Bitcoin versus fiat currency: Did the cryptocurrency promise to transformmoney die of its own shortcomings or was it killed by central banks?

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Bitcoin has demonstrably failed to deliver on its initial promises. Although more than 15,000 businesses around the world accept Bitcoin as payment, and both payment service providers and credit card companies are making it easier to move between Bitcoin and fiat currency, it is still extremely hard to spend Bitcoin in a shop or restaurant. 

This is not surprising, since the day-to-day value of Bitcoin is so volatile that consumers are reluctant to use it and merchants to accept it. In addition, Bitcoin has proved that even peer-to-peer transfers cannot escape transaction fees, which also turn out to be highly volatile. Nor is Bitcoin safer than notes and coins or a bank deposit. Though Bitcoin has not been hacked since 2014, holders regularly lose their private keys or find a crucial storage device has failed. 

The volatility in the value of Bitcoin reflects its reliance not on a creditworthy issuer but on the ability of the largest holders to attract successive waves of investment, mostly from retail investors. Like so many conventional financial products, Bitcoin functions mainly as a means of enriching the wealthy and the professional at the expense of retail investors, with the added disadvantage of proving useful to criminals and sanctions evaders. 

So it is not surprising that the one burden regulators in developed markets have laid on participants in the Bitcoin market is Anti-Money Laundering (AML), Countering the Financing of Terrorism (CFT) and sanctions screening tests. For similar reasons, a growing number of regulators are restricting the marketing of cryptocurrencies – of which Bitcoin remains the most important - to retail investors. 

The otherwise light regulatory touch has had the opposite of the anticipated effect by inhibiting direct institutional investment in Bitcoin, though institutional money has shown interest in Bitcoin derivatives and spot Bitcoin Exchange Traded Funds (ETFs). ETFs became available only after a court judgement forced the Securities and Exchange Commission (SEC) to allow them to be issued in spite of concerns about the impact on retail investors. 

The uncertain regulatory position of Bitcoin has had wider effects. Though Bitcoin is credited with pioneering the issuance of tokens on to blockchain networks, the unregulated nature of the cryptocurrency itself has blighted efforts to develop markets in tokenised securities, funds and deposits. This reflects continued misunderstandings of the differences between cryptocurrencies and tokens. 

Another mixed legacy of Bitcoin is the proliferation of blockchain protocols which are not inter-operable, suppressing the development of liquidity in the wider token markets. Even where adoption of Bitcoin-inspired innovations is occurring, such as in the issuance of central bank digital currencies (CBDCs) to bring the unbanked within the financial system or to make cross-currency payments cheaper and faster, progress is more apparent than real. 

15½ years have now elapsed since Bitcoin was launched in January 2009. Bitcoin today is a US$1.1 trillion speculative asset, without any meaningful underpinnings, controlled by a small number of large holders and exploited by both professional traders and criminals. A meaningful use-case for Bitcoin has yet to be identified. Thanks to its correlation with conventional assets, it cannot fulfil even the original ambition of its creator: to be a haven outside the legacy financial system. Bitcoin appears increasingly to be a failed experiment in creating a non-bank alternative to fiat currencies. 

Benefits 

• Bitcoin deserves credit for inspiring the development of peer-to-peer transfers of value on blockchain-based networks, not just in the payments industry but in the securities and funds industries too, presaging a future in which the costs of all types of financial transactions are lowered by disintermediation. 

• Bitcoin also deserves credit for pioneering (via the Lightning Network, where minimum transaction sizes and fixed transaction fees do not apply) the possibility of making high volumes of micro-payments, where an obvious use-case is paying consumers for contributing to data sold by technology companies. 

• The true long-term value of Bitcoin will likely lie not in Bitcoin as a form of money or as a payment instrument but in the use of blockchain technology to support central bank digital currencies (CBDCs) and make cross-border payments cheaper, faster, more transparent and more accessible. 

• Bitcoin might develop as an alternative form of money to fiat currencies if physical cash disappears and consumers do not believe that CBDCs are anonymous, despite claims that privacy-preserving technologies are being developed for bearer versions of CBDCs. 

  
  

Issues 

• Bitcoin is not comparable with commodities sometimes treated as money (such as gold) because it generates no income and has no alternative or industrial uses, making its value entirely dependent on flows of speculative capital into and out of the asset class. 

• Bitcoin can be treated as a store of value only as long as holders of Bitcoin believe it can retain and even increase its value, and the rapid collapse in the value of other cryptocurrencies indicates this confidence is fragile, creating a risk that the fair value of Bitcoin is zero. 

• The slow speed, reversibility and transaction costs of Bitcoin payments compare unfavourably with the real-time gross settlement systems (RTGSs) operated by central banks, especially in terms of speed (which can be instantaneous) and finality (by which transactions are legally irreversible). 

• Bitcoin has failed to win the confidence of legitimate consumers or merchants even in El Salvador, where the government made it legal tender in 2021, because of its price volatility, concerns Bitcoin transactions are not private and the fact that the official digital wallet is hard to use. 

• The anonymity of Bitcoin transactions (however attenuated in practice, with experience showing that Bitcoin transactions are traceable) allows criminals to engage in nefarious activities, citizens to get round exchange controls and sanctioned entities and states to bypass sanctions. 

• Bitcoin is unlikely to be prove a popular flight-to-quality asset in a financial crisis because of the strong correlation between the market performance of Bitcoin and the market performance of conventional financial assets, making Bitcoin useless as a hedge against price declines in financial markets. 

Regulation 

• Despite evidence of addiction to cryptocurrency trading, Bitcoin should not be regulated in the same way as gambling, alcohol, tobacco or narcotics but must instead be regulated (as derivatives were) as a new and separate asset class, currently being pioneered by the Markets in Crypto Assets Regulation (MiCAR). 

• Regulation of Bitcoin is complicated by the absence of an issuer to regulate (or sue in the courts) and by the permissionless nature of the Bitcoin network, which means only the on- and off-ramps can be regulated, not the market participants or the instrument itself. 

• Institutional interest in holding Bitcoin as an asset directly (as opposed to via exchange-traded funds and derivatives) is inhibited by the unclear regulatory status of Bitcoin, and the lack of regulated third party custodian banks to hold Bitcoin on behalf of investors, as well as its volatility and lack of asset backing. 

• The new-found enthusiasm of US presidential candidate Donald Trump for Bitcoin reflects his political interest in appearing to support Main Street versus Wall Street, stimulating economic growth via deregulation and satisfying the sources of some of his campaign donations.