value: it maintains relative value over time and it is able to capture the faith and belief of the people using it.

Historically, commodities and precious materials such as cocoa beans and gold were used as payment methods because society viewed those materials as holding stable value. However, because of the unpracticality of these materials in terms of storage and transportation, many societies turned to minting coins made from metals (Gold, Silver, Copper…) that are inherently valuable and are very durable.

After some time, these coins were replaced by notes that do not hold the intrinsic value of coins but were still tied to commodities such as gold in such a way that they were exchangeable for a set amount of said commodities.

Today, countries moved away from the gold standard and started using Fiat currency. Fiat currency is issued by the government and not tied to any commodity, though the only value they hold is the faith that they will be accepted by individuals and governments.

Most societies have determined that fiat currencies are the most durable and the least likely to deteriorate or depreciate.

The chart below shows the different traits of money across Gold, Fiat (USD), and Bitcoin:

 Traits of Money Table
Figure 1: The Traits of Money Table

 

As seen in Fig. 1, Bitcoin does a great job compared to fiat currencies and even holds an upper hand when it comes to decentralization because of the nature of the blockchain system. It is also Smart, in other words, the whole Bitcoin transaction system can be modified or updated in real-time, although this is very hard to do because all the nodes in the blockchain must simultaneously validate the change.

Ray Dalio, founder of the world’s largest hedge fund Bridgewater and esteemed economist pointed out the utility of Bitcoin in terms of wealth storage in times of uncertainty within the equity market. In the current economic climate, where governments are looking to depreciate their currencies as the equity markets are booming and bond yields are converging towards  0%, Bitcoin is a reasonable asset to store wealth into, the same as gold or real-estate, as it is not controlled by a government entity and cannot be affected by any incoming government monetary policy.

Another valuable characteristic of Bitcoin, which gold lacks, lies in its exchangeability ie. the ability to make purchases with the currency. For example, if any given person wants to start using Bitcoin, all they need to do is download a Bitcoin wallet which is an app that allows you to send and receive Bitcoin. They can then purchase Bitcoins using that same wallet. Then in order to send Bitcoin all they would need to do is scan a QR code of the receiver which will then take them to the wallet, they can then enter the amount of money they want to send to complete the transactions.

However, this very quality poses a risk as excess freedom and privacy in value exchange can lead to increased malicious activity such as hacks, fraud, and theft. 

 

The current state of Bitcoin

In the current market, top investment bank leaders have shown resistance towards Bitcoin saying that it is a bubble waiting to burst and that it would eventually become irrelevant. One of these is Jamie Damion, CEO of JPMorgan Chase,  who stated that Bitcoin will be ultimately be shut down by the government when the currency starts being used for malicious intent. He added that, at its core, Bitcoin is not an actual currency and holds no value. This view has been shared by the most successful investor, Warren Buffett, CEO of Berkshire Hathaway, who also referred to the asset as ‘a rat poisoned square’. 

However, despite the attacks of highly esteemed personalities within the financial industry, cryptocurrency was crowned the top-performing asset class of 2020-21 with an 800% return. Bitcoin saw a surge at the beginning of 2021 and is currently valued at 59,000 USD per coin with over $1 trillion in circulation. This surge was due to the adoption of digital currency by very large companies. One of such companies is MicroStrategy (MSTR: NASDAQ), a publicly-traded business intelligence firm, which made headlines by buying $2.19 Billion worth of Bitcoin, equivalent to 90,895 BTC.

In recent news, Elon Musk CEO of Tesla announced that it is now possible to buy a Tesla using Bitcoin. The electric vehicle manufacturer also reported to the SEC that it purchased $1.5 billion of Bitcoin and that the bitcoins it will receive from clients buying its vehicles will not be converted to any other asset and will instead be kept in its original form.

Additionally, Morgan Stanley, one of the biggest investment banks in the world, started offering its rich clients exclusive access to three funds that will allow them to own Bitcoin. However, the bank made it clear that this move is solely for clients with a ‘high-risk tolerance’ and who own $2 Million USD minimum in assets with the firm. 

These moves will encourage other businesses in adopting the digital currency as a form of payment and push it into the mainstream. 

Fig. 2 shows the sharp increase in valuation directly resulting from these companies adopting the digital currency:
Fig. 2 shows the sharp increase in valuation directly resulting from these companies adopting the digital currency:

 

Overall, it is apparent that Bitcoin has the main characteristics of a viable and reasonable asset to store wealth in. However, it is important to acknowledge that it is a relatively new concept that can and most likely will be subject to government regulations, cyber-attacks, fraud, quantum computing, and other threats that are not yet on the horizon. 

Citibank stated that Bitcoin could become the form of payment of choice for international trade. Citibank also noted that the future of Bitcoin is still blurred, however, there are many signs leading towards the acceptance of the digital currency by the public.

 

Nigeria, the global leader in Bitcoin Trade

Nigeria presents a particular case. Currently, Nigeria holds the position of the largest Bitcoin market by trading volume in Africa, and the second-largest global Bitcoin market behind the USA according to the New York-based cryptocurrency trading platform Paxful, with more than 33% of Nigerians either using or owning Cryptocurrency. This is due to the reliance on the peer-to-peer phone payments method, lack of formal payment processing infrastructure, as well as the severe devaluation of the Naira bringing about tight restrictions on offshore transactions and limited cash withdrawals. 

Bitcoin has made it possible for Nigerians to bypass the $100 dollars withdrawal limit on the naira debit card. 

However, in February 2021 Nigeria’s Central Bank issued a letter stating that banks are no longer allowed to facilitate any transactions with companies that deal with cryptocurrency. The reason behind this immediate ban is to prevent the underlying fraud and money laundering that the country has been struggling with which is facilitated by the privacy and lack of regulatory policy on Bitcoin. 

As it is widely known, Bitcoin transactions are private, do not involve any third party entity, and do not follow a regulatory policy which is one of the pitfalls of the currency that will ultimately need to be addressed if the currency wants to stay relevant and become more mainstream as a currency.

Othman Zidane
Sources: 

https://www.investopedia.com/ask/answers/100314/why-do-bitcoins-have-value.asp\

https://www.cnbc.com/2021/03/17/bitcoin-morgan-stanley-is-the-first-big-us-bank-to-offer-wealthy-clients-access-to-bitcoin-funds.html

https://www.bridgewater.com/research-and-insights/our-thoughts-on-bitcoin

https://edition.cnn.com/2021/03/24/tech/tesla-bitcoin-elon-musk/index.html

https://www.investopedia.com/tech/what-will-happen-bitcoin-next-decade/#:~:text=Citi%20noted%20that%20Bitcoin’s%20future,the%20digital%20asset%2C%20noted%20Citi.

https://www.aljazeera.com/economy/2021/3/25/nigerias-crackdown-on-bitcoin-echoes-global-crypto-conundrum

https://www.bbc.com/news/world-africa-56169917

https://www.statista.com/chart/18345/crypto-currency-adoption/

https://bitcoin.org/en/how-it-works#:~:text=The%20block%20chain%20is%20a,actually%20owned%20by%20the%20spender.

https://www.dummies.com/personal-finance/brief-history-bitcoin-blockchain/#:~:text=In%20very%20simple%20terms%2C%20the,mining%20for%20the%20cryptocurrency%20Bitcoin.

https://www.freshbooks.com/hub/accounting/what-is-a-ledger\

https://www.npr.org/sections/money/2011/04/27/135604828/why-we-left-the-gold-standard

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