Bitcoin captivating the Covid monetary revolution

We are living through a monetary revolution so multifaceted that few of us comprehend its full extent. The technological transformation of the internet is driving this revolution. The pandemic of 2020 has accelerated it. To illustrate the extent of our confusion, consider the divergent performance of three forms of money this year: the US dollar, gold and Bitcoin.

The dollar is the world's favourite money, not only dominant in central bank reserves but in international transactions. It is a fiat currency, its supply determined by the Federal Reserve and US banks. We can compute its value relative to the goods consumers buy, according to which measure it has scarcely depreciated this year (inflation is running at 1.2 per cent), or relative to other fiat currencies. On the latter basis, according to Bloomberg's dollar spot index, it is down 4 per cent since Jan. 1. Gold, by contrast, is up 15 per cent in dollar terms. But the dollar price of a bitcoin has risen 139 per cent year-to-date.

This year's Bitcoin rally has caught many smart people by surprise. Last week's high was just below the peak of the last rally ($19,892 according to the exchange Coinbase) in December 2017. When Bitcoin subsequently sold off, the New York University economist Nouriel Roubini didn't hold back. Bitcoin, he told CNBC in February 2018, had been the "biggest bubble in human history." Its price would now "crash to zero." Eight months later, Roubini returned to the fray in congressional testimony, denouncing Bitcoin as the "mother of all scams." In tweets, he referred to it as "Shitcoin."

Fast forward to November 2020, and Roubini has been forced to change his tune. Bitcoin, he conceded in an interview with Yahoo Finance, was "maybe a partial store of value, because … it cannot be so easily debased because there is at least an algorithm that decides how much the supply of bitcoin raises over time." If I were as fond of hyperbole as he is, I would call this the biggest conversion since St. Paul.

So, what is going on?

The pandemic accelerated our advance into a more digital word: What might have taken 10 years has been achieved in 10 months. People who had never before risked an online transaction were forced to try, for the simple reason that banks were closed. Second, and as a result, the pandemic significantly increased our exposure to financial surveillance as well as financial fraud. Both these trends have been good for Bitcoin.

Two years ago, I estimated that around 17 million bitcoins had been mined. The number of millionaires in the world, according to Credit Suisse, was then 36 million, with total wealth of $128.7 trillion. "If millionaires collectively decided to hold just 1 per cent of their wealth as Bitcoin," I argued, "the price would be above $75,000 — higher, if adjustment is made for all the bitcoins that have been lost or hoarded. Even if the millionaires held just 0.2 per cent of their assets as Bitcoin, the price would be around $15,000." We passed $15,000 on Nov. 8.

What is happening is that Bitcoin is gradually being adopted not so much as means of payment but as a store of value. Not only high-net-worth individuals but also tech companies are investing. There are three obvious defects to Bitcoin. As a means of payment, it is slow. The Bitcoin blockchain can process only around 3,000 transactions every 10 minutes. Transaction costs are not trivial: Coinbase will charge a 1.49 per cent commission if you want to buy one bitcoin.

There is also a significant negative externality: Bitcoin's "proof-of-work" consensus algorithm requires specialized computer chips that consume a great deal of energy — 60 terawatt-hours of electricity a year, just under half the annual electricity consumption of Argentina. Aside from the environmental costs, one unforeseen consequence has been the increasing concentration of Bitcoin mining in a relatively few hands -many of them Chinese - wherever there is cheap energy.

But these disadvantages are outweighed by two unique features. First, as we have seen, Bitcoin offers built-in scarcity in a virtual world characterized by boundless abundance. Second, Bitcoin is sovereign. The advantages of scarcity are obvious at a time when the supply of fiat money is exploding. Take M2, a measure of money that includes cash, bank accounts (including savings deposits) and money market mutual funds. Since May, US M2 has been growing at a year-on-year rate above 20 per cent, compared with an average of 5.9 per cent since 1982. The future weakness of the dollar has been a favourite 2020 talking point for Wall Street economists such as Steve Roach. You can see why. There really are a lot of dollars around, even if their velocity of circulation has slumped because of the pandemic.

The advantages of sovereignty are less obvious but may be more important. Bitcoin is not the only form of digital money that has flourished in 2020. China has been advancing rapidly in two different ways.

Nowhere in the world are mobile payments happening on as large a scale as in China, thanks to the spectacular growth of Alipay and WeChat Pay. At the same time, the People's Bank of China has accelerated the rollout of its digital currency. The potential for a digital yuan to be adopted for remittance payments or cross-border trade settlements is substantial, especially if - as seems likely -countries participating in the One Belt One Road program are encouraged to use it. Even governments that are resisting Chinese financial penetration, such as India, are essentially building their own versions of China's electronic payments systems.

Some economists, such as my friend Ken Rogoff, welcome the demise of cash because it will make the management of monetary policy easier and organized crime harder. But it will be a fundamentally different world when all our payments are recorded, centrally stored, and scrutinized by artificial intelligence - regardless of whether it is Amazon's Jeff Bezos or China's Xi Jinping who can access our data.

In its early years, Bitcoin suffered reputational damage because it was adopted by criminals and used for illicit transactions. Such nefarious activity has not gone away, as a recent Justice Department report makes clear. Increasingly, however, Bitcoin has an appeal to respectable individuals and institutions who would like at least some part of their economic lives to be sheltered from the gaze of Big Brother.

Rather than seeking to create a Chinese-style digital dollar, Joe Biden's nascent administration should recognize the benefits of integrating Bitcoin into the US financial system - which, after all, was originally designed to be less centralized and more respectful of individual privacy than the systems of less-free societies. (Bloomberg)