Will Bitcoin challenge the hegemony of the US dollar? (2)

Bitcoin, Dollar and Geopolitics

Henry Paulson, former U.S. Treasury Secretary, published the article "The Future of the Dollar: The Financial Power of the United States depends on Washington, not Beijing" in Foreign Affairs last May. He believed that Washington's economic policy to resist the COVID-19 outbreak will test the status of the dollar, depending on whether the United States can manage its national debt and curb its structural fiscal deficit over time.

"Washington should keep a clear head on the risks it really faces in its competition with China. The United States should maintain a leading position in financial and technological innovation, but there is no need to exaggerate the influence of digital cash on the US dollar. Most importantly, the United States must first reserve the conditions for creating the dominant position of the US dollar: a vibrant economy based on sound macroeconomic and fiscal policies.

A transparent and open political system. As well as the leading position in international economy, politics and security. In short, maintaining the dollar status will not depend on China's situation. On the contrary, it will depend almost entirely on the ability of the United States to adapt to the economy after the COVID-19 outbreak. "

Paulson does not believe that the introduction of digital RMB by the Central Bank of China will end the dominant position of the US dollar. Although the currency form may be changing, its nature has not changed. Digital RMB is still RMB. The tokens used for trading may be different, but the prospect of China's reserve currency status depends on the same set of factors applicable to RMB issuers. Although the Chinese government has advocated the use of RMB to settle trade, which is an effort to internationalize RMB, oil and other major commodities are still priced in US dollars.

With the passage of time, the international monetary system will probably give relatively equal attention to two or more global reserve currencies again. Renminbi is the main competitor because it has become a reserve currency together with Japanese yen, euro and British pound. In addition to major disasters, China's economy is expected to become the world's largest economy in the foreseeable future. It will also be the first major economy to recover from the new crown crisis.

Nevertheless, it is still uncertain whether RMB can join the ranks of the US dollar as the main reserve currency. In order to achieve this status, China needs to reform its economy and develop its capital market, but this may be subject to political factors. It is impossible to establish an international financial center when capital control is implemented and the currency is not determined by the market. The same holds true for the prospect of RMB as the main reserve currency.

At the same time, Paulson believes that although the digital cash supported by Beijing itself is unlikely to destroy the dominance of the US dollar, it can undoubtedly promote the internationalization of RMB. In countries and regions with unstable currencies, such as Venezuela, digital RMB can replace local currency. Chinese companies (such as Tencent) have already occupied a considerable market share in developing countries in Africa and Latin America, and they can lead the future digital RMB to gain market share. This may help enhance the global status of RMB and become part of a broader strategy to project China's economic and political influence overseas.

Other international observers also believe that the digital RMB is expected to replace the US dollar in countries along The Belt and Road Initiative. Once the digital RMB erodes the market share of the US dollar, even if the Chinese government does not support Bitcoin, it will make the US dollar a more vulnerable opponent of Bitcoin.

Most likely, even many governments that do not support Bitcoin and cryptocurrency on the surface will realize the strategic value of bitcoin, which indicates that controlling the production and circulation of Bitcoin will involve financial system security and national security, and many countries may evade the actual or threatened economic sanctions of the United States by hoarding and manipulating Bitcoin behind the scenes.

Therefore, even if Bitcoin claims to be a currency that cannot be confiscated or destroyed by any government, the most likely scenario is that Bitcoin and (digital) RMB will take away the market share of the US dollar, but when will the US government feel the threat of cryptocurrency to the hegemony of the US dollar?

The troll in the magic bottle

On the whole, although anarchists hope that Bitcoin will eventually bring utopia of monetary freedom, as long as human beings still believe in social organization, basically Bitcoin will completely replace the US dollar or any legal currency, and the possibility is almost zero.

According to Statista data, during the financial crises in 2009, 2010 and 2011 and the subsequent recovery period, the US dollar accounted for more than 60% of the global foreign exchange reserves. Even after the COVID-19 crisis, according to the International Monetary Fund, the US dollar accounted for 61% of the global currency reserves in the second quarter of last year.

"Bitcoin maximists" often think that although Bitcoin may have some problems such as scalability and smart contract application, it will monopolize the market in the future. But the "decentralization" of Bitcoin is also its weakness. As a matter of fact, the exchanges that provide Bitcoin transactions are fragmented and centralized, and still can't get rid of people-oriented.

Another consideration is that the world's central banks not only hold US dollars, but also hold US Treasury bonds.

According to Statista, as of June 2020, the value of US Treasury bonds held by Japan was 1.26 trillion US dollars, and that held by China was 1.07 trillion US dollars. According to the data of the Federal Reserve and the U.S. Treasury Department, as of June 2020, foreign countries held US Treasury bonds worth 7.04 trillion dollars.

Mark Chandler, author of "The Awareness of the Dollar", said: "The largest, deepest and most transparent government bond market in the world supports the dollar. From that perspective, I really don't know how Bitcoin can replace the dollar."

In July last year, the Office of the Comptroller of the Currency of the United States allowed American banks with national licenses to provide cryptocurrency custody services. Before that, only professional companies with state licenses could provide services for large investors, which meant that large banks that provided similar custody services for stock certificates could join the competition.

In October last year, the US Department of Justice also published a white paper entitled "Cryptography: Law Enforcement Framework", which put forward the law enforcement response plan for digital cash and how the US Department of Justice established cooperative relations with domestic and global regulatory and law enforcement units in the United States.

All these measures give cryptocurrency a certain degree of "legitimacy". However, although the currency circle thinks that the government can't eliminate cryptocurrency, the government's negative measures can still suppress its practicability.

Up to now, the U.S. government can't completely ban bitcoin, mainly because it's done, and too many interest groups have joined the ranks of bitcoin. However, in view of the fact that cryptocurrency may become a weapon to start a "currency war", will the United States promote the international convention mechanism to supervise cryptocurrency?

Based on the potential strategic value of Bitcoin and blockchain, the consideration between governments must also include whether expelling Bitcoin will give other countries an advantage in blockchain finance.

The paradox here is that unless the US dollar is really threatened, the US government will probably not take action against Bitcoin. On the other hand, if we don't take action now, the troll will have escaped from the magic bottle when Bitcoin really develops to the level that threatens the dollar.

Challenges of other cryptocurrencies

In the cryptocurrency family with 8655 members (according to the data of March 2nd), Bitcoin, as the ancestor, and its extensive "network effect", naturally has the advanced advantage of becoming a global reserve currency compared with other cryptocurrencies.

According to Citibank's report, many potential problems may hinder institutions' participation in bitcoin, cryptocurrency and digital assets. It is necessary to continuously enhance their confidence in the network and solve their concerns about capital efficiency, custody arrangements, asset insurance, market security, the possibility of false collateral claims and the impact of ESG (environmental, social and governance performance).

With Bitcoin and other cryptocurrencies becoming more mainstream, the requirements of regulatory compliance mostly depend on traditional tools, such as "know your customers", anti-money laundering and monitoring the financial system, which are largely incompatible with the genes of cryptocurrencies. Originally, "network punk" wanted to provide a chain for extra-legal use through a decentralized and user-controlled network, but the "data transfer rules" used by the Financial Action Task Force against Money Laundering to manage digital assets have caused widespread concern in the currency circle.

Although some early pioneers in the field of crypto may regard increasing regulation as the natural development of ecosystem maturity, some of them may resist. Many of the most innovative and talented developers may choose to quit the deployed platform and move to new fields. This may eventually split the liquidity in the system.

Institutional participants and many individual investors may choose to embrace the regulated part of the digital ecosystem, thus investing more and more money. Although this may promote the recent wave of growth, in the medium and long term, the valuation of the regulated crypto business and the prices of the regulated bitcoin, cryptocurrency and digital assets may lose the attractiveness of innovation and be closer to the traditional investment products. Just as Exchange-traded Fund (ETF) was a unique investment product at first, and then evolved into another investment package, with the integration and development of old systems and emerging systems, the novelty of Bitcoin and blockchain ecosystem may gradually disappear.

Citibank believes that under this background, developers may turn to another wave of disruptive innovation, and they may try their best to create new crypto products that are more resistant to supervision. Speculative capital and investors who want to join the anti-establishment movement may turn to new fields.

Although Bitcoin is still the most liquid and well-funded token, the market value of Bitcoin has increased by 2.7 times in 2020, but the market value of other cryptocurrencies has increased by 3.75 times in the same period. As a result, the market dominance of Bitcoin is declining. Its market share has dropped from 94% in 2013 and 69% in 2019 to 62% in 2020, and it is currently maintained in the range of 60% to 62%

Newer platforms provide programmable intelligent contracts and open protocols, which make it easier for innovative developers to experiment and create new products to attract users. Games, gambling and decentralized financial products are all created in the blockchain. Users who want to participate must pay coins issued by the platform itself.

The hot platform may make the value of tokens exceed bitcoin. Ethereum platform has settled more transactions denominated in US dollars than Bitcoin platform. Will these eventually overshadow Bitcoin? People in the currency circle believe that Bitcoin will be "digital gold" and used as value storage, while cryptocurrencies such as Ethereum will be "use tokens", each with its own advantages.

However, Citibank pointed out that if the economic rebound exceeds expectations, and the central bank and government can reduce their financial plans and start to raise interest rates faster than expected, this may lead institutional investors to redistribute capital to the traditional stock and bond markets. The weakening of institutional enthusiasm will eliminate the main source of support for Bitcoin and the wider cryptocurrency ecosystem, thus pushing it back to the more speculative source.

According to the analysis report of Bank of America, the main argument for holding Bitcoin in the portfolio is not diversification, stable returns or preventing inflation, but the expectation that prices will continue to rise. Bitcoin is similar to other commodities, and its price is completely determined by the relationship between supply and demand.

Since the supply of Bitcoin is fixed, the fluctuation of demand is the only factor driving its price trend. Bitcoin has also been associated with risky assets, which is not related to inflation and fluctuates abnormally. Therefore, it is impractical as a means of storing wealth or payment mechanism.

The report also points out several barriers that will prevent Bitcoin from spreading further, including centralized ownership: about 95% of bitcoins are controlled by 2.4% accounts, and the distribution is heavily biased towards the largest "whale" account. By contrast, according to the latest data from the Federal Reserve, the top 1% of Americans "only" control 30.4% of the wealth of all American families.

Moreover, the price of Bitcoin is extremely affected by capital flows: only $93 million can increase the price of Bitcoin by 1%. At least $2 billion of capital inflow is needed to increase the price of gold by one percentage point, while more than $2.25 billion is needed to exert the same price influence on national debt over 20 years.

Another consideration is the degree of correlation: Bitcoin is no longer related to other major risky assets. Bitcoin has a higher correlation with stocks and commodities, while its correlation with safe-haven assets such as US dollars and US bonds is neutral or negative.

The energy consumption of Bitcoin is also a policy consideration: according to the research of Bank of America, the energy consumption of Bitcoin can be compared with that of American Airlines and other large companies, and American Airlines transports more than 200 million passengers every year. The report estimates that for every $1 billion inflow, Bitcoin consumes the equivalent of 1.2 million cars. "In other words, buying a Bitcoin at a price of about $50,000 has a carbon footprint of 270 tons, equivalent to 60 internal combustion engines. car." From this point of view, Tesla's $1.5 billion investment in Bitcoin generates a carbon footprint equivalent to the annual emissions of 1.8 million cars.

Although the defenders of Bitcoin advocate that the energy for Bitcoin mining will come from renewable energy, the
data of the Bitcoin Power Consumption Index Map in Cambridge at the beginning of this year shows that China currently accounts for about 65% of the global hash rate. Bank of America said: "Nearly 60% of China's electricity comes from coal-fired power plants, and less than 20% comes from natural gas or renewable energy. This means that most Bitcoin mining depends on unsustainable fossil fuels. "

The Bank of America report also pointed out that the carbon footprint of Bitcoin is directly related to the price. As the price rises and more and more crypto miners participate, the emissions will rise. On the contrary, the Bitcoin network must become more complex in order to meet the demand and prevent hackers from invading. This will require more hash power, which will increase energy consumption. In view of the linear relationship between Bitcoin price and Bitcoin energy use, Bitcoin energy consumption is estimated to have increased by more than 200% in the past two years.

The energy consumption of Bitcoin and cryptocurrency is bound to continue to be debated. If this becomes the pretext for governments and international carbon neutral conventions to suppress it, Bitcoin will be further away from challenging the hegemony of the US dollar.