Dedollarization: a positive point for bitcoin?

The world’s foreign exchange reserve has been the US dollar for several decades. The question of dedollarization comes up very often since there are possibilities that it will happen A day. This is where we will look at the positive role bitcoin could play in the face of dedollarization.

Dedollarization and dollarization

The principle of dollarization is to use the US dollar as an exchange currency to avoid global turbulence. The principle of dollarization makes it possible to avoid crises of different currencies or problems of devaluation. In the opposite principle, dedollarization is the end of the use of the currency of the US dollar by replacing it with the use of another currency. This is based on the principle that it is the currency of exchange at the global level.

Dedollarization is brought back to the fore as we have undergone some changes lately. For example, we have Saudi Arabia which now accepts exchanges in yuan (agreement with China) for the purchase of oil. On the other side, we have China and Brazil, which have reached an agreement to allow themselves the possibility of trading in their own currency. A change that became almost inevitable since China became the main partner of Brazil (formerly the United States). On the other hand, Russia replaced the US dollar with the yuan after the latest tensions following the war in Ukraine. It is clear that geopolitical tensions are accentuating the transition to a possible dedollarization.

The factors pushing for dedollarization

Several geopolitical conflicts have gradually pushed certain states to dedollarize for various reasons. For example, faced with the sanctions imposed during the Russia-Ukraine conflict, Russia had to find other agreements. This was particularly the case with China, they teamed up to reduce dependence on the US dollar.

On the other hand, for several decades, the fact that the US dollar has lost much of its value has made it more vulnerable. This is even more the case with money printing, which has increased in recent years. Faced with this, some states are trying to find alternatives to reduce their independence from the US dollar.

Until 1971, US dollars could be converted into gold. However, since the supply of the US dollar was too large in the 1960s compared to that of gold, this made the task of conversion difficult. Consequently, President Nixon put an end to the possibility of converting the dollar into gold. This meant the end of standard gold but also the end of limited money printing. After the high inflation of the 1970s, the US dollar had retained much of its value. Thereafter, there are other events and interventions which reduced the value of the US dollar. For example, faced with the financial crisis in 2008, the US central bank injected liquidity. Having an expansionary monetary policy increases the currency in circulation and decreases the value of the dollar. The same event repeated itself with the arrival of the COVID crisis. This time it happened much more exponentially resulting in a spike in inflation thereafter.

Alternatives to dedollarization

There have been several alternatives to dedollarization that have been put forward such as cryptocurrency and digital currency. Other more tangible proposals have been proposed such as rare metals, copper. For example, Russia is working with Iran to develop a cryptocurrency with gold as collateral. And as explained above, several countries are working together on agreements to reduce its independence from the US dollar.

Gold still retains its usefulness and also its position as a reserve value. We can precisely see that the central banks have collected a lot of gold in recent years.

Is this the end of dollarization? Not quite, you should know that the US dollar reserve with central banks is around 60%.

The Changing Curve of Bitcoin Adoption

There is always a process in adopting something new. This was the case with the internet and several technologies such as telephones, tablets, cars… This will also be the case with bitcoin. To refer to this, we can use the “S Curve” which often represents the process of adopting a new technology. It is called the “S Curve” because the figure is represented in the form of an S. For now, we are still at the beginning of the adoption phase.

To ensure the continuity of adoption, demand must persist knowing that at the same time, the supply of bitcoin remains limited to 21 million bitcoins. Demand can be in the form of new user growth or incoming flows. At the same time, the principle of the halving, which makes it possible to reduce supply every 4 years, creates the phenomenon of scarcity in addition to demand.

When the laggards arrive (the last 10%), it means that the reluctant people end up using bitcoin. We are still far from that since in terms of % in relation to the population, we are only at 0.35%.

The risk of US debt default: US dollar vs bitcoin

The debate on the limit of the debt ceiling is again topical since it was reached in January 2023. If the result of the debate would be not to increase the debt ceiling, this would lead to the default of the US. The consequences of a situation like this would be a major risk for the United States but also globally. This could plunge the US into a deep recession via a massive rise in unemployment. We know that the defect thesis is the furthest away, but it must still be taken into account. Even if the reserve of the US dollar is important (about 60%), a default of the country would drive away foreign investors, resulting in a weakening of the US dollar. Therefore, a decline in the US dollar could be a long-term positive for bitcoin. For what ? The US dollar is a factor influencing the variation of bitcoin.

Default risk would also be a major risk at the banking level. And as bitcoin reacted positively to the Fed’s intervention in the face of banking risk in March 2023, this could be a positive criterion for it.

Dollarization: the impact on bitcoin

Dollarization remains an advantage for bitcoin. To understand this advantage, one must look at the usefulness of bitcoin to see how the aspect of dollarization helps to increase the value of bitcoin. First, as it is the main exchange currency (the US dollar), it is also the currency to buy assets and in particular bitcoin. As the US dollar remains inflationary (monetary expansion) while bitcoin keeps a limited supply, it is here that we can see the advantages of bitcoin compared to dollarization.

To better understand, we will explain the inflationary and deflationary aspect of the fiat currency. The US dollar is inflationary because the expansion of the money supply decreases the value of the US dollar. The principle of a deflationary currency is to have a supply that decreases over time.

It is already known that bitcoin has a limited supply of 21 million bitcoins. And the second aspect of bitcoin remains the halving, which decreases production over time (more particularly every 4 years).

As bitcoin was created in 2008-2009 in parallel with the financial crisis in the US. Faced with this crisis, the American central bank, the Fed, intervened by injecting liquidity into the financial system in order to revive growth. Consequently, it increased the money supply and it decreased the value of the US dollar. Bitcoin was designed to limit both the number of bitcoins, but also by programming a drop in production of it every 4 years.

Does dedollarization lead to bitcoin?

Bitcoin has a lot of virtues as a whole. It can be considered as a hedge against monetary expansion, against banking risk, geopolitical risk. It has proven to us on several occasions its responsiveness to this kind of turbulence.

However, there are concepts that are going to be harder to convert for bitcoin to become a primary currency like the US dollar. We will name a few:

1/ The simple fact that we cannot print bitcoin remains a factor that will limit its potential to be an official currency. As there is a limited supply, the loan potential may be limited. Therefore, this can limit the effects on economic growth via credit. And credit is still a variable in the economy. So yes, it is possible to use fractions of bitcoin but you cannot print bitcoins. On the other hand, if we face a major economic problem, it could become difficult to intervene as central banks do. For what ? because bitcoin is not regulated by a central bank like fiat currency.

2/ The other point remains the final adoption process, as well as its production. If bitcoin becomes an official currency of exchange, and at the same time, the 21 million bitcoins are mined and adopted (end of the adoption curve), demand will peak.

3/ For the moment, in terms of volatility, the use of bitcoin also remains a limitation. For what ? you cannot buy a wand with a currency that can take or lose 100% or -60% of its value so quickly. Time measurement is important if there is no time to absorb the price variation. However, the more it will be capitalized, the more there is a risk of having less volatility. It is in the same principle as a small market capitalization which will be more volatile than a large capitalization.

CONCLUSION

Bitcoin benefits more from the loopholes of dollarization (loss of value) than from the dedollarization process. Even if the bitcoin can have its limits as an official currency, its usefulness and its mode of operation with the limited supply and the halving make it possible to attribute several assets to it.