Disclaimer: I am a heavy advocate and believer in the ethereum platform, and similar technologies. This assumes that the reader has heard of cryptocurrency and might have the most basic understanding of its underlying technology. I do not presume to be an expert in cryptography, blockchain, the internet, or anything for that matter. I simply wish to express my views for the sake of learning from other’s viewpoints.

A Personal View on Bitcoin

“Bitcoin is going to change the world.” A few words that I heard in 2014 at a startup conference that stuck with me for the next few years. As an engineer, I looked into bitcoin, blockchain and the technologies that began making headlines (e.g. ethereum, litecoin, etc.). My research led me to make investments into cryptocurrency. However, with the recent explosion of Bitcoin throughout the media, I formed a more rigorous hypothesis that led me to question mainstream thinking. Basing my thoughts on a semi-technical understanding of blockchain and basic economics knowledge, I arrive at three main argument points on the validity of bitcoin, or any cryptocurrency for that matter.

  1. Will bitcoin be able to become a currency that is widely used?
  2. Will bitcoin become a valued asset that yields significant dividends?
  3. Will bitcoin become a mode of intermediate to long term value storage like gold?

I address all three points from what I have researched and experienced with the conclusion that bitcoin is not worth the financial hype. (Similar blockchain technologies like ethereum are another topic for another time)

I will do my best to break each general question into a series of hierarchical simple questions. These will guide my thinking and I hope I can convince to come to the same conclusions I have.

Can Bitcoin Become a Largely Used Currency?:

Society uses currency as a way of exchanging value and goods. Traditionally we defined goods as perhaps a cow, spices or leather goods. Instead of trading refined tea leaves for a pair of leather shoes, we come to an agreement on a common value holder. We agree that tea leaves are worth $X and therefore one would be willing to trade leather shoes for $X knowing that they can then use $X to buy tea leaves. We need currency because this enables this fundamental exchange of goods and services. Now enters bitcoin. A disruptor within the currency world. A David to the US dollar’s Goliath. It becomes easy to be blinded by the trillions of value that the USD holds, whether it is in retirement funds, or global banks. As a currency, it is necessary that there is universal usage and stability. Having USD is only valuable because there are many people that are willing to exchange goods and services for it because they know that it has a universal value. The USD is stable in that purchasing goods for $10 one day probably means that those goods are still worth $10 the next. Bitcoin is slightly flawed and different in a few ways that are important to note.

It is common knowledge that Bitcoin has wild fluctuations in pricing. If people are buying into bitcoin believing it can be the currency of the next-generation and this causes massive fluctuations, then this is inherently contradictory. No one will use Bitcoin as a currency if buying goods for 5 Bitcoin costs 1 Bitcoin, or 200 Bitcoins in the next hour. This then leads to the next point of Bitcoin as having universal usage. While it is true that Bitcoin overcomes many barriers in global transactions that current transaction systems have, it still will not become universally accepted. It has the technical features that can allow it to be easily universally accepted, but it is up to society to implement paths to accept Bitcoin as a method of payment. However, in order to be universally accepted as a currency, it has to demonstrate that it can function as a currency. This leads to a circular dependency that will be hard to solve given Bitcoin’s limited functionality. Without true universal usage and stability, Bitcoin will not be able to achieve status as a widely used currency.

Can Bitcoin Become a Dividend Yielding Asset?:

Stocks and bitcoin dreamers have one thing in common. Their value is tied to the assets and value that they provide society. We buy equity in Amazon because we think their value will increase in the future. We think that because we believe their total market cap (valuation) will continue growing. Bitcoin has been touted to possibly be able to act as a secure, fast, and robust transaction system. Many people buy into bitcoin because they think it will accumulate future value. This is falsely over exaggerated. Bitcoin as of now and the foreseeable future is only capable of creating value in society for certain transactions. Its use in society would be to provide services as a transaction system. If we buy in believing that we will get a return on investment, then we believe that its service provided will continue to increase in value. So this argument line is predicated on the ability of bitcoin to increase its value add as a transaction system to society.

Without getting into the technical details of bitcoin and blockchain, I present three examples of how this is highly unlikely. Firstly, bitcoin transactions are currently dependent on expensive hardware, which incur large electricity bills. This builds a reliance on centralized mining organizations formed and it is important to note that much of the computing power is located in China, under the jurisdiction of the government there. This demonstrates two unintentional flaws in the bitcoin network: centralization and unlikely scalability. Bitcoin was designed to be decentralized to incur all the benefits that would come with it (I would encourage everyone to do their own research into this, since it is a complex topic itself). However, due to the nature of mining on the bitcoin network, mining organizations have formed, which inherently form centralized hubs of bitcoin network computing. Secondly, bitcoin scalability heavily relies on expensive hardware, which is not readily accessible by the average consumer. The idea of scaling bitcoin, so that it is completely decentralized with most consumers contributing to the network to process transactions is flawed. Most average users will not buy expensive hardware to contribute to the bitcoin network and those that do will most likely join a mining organization, thereby preventing scalability and decentralization. This in turn argues against the idea that bitcoin has a future value tied to its ability to become a largely implemented transaction system.

One might ask how Bitcoin might overcome this reliance on expensive hardware to solve these downstream problems? There has been online conversations of changing the Bitcoin network’s internal infrastructure. Currently bitcoin uses a very secure algorithm called, Proof-of-work (PoW), which relies on a lot of heavy computing power to process transactions. There are other algorithms that have been in academic research, and have shown improved scalability and speed. One such example is Proof-of-stake (PoS), which has been shown to be just as secure under certain assumptions. The largest difference is that PoS will not rely on heavy computing power, thus enabling the average consumer to become part of the blockchain network and extinguish the need for centralized mining organizations. However, Bitcoin has shown that it will not take action to implement any changes like this. Unfortunately, the creator of Bitcoin, Satoshi Nakamoto, has faded into the shadows in terms of contributing a voice to the direction of Bitcoin. Thus, there is no evangelist that can lead the charge in voicing necessary changes to the Bitcoin network. Most users and developers on the network have differing views on how Bitcoin can be improved, but without a centralized leader to take charge on these improvements, they are unlikely to occur. A slight tangential example can be seen in Ethereum, where the creator and evangelist of Ethereum has taken a strong voice in leading the most important improvements to Ethereum. If Bitcoin chooses to implement various changes to the network, then it is quite possible by that time, there are new cryptocurrencies that were built and designed to overcome these various challenges from the start. Then one might ask, what is the point of owning Bitcoin over these other coins that actually have more potential value add to society?

Can Bitcoin Become an Intermediate/Long Term Value Storage?:

This final view on Bitcoin is slightly related to its potential as a currency, but with some differences. A value storage asset is something like a house, gold, or jewelry, where the value is retained over time (or grows for that matter). The primary necessity for any value storage are liquidity and a limited supply. Gold and Bitcoin both have fundamental economics that drive their pricing. There is a limited supply, and demand for this supply will determine its pricing. We have talked about how demand for this supply might come in the form of using it as a currency, or holding it as a value-incurring asset. Now, I discuss a related point of using Bitcoin as a vehicle for storing value. For any average consumer, putting money into gold means that you want to be able to extract the value of that money at any time, and expect similar, if not grown value. This is similar to its properties as a currency. Gold is an example of a liquid investment because it is able to be sold easily at any time and maintains a relatively stable pricing. This is contrary to Bitcoin, where prices fluctuate wildly and it is not as easily converted into cash. It is true that there are now many Bitcoin exchanges where Bitcoin can be sold and converted into cash. However, these are subject to centralized regulations from governments. For example, just recently, China enforced some heavy regulations that shut down cryptocurrency operations within the country. So even though consumers can directly use the Bitcoin network to liquidate their Bitcoin investment, it is highly unlikely that many consumers will have the tools and knowledge to be able to do so. Thus, they rely on these centralized exchanges that have been shown to be subject to the whims of the local government. Although Bitcoin has a limited supply, it has unintended flaws in its liquidity that do not allow it to become an attractive vehicle for long term value storage.

In addition, to a problem with liquidity, there is a problem with competition. In rare metals, like gold and platinum, there are no gold replicas, or platinum replicas; there is only gold and platinum. With bitcoin and cryptocurrencies, there is an explosion in different implementations and designs that seek to improve on the original bitcoin. These create digital competitions in the sense that, we cannot have multiple “irreplaceable digital gold.” This is inherently contradictory, and so the argument that bitcoin can be a replacement for gold does not hold true because of these alternative coins that have more or less the same functionality.

Conclusions and Summary:

So I've discussed three viewpoints of Bitcoin as a cryptocurrency: i) usage as a currency, ii) a dividend-yielding asset, and iii) a "digital gold" as a value storage. While all these points of view have some valid arguments in favor of Bitcoin, they have some underlying flaws that are hard to solve. They are hard to solve because of numerous reasons, but in my opinion, it is due to the way Bitcoin was originally designed and it's mechanisms for change. I think that a truly successful cryptocurrency will be able to encompass all three viewpoints by not only having a well-thought-out initial design, but also a robust mechanism for changing the blockchain operations.

Bitcoin has a lot of problems. Nonetheless, it is the first mainstream technology of its kind, and it will spur a generation of technologies that will change the world for the better.

References:

  1. China shuts down bitcoin exchanges
  2. South Korea Clamps Down On Bitcoin Exchanges
  3. Link to centralized mining rigs for bitcoin
  4. Link to usd total assets in world