“A specter is haunting the world—the specter of false promises.” That is perhaps how Karl Marx and Friedrich Engels would begin their “Communist Manifesto” today, referring to a phenomenon of global financial capitalism that is as absurd as it is frightening: The cryptocurrency Bitcoin and others of its kind.
Financial and legal intermediaries, such as banks, exchanges, notaries, and various government institutions (e.g., central banks, tax authorities or regulators) control a large part of our economic life. That privileged position rests on a crucial condition for smooth economic activity – trust.
Banks assure that money paid in can be withdrawn, notaries affirm the legal security of a contractual agreement, central banks offer transaction bills (money) with reliable value and governments ensure that rules are followed. They are all “agents of trust.” That these agents can themselves fail is demonstrated by jarring banking, financial, economic, fraud and political crises, which have resulted in hyperinflation, bank failure, credit crunches and dysfunctional or failed states.
Digital technologies promise a new way forward, offering self-declared transparency and de-centralization, even democratization of how goods, services and information are exchanged in society. The promise is to cut out the intermediaries, opening the way for direct interaction among individuals.
Cryptocurrencies are a prime example. Instead of a government-issued and regulated currency, Bitcoin and its offshoots enable de-centralized economic exchange networks. That is the core appeal of “blockchain” technology, which can process payments without the need for a central bank or a national currency.
Whereas with ordinary (cashless) payments, participants must trust a bank or similar intermediary (e.g., a credit card company) to guarantee the security of the transaction, in the world of cryptocurrencies blockchains are the responsibility of the community of all participants. A payment is approved by the majority of participants upon presentation of the correct digital keys. Corrections to the system are only possible if the bulk of participants agree to them, which is typically difficult due to the vast number of participants. Blockchain technology thus replaces intermediaries, including money, banks, and regulators, with a community of many users.
The promise of blockchain is nothing less than the overthrow of the traditionally non-transparent, corruption-prone, and overpriced business model of banks, yielding more economic control and power to individual crypto-participants. In some quarters, blockchain is even heralded as the tool to advance fairness in global trade, enforcement of social justice and economic opportunity for those left behind by the opaque web of finance, law and government.
Were it only so!
Unfortunately, the reality is quite different. To see why, it is useful to take a closer look at the four criteria Bitcoin claims to meet in its quest to replace conventional currencies:
- Acceptability and scalability as a payment system. Bitcoin and other cryptocurrencies are ubiquitous in the financial press and the get-rich fantasies of speculators. But, they hardly show up in the everyday use of money, namely as a means of payment for goods and services. Ironically, even some crypto conference organizers refuse to accept Bitcoins for their participation fees. Quite apart from the enormous volatility of cryptocurrency prices, which can wipe out a holder’s wealth within hours, the practicality of using cryptocurrency for payment is severely handicapped by its technology. Bitcoin today can only process about five transactions per second. By comparison, the Visa network alone can process more than 2,000 transactions per second, a figure Visa heralds it can lift to 65,000 per second. In short, cryptocurrencies are clunky when it comes to transactions.
- Security. Bitcoin’s price volatility exceeds that of all other investments. One reason is that cryptocurrencies are much more exposed to fraudulent and illegal activities. Reports of price manipulation, such as frontrunning on exchanges, are widespread. Cryptocurrencies also are inviting for criminal activity, ranging from money laundering, ransomware, embezzlement, arms trafficking and terrorist financing. Organized crime rejoices in the anonymity of the blockchain. Yet at the same time, protections for individuals are scant. If a credit card or bank account is hacked or stolen, banks and financial institutions offer protection. If, on the other hand, the private key of a cryptocurrency deposit is stolen or lost, the assets are gone forever. Lastly, insofar as the vast majority of Bitcoin trading takes place on centralized exchanges, which are relatively easy to hack, fraud is a recurring risk.
- Decentralization: Cryptocurrencies are prone to market manipulation. Dominant players (‘whales’ in the parlance) control much of the value of Bitcoin and other cryptocurrency trading. Programmers and ‘miners’ often retain outsized control over their creations. They have used that power to reverse transactions that were supposed to be immutable. And many cryptocurrency miners are located beyond the reach of Western law enforcement in autocratic countries such as China, Russia, and Belarus.
- Store of value. Most assets – such as stocks, bonds or real estate – owe their value to predictable income streams or have a tangible utility (e.g., housing). They may offer some other benefit, such as liquidity or flexible means of payment. An exception is gold, which produces no income, but has a long history as a unit of account and store of value. Bitcoin’s fundamental value, on the other hand, is ill-defined. As noted, it is an inefficient means of payment, its volatility makes it an impractical unit of account or safe store of value. It is worth what the next buyer is willing to pay. In the minds of some, it may be a hedge against intrusive governments, illegal seizure of assets, criminal concealment or fiat currency debasement. But those sources of demand, however legitimate, make it impossible to determine, even at a first approximation, Bitcoin’s intrinsic value. Indeed, it can be argued that when taking into account the immense amounts of energy it takes to mine cryptocurrencies, their cost exceeds their value, implying negative net social worth, particularly if crypto miners were forced to face the true cost of the externalities involved (e.g., carbon footprint, enabling illegal economic activity).
In short, it is not political idealism nor the prospect of a more just society that drives the current hype around Bitcoin and which contributes to its soaring price. Rather, Bitcoin is far more akin to a modern-day gold rush, with the key difference that miners today only need to travel to the internet to dig for the new lucre.
Unfortunately, and as noted above, this 21st century gold rush comes with immense environmental costs. Mining Bitcoin, which is necessary to maintain its underlying blockchain infrastructure, requires an enormous amount of computing power, and thus electrical power. From October 2020 to February 2021, the amount of electricity required for cryptocurrencies to exist nearly doubled. The high-tech computers employed by Bitcoin miners will soon consume more electricity annually than the whole of The Netherlands, and the trend is rising sharply. Some 65% of mining activities now take place in China, owing to low-cost energy derived from coal-fired power plants. Little wonder that the renowned computer security expert Felix von Leitner calls Bitcoin “organized environmental pollution”.
In sum, Bitcoin and other cryptocurrencies offer questionable economic and social value, particularly relative to their environmental and (il)legal costs. Bitcoin mania seems primed to run further, but from our perspective it is time to speak truth to calamity and draw a line on this absurdity.