What We Don’t Know About Bitcoin — and Why It’s a Problem

Bitcoin was intended to be transparent and decentralized, but as it has grown, the core framework has been augmented with retrofitted capabilities that hinder true visibility.
headshot of author Jonathan Beck
Jonathan Beck
Expert Contributor
February 2, 2021
Updated: July 13, 2021
headshot of author Jonathan Beck
Jonathan Beck
Expert Contributor
February 2, 2021
Updated: July 13, 2021

The price of Bitcoin has reached record highs over the past few months, prompting the CEO of Galaxy Digital to call the cryptocurrency a digital gold story. However, the comparison is a flawed one.

While gold has shown time and time again that it is a resilient form of money, the price of Bitcoin saw the biggest single crash in its history at the beginning of the year. Blockchain-based cryptocurrencies like Bitcoin are volatile, and they lack the necessary components to scale as a global currency and payments platform. The way in which blockchain was designed will ensure it remains so.

Blockchain technology lacks fundamental regulatory guidance and therefore poses a number of risks to crypto holders. Bitcoin was intended to be transparent and decentralized, but as it has grown, the core framework has been augmented with retrofitted capabilities like off-chain transactions — where deals cannot be publicly tracked and don’t actually write transactions to the public ledger when they are made.

This lack of visibility is a problem in any financial setting, and that’s just one of the problems of blockchain-based cryptocurrencies like Bitcoin. Blockchain has instabilities that are inherent to its framework: They cannot be fixed, and ultimately result in a poor store of funds for money and savings purposes. Whats more, the increased utilization of blockchain-based cryptocurrencies like Bitcoin will only serve to exacerbate these issues. And as people adopt crypto, leveraging blockchain as the distributed ledger of choice, these problems will grow larger and expose a looming end-of-life. Crypto traders won’t exactly be advertising these weak points.

So if no one’s told you before, here's what you should know about Bitcoin, other blockchain-based cryptocurrencies and how it affects you.

 

Cryptocurrency Instability Will Continue

Cryptocurrencies are subject to quick and severe value changes. The surge in price over the past few weeks is not the beginning of a settling period, its most likely been triggered by a drop in the U.S. dollar and investors flocking to a seeming “safe haven” in the coronavirus pandemic (probably encouraged by BlackRock expressing interest in Bitcoin and Paypal launching a new service to buy, sell and hold crypto).

Its important to remember that Bitcoin is historically volatile. Just this year, its price was sliced in half between February and March, before doubling in price between November and the end of the year. Even after hitting its record high on January 3, its value fell by nearly 15 percent only hours later.

Because cryptocurrencies hold no intrinsic worth, their value is purely speculative. Unlike other financial assets like gold — which has other uses such as material for electronic devices, medical equipment and jewelry — cryptocurrencies also dont serve any other purpose other than a store of value. As a result, there is no real connection between the price and longevity of cryptocurrencies, so the bubble around them could burst at any time.

This volatility means that Bitcoin and cryptocurrencies in general cannot offer the long-term security that people need — especially not during a recession and such uncertain market conditions. As the Guardian’s Kenneth Rogoff puts it, Like lottery tickets, there is a high probability that [cryptocurrencies] are worthless.

Theres also the crypto paradox, whereby people buy cryptocurrencies but dont use them because they want their value to grow. Ironically, unless crypto is used as a currency (its only purpose), its value will fall and investors will eventually offload it to avoid further losses. Theres no sign of cryptocurrencies becoming widely accepted as payment either, as the volatility and lack of transparency makes it too high risk for most vendors. These reasons are why leading economists predict that cryptocurrencies will sooner or later return to a value near zero.

 

Off-Chain Transactions Can Be Manipulated

The previously mentioned off-chain transactions are particularly problematic for cryptocurrency users because they arent individually written to the blockchain. That means people can buy and sell crypto coins outside of the wider blockchain consensus — essentially undermining the entire reason to use the technology in the first place.

These off-chain transactions are supported by constructs like the Lightning Network, which operates as an external layer on top of a cryptocurrency blockchain and allows for private payments to take place separately before being written back onto the main blockchain.

Blockchain is intended to be a trustless environment: Every transaction requires the different nodes in the system to reach a consensus, so no single actor is responsible, and its nearly impossible to manipulate. But off-chain sales depend on the individuals managing those transactions, which opens the door for foul play. Its already been discovered that off-chain transactions can be manipulated before being written to the blockchain. For example, if an off-chain transaction takes place but one party stops cooperating, the transaction wont be confirmed back into the blockchain, and the other party wont be able to withdraw their money or take action to redeem the transaction.

 

Virtual Currencies Can Undermine Your Finances

Bitcoin cant be the “digital gold” investors are alluding to because it doesnt have the characteristics to make it a good store of value. Gold has intrinsic value and is in finite supply: Theres a fixed amount of it in existence, and it cant simply be manufactured out of thin air. While Bitcoin can be considered finite because there is a limited amount of it, there is no cap on the number of other cryptocurrencies that can be created. This ability to continually reproduce cryptocurrencies will dilute their value over time, which is why they’ll never be a place for people to safely store their money.

The speculative nature of cryptocurrencies also means that their purchasing power is unstable. That means that anyone who buys crypto could find that when they need to buy services, be it the following day or the following year, they have less money than when they started out.

There’s also great concern over cryptocurrencies in the banking sphere. In 2019, eight of the 10 major U.S. retail banks had dealings with illicit crypto money service businesses. The U.S. Financial Crimes Enforcement Network has since emphasized the importance of anti-money-laundering schemes in relation to cryptocurrencies, but many banks still find themselves unsure of protocols when it comes to virtual currencies. If banks are plagued by such crypto gray areas, it could seriously undermine their stability as financial institutions.

Just as fiat (government-run) currencies lose their value over time, so will Bitcoin and other cryptocurrencies — but at a greater pace. Already, a large majority of cryptocurrencies have ended up listed as dead coins,” or failed currencies. Spikes in crypto prices should not be taken as a sign that they are “digital gold” but rather that there are so many unknowns surrounding virtual currencies that raw speculation is dictating their price. This couldn’t be further from the historic reliability of gold: As the world’s oldest currency, gold has endured countless recessions and economic dips and dives. Yet it has come out stronger than ever, and it continues to be used as money universally. Any emerging currency has to pick up a lot more mileage, experience and security before drawing such a comparison.

 

Blockchain-Based Crypto Cant Scale to Mass Adoption

As blockchain-based crypto utilization expands globally, there are clear limitations to their speed and scale. It takes huge computational time and energy to write transactions to a blockchain, which is why fewer than 10 transactions are written per second. This slow speed cannot be improved without rebuilding the original framework of the Blockchain technology. But even if this were successfully done, the augmentations would mean that the blockchain wouldn’t have the same security as before, nor the same capabilities, and it would be proven to be susceptible to modifications.

Blockchain also relies on the immutability of previous transactions and the related algorithms that maintain the network. That means blockchains are intrinsically difficult to enhance; they cant be simply upgraded from version to version and still maintain the integrity of the original system.

There are also concerns around the environmental impact of crypto processes. Transactions made by Bitcoin users are verified via mining, a process that involves solving a problem on a computer. Because people are rewarded with cryptocurrencies for correctly solving the problems, Bitcoin mines have emerged: warehouses full of mining computers that run all day. The energy consumption associated with crypto is breathtakingly high; estimates show that Bitcoin uses around 90 TWh of electricity per year, about as much as the entire country of Finland.

Bitcoin and blockchain can be thought of as version 1.0 of cryptocurrencies. They were built to serve the core purpose of providing a distributed ledger of tokenized assets that utilizes cryptography principles and a trustless network of distributed ledgers (nodes) to ensure the security, accuracy and non-repudiation of cryptographic transactions. Version 2.0 added the ability to use the same blockchain framework to support binding legal contracts, but it still suffers from the problems of scalability.

 

The Modernization of the Distributed Ledger Space

There is an alternative distributed ledger technology to blockchain that could support digital payments outside of cryptocurrencies, while providing a far more efficient and borderless service compared to traditional banking.

Hedera Hashgraph can be considered version 3.0 of distributed ledger technologies. Hashgraph takes all the benefits of a distributed ledger — security, cryptography, binding contracts between entities, non-repudiation — and builds a secure, mathematically proven distributed ledger framework that can scale to support the demands of global adoption.

As a distributed ledger platform, Hashgraph is much faster and more secure than Bitcoin, supporting up to 10,000 transactions per second compared to Bitcoins 2.8 per second. The network also utilizes a gossip protocol to ensure the network remains resilient even if the entire internet was turned off in the middle of a transaction. Furthermore, the network has been proven to be Byzantine-fault tolerant, meaning that, as long as two-thirds of the nodes are controlled by reputable entities, no data can be manipulated on the DLT. Byzantine-fault tolerance is also proven mathematically to be the best possible outcome any distributed network of nodes can hope to achieve.

 

Crypto Should Provide Long-Term, Intrinsic Value

Distributed ledger technologies stand poised to change the landscape not only for fintech as a means to transact and allocate funds but also as a mechanism for cradle-to-grave asset tracking, legally-binding contracts between entities and, of course, as a platform for generating an infinite number of cryptocurrencies.

In order to properly utilize crypto as a transactional currency with a long-term store of value, it must satisfy two requirements:

  1. It should use a modern distributed-ledger framework that can scale to meet the demand of a global community.
     
  2. It should also provide intrinsic value by being tied directly to a physical asset that has value in the world to set it apart from the myriad of other cryptocurrencies that can be created.

Due to the inherent gaps in both scalability and as a store of value, its my view that Bitcoin will never live up to the hype surrounding it as a crypto platform.

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