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Bitcoin, a decentralized digital currency, is considered a potential alternative to traditional currencies. However, despite its growing popularity, there are many concerns and debates about whether Bitcoin can replace traditional currencies, particularly the U.S. dollar.
In early 2022, the U.S. Federal Reserve released a report as "first step" towards discussions between the Federal Reserve and stakeholders about Central Bank Digital Currencies.
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Here's why the U.S. cannot [or will not] adopt Bitcoin as its primary currency.
Volatility:
One of the biggest challenges facing Bitcoin's adoption as a currency is its volatility. Bitcoin's value fluctuates significantly, sometimes even by thousands of dollars within a few hours. This instability makes it challenging for businesses to price their goods and services in Bitcoin, as its value may change drastically before the transaction is completed. Moreover, this makes it challenging for individuals to hold Bitcoin as a store of value or as a means of exchange.
One well-reported example of its volatile is the price fluctuations experienced in December 2017. At the beginning of the month, Bitcoin was trading at around $10,000. By mid-December, its price had soared to almost $20,000. However, within a few days, its price dropped to around $11,000, and then continued to fluctuate rapidly, with daily swings of several thousand dollars. By the end of the month, its price had fallen to around $14,000. This extreme volatility is one of the reasons why many people view Bitcoin as a risky investment.
Other examples are the following:
In November 2013, Bitcoin's price rose from $200 to $1,200 within a few weeks before dropping back down to $500 in a matter of days.
In January 2018, Bitcoin's price fell from $20,000 to $10,000 within two weeks.
In September 2019, Bitcoin's price dropped by over $2,000 in a single day, falling from around $10,000 to $8,000.
In March 2020, as the COVID-19 pandemic swept across the globe, Bitcoin's price fell by over 50% in just two days, dropping from $9,000 to below $4,000.
All of Bitcoin's price history can be found here at the Bankrate website.
Regulation:
Another significant challenge to the adoption of Bitcoin is its regulatory environment. The U.S. government has been grappling with how to regulate cryptocurrencies, and the lack of clarity has led to uncertainty and skepticism. And, the lack of regulatory oversight makes it easier for illicit activities like money laundering and terrorist financing to occur, which is obviously a significant concern for the U.S. government.The government's ability to regulate Bitcoin as a currency is limited by several factors:
Decentralization: Bitcoin is a decentralized currency, meaning that it is not controlled by any single entity or government. As a result, it is difficult for governments to regulate or control Bitcoin, as they do not have the authority to do so. Plain and simple.
Global Scale: Bitcoin operates on a global scale, and there is no central authority that governs it. This makes it difficult because Bitcoin operates outside of U.S. jurisdiction.
Lack of clarity: The regulatory environment for Bitcoin is still unclear, with many governments struggling to define Bitcoin's legal status. In the U.S., for example, the IRS classifies Bitcoin as property rather than currency, which means that individuals must report any gains or losses from Bitcoin transactions on their tax returns.
Complexity: Bitcoin is a complex technology that is difficult for many people, including regulators, (especially regulators) to understand fully.
Innovation: Bitcoin is a relatively new-ish technology that is constantly evolving, with new use cases and applications emerging all the time. This makes it challenging for governments to keep up with the rapid pace of innovation in the cryptocurrency space. I mean, have they ever kept up with anything?
Privacy concerns: Bitcoin transactions are pseudonymous, which means that they are not linked to the real-world identities of users. This raises major concerns about money laundering, tax evasion, and other illegal activities. How could they possibly regulate it without compromising user privacy?
Limited Acceptance:
Bitcoin is still a relatively "new" technology, and its adoption is limited compared to traditional currencies like the U.S. dollar. While some businesses and individuals have started accepting Bitcoin as payment, the vast majority still do not. Therefore, it is very difficult for it to compete with the U.S. dollar, which is widely accepted as a means of payment.
One example of Bitcoin having limited acceptance is in the retail sector. While there are some online retailers that accept Bitcoin as a form of payment, it is still not widely accepted as a means of payment for everyday goods and services. This is partly due to the fact that Bitcoin transactions can be slow and expensive compared to traditional payment methods like credit cards.
For example, the travel booking site Expedia stopped accepting Bitcoin as a form of payment, citing concerns about the volatility of Bitcoin's value and the complexity of the payment process, but then later accepted it again as new methods for transacting came along. Similarly, the popular online retailer Amazon does not currently accept Bitcoin as a form of payment, although there have been rumors that they may be considering it in the future.
This limited acceptance can make it difficult for people who hold Bitcoin to use it to purchase goods and services in their daily lives, which may be a barrier to wider adoption of the cryptocurrency.
Network Capacity:
Bitcoin's network has limited capacity, which has resulted in high transaction fees and longer wait times for transactions to be processed. This makes it challenging for Bitcoin to compete with traditional payment systems, which can handle much higher volumes of transactions at much lower costs.
While improvements to the Bitcoin network are always underway, it will take time for these improvements to be implemented and for the network to become more efficient, and as efficient as traditional systems. One example of the problem with Bitcoin's network capacity occurred in late 2017, when the price of Bitcoin began to surge and the number of transactions on the network increased significantly. There is research stating that it was primarily caused by market manipulation. As a result, transaction fees on the Bitcoin network began to skyrocket, with some users paying more to have their transactions processed in a timely manner. This made it impractical for many people to use Bitcoin for small transactions, as the fees were often higher than the value of the transaction itself.
The problem with Bitcoin's network capacity was largely due to the fact that the size of each block on the Bitcoin blockchain is limited to. This means that the network can only process a limited number of transactions at any given time, which can lead to delays and higher transaction fees during times of high demand.
To address this issue, some developers have proposed increasing the block size limit or implementing other solutions. However, these proposals have been met with some resistance, as they would require significant changes to the Bitcoin protocol and could potentially compromise its decentralization and security.
Centralization:
Bitcoin is designed to be a decentralized currency, with no single entity or organization controlling it. However, the reality is that a few large mining pools and exchanges control much of the Bitcoin network, which can lead to centralization concerns. Just two mining pools controlling 51% of the global hash rate. Plus, it could likely lead to a concentration of wealth among those who control the majority of the Bitcoin network, further exacerbating income inequality in the country.
If a single mining pool were to gain control of more than 50% of the network's computational power, they could potentially manipulate the blockchain and carry out what is known as a 51% attack. This could allow the attackers to double-spend Bitcoins, reverse transactions, or even destroy the network entirely.
While the risk of a 51% attack is relatively low, it is still a concern for many in the Bitcoin community, and some have called for measures to decentralize the network's mining power. Kinda defeats the whole purpose of decentralization.
Energy Consumption:
Bitcoin mining is a highly energy-intensive process, with estimates suggesting that Bitcoin mining consumes more energy than entire countries like Argentina and Norway. This energy consumption is not sustainable in the long run and raises concerns about the environmental impact of Bitcoin. Also, if Bitcoin were to become the primary currency of the U.S., it would require a significant amount of energy to maintain the network, further exacerbating the environmental impact of Bitcoin.
One example of the energy consumption problem with Bitcoin occurred in May 2021, when the Chinese government cracked down on Bitcoin mining operations in the country. At the time, China was responsible for around 65% of global Bitcoin mining, and the closure of these operations led to a significant drop in the network's computational power. This drop in computational power made Bitcoin transactions slower and more expensive, highlighting the impact that Bitcoin mining has on the network's performance.
One reason for Bitcoin's high energy consumption is the Proof of Work (PoW) consensus algorithm used to validate transactions and add them to the blockchain. PoW requires miners to solve complex mathematical problems using specialized computers, which consumes a significant amount of energy.
To address this issue, some developers and advocates have proposed alternative consensus algorithms that are less energy-intensive than PoW, such as Proof of Stake (PoS) or Proof of Authority (PoA). These algorithms would allow for faster and more energy-efficient transactions on the Bitcoin network, but they would require significant changes to the Bitcoin protocol and may face resistance from those who prefer the security and decentralization of PoW.
What's next?
While Bitcoin has gained significant attention and popularity, it is unlikely to replace the U.S. dollar as the primary currency of the country. Bitcoin's volatility, regulatory environment, limited acceptance, network capacity, centralization concerns, and energy consumption are significant challenges that make it difficult for Bitcoin to compete with traditional currencies like the U.S. dollar. However, Bitcoin's potential as an alternative currency and its underlying technology cannot be ignored, and it is likely that Bitcoin and other cryptocurrencies will continue to play a significant role in the financial landscape in the years to come.
In 2012, El Salvador became the first country to adopt bitcoin as legal tender. This means that businesses in the country must accept bitcoin as payment for goods and services, and the government will accept it for taxes and other obligations. Other countries, such as the United States, Canada, and many European countries, have regulated (or partially/attempt to regulate) bitcoin as a commodity or security rather than a currency. In these countries, people can use bitcoin to buy goods and services, but it is not recognized as legal tender.
Only time will tell...
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