Type to search

Opinion: The Problem with Bitcoin


No financial topic arouses, or indeed has ever aroused, quite the same level of passion that Bitcoin does. Its evangelists are convinced that the decentralised digital currency, invented in 2008 by the still pseudonymised Satoshi Nakamoto, is the future: a truly democratic open-source unit of exchange that’s free from central control. They are, unfortunately, mistaken, and Bitcoin faces major, in some cases insurmountable, hurdles to becoming what many expect it to be.  

First, Bitcoin faces an existential crisis: what is it? In Nakamoto’s 2008 white paper, he proposes that the value of Bitcoin is as a currency. More specifically: it is proposed as an exchange network that does not require a mediating third party, and one, therefore, that avoids the associated inefficiencies. Money, or currency, must be a store of money, a unit of account, and a medium of exchange. In today’s world, one can expand on this, and say that money must be durable, portable, divisible, uniform, and limited in supply. Bitcoin fails to satisfy any of these conditions. Wild price swings mean that it is neither a good store of money nor an adequate unit of account. Its anonymity means that it is loved by criminals, deterring law-abiding citizens and business, thus making it a poor medium of exchange. And whilst Bitcoin is technically limited in supply, the rapidly growing market of cryptocurrencies (estimated to be around 6,000) means that aggregate supply is potentially infinite. Bitcoin therefore cannot be considered, at least in its current form, as a reasonable alternative to fiat currency. I doubt it ever will…

As part cause and part consequence of its inadequacy as a currency, Bitcoin is treated as an asset, and here lies its greatest problem: its value, or lack thereof. In this respect, Bitcoin acts as the almost perfect example of an industry in which value has divorced function. In the absence of any relevant fundamentals, its price reflects nothing other than the speculative fervour in its market. It is the purest greater fool theory investment. Owing to this, it has become a honeypot for naïve investors without the resources to operate in other, more traditional, financial markets. These investors often do not understand the risks of the market and risk losing everything. Bitcoin’s non-productivity is additionally dangerous because it diverts capital away from productive avenues. As of the 25th of October, Bitcoin has a market capitalisation of $1,192,208,471,193. Imagine if that money had been invested in green initiatives.

The Bitcoin market is not only used to facilitate crime by virtue of its anonymity; it is, on occasion, a crime scene itself. A study of crypto trading has just been conducted by an eight-strong team of computer scientists based in America and Switzerland. Their research set out to determine whether cryptocurrency trading is fair when it takes place on decentralised exchanges (DEXes), where individual traders cut deals directly with each other in a relatively transparent way, without a central authority. These exchanges are similar to the dark pools found in other markets. Their research found that the networks have become infested by computer bots. More specifically: some unscrupulous miners and traders have apparently created these bots to anticipate and gain from others’ everyday trades by gaining advantages in the platforms’ information flows, enabling them to siphon off millions — or even billions — of dollars a year in profits. “Like high-frequency traders on Wall Street, these bots exploit inefficiencies in DEXes, paying high transaction fees and optimizing network latency to front-run trades,” the research paper declares. Bitcoin is not the democratic utopia its evangelists laud it to be. And the inevitable atom bomb of regulation (that will send speculators into coronary arrest) will not make it so.

To give Bitcoin some credit, the technology behind it increasingly looks like it may have a useful future. “Distributed ledger technology” including “blockchain” might prove valuable in making activities dependent on safe record-keeping, notably finance, more efficient and secure. A huge number of experiments are underway. A recent Geneva Report on the Impact of Blockchain Technology on Finance, argues that such technology can “mitigate the ‘cost of trust’” and so “lower overall costs, reduce economic rents and create a more secure and fairer financial system”. I hope so.

In the meantime, for those who have made fortunes off their Bitcoin investments: well done – you have played an impossible market with luck and skill. For those who intend to in the future: good luck.

Leave a Comment