Bitcoin: A currency for a crisis?
Prof. Dr. Philipp Sandner — Head of Frankfurt School Blockchain Center
This article will briefly describe the architecture of Bitcoin and especially highlight its similarities to gold as a safe investment. Countries like Switzerland and Germany have created a regulatory framework that allows and even legitimizes increasingly safe investment in Bitcoin for professional investors. In an economic crisis like the one now being triggered by the coronavirus, assets that are subject to scarcity will become increasingly interesting for investors. Maybe also Bitcoin.
What is Bitcoin?
Bitcoin has been declared dead several times — and it still exists. It has been called a fraud, a Ponzi scheme, and a tulip bubble. And yet it turns out: It is brilliantly designed and its underlying blockchain has so far been running without technical problems for more than 11 years. It is technically impossible to shut it down. So it will stay with us for the next years and probably the next decades. It is therefore worthwhile to take a closer look at Bitcoin. These statements may cause some people to shake their heads. However, experts agree that the architecture of Bitcoin is very similar to the architecture of gold. In the Bitcoin world, what the mines are for gold mining corresponds to the Bitcoin mining facilities. What the excavator is in a gold mine is the computer hardware in the Bitcoin world. Gold mines use human hands, diesel, electricity and excavators; Bitcoin uses IT specialists, computer hardware and electricity. Of course, the electricity consumption of Bitcoin is to be criticized, but still: Bitcoin is simply there like a commodity. Like gold.
Bitcoin is like “digital gold”
Although it is not easy to understand, we argue that Bitcoin has great similarities to gold. Experts therefore speak of “digital gold”. What is identical for Bitcoin and gold is the scarcity. With gold, the scarcity is physically guaranteed; with Bitcoin, the scarcity is electronically guaranteed. Bitcoin is scarce but unlike gold, which can be touched, Bitcoin is dematerialized. Differently to gold, the belief in the scarcity of Bitcoin is not widespread. In the case of gold, the belief in scarcity is something we were born with. In the case of Bitcoin, relatively few people have so far recognized that scarcity is electronically generated.
Bitcoin is a fascinating system
In order to understand the fascination and potential of Bitcoin, a deeper understanding of the underlying technology and environmental factors are essential. In order to form a well-founded opinion, it is therefore important to study Bitcoin in depth without shying away from the complexity involved. After all, unfounded skepticism often arises from an inappropriate education. Bitcoin is a complex technical-economic system. Presumably, one must have spent at least 40, rather 60, or even 100+ hours intensively studying Bitcoin in order to understand the concept approximately. A YouTube film here or a short article there is not enough. Instead, intensive studying is required. And it turns out that when people study Bitcoin in depth, they find this approach usually fascinating and brilliant.
What effects does the coronavirus have?
The coronavirus will cause considerable economic damage. The economy is slowing down worldwide, the GDP is shrinking by double-digit percentages, and this is happening worldwide. It is already clear today that numerous governments and central banks are trying to save the economy from collapsing with hundreds of billions US dollars. This will inevitably lead to a threatening increase of the debt levels of dozens of countries. The markets are flooded with hundreds of billions of US dollars. It can be assumed that so much money in circulation will sooner or later lead to a reduction in purchasing power. Investors will therefore invest their assets in supposedly “safe” investments, especially in real assets. But what exactly is “safe”? Above all, scarce goods should be safe. These probably include real estate, of course, but also commodities such as gold. Does Bitcoin also belong to said safe assets? In theory this is clearly affirmed; but in reality — especially in the short term — Bitcoin will not yet be part of it. Among widespread investors, too little is known about the technically guaranteed scarcity, which is the core characteristic of Bitcoin. Put differently, the knowledge of the scarcity Bitcoin has so far not yet sufficiently wide spread. In the short term, therefore, it cannot be assumed that Bitcoin will develop into a crisis investment like gold. This is nicely illustrated by the significant drawdown of the Bitcoin price in March which happened in perfect synchrony to many other asset classes. But if the understanding of electronically guaranteed scarcity spreads and, subsequently, the demand for Bitcoin increases, the price of Bitcoin could rise.
Demand for Bitcoin
The demand for Bitcoin would increase if investors increasingly understand Bitcoin for what it is: electronically created and guaranteed scarcity. Furthermore, the technical and regulatory infrastructure is being improved these days. This is exactly what the German government for example is doing with its so-called “crypto license”, which came into force in Germany on January 1, 2020. This means that banks, asset managers, financial service providers and stock exchanges can now invest in Bitcoin, also on behalf of their customers. Several banks in Germany are currently investigating this. The Stuttgart Stock Exchange (Börse Stuttgart) is the blockchain primus within the financial services sector in Germany. It has allowed private investors to trade Bitcoin with its smartphone app “Bison”. In less than a year, it has now acquired approximately 100,000 customers, with currently estimated one million Bitcoin owners in Germany. Deutsche Börse and other companies are also starting to investigate Bitcoin. It is hard to believe but with the new “crypto license”, Germany is now one of the leading countries in Europe. Other similarly progressive European countries are Switzerland and Liechtenstein.
Will the price of Bitcoin rise?
Countries such as Germany and Switzerland now provide a legal infrastructure for Bitcoin investors, which ultimately has an impact on investor protection. Companies in the financial sector are beginning to jump on this bandwagon. A decisive factor may be the increasing demand of investors — in the flood of cheap money in the financial markets — to invest in proven scarce assets. According to this logic, the price of Bitcoin should rise. However, the fact that other countries are sceptical concerning Bitcoin would be a counter argument. In addition, there are significant IT risks. Most important, the necessary knowledge about Bitcoin is still not very widespread among investors. The current mixed situation does not allow a final assessment in the short term, but there are good reasons supporting the argument that Bitcoin, as a scarce asset, could have a very interesting future in the medium term.