Impact of Bitcoin as a World Currency

By Prof. A Seetharaman M Com MBA FCA DMA CA(M) PhD | Dean – Research, SP Jain School of Global Management.

In an era of technology advancement when the entire world is talking about the “Internet of Things” whereby we are expected to have connectivity between anything and everything, Currency cannot be left behind. Paper currency is bound to be a thing of the past, as virtual currencies will start taking over and Bitcoin is well poised to achieve this feat.

USD as a world currency has survived for decades, though Japanese Yen did become increasingly popular as an international currency during the 1980s. Of late, both Chinese Renminbi and EURO are challenging the USD in the International Finance. It is also evident from the fact that the share of USD in the reserve currency is falling, though overall the Reserve Currency globally is increasing. However, neither Yuan nor EURO can compete strongly with USD due to its valuations problems, i.e. Chinese Yuan is considered as undervalued whereas EURO being as Overvalued.

Not only Bitcoin will revolutionize the way payments are made, but also have potential to impact the future of world currencies like USD, which is already facing challenges from EURO or Chinese Yuan Renminbi (CNY). The rise of crypto currencies will add a new dimension to this challenge for US Dollar (USD).

The focus of this study is to understand multiple factors which are translating Bitcoin (BTC) that is gaining momentum in various fields of global finance and how disruptive it can be, including replacing main fiat currencies in the financial system impacting mainly USD. The key variables studied are Regulation or lack of it around Bitcoin, Bitcoin Technology, Bitcoin Economy and the usage of Bitcoin as a Currency. The observations of this study will help understand the future of global finance from multiple standpoints, especially Regulation, Cryptocurrencies and fiat currencies.

As far as the regulation on Bitcoin is concerned, there is no consistency in a way various countries deal with Bitcoin. There is no consistency in guidance on the legal, accounting, tax and audit-related standards. Thus, Regulation has become one of the most debated issues facing the digital currency industry. Bitcoin technology has many of the unique and unprecedented features that give it the potential to be disruptive and impacting a broad range of industries and institutions. The ability to send money anywhere in the world in minutes, its peer-to-peer decentralized nature of value transfer and its completely digital existence, makes effective regulation of digital currencies so challenging for governments and policymakers have no clear legislation on digital currencies, which makes the process even more complex.

In Europe, both the European Central Bank and the European Banking Authority discuss the risks of Bitcoin and potential regulatory stand. The ECB is focused on aspects relevant from central bank’s perspective, i.e. risk to price stability, financial stability, the payment system, and reputational risks for central banks. In summary, the ECB concludes that virtual currency schemes do not pose significant risks, because of their relatively low volume and limited interrelation with the real economy. Nonetheless, this could change if cryptocurrency schemes became more important and their use more extensive. The ECB further states that, as payment systems, virtual currency schemes.

Bitcoin Technology is complex and not easy to comprehend by a layperson. It could be one reason why new user or public at large are still not comfortable to use this technology. Though, this technology existed and used in multiple areas. The Bitcoin transaction process uses cryptography to verify transactions, process payments, and control the supply of Bitcoins. The particular cryptographic schemes implemented in the Bitcoin protocol are not new and are used in a wide range of information security applications.Bitcoin relies on two cryptographic schemes (a) digital signature, which enables the exchange of accurate (payment) instructions between the parties of a transaction, and (b) cryptographic hash function, which is used to enforce discipline in writing transaction, records in the public ledger. Neither of these schemes is unique to Bitcoin; they are widely used to secure commercial and government communications.

Bitcoin Economy - Over a period, it’s seen that some high-profile online retailers begin accepting payments in Bitcoin, and the rise of solid and reliable payment service options looks to make coming years a game-changer for Bitcoin as an e-Commerce currency. It is evident from that fact that that we see huge Venture Capital Investments in Bitcoin-related startups, especially, Internet pioneers are betting on a bright future for Bitcoin. Investors such as Netscape founder Marc Andreessen and LinkedIn founder Reid Hoffman put $315 million into Bitcoin-related projects in 2014 which triple the venture-capital investment of 2013, according to the digital currency news site Coindesk. Digital wallet provider Coinbase had announced of a $75 million injection of new funds by investors including the New York Stock Exchange and the venture arm of the Spanish banking giant Banco Bilbao Vizcaya Argentaria SA. Bitpay and Bitfury were the two biggest VC deals in the second quarter of 2014 which was for $30 million and $20 million respectively.

Bitcoin as a “Currency”- In earlier times, the currency was essentially a receipt for a commodity redeemable in most cases for physical gold. Today, however, the majority of currencies are known as “fiat” currencies, meaning these currencies are neither inherently valuable nor redeemable for a commodity but, instead, are issued and backed by some central authority such as the United States Federal Reserve. The value of such currencies derived from the trust placed in the central authority by the users of the currency.

In economics, money defined by three functions - a unit of account, means of payment and store of value. Even in a current economic scenario, there is a single unit of account in every currency territory, which is considered to be an efficient solution. Having all prices in a currency area denominated in the same unit makes them comparable and enables the operation of markets. Typically, means of payment issued as official currency by a regulatory body, which is a central bank for that country which is in charge of ensuring the quality and quantity of that money.

In most countries, such a mandate necessitates ensuring the functioning of these means of payment as a stable and most liquid store of value over the short to medium term fall under the purview of central banks and therefore they also need to take into account probable Reputational Risks as central banks may be held responsible by the public for incidents involving Bitcoins.

Bitcoin has a huge potential, but it cannot in its current form, affect the USD though it can harm it significantly, if its exchange rate versus USD increases drastically. The reason for this conclusion is a major regulatory hurdle that Bitcoin is facing, which will not allow it to increase, the way it would have increased if it had Regulators’ support. Another important aspect is the limited supply, primarily due to the limited units, i.e. 21 million. One may argue that Bitcoin is capable of reducing itself to a “Satoshi: i.e. the smallest fraction of a Bitcoin which is 0.00000001 BTC, meaning a hundredth of a millionth BTC. Again, if this fraction of BTC has to be used in transactions, it should have some respectable value, i.e. the exchange rate with other major currencies in the world should be very high.

The positive message that can be seen is that people are willing to explore technology and is open to adopting different formats of the virtual currency provided they get some reasonable assurance that the underlying virtual currency has a regulatory backing and therefore will also have some stability in its value. Will this happen in future?