By Adam Aluzri
At the time of writing, Bitcoins were valued at around $8,000 each. This value is down $10,000 from its peak value of $18,000 in December. It’s possible that this is a temporary downturn, perhaps related to recent upheaval in the stock market. It’s also possible that Bitcoin’s value will never reach its previous peak again, and that its initial rise was simply a bubble. The future viability of Bitcoin is a nearly inexhaustible topic online—there’s an entire website devoted to tracking how many “Bitcoin Obituaries” have been published proclaiming the imminent death of Bitcoin. Considering the recent downturn in Bitcoin’s value, this question is worth reexamining. As noted, many online pundits are already doing that, though, so I want to look at why we should care about Bitcoin’s future beyond its role as a gimmick for making (or losing) a quick buck. Why is this topic so contentious? As it turns out, Bitcoin’s future is tied up with the future of a technology that has potentially revolutionary—and potentially dangerous—implications for the economy.
Explaining the technology behind Bitcoin is a monstrous task, but it’s worth briefly addressing. Bitcoin is based on something called blockchain technology. A blockchain is essentially a massive digital ledger—every Bitcoin transaction is stored on this ledger, including the digital addresses of the payer and payee and the number of Bitcoins transferred. The reason this technology is exciting is that it is not stored and maintained by a single organization. Rather, it is globally accessible to any Internet-connected device and its entries are verified and secured by volunteers in a peer-to-peer network. Essentially, whenever you trade away a Bitcoin, you openly announce to the entire Internet that this trade has occurred, effectively bypassing the need for a middleman like a bank. In order to secure such a system from fraud, each transaction is encoded with a cryptography problem (hence the name “cryptocurrency”) and must be independently verified by one of the volunteers. The volunteers, called “miners,” set their computers to work randomly guessing the solution to the cryptography problem until one of them eventually cracks the code and verifies the transaction, at which point the transaction is appended to the ledger. The miners are not purely altruistic, of course—the reason they spend exorbitant amounts of money on electricity and graphics processors to solve these problems is that they are rewarded with Bitcoins every time they solve and append one transaction. If miners think more people will buy into Bitcoin in the future, raising its value, they’ll be willing to spend more on mining.
That’s all well and good, but why does any of this matter? Why should anyone but a miner be involved in this scheme? Economists often speak of the network effect, wherein systems gain more value as they gain participants. Uber, for example, is only valuable to consumers if lots of drivers use it, and only useful to drivers if lots of consumers use it. Bitcoin functions on the same basis—it’s mostly useless if nobody is participating. It might have another, subtler, source of value, though: it sends a signal marking its owners as members of a community with a common vision for the future. This view is articulated in the article “Is Bitcoin Intrinsically Worthless?” by none other than Kenyon’s Professor William Luther, whom I interviewed for much of the information in this article.
Professor Luther’s argument is this: Bitcoin’s role as a currency is clearly important, as changes in demand for Bitcoin have dramatically affected its price in the past (like when Steam started refusing to accept Bitcoin for games, or when China banned cryptocurrency exchanges). But it might never have taken off as a currency if not for its more abstract role as a novelty or badge of honor for those who took part in the project early on. Those early tech-savvy participants were excited by the prospect of a currency outside the control of banks and governments. In this way, Bitcoin is often touted as an anarcho-capitalist project. Professor Luther described “the natural appeal of Bitcoin to anarcho-capitalists and technologists, who might signal their respective views by holding Bitcoin.” Bitcoin could therefore have some intrinsic value as a result of its symbolism of a vision for the future and its associated novelty status.
Just as the marketplace of ideas is diverse, so too is the marketplace of cryptocurrencies. There are over 1,300 different cryptocurrencies now in circulation, and each one has its own associated vision and set of values to justify its existence. Take, for example, Dogecoin, a currency based on the Doge meme, and… nothing else, really. The only intrinsic value it has is that it’s a meme and memes are pretty great (turns out this is enough to elevate it to the 84th most traded cryptocurrency). Another example is Monero, which was developed because of privacy concerns with Bitcoin. Those who seek (almost) entirely private and untraceable transactions would therefore prefer to use Monero. But if nobody else is using it, it holds no value since it can’t easily be used as a signal (being untraceable and all). Monero, therefore, is intrinsically worthless.
Cryptocurrencies, however, may have an additional and even more interesting source of value. Before addressing that, though, it’s helpful to distinguish between cryptocurrencies and blockchain protocols—the former are the coins themselves, which can be used for investment or trading, and the latter is the technology used by each cryptocurrency for ledger-tracking. Cryptocurrencies themselves can have a big impact on our society, but even if we ultimately just keep using our credit and debit cards for most everything, blockchain technology might be where the real value lies.
New York Times contributor Steven Johnson recently wrote an article called “Beyond the Bitcoin Bubble” in an attempt to discern possible future uses for blockchain technology. He notes that perhaps the most important implication is the ability to send information out to the entire Internet as opposed to single corporate-owned servers. An app developer could then build software, which interprets the contents of that blockchain and uses it to provide new and innovative services. Johnson’s big example is peer-to-peer transport technology—in other words, Uber. Because Uber was the first large-scale company to take advantage of peer-to-peer transport, it has the first-mover advantage over potential competitors. Once you’ve stored your info on Uber, it becomes a hassle to switch over to a potentially better service like Lyft—economists would call that a switching cost. Uber’s advantage is exacerbated by network effects—if Lyft doesn’t have as many users as Uber does, it’s simply more convenient to use Uber. This leads to monopolistic market conditions and stifles innovation; think of how much time it took Uber to simply add a tipping system. With a blockchain protocol, though, you would not be submitting your location and travel plans to Uber. Instead, you’d be submitting it to an entire network of applications connected to the publicly available blockchain. You might receive transport offers from Uber, Lyft, your local cab company, or even your municipal bus system, at which point you can choose whichever is cheapest or makes the most sense to you. This would be incredible for consumers, and it isn’t limited to transportation. You can also imagine such a system being applied in other areas such as electricity distribution, social media, and research databases.
There are already some systems in early development, which aim to take advantage of such peer-distributed services, like Golem. Golem allows you to contribute your computer’s idle processing power in exchange for its associated cryptocurrency, GNT. Buyers can use GNT to purchase spare processing power for CPU-heavy tasks, like CGI rendering, effectively making Golem a decentralized supercomputer. In that sense, GNT has yet one more source of value beyond its use as a means of transaction and as a value signal/novelty: it is the sole means by which you can access Golem’s services. This is not an inherent source of value, since Golem’s services are also only valuable insofar as others participate in them, but it is important nevertheless.
Cryptocurrencies are necessarily linked to these decentralized ledger-based services. Public blockchains are difficult and expensive to maintain, so miners will always need a monetary incentive to help keep them running. They can’t be paid with a traditional currency like US dollars, as that would require a centralized organization to make payouts, defeating the purpose of decentralized blockchains. So for now, these technologies rely on cryptocurrencies with a set monetary supply to give them value. At its outset, GNT, for example, is only valuable insofar as it acts as a signal of faith that others will value decentralized computing services. For many projects, that faith is misplaced, and even those cryptocurrencies, which manage to get off the ground have no guarantee of entering the mainstream. This is where the utopian anti-monopolistic vision begins to fall apart.
The problems with cryptocurrencies are myriad. For starters, blockchain technology is environmentally harmful because of just how much electricity it uses to mine. Online journal Digiconomist has estimated that Bitcoin mining alone now releases more pollution than gold mining and requires about as much electricity in upkeep as the country of Singapore. Second, cryptocurrencies are not as immune to security breaches as they might seem. In 2014, the now infamous Mt. Gox Bitcoin trading exchange reported theft of 750,000 Bitcoins through its own exchange software. This was worth almost half a billion dollars, and constituted about 7% of all Bitcoins that existed at the time. For various reasons, this is less likely to occur on such a scale for Bitcoin again, but newer cryptocurrencies with more thinly traded markets and less established exchanges are highly susceptible to price manipulation and theft. Third, cryptocurrencies scare security analysts because of their potential ability to circumvent taxes and sanctions. That in and of itself is not an obstacle to crypto, but it leads directly into one: cryptocurrencies are at high risk because of regulation. Countries have implemented varying levels of regulation on cryptocurrencies—they’re legal in the US, but all exchanges must comply with know-your-customer laws so that law enforcement can track the individuals behind suspicious-looking transactions. Other countries, like Bangladesh, have outlawed cryptocurrencies under threat of imprisonment. China in particular is of major concern as it has recently cracked down on crypto exchanges and mining operations. Fourth, a huge number of cryptocurrencies are pump-and-dump schemes. Scam-artists frequently utilize price manipulation and online advertising to attract investors to their currency before selling all of it off and running. This has led to serious consumer protection concerns. Facebook, for example, has responded by banning all cryptocurrency ads on its site. Finally, and partially as a result of all the other issues, cryptocurrency values are tremendously volatile. This scares off potential investors, which dampens the potential for any of these cryptocurrencies’ associated services to take off.
This leads back into the perennial question: will Bitcoin last? If I had to predict, I would say that Bitcoin itself has almost no chance of surviving the next decade. In “Bitcoin and the Future of Digital Payments,” Professor Luther noted that he thinks Bitcoin will survive but that it will not become a major currency in the way Bitcoin proponents suggest. Either way, Bitcoin itself probably won’t alter our social landscape all that much. Blockchain technology as a whole, however, has great potential, which means that some cryptocurrencies will probably survive and thrive. However, the obstacles facing blockchains and cryptocurrencies won’t disappear without cogent solutions—governments will respond to its high electricity usage, to the numerous pump-and-dump schemes, and to security threats, and those responses are unlikely to benefit crypto. In all likelihood, government responses will serve only to regulate blockchains and cryptocurrencies into the ground.
Therefore, it’s incumbent on everyday users to keep track of this admittedly complicated issue and remain politically active. There are numerous reasons for everyone, not just Silicon Valley geeks, to care about this topic. Unfortunately, most mainstream media coverage has only delved into Bitcoin’s role in speculation and hedging, making it seem like little more than a toy for wealthy investors. Hopefully we can get past this speculation phase soon and start seeing this technology for something more.