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Tam Hunt: What Happens When Bitcoin Pushes Out National Currencies?

“We are about to see massive disruptions,” International Monetary Fund chief Christine Lagarde said in a recent interview. She added in a different interview: “In many ways, virtual currencies might just give existing currencies and monetary policy a run for their money.”

Bitcoin is now the world’s 30th-largest currency, with a market capitalization of more than $170 billion at the time of writing. It is not entirely crazy anymore to imagine that Bitcoin will replace some or even all national currencies in the not-too-distant future. Deutsche Bank has suggested that we may be looking at “the start of the end” of fiat (government-issued) currencies.

The growth curve in the value and adoption of Bitcoin, if extrapolated merely two decades ahead, brings us to the point where all of the world’s currency is comprised of Bitcoin in just a few years.

Will this actually happen? It’s highly unlikely that it will happen that fast, and we’ll probably see some real tug-of-war back and forth for a number of years as governments around the world use all the tools at their disposal to resist.

We can’t say exactly how this will all unfold, of course, but this piece will examine what it will take to get to a “Bitcoinized” world and what the world might look like once Bitcoinization on a global scale has taken place.

Annual growth in market cap has averaged about 1,400 percent — yes, 14 times growth per year — in the past few years (Figure 1). Global fiat currency market cap totals about $37 trillion. The current Bitcoin market cap is, accordingly, only 0.5 percent of the fiat market cap. This is trivial for now, but exponential growth can quickly change trivialities into global transformation. Well-known trader Mike Novogratz predicts $2 trillion in total cryptocurrency market capitalization by the end of 2018. And when the value has grown on average 14 times every year it’s quick indeed to rival fiat currency.

Figure 1. Growth in Bitcoin market capitalization ($billions). Click to view larger
Figure 1. Growth in Bitcoin market capitalization ($billions). (Source: blockchain.info)

Figure 2 shows what happens if this growth continues under various growth rates. It is likely that the growth in market cap will slow considerably because it seems that various obstacles will appear and prevent the torrid rate of growth we’ve witnessed in recent years from continuing. But as the chart shows, even at significantly lower rates of growth than we have seen we still reach quite respectable numbers.

Figure 2. Market cap growth scenarios.
Figure 2. Market cap growth scenarios.

At an average 30 percent annual rate of growth in Bitcoin market cap, Bitcoin’s value would be equivalent to all fiat currencies today by about 2038. And keep in mind that the average annual growth in recent years has been 1,400 percent, just a bit higher than 30 percent.

These numbers are pure speculation, obviously, but what they do show is that even at a low rate of growth in Bitcoin’s value we arrive pretty quickly at a world in which conceivably all money is Bitcoin. What would such a world look like?

Looking at how Bitcoinization will change the world, I’ll focus on just two major shifts that are likely to occur: 1) possibly less incentive to spend and thus potentially lower economic growth; 2) less national control over currency and lower tax revenue.

It’s also likely that a Bitcoinized world would lead to more democracy because of the power for blockchain voting to allow for highly secure online and mobile voting. I’ll look at this issue in more detail in a different piece, but this possible consequence of Bitcoinization is particularly intriguing to me since I’ve long been an advocate for more direct democracy.

Will people hodl their Bitcoin forever?

No, hodl is not a typo; it’s a running joke. Hodl was originally a typo, but it became a meme, and now the term is widely used to refer to a tendency for Bitcoin holders to hold (hodl) rather than spend. It’s long been recognized that people in general like to “hodl” their Bitcoin because of the likelihood that its value will just keep going up and up.

Bitcoin is an intentionally deflationary currency, which means that its value is designed to go up over time rather than down. Fiat currencies are always inflationary because central banks push for a 2 to 3 percent inflation rate in order to both incentivize spending over saving and to ensure that banks will always earn rents on their capital. Bitcoin and other deflationary currencies change this game rather dramatically.

Will people actually hodl and not spend even as Bitcoin’s value goes up and up and its use becomes more easy and widespread? It comes down to individual reasons for buying Bitcoin. If it’s seen purely as an investment, then hodling will continue to be the norm, but as Bitcoin is increasingly widespread, accepted by merchants, and considered normal rather than exotic, we’ll see hodling decrease. My money is on the latter scenario being more likely.

Inflation is not the only reason people invest or spend money more generally. Not at all. In fact, it’s a rather small consideration for most people. And, in fact, most people don’t have much money to hodl or invest, for that matter. My view is that governmental policies pushing a desired level of inflation are less about spurring investment by regular folks and small businesses than they are about ensuring a minimum level of return by banks on loans.

Will national governments lose control of their currency and tax revenue?

A major case for Bitcoin since its inception has been its ability to cut government out of the money business — disintermediation in the technical lingo, which just means to cut out the middle man. The idea is that if we send payments directly person to person, without governments playing a role, wouldn’t that be a better system?

Governments have played a role in money control and regulation for eons because it was thought (usually accurately) that we needed a large and powerful entity to provide the basis for trust in the currency at issue. Dollars are backed by the “full faith and credit” of the U.S. government, the most powerful nation to ever bestride the Earth.

The game-changing feature of Bitcoin is that it decentralizes trust through a large network called the blockchain. All transactions are recorded in each node of the blockchain, making the network basically hacker proof. The end result is that peer to peer transactions, or whatever kind of transaction we’re looking at, can be done with just the blockchain recording the transaction for all to see and to verify if needed.

Second, governments can’t print Bitcoin. No one prints Bitcoin. It’s “mined” with very powerful specialized computers that solve increasingly difficult math problems in order to unlock each new block of coins. So instead of the full faith and credit of the U.S. government (and the economic and military power behind it) backing the currency, it’s an army of powerful computers around the world that backs Bitcoin’s value.

Will Bitcoinization result in loss of control by governments over their currencies? Possibly. Bitcoin could certainly continue to grow alongside fiat currencies (the term we use for government-issued currencies) for many years and not necessarily impinge on government control of those currencies. This could happen if people continue to view Bitcoin as basically digital gold, a store of value rather than a unit of exchange. Under this scenario, Bitcoin literally takes the place of physical gold as a kind of “rainy day fund” for people who worry about their money losing value.

But there is also an increasingly realistic scenario in which people start to use Bitcoin as a unit of exchange in large numbers, that is, to buy things. Despite its reputation for speculation, we are seeing already significant numbers of people use Bitcoin for transactions.

A recent survey found that more than 8 percent of U.S. college students had used Bitcoin for transactions in the past year, rather than just “hodling.” College students are our future so if almost 1/10th are already using Bitcoin for transactions we can rest assured that this number will grow substantially in the coming years.

There are a number of easy-to-use apps and debit cards for using Bitcoin to buy things either online or at the point of sale, including blockchain.info’s wallet app for peer-to-peer transactions or sending or receiving Bitcoin or other currencies, the Mobi phone app for similar uses, the Cryptopay.me debit card (either physical or virtual), and similar features with bitpay.com and a growing number of other offerings.

Under these trends, it’s reasonable to see more and more people using Bitcoin for everyday transactions. (I’ll set aside for now the difficulties with Bitcoin’s block size and cost of transactions because I have some confidence those issues will be resolved before too long.)

As more and more people convert their fiat currency to Bitcoin and start using Bitcoin increasingly for regular transactions, government control over currency and monetary policy begins to slip away. It could be a quick death spiral as people shift en masse to Bitcoin once a certain tipping point is reached in each country.

Similarly, taxation will face increasing issues. Governments will do their best to tax Bitcoin and already are, but these efforts will become increasingly desperate as people realize that it’s not that hard to avoid taxation of Bitcoin gains. Governments can’t seize Bitcoin currency as they can seize regular currency in peoples’ bank accounts or from employers.

The U.S. Congress is currently holding hearings on how to include Bitcoin and other cryptos under money laundering laws. My advice on taxes is this: just pay the taxes due on your Bitcoin and avoid becoming an outlaw.

The potential decline in tax revenue may well lead to some serious problems that I don’t look forward to. I don’t mind paying taxes for most domestic items such as roads, education and infrastructure. But a lot of people greatly dislike paying taxes for war or overly aggressive foreign policy, whether they’re in the United States, Russia, China or elsewhere.

Will Bitcoin spell the end of war because governments can’t raise money to wage war anymore? That’s a topic for a different essay, but it seems likely that as the world Bitcoinizes we may well see less use of coercive and violent power, which counts as a good thing to me.

An interesting interview with Rick Falkvinge, the founder of the Swedish Pirate Party, describes the Bitcoin phenomenon as a massive shift of wealth, to “geeks and nerds,” not seen since the 1850s when there was a similar transfer of wealth to those who found oil around the world.

I suspect, though I have zero evidence, that governments are starting to buy Bitcoin in large amounts, and will continue to do so, as they start to realize how important this new economic system will be for the future. If this is true, we’ll see the price crazy for Bitcoin continue far higher.

The future economy may rest on which governments have the most Bitcoin. This trend may mirror the large transfer of wealth at the individual level if some of today’s powerful governments don’t see the light soon enough.

So what happens when geeks and nerds are the new moneyed elite on a global scale? Well, we’re about to see.

— Tam Hunt is a lawyer and writer based in Hawaii.

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