Bitcoin has surged to historic value while its volatility has receded, according to an article in The Wall Street Journal by John O. McGinnis, a law professor at Northwestern University, and Kyle W. Roche, a lawyer at Boies Schiller & Flexner LLP. This has happened during a time when recent events might have caused bitcoin to lose value, such as the Security and Exchange Commission (SEC) rejecting a bitcoin ETF that would have allowed small traders to invest in bitcoin on the stock market.
The SEC action resulted in obituaries for bitcoin, but the naysayers have been proven wrong. A big reason, according to the authors, is that many people distrust government currency and want to use bitcoin as a hedge or an alternative payment tool when government currency doesn’t efficiently perform these functions. Millennials are investing in bitcoin at a faster rate than other consumers.
Flaws In Fiat Currency
McGinnis and Roche argue that a big reason for bitcoin’s popularity is that it has advantages over fiat currencies. Fiat currencies rely on trust in government. Some government entities, like the Federal Reserve Bank, inspire trust, but others have monetarily oppressive regimes. Argentina, for example, debased its currency up until last year, while China restricted transferring currency out of the country. Bitcoin trading has been strong in both countries.
Bitcoin does not rely on a government entity that politicians can manipulate. Instead, trust is placed in the decentralized order of the parties that verify bitcoin transactions. These “miners” maintain the bitcoin blockchain.
Bitcoin’s Genius: Decentralization
Bitcoin’s innovation is its decentralized process for updating the blockchain as new transactions occur. Any individual with Internet access can update the blockchain by using computer power to solve a mathematical problem. The miner who solves the problem first gets the rights to add a block of transactions to the blockchain. The miner gets rewarded in new bitcoin. The process occurs every 10 minutes to assure an accurate record of transactions.
New bitcoin code is adopted when miners agree on changes to the code. Miners sometimes disagree over how to meet the needs of the market, as demonstrated by a current dispute over the optimum size of each transaction block. But because they are paid in bitcoin, they are incentivized to support bitcoin’s value.
Government officials, by contrast, do not always face such incentives to sustain their currency’s value. Such interests in developing countries include confiscating property. In developed nations, ideological perspectives, promotion and job retention impact officials’ behavior.
Order Without Centralization
Bitcoin creates order without centralization. This is not unknown in society at large. Social norms are known to regulate behavior without the need of formal laws. Etiquette rules inform people how to act without offending others.
While a person an ignore a social convention, they cannot ignore an algorithm that tells the world someone owns a bitcoin.
To prosper, bitcoin does not have to become a stable store of value more than the U.S. dollar. It can continue to rise by gaining more support than other currencies. It is doing this in monetarily oppressive countries and is helping impoverished immigrants in the developed world send money home to relatives.
As bitcoin grows, it can become more competitive against other currencies since even the strongest fiat money is subject to political risks.
Global and national crises will continue to support bitcoin’s popularity. Instability caused by the euro, Brexit and the rising ratio of debt to gross domestic product in western nations undermines the value of established currencies.