Bitcoin… it’s a new form of money – a digital currency, to be exact – but just how do these work? And why is Zimbabwe leading the news on this subject given “record prices”?Why would people want a digital currency?
In 2008, as the global financial system looked ready to collapse, many countries engaged in “quantitative easing”: they turned on their printing presses.
Central banks flooded the markets with liquidity and slashed interest rates in order to prevent a repeat of the Great Depression of the 1930s.
Large-scale fluctuations in fiat currencies resulted in “currency wars” – a race to competitively devalue so that an economy can become more viable simply by its goods and services being cheaper than those of its neighbours and global competitors. The response of central banks around the world was bail out affected banks and print extra money, further devaluing the existing money supply.
On 1 November 2008, a still-anonymous person named Satoshi Nakamoto posted a research paper to an obscure cryptography electronic mailing list describing his design for a new digital currency that he called “Bitcoin.”
What made his so important?
His creation cracked a problem that had stumped cryptographers for decades. The idea of digital money which was convenient and untraceable and liberated from the oversight of governments and banks followed the founding principles of the Internet.
Several failed attempts were made to create a usable, trustworthy digital currency were made in the 1990s but ran into a major challenge: the double-spending problem.
Simply put the question was how to prevent people from copying and pasting the digital dollar as easily as a chunk of text, “spending” it as many times as they want? A trusted third party to maintain a ledger was the conventional answer but who would be capable? Nakamoto’s solution was elegant: he created the “block chain” and thus publicly distributed the ledger, creating a decentralised network.
How would this make a difference?
Decentralization means all users are part of the Bitcoin ecosystem, and all contribute to it in different ways. Rather than relying on a government, bank, or middleman, Bitcoin belongs to everyone, in a system called “peer-to-peer,” and we all make up the Bitcoin network.
Users devote CPU power to running a special piece of software for the network are called miners and maintain the block chain collectively. In the process, they also generate new currency to a total value of 21 million coins, currently predicted to be attained by the year 2140.
Transactions are broadcast to the network, and computers running the software compete to solve irreversible cryptographic puzzles that contain data from several transactions. Bitcoin was the first true crypto currency and today remains the biggest of nearly 1,000 similar systems. As it was the first and remains the biggest, we’ll refer to “Bitcoin” as a shorthand for cryptocurrencies in the rest of this briefing.
What is a cryptocurrency?
A currency is a medium of exchange. As newly defined, a cryptocurrency is the virtual or digital version of a currency.
This type of currency is generated by computers using the art of writing or solving codes and thus making them secure. Because it has no physical denominations, cryptocurrencies such as Bitcoin only exist inside of an interlinked computer network system. This is not entirely unique, as much of the U.S. dollar supply only exists in digital account balances instead of as actual green pieces of paper.
So how do they have a value then?
Those who punt the adoption of digital currency argue they have value because they are useful as a form of “money,” i.e. a medium of exchange. Bitcoin has some of the characteristics of money (durable, portable, fungible, scarce, divisible, and recognisable) rather than relying on physical properties (like gold and silver) or trust in central authorities (like fiat currencies).
With these attributes, all that is required for a form of money to hold value is trust and adoption. Bitcoin has value for exactly the same reason as the paper money in your wallet: it simplifies the exchange of goods and services, not in a market on the street or store in a mall, but in the current setting of modern internet-enabled life.
What determines Bitcoin’s price?
As stated, Bitcoin has a maximum of 21 million whole units, divisible 100 million times. With over 7 billion people on the planet, if even 1 billion were to adopt Bitcoin, 21 million whole units would not spread very far without a significant price tag.
Part of the appeal is that the total number is inherently limited meaning no central bank can jump in and issue a whole lot of new coins and devalue those already in circulation.
Like other commodities, the price of a Bitcoin is determined by supply and demand. Despite the current jump in price, most international analysts would see its ultimate market capitalisation in the next 20 years as US$1.75 trillion which would make each Bitcoin worth $100,000.
Is Bitcoin legal tender in Zimbabwe?
This is a tricky question to answer as we have no specific laws in Zimbabwe regulating the use of such cryptocurrencies. The RBZ has yet to introduce any specific regulations but RBZ director Norman Mataruka stated this week that Bitcoin is not legal.
He said until the Zimbabwean central bank had “actually established and come up with a legal and regulatory framework for them” Bitcoins “will not be allowed” in the country, a rather unrealistic statement since he can’t stop this or even know who holds them!
As of writing, there is no actual legal impediment to the use and possession of Bitcoins. It would seem that practice up to present has been to view them as foreign currency.
What’s fuelling the bonanza in Zimbabwe?
The country ranks third on the Bitcoin Market Potential Index, created by economic historian Dr. Garrick Hileman of the University of Cambridge, just behind the inflation-plagued economies of Argentina and Venezuela.
The Index cites Zimbabwe’s vast informal economy and history of financial crises as key factors that could drive Bitcoin adoption.
An easy answer to the recent surge in demand is that it’s due to the acute cash shortage, drying up of the supply of US dollars, and settling foreign creditors. Taurai Chinyamakobvu, co-owner of local Bitcoin operator Golix, says his outfit has processed more than US$1 million of transactions in the past 30 days, compared with turnover of US$100,000 for the whole of 2016, according to data on the exchange’s website.
Is this Bitcoin craze a Ponzi scheme?
A Ponzi (or pyramid) scheme is a fraudulent investment operation that pays returns to its investors from their own money, or the money paid by subsequent investors, instead of from profit earned by the individuals running the business.
Those in favour argue that Bitcoin is a free software project with no central authority and thus, no one is in a position to make fraudulent representations about investment returns. In Zimbabwe, as usual, the situation is a little different due to the unique trading environment. Bitcoin locally currently trades at a premium of about 90% to the global rate, which is pretty much where the parallel rate is for transfers.
Analysts aren’t seeing an end to the skewed prices due to a shortage of liquidity for locally traded coins. According to Quartz, Bitcoin brokers for Zimbabwe were trading at “normal” rates, but this is probably those with local addresses using offshore funds. “It’s the brokers who offer to settle transactions in cash, instead of online payments or via bank transfers, who are demanding a steep premium in Zimbabwe.
They are asking for $17 000 to $20 000 a coin from buyers who pay them in physical US dollars,” said Quartz.
So why is it so high?
The price is possibly being pushed by wary (weary?!) investors as a hedge against local economic uncertainty exacerbated by a low liquidity in locally available cryptocurrency networks.
Speaking from Venezuela, which is currently experiencing inflation and government interference in the economy, Gavin Serkin, managing editor of Frontier Funds Media & Intelligence, simply said, “it’s a good alternative to hoarding TV sets and other stuff you don’t need.”
Ultimately this rise in value is based on speculation and not productivity – and even if it were productive, the price of this asset simply does not rise this fast. Technological gains that were supposed to be delivered by the dot.com boom failed to materialise and share prices crashed in 2000 when this was not apparent. “Buyers beware!” would appear to be the lesson here.
What are the main attractions of Bitcoin in Africa?
The main opportunity is in remittences from the diaspora. Conservatively, it is estimated that at least 2.6% of Africa’s total GDP comes from Africans sending money home.
Given the very large influx of African migrants from some regions of Africa due to socio-political issues which are not being addressed (i.e. European migrant crisis), they will work overseas and send money home.
Established means such as Western Union, banks (with their greedy charges and poor cross-exchange rates), and the many un-bankable regions of Africa, it is no wonder Bitcoin is potentially an incredible opportunity to quickly funnel money to where it is wanted by the people themselves, faster and cheaper, and safer than unstable currencies and restrictive central banks of some regions of Africa.
But is this new and improved money?
“Money is gold, and nothing else,” said mega-banker J.P. Morgan, while the current JP Morgan boss, Jamie Dimon called Bitcoin “a fraud.”
These may be suitable sentiments for the world in the near future as electronic money adoption balloons.
By September 2017, Zimbabwe processed up to US$11 billion through mobile and electronic transaction platforms, a massive 62% rise in the value of transactions effected through the same platform during the same period last year. this is due to the drying up of cash availability but there are wider implications.
Currently, no one is saying that Bitcoin has to replace the local currency anywhere.
Both systems can coexist peacefully although we see many governments taking fright – led by the Chinese – starting to regulate the issuing of new token currencies.
There are no protections for investors and no securities laws currently apply anywhere in the world. Which means bubbles will continue to form and burst – but for how long will people tolerate the volatility of digital monies?
What is undeniable is that if the tide turns it won’t just be the prices of leading digital coins that get whacked, but the future of an entire new investment industry would be at risk.