by Colin Chilcoat
Cryptocurrencies, or digital mediums of exchange, have been trading since 2009. Bitcoin (BTC), the first of these alternative currencies to become available, recently traded at values greater than 1,000USD/1BTC. The digital currency has gained notoriety for its use on the Silk Road, a virtual black market, which deals heavily in the trade of narcotics. More recently, bitcoin has been pegged as a surprise candidate to usurp America’s monetary hegemony over oil pricing, an institution since the early 1970’s. The decentralized bitcoin certainly has a lot to offer frustrated OPEC (Organization of the Petroleum Exporting Countries) producers. However, all that (digitally) glitters is not gold.
Bank of America recently assessed Bitcoin’s maximum market capitalization at $15 billion.
What’s Behind a Bitcoin?
If at first glance Bitcoin seems to be drawn from thin air, that’s because it more or less is. The fundamentals of Bitcoin are loosely based on finite minerals like oil and gold. However, cryptography and complex algorithms developed by the US National Security Agency (NSA) have replaced Earth’s natural processes. Unlike fiat money, which derives its value from government regulation, no one party can manipulate the production of bitcoin or similar cryptocurrencies. Simply put, the number of possible units has been capped and further production follows a predetermined path. In one final parallel, bitcoins are useless without “miners” to extract them. The good news is anyone with a computer can mine bitcoins. The bad news is few actually have a chance of succeeding.
Mining is technically a “distributed consensus system,” but can be more easily understood as a cross between public bookkeeping and entering the lottery. Each bitcoin transaction is added to a public ledger, which is shared between every Bitcoin user. The first miner to not only verify the transaction, but also encrypt it, is awarded freshly minted bitcoins in addition to transaction fees. A sizeable amount of computational power is necessary to accomplish this task and for all, but the most dedicated users, the energy costs outweigh the gains. It is possible for miners to pool their resources and distribute the computational load across several users. However, the computing power of the field still has a vast advantage over any mining collective. Miners are integral to the survival and overall security of the Bitcoin network, but mining is not the only means to the end.
For several OPEC producers, supplanting the petrodollar system has both significant financial and ideological considerations.
Bitcoins are most commonly acquired through exchanges, online or face-to-face. With no one entity controlling the worth, these exchanges represent the genesis of bitcoin’s tradable value, which remains very much subjective. However, Bank of America recently assessed Bitcoin’s maximum market capitalization at $15 billion, lending some credence to its promise as a medium of exchange. While governments are taking a wait and see approach, bitcoin is pushing the boundaries of what was previously thought possible. The currency has already expanded beyond online retail and today trades at ~500USD/1BTC. The future appears bright, but does this path lead to the Middle East?
Moving Away from the Petrodollar System
In 1973 Saudi Arabia agreed to accept only US dollars for its oil in return for American military protection. The remaining OPEC nations followed suit soon after and the petrodollar system, as it’s called, has dominated world oil trade ever since. In the wake of the Bretton Woods system, which mandated a monetary policy for participating nations tied to the US dollar, the deal cemented the dollar’s hegemonic status as the primary currency for international trade and has guaranteed that the demand for those dollars remains high. In short, the petrodollar system, and the dollar’s status as a global reserve currency in general, is quite advantageous for the US and its fiscal policies. In spite of America’s declining influence worldwide, and especially in the Middle East, the arrangement survives today. For several OPEC producers, supplanting the petrodollar system has both significant financial and ideological considerations. There are few examples of countries completely abandoning the dollar, but current trends indicate the dollar will have company at the top.
The relative strength of the euro over the dollar made it an early suitor and in 2000, then Iraqi dictator Saddam Hussein made the euro Iraq’s default currency for its oil exports. The change, largely in response to heavy sanctions imposed by the United States, was short-lived and following US intervention in Iraq, the tender was switched back to dollars in 2003. Similarly burdened with sanctions, oil-and-gas-rich Iran has long sought a replacement for the petrodollar, utilizing the euro and more recently Chinese renminbi. With China primed to take over the US as the number one consumer of oil, pricing leverage has the potential to shift eastward. For the time being however, stricter financial regulations in China favor the dollar. Enter Bitcoin, devoid of politics and easily movable across borders.
Chief among the cons is the lack of government backing. To date China and Russia have both declared the currency unusable in their respective banks.
OPEC producers looking to step outside the influence of national banks may find solace in the decentralized bitcoin, of which production can never be manipulated. Score one for the cryptocurrency. Additionally, with low transaction costs and relative anonymity, dealing in bitcoin is ideal for those looking to circumnavigate rigid sanctions. Volatility is currently extremely high, the result of an influx of speculators, but its founders insist the growing pains will eventually give way to a relatively inflation-free future. What bitcoin doesn’t have, however, is faith. The startup currency has few believers, at least where it matters, and perhaps for good reason.
Growing Pains and the Future of Cryptocurrencies
First, its rise to popularity on the tails of the online black market vendor Silk Road has done it no favors. Second, security is a big issue. Bitcoin’s largest exchange, Japan-based Mt. Gox, was recently hacked, an act, which many users believe to have been carried out by its developers to siphon the digital wallets of the users. Despite its high levels of encryption, the Bitcoin network is a hot bed for cyber criminals and the potential for criminal activity will only grow with the user base. Chief among the cons is the lack of government backing, ironically enough. To date China and Russia have both declared the currency unusable in their respective banks. The United States has yet to make a significant ruling, but in any scenario featuring limited OPEC adoption it’s hard to envision a judgment in favor.
Today, the chances of ever seeing petrobitcoins are remote. Nonetheless, the currency has proved it has value and could easily find a role in the larger scheme of payments system for oil and gas.
The market for startup currencies is now burgeoning thanks to Bitcoin’s early successes. At worst, the cryptocurrency is a fresh take on the way we think about money and how we value it. Commodities are transacted today in an increasingly diverse array of currencies, under a variety of conditions. The dollar’s status as the global reserve currency is likely safe for the foreseeable future, but global forces may indeed bring about an overhaul of the petrodollar system. While several other currencies lie in wait, bitcoin offers a unique alternative. Today, the chances of ever seeing petrobitcoins are remote. Nonetheless, the currency has proved it has value and could easily find a role in the larger scheme of payments system for oil and gas; all it needs is opportunity.
Colin Chilcoat is an ENERPO alumnus and deputy editor of the ENERPO Journal.
BitcoinX. “Bitcoin Mining Profitability Counter.” <http://www.bitcoinx.com/profit/>.
Conerly, Bill. 2013. “Future of the Dollar as World Reserve Currency.” Forbes. <http://www.forbes.com/sites/billconerly/2013/10/25/future-of-the-dollar-as-world-reserve-currency/2/>.
Dougherty, Carter. 2014. “Goldman Sachs Sees Bitcoin Future in Payments Over Money.” Bloomberg. <http://www.bloomberg.com/news/2014-03-12/goldman-sachs-sees-bitcoin-s-promise-in-payments-over-currency.html>.
Hals, Tom. 2014. “Mt. Gox Files U.S. Bankruptcy, Opponents Call it a Ruse.” Reuters. <http://www.reuters.com/article/2014/03/10/us-bitcoin-mtgox-bankruptcy-idUSBREA290WU20140310>.
Hill, Kashmir. 2014. “China Bites Into Bitcoin.”
Hoyos, Carola and Kevin Morrison. 2003. “Iraq Returns to International Oil Market.” Financial Times. <http://www.thedossier.info/articles/ft_iraq-returns-to-international-oil-market.pdf>.
King, Ritchie, Sam Williams and David Yanofsky. 2013. “By Reading This Article You’re Mining Bitcoins.” Quartz. <http://qz.com/154877/by-reading-this-page-you-are-mining-bitcoins/#/h/35499,2/>.
Lee, Timothy B. 2013. “Bitcoin’s Volatility is a Dis-advantage, But Not a Fatal One.” Forbes. <http://www.forbes.com/sites/timothylee/2013/04/12/bitcoins-volatility-is-a-disadvantage-but-not-a-fatal-one/>.
Quiggin, John. 2013. “The Bitcoin Bubble and a Bad Hypothesis.” The National Interest. <http://nationalinterest.org/commentary/the-bitcoin-bubble-bad-hypothesis-8353>.
RIA Novosti. 2014. “Russian Central Bank Says Bitcoin Lacks Real Value.” <http://en.ria.ru/russia/20140224/187851223/Russian-Central-Bank-Says-Bitcoin-Lacks-Real-Value.html>.
Tennant, Jill. 2014. “Can the Bitcoin Become the Global Currency for Oil?” OilandGasInvestor.com. <http://www.oilandgasinvestor.com/Finance-Industry-News/Can-Bitcoin-The-Global-Currency-Oil_128429>.