Bitcoin as Good as Gold
To many outsiders, Bitcoin is a cryptocurrency that’s no longer fashionable. It was in the limelight when it hit a high of US$18,000 in December 2017. Thereafter, it fell to US$3,500 a year later.
Even though it trades under US$10,000 today, it has lost its novelty because there are so many other crypto-currencies around to challenge its intended use as a new form of money.
But three interesting developments have happened in the past three weeks. They tell us that it would be wrong to dismiss Bitcoin’s role as an important asset class.
The first development was on 11 May 2020. That’s when Bitcoin went through the third halving of its 11-year history. This means that all the effort put into mine or create a bitcoin will now yield half the reward.
The idea behind such halving is to make the supply of bitcoin limited, unlike the other cryptocurrencies, and the endless paper money printing we have today.
All in, only 21 million bitcoins will be allowed by the software to be created. Currently, there are 3 million bitcoins left to be mined.
One great feature of Bitcoin that makes it ideal as money is its ability to be fractionalised to eight decimal places. This means that it can be used to buy a US$1 cup of coffee.
As a digital currency, Bitcoin offers many advantages over our current paper money. Bitcoin offers lower to insignificant transaction fees when money is sent across national borders. It challenges the current payment systems (SWIFT) which can cost from 3% to 6% for each transaction.
Bitcoin can be used anonymously and operated by a decentralized authority. This means that no one can stop another person from using bitcoin as a form of payment. For instance, with bitcoin, the US government cannot stop its enemy (eg. Iran) from selling its oil as easily.
Essentially, Bitcoin can cause major disruptions to the current banking and monetary systems dominated by the US dollar. Not only that, bitcoins can be used for black market transactions, money laundering, illegal activities or tax evasion.
These threats understandably motivate all governments to regulate, restrict or ban the use and sale of bitcoins. And many such restrictions have arisen.
Instead of challenging Bitcoin, the alternative is to embrace its best points. This is the second significant development for bitcoin. On 30 April, China introduced its digital yuan, or DCEP (digital currency electronic payment).
Unlike Bitcoin, the digital yuan is centralised and tightly tracked and controlled by the Bank of China. To those who wish to do illegal activities, or evade taxes, the digital yuan is bad news.
To those millions of Chinese who use e-payment systems like AliPay and WeChat Pay, the switchover would be easy. It could be more convenient for these users because there is no reliance on the traditional banking infrastructure.
The biggest benefit will go to those businesses which deal with international payments. The low or insignificant transaction cost of sending money would be a great incentive for them to embrace it.
Right now, the digital yuan is at its trial stage. When launched for global use, perhaps after the Beijing Winter Olympics in February 2022, the global demand for it should soar.
The dominance of the US dollar in global trade would be undermined further, to put it mildly.
China is not the only country trying to take advantage of a national digital currency. Many countries are rushing in. The evergreen question of the over-issue of digital currencies, just like the endless printing of paper money, will crop up again.
One way of fostering trust that there will be no over-issue of digital currencies is to revert to a form of Gold Standard. Like paper money, this is when a digital currency is backed by something limited and desirable.
In the past, gold was the answer. China could revive a variation of the Gold Standard again. Officially, China has less than 2,000 tonnes of gold. Unofficially, gold bugs will tell you that China has probably 5 to 10 times more gold than it claims it has. That’s 10,000 to 20,000 tonnes of gold. At 10,000 tonnes, China’s gold holdings would surpass that of the US.
One of the reasons the US dollar became the global currency right after 1945 was its large gold holdings of 8,000 tonnes. If China indeed holds 10,000 tonnes of gold, the yuan has equal bragging rights to be a global currency.
Gold, however useful as a backing for the digital yuan, lacks the monopoly factor for China. Let me explain.
Altogether, the world’s central banks own under 25% of all the world’s gold (total 171,000 tonnes). At 10,000 tonnes, China would have less than 6% of the world’s gold. This is not a dominant hold on the gold market.
The rest of the gold, almost 50% (84,000 tonnes) of the world’s gold, are in private hands in the form of jewellery.
Central banks hold less than 25% of the world’s total gold
Other than gold, bitcoins could also be used to back the digital yuan. It has all the advantages gold traditionally has – scarcity, acceptability, divisibility and availability.
The great thing about bitcoin is that Chinese miners own at least 65% of the world’s bitcoins. This estimate was derived in a recent report by CoinShares in December 2019. The research showed that Chinese miners control more than 65% of the bitcoin network’s processing power (hash rate).
Apparently, Chinese miners have been quietly accumulating bitcoins in recent years. It coincided with the country’s drive to embrace blockchain cryptocurrencies.
The third significant bitcoin development came out last week (10 May) from a district court case in Shanghai. It centred around a theft case, which included bitcoins, committed by the thief a year before.
The thief refused to return the stolen cryptocurrencies on the grounds that cryptocurrencies were not recognised under Chinese law. His case was dismissed. The court ruled that the bitcoins in question were “property” and should be protected as any property should be. The market value of the cryptocurrencies was then returned to the victim.
This court ruling is significant because it means that bitcoins are accorded a monetary value in China linked to its market value. Were the digital yuan to be backed by gold and bitcoins, anyone would be able to convert his holdings of digital yuan.
Imagine the extra confidence suddenly entrusted to the digital yuan. This is very unlike our current US dollar, which is only backed by more US dollars.
It’s been a long journey. But the three bitcoin developments – the halving of bitcoin, the introduction of the digital yuan, and the Shanghai court ruling on bitcoin as property – takes us another step closer to the day when the digital yuan will be a dominant currency in the global markets.