Bitcoin

Will Bitcoin [BTC]’s legacy be the destruction of the 21 million coin supply cap?

Opinion: Bitcoin [BTC]’s first block remains, until this day, with a message indelibly etched into it. A headline from the newspapers on that day: January 3, 2009. “Chancellor on brink of second bailout for banks” was the headline, depicting the reason Bitcoin was created, to take the power of value away from banks and corporations, decentralize it and give it back to the people.

Now, 10 years down the line, one of banking’s biggest “problems” is coming to the blockchain, courtesy of none other than Mastercard. A patent was filed late last month, called the “Method and system for linkage of blockchain-based assets to fiat currency accounts”. This aims to introduce fractional reserve [FR] banking to the blockchain, effectively “solving the problem” of Bitcoin’s scarcity and dilute the supply.

Fractional Reserve is a banking system which effectively allows banks to only hold a fraction of the assets that they manage. This effectively means that more capital is freed up for loaning out to various parties, effectively introducing a large amount of debt into the picture. Moreover, banks are required to only hold 10% of their deposits as reserves.

FR is one of the many methods to increase the “paper supply” of an asset, in the same way that Wall Street has been doing to silver and gold for the past eight years. This can also be done through offering derivative products, which are being carried out by Goldman Sachs with their derivative products offered to a “small number of clients”.

If the principle is applied to Bitcoin, one of its biggest value propositions, the fact that there will only be 21 million coins in circulation, will effectively be rendered moot. As financial institutions are effectively required to hold 1 Bitcoin for every 10 Bitcoin they “lend”, the supply of Bitcoin can be inflated to levels that would compromise its scarcity.

This can be added to the list of complaints that the Bitcoin and cryptocurrency community has towards the increasing institutionalization of the cryptocurrency. Its acceptance as an asset class will lead to the dilution of its supply by paper-Bitcoin, which is usually a cash-settled product which does not trade on exchange platforms. This effectively means that while underlying spot markets might decide the price of the asset, derivative products can effectively be traded without the need for markets to decide the price.

This marks the beginning of a dangerous path for Bitcoin, and one that might see it move away from its fundamental philosophies. However, even if Bitcoin turns into being the direct successor to banking, that message will always remain in the first block, deciding the values of the coin in an absolutely immutable fashion.


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