Why Bitcoin is the largest Ponzi scheme in human history
Bitcoins’ market price is almost certain at some point to crash and burn, just as the dotcoms did
During the late ’90s, Silicon Valley venture capitalists and New York City investment bankers used phrases such as “monetising eyeballs”, “stickiness”, and “B2C” to justify the ridiculous valuations of Internet companies. They claimed that conventional methods were inapplicable in valuing the dot-com companies — which had no revenue — because they were entering into an entirely new economy.
Believing these people and being afraid to miss out on the gold rush, small-time investors, grandma and grandpa, and barbers and taxi drivers invested their life savings in companies such as Pets.com, Webvan, and eToys. The bubble burst, and they lost everything. Through a transfer of wealth in the billions of dollars from Main Street to Wall Street, venture capitalists, unscrupulous CEOs, and bankers had effectively enriched themselves at the expense of hundreds of thousands of ordinary investors, leaving them to despair about their futures.
History is repeating itself now with Bitcoin. This time, it isn’t just Main Street US that is about to lose its shirt; it is the developing world. Technology has made it possible for hypesters in Silicon Valley, China, and New York to fleece anyone, anywhere, who has a bank account and an Internet connection.
The story that Bitcoin victims are being sold is one in which, on the basis that we cannot trust government-issued currencies, Bitcoin is the future of money. A PayPal director predicts that Bitcoin’s price will reach $1 million in the next five to 10 years; asset managers say it is the new gold.
This is complete nonsense. Yes, the price of Bitcoin may yet double or even quadruple — because its price is based on pure speculation, and these stories are feeding such speculation. But Bitcoins’ market price is almost certain at some point to crash and burn, just as the dotcoms did, and for the same reason: because it is all hype. And there will be no one to turn to when it does, because no government or bank is backing it; and the people who are hyping Bitcoin will have cashed out and be long gone.
Bitcoin’s price is not a reflection of its growing usage as currency; it reflects merely demand for the mirage of its speculative value, a mirage kept in artificial scarcity. Its price is rising only because people all over the world are hearing stories of how others doubled or tripled their money in a short period — and they don’t want to miss out. Unsophisticated investors are taking out loans to buy Bitcoins. Those who have spent a Bitcoin feel remorseful when they see its price subsequently increase, so they hoard it.
Bitcoin was invented by an unknown person or group to be a digital currency. It allows money to be transferred directly between individuals using cryptography. The bank ledger is distributed to all users, and complex mathematical transactions ensure transaction integrity. Such a system makes it difficult for governments to know the identities of people exchanging money so it has become a haven for money laundering, drug dealing, and corruption.
Beyond its useability for crime, Bitcoin has major design flaws.
Bitcoins are created (or “mined”) at predetermined and gradually decreasing rates, with a total limit of 21 million issuable coins. The rate of increase in available Bitcoins is not keeping pace with the number of people keen to buy them, so the price of a Bitcoin keeps increasing. Because its price increases, both its “miners”, who use their computers to do complex calculations to create the currency, and those who buy Bitcoins from others feel reluctant to use them as currency by spending them. Instead, they sit on their coins while they wait for their price to rise further. With Bitcoin supply constrained and increasingly falling short of demand, instead of functioning as a currency, Bitcoin is a speculative empty asset.
Then, there are problems with the technology itself.
First, anyone who has access to a Bitcoin password (or private key) has the authority to spend the Bitcoins it unlocks; loss of the password means loss of all of the associated Bitcoins, with no recourse. Second, linear growth in the chain of blocks that make up Bitcoin is resulting in exponential growth in the computation necessary to process and verify transactions: transactions that used to take 10 minutes now take hours. Third, with Bitcoin transactions fees hovering above $25, a ₹500 payment now costs more than ₹2100. This obviously is not a workable digital currency.
What is most worrisome for the planet is the energy expenditure that verifying transactions now requires.
The Bitcoin network is reportedly consuming energy at an annual rate of 32TWh — about as much as the entire nation of Denmark. Each Bitcoin transaction consumes 250kWh, enough energy to power an average western home for nine days. China has become the dominant Bitcoin-mining nation with its provinces providing ultra-cheap energy to miners.
Digital currencies surely are the future, but other countries are already racing ahead in developing these. Take China’s WeChat Pay and Alipay, which already process $5.5 trillion of payments or India’s Unified Payments Interface, which makes it possible to transfer money between people within seconds — for no fee. This occurs bank to bank and provides customer support and security.
There are better and simpler ways Vivek Wadhwa is a Distinguished Fellow at Carnegie Mellon University at Silicon Valley and author of The Driver in the Driverless Car: How Our Technology Choices Will Create the Future. The views expressed are personal