When Bitcoin first launched, there was a great deal of interest in the digital currency. Bitcoin investors were all over the news, talking about the virtual pot of gold they saw in Bitcoin, and encouraging everyone else to get on board. It seems that, perhaps not shockingly, this was bad advice. Bitcoin has seen its value collapse over the last few months, and in this article, Australian professor David Glance explains some of the fundamental flaws of the Bitcoin model. – FD
Bitcoin’s continuing price fall unmasks its underlying flaws. Is this its end?
Bitcoin was dubbed the worst investment of 2014. As predicted however, 2015 has seen the continued fall in value of the currency that was supposed to fuel the digital age. In the last 10 days alone, it has lost 26% in value.
If 2014 was a bad year for the digital currency, 2015 looks like it will be even worse. Barely days into the year, UK-based Bitcoin exchange Bitstamp was “hacked” and 19,000 Bitcoin stolen. At the time, this loss was valued at US $5 million. Bitstamp has since come back online, with revamped security from BitGo. It may however, all be a bit too late.
Hacks of Bitcoin exchanges have come to characterise the Bitcoin world. It isn’t something that is necessarily inherent in Bitcoin itself, but more of a feature of the types of companies that have sprung up around the troubled technology. At best, the hack of one-time leading Bitcoin exchange Mt Gox, was a result of sloppy coding and business practices. At worst, it was an inside job, defrauding its customers of $487 million.
A more ominous problem has cast its shadow on the future of Bitcoin. Bitcoin relies on people to engage in “mining” to validate every exchange of the virtual currency. Miners, do some agreed calculations, and if they are fast, or lucky, enough, will succeed in winning some newly produced Bitcoin in exchange for adding the transaction onto the Bitcoin ledger called the Blockchain.
The strategy of mining has become Bitcoin’s achilles’ heel. The design of Bitcoin dictates that the difficulty of mining will increase as more Bitcoins are produced and more miners get involved. This has led to mining being dominated by companies that can scale to the point where they can guarantee to earn a certain percentage of Bitcoins created each day. As Bitcoin’s value has dropped, the economics of the mining operation have changed, to the point that mining ceases to be economically viable.
Cloud mining company CEX.io suspended their mining operations this week, declaring that it needed the price of Bitcoin to be at least $320 before it would be able to resume its operations. Unfortunately for them, the price has dropped even further since and the likelihood of it climbing back to $320 seems slim.
Another mining company, CoinTerra, is being sued by a data centre provider for $5.4 million for unpaid fees. The cost of power alone to run CoinTerra’s services was $12,000 a day.
The underlying protocol of Bitcoin does allow for the relative difficulty of mining to be eased if it becomes to hard for miners to stay in operation. In fact, this happened last month for the first time since 2012. It could theoretically continue to become easier as the Bitcoin price drops. The issue is however, that this wasn’t supposed to happen. Bitcoin’s price was supposed to keep increasing as more Bitcoins came onto the market.
Bitcoins value relies purely on the belief of the people who buy and sell it. There is no central bank or government around to support it in the case of its value crashing to zero. Once that belief is questioned, Bitcoin becomes unsustainable. Even if the price of Bitcoin doesn’t go to zero, the chances the Bitcoin community convincing the wider public, governments, and industry that Bitcoin really represents the future of the world’s digital economy will become extremely unlikely.
For the time being, Bitcoin still has enough devotees who believe that the currency will eventually recover and still claim the crown as the future enabler of all digital commerce. However, even they are having their doubts that this grand technological experiment may have run its course.