US Treasury Secretary Janet Yellen failed to warn about Bitcoin’s insolvency earlier last week, and cryptocurrency prices plummeted. Although they were already losing ground, for some the price volatility after the statements was strong evidence of the instability criticised by Yellen.
For others, like Square and MicroStrategy, it was an opportunity to “buy”, based on encouraging words from Cathie Wood of the Ark Investment Fund, a classic Bitcoin bull.
Ultimately, corporate investors in Bitcoin will improve price stability. At the same time, the rise of concentrated corporate holdings could create a different kind of risk.
The “imbalance” of wealth in bitcoin
One bitter criticism of Bitcoin is that its user base resembles the wealth distribution in North Korea: only 2% of Bitcoin accounts hold 95% of the cryptocurrency in circulation. Although technically true, the facts are somewhat misleading.
There are approximately 6.5 million Bitcoin addresses that control cryptocurrencies worth at least $100. By comparison, 43 million users rely on Coinbase to retain more than $100 billion worth of Bitcoin.
The three largest Bitcoin addresses are controlled by cryptocurrency exchanges that serve tens of millions of users. While Bitcoin makes it easier for everyone to play the role of their own, personal “bank”, the fact that the vast majority of Bitcoin users prefer to let third parties retain their assets somehow negates the purpose of a decentralised cryptocurrency.
Bitcoin was designed to minimise dependence on potentially corrupt human institutions. In its early days, each user had to run their own copy of the software, which ideally worked as a wallet, miner, accountant and auditor. To the extent that everyone independently verified each new transaction, the network would remain secure against possible censorship or fraud.
Corporate reserves are less likely to manage their own funds. It is a matter of practicality. Bitcoin is a bearer title and the industry is full of stories of users who carelessly lost millions of dollars and then found themselves looking for it even in landfills.
In a recent interview, MicroStrategy CEO Michael Saylor likens Bitcoin self-defense to operating an explosive device:
“It’s like finding three of your employees and giving each one a little nitroglycerin, telling them: “Take this home with you and bring it back in the morning. All three be careful not to get too close to each other. And be careful not to fall”.
Bitcoin is not a physical coin, not even a digital one. It is a global accounting book that participants follow the same set of rules. Theoretically, those who use their own Bitcoin software are vulnerable to unauthorised breach of protocol. In practice, money is a social construct. It is not enough for a sovereign person to keep his own accounting book, others must also recognise its contents.
A medium of exchange has value if people accept it in exchange for things of value. Acceptance does not have to be voluntary. In the US there is legislation on legal means of exchange. In the absence of state coercion, Bitcoin nodes uphold the network’s consensus rules by engaging in economic activity. Power of control over the protocol is retained by those who wish to receive Bitcoin in exchange for goods, services or as a ransom.
This scrutiny became apparent in 2017, when the founder of the Grayscale Bitcoin Trust convened a group of Bitcoin corporate executives to propose a controversial change to the core protocol. The modification seemed harmless – it would double the number of transactions recorded per minute in the blockchain – but without retrospective application. The amendment would split the network in two, potentially leaving two separate cryptocurrencies arguing over what true Bitcoin is.
Bitcoin traders and stock exchanges resisted and signalled their opposition to change. These financial participants threatened to reject any transactions that would not follow their preferred protocol and thus effectively boycotted the amendment. The agreement was eventually abandoned.
Elon Musk has left open the possibility of Tesla allowing its customers to pay for their cars in Bitcoin. In this way, Tesla will have a much greater influence on the Bitcoin protocol than it does with simply owning $1.5 billion worth of Bitcoin.
Meanwhile, the corporate interest in Bitcoin motivates traditional financial institutions to participate in the program. BNY Mellon, the world’s largest custodian bank with more than $2 trillion in assets under its management, has announced an initiative to provide cryptocurrency infrastructure. Mastercard and Visa also follow.
Just five years ago, the idea of Bitcoin as a corporate asset would have met with ironic looks and ridicule. Its adoption by institutional investors is a sign of Bitcoin’s maturity, but its impact could potentially overshadow the preferences of smaller, independent users in the event of future protocol disputes.
On the other hand, if Bitcoin is to become the dominant currency that overturns the foundations of classical banking, it needs the price stability that will come from its presence in many “institutional” balance sheets.