Economic and Philosophical Bitcoin Considerations
I recently had a conversation about bitcoin over dinner and some interesting philosophical and economic questions were brought up. As I mentioned in a previous blogpost, Bitcoin is just one example of a type of cryptocurrency transaction that can occur on a blockchain. Though I do not claim to be a bitcoin expert here are some brief answers to some of the questions we discussed.
Does it matter that there are a finite number of bitcoins in the world? How is it similar to gold?
• When Bitcoin was founded, a finite limit on the number of bitcoins was set, just as there is a finite amount of gold in the physical world. The number was 21M and so far more than 12M are in circulation. Therefore, there are less than 9M bitcoins waiting to be discovered through mining (Mining was defined in a previous blogpost).
• There are people buying and selling existing bitcoins. They either exchange them for fiat currencies (U.S. Dollar) or purchase goods with them (Overstock is a popular online merchant that accepts bitcoin). Bitcoin is also known to be a popular currency for illicit practices like prostitution and drug purchasing.
• Like gold, 1 bitcoin can be divided into smaller nano units (there are 100,000 satoshi to each bitcoin). Therefore, the cap number on bitcoins is arbitrary.
• So why was it capped-Because the creator of bitcoin, Satoshi Nakamoto, wanted it to be a deflationary currency. Someone couldn’t go out and create more bitcoin in the way that central banks print more cash. Thus, the currency could not be manipulated by any one entity.
Can bitcoin be the new world currency?
• All transactions in the world can’t occur on bitcoin because it is inherently very slow.
• Currently, Bitcoin can only tolerate up to 7 transactions per second, this is extremely slow in comparison to the volume of transactions that the big card networks like MasterCard or Visa process per second (around 47,000 transactions per second.)
• Bitcoin’s capacity limit comes from the way transactions are recorded in batches known as “blocks” (Blocks were defined in a previous blog post).
• Every 10 minutes a new block is added to the blockchain maintained by the computers in the Bitcoin network, but those blocks have a maximum size of 1 megabyte (Enough for only 7 transactions a second).
Why are governments apprehensive about Bitcoin?
• Inflation is defined as the increase in prices for goods and services. There are two main types of inflation:
Demand-Pull Inflation: If demand is growing faster than supply, prices will increase
Cost-Push Inflation: When companies’ costs go up, they need to increase prices to maintain their profit margins
• As bitcoin is a deflationary currency, no government and central bank can control how much it is worth. Therefore, in times of high inflation and uncertainty people will seek to purchase more bitcoin in the way they purchase more gold.
• The emergence of Bitcoin as a world currency could potentially erode the necessity of central banks in the global economic ecosystem.
Is bitcoin the only cryptocurrency?
• There are many other popular cryptocurrencies: Litecoin, Bitcoin, Ethereum, Dash, Ripple, etc.
• The biggest difference between them is their verification method. Bitcoin uses proof of work by miners (Proof of work was defined in previous blogpost).
• Bitcoin is the most popular- its accepted at a number of retailers and is currently valued at $1,224. Though it has experienced many fluctuations and is extremely volatile.
Is bitcoin safe?
• A cryptocurrency could be compromised with a software update (a fork to increase block times). A fork could be used to convince miners to download a new software that could contain bugs potentially compromising all of the stored value that has currently been built up on the blockchain.
• Several bitcoin exchanges, like MT Gox and Bitfinex, have been hacked resulting in more than a hundred million dollars being stolen.
• Most bitcoin theft is the result of inadequate digital wallet security (remember that bitcoins are stored in digital wallets).