Bitcoin, the cryptocurrency, has seen its price see-sawing wildly over the last 12 months, making it one of the most volatile assets.
Now whether it can be considered at all a currency — a token of money that can be exchanged for other goods — is another question.
At its current price in dollars, one Bitcoin is trading for $9,120, down by about half from its highest price of $19,206 a month ago. It is still nine times what it was trading only 12 months ago. The prices of all other cryptocurrencies have followed the swings in the price of Bitcoin. Among all cryptocurrencies, and there are more of them, Bitcoin is by far the biggest.
The hype over Bitcoins and similar cryptocurrencies has been that they are not created by governments and their prices are outside government control. This makes them a libertarian dream.
For those not familiar with this brand of American politics, libertarians are those who oppose any role for the State in the economy, but passionately believe in its repressive role as a protector of private property. They should not be confused with anarchists who, unlike libertarians, also oppose private property.
There are some fundamental misconceptions about such cryptocurrencies, one of them being that they cannot be regulated or taxed.
Of course they can be regulated, as they are traded in various exchanges. The simple statement of intent by South Korea of regulating Bitcoins has seen their price crash significantly in just a few days.
The bulk of the Bitcoins are held in what are called digital wallets, created by companies, which also function as exchanges for Bitcoins. All these companies exist under some legal jurisdiction. All such trades — Bitcoins for other currencies in different countries — exist under exchange control rules of governments.
All of such wallets, or trades, can be taxed through wealth, or transaction tax; or the government could define wealth to include cryptocurrencies, and levy a capital gains tax. The problem is not that they cannot be taxed, but the instruments of such taxation — wealth, capital gains and transaction taxes — are anathema to the financial oligarchies that run governments today.
What Are Cryptocurrencies?
Unlike governments, which print legal currencies and guarantee their value, in the cryptocurrency world, who determines what is the amount being exchanged? And does it really belong to the person initiating the exchange?
If we use paper money, printed and guaranteed by the State, it is recognised by both sides of the transaction as money: the verification is almost instantaneous. In the world of digital transactions, it is a bank or a credit card company that verifies such transactions through a centralised bookkeeping system.
How does it work for cryptocurrencies? How are cryptocurrencies created, and how are they exchanged without such a centralised authority?
Satoshi Nakamoto, a pseudonym for the unknown founder of Bitcoin, in 2008 proposed a cryptographic solution for solving this problem. His solution combined the two parts of the problem — how transactions could be recognised, and how currency could be created — into one. He based it on a distributed processing model, where no centralised verification of transactions through a central ledger would be necessary, creating a technology now known as blockchain.
Blockchain technology is a system of distributed ledgers, and collectively verifies these transactions. The record of all transactions are in a chain of blocks, hence the name.
Nakamoto detailed how digital cash could be created and maintained without a central authority. This money would depend on computational power and a distributed set of computers that keep a record of these transactions. Each node of the system would then have a copy of this ledger, and these distributed ledgers would verify the transactions, making it nearly impossible to defraud the system.
How are Bitcoin transactions verified and how are Bitcoins created?
Each block in the blockchain system underlying Bitcoins contains a set of Bitcoin transactions. You cannot register two transactions with the same set of Bitcoins, as the verification would show you no longer own them. For each block of transactions to be recognised and added to the system, all the nodes simultaneously work on “recognising” this block — called “mining” in the Bitcoin world — by embedding the transactions in a computational problem, and then solving it. Once a node finds the answer, it is transmitted to all the other nodes, which can verify that it indeed is the correct answer. Once a set of nodes have accepted the answer, this block is added by all the nodes in the system. The node originating the solution then gets a set of Bitcoins — currently 12.5 Bitcoins — for solving the problem.
While the answer is easy to verify, finding the answer to the question — is this a valid block of transactions? — is computationally intensive, and has a chance element to it.
The race does not go to the fastest, though you are not even in the race, without having powerful machines. As machines become more powerful, and more nodes are added to the system, the difficulty level is raised, so that the rate of mining — 12.5 Bitcoins every 10 minutes — remains nearly constant. The number of Bitcoins awarded to the successful miner is also going down, and was halved from 25 to 12.5 in 2016, and will continue to be halved in the future coming to zero at some point.
The final number of Bitcoins that can be created by this method cannot exceed 21 million Bitcoins. So far, around 80 per cent of all Bitcoins that can be created have been released into the system.
Anybody who buys, sells, or creates Bitcoins, needs a personal key, a string of characters known only to the person. The private key pairs with a public key in the public domain, which can then be used to de-encrypt whatever is encrypted by the paired private key.
Crypto money is associated with a key, and not a person, and without the key, there is no access to the money. If you lose your key due to a hard disk crash, or your computer being hacked, you also lose your access to the crypto money. And in this libertarian paradise, you cannot go crying to big momma for losing your password/passkey, and demanding a new one; or complain that somebody has stolen your key. Your key, in the Bitcoin world, is you!
Is Cryptocurrency money?
Money, as we know, has two functions. It can be used for transactions, or it can be held as an asset. Is Bitcoin then a means of transaction, or is it an asset? Or is it both, as almost all currencies are?
I would argue that Bitcoins cannot be meaningfully used for transactions, except in a very restrictive sense, and hence are not money.
It is an asset class, and speculative pressures explain the volatility of its price. I am restricting myself here to Bitcoins, considering it to be representative of other cryptocurrencies.
The reason that Bitcoins are not used for everyday transactions, unlike all other forms of money, is because it simply cannot be scaled. Any transaction in paper money is independent of any other transaction; it is independent of how many other transactions are taking place simultaneously in the system. It is fully scalable, subject only to the amount of currency in the system.
In the world of digital transactions, decent credit card systems today can handle 60,000 transactions a second. Bitcoin, as it involves solving a hard cryptographic problem, can currently handle only 3 to 7 transactions a second, as each block contains a maximum of 2,000 transactions, and takes about 10 minutes to mine. That means that transaction completion times can be anything from a few minutes to hours, and if it is for everyday transactions, the transaction cost can become a very large fraction of the transaction itself.
One set of transactions with cryptocurrency can still happen in the real world. These are criminal transactions, where anonymity is the key; where those hijacking your computer using the Wannacry ransomware demand to be paid in Bitcoins. Apart from such criminal transactions, there does not appear to be any reason why transactions in the real world should take place in Bitcoins.
Why is the value of cryptocurrencies than yaw-yawing wildly?
As we answered, it is largely speculation. More than 40 per cent of all Bitcoins are held by less than 1,000 accounts, leading to the potential for large market manipulations. Further, with transborder flows becoming important in the age of tax havens, a number of the super rich want to hedge their bets by holding their wealth in different forms: from stolen paintings to Bitcoins.
In the age of global financial oligarchy, the hype in Bitcoins and its wild fluctuations are simply indicators of the increasing criminalisation of the financial system.