- Financial Services
The Challenge of Bitcoin
Bitcoin was supposed to be the white whale of modern monetization. It was set up specifically, like any open-source project, to not be controlled by any one government, a central bank, company, or even an individual. Instead, Bitcoin is governed by its users and miners. Bitcoin, and blockchain-based cryptocurrencies more generally, work via an immutable public ledger, meaning transactions occur and become part of a history that is unchangeable – an approach that is meant to create security and reliability of transactions and thus render a central force (like a bank) unnecessary. In fact, no third party is needed to qualify transactions their existence on the blockchain is all that is required.
This lack of requirement for any third party is the fundamental concern about bitcoin. One that challenges conventional understanding of governance and regulations, and is ultimately a radical departure from the standard economy. Governance in the blockchain economy is thus called into question, and concerns are raised about how sound the blockchain approach is to protecting and securing transactions. Namely, printed money functions as a currency because the government guarantees its value.
The views about the lack of governance range from believing in its value to perceiving it as a threat. There is a belief that because Bitcoin itself is the first successful, most liquid, and most widely known crypto-currency that a lack of governance means it will not reach its full potential, as KPMG has recently noted. On the other hand, bitcoin governance goes against the ethos of cryptocurrencies, where Satoshi Nakamoto, the currency’s creator wanted to remove governance to ensure a more transparent system. Ultimately that transparency is still questionable but is not enough to sway the concerns of government and financial institutions.
As more of our world transitions to technology-based approaches, it stands to reason that so too will our financial transactions change. Bitcoin is built on the fundamental economic concept all currencies face scarcity. This concept of controlled supply is how the cryptocurrencies retain value. Their value is created through the limitations of scarcity as well as expectations of future investors, much more akin to the value created by collecting rare stamps than the Euro or the Pound. Meaning investors can rely on Bitcoin having a long-term value because it is finite.
Bitcoin itself has a limited number of coins, capped at 21 million Bitcoins available for mining. It is known that it will take until 2140 to mine the Bitcoin money supply. However, because the money supply is predictable, this doesn’t have the deprecatory effect of whimsical government money supply increases.
This cap is in stark contrast to national currencies, where governments can increase their money supply (and devalue their currency). The cap helps to decrease the flow of new Bitcoins and ultimately keep inflationary pressures at bay, thus preventing the devaluation ‘traditional’ currencies face.
Despite concerns over regulation and reliance on controlled supply, one of the largest issues cryptocurrencies face is scalability. With Bitcoin, the miners are responsible for confirming transactions in this decentralized approach.
The records (known as blocks) these miners confirm are limited in size, meaning the volume of transactions themselves are limited. These blocks form the blockchain, which is the technology that drives cryptocurrencies like Bitcoin. Originally, creator Satoshi Nakamoto limited this 1MB of data, resulting in significant processing times as the currency’s popularity grew.
In order for Bitcoin to overcome the I MB size limit on blocks and thus the problem of the network’s transaction processing limit, the proposed solution required a “fork” in the Bitcoin network. The result of this fork meant that in 2017 Bitcoin split into two cryptocurrencies. The split from just bitcoin, or BTC/Bitcoin Core, into BTC and Bitcoin Cash, or BCC allowed the formation of two separate ledgers.
The key debates around this split center around with it is against the ethos of Bitcoin to allow larger blocks and thus prevent smaller miners from processing. In essence, it serves to centralize power to those with the resources to mine those larger blocks, stepping away from the notion of an alternative to centralized currencies.
Given that this processing time is a key issue with Bitcoin, competitors have emerged to challenge the status quo in recent years. For example, industry leader Bitcoin can conduct transactions at approximately 5-7 TPS (transactions-per-second), whereas competitor Ethereum is marginally better at 15-20 TPS. In what is being termed as ‘Blockchain 3.0’, a new company called COTI has emerged based on a DAG (Directed Acyclic Graph) protocol, a block-less and miner-less blockchain aimed specifically at bypassing this key scalability issue.
Bitcoin was developed to bypass the centralized economic system and offer a platform for electronic cash that valued peer-to-peer exchanges. In recent years, as more competitors have entered the field, it has challenged both the status quo of currency and encourages cryptocurrencies to quickly evolve. This growth has led to greater fluctuations in value, but also a greater focus on cryptocurrencies having greater recognition in the marketplace. As technology continues to evolve, it remains feasible that ‘traditional’ national currencies could be replaced by cryptocurrencies in the years to come. However, a greater understanding of how best to regulate an approach meant to be self-regulating, and how this will impact economic systems and government planning remains to be seen.Back to Blogs