The Bitcoin option

In the last piece we discussed the future fiat currency in Zimbabwe and we briefly touched on some of emerging alternatives namely crypto-currencies and good old barter trading. Today we zero in on crypto-currencies; Bitcoin, Etherium, etc.





There is no doubt, the Bitcoin epitomizes crypto-currencies, after all this was the most searched word on Google in 2017 as people around the world took a keen interest. Bitcoin value surged from a value of almost zero in 2009, to reach values exceeding $10000 by the end of 2017 and the trend continued into 2018 when it surpassed the $20000 mark.

This unusual growth presented exciting opportunities for would be investors but at the same time, it alarmed global monetary authorities as well as their cohorts within the global financial system.

Whereas the Bitcoin offers an opportunity to ordinary people to preserve value, established global financial players feel threatened. Apparently some of them are convinced crypto-currencies will disrupt the structure of global finance as we know it.

Prominent names in and outside global financial markets initially took turns to give negative reviews of the Bitcoin, often citing the currency’s limited track record, lack of regulation and volatility.

Bill Gates told CNBC that ‘as an asset class, you're not producing anything and so you shouldn't expect it to go up. It's kind of a pure 'greater fool theory' type of investment.’

Warren Buffet said Bitcoin is an asset that creates nothing while George Soros said its bubble although reports would emerge later that his fund planned venturing into crypto-currencies. Getting attacked like that by these billionaires is equivalent to getting the death penalty, it is hard to survive after that.

Yet the attacks have so far failed to completely destroy the Bitcoin precisely because there is one element of this currency that seems to offer a genuine alternative to the moribund fiat currency. Blockchain, the technology underlying crypto-currencies, is the first viable attempt outside the traditional central banking system to offer an alternative to fiat money.

In very simple terms, Blockchain technology pre-empts the problem of over printing of money, in this case the over-printing of Bitcoin. Ironically, the prominent figures attacking Bitcoin hardly contest the value of Blockchain technology, they just don’t like the digital currency.

According to the anonymous creators of this technology, there is a finite amount Bitcoin that can be mined or produced, about 21 million to be exact. So any attempt to debase, i.e. to create extra crypto-currencies will be rejected by a network of computers that perform a series of ‘complex’ calculations before any addition to the Blockchain is validated.

In other words, crypto-currencies are an attempt to cure the twin problem of inflation and currency depreciation caused by producing money disproportionate to a country’s output levels. As we explained before, central banks are tools used by the states to support the quest to live outside their economic means. This is achieved through either, the issuing of financial instruments like treasury bills (TB) and negotiable certificate of deposit (NCD) or currency printing for instance.

To illustrate, during the global financial crisis of 2008, the US Federal Reserve created a bailout fund known as Troubled Asset Relief Program (TARP) on behalf of the US government. The TARP was a response to the sub-prime loan crisis that had engulfed the US financial system. The US government wagered that by pumping about $700 billion into troubled businesses it could stop the total collapse of the US economy.

Since the US government did not have the $700 billion, it relied on the US Federal Reserve’s quantitative easing—euphemism for currency debasement—to finance the bailout.

Normally this causes a significant depreciation of a currency followed by inflation. However since many countries peg their currencies against the US dollar, many people did not immediately realize this and the gamble paid off. In any case, the US dollar is the reserve currency of many countries, so while it lost value after this period, the exchange rate of the US dollar versus the Euro has not changed much.

Three years prior to the financial recession, the Euro dollar exchange rate was € 1:$1.25 but went up at the height of the sub-prime loan crisis to an average of € 1:$1.4 in 2008. Yet by December 2018, the US dollar had recovered to €1:$1.13. The same is also true with respect to Dollar/Yen exchange rate or Dollar/Rand exchange rate.

In a way, the US managed to minimize the effect of quantitative easing (currency debasement) on its economy by virtue of the perceived strength of its currency. Since countries continue to hold the US dollar as a reserve currency, they unwittingly helped the US by absorbing some of inflation burden that resulted from the US Federal Reserve actions.

Smaller countries often attempt to copy the US government’s financial engineering maneuvers but the dynamics are different. Zimbabwe did something similar and the outcome has been devastating. Zimbabwe’s government sponsored agricultural program, the Command Agriculture as well as the bailing out of loss-making state owned companies are some of the expenditures financed through the RBZ’s own form of quantitative easing. Through a combination of TBs issuance and an overdraft facility, the central bank enabled government to increase its domestic to almost $10 billion in local currency.

Unfortunately for the RBZ, Zimbabwean money only circulates inside Zimbabwe, it has no appeal outside the country. So when government initiated these expansive expenditures, the negative effects of this form of currency debasement were felt quickly because the country could not spread the inflation burden like the United States can. So after their introduction two years ago, the bond note currency now look destined for a collapse just like the Bearer cheques or the Zimdollars before it because of the dilutive effect of the TBs issuance or the printing of money.

Crypto-currencies can potentially offer countries a break from the situations explained above. If what occurred in the US 2008 had happened in a crypto-currency dominated environment, then the US government would have been forced to find other ways to solve the crisis since it could not ease its way out. Deep spending cuts would have been initiated and inefficient companies would have been allowed to collapse. In fact, the US would have been forced to carry out economic reforms similar to those it is now prescribing to Zimbabwe!

Crypto-currencies have a potential to force governments to live within their means while bringing back confidence into the global financial systems. For smaller central banks, holding crypto-currencies as reserves will provide cover in case bigger institutions like European Central Bank or the US Federal Reserve pump billions into financial markets again.

 There are many possibilities that crypto-currencies offer but there are niggling issues the anonymous creators of Bitcoin need to address. The creators obviously have reasons for choosing to stay anonymous but that has given room to objectionable elements to use this technology inappropriately.

Central banks’ have used this ability to transact anonymously as their main line of attack against the Bitcoin. Criminal gangs, money launderers, tax evaders and terrorists could be using Bitcoin to finance their operations something that should concern people behind the name Satoshi Nakamoto, the creator of Bitcoin.

Also the possibility of losing digital currencies because of cyber-theft, bankruptcy of a digital currency exchange, or volatility in the price of digital currencies is something that concerns most potential buyers of crypto-currencies.

 Addressing some of these concerns will ease genuine concerns thus ensuring crypto-currencies will become part of the mainstream regardless of the opposition by financial elites.