Bitcoin and the Future of Digital Currency

Rebecca Frost

January, 2018


 

It is almost impossible to escape the excitement about Bitcoin. From news briefs detailing the bullish debuts of bitcoin futures on trading floors in New York and Chicago, to profiles on Tyler and Cameron Winklevoss  – the twin brothers who became the world’s first Bitcoin billionaires - the hype about Bitcoin’s rise has saturated the media over the past few months. Whether you hope to become the next Bitcoin billionaire, are lamenting not buying in sooner, or think the whole thing is a bubble heading for a catastrophic collapse, the Bitcoin story is an incredible one, and Bitcoin’s fate will be instrumental in shaping the role cryptocurrencies play in our economic future.

Despite its name, a Bitcoin is not really a coin; rather, it is a line of code. These lines of code are traded (for traditional currency), and these transactions are recorded in a system called The Blockchain, which functions as a sort of virtual record book. People around the world then verify the transactions in a process called “mining”.

Mining consists of using a computer program to solve complex mathematical problems in order to verify the Bitcoin transactions. In the early days of Bitcoin, this was done on desktop computers; now, there are massive Bitcoin mining operations throughout the world that are made up of highly sophisticated equipment. This mining process also uses a tremendous amount of energy. Some estimates have pegged Bitcoin’s annual energy consumption to be greater than that of the country of Denmark.

There is significant incentive to mine. Whoever finishes the current blockchain gets to place the next block. This entitles them to the fees that Bitcoin traders pay to trade on that block, as well as some freshly minted Bitcoins.

The supply of Bitcoins is not infinite. The number of bitcoins awarded after a block is finished halves every 210,000 blocks. This caps the total number of Bitcoins every allowed to exist at approximately 21 million. Because the mathematical problems in the mining process automatically adjust in difficulty to keep the rate of block completion relatively constant, this reward halving takes place approximately once every four years.

Bitcoin has existed since 2009, but its value has recently skyrocketed, scooping up media attention and investment dollars along the way.

A single Bitcoin cost 0.30 USD on January 1, 2011. On January 7th, 2018, a single Bitcoin cost just under 16 000 USD[11].

While Bitcoin has been drumming up intense excitement, some are skeptical of it. One notable critic of the cryptocurrency has been economist and Nobel laureate Robert Shiller. Shiller received the Nobel prize in economics for his work on economic bubbles. The findings of his work are detailed in his book Irrational Exuberance. In an interview in 2017 with Quartz Media, Shiller described Bitcoin as the best contemporary example of a speculative bubble.

Several economists have compared the current Bitcoin situation to the NASDAQ Dot Com Bubble of the late 1990s. Although it is very difficult to predict when a speculative bubble will burst, there seems to be a consensus among those who study financial markets that the price of Bitcoin will eventually collapse.

What will become of Bitcoin after the exuberance wanes it uncertain. Economist Jim Rickards has speculated that the price of Bitcoin will not go to zero, but hover between zero and 200 USD. He believes this price will be sustained primarily by the popularity of anonymous Bitcoin transactions among criminal organizations.  

Rickards has also pointed out that governments may eventually crack down the trading of cryptocurrencies, or step in to regulate them as there is significant speculation that gains from Bitcoin trading often go undocumented on tax returns.

Other experts are more optimistic about the future of Bitcoin and similar currencies. Chris Robert, Adjunct Lecturer at Harvard University, told Tech Crunch, an online technology news publication, that he believes Bitcoin will likely remain a popular vehicle of financial speculation.

There may be some evidence for Robert’s hypothesis. Bitcoin futures have become popular items in the Chicago and New York futures markets. This allows people to speculate on Bitcoin prices without directly involving themselves in the nebulous world of actual Bitcoin trading.

Even if Bitcoin eventually meets with doom, it will likely not be the last digital currency to make waves in the global financial markets. Other digital currencies, such as Ethereum and Litecoin, are becoming increasingly popular.

Phillip Coggan, Buttonwood columnist at The Economist, has pointed out that just as it was impossible to tell which companies would be the leaders of the tech industry during the height of the Dot Com Bubble, it is very difficult to tell whether Bitcoin will come out on top as the world’s leading digital currency, or if something else will take its place.

Many questions about Bitcoin remain unanswered. How Bitcoin mining’s rapidly growing energy use will be addressed in an age of increasing concerns about energy use and climate change is not yet clear. Some media outlets have drawn attention the concern that North Korea may be using Bitcoin to amass fortunes despite heavy sanctions; raising questions about how sanctions ought to be enforced in an age of digital currency trading. How governments will ensure compliance with tax laws surrounding capital gains from digital currencies is also unclear.

As it seems unlikely that digital currencies will leave the financial landscape any time soon, how regulators respond to this new phenomenon will likely have lasting impacts on the future of global commerce. Whether or not Bitcoin survives in the long run, how the world responds to its rise will likely be central in shaping how the world interacts with digital currencies.