Bitcoin #2

Financial, societal and environmental implications

Following our Three-thinkers business club on Bitcoin this blog takes a three-thinking approach that looks holistically at the financial, societal and environmental implications of the technology.

Financial

Bitcoin was launched to the backdrop of a global economic crisis and credit crunch that started in 2008. That crisis has served to remind us that even major currencies are vulnerable and dependent on the confidence of those using it. Therefore the prospect of a having a more diverse range of currencies to serve specific purposes or a particular local area might help to develop more resilient financial system. Crypto-currencies such as Bitcoin may play a role in that.

As a smaller business, it is possible to accept Bitcoin for payment and the transaction costs associated with accepting it are low. However, the business case for adopting in the UK doesn’t yet appear to be that strong. Bitcoin users are a relatively niche bunch so there are relatively small number of consumers to appeal to. Additionally, there are risks involved. Not having a central authority to govern it is a double edged sword if you’re the victim of a fraud for example, and for ‘bricks and mortar’ retailers the long transaction confirmation process is a less than ideal feature. The value of the currency also remains highly volatile, In December 2013 one Bitcoin was trading at $1,200 USD, whereas today the price is around $600[i].

One of the attractions of Bitcoin is its ability to transfer money between countries quickly and cheaply and as such Bitcoin could be an attractive option for remitting money abroad. Many workers overseas need to send money home, and at the moment this is an expensive business. Most people in developing countries have mobile phones, but many don’t have bank accounts.  Services like the newly launched Bitpesa[ii], take advantage of this, facilitating the transfer of money abroad quickly and cheaply – in Bitpesa’s case, to Kenya[iii].

Whether or not such remittance businesses have a long term future depends how regulation develops. Part of the reason existing money remittance services are expensive is due to the compliance processes that they have to implement, Bitcoin is cheaper in part because it can avoid them. Increasingly governments are looking to regulate Bitcoin in a similar way to their national currencies, which will make the process more expensive and has already deterred some potential businesses from entering the Bitcoin remittance market[iv].

One of the other significant economic debates around Bitcoin revolves around the deflationary nature of the system. This discussion moves us into debates around economic theory and so for the purposes of this blog the discussion is necessarily simplified. In most currency systems, central governments (and their banks) increase the money supply over time and aim to keep a low but positive level of inflation. A low level of inflation is seen as desirable for encouraging economic activity, and helps solve the problem of wage and price ‘stickiness’, the observed phenomenon that wages and prices don’t necessarily adjust downwards to reflect falling demand for goods and services.

The Bitcoin system is quite different in that the maximum amount of currency in circulation is predefined. There can never be more than 21 million Bitcoins in circulation, something which will occur around the year 2030. Where Bitcoin is simply treated a payment system and people are converting from sterling or dollars to Bitcoin this is doesn’t present a problem[v]. However, in a scenario where Bitcoin is a major currency, the constriction of the money supply as fewer and eventually no Bitcoins are mined would make those that are in circulation more valuable.

The deflationary aspect of the currency might be intuitively appealing from an environmental perspective. People are incentivised to hold onto savings rather than spend on consumer goods, with the implication is that this might help to incentivise spending habits that favour higher quality, longer lasting products.  However, more significantly it also runs the risk of stalling the economy as economic agents simply stop trading with each other and hoard their Bitcoins as an increasing store of value. Because wages don’t tend to be realigned downwards, this could result in unemployment which serves to exacerbate the problem leading to a deflationary spiral.[vi]

Social impact

The way in which Bitcoin replaces the need for a central controlling body may have significant societal implications. The Bitcoin protocol acts like a kind decentralised voting mechanism, whereby the validity of a transaction is dependent on many users validating a transaction and in a sense ‘guaranteeing’ the system. Regardless of the success or not of Bitcoin, this principle of distributing and embedding security and integrity across the network of users has potential applications elsewhere. For example a new email application called Bitmessage, uses similar principles with encryption and security functions spread across the system rather than one central server[vii]. Thomas Spaas, a lawyer from the Belgian Bitcoin Association, has gone as far to suggest this principle can be used to protect and further human rights as the need for centrally trusted parties that can then abuse their power is diminished[viii]

However, it is possible to overstate the democratic nature of these types of system. Although the Bitcoin system relies on many miners, the complexity of the system now means that on top of the technical know-how, you now require powerful computers and specialist technology in order to join the ‘mining’ community. The resulting concentration of ‘mining’ power means that one group of ‘miners’ has recently grown large enough to control over half of all Bitcoin mining[ix]. Bitcoin wealth itself is also extremely concentrated with one estimate suggesting that over half of all Bitcoins are held by 0.1% of those holding Bitcoin wallets, suggesting that the Bitcoin system has a less equal distribution of wealth than society as a whole.[x]

Environmental impact

While Bitcoin itself may be virtual there is a very real world impact in terms of resources being used to create the currency, most significantly in the energy required to solve the ever more complex mathematical problems on which the systems integrity depends. This is where Bitcoin is similar to older commodity based currencies such as those based on gold and silver, and where the analogy of ‘mining’ is quite apt. It can be argued that the effort required to ‘mine’ Bitcoin, stands as a kind of proof as to the currency’s value in a similar way that the effort required to mine silver of gold are testament to those precious metals’ value [xi]. The economist Paul Krugman, argues that this is ‘retrograde’ step, and invokes 18th Century moral philosopher and political economist Adam Smith’s critique of commodity based currencies that he argued provided only a symbolic purpose but in doing so used up real (and scarce) economic resources [xii].  

Regardless of the exact KwH used, a fact of the Bitcoin system is that it does rely on significant energy to make the system run and that has a very obvious knock-on environmental impact. What I’ve not seen discussed, is how this energy use compares to the cost in resources saved of a centrally run management system which otherwise be used to administer and oversee the system, as in part the energy used is replacing that centralised function of people and offices. It’s perhaps an impossible question to answer with any certainty but a valid point of inclusion in the Bitcoin environmental impact discussion.

Emerging questions

At our Bitcoin Three-thinkers event, we had an interesting discussion on the themes outlined above, which led to the following additional emerging discussion points:

  • Bitcoin was devised to see if a currency could be created without a central authority. Would it be possible to create a currency whose mechanism incentivises other societally beneficial behaviours for example around sustainability. Solarcoin is a new cryptocurrency that seems to be doing just that[xiii].
  • Bitcoin relies on the solving of ever more complex cryptographic algorythms in order to work, which relies on increasing levels of computer power and energy. To what extent is this compatible with a low carbon future. Will Bitcoin be frowned upon for its profligate use of energy, or will it be a non-issue because we’ll have switched to renewable energy sources to power it?

 

Also in this blog series:

Bitcoin #1 - What Bitcoin is and how it works

 

References:

[i] Foxton, Willard, ‘Could the so-called Bitcoin 'price crash' be good for the cryptocurrency?’ The Telegraph, 6th August 2014. Available at: http://blogs.telegraph.co.uk/technology/willardfoxton2/100014074/could-the-so-called-bitcoin-price-crash-be-good-for-the-cryptocurrency/ (Accessed, 8th August, 2014)

[ii] Bitpesa website https://www.bitpesa.co/ (Accessed, 8th August 2014)

[iii] Jamie Bartlett ‘How Bitcoin can transform the developing world’ The Telegraph. 3rd July 2014. Available at http://blogs.telegraph.co.uk/technology/jamiebartlett/100013941/how-bitcoin-can-transform-the-developing-world/
(Accessed 18/07/2014)

[iv] Risso, Pete (2014) ‘Why Bitcoin faces an uphill battle in the remittance market’ Coindesk 31st March 2014 (Accessed 8th August, 2014)

[v] Weisenthall, J. (2014) “Why Bitcoin Will Never Have A Problem With Deflation” Business Insider. February 4th, 2014. Available at: www.businessinsider.com/bitcoin-doesnt-have-a-deflation-problem-2014-2#ixzz3ASnQRZq4 (Accessed, 15th August 2014)

[vi] The Economist (2014) “Money from nothing : Chronic deflation may keep Bitcoin from displacing its fiat rivals”. The Economist. March 15th, 2014. Available at: http://www.economist.com/news/finance-and-economics/21599053-chronic-deflation-may-keep-bitcoin-displacing-its-fiat-rivals-money
(Accessed, 10th August, 2014)

[vii] Cawray, Daniel (2014) ‘Bitmessage is the bitcoin of online communication’. Coindesk 3rd June, 2014 (Accessed 10th August, 2014)

[viii] Spaas, Thomas (2014) ‘The concepts of Bitcoin and their impact on the worldwide legal space’ TEDx Hassalt University, March 2014. Available at: https://www.youtube.com/watch?v=20r6DLhn7o8
(Accessed 10th August, 2014)

[ix] Lawler, J. (2014) ‘Bitcoin’s new problem’. Washington Examiner. June 17th 2014. Available at: http://washingtonexaminer.com/bitcoins-new-problem/article/2549847
(Accessed 10th August, 2014)

[x] Fung, B. (2014) ‘Forget the 1 percent. In the Bitcoin world, half the wealth belongs to the 0.1 percent.’ The Switch. The Washington Post. 3rd March 2014. (Accessed 10th August, 2014)

[xi] Velder, F. ‘Bitcoin: A Primer’ Chicago Fed Letter. Essay on Issues. Chicago Federal Reserve Bank. December 2013. Number 317.

[xii] Krugman, P. (2013) ‘Adam Smith hates Bitcoin’ Blog post. New York Times. April 12th 2013. Available at: http://krugman.blogs.nytimes.com/2013/04/12/adam-smith-hates-bitcoin/
(Accessed 10th August 2014)

 

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