Much ink has been spilled on Bitcoin and its smaller cryptocurrency siblings. I’ve recently thought a lot about the impact of cryptocurrencies on financial systems and on the world at large. While I do not expect that any conclusions may stand for long, I’ve tried to sum up what I understood so far and digest it for my readers here. Apologies for any technical inaccuracies – please highlight them in comments.
First, a few thoughts on what’s new and different about Bitcoin:
- The intellectual and technical work that Bitcoin stands on, my geekier friends agree, is an astonishing leap forward from everything we’ve seen before. Satoshi Nakamoto is not one person, as multiple disciplines from cryptography to software engineering were involved in its conception, but may have been a small group of people with the extraordinary discipline to publish some brilliant open source code and yet not to come forward and reveal themselves, at least so far. Code that is an achievement in that it is not just smart, but also amazingly robust. If Satoshi Nakamoto were one person, his achievements would be on par with those of Sir Tim Berners-Lee.
- The main reason why it’s difficult to explain Bitcoin to people is that it’s a system where flows, not stocks, are certified. If I start with $100 in my bank account, I deposit $50, and then I take out $30, my bank knows what I did, knows that I have a new balance of $120, and can print me a statement with that balance. If I do the same with Bitcoin, all that’s monitored is the flow: “in 50” and “out 30” are recorded on a ledger replicated on thousands of servers all over the world, but my new balance of 120 – just like my old balance – is strictly my information, and nobody else has it. The Bitcoin community validates the flows; the algorithm cares not one bit about stocks.
- The total quantity of Bitcoin in the Bitcoin system is algorithmically predetermined, and in that sense is the only stock that matters to the system. This also means that, at some point (roughly around the year 2140), mining will stop and the quantity of Bitcoin will be fixed. No central bank, commercial bank or other authority will be able to print more. As we’ll see below, this has important macroeconomic implications.
- Other things that strike people as weird are that Bitcoin is strictly a bearer instrument (you lose it, you have no recourse) and that transactions, once validated, are irreversible – unlike with your credit card or your PayPal account, there is no chargeback mechanism. Transactions are final.
- Most importantly, a “trustless” network that keeps working with no central authority and never collapses – because trust is distributed and resides in the consensus mechanisms that enables the endless replication of the blockchain – is in itself a concept that takes a bit of time getting used to.
- Volatility? Oh yes, plenty. Don’t stash your mom’s retirement nest egg in a Bitcoin wallet. That’s not what it’s for, really.
Where different players stand:
- Economists are intrigued, but do not believe that at a macro level Bitcoin can power a sophisticated economy. While the developer community is working to overcome this limitation, for example, Bitcoin as it stands today can carry out only a limited number of transactions: 7 transactions per second. (Visa, depending on which source you believe, is said to support 10,000-50,000 per second).
- Also, there is not enough Bitcoin in the system, and there never will be enough for a significant world economy to adopt it to the exclusion of other currencies. If output is to grow and the quantity of money cannot grow, deflation wreaks havoc because the debt in the system becomes unsustainable. And “debt is to capitalism that which Hell is to Christianity: seriously unpleasant but absolutely necessary”, claims economist Yanis Varoufakis (yes, he who just became Finance Minister of Greece).
- Regulators are walking a fine line. Err on the side of protecting consumers from risk, and you stifle innovation; err on the side of fostering innovation, and a lot of people will go bust. Not because the Bitcoin technology per se is unsafe, but because issues come up at the edge, in the wallets and exchanges that sit at the crossroads of Bitcoin and fiat currencies. The blockchain is resilient and continues to function when mayhem happens, but people get burned.
- London is trying to ride the Bitcoin wave, with a light regulatory touch and a Chancellor of the Exchequer who has voiced support for cryptocurrencies as an enabler of financial innovation – although the Treasury review he commissioned is taking longer than expected. New York State is working on a “BitLicense” regulatory framework, although critics say it is too restrictive for New York to become a Bitcoin hub. The US Commodities Futures and Trading Commission says Bitcoin is a commodity, not a currency, and falls under its remit. The European Central Bank and the European Banking Authority have highlighted risks for consumers, recommended that banks refrain from buying or holding bitcoin, and then mostly kept silent: one gets the feeling that they would really rather see the whole headache go away. But Bitcoin has no borders, does not reside anywhere and recognizes no nations: shouldn’t we aim for a global framework, instead of burdening the ecosystem with incompatible rules, lack of interoperability, and unsustainable compliance costs?
- Financial institutions, though listening to regulators out of one ear, are eager to become players in the Bitcoin economy, or at least to be seen as such. See the recent investment by, among others, BBVA and the NYSE in Coinbase.
- There already are better ways than Bitcoin to implement an alternative and decentralized payment network. Ripple, although not perfect, is said to be one. Stellar is another one.
- Expecting that Bitcoin will be a major world currency five or ten years from now would be a bit like betting in 1995 that AOL would be the dominant Internet service in 2015. It’s still very early days. The entire Bitcoin system is barely six years old. We haven’t seen anything yet, really.
- In addition to finance, there are a lot of things you can do with a system that decentralizes the hard work of certifying a transaction between two parties. Indeed, some go so far as to say that Bitcoin isn’t the point of the Bitcoin technology: “Bitcoin as a currency has been a red herring driven by speculative investment, but that’s not the ultimate potential or the most exciting thing about it” (Coinbase CEO Brian Armstrong, quoted in Quartz). In other words, a virtual currency is just one application enabled by the blockchain: it has been and is important as an incentive to participants (miners) and to create liquidity in the system, but it won’t be the only use of the technology in the future.
- Sidechains – ledgers that experiment with features that might be added the Bitcoin core, or might serve some entirely new purpose, without actually jeopardizing the stability of the blockchain – will be big. See Austin Hill and Adam Back’s Blockstream, which is now backed by Reid Hoffman.
- Under so-called “Bitcoin 2.0” frameworks, you can make money programmable, for example tag a certain bitcoin for spending only with certain counterparts. You can also have a bitcoin represent other types of assets than money, such as a car, a company share, a vote in an election (video).
- The most ambitious project inspired by the Bitcoin blockchain (but entirely separate from it) seems to be Vitalik Buterin’s Ethereum, not just a platform allowing for contracts written as computer code, but an entire scripting language and programming environment to create an ecosystem with self-enforcing contracts, distributed autonomous corporations, and perhaps entirely novel models for political organizations.
- Would a software-based societal model be resilient enough to cope with the real world, or would it be too brittle to withstand shocks by reacting intelligently? Would the utopistic libertarians willing to delegate a part of their life to a blockchain risk waking up in a dystopia of inequality, polarization and control? Hard to say. What we can say is that as a society we need to understand the technology, weigh the upside potential against the risks, and make collective choices that will serve us well for the future.
Images credits (and recommended article): Quartz. Thank you to some of the smartest among my friends and colleagues, who helped me clarify my thoughts on the topic: Giovanni Daprà, Vincenzo Di Nicola, Raffaele Mauro and Stefano Quintarelli.