Even after a decade, Bitcoin has not been accepted as a medium of exchange globally by governments, centralised authorities and financial institutions. The European Union has warned the masses against investing in cryptocurrencies, declaring it highly risky, speculative and unsuitable for most retail customers as an investment or a means of payment or exchange.
But the question is, what’s wrong with cryptocurrency? The answer is simple: Bitcoin lacks decentralisation, with a few entities monopolising the Bitcoin economy.
Bitcoin (BTC) was launched in 2009. Before this, Satoshi Nakamoto — a pseudonymous name — sent an email to a cryptography mailing list on Nov 01 2008 stating: “I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party.”
While explaining Bitcoin in his white paper, he claimed that Bitcoin is a decentralised currency and does not require a trusted third party, ie, a bank or any financial institution, for its operation.
However, in the first few years, little interest was developed in Bitcoin, which is evident from the number of transactions included in the blockchain in the first year(s). Later, when enormous pay-outs in BTC — up to 10x, 100x, and even 1,000x — were given through the gambling website SatoshiDice DApp, people took an interest in Bitcoin.
The belief that no government, institution, or person can influence Bitcoin’s price seems incorrect
A time came in June 2012 when more than 60,000 transactions were taking place each day through this gambling website. This results in hundreds of transactions added to the Bitcoin blockchain — the majority of which were due to the use of Bitcoin in gambling. Afterwards, the interest in Bitcoin gained momentum due to its open-source nature and wider interest by the international community.
Despite the initial claims, some studies argue that Bitcoin is not a decentralised currency — a few entities control the Bitcoin economy, and mining pools are among those. Mining pools control the majority of the computation power, and if they collude, they could control transactions in the Bitcoin blockchain.
More precisely, a random snapshot on Aug 05, 2022, of Blockchain.com’s data on the market share of the most popular bitcoin mining pools shows that six mining pools control 55 per cent of the computation power. This control increased to over 65pc when analysed over the year’s data. This indicates that a small fraction of miners hold most of the wealth and power.
Cryptocurrency exchanges influence the prices of Bitcoin by controlling its demand and supply. One recent example is Celsius Network, a cryptocurrency lending private company that froze withdrawals and transfers of 1.7 million accounts of its customers. This action resulted in a 60pc price drop in Bitcoin and Ethereum.
This is against the principles of decentralisation and the promises made by Bitcoin. Additionally, wallet service providers can also manipulate the Bitcoin prices and control the Bitcoin you possess.
A study, ‘Characterising Wealth Inequality in Cryptocurrencies’, reveals that 0.01pc of Bitcoin addresses contain over 58.21pc of all Bitcoins in circulation. Thus, Bitcoin also follows the typical Pareto distribution of real-world economies ie, 20pc of the population controls 80pc of the wealth.
However, cryptocurrency is worse than real-world economies. A study, ‘Cooperation among an anonymous group protected Bitcoin during failures of decentralisation,’ also referenced in the New York Times, reveals that for two years — from the launch of Bitcoin to BTC price reaching $1 — 64 key players mined most of the Bitcoin. This is once again contrary to Bitcoin’s promise of egalitarianism.
Ideally, everyone can participate in the Bitcoin mining process and earn Bitcoin as a mining reward and transaction fees. However, due to the increased hash Rate [a measure of the computational power used to mine and process transactions on a proof-of-work blockchain network] and the dominancy of mining pools, the chances of winning the cryptographic puzzle for a normal person are almost negligible. Thus, the fate of Bitcoin is not in the hands of an average person.
Due to cryptocurrency’s highly speculative nature, economists believe that neither it can be treated as a medium of exchange nor store value. Above all, Bitcoin does not have any intrinsic value, and even as such, Bitcoin does not digitally exist — it is just an entry in the Bitcoin ledger. In simple words, when Alice transfers Bitcoins to Bob, it is only an entry in the distributed ledger that is being updated in the form of transactions.
Transactions show the ownership rights of Bitcoin and can easily be tracked through Unspent Transaction Output (UTXO) and Spent Transaction Output (STXO) in the publicly available ledger of Bitcoin.
The government does not back cryptocurrencies thus, they do not have a financial services ombudsman. If you invest in crypto and lose, you may lose a large amount or even all the money invested, and you have nowhere to go and fight for your customer rights.
Social media influencers have their own vested financial interest, so one should beware of such biased marketing about cryptocurrency. Further, one should be careful as a lot of scams and fake crypto assets exist. One can even create one’s own cryptocurrency. Some studies argue that black money holders use cryptocurrencies to make their money white. Crypto can also be used in money laundering because Know-Your-Customer rules are not applicable here.
Though currently, Bitcoin’s market capital is more than $400 billion and together with Ethereum, it is among the top two cryptocurrencies, it is still used for gambling and as a medium of investment instead of as a means of payment or exchange.
Bitcoin was the hope of many because it allows to send money directly and challenges the monopoly of governments, centralised authorities, and financial institutions. Nevertheless, a few entities control Bitcoin’s economy. The claim that no government, institution, or person can manipulate a cryptocurrency’s price or influence Bitcoin prices seems incorrect.
The writer teaches Computer Science at Munster Technological University (MTU), Ireland.
X (formerly Twitter: @MRehmani)
Published in Dawn, The Business and Finance Weekly, September 18th, 2023