Will Bitcoin become a transaction currency?

BLOCKCHAIN refers to a technology characterised by a peer-to-peer network that uses cryptography extensively to ensure transparency and immutability of data published on the blockchain. Bitcoin was the first and probably the most famous example of blockchain in action. That is why Bitcoin and blockchain are so often linked together, but they are not the same thing.

Cryptocurrencies like Bitcoin leverage the transparency and immutability characteristics of blockchain to record transfers of cryptocurrencies without the interference of a third-party authority such as Visa, a bank, or the government. But blockchain has wider applications beyond cryptocurrency. Blockchain can also be used to record other forms of digital transactions or execute smart contracts, acting as a computer code that checks if specified conditions are satisfied before transferring digital assets like payments to other parties. Such functionalities are often used by enterprises to facilitate a shared and transparent system of records across ecosystem partners.

The increasing interest in cryptocurrencies is largely fuelled by the increase in the price of Bitcoin. The volatility of Bitcoin, however, makes it a poor candidate for a currency. Using Bitcoin to pay for a product may cost the user double or half the amount in a span of a couple of days. The exchange rate risk associated with Bitcoin is thus significant, as the timing of when users use their Bitcoin or other volatile cryptocurrencies will significantly influence the value that is associated with the product.

Further, the number of merchants accepting cryptocurrencies is limited. In Singapore, only 51 merchants have declared acceptance of Bitcoin for payment. Also, Bitcoin and cryptocurrencies cannot reach the scale of transaction processing associated with payment giants such as Visa and Mastercard, as the speed of Bitcoin transaction ranges from days to hours (Bitcoin processes 4.6 transactions per second, compared to 1,700 transactions per second, on average, for Visa). Bitcoin has also attracted much criticism for the wastage of electricity associated with the competition among Bitcoin miners to reap mining rewards linked with publishing transactions on the Bitcoin blockchain.

Stablecoins represent a potential solution to solve the volatility problem associated with cryptocurrencies like Bitcoin. Stablecoins usually reduce price fluctuations by associating cryptoccurencies to stable assets, like fiat currency such as the US dollar, or collateralise the stablecoin by the value of an underlying asset. Therefore, stablecoins have the potential of leveraging the advantages of cryptocurrencies - transparency, immutability, security - while overcoming the disadvantage of volatility.

DECENTRALISED FINANCE

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Governments like the United States' have announced that they are now ready to take a favourable position on banks exploring the use of blockchain technologies and stablecoins. Central bank digital currencies, which also represent a form of stablecoins, are also gaining more prominence. This trend highlights the increasing importance of stablecoins in influencing the future of cryptocurrencies. The importance and role of stablecoins will depend on the level of merchant adoption as well as regulatory and supervisory frameworks adopted by governments around the world.

Stablecoins are important to watch because of the potential promise to facilitate international payments, and because of their ability to provide the infrastructure support for decentralised finance (DeFi), which may potentially be able to serve large masses of the underbanked. DeFi represents a new approach of providing financial services where users are expected to conduct financial transactions on a blockchain network without the involvement of financial institutions. This promise of DeFi has attracted the interest of financial institutions, big technology organisations as well as fintech startups.

While Bitcoin has been the poster child of blockchain, we need to clearly differentiate between the underlying blockchain technology and the cryptocurrency as a use-case of blockchain. Blockchain has a much wider set of use cases, such as enabling traceability in supply chains and industries like healthcare. While Bitcoin was designed with the goal of fixing the problems associated with traditional currencies and placing the power democratically in the hands of currency holders, this aim has been difficult to achieve due to issues related to volatility, scalability, and sustainability, among others. As a result, Bitcoin has been used mainly as an instrument for investment or speculation.

Stablecoins have a better chance of fulfilling the purpose originally envisioned by Bitcoin, but the potential is largely dependent on how governments decide to regulate cryptocurrencies and stablecoins. Overall, there is much potential for cryptocurrencies to serve as the basis for change in finance, but not on their investment potential like in the case of Bitcoin. Rather, there is potential for stablecoins to be sufficiently regulated and for widespread adoption to facilitate decentralised finance.

• The writers are from Nanyang Business School, Nanyang Technological University, Singapore. Professor Boh is deputy dean and professor of information systems; Dr Zheng has recently completed her PhD in information systems.