Been paying much attention to Bitcoin lately?
For many people (well, most people, let’s be honest) the digital cryptocurrency hasn’t been a particularly newsworthy topic for at least a year – at least, not since the bubble which saw the price of one bitcoin peak at $1,242 in November 2013, before popping, rising a bit again in early 2014, and then declining again. Regardless, a number of online retailers now accept Bitcoin instead of fiat currency from customers, and there are even major sporting events sponsored by Bitcoin companies.
The media (and I include myself here) became bored of Bitcoin as it became just another tech novelty, like Google Glass or virtual reality. Not necessarily ignored, though – major crises, like fraud in the large Bitcoin exchanges, or a black market being shut down, are still interesting – but post-bubble there’s been very little of relevance to those outside of the fields directly related to it, like online retail, or cryptography.
This has been just fine for many of Bitcoin’s most passionate advocates, who saw the media’s scrutiny as a primary factor in causing its earlier speculative bubbles. One of the defining quirks of Bitcoin is that it’s simultaneously a currency and a commodity (to the chagrin of tax authorities worldwide), though, and this caused some tension among those who hope to see it become a serious threat to, say, Western Union: the long-term health of Bitcoin is generally seen as dependent upon it becoming seen as being as boring and reliable as cash, but at the same time speculators driving up the price were by far the best way to both raise awareness among the lay population and convince others to invest in “mining” it.
But, of course, that speculation has given Bitcoin a price volatility that has scared away exactly the kind of people who need to be confident their currency isn’t going to devalue overnight, without warning, and without the kinds of consumer protection that central banks and nation states offer. That’s been the problem from the start, really. Bitcoin isn’t going to replace any fiat currencies as long as it feels intuitively safer for most people to keep their savings in a bank account instead of in a digital wallet.
This brings us to the current crisis in Bitcoin: far from widespread adoption giving it resilience and reliability, the system may be starting to fall apart. The price of a Bitcoin versus the dollar has been falling steadily since that brief post-bubble “recovery” in early 2014. Here’s a chart from bitcointicker.co of BTC versus the US dollar going back roughly 18 months:
The trend is clearly down, and has been for a while, the occasional rally excepted. Worse still for those holding BTC, too, it seems to be speeding up – particularly in the last week:
The price of a bitcoin is skittering around just above $150 as of writing, but there’s no reason to think it won’t keep falling, for two reasons.
Firstly, as with many previous crashes, there’s been a spike in the volume of trading on Bitcoin exchanges – particularly this week. But unlike the situation with previous crashes, this is taking place in the context of that year-long decline in BTC price. There are a lot of people who bought big in Bitcoin back when it was worth more than gold, and they’ve spent most of the last nine months hurting for it; most infamously, Bitcoin was one of the few investments in 2014 to give a worse return than the rouble.
There’s plenty of anecdotal evidence to suggest that groups (like hedge funds, for example) which bought huge numbers of bitcoins are now dumping them onto the market as they try to get out of what looks to be a lost cause. Some of these groups have hundreds, if not thousands, of bitcoins in reserve, and the depressive effect on the market price is considerable. In effect, it’s the likely end of Wall Street speculation on Bitcoin as a commodity, and a return to acting primarily as a currency.
That means Bitcoin will increasingly need to prove itself as a viable currency from now on to survive, but that’s also a problem, because of the second reason for the price decline: there are fundamental problems with Bitcoin’s infrastructure, and as of yet nobody appears to have a fix for them. It’s still far too easy to steal bitcoins, for example – Bitstamp, one of the most popular wallet services, had $5.6m worth of customers’ bitcoins stolen just last week, forcing a temporary halt on withdrawals. There’s no way to get stolen bitcoins back, either.
Then there’s the incoming rent-energy-return on investment crisis in mining. Bitcoin’s meant to work like this: the record of every single transaction is the blockchain, which is updated every ten minutes by “nodes”, or computers running dedicated Bitcoin software. Every time someone sends someone else bitcoin, that’s noted by a nearby node, which then sends further copies out to other nodes, and so on and so on, until as many nodes as possible have a record for when the next blockchain update has to be finalised. If a transaction is recognised by 50 per cent+1 of the nodes on the network, it’s legit, and goes through; if it isn’t, it’s ignored, and that (in theory) means there can’t be falsified financial records on the blockchain even though there’s no central entity checking every single one.
There are also a predetermined number of bitcoins in circulation, increasing at a set rate – so as an incentive to get people to run nodes 24 hours a day, seven days a week, the new coins coming in get given to the node-runners. Bitcoin transactions are encoded with some complex cryptography, and keeping track of them all requires some decent computing power. It’s like trying to crack codes, over and over again, with increasing difficulty, and it’s known as “mining”.
What’s happened over the years, however, is the professionalisation of mining, to an astonishing degree – there are companies selling dedicated mining rigs, and other companies running huge mining operations in basements or warehouses. Vast, hot computers running at top speed, only kept from melting down by equally vast fans. It’s a business that comes with a significant cost when it comes to electricity bills and rent. That was fine when the price of a bitcoin was $1000, or $600, or even $400, but as the price of a bitcoin falls it makes those bills inherently more expensive. And Bitcoin is intentionally built so that the difficulty of mining goes up as time goes on, and the number of bitcoins distributed via mining goes down.
In theory, there’s a transaction fee on every Bitcoin transaction that’s meant to be redistributed to every node owner, and that’s in turn meant to compensate for the decrease in the number of mined bitcoins – but again, anecdotal reports seem to indicate that those aren’t enough for many miners. And without miners, the bureacratic backbone of the site – the blockchain – becomes more vulnerable.
Similarly, one of the main ways users try to keep costs low is by ganging together into “mining pools”, working together and splitting the profits. Yet this comes with yet further issues: some mining pools have managed to grow so large that they briefly threaten to constitute more than 50 per cent of the nodes on the network, meaning that anyone who managed to control every computer within the pool could, if they wanted to, completely fabricate a new blockchain, and with it give themselves as many coins as they want. If they did it subtly, without being obvious and causing a panic, they could milk the system for a far greater return than any honest mining could provide.
These issues add up to what we’re seeing now – the slow, inexorable decline in the price of a digital currency with no value beyond the trust in the system. Where it bottoms-out will depend on how much trust the community has built up among retailers and users up to this point.