The price of Bitcoin, the world’s leading cryptocurrency, crashed by more than 50 per cent during one week in May, and continued to fall in June, shedding the gains made from its remarkable rise since the beginning of the year. What might explain the price plunge? First, a tweet from Elon Musk on 12 May stated that Tesla would no longer accept Bitcoin for vehicle purchases owing to concerns around fossil fuel energy consumption – a 180-degree turnaround from his position at the start of 2021.
Second, Andrew Bailey, the governor of the Bank of England, warned in May this year that cryptocurrencies were a danger to the public, saying: “I’m sceptical about crypto assets, frankly, because they’re dangerous and there’s a huge enthusiasm out there.” (Last month, the UK’s financial regulator, the Financial Conduct Authority, banned Binance, a major crypto exchange, from regulated activity in the UK.)
Third, the Chinese government announced a crackdown on Bitcoin “mining”, the computing process that uses cryptography to produce new Bitcoins and secure the overall network. This led to Chinese miners – who account for around 75 per cent of the Bitcoin computational capacity used to secure the network – dumping the cryptocurrency and adding to the negative sentiment.
It is human nature to create reductive stories to help us comprehend the complexity and uncertainty of the world. However, in the case of markets the prevailing “narrative” is often something that rationalises market behaviour after the fact, rather than giving an accurate summation of its causes. Nassim Taleb coined the phrase “narrative fallacy” to describe this tendency in his 2001 book Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets.
[See also: Bitcoin – the future of money or a speculative bubble?]
In any event, whether the recent Bitcoin crash narratives are accurate or not, it is important to take the wider perspective. One million dollars or zero – these are price predictions for the value of a single Bitcoin given by advocates and critics respectively. Those in the million-dollar camp include Raoul Pal, a former Goldman Sachs executive who has invested heavily in Bitcoin, while the sceptics include Warren Buffett, the CEO of Berkshire Hathaway, who is considered one of the most successful investors of all time. The price of Bitcoin hit an all-time high of $64,000 in mid-April, which made it the best performing financial asset of the decade, with an annualised return of 230 per cent. In May 2010 (when a Bitcoin was worth less than half a cent) a man in Florida bought two pizzas for 10,000 Bitcoins. If he’d kept those coins, they would be valued today at more than $300m.
Unlike government-issued currencies, which can be generated at will by central banks, Bitcoin has a maximum supply cap written into its code. This scarcity is a valuable characteristic for a currency, as no matter how much demand for it increases, its supply is fixed, barring major changes across the majority of its network – and therefore its value can increase indefinitely.
Bitcoin’s most ardent proponents argue that it is the foundation of a new global monetary system. Recently, demand has been driven by recognition of Bitcoin’s core use as a kind of “digital gold”, which can provide a safe harbour for investors during periods of inflation and/or currency debasement, as well as a way to make payments without the need for a bank. While the Bank of England’s Andrew Bailey is a critic, some central bankers are beginning to see real value in Bitcoin. “Right now it’s clear Bitcoin is a store of value,” said Robert Kaplan, president of the Federal Reserve Bank of Dallas, in April this year. (Kaplan also noted that Bitcoin’s swings in value “could keep it from spreading too far as a medium of exchange and wide adoption, but that can change”.)
Last month El Salvador became the first sovereign nation to adopt Bitcoin as legal tender (alongside the US dollar), purportedly to help the 70 per cent of its population currently outside the banking system, and to exclude the middlemen who eat into remittances sent home from overseas workers. Other countries, such as Paraguay, are considering similar legislation.
Elsewhere, some countries are actively considering their own central bank digital currencies (CBDCs), with China, inevitably, at the forefront. CBDCs could enhance the powers of the surveillance state and assist governments’ control over their citizens’ behaviour. Imagine if, after a future economic shock (such as another pandemic), the government issued support in the form of a digital-currency credit, instead of handing out benefit payments in cash that might be hoarded, gambled or spent on alcohol. This CBDC could be programmed to expire in three months and only be spent on certain “socially desirable” goods or services – one example of how CBDCs could be used to restrict liberty and influence behaviour through social engineering.
Even if widely adopted, CBDCs would not eliminate the investment case for Bitcoin, because a central bank could just as easily resort to the money-printer with CBDCs, in the way central banks have been using quantitative easing (QE) to manage the supply of their existing fiat currency.
Beyond Bitcoin, thousands of other crypto assets have emerged. “Fan tokens” based on blockchains – the digital transaction ledgers on which Bitcoin and other crypto assets operate – can be bought and traded by sports fans, allowing them to vote on club matters and access member privileges (teams partnered with the Socios platform include Barcelona, Manchester City and AC Milan), and similar digital assets have been enabling artists and musicians to reclaim control over the distribution of their creative output. The band Kings of Leon recently issued a crypto-distributed album, and the art world was astonished by the sale of a digital artwork for $69.3m at Christie’s. Titled Everydays: The First 5,000 Days, the digital collection was created by the artist known as Beeple. It is the most expensive digital artwork ever sold, and has made Beeple, also known as Mike Winkelmann, the third most expensive living artist after Jeff Koons and David Hockney. The work was bought by a crypto investor.
The broader crypto world also contains its share of losses from scams, bug-infested computer code and crypto exchanges that have failed (the first and most notorious was the Mt Gox exchange in Japan). There are many crypto assets that have no discernible utility, and Dogecoin is arguably one example. It was created in 2013 as a joke inspired by the Shiba Inu dog meme (which became, for a spell, synonymous with internet frivolity), and its value has recently soared, largely as a consequence of Elon Musk promoting it on social media. Dogecoin’s market value hit $49bn at the beginning of June this year – larger than that of Barclays bank. It’s hard to see a long-term future for those crypto assets that don’t possess a clear real-world function; the challenge is to understand what will survive and thrive.
Who is behind all this crypto activity? The early adopters from 2009 to 2013 included techno-utopians known as “cypherpunks” whose origins were in San Francisco. Writing in Bitcoin Magazine, Alex Gladstein has characterised them as a group of civil liberties advocates concerned about “how personal freedoms could survive the great electronic transformation of society”. Their early aspirations were, he says, “to separate money from governments and corporations, check the growth of the global surveillance state and preserve human rights in an increasingly digital age”. In 2013 Julian Assange wrote in an article for the Guardian that “strong cryptography is a vital tool in fighting state oppression” – this was also the message of his book of the previous year, Cypherpunks: Freedom and the Future of the Internet.
More recent participants include entrepreneurs in the developing world – often using smartphones to access loans and payments to grow their businesses – and, increasingly, mainstream financial institutions such as JP Morgan, Goldman Sachs and Fidelity, as well as corporations such as Square, MicroStrategy and MassMutual.
For middle-class citizens in countries suffering from government tyranny, economic mismanagement, unlimited money printing and hyper-inflation, Bitcoin could provide a financial life raft for maintaining the value of savings and making payments to live. A recent tweet from a young man in Venezuela pleaded: “I live in Venezuela. Three weeks ago I used some Bitcoin I had from 2017 to afford Covid-19 treatment medications. I paid ZERO commissions to exchange. Had I kept government-issued currency instead I’d be probably dead.”
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Last year the Feminist Coalition – a gender-equality group in Nigeria protesting against police brutality – used Bitcoin to raise funds when it noticed its bank transactions were being blocked. Its initiative even received support from Jack Dorsey, the co-founder of Twitter. The Human Rights Foundation – which promotes human rights globally – is a strong advocate of the benefits of Bitcoin. Alex Gladstein, its chief strategy officer, recently stated: “For millions of people around the world, it’s an escape hatch from tyranny – nothing less than freedom money.”
As with any new technology that undermines existing orthodoxies and changes the way we live, the crypto world is bewildering. According to British science-fiction writer Arthur C Clarke: “Any sufficiently advanced technology is indistinguishable from magic.” Bitcoin can seem like magic to the uninitiated.
In The Sovereign Individual, which has become a defining book for libertarians since its publication in 1997, JD Davidson and William Rees-Mogg predicted that the decline of nation states burdened by excessive sovereign debt, together with technological disruption, would lead to the emergence of a cyber-economy and “cyber-money”. The new cyber-currencies, they argued, would operate beyond government regulation and would lead to an irrevocable reconfiguration of the relationship between individuals and the state.
“It will consist of encrypted sequences of multi-hundred-digit prime numbers,” the authors wrote. “Unique, anonymous and verifiable, this money will accommodate the largest transactions. It will also be divisible into the tiniest fraction of value. It will be tradable at a keystroke in a multi-trillion-dollar wholesale market without borders.”
This sounds a lot like Bitcoin, which was not created until 2009. It was only 12 years ago that the pseudonymous creator of Bitcoin, Satoshi Nakamoto, mined the first Bitcoin. This first block was dubbed “Genesis” – the biblical reference perhaps alluding to the displacement of traditional religion by techno-utopianism, with technology as the new god.
Built into Bitcoin’s code is a fixed maximum global supply of 21 million Bitcoins, which no central banker, politician or multibillionaire such as Musk can change. Bitcoin is a scarce financial asset; it is secure and durable, cannot be counterfeited, does not require a bank account and is easily transferred by anyone with a smartphone. Nakamoto once commented that “writing a description for this [Bitcoin] thing for general audiences is bloody hard. There’s nothing to relate it to.” Bitcoin is a philosophy as much as a currency, and it leads to an economic system that is enabled by technology.
The first ever Bitcoin block contained a coded message – “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks” – referring to the UK government’s response to the financial crisis of 2008.
This hints at Nakamoto’s impetus for creating Bitcoin as a non-sovereign currency and long-term store of value – it could act as a bulwark against the kind of financial chaos engulfing the world at the time. During the early months of the Covid pandemic both gold and Bitcoin surged in value, because they were considered safe havens against money printing. However, since the autumn of 2020, gold and Bitcoin have decoupled dramatically. Since the total value of Bitcoin in circulation – estimated at around $650bn – is approximately 5 per cent of gold, there remains significant potential for further price appreciation if Bitcoin continues to displace gold as a safe haven.
In 1933, when Franklin Roosevelt mandated the sale of personal gold holdings to the Federal Reserve, he said it was to prevent private hoarding, which might stall economic growth and worsen the Great Depression – but the real reason was to allow the Federal Reserve to increase the money supply, which was at the time backed by gold. Bitcoin offers the additional benefit for those who hold it that it cannot be seized without consent if stored securely.
Physical gold has been used as a medium of exchange since around 1500 BC in the ancient Egyptian empire, which profited from its gold-bearing region, Nubia. In the next few years, could there be an unprecedented shift from gold as a 3,500-year-old physical store of value towards Bitcoin as its digital replacement?
As Davidson and Rees-Mogg observed: “The new digital gold will overcome many of the practical problems that inhibited direct use of gold as money in the past. It will no longer be inconvenient, cumbersome or dangerous to deal in large sums of gold. Digital receipts will not be too heavy to carry.”
Critics of Bitcoin, such as Andrew Bailey, would argue that the energy consumption required to power Bitcoin mining is wasteful, given the climate crisis. In February the Cambridge Centre for Alternative Finance (CCAF) put Bitcoin’s annual electricity consumption at around 121 terawatt-hours (TWh) – more than the annual energy consumption of Argentina.
Advocates would counter that the energy costs of powering the global banking system, as well as gold mining, are also substantial, and in aggregate more than those of Bitcoin. However, Ark Invest, an investment management firm with substantial holdings in Bitcoin, calculates that the cryptocurrency consumes less than 10 per cent of the energy of traditional banking, and around 40 per cent of the energy used in gold mining. (It should be noted, though, that there is currently a big size difference between the mainstream banking market and crypto, and it has been calculated that a Bitcoin transaction uses much more energy than one made on Visa.)
The question, then, should not be how much energy is consumed, since every economic activity consumes energy, but rather, how green is the energy source today, and how can carbon emissions be reduced? Bitcoin mining farms can and should be located in remote areas in order to harvest renewable energy such as solar or hydro that might otherwise go to waste. In Canada, a company called Upstream Data is converting waste natural gas at well sites, which would otherwise be released into the atmosphere, into electricity in order to power mining farms. These mining operations are arguably carbon-positive. Recent research from Ark Invest and Square (a financial payments company founded by Jack Dorsey) argues that Bitcoin could be a key accelerator of the global transition to renewable power. Recent estimates of the percentage of green energy in the overall energy mix for Bitcoin mining have ranged from 39 per cent (CCAF) to 73 per cent (CoinShares Research) – even at the lower end, Bitcoin mining would be twice as green as the US grid. Since his market-moving tweet in May, Elon Musk has participated in the formation of the Bitcoin Mining Council, which plans to publish the renewable energy usage of Bitcoin miners to improve transparency and increase sustainability.
Beyond Bitcoin – whose validation process is called “proof of work” – most new blockchains use or are moving towards a validation process called “proof of stake”, which uses financial stakes as validation, rather than energy consumption, to secure their networks. The aim is to render the energy consumption debate nugatory.
Several years after Bitcoin’s launch, Vitalik Buterin, a young Russian living in Canada, recognised its limitations: its mining consumes large quantities of energy, it is slow and it does not scale well. Buterin saw an opportunity to introduce algorithms called “smart contracts” that sit on top of a blockchain. These would enable autonomous transactions to be performed without human intervention. This led to the release in 2015 of the Ethereum blockchain, which is now the second-largest crypto asset in the world. The name is a reference to the “ether” – the invisible medium once thought to permeate the universe allowing light to travel. Buterin wanted his platform to be the imperceptible underlying medium for the applications running on top of it.
Smart contract capability has led to the creation of hundreds of decentralised autonomous organisations (DAOs) that perform multiple functions, such as:
Decentralised finance (DeFi) – the trading, lending and borrowing of crypto assets on decentralised exchanges and lending platforms.
Stable coins – cryptocurrencies that are convertible on a one-to-one basis with the US dollar or another national currency or asset, which can then be sent worldwide more quickly and cheaply than via banks or traditional payment services providers. The cost of remittances using traditional means can be up to 30 per cent of the payment itself; using blockchain-based services, this cost can be reduced to a few cents, a boon for the international worker diaspora.
Non-fungible tokens (NFTs) – digitally secured assets that provide unique ownership of creative content, whether it is music, art or video. NFTs enable artists to bypass rent-seeking intermediaries and distribute works directly to customers, enabling them to take a greater share up front and ensuring they have an ongoing participation in royalty payments on future sales.
Metaverses – blockchain-based virtual worlds such a Decentraland have created “metaverses” that users can explore as avatars. These are not games; rather they are rich visual and auditory 3D environments where users can roam, socialise with other avatars, buy and sell online real estate and open online businesses to earn cryptocurrency. The nightclub Amnesia Ibiza is planning to open a virtual venue later this year in the metaverse. In addition to virtual clubbing, users can access an NFT store selling electronic music, DJs’ autographs and wearables with which to dress up their avatars. Atari plans to open a retro arcade and casino. The owner of the Beeple artwork plans to put the piece on display in several virtual-world environments.
Alongside these technological developments, new, more democratic and inclusive business models are emerging based upon an alignment between customers, producers and capital. These are analogous to employee/customer-owned cooperatives or mutuals in the traditional business world, such as John Lewis, or the old building societies. Such “digital collectives” are replacing baby-boomer-led hierarchical power structures with community approaches led by Gen X and millennial innovators. The Ethereum community tends to attract left-leaning progressives seeking to create a better form of capitalism; hardcore Bitcoiners are invariably libertarians obsessed with individual sovereignty.
Crypto is more than just technology: it is a new political, economic and cultural paradigm. It is for the middle classes in failed states seeking to preserve wealth, and for entrepreneurs in developing nations seeking to access banking services. It creates opportunities for artists, and jobs and social engagement for millennials jaded by the iniquities of turbo-capitalism.
Bitcoin is a digital currency, a network and a global open monetary system with fixed scarcity. It resists censorship, exists outside the control of any politician, corporation or billionaire and is accessible to anyone in the world with a smartphone. The recent crash in its value has shaken emerging mainstream acceptance in the short term, but crypto will achieve greater adoption in time.
Over the past 30 years the internet has transformed the exchange of information. During the coming years blockchain and crypto will likely become just as ubiquitous – in the exchange of value, in the creation of online communities and in the preservation of individual liberty.
Simon Chapman is an observer of the nexus between government, finance and technology
This article appears in the 07 Jul 2021 issue of the New Statesman, The baby bust