Let’s assume for a moment around year 1860 you are horse rider working for the Pony Express. You and your colleagues are doing, on a daily basis, a fantastic job delivering messages between the Atlantic and Pacific coasts ( it takes approximately 10 days). During a ride you start to see placement of wires on poles. You try to understand and to explain to your partner of this. What would you say? “ they are building a continental fence high up in the air” or at some point you understand some aspects of what this new thing does. At the moment of realisation would you still be convinced that only people on horses working for solid companies can reliably deliver messages over such a long distance. Eventually working in this paradigm will no longer be valid as you notice the decrease in demand for horses and riders.
Now let’s switch back to crypto currencies with Bitcoin as the prominent example and have a look at some of the arguments discussed on various media these days. It is very difficult to explain cryptocurrencies, such as Bitcoin, with a simple comparison to something else.
“Bitcoin has no value” – this is somehow the wrong discussion. Most currencies don’t have one – fiat currencies have declared value by authorities and maintain it as long as people trust the system. The latin word ‘fiat’ simply means “it shall be’ – an authority declares something to be a currency. Bitcoin was created in the last financial crisis. The genesis block contains the message “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. It is an attempt to create a decentral form of money where no central authorities have an influence. So the key question is not the ‘value’ – it is about how trust is built. What’s better – the declaration of an authority or the community?
“Bitcoin is a currency” – sounds reasonable as we all deal with one or more currencies each day and as Bitcoin started to become an aspect in our daily life. But what is a currency? It turns out that currency definitions like the one on Investopedia are not so helpful.
“Currency is a generally accepted form of money, including coins and paper notes, which is issued by a government and circulated within an economy. Used as a medium of exchange for goods and services, currency is the basis for trade. ”
If this definition is true, then Bitcoin is not a currency as it is not issued by a governmental authority. Also, the definition of money is linked to a government. Hence Bitcoin is also not money, if the definitions are considered to be valid.
“Bitcoin is not a medium of exchange” – as transaction costs and volatility are high and making small transactions unattractive to mine. Although Bitcoin is currently not an option for small amounts but could well be used for large ones.
“Bitcoin is made of thin air” – on the basis that there is no underlying physical resource. But what does this mean? Bitcoin is itself a resource on a strict mathematical base. It is not created out of thin air – its creation is the result of a well-defined and completely transparent algorithm which we all can verify and decide to trust or not to trust. Comparing this to ‘fiat currencies’ do you know how ‘fiat currencies’ are created? Do you know who decides to increase the amount of currency or to adjust the value of one against another currency? Is this done in a transparent way?
“Bitcoin is fraud” – what is the basis and evidence of such statement?. Looking at the original whitepaper of Satoshi Nakamoto this is simply wrong. Sure, there are fraudulent use cases, but this is also the case with all other currencies or assets. It turns out that Bitcoin is not really a good medium to be used e.g. in ransomware. All transactions in Bitcoin are publicly observable – we do not know the individual owning an address but that does not hinder to monitor target addresses and intervene at exchanges when they are used. In other words – using Bitcoin always leaves traces while using e.g. cash does not.
“Bitcoin needs regulation” – sounds also great as rules are essential to create trust. A system which is weak needs a lot of surrounding rules and interventions while there are systems which contain the rules transparently in their core. Bitcoin itself is regulated by the maths embedded in the system itself but not by the traditional financial services regulators or national banks. What authorities can and should do, is to think about the exchange of Bitcoin against the fiat currency they oversee and the implications.
“Bitcoin is the mother of pyramids” – sounds also somehow true as the ones who bought Bitcoins early now profit from those who come late. But what is a Pyramid Scheme?
“A pyramid scheme (commonly known as pyramid scams) is a business model that recruits members via a promise of payments or services for enrolling others into the scheme, rather than supplying investments or sale of products or services. As recruiting multiplies, recruiting becomes quickly impossible, and most members are unable to profit; as such, pyramid schemes are unsustainable and often illegal.”
At least I’m not aware somebody recruits members in a multiplier scheme. And anybody can decide at any time to get buy or sell Bitcoins. Hence the comparison seems also to be misleading.
“Bitcoin is a bubble” – looking at the price evolution is 2017 suggests that this could be a bubble. But what is a bubble?
“A bubble is an economic cycle characterized by rapid escalation of asset prices followed by a contraction. It is created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behavior. When no more investors are willing to buy at the elevated price, a massive selloff occurs, causing the bubble to deflate.”
Well, it is most likely some sort of a bubble – there will be price corrections and at some point in time Bitcoins will be super-seeded by a technology eliminating its constraints in terms of fairness, transaction rate and energy consumption.
“Bitcoin uses enormous amounts of energy” – this seems to be one of the concerns people love to make comparisons and also promote the idea that more transactions results in more energy consumption. Yes, it uses a lot of energy but this energy is what makes the network safe in the current proof of work- mining. An attacker would need to invest a substantial amount of these resources to destabilize the bitcoin network. The amount of energy used does however not correlate with the number transactions processed.
“Bitcoin is the new gold” – this seems to sound right when thinking about mining Bitcoins. There are the miners who produce gold and the limited supply makes gold valuable. The amount of natural gold on the planet is limited like the total amount of Bitcoins. But astro mining will change this for gold not too far in the future – experts talk about 20 years from now. Bitcoin’s mathematical foundation stays.
These points are properly summed up in Steve Wozniak’s statement “Bitcoin is mathematical. I am a mathematician. There are only 21 million. It is more legitimate than other systems”.
The following is a pretty good description:
- It says that it is a limited resource currently slowly increasing day by day peaking at 21 million. So far, all resources which are limited and of interest, increased in value. While Bitcoin was rather unknown even 2 years ago it is now a hot topic in all media with people making harsh statements primarily defending their own interests.
- Steve also calls it a system – there is neither a government nor a company with management nor an individual running Bitcoin. The system is very cleverly built – it is an amalgamation of many disciplines and was so far self-balancing gravitating towards a stable state where all the participants jointly benefit.
Maybe we add the following characteristics
- The system is transparent – everybody can observe all transactions.
- The system is democratic – everybody can use it or become a miner.
- The system is self-balancing – no government or company decides its direction
- The system is energy inefficient – a result of the proof of work mining approach
- The system is not completely fair – miners can prefer juicy transactions
- The system is open – all technology is freely available
A hyperconnected digital economy needs inherently digital media of exchange. Bitcoin is most likely the first step into such a direction. It’s ten years history demonstrates that such a system is possible and triggered a whole new set of echnology innovations. Crypto currencies represent a fundamental upgrade to the economic systems of the world. Once they have matured and are integrated into the mesh economy, the world will look very, very different.
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