Decentralized cryptocurrencies such as bitcoin are taking over the world. The hope is that bitcoin becomes the ‘next gold’ and, considering that it hasF already surpassed silver in monetary value, this hope isn’t too far out. The problem, however, is that bitcoin is not the decentralized currency that it promises to be.
To understand why bitcoin is failing, we must first describe how bitcoin really works. For those here worrying about the environmental impact of bitcoin, this description will also shed a technical light on why bitcoin must fail if we are to reduce worldwide energy consumption. So, let’s try and explain the terms ‘blockchain’, ‘SHA256 hash function’ and ‘bitcoin mining’ in a language that is as accessible as possible.
The blockchain is the foundation of bitcoin which contains all bitcoin transactions ever made. More specifically, blockchains are what coders refer to as linked lists where each entry in the list contains transactional details (e.g. person A sent person B this much bitcoin). The linked aspect then defines that each entry/block knows which block comes after itself in the list/chain. This link between blocks ensures that the chain can never be internally hacked as you can only insert blocks at the end of the chain. Therefore, blockchain security only requires validation of the newest block before being appended.
It is important to note that billions of dollars worth of bitcoin are traded each day. To ensure the blocks on the chain aren’t excessively large in data size, bitcoin uses the SHA256 hash function. A quick explanation is that the SHA256 hash function takes a block with all its transactional and protocol information and transforms it into 64 letters and numbers. This process is actually far more complex, but all we need to know is that 1) the hash function decreases the data size, 2) it encrypts the data for security, and 3) it is the groundwork of bitcoin mining.
Bitcoin miners must find a number called a nonce. The sum of the nonce and the hash function’s output (given a transactional block) must then be lower than a specific target value. The target value, therefore, defines the difficulty of discovering the nonce and is dependant on the number of miners in the world. The more miners the more difficult the target value. This is the gist of bitcoin mining. If you can find the nonce (once every +- 10 minutes), you earn more than 400 000$ (14/04/2021). This might seem simple, however, because of the intricacies behind the SHA256 hash function, finding the nonce mathematically or algorithmically is considered near impossible. So, instead, people design computers to randomly guess nonce numbers until they hit the correct one.
Guessing random nonce numbers isn’t computationally expensive. However, calculating whether the guessed nonce number is correct or not is very expensive. This is why excessively large bitcoin mining farms have popped up across the world. Bitcoin mining farms collectively use +- 120 Terra Wats per hour, which is more than 85% of countries in the world use. For environmental impact, bitcoin is an absolute disaster. The more money is invested in bitcoin, the more miners pop up, and the more energy is used.
Before getting to the crux of why bitcoin has become a centralized currency and is doomed to fail, I first want to discuss a possible solution to the mining energy problem. This might be useful for future cryptocurrencies.
The computational power required to find the nonce is directly dependant on the target value. The target value is dependant on the average time it takes to find the nonce by all miners in the world. If the nonce is, on average, found faster than 10 minutes, the target value is made more difficult, and, visa versa, if the nonce is, on average, found slower than 10 minutes, the target value is made easier. Simply put, the more miners there are competing with each other to find the nonce, the more difficult it becomes. As to say, more miners means more computational power required to mine bitcoin.
My solution to this is simple. Governments should be the only entities that are allowed to mine. Be this for future cryptocurrencies, or bitcoin itself. On the one hand, this would decrease the required computational power (and, therefore, the energy) to find the nonce as there is only a single miner. On the other hand, this would entail an influx of capital to the Government which would benefit the public sectors. In turn, this could greatly benefit the private sectors as tax could be drastically reduced given the Government’s new capital flow.
Back to why bitcoin is no longer the decentralized currency that it promises to be. For this, there are three factors that need to be addressed: 1) the regulators of bitcoin, 2) the exchanges which act as banks of bitcoin and 3) the mining dilemma that places more bitcoin into the hands of those that have more bitcoin.
When bitcoin was first released to the public, it was very cheap. Today, when you discover a nonce you receive 6.25 bitcoin which is +- 400 000$. When bitcoin was first released, anyone who discovered a nonce received 50 bitcoin which is today worth 3.23 million$. Note that at the initial launch, very few miners existed meaning that only a handful of people were making 50 bitcoins every 10 minutes. Bitcoin is, consequently, rumoured to be regulated by a few excessively wealthy individuals. One major advantage of a decentralized currency is that it isn’t regulated posing uncertainty over bitcoin.
The idea that bitcoin is being regulated by a few people is only hearsay as no such person has come forward to the public. Why would they? These individuals are, most likely the richest people on earth and they control a currency that is can topple over global financial systems. Placing that much power in the hands of anonymous individuals is both dangerous on a political perspective, and means that bitcoin isn’t decentralized, but instead centralized around these few people.
Exchanges are where people can buy and sell bitcoin. On the 14th of April, the largest exchange in the world CoinBase became the first to make a public listing making bitcoin’s price skyrocket. Note, there are multiple exchanges across the world. Exchanges, to me, sounds very similar to the middle banks that bitcoin aimed to remove in the transaction process. Again, does this mean bitcoin is centralized around exchanges?
Finally, the current setup of bitcoin mines also centralizes bitcoin. Simply put, because the person/entity with the most money is able to build the biggest bitcoin mining farm, said entity will also make the most amount of bitcoin in the mining process. I hope it’s clear that bitcoin, as with any other currency, is doomed to be controlled by a few people. A decentralized currency seems wonderful. Bitcoin, unfortunately, does not deliver.
This all being said, why do I believe bitcoin will fail but crypto will thrive? Note that this conclusion is purely opionated based on the information described above. Here are my thoughts:
- The world is yearning for a global decentralized currency. Bitcoin is version 1.0 that tried to make this a reality. I predict a version 2.0 based on similar principles will eventually replace bitcoin as technology always does.
- The above prediction relies on bitcoin crashing. Many economists believe it will crash simply because bitcoin is bought and sold for the purpose of making money. The future decentralized global currency won’t be bought and sold like a share, but will instead be used to buy and sell physical products.
- Governments cannot allow a few individuals to control the world economy. Regulations will play a crucial part in bitcoin’s future. The U.S.A. need only make one regulation against bitcoin and its glorious bubble will burst.
- Climate change and the effects thereof will see more scrutiny against bitcoin mining. This by itself might not cause bitcoin to fall, but it will certainly cause many individuals to sell their bitcoin. Bitcoin holders are too fickle to not believe bitcoin will eventually crash and burn.
Cryptocurrencies are a beautiful technology that has and will change the economics of human beings. Whether or not version 1.0 will be the main version is where I and many others are sceptical. Governments always take a while to jump on technological trains. But with this rise in bitcoin and the inevitable future rise of bitcoin, Governments won’t have a choice in a couple of years to address the future of cryptos. Just make sure that version 2.0 is an improvement of version 1.0.
Your angle, Emile.