The case for Bitcoin as an alternative to central banks is based both 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.”
Within the context of a financial infrastructure system dominated by central banks, Bitcoin solves three problems:
First, it eliminates the problem of double-spending. Each bitcoin is unique and cryptographically secured, meaning it cannot be hacked or replicated. Therefore, you cannot spend bitcoin twice or counterfeit it.
Second, even though it is decentralized, Bitcoin’s network is still a trustworthy system. In this case, trust is an algorithmic construct. Transactions on Bitcoin’s network have to be approved by nodes spread out across the world to be included in its ledger. Even a single disagreement by a node can make the transaction ineligible for inclusion in Bitcoin’s ledger.
Third, Bitcoin’s network eliminates the need for a centralized infrastructure by streamlining the process to produce and distribute the currency. Anyone with a full node can generate bitcoin at home. Intermediaries are not required for peer-to-peer transfer between two addresses on Bitcoin’s blockchain. Therefore, a network of banks chartered by a central authority is not necessary to distribute the cryptocurrency.
However, the economic independence promised by Bitcoin comes with several catches:
The first of these is Bitcoin’s status as a medium of transaction. Since it was released to the general public, there have been very few legitimately recorded uses for bitcoin.
Second, Bitcoin’s status as a medium for legal transfers is unknown. The cryptocurrency has become legal tender in El Salvador, but that remains the only country to allow the cryptocurrency for transactions
Finally, Bitcoin is volatile and restricted in its supply. There will only be 21 million bitcoin mined. A cap on the number of bitcoin in existence severely limits its use. Scarcity has also made cryptocurrency an attractive asset for speculation. Its price swings between extremes, making it difficult to use in daily transactions.
The problems with Bitcoin’s use have not deterred central banks from adopting elements of the cryptocurrency to design their own digital currencies. Central bank digital currencies (CBDCs), as the currencies are known, are being explored by several central banks for use in their economy. A digital currency issued by central banks may possibly remove intermediaries, such as retail banks, and will use cryptography to ensure that it is not replicated or hacked. It may also work out to be cheaper to produce compared to metal coins.