Analysis of Bitcoin's viability as a National Currency


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Team Member

Peter Leng (phl2ds)

Abstract

My project will analyze Bitcoin’s potential to fulfill central authority in maintaining a credible currency. I will recommend whether it is in a countries best interest to allow foreign powers to influence its national currency and how this relates to Adam Smith’s free market ideology. My project will analyze the potential dangers that fiat currencies face such as inflation, deflation, and currency exchange and how these concepts apply to the use of Bitcoin In executing economical mechanisms such as quantitative easing, stimulus packages, setting interest rates, etc…, and whether Bitcoin allows for that level of control.

Motivation

I want to create a report that will be valuable to countries with unstable currencies in gaining a better understanding of Bitcoin and its viability as a national currency.

Background:

Dyhrberg, Anne Haubo. "Bitcoin, Gold and the Dollar – A GARCH Volatility Analysis." Finance Research Letters (2015): n. pag. Web. 23 Nov. 2015.

Conclusions:

The volatility is cyclical with a higher volatility during price increases and decreases. As Bitcoin use becomes more widespread, the volatility will decrease. Bitcoin's inverse relationship with the US dollar mirrors that of gold even though Bitcoin itself is a fiat currency. Bitcoin plays this role because of its limited supply like that of gold. This is supported by the "long run equilibrium" evidenced by the graph like gold to a constant value wheres the value of the US Dollar changes over the long run. As computer literacy increases, Bitcoins volatility will decrease. However, the "long term" analysis so far is only a few years whereas the data for the US dollar is much more extensive. Based on current data, bitcoin is a hybrid between the US dollar and gold because it reacts to demand shocks like the dollar whereas it is also hedged against the dollar like gold and has a limited supply like gold.

Van Alstyne, Marshall. "Why Bitcoin Has Value." Communications of the ACM 57.5 (2014): 30-32. Computers & Applied Sciences Complete. Web. 6 Dec. 2015.

Conclusions:

Bitcoins use has already been banned by China and Russia's central banks. This shows that Bitcoin poses a threat to the use of national currencies. The concept of built in control versus governmental control is described to be a key difference between bitcoin and current national currencies. Like national currencies, Bitcoin derives its value through its integrity of ownership and use by businesses but unlike national currencies Bitcoin has built in controls of value. The notion that a central governmental authority must back bitcoin is falsely contrived and not historically backed as with the case of salt, gold, and beads.

Dwyer, Gerald P. "The Economics of Bitcoin and Similar Private Digital Currencies." Journal of Financial Stability 17 (2015): 81-91. Web.

Conclusions:

Bitcoin characteristics of low transaction fees, evasion of governmental regulation, and lack of capital control make contribute to Bitcoin's appeal for users. Bitcoin's mirroring of the US trading time also shows inherent connections between Bitcoin and the dollar which it may replace. Bitcoin stands alone with its characteristic of benign a fiat currency without an immediet store of value that is not regulated by a central authority.

Coomer, Jayson, and Thomas Gstraunthaler. "The Hyperinflation in Zimbabwe." Quarterly Journal of Austrian Economics 14.3 (2011): 311-46. Econlit with Full Text. Web. 9 Dec. 2015.

Conclusions

The various parties of the Zimbabwean government practiced anti capitalistic laws in an attempt to directly control the economy. Land acquisition, cutting of aid by the IMF and World Bank, and Price Controls caused rapid inflation to the point where Zimbabwe now uses foreign currency as its medium of exchange. The various economic policies made by the government were politically driven and failed to take into account the short term and long term consequences.

McCallum, Bennett T. "The Bitcoin Revolution." CATO Journal 35.2 (2015): 347. MasterFILE Premier. Web. 23 Nov. 2015.

Dowd, Kevin, and Martin Hutchinson. "Bitcoin Will Bite the Dust." Cato Journal 35.2 (2015): 357-82. Econlit with Full Text. Web. 13 Nov. 2015.

Conclusions:

Interestingly, this article appears after "Bitcoin Revolution" in the CATO Journal. Aside from the late 2013 bubble burst when it first became widely known, Bitcoins use continues to be widespread and consistent. So far, there is no hard evidence to support a short term or long term failure. Though the illustration of Ghas.io's 42% hashing power frames it as a potentially crippling issue, it contradicts itself in how Ghas.io issued a warning statement to its miners to diversify the hashing power. It is also in Ghas.io's iterests to not gain a majority of the hashing power because if they do, Bitcoin's foundation of trust will be violated thereby leading to a drastic decline in Bitcoins value thereby leading to the collapse of Ghas.io's business. Ghas.io's hashing power can be likened to a nuclear bomb; if one country has all the nukes, most will lose but if there are multiple countries with nukes then there is a balance of power. Since Ghas.io, other mining pools have adopted similar business models and have distributed the overall hashing power into larger portions.

Parthemer, Mark R., and Sasha A. Klein. “Bitcoin: Change For A DOLLAR?” Journal of Financial Serivce Professionals 68.6 (2014) 16-18. Buisness Source Complete. Web. 13 Nov. 2015

Conclusions:

IRS treatment of Bitcoin is contradictory in how they require W-2 for wages paid in bitcoin but insist on treating Bitcoin as property. This could be a result of the complications if they were to treat Bitcoin as a currency. From a Federal standpoint, if an individual has the power to create their own currency of no intrinsic value then they are undermining the Federal Governments authority to enforce the clause "This note is legal tender for all debts public and private" printed on the US dollar. The article also mentions how Bitcoin's use is not mainstream and the future of bitcoin is unknown, however, current trends show that merchant adoption is on the rise in economic powerhouses including the US and Singapore. (http://cointelegraph.com/news/112561/top-10-nations-in-bitcoin-merchant-adoption)

Explanation:

I used academic articles from VIRGO to analyze the relationship between Bitcoin and national Economies. I took notes on important points that stood out and then drew conclusions from them.

Results:

Bitcoins use as a national currency is very promising because it shares gold's function of hedging against US dollar and the stock market. Most economists agree that Bitcoin acts more like gold as opposed to the dollar due to its mining characteristics. The GARCH (Generalized AutoRegressive Conditional Heteroskedasticity Process) analyzes the volatility and shows a convergence to a "long run equilibrium" like gold while experiencing similar shocks to demand like a dollar. This hybrid nature is characterized by the IRS as an asset rather than a currency. However, the IRS contradicts itself by requiring Self-Employment Tax for Bitcoin miners, and Companies that pay wages in Bitcoin to file a W-2.

Bitcoin stands in a unique position with regards to Economic policies implemented by national governments. China and Russia have already banned the trading in Bitcoin. Bitcoin's nature of having built in controls versus a currency controlled by government policy threatens a governments control over their economies. This build in control of value can be linked to a currency backed by the gold standard or currencies of the past that were minted with precious metals. With currencies directly linked to gold, the government only has limited control over how much it can increase or decrease the money supply. Furthermore, the demand for such currencies will be relatively constant due to the limited supply. Bitcoin limits supply through a pre-planned mining cycle and a pre-determined total supply of Bitcoins. Governmental controls such as the raising or lowering of interest rates, use of quantitative easing, and stimulus packages through Bitcoin will not be possible because Bitcoin has to be mined for it to be accepted as valid in the network. Furthermore, built in controls adjust for 1 bitcoin to be approximately mined every 10 minutes.

Across all the national economies of the world there are two economic extremes. On one end is the United States Economy denominated by the US Dollar and on the other is the Zimbabwean Economy denominated by the Zimbabwean Dollar. The US dollar is a International Monetary Fund Reserve Currency and is the most frequently traded international currency among the economies of the world. Trust of the US dollar is steady and is evidenced by the low yearly fluctuations in its value. The Zimbabwean currency has faced hyperinflation resulting from economic policies such as price controls, forced land redistribution, and pressure from foreign governments.

The root cause of the Zimbabwean hyperinflation can be traced to the land redistribution process from white owners to the local Zimbabwean population. The initial 1992 Land Acquisition Act that made mandatory sale of land by absentee landlords and owners with multiple farms was extended upon through subsequent actions by President Mugabe in confiscating white owned commercial farms. These actions were coupled with a reactive economic policy to try to counteract the effects of moving against free capitalistic trade. Although the actions by the Zimbabwean Government can be justified through certain political perspectives, forced control of a capitalistic economy has never worked historically as seen with the collapse of the USSR. The economy will always eventually reflect the dynamic relationship between supply and demand in the value of the mediums of exchange used. If Bitcoin had been used in the Zimbabwean economy as its national currency, the effects of inflation would never materialize due to the cap on the overall supply of bitcoin and the built in mining difficulty. Furthermore, the effects sanctions by the international community in preventing trade with Zimbabwe would be diminished because of the anonymous nature and lack of central authority in regulating the general Bitcoin economy. Overall, the Zimbabwean economy would have benefited had it used Bitcoin through Bitcoin's built in mechanisms in preventing irresponsible generation of money and Bitcoin's bypassing of trade regulations set forth by political policy.

The use of Bitcoin by the US economy is a much different story from Zimbabwe's economy. Currently the US benefits from being the provider of the world's most trusted and traded currency through the control the US government has over the US Dollar. The United States Government can directly control the international economy by raising or lowering interest rates and mandating international industrial trade such as the buying and selling of oil in OPEC countries to be denominated in the US dollar. If the US implemented Bitcoin as its national currency, it would relinquish many of the benefits it gains through the current status-quo. Currently, the US government's stance ,as evidenced by Supreme Court Justice Ginsberg's verdict that the constitution does not prevent the creation of private money, remains neutral. If Bitcoin were to be used a major currency within the US economy it would have to do so through organic growth. Bitcoin's current rise in use can be linked to its low transaction fees, security against theft and counterfeit, and expanding acceptance by businesses. Whether or not the US government will embrace Bitcoin once it reaches a critical mass remains to be seen.

I would recommend the use of Bitcoin by politically weak economies such as Zimbabwe's economy because of Bitcoin's characteristics of built in control mechanisms and ability to bypass political trade regulations. I would not recommend the use of Bitcoin by major economies such as the US who benefit much from its limited status quo control over the international economy.