Daniel Suchenski
April 4, 2016
Introduction
Cryptocurrencies have been largely
sidelined in the financial world since their creation only a handful of years
ago. This has led many to question, why were cryptocurrencies created in the
first place? Putting aside the argument that it is uniquely human to seek to
create and explore, push the boundaries, and want more, perhaps a real need for
such currencies is part of a much larger discussion. In a 2015 interview with
Jeffrey Tucker, the Foundation for Economic Education’s (FEE) director of
digital development, he speaks to his own process of looking at cryptocurrencies
through a new lense so as to understand what we are really talking about when
we speak of the history and future of such money. As a distributed network,
cryptocurrencies are constantly changing “as
capital, it is not owned by any one institution, which is amazing. And yet it
puts massive economic power into the hands of the individual. The great
economic debate really came down to: which is worse, big government or big
corporations? That’s a terrible way to frame the debate but we weren’t able to
avoid it.” Tucker goes on to ask “Maybe that won’t be the main question in the
future. Maybe the question will be: which is better, universal and distributed
capital or centralized institutions of all sorts? We can win this one. It
changes the political dynamic. Suddenly everyone has so much to lose from the
continuation of monopolization policies.”[3] This raises some questions
including the impact that such decentralized but never-the-less unifying
currencies like cryptocurrencies can have on the global system including the
reduction of hostilities, waste, confusion, risk, and so much more. What is the
real power of a cryptocurrency like Bitcoin?
Few issues in international finance
has gotten such confused reactions by investors and the public than the advent
of the cryptocurrency, Bitcoin. A digital currency that, as the name might
suggest, exists online and has no tangible tender either in the form of coins
or printed bills. Part of the confusion over Bitcoin, in addition to it being a
new form of currency, has a mysterious beginning. According to the Financial
Times, the founder of Bitcoin is supposedly called "Satoshi
Nakamoto”. A Japanese name, it is still unclear if Satoshi Nakamoto is a
person, a group of people, or even if anyone involved with Bitcoins creation
are actually Japanese. What is known is that whoever the founder(s) were, “they
mistrusted government enough to set up a private currency and an online bank
account system outside its reach.”[4]
Created in 2008, the defining characteristics of Bitcoin, like all
cryptocurrencies (thus far) is that it’s decentralized, electronic, and encrypted.
The Oxford Dictionary defines cryptocurrency as “A
digital currency in which encryption techniques
are used to regulate the generation of units of currency and verify the
transfer of funds, operating independently of
a central bank.”[5]
Adding to its intrigue and confusion, Bitcoin was created with a built in cap.
“There can never be more than 21m registration numbers. In a process that is
similar to a continuous raffle draw, "mining" nodes on the network
are awarded Bitcoins each time they find the solution to a certain mathematical
problem. The reward for solving a block is automatically adjusted so that the
number of Bitcoins created decreases as time goes on.”[6]
While Satoshi had suggested that the cap for Bitcoin should be temporary, the
original intention of the cap was to “ensure
that the computers supporting the network, and processing the transactions,
would not be overwhelmed by an enormous quantity of data.”[7] While this cap was a very clever idea at the currency’s
birth to help promote both legitimacy and stability, years later, this system
has lead question the qualities it sought to encourage. In an article from
March 2nd, 2016, Ben Popper explains how the growing attractiveness
of the currency took a big user experience hit. The network “reached its
capacity, causing transactions around the world to be massively delayed, and in
some cases to fail completely.” The average time to confirm a transaction using
the system for bitcoin “ballooned from 10 minutes to
43 minutes. Users are left confused and shops
that once accepted Bitcoin are dropping out.”[8]
The up and downs of the popularity and usability of Bitcoin has led many to
wonder if the ideals that Tucker put forth are possible and if cryptocurrencies
will ever be much more than a sidelined player in the international financial
system.
Part One: Foundations of
International Financial Management
The need for International Finance
and Bitcoin – The authors of the 7th edition of International Financial Management, Cheol S. Eun and Bruce G.
Resnick, ask ‘why do we need to study “international” financial management?’
while this questions may seem surprising to those either already proponents of
cryptocurrency or those that follow ever-growing interactions between countries
and global citizens, the premise behind the question is still important. The
authors themselves assert that the answer to this question is straightforward. “We
are now living in a highly globalized
and integrated world economy”[9]
where it is no longer enough for managers of MNCs to not think globally when
making decisions and managing enterprises that are increasingly operating
across more than one country market. Using the provided definition, a follow-up
question arises. Is Bitcoin the natural extension of an ever more-globalized
and integrated world economy? Eun and Resnick do not address cryptocurrencies
in their book from 2015 but they do seem to strongly hint that even their
updated book is perhaps not comprehensive to cover the constantly changing
landscape of the integrated global financial system. The global shift in the world is in “marked contrast to a few decades
ago when the authors of this book were learning finance. At that time, most
professor’s customarily ignored international aspects of finance. This
parochial attitude has become untenable since then.”[10]
Laudable as it is to acknowledge a shifting landscape and one’s own need to
adapt, it is entirely possible that adaptation in a world of limitless
connectivity, that such an adaptation, as important as it may be, may itself
still be inadequate. Regardless of the adequacy, there is still no doubt as to
the merits of understanding international financial management.
If Bitcoin is to find a place in the
international monetary system an examination of the history of the system is
perhaps necessary. Starting with the gold standard of 1875 – 1914, there is
already a precedent for a unified reserve in the global marketplace. As the
limitations of a reserve that was tangible became more and more apparent, the
advent of the fiat currency gained prominence. The question now lingers that if
we replaced the gold standard with another system as we began to see the
limitation of continued growth under the current system is a decentralized
system now the next logical adjustment for the fiat monetary system? If the
answer to this question is yes then would such a system look like and would it
bring about the prosperity that is being predicted?
Part Two: The Foreign Exchange
Market, Exchange Rate Determination and Currency Derivatives
”Trading in foreign-exchange markets averaged $5.3
trillion a day in April 2013, reports the BIS in its latest “Triennial Central
Bank Survey”. This was up from $4 trillion in 2010 and $3.3 trillion in 2007.”[11]
The largest financial market by most
accounts, the Forex market is a perfect economic example of inefficiency in the
system and a perfect opportunity for an electronic currency to thrive as a
clear and easy alternative to the excesses of the marketplace. When individuals
can make exchanges across geopolitical boundaries quickly and without
intermediaries, the global financial system as a whole would be better served. According
to an study by the CATO institute, a merchant who accepts payments in bitcoins
as many retailers in the last years have begun doing including Microsoft,
Overstock, Dell and Expedia, “avoids all exchange rate risk of holding
bitcoin.”[12]
There are still many drawbacks for adoption of cryptocurrencies in a larger
scale but this might well be one of the largest and most notable benefits of
such adoption.
Part Three: Foreign Exchange
Exposure and Management
For currencies like Bitcoin and the
assumption that in the future global currencies will gravitate towards one
dominant and universally reserved currency that is likely to be the majority
currency in all transactions for its relative stability and ease of use, such a
future would naturally result in a significant reduction and possible
elimination of not only a foreign exchange market but also the concerns of
transaction, translation and economic exposure.
Part Four: World Financial Markets
and Institutions
International Banking Services – One
of the biggest weaknesses of bitcoin is that as an industry it is small and up
until recently pretty volatile (see image above). The bitcoin market is significantly
smaller than would be needed to take on global banking institutions. Size of the Bitcoin industry. As of March 31,
2016, the market price of Bitcoin is “USD 417. There are currently 15,378,575 Bitcoins in circulation, and 337,655 Bitcoin users (unique
addresses). Since Bitcoin's inception in 2009, there have been a total of 119,469,454 Bitcoin transactions.”[14] Contrast these numbers to
the world’s current dominant currency the USD. According to the US Federal
Reserve Bank There was approximately “$1.4 trillion in circulation as of
February 18, 2016, of which $1.38 trillion was in Federal Reserve notes.”[15] Looking at these numbers it seems
almost impossible for Bitcoin to make a significant impact on the global market
but it’s important to remember that Bitcoin has only been around for a short
couple years and will have a number of hiccups like everything new and despite
these growing pains, the currency still has experienced phenomenal growth. Magister
Advisors has compiled data on the amount of venture capital and investments
that have been allocated to cryptocurrencies just the last two years of 2015
and 2014 (see below).
It seems clear that given the
continued interest in cryptocurrencies, the importance and use of them will
only continue. Indeed, Magister Advisors predicts that Bitcoin might well
become the 6th largest reserve currency in the world if current
trends continue. The prediction calls for this possibility by 2030. That would
mean that a currency that didn’t exist 12 years earlier will be a leading
global currency by 2030. To put that in perspective, China, a country that has
experienced unprecedented growth in all aspects of its financial and economic
markets over the last decades is still only a small fraction of the foreign
currency exchanges. Despite being added to the IMF’s basket of global reserve
currencies in 2015 “the yuan hasn’t truly become much more
widely used than the Norwegian kronor.”[17]
Part Five: Financial Management of
the Multinational Firm
What will Foreign Direct Investment
mean in a Bitcoin world? USA is the default inflow and outflow of FDI around
the world.[19] If
predictions of the future importance of Bitcoin are to come true then there
will likely be an increased use as a device for FDI. For scalability, the
common belief is that “bitcoin will find a home in emerging markets. He
says: "Emerging markets are much more bitcoin native. Look at an area like
Argentina, where there are capital controls, challenges in the local financial institutions,
and there’s a need to do cross border payments.”[20] This prediction is echoed
by the Cato Institute’s study on cryptocurrencies where Auroracoin in Iceland,
Scotcoin in Edinburgh and the CzechCrownCoin in the Czech Republic among
others.[21] This growth and inherent
start in multi-countries alleviates the maturity theories for currencies to be
stable and backed by central banks long enough to be used abroad. Both for
transactions and as a reserve. Since these cryptocurrencies are starting in
emerging with the intention to be used across national borders This should not
only allow Bitcoin and others to be used easily as a vehicle for FDI but also
to help manage risk and the impact of sovereignty. As least in the near-term,
there is not enough regulations of these currencies in emerging markets to stop
the free-flow of electronic currency.
Future of Cryptocurrency: Central Bank adoption
Perhaps the biggest indications thus far
of the future of cryptocurrency was announced in early 2016 when two researchers
from the University College of London, at the suggestion of the UKs central
bank, the Bank of England, developed RSCoin.
Ben Broadbent, the banks deputy governor, in a speech discussing the
growing interest by the bank in what he calls “decentralized
virtual clearinghouse and asset register” (DVCAR) said that in principle, this
technology behind cryptocurrency or
could be applied to many things, “not just the exchange and registering
of financial assets. A recent official report in the UK suggested that
distributed ledgers might eventually be used for a wide variety of government
services, including the collection of taxes, the delivery of benefits –
potentially including new “smart” transfers that could target particular groups
– the keeping of business registers and other things besides5. If so, then
there may be similar potential uses in the non-financial private sector.”[22] In addition to helping
with a number of financial issues that Mr. Broadbent explains, Tom Simonite
writing for MIT Technology Review, sums up the rest of the speech by noting
that RSCoin will “make retail payments more efficient and the financial
system as a whole more resilient. Software that can instantly move digital cash
from place to place should be able to make many transactions, both large and
small, faster and less costly.”[23]
While it’s still too early to know the impact that RSCoin will have on the
centralized and decentralized market, there are plenty out there that are
predicting a game-changing event in finance that will allow a near-universal
currency to flourish while being stable and scalability with a clear governance
and accountability structure. Critics of Bitcoin cite the inherent restrictions
of scalability as a major negative of that the code that created Bitcoin can
only handle 21 million bitcoins and that the system of decentralized computers
can only handle 7 transactions a second.
According to Dr. Danezis, one of the designers of RSCoin at University
College London, Bitcoin is "a Peter Pan system, and it doesn't really grow
up.”[24]
Additionally, critics also note that Bitcoin is also vulnerable to "double
spending attacks", “a form of manipulation where the same money is paid to
two different people. One of them is tricked and receives nothing. The victim
has no legal recourse.”[25]
Conclusion
While Bitcoin has a great deal of
growing still to do and it’s not clear that Bitcoin, while the current leader
among cryptocurrencies, will remain the natural front-runner and face of the
growing digital currency movement. As Jeffrey Tucker said in his interview, “Our national monies are extremely old fashioned, having been
nationalized for 100 years, while our payment systems are half a century out of
date. This is unsustainable. Bitcoin has been invented and won’t be uninvented.
It is on an inexorable march toward mainstream acceptance.”[26] That level of acceptance
and also usage may still be some time away but as such alternatives to national
currencies take hold and continue to grow Tucker also predicts that this will
help make armed conflicts less likely in the international community. While not
a widely held belief, the idea goes that large modern wars have been the direct
result of the monopolization of money by central banks. While there is no
reason to necessarily believe that privatized money will be an inherent
deterrent to wars, the increased integration of international systems like
finance and trade has a long history of ensuring stability and peace.[27]
While the verdict is still out on whether Bitcoin or any
other cryptocurrency, even ones planned by central banks, will have a lasting
if not significant impact on our financial lives, what is clear is that despite
the confusion, the naysaying and the general aversion to all things new and
unknown, cryptocurrencies have already made a notable and decisive contribution
to the ideals that our global financial systems have on our lives from a
philosophical and even practical manner.
Additional References:
[1]
http://en.bitcoinwiki.org/images/thumb/5/50/Bitcoin.png/256px-Bitcoin.png
[2]
https://blog.adafruit.com/wp-content/uploads/2014/03/adafruit_2738.jpg
[3] Amanda B.
Johnson. “From Bitcoin Skeptic to Evangelist by Amanda B. Johnson”Dr. Rich
Swier. Retrieved on March 11th, 2016 from:
http://drrichswier.com/2015/11/25/from-bitcoin-skeptic-to-evangelist-by-amanda-b-johnson/
[4] Financial Times.
“Definition of Bitcoin.” Retrieved on March 11th, 2016 from:
http://lexicon.ft.com/Term?term=bitcoin
[5] Oxford Dictionaries. “Cryptocurrency.”
Retrieved on March 11th, 2016 from:
http://www.oxforddictionaries.com/us/definition/american_english/cryptocurrency
[6] Financial Times. “Definition of
Bitcoin.” Retrieved on March 11th, 2016 from:
http://lexicon.ft.com/Term?term=bitcoin
[7] Nathaniel Popper. “A Bitcoin
Believer’s Crisis of Faith.” New York Times. Retrieved on March 11th,
2016 from:
http://www.nytimes.com/2016/01/17/business/dealbook/the-bitcoin-believer-who-gave-up.html?_r=0
[8] Ben Popper. “Bitcoin’s nightmare
scenario has come to pass.” The Verge. Retrieved on March 11th, 2016
from:
http://www.theverge.com/2016/3/2/11146584/bitcoin-core-classic-debate-transaction-limit-crisis
[9] Eun, Cheol S. & Resnick, Bruce
G. “International Financial Management 7th Ed.” McGraw Hill
Education. New York, NY. 2015. Page 4.
[10] Eun, Cheol S. & Resnick, Bruce
G. “International Financial Management 7th Ed.” McGraw Hill
Education. New York, NY. 2015. Page 5.
[11] The Economist. “Global
foreign-exchange turnover”. Published Sept 14th 2013. Retrieved
4.1.2016 from: http://www.economist.com/news/economic-and-financial-indicators/21586351-global-foreign-exchange-turnover (includes quote and picture)
[12] White, Lawrence H. “The Market for
Cryptocurrencies.” Cato Institute. Cato Journal, Vol. 35, No. 2 (Spring/Summer
2015). Retrieved 4.1.2016 from: http://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2015/5/cj-v35n2-13.pdf
[13] Williams-Grut, Oscar. “This epic
slideshow tells you everything you need to know about bitcoin and blockchain
right now.” Business Insider. Published Dec. 15, 2015. Retrieved on 4.1.2016
from:
http://www.businessinsider.com/magister-advisors-report-on-bitcoin-and-blockchain-ecosystems-2015-12?r=UK&IR=T
[14] Bitcoin Currency Data. Quandl.com
Retrieved on 4.1.2016 from:
https://www.quandl.com/collections/markets/bitcoin-data
[15] Board of Governors of the Federal
Reserve System [for the United States]. “How much US Currency is in
circulation?” Last updated Feb. 29th 2016 retrieved on 4.1.16 from:
https://www.federalreserve.gov/faqs/currency_12773.htm
[16] Williams-Grut, Oscar. “This epic
slideshow tells you everything you need to know about bitcoin and blockchain
right now.” Business Insider. Published Dec. 15, 2015. Retrieved on 4.1.2016
from: http://www.businessinsider.com/magister-advisors-report-on-bitcoin-and-blockchain-ecosystems-2015-12?r=UK&IR=T
[17] Guilford, Gwynn. “The Chinese yuan
won’t become a global reserve currency anytime soon.” Quartz. Published Nov. 30th
2015 Retrieved 4.1.16 from: http://qz.com/561635/the-chinese-yuan-wont-become-a-global-reserve-currency-any-time-soon/
Eswar Prasad and Lei Ye. “Will
the Renminbi Rule.” International Monetary Fund. Published March 2012.
Retrieved 4.1.16 from: http://www.imf.org/external/pubs/ft/fandd/2012/03/prasad.htm
[18] Williams-Grut, Oscar. “This epic
slideshow tells you everything you need to know about bitcoin and blockchain
right now.” Business Insider. Published Dec. 15, 2015. Retrieved on 4.1.2016
from:
http://www.businessinsider.com/magister-advisors-report-on-bitcoin-and-blockchain-ecosystems-2015-12?r=UK&IR=T
[19] Eun, Cheol S. & Resnick, Bruce
G. “International Financial Management 7th Ed.” McGraw Hill
Education. New York, NY. 2015. Page 406.
[20] Williams-Gurt, Oscar. “Here’s one
of the most interesting predictions for the future of bitcoin.” Business
Insider. Published December 27, 2015. Retrieved 4.1.16 from: http://www.businessinsider.com/future-of-bitcoin-jeremy-millar-blockchain-emerging-markets-2015-12?r=UK&IR=T
[21]
White, Lawrence H. “The
Market for Cryptocurrencies.” Cato Institute. Cato Journal, Vol. 35, No. 2
(Spring/Summer 2015). Retrieved 4.1.2016 from: http://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2015/5/cj-v35n2-13.pdf
[22]
Ben Broadbent. “Central banks and digital currencies – speech by Ben
Broadbent.” Bank of England. Published March 2nd 2016.Retrieved 4.1.16 from: http://www.bankofengland.co.uk/publications/Pages/speeches/2016/886.aspx
[23]
Simonite, Tom. “A Bitcoin-Style Currency for Central Banks.” MIT Technology
Review. Published March 10th, 2016 Retrieved 4.1.16 from: https://www.technologyreview.com/s/600980/a-bitcoin-style-currency-for-central-banks/
[24]
Evans-Pritchard, Ambrose. “Central banks beat Bitcoin at own game with rival
supercurrancy.” The Telegraph. Published March 13th 2016 Retrieved
4.1.16 from: http://www.telegraph.co.uk/business/2016/03/13/central-banks-beat-bitcoin-at-own-game-with-rival-supercurrency/
[25]
Ibid.
[26] Amanda B. Johnson. “From Bitcoin
Skeptic to Evangelist by Amanda B. Johnson”Dr. Rich Swier. Retrieved on March
11th, 2016 from: http://drrichswier.com/2015/11/25/from-bitcoin-skeptic-to-evangelist-by-amanda-b-johnson/
[27] Eric Weede. “The Diffusion of
Prosperity and Peace by Globalization.” The independent Review. Retried on
March 11th, 2016 from:
http://www.independent.org/publications/tir/article.asp?a=457
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