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Bitcoin – The Good, The Bad & Our View

Before we dive deeper into this discussion it is worth placing bitcoin in perspective with a few facts.

Who created the Bitcoin idea?

Bitcoin (BTC) was first established in an anonymous paper published by a certain ‘Satoshi Nakamoto’ in October 2008 titled ‘Bitcoin: A Peer to Peer Electronic Cash System’. The first bitcoin software was released in January 2009. Many theories have been touted to the identity of Nakamoto but has yielded little, some have claimed the title with no proof.

Limited number of Bitcoins

The total number of bitcoins that will ever be available is limited to 21 million At the time of writing this there are 16,724,111 bitcoins in circulation worth around US$286bn.  

10 or 9 mins

Approximately every 10-9 mins a block is produced with a reward of 12.5 bitcoins. This reward falls 6.25 bitcoins when the total number of blocks is 630,000, today there are 499,902 blocks

Highly energy consuming

If Bitcoin and Ethereum (another cryptocurrency) were countries, they would rank 71st in the amount of electricity consumed. A bitcoin transaction consumes the equivalent energy to power 8 homes in the USA per day.

Extremely difficult to find/mine

There are 2^256 possible combinations of digits (that’s 1 followed by 77 zeroes) required to attain a block which in turn provides a reward of 12.5 bitcoins. Put another way in comparison the edge of the observable universe is 4.16^23 kilometres (that’s approx. 4 followed by 23 zeroes or 416 billion trillion or 0.416 septillion).

China Mines

It is estimated that China mines over 80% of bitcoins according to buybitcoinworldwide. This would imply that most Bitcoins are held by the Chinese.

Expensive Pizzas worth $170m today

The first use of bitcoin was to buy two pizzas for $25 using 10,000 bitcoins. The transaction was between Satoshi and Hal Finney in 2009. Those 10,000 are now worth over $170m.

Transaction fee’s aren’t always cheap

The bitcoin network charges transaction fees when bitcoins are transacted upon. More recently it cost $20 per transaction.

In this note we purposely focus on the technological impact Bitcoin or more pertinently, the Blockchain technology and ideology might have on the future. Making predictions of where the price of bitcoin will be, I leave for others.

What is Bitcoin?

The idea behind bitcoin was established by a figurative individual that no one seems to know or be able to trace, allegedly his name is Satoshi Nakamoto, it is widely accepted that this is only a pseudonym. This detail maybe superfluous but what he/she created seems to have the world beguiled where millionaires if not billionaires are created overnight. He/she has created so much wealth it rivals the tulips mania of the 17th century which in the end concluded as tulip prices tumbled.  

In a nutshell without getting technical, a bitcoin is a series of alphanumeric digits that are awarded as  prize when one is able to solve a puzzle known as a block (currently 12.5 bitcoins are awarded to a correct solution). Think it as a digital game where the aim is to solve a very complex problem. To solve this problem participants use software to generate a series of alphanumeric codes which if correct, unlocks or solves the puzzle. Upon finding a solution, a number of bitcoins are issued to the solution provider, represented as a series of digits. In this game, once the solution to the puzzle (or block) has been identified that block records various details, much like a database record, it contains attributes of the puzzle that was solved as well as subsequent transaction details of bitcoins that may have been bought or sold. When a solution is found for the puzzle the answer needs to be verified by the blocks that have previously been solved, in a peer to peer process. Only once the solution is verified by the network of blocks does a new block attached itself to the previous blocks creating a chain of blocks, known as the ‘Blockchain’. The gatekeepers who validate the solution are the previously authenticated blocks, collective known as a peer to peer network. Software within this ecosystem allows for newly generated blocks to be accepted or rejected based on valid submissions of answers to the puzzle.  Over time more puzzles or blocks are solved and added to the previous blocks.

There are no limits to the number of blocks that will be added to the chain but there is a limit to the number of bitcoins that will be released, this is capped at 21 million. So, in principle there will be no incentive to solving this puzzle when 21 million bitcoins are in circulation. Transaction fees are generated to members of the blockchain for maintaining the chain with their computers.  

Our view

In short, the underlying technology behind bitcoin called the ‘Blockchain’ will likely have use cases that are yet to be discovered. There is little point scribing about hypothetical use cases until some of the fundamental issues in blockchain technology has been resolved. However, today there are companies working on using Blockchain for some transaction based processes.

Companies are fervently working to adapt the ideas and technology that bitcoin is based upon to create applications that one day could be used for transaction purposes. At its nucleus it’s a shared network of resources with incentives for those that facilitate the network with permanent records stored.

If we were to ignore the Bitcoin aspect of the technology and focus on the guts of the blockchain technology one will notice how the potential of blockchain can be used for a variety of cases. In simple terms if we step back and examine blockchain it reveals a smart database of records that allows new records to be added and validated once a set of criteria have been met. This potentially does away from intermediaries that require validation and verification of data for a given transaction. In another example, its the ability to use blockchain to allow network participates to get paid/rewarded for underutilised storage or compute (i.e. the use of the central processor) on their PC’s. The latter is like the current setup in Bitcoin where nodes (computers) are awarded a transaction fee for being part of the blockchain network.

Take the exchange of contracts for the purchase of a property. One needs a lawyer (trusted party) to verify all the data is legal and correct. Once the lawyer is happy the parties proceed to exchange contracts thereby transferring ownership of the house to the new buyer, simultaneously crediting the sellers bank account with funds. This intermediary friction can be avoided by adapting the concept of blockchain to effectively side step the lawyer and bank. In this case the buyer and the seller submit all the information into a specified blockchain that validates and verifies all the information and releases the funds as well as title deeds, creating a permanent verifiable record of this transaction. This is a simplistic representation but with further work the idea is wholly feasible allowing for some constraints we discuss later.

An analogy to the euphoria in the price of bitcoin would be to look at the prices of IP addresses or domain names during the tech bubble. At that time there was large scale speculative buying of domain names at astronomical prices, like business.com which sold for a record of $150,000 in 1997 to then be resold for $7.5m in 1999 a return of over 5000%. Then investors may have looked at this the same way they look at the price of bitcoin. Questions like ‘what value can the rights to business.com ever bring?’ were common, little did we appreciate the impact of the internet. Not many investors could have imagined the utility the internet has afforded the world at that time. In the main, it was technologist not the investment community that was able to monetise this space. Think of the early days of the internet no one would have thought that today the total value of all the IP addresses would be c$100bn (4.3bn IP address at $22).

Suffice to say, the blockchain will form some part of the fabric of future technologies, which part however, is difficult to predict. On the other hand, it could just be confined to the annals of technologies that have previously come and gone.

The Good

The paper written by the pseudonym Satoshi Nakamoto opened a school of thought that allows technology to change the way many age-old industries operate. As highlighted early there are a series of applications currently under development that are utilising the blockchain technology by disrupting industries and creating new ones. In 10 years’ time what the blockchain will morph into is difficult to predict but some derivative will likely have high utility.

The idea that the blockchain allows for transparency with permanent immutable record keeping provides visibility for governments as well as other organisations. Think for the purposes of real estate tax. Places like India and China where there is little in the way of Land Registries, albeit things are changing, it could have a dramatic impact. Blockchain adapted for this purpose would eliminate fraud and property crimes.   

The current crazy around bitcoins will abate and serious work will be carried out to provide some use cases for blockchain in the future. However, we caution, much like all new technologies this may be superseded by a new, yet undiscovered technologies.

Today, Ethereum uses the blockchain idea for commercial uses. Apps can be run on the blockchain such as Smart contracts much like the examples described above. Based on the blockchain technology premise but with different protocols, it is a contender to be a commercial viable platform in the real world. However, there are limitations to its ultimate use case, described below. Other derivatives of Bitcoin may emerge with various use cases with the idea of providing less frictional outcomes then current real world systems and processes.

The Bad

In its current guise, the bitcoin blockchain has very few use cases, apart from the current one (a store of value). The bottleneck that most commenters ignore is fundamental to the future of blockchain. It takes far too long for a block to be added to the existing blockchain. 9-10mins is a seemingly long time if you were to use this technology to process high volume transactions like clearing operations at the ASX or Visa transactions. In the US alone, 144bn noncash transactions occurred according to the Federal reserve. That is 274,000 transactions per minute. For blockchain to compete something must give. However, with its current construct the only thing to give is its security i.e. the complexity and the time it take to solve puzzle.

Scalability is in question, this is key to disrupting large scale systems currently in operation where most processes are centralised, for example bank transactions. Highlighted in this post are issues on the concept which question many aspects of blockchain.

Central to the jostling is the fact that to date blockchains fail to address the problem of scalability. To be a viable solution in the real world it needs to scale to levels that are comparable to current processes as well as stick to its knitting of being decentralised. A dichotomy in some senses as speed of transactions pays the ultimate costs in this trade-off, this is without even considering security issues.

The nefarious activities that are undertaken with cryptocurrencies is also a reminder that when digital currencies are not regulated or controlled it leaves open for criminal activities. Take Ransomware, where hackers penetrate your pc and demand money for access to your device. In reported cases bitcoin was the currency of choice for the release of locked devices. There is no recourse for fraudulent payments from a digital wallet holding bitcoins et al. So, caution must be taken when considering the consequences for the real-world use cases of Blockchain.