Could Bitcoin Replace The US Dollar As A Reserve Currency?

Could Bitcoin (BTC) replace the U.S. dollar as the global reserve currency? According to Coinbase Cofounder/CEO Brian Armstrong, the answer is yes. He predicted that the digital currency may very well supplant the greenback by 2030.^[1] However, to achieve this milestone, Bitcoin needs to overcome several obstacles.

Medium Of Exchange

For something to function as a currency, it must be an effective medium of exchange. In other words, individuals, companies and other organisations must be able to trade it for goods and services. As modes of exchange, currencies are the backbone of the modern financial system. Acting as fiat money, consumers utilise them in the buying of goods and services.

The U.S. dollar (USD) has certainly established itself in this respect, because it's the most widely traded fiat currency in the world. Beginning in the post-WWII era with the Bretton Woods Accords, the USD has enjoyed global reserve currency status.

Conversely, Bitcoin, which has been around since 2009, remains in its infancy. BTC is not yet considered to be a major global currency but is beginning to gain mainstream adoption. In fact, BTC is the leader of the fastest growing asset classes: cryptocurrencies.

Volatility

One major issue that undermines Bitcoin's use as a medium of exchange is its intense volatility. It's not uncommon for the daily Bitcoin price to fluctuate 3% or more.^[11] Given the intense price action, a trending BTC is the norm, not the exception.

A severe example of this volatility occurred in 2017, when the digital currency's price climbed almost 2,000 percent, rising from less than US$975 to nearly US$20,000.^[2] This sharp rally may have been great for investors, but the fact that Bitcoin experiences such intense price fluctuations lessens its use as a medium of exchange. However, with the expansion of the decentralised finance sector (DeFi), BTC may overcome the volatility and function effectively as a currency.

The U.S. dollar loses a small amount of its buying power every year due to inflation. This "devaluation" is actively managed by the U.S. Federal Reserve (Fed) via monetary policy. Accordingly, inflation typically takes place slowly and market participants are not subject to severe price swings.^[3] While Bitcoin's fluctuations are far more severe, Armstrong has asserted that the problem will take care of itself.^[1]

"Volatility is a self-correcting problem, and we've seen that as it's dropped in the last three years, year-on-year," Armstrong said in late 2014.^[1] "I foresee it continuing to do that over the next few years."

Only time will tell if volatility will subside for BTC, Ethereum, Ripple, and the entire crypto asset class.

Bitcoin Must Overcome Key Challenges

Armstrong is not the only market observer who has made these comments. Zeynep Gürgüç, a researcher at Imperial College Business School, and William Knottenbelt, a professor at Imperial College London, both identified this incidence of sharp price fluctuations as a key challenge that cryptocurrencies must overcome to become widely used methods of payment.^[4]

The two academics outlined a total of six specific challenges that digital currencies must address if they are to become more conventional payment methods for the first time. Examples of these issues are scalability, usability and regulation.^[4]

Also, some blockchains were not designed to handle the traffic of a high number of users, a matter that industry participants must address for digital currencies to achieve more mainstream use.^[4] Further, the regulatory environment is highly complex because many nations have separate sets of rules, which means that global regulations are greatly fractured. British citizens, Americans and Australians are not subject to the same regulatory guidelines.

Store Of Value

Another key requirement of a currency is that it must function as a store of value. For Bitcoin to meet this requirement, it will need to hold value over the long-term. While some market observers believe that it's effective in this particular capacity, it's not unanimous.

Bitcoin is "an incredible store of value in the rest of the world," Bill Gurley, a venture capitalist, said in late 2017.^[5] He emphasized that the digital currency can be a sort of "gold standard" in parts of the world that suffer from significant geopolitical turmoil. In fact, BTC is more stable than many emerging market currencies that experience substantial changes in value overnight.

Gurley is not alone in saying this, as Gurguc and Knottenbelt have asserted that cryptocurrencies have already established themselves in this way.^[4]

Experts Question Bitcoin As Store Of Value

However, Raoul Pal, author of investment newsletter The Global Macro Investor, has questioned Bitcoin's ability to serve as a store of value. He said that the digital currency's basic rules could change significantly as a result of a permanent alteration in code known as a hard fork.^[6] "Bitcoin was supposed to be a store of value, you couldn't mess with the formula … and now they are talking about a 'hard fork' changing it?"

He elaborated: "Even if they don't change the formula, the fact that they could? That's enough to say it's not a long-term store of value."^[6]

Unit Of Account

The third requirement that Bitcoin needs to meet in order to function as a currency—and possibly replace the U.S. dollar as the world's reserve currency—is to function as a unit of account. The extent to which Bitcoin serves this purpose is a matter of debate, as it is not managed by a central bank.

Joe Davis, a Vanguard economist, wrote an op-ed piece on ETF.com that digital currencies function as stores of value as they can be used to quantify the value of other goods and services. One example is that all the alternative protocol assets (or "altcoins") that must be purchased by using Bitcoin instead of fiat currency.^[8]

Is Bitcoin Simply Too Volatile?

Others have provided a different assessment, such as David L. Yermack, a professor at the New York University Stern School of Business, who asserted that Bitcoin is too volatile to be an effective unit of account.^[9] He said in 2013 that the digital currency's exchange rate relative to the U.S. dollar was 10 times that of the greenback's exchange rate versus other fiat currencies like the euro and yen.

Chris Burniske, an analyst for investment manager ARK Invest, agreed with this premise, contending in a 2015 article that Bitcoin's volatility undermines its use as a store of value.^[10] However, he added that the digital currency's generalised lack of adoption exacerbates the situation.

The situation could change, though, if one or more nations with a highly volatile native currency links their fiat currency to Bitcoin instead of the U.S. dollar.^[10]

Summary

Bitcoin could potentially replace the U.S. dollar as the world's reserve currency, but for this to happen, the digital currency would need to make progress in several important areas.

Currencies serve as a medium of exchange, a store of value and a unit of account. While the U.S. dollar has established itself well in these particular areas, some analysts have voiced their doubts that Bitcoin could fulfill these key roles.