Bitcoin as a Digital Currency

In the age of a digital economy, there has been a clear distinction among the two types
of currency. One, that is issued by government in the form of cash or regulated digital
currencies and the other, virtual currencies without any central issuing body.
Bitcoin is arguably the most popular and widely circulated among the latter. In 2009,
Satoshi Nakamoto published a whitepaper of a peer-to-peer currency that will eliminate
the need for a central minting authority. Not only he intended to remove any transaction
costs but he also them to be completely untraceable, making it the world’s first
anonymous and decentralised currency. Bitcoin can be held in electronic devices and
can be transferred as a medium of exchange over the internet.
A contrasting feature of Bitcoin when compared to fiat currencies is the upper limit to
the amount that can be generated by the software that runs Bitcoin. In that way, Bitcoin
shares a resemblance to the gold standard of currency when it was impossible to
manipulate currency supply by controlling monetary instruments. In a world where
Bitcoin serves as the central currency, the monetary policies will have their effects
dramatically reduced as the authority to supply currency will be stripped from their
hands. This also arises the risk for economic deflation with no way out of it.
Money, or currency should ideally be able to fulfil three conditions. First, it should serve
as a medium of exchange. Bitcoin fulfils this requirement partially as it can be used to
buy goods or services only if the transaction partner accept it as a payment. Since it is
yet to be legalized in most countries across the world, Bitcoin faces a lot of regulatory
challenges. However, Bitcoin being free of any government intervention, it can be freely
sent across international borders without any hassle and intermediate costs, making it a
good option while making micropayments internationally.
The second condition is that it should be able to serve as a unit of account. A currency
represents the value of the good or service it is enabling. This means it can be used to
denominate the items that are available in a market. Bitcoin, even after being accepted
as a medium of exchange, is almost never used for that purpose. Businesses still prefer
to list the value of commodities in traditional fiat currencies because – 1. Bitcoin prices
are just too volatile and would be a pain to regularly adjust the prices according to it. 2.
The notion of fiat currencies is deeply woven into the mental fabric of the society. It is
very hard to think of prices in a different currency that what they have in their bank
deposits.
The third, and possibly the most important function of a currency is that it should serve
as a store of value. For this, lets compare Bitcoin to the most widely used stores of value
across the world – Gold and US Dollar. Over the past few years, the inflation has been
fairly stable and a certain amount of USD would buy you almost same amount of goods
and services as it did 5 years back. Bitcoin on the other hand have seen its prices rising
over 5000 % at its peak and then losing over 80% at its worst. From this, Bitcoin can
be concluded as a poor store of value. Not being issued by a central authority or pegged
to a real-life asset, Bitcoin prices vary dramatically with public perception. Apart from
being stable, a good store of value should be durable. Gold perfectly fits in this criterion
as it is a non-corrosive metal and can last for ages without losing its properties. While
being called a “digital gold”, Bitcoin value is held in devices run by huge amounts of
electricity and hence, is vulnerable to a shutdown. Moreover, due to the architecture of
Bitcoin, it is impossible to recover Bitcoin once it is lost in such an event.
The above discussion clearly demonstrates why Bitcoin doesn’t fulfil the currency
aspect of being a “digital currency”. However, it can still an asset and used for
transactions in very particular situations.
Bitcoin is virtually impenetrable as a digital system and is completely anonymous. Its
utility lies in cases where huge amounts needs to sent across borders without being
traced. Inevitably, this creates a huge potential for criminal activities, but it also opens
doors for people who have been marginalised from financial systems by their own
governments.
Micropayments is another domain where Bitcoin finds a utility. Being devoid of any
central authority unlike cards and net-banking gateways, Bitcoin has virtually zero
transaction fees.
It is very unlikely that Bitcoin will ever replace fiat currencies. Many governments are
taking initiatives to launch their own digital currencies backed by risk-free government
securities, further reducing the scope for Bitcoin. Nonetheless, Bitcoin does open doors
for further innovations on this technology and has set a benchmark for future digital
currencies to come.