According to bitcoin lore, the world’s first cryptocurrency transaction was made on May 22, 2010, when 10,000 BTC were exchanged for two pizzas. Bitcoin has been relatively well known in techie circles ever since. But Joe and Jane Average pretty much remained clueless about digital alternatives to fiat money until last year. When did bitcoin officially go public with a bang? The exact date is debatable, but a good guess is late last November. After all, that’s when it had a starring role on the TV sitcom The Big Bang Theory.
In an episode entitled “The Bitcoin Entanglement,” TV’s favourite science nerds frantically search for a misplaced computer that holds bitcoins they had collectively mined by solving math problems back when the cryptocurrency was virtually unknown, not to mention worthless. When the script in question was finalized, the missing cryptocurrency was given a value of US$5,000 per token. But there is always a lag period between when a taped TV show is written and when it is televised. By the time the episode aired, the market value of bitcoin had doubled. In the weeks that followed, it soared above US$19,000, then crashed back under US$10,000.
This volatility should not have caught anybody by surprise, not even on Main Street. After all, the possibility that bitcoin demand is based upon unrealistic expectations also went mainstream in late 2017 — when more than a few Twitter votes for best Halloween costume of the year went to a guy sporting a bitcoin bubble suit.
Bitcoin is not easy to understand, not even for a rocket scientist. The concept was first described in a research paper published online during the global financial crisis. Posted under the pseudonym Satoshi Nakamoto, it covered a variety of topics, ranging from transaction costs, trusted third-parties, to the money supply to distributed decision-making, data routing, cyberattacks and cryptography. Shortly after introducing the idea, bitcoin’s unknown creator(s) published enough code to create the world’s first decentralized cryptocurrency, which now exists in a software ecosystem comprised of pseudonymous users and miners who are rewarded for maintaining the so-called blockchain of transactions.
With its roots in the anti-establishment cypher-punk movement, which advocates the use of cryptography to protect individual privacy and liberty, the bitcoin revolution has true believers who see the world’s original cryptocurrency as an ideal replacement for government-backed money, which is always at risk of being inflated or deflated by fiscal or monetary mismanagement. According to this camp, bitcoin is destined to be worth much more than its recent peak. Market bears, on the other hand, insist the bitcoin revolution is nothing more than a libertarian fantasy based upon already-dated technology.
Bitcoin will always be worth exactly what buyers are willing to pay for it. But as former U.S. Federal Reserve Chairman Alan Greenspan noted a few years before the dot-bomb market crash, buyer demand isn’t always rational. And demand for bitcoin has spawned comparisons to the “irrational exuberance” that generated tulip fever during the Dutch Golden Age of history — when some tulip bulbs were reportedly sold for more than 10 times a local craftsman’s annual income, before the world’s first recorded asset bubble popped.
Last October, CNBC reported on a Dutch family that had sold everything they own — from house to shoes — to buy as much bitcoin as possible. According to the Dutch clan’s father, risking everything seems like a good idea because the world economy is “going through a revolution that’s changing the monetary system.” But if that’s true, the revolt remains bloodless, meaning government-backed money isn’t even close to being displaced.
With the following headline, the Wall Street Journal nicely summed up what many optimistic investors apparently fail to see: “Bitcoin Is the World’s Hottest Currency, but No One’s Using It.” As things stand, using bitcoin might make sense for making dodgy transactions, but spending it can be an expensive pain in the butt for most of the activity that drives mainstream economics.
Why does it cost money to use bitcoin? While the system is peer to peer, transactions still need to be verified by bitcoin miners, who compete to solve complex math problems, hoping to win the right to update the blockchain ledger in return for transaction fees, which rise and fall with system activity. These data mining operations, which reportedly already burn as much energy as the Irish economy, are also rewarded with newly minted bitcoins until the total number of tokens generated reaches 21 million. And nobody knows what will happen to transaction fees when there are no more bitcoins available to offer as an incentive. A majority cartel of miners could conspire to increase the supposedly limited supply of bitcoins to keep profiting off maintaining the system. Or fees — which hit about US$30 per transaction last year — could skyrocket.
Whatever happens down the road, the bitcoin system just isn’t good enough to take out government-backed money. None of this necessarily spells doom for the cryptocurrency revolution. But there is no reason to bet that bitcoin can maintain its position as revolt leader.
“Bitcoin is dead,” concludes Jean-Philippe Vergne, founding coordinator of Ivey Business School’s Crypto Capitalism Center. In “Disrupting the IPO,” an Ivey Business Journal article that examines the potential of initial coin offerings, Vergne notes bitcoin’s legacy is secure since it opened the door for cryptocurrencies to be taken seriously. But when the crypto chapter in history is finalized, bitcoin probably isn’t going to go down as the slayer of establishment money.
“The bitcoin project has shifted from being electronic cash to a digital store of value,” says Vergne, who also serves as co-director of Ivey’s Scotiabank Digital Banking Lab. In other words, if bitcoin has a future, it probably lies in giving gold a run for its money as a hedge against the fiat money.
So, the multibillion-dollar question is whether demand will increase or decrease as investors realize that bitcoin’s long-term potential is probably greater as a digital store of wealth not backed by any physical commodity or even the political support behind national currencies.
• Thomas Watson is editor of Ivey Business Journal, published by the Ivey Business School at Western University.