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Bitcoin and Trust: conflicting terms?

As opposed to fiat currencies, such as the US dollar or the British pound sterling, that are issued by countries’ central banks and were determined to be legal tender, the cryptocurrency Bitcoin is not linked to the agency and structure of a government. While currencies are classified as government liabilities, meaning that when a central bank issues additional money that this country’s level of debt increases, bitcoin is not managed by the state and neither is its value dependent on a government’s geopolitical performance or our trust in prudent monetary policy.

Traders understand that demand for a certain currency depends on its relation to another currency. The question is always: will A’s price increase or fall against the price of B. A strong driver of the price are the monetary policies enacted by the central banks, who are constantly under pressure to adjust interest rates or to inject money into an economy in order to keep their currency’s price stable against others. Since the suspension of convertibility of paper U.S. currency into any precious metal in 1971, the U.S. dollar has, however, rapidly lost purchasing power.

The graph shows the average price for consumer goods as measured against the dollar, implying that the consumer must spend considerably more dollars for the same amount of goods. This is not the case for bitcoin. Its fixed monetary policy determines two things: an eventually finite amount of 21 million bitcoins in circulation guarantees its scarcity, and the calculable issuing speed of the currency guarantees a decelerated inflation rate. This means that no unpredictable amount of bitcoin will suddenly be diluted by the network which would lead to abrupt information processing, that is, strong price volatility.

Nevertheless, people’s trust in bitcoin is still low compared to government-issued money. A significant concern is – while unjustified – that there is nothing of accepted value underlying a bitcoin, which it could derive its value from. This is not correct. The growing process of keeping the bitcoin network decentralised, a competition of large computing centres that verify transactions of bitcoins, requires real energy. The underlying commodity of bitcoin is electricity.

Oil and gas extraction sites have begun to realise that it is more profitable for them to invest in bitcoin-mining hardware – powerful computing stations – rather than burning the side products from oil drilling. In a process called routine flaring, natural gas is also brought to the surface, and subsequently flared as waste or unusable gas. These oftentimes unsaleable products are now rather converted into electricity and subsequently used to mine bitcoin.

A further positive aspect of this is the emerging possibility to settle future oil contracts in bitcoin rather than US dollars which enables producers of fossil fuels, e.g. many middle-eastern countries, to store their revenue independently from the Federal Reserve in the U.S., unlike it is currently the case.

Finally, the volatility of this novel asset class’ price is a famous hurdle for trust. From about US$3,000 in early 2019 to over US$12,000 in June of the same year to almost US$8,000 in early March 2020, it becomes understandable why conservative investors are hesitant. Looking at longer timeframes, however, returns on investments have been 5,672.27 percent since coinmarketcap’s price data collection in 2013. In other words, a US$100 investment in bitcoin in 2013 are worth US$56,722.7 in March 2020.

With improved storage methods, such as Coldcards or Nano Ledgers, user friendliness is continuously improved, even though these are early-stage products. As the monetary crisis is beginning to unfold, uncovered by the early consequences of the global COVID-19 pandemic, bitcoin’s role will reveal itself. Discovering the positive implications of this trust-minimised peer-to-peer network will certainly drive its adoption.

Edited by: Patrick Lehner

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