Everybody’s talking about Bitcoin. As an IT person, I’ve been hearing about it for years, but the rest of the world is increasingly in an uproar. So, let’s combine some technical and economic knowledge and see what it’s all about.
Some basics first. When somebody says Bitcoin, you’ll probably say: ‘Oh yeah, Bitcoin, that’s a digital currency.’
Bitcoin is in fact a distributed digital wallet system based on cryptography. The distinction is important. The problem with the word ‘currency’ is that it isn’t a very clearly defined term. When you call something ‘currency’ you call to mind a host of positive and negative associations that might or might not apply to Bitcoin. Instead, I’ll start with explaining my definition and move on to describing the consequences and in what way it is similar to well-known things.
A digital wallet is the digital equivalent of the thing you have in your pocket. It is a place you store stuff. In the case of Bitcoin it contains the bitcoins you own. In that way it is similar to a bank account. Where it differs, is that you can’t simply transfer your bitcoins to real money, or pay with them in stores. You have to find a buyer first, much as if you were selling goods.
Distributed, in this case, means that all bitcoin transactions are maintained in ledgers that are spread out across the globe. With banks, the bank is the central party that handles transactions and you have to trust them. With Bitcoin, the process is spread out and you theoretically have to trust nobody. This is why Bitcoin is the libertarian’s wet dream. It’s also what sets it apart from the traditional banking system. More on this below.
The next thing you may know is that bitcoins are created through ‘mining’ and you use lots of computer power to do that.
Well, that’s all true, but that’s not the whole story. Because the first thing you might assume from the above statement is that mining is something separate from Bitcoin usage, and you could be environmentally friendly by only buying bitcoin, and not mine it.
Bitcoin mining does use all that computing power for mining, but a large part of the mining process is verifying the so-called blockchain over and over again. Blockchain is what underpins the distributed ledgers of all bitcoin transactions, and the mining process ensures that the ledger is still valid.
At a bank, the transactions are all handled by that bank and you just have to trust that they handle it well – well, that and the fact that they are heavily regulated by the government. With blockchain, the transactions are handled in several places, but checked again and again and again by bitcoin miners, ensuring everything is aboveboard.
In other words, the mining is an integral part of Bitcoin. Even if you stopped creating new Bitcoins, mining would still costs shitloads of energy. That energy consumption is estimated to be anywhere between 15 and 35 TWh a year. For comparison, the country of Ireland (hosting several large data centers) only consumes 25 TWh a year.
Now for some consequences. The value of a thing is determined by how much value people attribute to it. Value is a completely fabricated concept. As much as some people (mostly those with a lot of captial) would like you to believe, value is not something absolute.
As an example, imagine yourself with a new iPhone X. Pretty valuable, right?
Now imagine you’re magically transported to the time of the dinosaurs. Still think your 1000+ dollar device has much value? Or any value?
Essentially, the value of a thing is determined by the belief people have in its utility and its scarcity. The utility is how much people like it or need it, and the scarcity is how rare it is. You need both for something to be valuable.
If you paint a painting, this will be your unique work, but people might not like it. Scarcity is high, utility low. If you manage to get famous enough, the utility will rise (people will enjoy it, and like the status of owning it) and the value increases.
On Bitcoin value
Back to Bitcoins. The mining process has been set up in such a way that scarcity is a given. There will never be more than 21 million bitcoins. That’s been baked into the way bitcoin works.
However, the other side of the coin (yeah, bad pun) is the utility. Bitcoins have zero utility by themselves. Like cash and digital money, it relies completely on the trust placed in it. And that’s where the differences with the rest of the financial system really start to show.
As I wrote earlier, bitcoin is distributed. There is no single party responsible for the things. Contrast that to regular money: there are banks behind that, which are regulated by central banks, which have countries behind them.
Regular money can fail, certainly. The bank can go bankrupt, and the regulations behind it can fail, and even the country behind that can mess up. This is what happened in 2008, when the banking system came crashing down like a house of cards.
The thing is, things came crashing down because government oversight was failing – and still is, we’ve just masked it for now. I know some people out there don’t trust the government, and would rather trust corporations – that’s you, Libertarians. Personally, I’d rather trust an organization that I have a vote in that was created to benefit me (the government), than an organization that I have no control over that was created to benefit a small group of people (corporations).
Bitcoin is unregulated. There is no government or central bank behind it, just investors and organizations. This makes it a Libertarian’s wet dream, like I said, but there is no oversight or safety net either. If Bitcoin collapses, it’s doubtful anybody will be bailed out. At this point in time anyway.
On the other hand, Bitcoin is very popular on the black market. That’s because it’s unregulated. Note that this is actually only partially true. Bitcoin is still traceable. You just need to figure out who owns a certain wallet and every transaction is easily accessible. It’s not foolproof, just better for nefarious purposes than wads of cash money or regular bank transactions. But the law is catching up.
That does not mean, however, that Bitcoin will fail. The insidious thing is that corporations are now more powerful than countries. If they get behind bitcoin, they could very well ensure that there is enough trust in it to keep it afloat. And if Bitcoin becomes entrenched enough, it might become ‘too big to fail’.
Note however, that this is still different from cash and digital money. When there is a country behind it, there is always, somewhere down the line, the backup of a group of people that can perform labor and land that may have natural resources. Although, when that country is Iceland, it can turn out that that isn’t worth much either, as we saw in 2008. Still, it’s better than what Bitcoin currently has: nothing.
On the future of Bitcoin
So, in short, Bitcoin is bad for the environment, has no intrinsic utility, and there are no regulatory safety nets. However, if enough people and corporations keep believing, it will actually stay afloat.
What we’re seeing now is mostly an influx of a shitload of money. Everybody and their uncle is investing in Bitcoin. However, that makes it nothing but a pyramid game until that is balanced by an outflux of money – yeah okay, that’s not a word. What I mean is that to become more stable, it must become possible to exchange bitcoin for real-world labor or goods, or for money.
If banks and companies start to accept bitcoin as a valid currency, then the value will start to stabilize, and it will become something akin to gold: something that can be invested in that has value.
I would never put my pension in Bitcoin, or any money I needed to live. There are no safeguards, and for now there are no guarantees of stability. It’s like putting you money in paintings of currently famous artists, gambling that they will still be worth a lot of money down the line.
And that’s besides my very big gripe with Bitcoin: the environmental impact. We are currently killing our planet, and Bitcoin is contributing thousands of tons of CO2.
So in short, Bitcoin isn’t for me, but it might be for you.
I hope this at least helped understand it better.