The Renaissance of Bitcoin

It has been approximately one year since the cryptocurrency market collapsed. While many people became extremely rich, others have lost huge investments. Today, Bitcoin and other digital currencies have faded to the background and the media are not paying much attention to this topic anymore. Are cryptocurrencies doomed to die?

The initial need for cryptocurrencies started when America’s banking system provided subprime mortgages to poor citizens who could not meet their monthly interest payments. Ultimately, banks were too proud to take their losses and bundled many of these subprime mortgages into packages, or so called mortgage-backed securities. Hoping they would re-earn some money, financial institutions traded with these securities, knowing it would be perilous. Eventually, banks bankrupted and the global financial system collapsed, resulting in the financial crisis of 2008. As a result, trust in the banking system disappeared which was the foundation for the increased demand in cryptocurrencies.

“In the traditional financial system, banks serve as a middleman in transactions to verify every payment. But what if this trusted third party cannot be trusted anymore?”

But how can cryptocurrencies recover the trust in financial institutions? They cannot. The solution is found in the technology behind cryptocurrencies, Blockchain, which enables parties to eliminate intermediaries within transactions. In the traditional financial system, banks serve as a middleman in transactions to verify every payment. But what if this trusted third party cannot be trusted anymore? Let’s cut out the middleman. The purpose is avoiding risk seeking behavior by banks and therefore preventing them from causing a financial crisis in the future. Bitcoin and cryptocurrencies enable this through Blockchain. I will not go into detail explaining the technicalities, but Blockchain technology is a network in which parties can make real-time peer-to-peer online payments. In other words, transactions are done directly from one party to another without banks interfering. But why are people then so skeptical?

Since the commencement of the financial crisis, Bitcoin slowly became known among the public, and from the beginning of 2017 onwards, the media were giving attention to it almost daily. However, the increased media attention was not because the technology was that promising, but due to the rapidly increasing price. On the 27^th of November 2017, Bitcoin’s price hit $10.000 and in seven days it had reached $22.000. Compare that to the eight years it took Bitcoin to hit $2.000. What a rise! This can easily be explained with the basic concept of demand and supply. Due to this rapidly upward moving price, people did not want to miss out on earning money quickly and easily. And who can blame them. Anyhow, demand increased and Bitcoin’s price rose even more. A snowball effect ensued. From this point forward, the media labeled Bitcoin as a bubble and predicted that sooner or later, just as with every other economic bubble, it would collapse. And they were right.

So can we agree that the future of Bitcoin and cryptocurrencies is doomed? In contrary! Cryptocurrencies will become enormously useful and important for businesses, and eventually for society. First of all, cryptocurrencies offer huge advantages. Transactions are done directly, within seconds, with lower transaction costs, and more transparent. The fact that it is much cheaper and done in real-time is for businesses the most important benefit. Here is an example: If you have a Dutch bank account, and want to transfer $100 via a Singaporean bank account, it can take 3-5 days before that person will receive it. It takes this long because multiple intermediaries (banks) in different countries check and verify the transaction. Since cryptocurrencies are exchanged directly, it enables to receive the money immediately. Moreover, these banks issue transaction costs for verifying the transaction, which is a percentage of the amount exchanged. When, for instance, a company sends 10M dollars to another company abroad, and the fee is 1%, they must pay $100.000 just to make the transaction happen. And transactions of this magnitude and higher are sent by companies every day. As a result, the world of business is very open to the use of digital currencies for making payments, because they only have to pay transactions costs once, which is just a small fee and therefore very cheap.

“In fact, the Bitcoin bubble is actually similar to what happened during the Dotcom bubble. A life-changing innovation, the internet, became known among the public and they started investing in it heavily, even though they did not know what it exactly entailed.”

But Bitcoin is a bubble, why would anyone be involved with it? Let’s take a closer look at how economic bubbles work. Bitcoin can be labeled as a life-changing bubble, since these bubbles are led by an innovation that is expected to change the business landscape dramatically. The phase after a bubble has popped is called the post bubble. During this phase, the value of Bitcoin and cryptocurrencies are rather low and searching for a value that represents the real value. Although one might argue that cryptocurrencies do not have an intrinsic value and are determined by speculation, it will take an unspecified period of time before that happens. The only way for cryptocurrencies to become just as stable and volatile as normal (fiat) currencies is when the right parties will comply with this new innovation. However, the lack of compliance in general is exactly the reason why cryptocurrencies are currently not widely adopted.

So why would they ever comply? It’s just a matter of time, because the post bubble is the phase in which it will be attempted (through regulation) to create a stable and solid market. When that happens, businesses, and in turn society, will be more open to explore the real utility of cryptocurrencies and eventually will use it. In fact, the Bitcoin bubble is actually similar to what happened during the Dotcom bubble. A life-changing innovation, the internet, became known among the public and they started investing in it heavily, even though they did not know what it exactly entailed. As a result, the price of internet stocks increased rapidly, way beyond their intrinsic value, after which the market collapsed. Finally, during the post bubble, the internet evolved to its current form. And let me ask you this: can you imagine a life without the internet today?

To wrap it up, the need to eliminate banks as an intermediary was just a trigger for cryptocurrencies to come to the forefront. The fact that it became a bubble was due to exuberance of people, which drove up the price rapidly. At the same time, it turned out that cryptocurrencies had more advantages than only cutting out the middleman. Businesses discovered that transactions are a lot cheaper and done real-time, which are for them the most important reasons to use it. Resistance from many parties is currently the main reason for an unstable market. However, when this market will be regulated, the real utility of cryptocurrencies will dominate. People will then become more familiar with the opportunities of digital currencies, which in turn leads to more confidence in the market. Eventually, using digital currencies will become very common, just as with the internet. It is therefore only a matter of patience before the Renaissance of cryptocurrencies takes place.