BITCOIN is, once again, having a really bad time.
Not only are Bitcoin holders suffering big losses (again) but the central bank for central banks just compared the crypto-currency to a bunch of shells and beads traded in early societies.
The Bank for International Settlements (BIS) gave Bitcoin a ferocious roasting this week, schooling crypto-fans on the track record of start-up currencies throughout human civilisation.
“History is a graveyard of currencies …” BIS says, giving several reasons why Bitcoin could be buried soon, adding that “history proves that money can be fragile”.
The bank points to two main ways currencies bite the dust, and Bitcoin is vulnerable to both of them.
1. SCALING UP
Currencies need to be able to handle it when people start using them. Bitcoin has failed dramatically in this task. By now you’ve probably heard about the fact that Bitcoin uses as much electricity as Switzerland, while doing very few transactions.
“Put in the simplest terms, the quest for decentralised trust has quickly become an environmental disaster,” according to BIS.
What you may not know is that Bitcoin is also extremely hungry for data. Everyone who wants to act as a node in the Bitcoin system has to download the whole history of Bitcoin — the “ledger” or list, of every transaction. The ledger is now over 150 gigabytes in size, and growing. (Tough to download on Aussie internet.)
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This is what they call a distributed ledger — it is distributed to every node in the system. Bitcoin only works if everyone in the system can confirm every transaction ever. That’s how Bitcoin does without a trusted middleman — it needs to knows the location of every Bitcoin so it needs to knows every time they ever changed hands.
“Only supercomputers could keep up with verification of the incoming transactions,” BIS says. “The associated communication volumes could bring the internet to a halt, as millions of users exchanged files on the order of magnitude of a terabyte.”
Bitcoin requires urgent changes to be able to scale up. One such change is a new system called “Lightning Network.” People use it to trade Bitcoin away from the Bitcoin network in a separate (but related) system. It reportedly works well — quickly and cheaply — but only by avoiding the actual Bitcoin ledger system. By which point you may be wondering what the point of using Bitcoin is at all.
2. MAINTAINING TRUST
The second big thing currencies must do to survive is be trustworthy.
It’s hard for business to trust Bitcoin when its price keeps changing. If you accepted Bitcoin at your shop last month, and you try to change it into regular money today, you find that it is worth 19 per cent less, as this next graph shows.
Bitcoin is also down by around 66 per cent from its peak over $US20,000 in December last year, a fall which has turned some crypto-currency fortunes to dust.
The trust issues go deeper than price. Yes, Bitcoin technology has proven itself over a decade, and most of the blips in its trustworthiness have to do with exchanges where Bitcoin is bought and sold, not the fundamental technology. But a surprise failure in the technology is still possible. For a currency, surviving hundreds of years is the goal.
“[C]oordination on how the ledger is updated could break down at any time, resulting in a complete loss of value,” BIS says.
SO WHY IS BITCOIN SO POPULAR?
Bitcoiners are very proud of the incentives built into Bitcoin: the people who confirm the transactions get paid in freshly-mined Bitcoins. It is very clever. But there’s another incentive: people who own a lot of Bitcoin have a big incentive to believe it is the future of money, and to try to convince everyone else too.
Lots of open-source software is made and shared online, and a lot of it is useful and has ardent fans. But never before have those fans had the possibility of becoming millionaires by talking it up. That’s the Bitcoin difference.
If the Bitcoin fans can convince enough people Bitcoin is the future of money, we could have a problem. Bitcoin could suffer a major crisis and harm the real economy. Just because Bitcoin is online does not mean it can’t be the cause of a financial disaster. It wouldn’t be the first time that greed ruined everything and it certainly wouldn’t be too surprising.
Jason Murphy is an economist. He runs the blog Thomas the Think Engine.