Bitcoin has had a huge run over the past year. This run has seen Bitcoin become legal tender in El Salvador, multiple publicly traded companies adding Bitcoin to their balance sheet, and an explosion in the price of the cryptocurrency.
The recent adoption of Bitcoin by El Salvador has led to much speculation about the potential for a sort of currency backed by Bitcoin to emerge. While we do admit that this is possible, it does not seem likely. With that in mind, we will explain how money backed by Bitcoin would work in practice.
Bitcoin Backed Money Is Possible
So, Bitcoin backed money is technically possible. It would work in a similar manner to how gold backed currency works (or, used to work).
Basically, a country would stockpile a lot of bitcoin. This would be done by making a purchase, seizing bitcoin, or mining it.
Next, the country would issue currency that is redeemable for bitcoin. For instance, $1 of US DollarBTC would be redeemable for $1 worth of bitcoin. Of course, the government would set the price of bitcoin.
Now, this is overall a pretty awful idea and something that would be absolutely awful for bitcoin. The next section will explain all the reasons why this would be such a terrible system for Bitcoin.
Here’s Why Bitcoin Backed Money Is A Terrible Idea…
There are almost too many reasons to list out why a Bitcoin backed money is a terrible idea. In fact, it would be shorter to write a list of why this would be a good idea because there are no reasons this would be a good idea.
Here are the top reasons why this idea would not work.
Bitcoin Is Already Easy to Use
The biggest reason why this idea would not work is that bitcoin is already so easy to use. This has already been observed in El Salvador with people using the Lightning Network to pay for goods and services.
It is actually even easier to use Bitcoin to pay for stuff than using cash because you do not have to deal with change. It is literally as simple as having someone scan a QR code and the money transferring to their wallet.
The fees are also ridiculously low because it’s the Lightning Network.
The only reason that paper money backed by gold emerged was because using gold to pay for stuff was difficult in large amounts. The government also likely saw an opportunity to hoard a large amount of gold without putting the gold into circulation.
That is beside the point, though. The overarching point is that using gold is far more difficult than using paper currency, so paper currency redeemable for gold was issued.
Bitcoin is so easy to use that people will likely not want the government to serve as a custodian for their bitcoin when they can simply do it themselves.
The Government Would Set The Price of Bitcoin
The other problem with money backed by bitcoin is that the central bank (government) would set the price of bitcoin.
How could they do this?
They set the price that you can redeem paper currency for bitcoin. If the government is willing to buy 1 BTC for $100,000, then the price of bitcoin would adjust accordingly as the government would suck up all the demand.
What would end up happening is that a bunch of bankers working at the Federal Reserve could easily set the price of bitcoin. The same thing happened with the price of gold when the United States moved to the Bretton Woods system after World War II.
The exact details are far beyond the scope of this article. The basics are that the United States set the gold to dollar exchange rate for central banks. And the United States kept devaluing the US Dollar until eventually unpegging it from gold in 1976.
The wider implication is that the United States essentially controlled the price of gold. The same exact thing could occur with a Bitcoin system because Bitcoin operates very similarly to gold.
Do You Trust a Central Bank Audit?
The other issue with a government issuing a bitcoin backed currency is that it would rely on trusting the government to serve as a custodian of your bitcoin. At its core, this problem boils down to a few separate issues:
- Do you believe the government will always redeem dollars for bitcoin?
- Do you trust that the government actually controls the wallet they claim is the reserve wallet?
Those are the two core issues. And really those issues relate to more than the rather absurd idea of a government issuing a bitcoin backed currency.
The same argument is also seen when cryptocurrency hardliners say lines like “not your keys; not your crypto” in regards to a centralized exchange.
Do you trust Coinbase or Binance to always remain solvent? What happens if Coinbase or Binance decide they do not want you as a customer?
The same idea applies to the government holding bitcoin in reserve. Don’t trust them to always redeem your currency.
Bitcoin Does Not Need This
We say the idea of money backed by bitcoin is absurd because, well, no one is talking about something like this.
However, this type of system would allow the banks to regain control of something that they cannot really control all that well. It is something that could happen, but it’s still extremely unlikely because of how easy Bitcoin is to use.
Remember, Bitcoin was created to get away from the current system. Turning the cryptocurrency into a replacement for gold in a government controlled system would be like taking two steps forward and one step back.
The end goal should be to eliminate all middlemen (ie. banks and central banks) to prevent manipulation. Bitcoin solves that by placing everything in a decentralized ledger.
There simply is no need for money backed by Bitcoin when Bitcoin itself is money.