Bitcoin is not the bold new future of money. (Blame the hoarders.)
Sometimes it’s hard to tell whether bitcoin is more like a Ponzi scheme or a pyramid scheme.
Whatever it is, though, it isn’t a currency. It’s a tech stock. Each bitcoin is really a share in a system that seems tomake it cheaper to transfer things online — money, stocks, bonds, even the deed to your house — by cutting out the middleman. Well, kind of. Bitcoin doesn’t remove the middleman so muchas replace him with middlemen who don’t make you pay much, but make society as a whole do so instead. Is this progress?
It’s supposed to be. Ever since the early days of the Internet, people have tried to figure out how to transfer money online without having to go through the financial system. The problem, though, is if I send you money, how do you know I haven’t already spent it or sent it to somebody else? You don’t. So the only solution has been to use a trusted third party, such as a bank. I send money to the bank, it verifies that I have this money to send, and then it sends it on to you— all for a 2 percent fee, of course.
Bitcoin’s breakthrough is to have a decentralized network of “miners” sit between us instead. These miners create a public ledger of every bitcoin transaction, what’s called the blockchain. That includes every bitcoin ever won, used or transferred. So now we don’t need a bank to know that I have the money I’m sending to you, and that I’m only sending it to you. The miners confirm this. Andthe best part is that instead of having to pay the bank myself to do this, the system pays the miners in new bitcoins.
The question, though, is how you get people to mine bitcoin. Sure, bitcoin is digital money people can use to buy things online, but they already have money to buy things online. And while merchants would be more than happy to save the 2.5 percent they pay in credit card transaction fees, customers are a lot more blase since they don’t pay them directly.
The answer, then, was to do what makes anything popular: Make it exclusive. Specifically, bitcoin limits the total number of coins that will ever be created to 21 million. Now, for bitcoin’s first year and a half, as Nathaniel Popper documents in his page-turning history “Digital Gold,” only a handful of people mined it. But that began to change when libertarians, convinced that the Federal Reserve’s money-printing would doom the dollar, discovered bitcoinandits non-inflatable money supply. A boom was born.
But what made people mine bitcoins is what has kept them from spending bitcoins. Think about it like this: Bitcoin’s finite supplymeansthat its price should go up, and keep going up. So if you have dollars that are losing a little value to inflation every year and bitcoins that are gaining it, which one are you going to use to buy things? The question answers itself, and it raises another. Why would this ever change? Unless you can’t buy something online with dollars — such as drugs — you’d always want to use dollars. Buying things with bitcoin would be like cashing out your Apple stock in 1978 to go grocery shopping even though you have plenty of actual cash lying around.
The Catch-22 is people buy bitcoins because they think the price will go to infinity and beyond once everybody uses them, but that’s also precisely why they don’t spend their own bitcoins. And so nobody uses them. So the bitcoin faithful have tried to not only convert people, but also persuade them to martyr themselves, financially speaking, for the crypto-cause.
But bitcoin is good for transferring money, or anything else for thatmatter, online.
“The design supports a tremendous variety of possible transaction types,” bitcoin’s inventor Satoshi Nakamoto wrote back in 2010, including “escrow transactions, bonded contracts, thirdparty arbitration, multi-party signature, etc.”
So anytime you need to send any kind of financial asset or agreement to somebody else, you can send it along with a bitcoin and, through the beauty of the blockchain, avoid having to pay fees. That’s why Wall Street banks are looking into whether they can build their own block chains to cut costs before their competitors do. And while sending money is cheap within the United States, doing so across international borders is not — the average transfer fee is 7.5 percent, according to the World Bank. It’s not hard to imagine that bitcoin could claim a big chunk of the $500 billion remittance market, although the difficulty of getting the physical cash to people in developing countries is a significant hurdle.
Wait. How does the blockchain cut costs again? Remember, instead of you paying the bank a fee to process a transaction, the bitcoin system pays miners new coins to do so. Then these transactions are added to the list of all others in the public ledger, the blockchain. But anytime it seems like you are getting something for nothing, the costs are probably just hidden.
What are those costs? Well, bitcoin mining is a pretty expensive business. Even the most specialized computers, which mine bitcoins and only mine bitcoins, require a lot of energy. So much so that bitcoin miners have set up shop in far-flung places such as Iceland, where geothermal energy is cheap and arctic air is cheaper still — free — for them to run and cool their machines at the lowest price.
Okay, but why should we care that bitcoin miners have big energy bills? The problem is the price you pay for energy does not include the cost we all pay for pollution. So energy-intensive businesses that are paying less than they “should” can generate environmental spillovers for everyone else. Once you take this into account, it is not clear how much bitcoin is cutting costs so much as shifting them.
It’s not clear what bitcoin is or what it will be, but it is clear what it’s not. It’s not a currency. People don’t set prices in bitcoin and, for the most part, don’t buy things with it either. The only function of money it comes close to performing is as a store of value, but it doesn’t even do that well. Even though it seems like bitcoin prices should go up and up and up, they haven’t for a year and a half. In fact, bitcoin’s $225-a-coin price is 80 percent less than its December 2013 peak.
That said, bitcoin might be a betterway to send things online— or at least the blockchain might. In fact, the future might not belong to bitcoin but to its technology.
Bitcoin coins are shown in an illustration taken at LaMaison du Bitcoin in Paris. Bitcoin’s finite supply means that its price should go up, and keep going up, which creates a bit of a Catch-22: People buy bitcoins in anticipation of rising prices, but that is also precisely why they don’t spend their own bitcoins, so hardly anyone uses them.