I have long thought the best DTN articles start conversations among us. DTN Contributing Analyst Elaine Kub lived up to that tradition a few weeks ago when she explained how the blockchain technology that powers today’s bitcoin phenomenon has practical uses for making grain transactions easier (see “Grain Markets Could Benefit From Blockchain Technology” at http://bit.ly/…).
While Elaine’s article focused on the technology behind bitcoin, I became interested in finding out more about bitcoin itself, and the impact it could have on all our markets. After all, these are big changes in unchartered waters, and I’m not convinced we, the general public, understand where this is all headed.
I asked Senior Analyst Darin Newsom for his thoughts. Like me, he was interested to learn more and noticed a generation gap of opinions. Older investment sages like Warren Buffet see the digital currency as a speculative fad with no measurable value. Supporters of bitcoin, on the other hand, tend to be younger and more tech savvy.
After scanning various articles, I noticed two threads of conversation. The first was the more practical aspect: How does this work and why would anyone want a bitcoin?
The short answer is that bitcoin appears to be a fairly secure, low-cost way of transacting business. Joe wants to buy Bill’s car and directs bitcoin payment from his digital wallet to Bill’s wallet. The payment Bill receives is instantaneous and verified to be free of any other claims, checked by an open source network of servers that will receive a small fee from Joe, the sender of the payment.
Understanding just how secure a bitcoin transaction is takes a lot of study, and that alone will keep many away. Satoshi Nakamoto, a pseudonym for the creator of Bitcoin offers this explanation:
“The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.” (https://bitcoin.org/…). For anyone familiar with Mad magazine’s Spy vs. Spy cartoons, the underlying admission here is that bitcoin is not foolproof.
The second thread of conversation has to do with bitcoin’s political appeal. For those who regard banks and governments as bad guys, Bitcoin is seen as a heroic revolution, ushering in a new age of markets that don’t require either. Before anyone gets caught up in utopian visions of how bitcoin, or other digital look-a-likes, might change the world, I have four practical points to keep in mind.
For those making small or modest-sized transactions, exchanging bitcoin can be a relatively safe, low-cost way to go, provided the seller accepts bitcoin. Currently the list of companies accepting payment in bitcoin is limited, but growing with the currency’s popularity. Bitcoin does offer competition to other methods of payment.
The amount of electricity used to power bitcoin and other digital currencies is expensive and growing rapidly. Digiconomist.net is a website created to raise awareness about this growing electricity demand. As of Nov. 25, Digiconomist.net reported that two digital currencies, bitcoin and ethereum used 40.8 terawatt hours over the past year. That is same amount used by 3.8 million U.S. households, which is nearly the size of Los Angeles. If bitcoin were a country, its energy usage would rank 64th in the world and is rising rapidly (see http://bit.ly/…).
For mega-transactions, bitcoin by itself is not ready for prime time. Anyone who has ever seen a movie drug deal go bad knows that the exchange of drugs for the briefcase of cash is where things go wrong. For large bitcoin transactions between strangers, some type of third-party oversight is needed to make sure both sides of the exchange go as planned.
Some use escrow services, which release funds when both parties agree, or some may use a multi-signature arrangement where two out of three approvals are needed to release funds. Joe, Bill and an arbitrator each have one vote and there is typically no charge if Joe and Bill complete the payment without dispute.
No matter what method is used, both parties still have to trust the third party and, the bigger the amount, the more difficult that can be. This issue of trust is an ancient problem for all transactions and is a major reason we have governments and central banks today.
As we were painfully reminded in 2008, even democratically elected governments and large financial institutions sometimes fail in their missions to keep transactions honest and currency prices stable. The public cynicism that follows such failures is understandable, but the uncomfortable truth is that even as popular as bitcoin currently is, it is no utopian replacement for government’s role in the economy.
As mentioned earlier, this conversation is just beginning and I welcome comments from readers with different views. But as far as I can tell, this binary glutton of electrical power lacks the basic requirement of what important transactions between strangers need most: a structure of trust, both for the value of the currency and the honesty of the transaction.
With Thanksgiving leftovers still in the fridge, I have to say that I’m thankful for our farmers that the U.S. dollar, and not bitcoin, is the world’s dominant currency. As difficult as it is for producers to see cash corn near $3.00 a bushel or less, consider that corn prices in terms of bitcoin are down 89% in 2017. Also note that bitcoin has no Federal Reserve-like institution to correct for times of severe deflation.
For now, bitcoin is a speculative investment priced over $9,000 with lots of excitement and, possibly, some serious hidden flaws. As old-timers know, price is not the same as value and there are other competing digital currencies on the way. Bitcoin is not the world’s next dominant currency or the fulfillment of a utopian dream. As electric bills go up the next few years and people start to figure out why, that popular little coin is not going to look so cute.