The strengthening case for Bitcoin as an alternative financial system

By Huf Haus

Introduction

Bitcoin was born in the midst of a banking crisis. In January 2009, the first block was mined on the Bitcoin network, known as the “genesis block,” and it had these words coded into it:

‘"Chancellor on brink of second bailout for banks"

That line comes straight from the headline of a newspaper headline from Jan. 3, 2009 detailing banks being bailed out (again) by the British government. Global banks like Lehman Brothers had already collapsed, residential homes were being repossessed across the world, and central agencies had very few options other than to print more money to save the financial system. Taxpayers footed the bill, and the bankers and brokers responsible for the mess went about their business again.

Amidst this chaos Bitcoin was created as an alternative financial system, free from the intervention of governments and central banks, governed by immutable code.

Just over 14 years later, and we have another widespread banking crisis on our hands, with the demise of several U.S. banks including Silicon Valley Bank, Signature Bank and First Republic. Bitcoin is also 14 years older, having gone from being an online experiment to the 12th largest asset in the world, with a market cap of $540 billion. That makes it more valuable than VISA, a world leader in digital payments.

Over this time, Bitcoin has also popularized the potential of decentralized payments networks, powered by a blockchain. This led to subsequent blockchains being developed such as Ethereum, Litecoin and Ripple. Each of these blockchains has its own token, which is used to facilitate transactions and incentivise participants to settle transactions. The total market cap now of all these cryptocurrencies including Bitcoin exceeds $1.2 trillion.

So if cryptocurrencies can gain such rapid traction post one banking crisis, what is the future of cryptocurrencies in this uncertain world with a wave of fresh banking failures? Opinions vary, from skeptics that say Bitcoin should be worth $0, to others that were willing to bet that Bitcoin would soon be above $1 million.

To dive deeper into the potential impact of the banking crisis, we have to turn our attention to the most powerful organization in the world, the U.S. Federal Reserve.

Role of central banks

The Federal Reserve has a dual mandate:

1.To maintain price stability (low inflation).
2. To maintain full employment.

To do this, they have a range of tools available to them, but ultimately it boils down to two major things:

1. Setting interest rates.

2. Controlling the amount of dollars in circulation.

These two policy tools not only affect governments and companies (who need to borrow money at that new rate), they also impact ordinary individuals, who have either debt they need to pay back, savings that get eroded in value, or things to buy which are subject to rising inflation.

Indeed, these two decisions also directly impact the price of a range of assets, including equities, bonds, commodities, foreign currencies and cryptocurrencies. Since 2009, the Federal Reserve has maintained a low interest rate policy, creating an environment where many asset classes flourished including cryptocurrencies. However, now that inflation is more than just a transitory phenomenon, the Fed have had to pull on their levers to increase interest rates, from 0.00% to >5% now.

The banks that had bought lots of U.S. government debt when interest rates were low, are now sitting on billions of dollars of losses as interest rates rise, and the value of those older bonds decreases (since newer bonds have better interest rates). This is a simplified version of what went wrong with SVB and other banks.

Bitcoin as money

In parallel, crypto has flourished this year. Bitcoin is +70% on the year and Ethereum is not far behind at +60%. Other more speculative cryptocurrencies have witnessed multiple 1,000%+ returns. Why? Because it’s brought about a refreshed narrative on the need for cryptocurrencies. Asset managers, individual savers, banks, foreign governments and multinational corporations are beginning to wake up to the reality that they are completely at the mercy of central banks and the almighty dollar.

See, for something to be considered “money,” it must exhibit three characteristics:

1. A unit of account ($1 is $1, 1 BTC is 1 BTC)

2. A medium of exchange (I can send you $1, I can also send you 1 BTC)

3. A store of value ($1 in 2023 buys you less bread than $1 did in 2009, but 1 BTC in 2023 buys you way more bread than 1 BTC did in 2009).

It’s this last characteristic, broadly related to inflation, that has cryptocurrency enthusiasts excited. The reason why people like Balaji Srinivasan believe Bitcoin prices are going to the stratosphere is because they believe hyperinflation of the dollar is about to begin, that monetary policy has become too loose (despite the recent rate rises), and the moral hazard has crept back into the system (whereby banks take all the risk, get all the reward and suffer the least).

In times of economic uncertainty, investors flee from “risk-on” assets like equities towards more “risk-off” investments like cash, gold and silver. Cryptocurrencies have been trading like “risk-on” assets in recent years, buoyed by the strength of the equities market. However, we are at an inflection point, where crypto has the opportunity to trade as both a “risk-on” asset in good times but also as a “risk-off” asset in the face of a declining dollar and looser monetary policy.

It’s beginning to manifest in this direction, where the correlation between cryptocurrencies and traditional asset classes is becoming very unpredictable. In countries like Argentina or El Salvador where there are very real debt and inflation problems, savers are much better off by keeping their assets in crypto than in their local currencies.

In contrast to holding your money on deposit with a bank or stuffed under the mattress, a cryptocurrency holder in these high-inflation countries can easily swap their Bitcoin and Ethereum for any other asset of their choice, with global peers, and thus exhibit greater control over their finances.

The case for crypto

Detractors will say that Bitcoin wasn’t an inflation hedge during the period of rising inflation over the past two years. They’ll also say that during the 2020 pandemic, cryptocurrencies fell even more sharply than equities. Finally, they’ll argue that making payments on the blockchain is still too slow, too expensive and not widely adopted. However, the narrative for cryptocurrency is stronger than ever before.

In an increasingly fragmented and digital world – with rising geopolitical risks, meddling central bankers, bank failures and sticky inflation – it’s natural to assume that crypto’s growth journey doesn’t end here.

Image Sources: Companiesmarketcap, Tradingeconomics

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Author Bio

Huf Haus is a professional investor with an extensive background in TradFi and DeFi. He is the Co-Founder of Pear Protocol, a novel pairs trading platform on Arbitrum, and is also currently Head of Investments at ReFi Pro, a proven on-chain asset management protocol. He tweets @hufhaus9.