The Future of an Emerging Cryptocurrency: Does Bitcoin threaten the Bretton Woods System?

Mohammed Alnour¹                                    Maysam Ali²

Over the last two decades, a great wealth of scholarship has been devoted to addressing the social and economic challenges resulting from the practice of e-commerce. But one area of research has fallen into neglect; the development of electronic currencies. A little attention has been given to trace the evolution of digital currencies in our increasingly computerized and complex digital economy. Recently great attention has been given to emerging cryptocurrencies particularly Bitcoin.

Bitcoin is a private digital currency traded online via a peer-to-peer network. Bitcoins are stored as electronic files on a computer's hard drive and can be accumulated or transferred just like an e-mail. It was designed to operate without the need for intermediaries or any central issuing authority. It does not depend on a central bank to issue it, a commercial bank to store it, or a credit card company to transfer it. Instead, users interact with each other directly and anonymously, without third-party intervention. Although only a few years old; Bitcoin is yet to gain widespread acceptance by many governments, institutions and organizations. Meanwhile, regulatory solutions for the challenges it presents will become necessary if Bitcoin continues to grow in popularity.

The International Monetary Fund (IMF) plays a fundamental role in regulating the international foreign currency exchange market, which is widely known as the Bretton Woods system along with the World Bank. Their major aim is regulating economic transactions including the foreign currency market in a way that help to stimulate the growth of international trade. Except for North Korea, every country is a member of the IMF, and therefore, bound by its regulations.

Because Bitcoin is not formally controlled by any institution, it is not bound by the IMF's regulations. In this article, we will discuss the future of cryptocurrencies specifically Bitcoin and to what extend it poses a serious threat to the prevailing global monetary system controlled by the IMF and World Bank. We will start by introducing the evolution of Bitcoin and its main advantages and drawbacks then discuss the possible threats to the economic stability of the foreign currency exchange market.

WHAT IS BITCOIN AND HOW IT WORKS?

By the time when countries of the world were working together to tackle the financial crisis of 2008 and to get rid of its impacts, in 2009 a pseudonymous hacker operating under the pseudonym Satoshi Nakamoto invented "Bitcoin," the world's first digital, decentralized, and partially anonymous currency. Nakamoto was motivated by a paper published in 1998 by Wei Dai.

Basically, Bitcoin is two things at once. First, it is a digital currency and has no physical counterpart with legal tender status. Second, Bitcoin is a private currency, provided by private enterprise aimed at combatting government controls on the supply of money, which means that traditional financial agencies, such as central banks or government institutions, are not involved with transactions. Bitcoin does not have a central authority in charge of the money supply or a central clearinghouse.

Bitcoins are computer files, similar to a music or text file, and can be destroyed or lost just like cash. They are stored on a personal computer. They can be spent on both goods and services. Individual Bitcoin transactions are encrypted, logged by a decentralized network running on thousands of computers, and recorded in a public ledger.  This public ledger records which Bitcoins have been spent or accepted but it hides the information of the transacting parties, thereby securing users' anonymity.

Bitcoin operates using a "cryptographic proof' system, which allows users to interact directly with one another without needing brokers to supervise the transaction. Each Bitcoin transaction uses public-key encryption to secure the transacting parties' privacy. Public key encryption generates two mathematically related keys. One key is retained by the payee somewhat like a personal password or pin. The private key is used to reach the Bitcoins kept in the payor's account. The other key is to make public-like the name of a bank or an account location where the funds exist.

Almost there are three possible methods for users to obtain Bitcoins. First, users can buy Bitcoins by exchanging real money such as the pound, dollar or lira, for Bitcoin files. Like a traditional exchange market, the price of Bitcoins floats against other currencies and is valued by the market forces. Second, users can obtain Bitcoins in exchange for goods or services, as is real for other traditional currencies. Lastly, users can get Bitcoins by generating them through a process called mining. Mining allows Bitcoin users to generate Bitcoins rather than buying them. A user who wants to "mine" a Bitcoin volunteers their computer's processing power to solve a complicated computer algorithm. Every ten minutes, Bitcoins are awarded to whichever miner can compute a number below a specific threshold.

Currently, the reward for solving the mining algorithm is fifty Bitcoins. But that number is halved with every 210,000 blocks created (nearly every four years). Bitcoin's software slows the generation of Bitcoins over time so that there will never be more than 21 million in circulation meaning that the number of Bitcoins in circulation is finite.

THE VIRTUES AND DRAWBACKSOF THE BITCOIN

Cryptocurrencies are characterized by many things. First, digital currencies do not require the physical presence of parties to finalize the transaction. Transactions can be done anytime. This advantage provides many significant economic benefits. The costs related to the production, transportation, and handling of physical currency can be substantial. Second, digital currencies require the use of software to function. Though, transitioning to a predominantly digital currency system might increase users' daily interaction with software systems. This, in turn, could help improve the skills and knowledge of users regarding personal finance software and finance optimization technologies.

Finally, some scientists confirmed that cryptocurrencies perform the functions of a currency more efficiently than other traditional physical money. A currency serves three primary functions. It serves as a medium of exchange, works as a unit of account and acts as a store of value of current earnings for future expenditure. Cryptocurrencies like Bitcoin have the potential to perform any of these roles more efficiently than traditional currencies.

Regardless of the potential virtues of cryptocurrencies like Bitcoin, their wide-spread adoption faces several obstacles. First, the uncertainty that is surrounding the operation and growth of cryptocurrencies. As can be seen in figure 2, the value of the currency is fluctuating over time and its future is hard to be forecasted since such currency value follows the random walk hypothesis. The second, the lack of regulations. Finally, cryptocurrencies like Bitcoin face the problem of network externalities. The benefit of using such currency depends on the number of other people interested in it: if only a few merchants accept digital currency, individuals have little incentive to adopt digital currencies.

FIGURE 1. BITCOIN PRICE OVERTIME

  Source: Statista

BITCOIN AND GLOBAL MONETARY SYSTEM

The International Monetary Fund was created to supervise and regulate the global currency exchange and to protect the world from global economic crises. As Bitcoin continues to grow in popularity and value, it poses an increasingly serious threat to the stability of the foreign currency exchange market and, more widely the international trade.

Although the Bretton Woods system is largely criticized due to its imposed regulations and economic and financial policies, the threats that are posed by the uncontrolled digital currencies might cause huge economic instability. Moreover, many governmental agencies and institutions reported that such currencies, since they are out of control, can be used to sponsoring terrorist acts and drugs trafficking. This will further cause social and political problems and security threats.

Therefore, finding a way to control Bitcoin is fatal and crucial in light of its potential destabilizing impacts on the foreign currency exchange market. Although there might be several ways to mitigate Bitcoin's impact via domestic legislation, those solutions are beyond the scope of this comment.

Although particular attention has been devoted to Bitcoin in this regard, the same can be true for any cryptocurrency that grows enough in terms of usage and value to be traded for substantial amounts of foreign currency. Without the ability to offer cryptocurrency as part of its currency reserves, the IMF would be unable to ensure global economic stability in the future where cryptocurrency becomes a major player.

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