Rahul Menon · Follow
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Introduction
Nobel Laureate Paul Krugman recently voiced his concerns against cryptocurrency when he proclaimed, “there are disturbing echoes of the subprime crash” in the cryptocurrency market [1]. Is Krugman warning the public about the danger and risks of cryptocurrency, or is he simply backward-looking and refusing to adapt to 21st century ways? At a first glance, Bitcoin seems to be the future of a cashless economy by replacing fiat currencies. However, Bitcoin is a curse and should be avoided at all costs as its energy consumption is extremely large and unsustainable and does not posses the required attributes to act as a global currency.
Founded in 2008 in response to the economic recession [2] by a group under the name of Satoshi Nakamoto, Bitcoin was invented to offer more transparency for transactions without the use of financial institutions serving as intermediates. The key innovation behind Bitcoin is its blockchain technology, which is a piece of software that acts like a ledger, logging every transaction ever made using bitcoin [3]. The difference between the Bitcoin ledger and ledgers of financial institution is that the Bitcoin ledger can be distributed and accessed to and by anyone. Another aspect of Bitcoin is its mining process [4], which allows the Bitcoin network to verify and secure the blockchain and new transactions. While these features are generally viewed as positives, the blockchain and mining technology is actually the reason why Bitcoin energy consumption is astronomical [5].
Bitcoin’s High Energy Consumption
According to the Cambridge Bitcoin Electricity Consumption Index run by Cambridge University, Bitcoin consumed almost 115 terawatt-hours (TWh) of energy in June 2021 [6]. For example, one Bitcoin transaction was recorded to take as much energy as 80,000 credit card transactions while consuming more energy than countries such as Argentina and Norway [7]. With millions of families in the United States not able to afford gasoline [8] due to the current energy crisis, the amount of energy that Bitcoin consumes is simply illogical.
As the current supply chain system depends heavily on energy for travel, transporting food and goods, and many other necessities, it is unjustifiable for a currency to consume this much energy.
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Furthermore, for a global economy heading towards a more sustainable age, Bitcoin’s mining process is counterproductive due to most Bitcoin mining done in Asian countries that rely on coal and other fossil fuel energy sources [9] which produces immense amounts of emissions and greenhouse gases. As the amount of Bitcoin left to mine becomes smaller due to its finite supply, the amount of energy computers will need to mine a Bitcoin will increase, which will result in even more coal and other energy consumed. With a heavier focus on relying less on fossil fuels and coal energy, Bitcoin mining has a ruinous effect on the environment due to large mining consuming coal and producing greenhouse gases.
Figure 1 [10]
Figure 2 [11]
Lack of Attributes to be Considered Currency
Furthermore, Bitcoin lacks the basic attributes to be considered a form of currency as it does not have the three main aspects to be considered money. According to many economists [12] money has three different attributes: it can function as a medium of exchange and had a unit of account and store of value. Bitcoin barely meets the only first attribute as the global usage of bitcoin remains tiny, especially in developing countries where many people do not even have internet access [13], yet alone access to Bitcoin. As a unit of account and having a store of value, Bitcoin forces sellers to quote prices out to four or five decimal points, while exhibiting high volatility and high volume of cyber-attacks and hacks. At its core, Bitcoin simply does not have the required attributes to act as a currency and should be avoided in the global economy.
Medium of Exchange
The difficulty of acquiring fresh bitcoins is one barrier to bitcoin being a commonly utilised medium of trade. A user must purchase bitcoins from internet exchanges or dealers and then figure out a way to store them safely unless they are successful bitcoin miners (a profession now dominated by supercomputers requiring enormous capital expenditures). The buyer must make a bank transfer or connect an existing bank account to the exchange in order to make these purchases, as they normally cannot be performed using a credit card or PayPal [14]. With developing countries still lacking in certain areas of health, education, and internet access, Bitcoin simply cannot be implemented as a global currency due to its lack of a medium of exchange.
Furthermore, it is impossible to get around the need to own bitcoins in order to use a merchant’s services. In most retail markets, it is common for customers to use consumer credit financed by the retailer or a third-party credit card issuer to make purchases without having cash on hand. Due to the lack of bitcoin-denominated credit cards and the seeming rarity of bitcoin-denominated consumer loans, these choices are not available for bitcoins. For Bitcoin to function, it relies on fiat currency underlining its inability to act as a currency.
Unit of Account
Consumers must treat a currency as a national currency when contrasting the costs of various retail goods for it to serve as a unit of account [15]. One problem that arises is Bitcoin’s volatility which will cause merchants to update prices continually, which will create even more menu costs [16] for businesses. One of the most overlooked yet serious issues with using Bitcoin as a currency is that it would force prices to be quoted up to four decimals which would result in massive complications, especially in a consumer driven economy where efficiency is a major priority. With prices such as 0.00023 BTC for a cup of coffee, it is hard to find any other currency in the world for which consumer prices are quoted in these units proving Bitcoin’s inefficiency as a unit of account [17].
Store of Value
The main aspect behind a currency’s store of value is essentially protecting it against theft [18], which has normally been putting it into a bank account. With Bitcoin however, it must be stored in digital wallets which are heavily prone to hacks and scams [19]. Even if a Bitcoin user is able to secure the account, they face the problem of managing the risk that comes from Bitcoin’s volatility.
Due to its decentralized nature, Bitcoin prices are allowed to freely fluctuate, causing it to be extremely volatile when two parties partake in a transaction. In a currency, volatility represents instability, an undesirable aspect [20]. Furthermore, if one wanted to hedge the risks against drops in price for Bitcoin, its volatility should be similar to other foreign currencies for it to be affected by macroeconomic events. However, Figure 3 “depicts the correlation between the two FX rates which on average is 0.49, fluctuating between 0.29 and 0.87 while Bitcoin volatility is which is on average higher (0.81) and fluctuates much more (between 0.28 and 0.99)” (Baur & Dimpfl, 2020). As Figure 3 shows, the correlation of volatility between Bitcoin and other currencies is very low on average indicating how Bitcoin is ineffective as a tool of risk management. Unlike other global currencies, it is very difficult to hedge any risks that affect the price of Bitcoin [21]. For Bitcoin to operate as a global currency such as the US Dollar and Great British Pound which are heavily influenced by events in the political and economic spheres of life, Bitcoin’s price seems to be completely unchanged with such events underlining its inability to have a store and value, and in return, to act as a global currency. Even recent movements in Bitcoin’s price [22] underline Bitcoin’s volatility and inability to be a global currency.
Figure 3 [23]
Lessons from the Gold Standard
One of Bitcoin’s advantages seen by the general public is its deflationary mechanism. With a finite amount set at 21,000,000 BTC, the inflation rate of Bitcoin decreases at a constant rate as the number of Bitcoin mined increases [24]. While this aspect does make Bitcoin quite attractive, historically speaking, it would actually be a negative if Bitcoin is used as a global currency. If bitcoin becomes phenomenally popular and replaces fiat currencies, it will have a deflationary effect on the economy since the money supply will not expand in tandem with economic growth. This condition would force most workers to accept annual salary cutbacks, potentially sparking political protests against the currency similar to those seen in the United States during the populist movement at the end of the nineteenth century [25]. Bitcoin’s behavior makes it a thin line between a risky commodity and unsustainable currency. Bitcoin has proven that it does not have the attributes to be considered a currency as it can barely function as a medium of exchange and does not have a unit of account or store of value. Furthermore, its high energy consumption is deleterious for a future with high hopes regarding renewable and sustainable energy. Simply said, Bitcoin is a curse and should not be integrated into the global economy.
However, if there is a time where Bitcoin somehow does become a global currency, there are certain lessons and ideas that can be learned from the gold standard as Bitcoin and gold both provide an international base money [26]. One reason for the gold standard to perform quite well was that “the Bank of England increased its foreign lending whenever economic activity turned down, damping rather than aggravating the international business cycle and by acting as international lender of last resort” (Kindleberger, 1973). However, the gold standard didn’t last very long [27] due to changes in the composition of voters in gold-standard countries, so that domestic interests became more significant and balance-of-payments concerns became less important [28]. In the end, the gold standard hampered politicians’ capacity to address concerns such as unemployment and inflation, particularly during times such as the Great Depression [29].
These sorts of events could also be a reality under the Bitcoin standard as large cyclical downturns or financial crises under the Bitcoin standard could result in political pressure and requests for central banks to remove the bitcoin fetters [30] that prohibit them from expanding to stimulate the economy or providing help to troubled financial institutions [31]. Central banks or governments would eventually have to succumb to this pressure and cut relations between their currencies and bitcoin, just as central banks and governments did during the Great Depression. Similar to the gold standard, central bank or governments would eventually have to return to fiat currencies should the Bitcoin standard ever become a reality underlining Bitcoin’s eventual fall should it ever be adopted as a global currency.
Over the last several years, a substantial amount of empirical research has challenged the premise that Bitcoin should be considered as the next shift in global currency. From the barter system to gold to credit cards, many believe that Bitcoin should be next in the evolution of money. However, money has distinctive attributes, none of which Bitcoin possesses. Furthermore, with rising energy prices, the amount of energy Bitcoin transactions consume is simply out of control. While society is always looking to improve on current ideas and methods, Bitcoin poses much more dangers than advantages and should not be integrated as a currency in the global economy.
Footnotes
[1]: Browne, R. (2022, January 28). Nobel laureate Paul Krugman says crypto has ‘disturbing’ parallels with subprime mortgage meltdown. CNBC. Retrieved June 2, 2022
[2]: Remember why bitcoin was created… — crypto news. Coin.fyi. (n.d.). Retrieved June 2, 2022
[3]: Hayes, A. (2022, June 24). Blockchain explained. Investopedia. Retrieved June 4, 2022
[4]: Bitcoin (BTC) price, charts, and news: Coinbase: Bitcoin Price, BTC Price, Bitcoin Coinbase. Coinbase. (n.d.). Retrieved June 19, 2022
[5]: Malkus, J. (2021). Cryptocurrencies — A Curse or Blessing? Jan Malkus Organization.
[6]: Malkus, J. (2021). Cryptocurrencies — A Curse or Blessing? Jan Malkus Organization.
[7]: Malkus, J. (2021). Cryptocurrencies — A Curse or Blessing? Jan Malkus Organization.
[8]: Cable News Network. (2021, July 13). Opinion: Rising gas prices will hurt low-income families the most. the government needs to help. CNN. Retrieved June 16, 2022
[9]: Malkus, J. (2021). Cryptocurrencies — A Curse or Blessing? Jan Malkus Organization.
[10]: Malkus, J. (2021). Cryptocurrencies — A Curse or Blessing? Jan Malkus Organization.
[11]: Malkus, J. (2021). Cryptocurrencies — A Curse or Blessing? Jan Malkus Organization.
[12]: Is bitcoin a real currency? an economic appraisal national … — NBER. (2013, December). Retrieved June 12, 2022
[13]: World Bank Group. (2018, November 21). Connecting for inclusion: Broadband Access for All. World Bank. Retrieved June 27, 2022
[14]: N-transactions. Blockchain.com. (n.d.). Retrieved June 5, 2022
[15]: Is bitcoin a real currency? an economic appraisal national … — NBER. (2013, December). Retrieved June 12, 2022
[16]: Kenton, W. (2021, October 28). Menu costs definition. Investopedia. Retrieved June 3, 2022
[17]: Is bitcoin a real currency? an economic appraisal national … — NBER. (2013, December). Retrieved June 12, 2022
[18]: Is bitcoin a real currency? an economic appraisal national … — NBER. (2013, December). Retrieved June 12, 2022
[19]: DUMITRESCU, G. C. O. R. N. E. L. (2015, September 13). Global economic observer. Retrieved June 9, 2022
[20]: Strebko, J., & Romanovs, A. (2018). Benefits and drawbacks of virtual currency Bitcoin — ResearchGate. ResearchGate. Retrieved June 7, 2022
[21]: Is bitcoin a real currency? an economic appraisal national … — NBER. (2013, December). Retrieved June 12, 2022
[22]: Curry, B. (2022, June 13). Why is bitcoin down today? Forbes. Retrieved June 27, 2022, from https://www.forbes.com/advisor/investing/cryptocurrency/why-is-bitcoins-price-falling/
[23]: DUMITRESCU, G. C. O. R. N. E. L. (2015, September 13). Global economic observer. Retrieved June 9, 2022
[24]: IAC Publishing. (n.d.). What were the main goals of the Populist Party? Reference. Retrieved June 3, 2022
[25]: Amadeo, K. (2022, March 17). Gold standard. The Balance. Retrieved June 11, 2022
[26]: White, L. H. (2018, January 11). How a Bitcoin System Is Like and Unlike a Gold Standard. Cato.org. Retrieved June 10, 2022
[27]: Weber, W. E. (2016). A bitcoin standard: Lessons from the gold standard. Bank of Canada = Banque du Canada.
[28]: Weber, W. E. (2016). A bitcoin standard: Lessons from the gold standard. Bank of Canada = Banque du Canada.
[29]: Similar to the gold fetters that were broken when Britain left the gold standard in 1931
[30]: Weber, W. E. (2016). A bitcoin standard: Lessons from the gold standard. Bank of Canada = Banque du Canada.
[31]: Weber, W. E. (2016). A bitcoin standard: Lessons from the gold standard. Bank of Canada = Banque du Canada.
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