Health + Tech /27 Mar 2018
Economists do not like Bitcoin. My favorite university professor is criticizing Bitcoin. Bitcoin is not money. Period. My favorite economist (who works for a commercial bank) is even more critical of Bitcoin. They miss the big picture.
Bitcoin is a digital currency, but it is much more than that. It is a digital currency that works without the intervention of a central institution. The founder of Bitcoin, Satoshi Nakamoto, came up with a method how two individuals who do not trust each other can make transactions without a trusted third party.
You can look at the international remittances market. $600 billion is annually transmitted, with average transaction costs being 7%. That’s a lot of money for a relatively simple task. Secondly, even if transactions costs were low, maybe you are not happy that most of the value trickles to one company. Uber is a $70 billion company, but its drivers earn close to minimum wage. Is that fair? Many people do not like that.
There are 7 main criticisms of Bitcoin:
1. Speed: By design, it takes about 10 minutes to verify a block of 2000 Bitcoin transactions. If you make a payment, it will always take around 10 minutes for that transaction to be verified. That’s fine if we talk about international payments, where we’re used to waiting a couple of days for those transactions to be verified. However, if we want to buy a cup of coffee, 10 minutes is too long. For security purposes, the recommendation is to wait for 6 blocks to be verified on top, which means we need to wait at least 60 minutes.
We want instant payments. To do this, we can improve the protocol. There is an army of developers and economists proposing various ideas how the protocol could be modified. Check out lightning network, plasma or proof of stake concepts. Follow the developments. In a couple of years we might have a fast working crypto currency.
2. Energy use: A typical criticism is that Bitcoin uses too much energy. As of today, Bitcoin’s network uses as much energy per year as all of Bangladesh. To put it differently, one Bitcoin transaction uses the same amount of energy as 27 American households use in one day. This is a big problem. It is related to the Bitcoin protocol design. All computers in the Bitcoin network work together to verify a block of 2000 transactions. They actually compete trying to solve a mathematical puzzle by randomly guessing a number. This is called mining. There will be only one winner per 10 minutes. If more computers are added to the network, the difficulty of the puzzle automatically increases, hence more resources are wasted.
This isn’t a very efficient system from an economic perspective. The lightning network functionality, or proof of stake verification model could solve the energy use problem. Many other ideas are also on the table. A great topic for academic research is how to fix incentives so that the system is safe, works faster and less resources are used.
An additional philosophical idea: banks have large buildings, expensive IT systems, an army of bank employees and their salaries. Is that a waste of resources or not?
3. Transaction costs: At the end of 2017 the average cost of one Bitcoin transaction reached $35. Bitcoin was promising us micro-transactions and now we have these huge costs. But that was a temporary spike in costs. Today, the average cost per transaction is less than $0.50. Is this still too much? You could also choose to pay nothing. In that case you might have to wait longer (as of today 20 minutes instead of 10). The nodes are prioritizing transactions that pay higher fees. Occasionally, high transaction costs is a temporary problem. If we move to a more efficient protocol, we will have instant payments with relatively low costs.
4. Security: Bitcoin’s decentralized ledger is very secure. It is almost impossible to alter transactions in the Bitcoin ledger. So far nobody has done it. The problem is our private keys (passwords). If somebody steals your key, your money will be gone. The best practice is not to store your passwords anywhere online. However, this is not very convenient. If you want a quick and simple way to trade Bitcoin, you will probably use an exchange, and your passwords will be stored there. If bad guys hack into that exchange, they will steal your private keys, consequently taking all your money away. The critics of Bitcoin cite numerous cases where exchanges were hacked and a lot of money was stolen. They make the wrong conclusion that Bitcoin is not safe. Bitcoin’s network is very safe. Keeping your Bitcoin passwords in an exchange is a risky strategy. Security and convenience trade-off is a big issue. A lot of companies are working to find a good solution.
5. Convenience: Bitcoin critics use a very entertaining example that even at a Bitcoin conference attendants were not able to pay the entrance fee with Bitcoin. Yes, this is a problem….