It has been over 10 years since the first cryptocurrency, Bitcoin, first begun circulating on the market.
Yet, to this day, it still doesn’t enjoy the trust that other assets – such as gold and equities – enjoy.
Over the past 12 months, however, Bitcoin has gained attention from investors due to its eye-popping rally from US$4,000 ($5,312.01) in March 2020 to US$40,000 on Jan 7 before falling back to US$30,000 a few weeks later.
The staggering rally, according to Bank of Singapore’s chief economist Mansoor Mohi-uddin, is comparable to the investment booms in the last few decades.
In an economics research report dated Jan 22, Mohi-uddin cites past examples such as gold in the 1970s, Japanese equities in the 1980s, internet stocks in the 1990s, and oil and technology companies in the 2000s and 2010s respectively.
SEE: Buy Bitcoin in Singapore Dollars at crypto-exchange Gemini
Bitcoin unlikely to replace national currencies
Despite the sudden surge in Bitcoin prices, Mohi-uddin says cryptocurrencies remain unlikely to replace national currencies as a primary medium of exchange.
This, he says, is due to the flow of cryptocurrencies.
“First, bitcoin, like gold, is too inefficient to make cross-border payments in a competitive manner,” he says.
“Second, digital currencies - often limited in supply like gold - are unable to facilitate growing economic activity if their ‘velocity of circulation’ does not rise correspondingly,” he adds. “This was the crucial disadvantage of the gold standard when governments linked their national currencies to the precious metal in the decades leading up to the 1930s Great Depression. Scarce reserves of gold constrained the supply of money, holding back economic growth and causing bouts of deflation.”
Third, Mohi-uddin says governments will not tolerate any “direct challenges to their monetary sovereignty”.
“Governments are very wary of any technology that could potentially displace national currencies. This would reduce the ability of policymakers to print money during economic crises or to benefit during ordinary times from ‘seigniorage’ - the financial gain from issuing fiat currencies at face value less the cost of producing notes and coins,” he writes, which goes against the original vision of the first Bitcoin holders, who wanted to issue digital currency in limited supply to prevent governments from debasing digital currencies in a way that was done through fiat or paper currencies.
As of now, several central banks are launching digital currencies using their own blockchain technology, with the new electronic money denominated in the respectively domestic currencies of the central banks.
Cryptocurrencies to replace gold?
On the other hand, Mohi-uddin sees digital currency taking on the role of gold, by offering an alternative store of value via electronic means compared to storing physical bars.
The way he sees it, there is a role for digital currencies as a potential safe-haven asset, provided it overcomes hurdles such as trust, volatility, regulatory acceptance and reputational risks.
On this, Mohi-uddin says there are advantages cryptocurrencies has over gold.
Beyond being a more popular alternative with younger people, Mohi-uddin believes cryptocurrency will gain traction over gold due to its easier storage.
“It is easier to hold bitcoins and other electronic money in digital wallets. In contrast, precious metals are unwieldly to use for everyday transactions and need to be stored in secure, physical locations,” he says.
Besides, cryptocurrencies are largely similar to gold in that neither earn any yield or interest, and their prices are largely determined by investor demand and financial speculation.
Furthermore, some cryptocurrencies such as Bitcoin are limited in supply like gold.
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Hurdles to overcome
Cryptocurrencies are not without their disadvantages.
For a start, prices are highly volatile, as evidenced by the rally in Bitcoin prices over the past year.
“One-month volatility is over 90 vols,” notes Mohi-uddin. “In contrast the same measure of implied volatility for the Euro and for gold are around 6 vols and 16 vols respectively.”
Unlike gold, Bitcoin is co-related with stocks and other risk assets instead of trading as a counter-cyclical safe-haven.
“In a financial crisis, cryptocurrencies are more likely to be dumped by investors during a market meltdown as occurred at the start of the pandemic in March 2020. In contrast, gold has been used since ancient times as a store of value and a hedge against inflation,” he notes.
During these times, there is also a risk of theft as cryptocurrencies can only be stored in digital wallets, which may be easily hacked.
Bitcoin also faces a bit of a bad reputation as it – along with other privately issued electronic currencies – may be used by drug dealers and other forms of crime as they can be used anonymously.
Finally, gold only faces competition from silver as a safe-haven precious metal, but there may be newer cryptocurrencies being launched in future, which could devalue existing ones.
The potential future of cryptocurrency
While Mohi-uddin doesn’t overrule the possibility of cryptocurrencies being used more frequently in future, he says there are a few factors that need to be looked at.
On the possibility of hacking, he says trustworthy institutions need to be able to hold them securely.
“Since bitcoin first appeared in 2009, the risk of holders losing the keys to electronic wallets or suffering theft from exchanges has been significant. In 2014, Mount Gox, an exchange in Japan, was hacked, resulting in customers losing around 850,00 bitcoins according to Bloomberg,” he says.
The volatility in cryptocurrency prices will also need to be managed.
“Even a decade after cryptocurrencies first started circulating, market action still often seems inexplicable and poor data on prices makes it hard to analyse current trends or make forecasts,” he notes.
Regulators themselves need to be more accommodative to cryptocurrencies, says Mohi-uddin, to allow more participation from retail and institutional investors.
Government agencies will also need to prevent criminal activity to reduce the risks of users holding digital money.
“The US Treasury is proposing that cryptocurrency custodians and exchanges should collect and report information that identifies large transactions involving ‘un-hosted wallets’ - cryptocurrency accounts held outside financial institutions - to protect national security and to clamp down on money laundering and other crimes,” he says.
