Can Bitcoin Kill Central Banks?

Bitcoin uses a decentralized system and a decentralized peer-to-peer ledger. It has the potential to become a globally accepted payment method and to revolutionize people’s access to finance and financial services. However, most governments do not control or recognize it, and central banks cannot influence it.

This raises some questions because there are those who favor the removal of the influence and regulatory positions that governments have on currencies. There are also those who believe that cryptocurrency is not a viable substitute for government-backed currency. So, is it possible that Bitcoin can replace central banks and fiat currencies? Learn more about what Bitcoin really is and whether or not the potential exists.

Role of central banks in an economy

Before examining the effect of Bitcoin on central banks, it is important to understand the role that central banks play in an economy. Central bank policymaking underpins the global financial system, and their mandates vary from country to country. For example, the Federal Reserve in the United States is responsible for controlling inflation and maintaining maximum sustainable employment. The Bank of England ensures the stability and solvency of the financial system in the United Kingdom.

Central Bank tools

Central banks use a variety of tactics, known as monetary policy, to achieve their mandates. However, they mainly manipulate the money supply and interest rates. For example, a central bank can increase or decrease the amount of money circulating in an economy. More money in an economy equals more consumer spending and, consequently, economic growth. The opposite situation—ie, less money in an economy—translates to one where consumers spend less.

Central banks use a network of banks to distribute money in an economic system. In that sense, they are the hub of an economy’s financial infrastructure, which consists of banks and financial institutions. Central banking policy can lead to economic booms and busts if not managed properly.

Perhaps the biggest benefit is that a central bank builds confidence in the system. A currency issued by the central bank is backed by a trusted authority and can be exchanged for a universal value. If each party in a monetary transaction issued its own coins, then there would be competition between the currencies, and chaos would ensue.

Range of Central Banks address

A chaotic currency situation existed in the days before the Federal Reserve came into existence. Money issued by non-bank entities such as merchants and municipal corporations circulated throughout the US monetary system. The exchange rates for each of these currencies fluctuated, and many were frauds, not backed by enough gold reserves to justify their valuations. Bank runs and panics have disrupted the American economy from time to time.

Immediately following the Civil War, the National Currency Act of 1863 and the National Banking Act of 1864 helped lay the foundation for a centralized and federal monetary system. A uniform national banknote redeemable at face value in commercial centers throughout the country was issued. The creation of the Federal Reserve in 1913 brought more monetary and financial stability to the economy.

A central decision-making authority

The problem with the structure described above is that it places far too much trust and responsibility on the decisions of a central agency. Debilitating recessions resulted from improper monetary policy measures pursued by central banks.

The Great Depression, the largest economic recession in United States history, occurred because of mismanaged economic policies and a series of wrong decisions by local Federal Reserve Banks, according to former Fed Chairman Ben Bernanke. The Financial Crisis and the Great Recession of 2008 occurred because the Federal Reserve loosened its grip on the economy and pursued a policy of loose interest rates for too long – which was taken advantage of by those in a position to do so.

Several academic papers and articles attributed the recession to exotic derivative trading in which home loans from insolvent borrowers were repackaged into complex products to make them look attractive. Attracted by profits from these trades, banks sold the products to unsuspecting buyers who resold the portions to buyers around the world.

The entire financial system generated fat profits. “As long as the music is playing, you have to get up and dance. We’re still dancing,” then-Citigroup CEO Chuck Prince infamously told journalists. All of these transactions were held back by money at the Federal Reserve.

The interconnected nature of the global economy means that policy-making decisions (and errors) are transmitted by one central bank across many countries. For example, the contagion of the Great Recession did not take long to spread from the United States to other economies and led to a global swoon in stock markets.

Can Bitcoin Kill Central Banks?

The case for Bitcoin as an alternative to central banks is based on economics and technology. Satoshi Nakamoto, Bitcoin’s inventor, defined the cryptocurrency as a “peer-to-peer version of electronic cash” that allows “online payments to be sent directly from one party to another without going through a financial institution go.”

However, arguments favoring Bitcoin to replace central banks and currencies have several problems. First, users need to understand what they are using. The first iteration of the cryptocurrency was introduced to the public using a command line and programming skills – something that many people still lack knowledge of.

Second, wallets with graphical user interfaces were created to make cryptocurrency easier to use. However, it introduced software vulnerabilities that make it just as easy to steal keys as it is money. So there is no reason to use it instead of issued currency.

Third, Bitcoin is a convertible currency in almost every jurisdiction on the planet, with an exchange rate based on whatever currency a user wants. To replace central banks and state-backed currencies, all governments and central banks will have to declare that their country’s currency is unusable and that only Bitcoin can be used.

Fourth, Bitcoin has a limited supply that will ever be issued. The intention behind this was to slow the rate at which it was introduced so that it would retain its value and act as an “inflation proof” measure. However, because it must be converted to fiat currency to be used, it is subject to the inflation that affects those currencies. One bitcoin can trade for $73,000, but how much each of those dollars buys changes over time — it usually declines.

Even if there were no other currencies besides Bitcoin, the amount that one bitcoin or satoshi could buy would change over time because the cost of producing goods and services always rises, regardless of the medium of exchange.

Finally, although there are probably many more reasons, Bitcoin has not been adopted at a rate that suggests it is likely to become a replacement for current financial systems. Instead, it has earned a place as a favorite for financial speculators and risk-takers because they believe its price will continue to rise, even with nothing to back it up but hype.

The Bottom Line

Central banks are at the helm of the modern global financial infrastructure in the current economic system. An overwhelming majority of countries worldwide use central banks to manage their economies. Although it offers several advantages, this form of centralized structure vests excessive power in a single authority and has led to severe economic recessions.

Bitcoin’s technology relies on algorithmic trust, and its decentralized system offers an alternative to the current system. However, due to the issues it raises and faces, it is unlikely to replace central banks any time soon.

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