Technically speaking, Bitcoin is a decentralized computer network. But this one has a special twist: Fearing inflation and currency devaluation, the first companies have exchanged parts of their account balances for Bitcoin. In El Salvador, Bitcoin has now become the second official state currency alongside the US dollar.
A “volatile” history
Bitcoin was launched in 2008 by an inventor who remains anonymous to date. In its early years, Bitcoin was a project for a fairly small group of IT professionals that wanted to improve the global financial system and began using Bitcoin for trades and investment. In 2013, the Bitcoin price briefly jumped above the US$1,000 mark for the first time, followed by a significant price drop and a few years of silence. Then, in 2017, Bitcoin reached the magic mark of 20,000 US dollars per Bitcoin. Again a significant price drop and a few years of silence followed. Then, in the spring of this year, bitcoin reached the $65,000 mark. Again, the price dropped significantly and is now hovering around $35,000 per bitcoin. What has happened over the years? Will Bitcoin come back again and again; only to pause for a few years at a time? As of today, the valuation of all Bitcoins combined is around $700 billion, which is about 6% of the valuation of gold. This means that Bitcoin has already reached a certain size. At least Bitcoin is so big that it deserves serious attention. Besides Bitcoin, there are countless other cryptocurrencies. All cryptocurrencies together have a valuation of $1.6 trillion. However, the biggest chunks of that are Bitcoin and Ethereum. These two technologies have it all. In contrast, many projects are not to be taken seriously, and numerous projects are even fraudulent.
First companies have bought Bitcoin
In the case of Bitcoin, it can be noted that it has slowly worked its way onto the world stage. One of the most significant events in the Bitcoin universe last year was when Microstrategy – an IT company from the U.S. – exchanged part of its account balance, normally quoted in U.S. dollars of course, for Bitcoin. The calculus of Michael Saylor, CEO of Microstrategy, was this: Saylor expects the U.S. dollar to weaken, which will be accompanied by a loss of purchasing power. The reason is years of piling up debt, which accelerated during the Corona crisis. This national debt was bought up by the central bank. Thus, one can confidently say that the central bank financed the national budget and ultimately, in effect, printed money. This money is now in circulation and is pushing into the markets. It is well known that the European Central Bank (ECB) has acted in exactly the same way here in Europe.
CEO Michael Saylor felt it was his duty to protect his company’s purchasing power and came to Bitcoin this way. Bitcoin is a scarce commodity and there will never be more than 21 million Bitcoins. Thus, it is limited in its supply – as is gold. In addition, Bitcoin spreads quite slowly over the years. Both developments combined have led Michael Saylor to classify Bitcoin as a future store of value.
What was perceived as a daring move by many in 2020 may turn out to be a smart move in the end. Last week, inflation was measured at 5% in the US. It is conceivable that inflation will rise even further. What does this mean? The purchasing power of the dollar is dwindling; fewer goods can be bought for the same amount of U.S. dollars due to rising prices.
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At this point, it is important to remember exactly what inflation feels like. Every European is likely to experience this personally in the coming months. Inflation feels like this: “Man, the hairdresser has become expensive. It used to cost 25 EUR, now it’s 35 EUR.” Or: “Hmm. This sandwich costs 8.50 EUR. It used to be cheaper.” Or: “Wow, gasoline hasn’t been so expensive for a long time.”
Inflation means that prices are rising. And how does this feel? When we feel like everything around us is getting more expensive. And when the shares of DAX companies reach new highs month after month, even though we are just stumbling out of one of the worst crises in decades. Or when you try to buy a property and even the most expensive properties are bought straight away directly after they have been posted on the real estate portal.
In Germany, inflation was recently recorded at over 4%. Anyone who has recently refueled gasoline can understand this. Anyone who is renovating their house will also see that various materials have become more expensive. Of course, there is a story for every commodity: in the case of gasoline, it is the oil-producing countries that have restricted their production quota. For construction, it’s a sudden shortage of wood. But the common denominator remains: Across the board, prices are going up; everything is getting more expensive. Time will tell if Microstrategy-CEO Michael Saylor had the appropriate tactics. At present, it seems he is right. The question now is: Will there be other companies that replace traditional currencies in parts with Bitcoin? Yes, Tesla also made this move in 2021. Some other more obscure companies as well.
In El Salvador, Bitcoin now becomes official currency alongside the U.S. dollar
Some weeks ago, the Bitcoin community could not believe its eyes when Nayib Bukele, the president of El Salvador, a small authoritarian-ruled country in Central America, announced that he would set Bitcoin as the second state currency alongside the US dollar. Just a few days later, this very step was put into action by the parliament in El Salvador.
What may seem bizarre and hard to believe could hardly be more interesting: El Salvador previously had only the US dollar as its official currency. As a result of the expansive monetary policy of the USA, El Salvador is also being affected by the softening of the US dollar: The 5% inflation – i.e. loss of purchasing power – naturally also has an effect in El Salvador. In this respect, it is even understandable if a state tries to become more independent.
Also last week, the first details of how both currencies can coexist became known: Prices can continue to be quoted in U.S. dollars. Citizens can continue to pay with U.S. dollars. But there will be an additional payment app that will allow every citizen in El Salvador to have a digital wallet to hold bitcoin. The president of El Salvador hopes that this will offer financial inclusion to large sections of the population who previously did not have a bank account. It remains to be seen whether this approach will succeed; there are good reasons to be optimistic about it. The bitcoin would then be in the payment app and can also be used for payment purposes. So at the moment of payment, the customer and the merchant would each have to decide which currency to use and which currency to credit to the merchant. For this purpose, El Salvador now wants to build up a Bitcoin currency reserve of 150 million US dollars. An invitation promptly followed from the International Monetary Fund, where an appointment will take place in the coming days. Certainly with awkward questions.
From all these stories, one can see several things: Bitcoin is spreading quite slowly, but the daily and weekly volatility transfigure the view of the essentials. Further, it shows that established institutions will sometimes have some difficulty making friends with Bitcoin. Last but not least, Bitcoin is a network where the activities of numerous players are interwoven internationally.
But what is behind Bitcoin?
First of all, Bitcoin is a decentralized network of 10,000 computing nodes, distributed in all countries in the world. This means there is no central authority. So there is no corporate headquarters, no corporate building, no company behind Bitcoin. The character of a decentralized network has it in itself, because only the technology is in the foreground, no operating company. So this decentralized network is beyond the reach of states. Who should the state address as well? Bitcoin has no summonable address, Bitcoin cannot be summoned by authorities. It is pure technology. And it has been running without interruption for over ten years. Nothing discernible should change this. Therefore, it’s safe to assume that Bitcoin will continue to run without interruption for the next few years. Incidentally, this does not only apply to Bitcoin, but also to the number two – Ethereum – and to numerous other decentralized protocols.
If you want to shut down Bitcoin, you would have to shut down the Internet – an impossible undertaking. Bitcoin could be hostilely taken over, but it can now be claimed that this is no longer factually possible: The Bitcoin network currently calculates 150 million tera hash operations per second. Behind a million tera hash is a number with 18 zeros. Presumably, no state in the world can muster as much computing power combined with the required power consumption. And if it were possible, it could only destabilize the network for a few minutes or even hours. After that, the network would just keep running. Therefore: we will have to get used to Bitcoin and other decentralized protocols. They are not going to go away.
As is well known, this computing power costs a lot of electricity. This can be criticized, but here, too, one has to go one level deeper: electricity consumption must first be evaluated neutrally. Or don’t you watch Internet TV in the evening? Do you never play computer games? Don’t write emails? All of this also costs electricity. Therefore, it matters much more whether brown electricity from coal and gas or green electricity from hydropower, solar or wind energy is used. The Bitcoin network uses 55% to 65% electricity from green sources, depending on the estimate. That doesn’t make electricity consumption any better, but it does put it in a slightly different context. It’s worth digging deeper. The problem is that Bitcoin’s architecture cannot be adapted in the short term and electricity consumption is more likely to increase.
At this point however, it must be clearly stated that Bitcoin is not unregulated. Individuals and companies that own, buy, and sell Bitcoin are, of course, subject to the legal system in which they reside. Those who interact with the network – owners, buyers and sellers of Bitcoins – must of course abide by the law, even if the network itself is beyond the reach of states. For companies in the financial industry, the state also issued clear rules at the beginning of 2021. For example, the German government already classified Bitcoin for private individuals quite clearly a few years ago. In short: people are allowed to own and trade Bitcoin as long as they do not engage in money laundering, do not commit tax fraud and do not carry out other criminal activities. Bitcoin is therefore not unregulated. This is essentially true for all other European countries and the United States as well. It turns out that these countries let their citizens and companies handle Bitcoin because the legal framework is mostly clear. This freedom therefore requires a functioning and effective state apparatus in order to be able to punish corresponding offenses. “Freedom, but within limits” is how one can summarize the attitude of Europe and America towards Bitcoin & Co. According to estimates, there are 1.5 to 2 million Bitcoin owners in Germany with a clear upward trend.
The situation is different in Turkey, for example. There, the inflation rate has risen to a value beyond 10% and the Turkish lira is increasingly losing value. To prevent young people in particular from using alternative payment methods, the use of cryptocurrencies for payment purposes has been stopped. But by no means are cryptocurrencies banned in Turkey. Investing and owning them are allowed, while usage as a means of payment is prohibited. The Indian government had decided to ban cryptocurrencies completely some time ago. One conceivable reason for this: because of the complex nature of governance in the Indian state, offenses and criminal activities are not punished as stringent as elsewhere. This could have been a major reason for the complete ban – as a possible result of ineffective state structures. Bitcoin is not fundamentally banned in China either, rather there are restrictions for certain services with cryptocurrencies, and recently large-scale industrial Bitcoin mining unless renewable energy is used. There is no sign of a trend towards uniform global regulation, even if Christine Lagarde of the ECB would like to see it. Instead, each state acts differently, but to some extent comprehensible in itself: from Bitcoin as legal tender in El Salvador to a complete ban in India.
In any case, cryptocurrencies are fascinating. A global ecosystem has emerged with, in some cases, completely different perspectives. It’s worth taking Bitcoin increasingly seriously. And it’s worth learning more about Bitcoin. A good start would be, for example, the Wikipedia page of Bitcoin.