Rags to riches tales abound in the media of prophetic technocrats who embraced and invested in Bitcoin over the past several years and are now sitting on millions of dollars. Fear of missing out (FOMO) appears to have struck would-be investors looking to cash in on a potentially colossal payday. Responsible investors should be asking some hard questions: What is Bitcoin and what is its intrinsic value? Will I make millions overnight or is it too late to invest in Bitcoin? How risky is Bitcoin and what are the risks? Perhaps you’ve heard horror stories about almost four million Bitcoin worth over one hundred and eighty billion dollars at September 2021 levels being lost – to never be regained (Popper, 2021). Maybe you’ve heard of unsavory characters exchanging Bitcoin for illegal and inhumane activities. Is Bitcoin investment-worthy or a speculative gamble? This paper aims to lay out the different sides of the debate, but for peace of mind, investors should remain skeptical of Bitcoin digital currency on account of high volatility, adverse environmental impact, and absence of oversight and regulation.
Bitcoin was conceived more than a decade ago as a consequence of loss of trust with financial markets – corresponding to the global financial crisis of 2007-2008 (Guegan, 2018). Bitcoin is software manifested as digital currency that allows any party to send funds to another anywhere in the world securely and anonymously (if desired) without having to involve a financial institution or government. An important element of Bitcoin is its distributed ledger system that stores every transaction to provide a decentralized network that no one entity controls (Underwood, 2016). Another important element is Bitcoin mining, which is a process of computing elaborate math equations to earn bitcoins and mint new ones. Though only home personal computers were necessary to mine when Bitcoin was first launched, expensive and powerful computing machines are now required to mine competitively (Campbell, 2021).
Volatility when observing markets refers to price fluctuations. Bitcoin volatility is incredibly chaotic when compared to stocks. In the last year alone the price of a single Bitcoin fluctuated from approximately $11,000 in September of 2020 all the way to $60,000 in April of 2021, to fall to $37,000 not even a month later (Binance, 2021). One key reason for volatility is the negative press due to bad actors, for example, hackers successfully breaching cryptocurrency wallets and exchanges, or early adopters using Bitcoin to anonymously exchange illicit goods and services on the online Silk Road black market. Another cause for the volatility is the uncertainty around digital security. If we happen to lose our private key which is akin to a password, it is impossible to recover the bitcoins which will remain lost forever. There are no guarantees with Bitcoin unlike the Federal Deposit Insurance Corporation (FDIC) insurance of up to $250,000 per bank depositor backed by the full faith and credit of the United States government.
This begs the question: What is Bitcoin worth? Surprisingly, Bitcoin has no intrinsic value. It is not a commodity like metals, energy, or grains. It is also not fiat currency – money that is backed by the government that’s issuing it. “The value of any currency comes from the backing of the state and the trust that people have over the government,” writes Gupta (2020), the CEO of CoinDCX – one of India’s largest cryptocurrency exchanges (para. 6). In order for currency to be exchanged, the network (buyers and sellers) have to implicitly trust the institutions backing the currency (para. 6). Gupta notes:
This is exactly where Bitcoin is gaining its value. The trust which millions of people have imparted on a cryptocurrency in a completely trustless environment decides the value of the cryptocurrency. Millions of miners and traders are altogether considered the participants of the Bitcoin network who trust the world’s largest cryptocurrency and are deciding its price on the sole principle of its demand and supply (para. 7).
This should cause no small amount of consternation and apprehension when considering a Bitcoin investment strategy.
A tangential cause for concern is the environmental impact of Bitcoin. In economics, a negative externality is a cost caused by a producer that is not financially incurred by that producer (Kenton, 2020). For example, pollution from a power plant is a negative externality. In “Bitcoin boom: what rising prices mean for the network's energy consumption” published by the journal Joule in early 2021, Alex de Vries argues that Bitcoin mining causes negative externalities. He points to evidence of countries confiscating and banning equipment because of power outages and destabilization of power grids caused by Bitcoin activities consuming unsustainable electricity loads.
De Vries (2021) provides a detailed methodology for estimating energy consumption built upon The University of Cambridge Bitcoin Electricity Consumption Index. The staggering take-away from the estimation walk-through that expounds upon a referenced paper by Christian Stoll et al. titled “The Carbon Footprint of Bitcoin” is that the future carbon footprint of the Bitcoin network is “roughly comparable to the carbon emissions produced by the metropolitan area of London” (de Vries, 2021). De Vries points out that excessive demand for Bitcoin mining equipment exacerbates the global chip shortage and contributes to electronic waste. In the current climate, chip shortages adversely impact economic recovery, working from home, and production of electric vehicles.
There is an abundance of evidence this year pointing to the misuse of energy consumption in mining Bitcoin. The consumption of energy has become so egregious in Malaysia that authorities in July cracked down on mining from stolen electricity by seizing and crushing with steamrollers over a million dollars’ worth of bitcoin mining equipment (Sigalos, 2021). In May, a crackdown by Chinese authorities was a result of among other concerns, the “enormous environmental toll of crypto mining, which undermines Chinese President Xi Jinping’s ambitious promise to make China carbon neutral by 2060” (Campbell, 2021). Inner Mongolian authorities in May also announced “that telecommunication companies, internet firms and even internet cafes would have their business licenses revoked if they engaged with crypto mining. The local government has even set up a new hotline so citizens can report suspected mining operations” (Campbell, 2021) In Iran, mining was entirely banned in May as it was blamed for blackouts across many Iranian cities. This was especially concerning since hospitals were struggling to maintain cold-storage for their COVID-19 vaccines (Turak, 2021). The rampant disregard for the environment and human life by Bitcoin miners as the world hurtles towards a climate change point of no return should give investors pause if not cause for profound contemplation.
The concentration of mining in countries like China also present an intriguing technical vulnerability. “One of the core security pillars of the blockchain technology upon which cryptocurrencies operate is that transactions are transparent and publicly verifiable. This means that if one actor within the system corrupts a ledger “block,” every peer can see the inconsistency, flag it and correct the mistake on their own corresponding records, maintaining order without the need for a central authority” (Campbell, 2021). One fear is that if there’s a high concentration of miners in a specific area, a nation-state or government may be able to manipulate the ledger which can cause quite a bit of turmoil in the markets. An April 2021 blackout at a coal mine in China’s Xinjiang province took out a “third of the entire Bitcoin network’s computational power” (Campbell, 2021). Not only was there a 15% fall in Bitcoin prices, but researchers were able to estimate that China may account for about 65% of the total share of miners, which means that the Bitcoin network is vulnerable to a majority 51% attack – which is the amount of network nodes it would take to override and “hack” transactions (de Vries, 2021). Orcutt (2018) claims that “part of the vision sold by the technology’s biggest promoters is that it can help solve problems of financial inequality created in part by traditional, centralized institutions. If digital currency allows wealth and power to pool in the hands of a few, that’s not so revolutionary.”
In Cryptoassets as National Currency? A Step Too Far, Adrian and Weeks-Brown (2021) from the International Monetary Fund (IMF) claim that macroeconomic stability is at risk if countries decide to adopt cryptoassets like Bitcoin without a comprehensive evaluation of the impact to the environment, financial institutions, and consumer protection. The authors argue that since cryptoassets are not widely available or stable, legal tender status is questionable. They point out that extreme volatility of Bitcoin carries risks that offset potential benefits. The lack of oversight and regulation means there are no legal protections. The aforementioned crackdown by Chinese authorities is also “largely driven by the inherently speculative nature of cryptocurrencies and the Chinese Communist Party’s (CCP) extreme aversion to risk—or anything outside its control” (Campbell, 2021).
Discounting the financial, environmental, political, and legal uncertainty and turmoil, what does Bitcoin in fact empower? Bitcoin provides a decentralized network that’s controlled collectively by everyone that’s on its network. Bitcoin provides anonymity. Bitcoin is permissionless with zero constraints from financial institutions. Bitcoin was meant to “prevent financial power from becoming too concentrated in a few institution’s hands” (Craig, 2019). In Bitcoin’s Decentralized Decision Structure, Craig (2019) points out that the “roots of the problem are in the discretionary authority of a centralized decision maker. In a currency such as bitcoin, such decisions are made by the entire body of users of the payment system [sic] and this reduces the ability of a group to discretionarily change the rules of the game” (p 2). Bitcoin software is open source, which means everyone has access to the code. That downside is that a consensus-based approach is needed to make changes. A completely democratic approach means that some changes won’t go through unless a majority approve. “When fraud occurs, it is harder to enforce accountability in a decentralized environment than in one with a central decision maker” (para 6). Though anonymity can be an advantage, “even simple disputes can be tricky to resolve quickly in a context where the agents are often anonymous, and the blockchain permanent” (p 4). Despite its flaws, what are some reasons speculators flock towards Bitcoin? Arguments for investment include hedging against inflation, diversification, and the scarcity of the Bitcoin itself (Weil, 2021).
From an investment perspective, Bitcoin is speculative at best. Though the philosophy behind Bitcoin is exemplary, signs of market stability are not apparent in the near horizon. High volatility will continue to be disruptive and cause financial panic. Increasingly frequent instances of hacking exploits will further drive the price down. For eco-friendly and ethical investors, the destructive environmental impact of Bitcoin mining is in direct opposition to the sustainability ethos. The lack of universal oversight and regulation of Bitcoin equates to no legal protections. Investing in Bitcoin at this stage is as risky as any bet placed in Las Vegas.
References
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