Many believe cryptocurrency like bitcoin is a candidate to open a new monetary era. New systems that use DLT for peer-to-peer asset transfers are suitable for personal as well as remote interactions regardless of national borders. Smart contracts open the possibility of programmable value transfers and the automation of terms enforcement between parties. No human intervention or control over protocol and inflation fixed in code eliminates the ability to tamper with the system, making everyone equal.
The original intent of Bitcoin was to offer a peer-to-peer payment system that eliminated the need for a trusted third party. Today Bitcoin provides both value transfer and storage, is gaining momentum, and being more closely watched by central banks and governments. In order to play a significant role and develop staying power, there are limitations and challenges to overcome. While no one knows what the future holds, many see potential that could change the global monetary system forever.
That said, let’s take a look at the challenges that will have to be overcome.
Legitimacy and Credibility Issues
In reality, bitcoin is as legitimate as any unbacked fiat currency, like the dollar or euro. Money itself has no intrinsic value and fiat currencies fail historically, taking 38 to 39 years on average. Like any asset, it is only worth what someone else is willing to pay you for it. However, mainstream perceptions about cryptocurrency are as volatile as the price. Credibility grows with partnerships such as Coinbase and PayPal allowing merchant acceptance of digital currency in place of USD. This expands the pool of legitimate businesses accepting bitcoin, but it is nowhere near enough.
Money has always been gold, silver, paper, a lot of things, but never code. The government establishes fiat’s value so we can exchange it for goods we need and it has the power to control flow and usage. Expecting the government to make Bitcoin legal tender is like asking for Monopoly money to be legal. The fact that Bitcoin is already being used, with no laws forbidding its use, is an unprecedented phenomenon. Legitimacy in the U.S. now seems to hinge on how it should be regulated. National, state or separate level is the question, but most agree it is just a matter of time as more states announce acceptance for bitcoin transfers, including for payment of taxes.
Bitcoin has the widest initial adoption and the highest level of enthusiasm but if it was accepted as a standard, early miners and speculators would already possess the most wealth. While a naive concern, it somewhat affects credibility because many people feel a new currency should mean everyone in the world starts with an equal amount. Other people realize that if that happened, no one would value the new currency because it would lack the incentive to create wealth, jobs, goods or services. Fortunately, we are in the early days of adoption so more upside lies ahead, and with less risk than what early miners and investors took.
The cryptography used today is based on the fact that no algorithm is able to solve the discrete logarithm problem in a reasonable amount of time for large numbers. However, new algorithms calculable with quantum computers could generate a private key from a public key in a reasonable time. The cryptography used will need to evolve to remain relevant, and experts agree even initial quantum computers are 10 years away. Of course, a quantum computer is more than just its processor, and will also need new algorithms, software, interconnects and a number of other yet-to-be-invented technologies specifically designed to take advantage of system’s tremendous processing power—as well as allow the computer’s results to be shared or stored.
The 51% attack plan is considered by some to be a limitation, but as time goes by feasibility appears to be diminishing. Scalability to increase the number of transactions per second without compromising decentralization is a technical limitation the Lightning Network seeks to resolve, as well as increase privacy. Mathematical pseudonyms (bitcoin addresses) were originally meant to ensure privacy, but it has become simple to identify the owners of addresses through extensive analysis such as what the FBI employs.
A monetary system based on a currency that exhibits huge and fast price variations of consumer goods would not work well. Price volatility must be stablized before bitcoin could be useful as a currency.
The system of rules governing the Bitcoin system, or protocols, are amended through agreement by the crypto community. If all do not agree to amend the protocol to update features simultaneously, a fork occurs. A fork splits the blockchain into two separate chains and for a monetary system, this would be a disaster. To avoid forks, developers need to proper coordination which is difficult to obtain with a consensus requirement. The underlying intent of Bitcoin was to be independent from any control authority, but to be used as a reliable currency, changes to the protocol must be implemented efficiently.
Bitcoin is the most widely accepted cryptocurrency, with the largest market cap and seemingly brightest future, but with technical and governance issues that also contribute to credibility and legitmacy concerns. It may be that bitcoin remains more of an asset than a currency, something that is traded like a stock or bond, rather than something exchanged for goods and services. An economy that uses bitcoin as the dominant currency would likely be more volatile.
In the words of Saifedean Ammous, it will be interesting to see if Bitcoin continues to behave as a speculative asset in the next financial crisis. Will people exit it toward safer, more liquid assets like gold or the dollar – or exit other things, particularly the altcoins, for the safety and liquidity of Bitcoin.