Jun 13th, 2021 | On The Intrinsic Bitcoin Value
Ecology, Sustainability, and Bitcoin News
This week, I observed a lot of discussion on the media related to ecology, sustainability, and Bitcoin’s place in the picture. I am now professionally involved in looking for value in people and projects. Therefore, I would like to make a brief recap of how Bitcoin works, and refer to the main arguments mentioned in the discussion. I would also like to mention what, to my mind, is the main Bitcoin value.
First of all, let me make two little disclaimers.
Disclaimer 1: Bitcoin Value Doesn’t Diminish Other Projects’ Value
By sharing some support for Bitcoin as a project, I don’t aim to criticize or diminish the value of any other blockchain project – including Bitcoin forks. I am aware of multiple solid projects based on methodological grounds and with a competent leader who can execute the vision perfectly (such as, e.g., Cardano led by Charles Hoskinson. Cardano is a sustainable, open-source blockchain-based on a proof-of-stake protocol known as Ouroboros. It was developed using academic workflow, i.e., peer review. Ouroboros optimizes multiple parameters related to blockchain performance and resilience to malicious hackers’ activity).
For more, among almost 10,000 cryptocurrency projects at the moment, there are dozens or even hundreds of valuable projects that create new value in the blockchain industry which I know nothing about. I believe that as long as the motivation of the creators is genuine and the project aims to offer some new quality rather than just another token that sells to investors and individuals who don’t know much about crypto – it is worth supporting. Anyway, I would like to focus specifically on the rationale and Bitcoin value, as this is a subject of media debate at the moment.
Disclaimer 2: Bitcoin News and Speculative Price Are Not Within Scope of This Article
This is not financial advice of any kind. As we all know, Bitcoin becomes a hot topic in the media every time its price surges or falls. I don’t want to speculate what the real underlying Bitcoin value is when you compare it to its market price. It is because the price of any asset acknowledged as a store of value depends on what the public collectively agrees (more on that later). Therefore, please do not treat this text as a suggestion that you should buy Bitcoin (or make any other financial decisions).
And now, to the point. What is the intrinsic Bitcoin value?
1. On the Energy Consumption of the Bitcoin Protocol
Currently, the biggest criticism against the Bitcoin value relates to its energy consumption. Namely, the fact that mining Bitcoin through the Proof-of-Work protocol is energy-consuming to a higher extent than other Blockchain protocols based on, e.g., Proof-of-Stake. Indeed, according to the Cambridge Bitcoin Electricity Consumption Index (CBECI), the Bitcoin network currently consumes approximately the same amount of energy as the Netherlands. Plus, more energy than countries such as Belgium, Israel, Switzerland, Hungary, and many others.
Sounds like a lot of energy, doesn’t it? Well, it depends on the point of view. According to the same CBECI, “The amount of electricity consumed every year by always-on but inactive home devices in the USA alone could power the Bitcoin network for 2.2 years.” That effectively means that American consumers alone (excluding American institutions and businesses) waste twice more energy in their households than the whole Bitcoin network needs.
Yet still, the question remains: is it a lot of energy or not? Well, let’s think of what we actually gain for this energy spent on sustaining the Bitcoin network. To understand this, we need to recall how Bitcoin works in the first place.
How Bitcoin Works: The Proof-of-Work
Proof-of-Work (PoW) is a mechanism for confirming electronic transactions between the network users maintained by multiple (electronic) users, further referred to as miners. The fundament of mining is the concept of a so-called hashing function. In Bitcoin, this function converts any string input into strings of 256 bits. It’s formula is unknown to the users. Miners need to race with each other to find unconfirmed blocks of transactions and validate these blocks.
Validation is performed by reading the header of the block and using computational power to find the nounce of that block. The nonce is a number which, combined with the header, becomes an input to the hashing function that gives an output with the desired number of zeros. After a miner announces a validated block, other miners can immediately verify it. They can simply achieve it by launching the hashing function on the input that contains the proposed nounce and checking the output.
The desired number of zeros at the beginning of the output string is a measure of the current mining difficulty. This parameter can be modified by the community depending on the current traffic in the network. Namely, if the joint computational power of all miners in the network significantly increases or decreases, the difficulty adjusts so that the miners still have a comparable chance to mine a block.
After adding the new block to the blockchain, the miner can search for another block and append it to the previously added block. After 10 minutes, the miner with the longest chain of confirmed blocks wins the whole competition. Those blocks are then officially added to the blockchain.
The Fairness of PoW
The clue of how Bitcoin works lies in the stochastic nature of the tasks. Namely, since miners look for the right nounce at random, i.e., by trial and error, PoW is probabilistic. The consensus confidence asymptotically approaches 100% along with every added block, although it never formally reaches 100%. However, in the real world scenarios, we can feel safe about the appended blocks as the probability of a malicious hacker attack in the PoW is very low and asymptotically reaches 0%.
In this architecture, the mining nodes solve mathematical puzzles by sampling random numbers in an attempt to find the right nounce. The purpose of this probabilistic procedure is to make sure that the chance for success in every node is proportional to the hashing power in that node. If the tasks were deterministic, the owner of the fastest node in the network would always win the competition and take it all.
In other words, for the network to stay decentralized, PoW needs to induce randomness in the network. It is because of the deterministic nature of mechanistic computation. And, that enforces the mining nodes to use large amounts of computational power and thus, generate associated costs. Therefore, the energy cost is necessary for the network to stay unbiased towards any miner, regardless of their computational power.
A Note On Inclusivity
This is what makes the Proof-of-Work highly inclusive. Unlike in Proof-of-Stake, where the users usually need to first acquire a considerable stack of coins to be allowed to confirm transactions (and as such, only the “whales” are can be active contributors to the network), in the Bitcoin protocol you can take part the process regardless of how much computational power you have, as your chances to win the race against other miners will be linearly proportional to your computational power. There are no VIP passes and no barriers to entry.
Mind also that your rewards as a miner as well as your transaction fees as a network user are entirely independent of your nationality or country of residence (which is true about every blockchain, actually). It is huge progress in terms of bridging economical gaps between the developed and developing countries. The system which we have now stands on its head. Namely, the residents of developing countries have the lowest earnings per hour, yet pay the highest bank fees for international transactions.
The Safety Factor
One particularly crucial aspect of the Proof-of-Work design is its bulletproof safety. Compared to other protocols, the basic layer of Bitcoin has a simple and energy-costly design, but it is hacker-proof. Namely, in the Bitcoin network, the only way of submitting a fraudulent transaction is to gain 51% of all the computational power in the network. In practice, it is impossible because the mining pools (the groups of miners who team up to mine together) stay under control concerning their collective mining power.
Many other (reputable) blockchains were hacked in the past. It was usually because of their more “energy-efficient” design as the cost of compromising on safety. For instance, the Ethereum hack in 2016 provoked forking Ethereum into Ethereum and Ethereum Classic. The Bitcoin network has been attacked by hackers every day ever since it launched in 2009. With no success to date.
Quality Always Costs
And looking into the whole history of technology and science, quality always costs. Since I have a background in neuroscience, let me use an example coming from my area of expertise. So, how do we typically track brain activity? Let’s compare two popular methods: electroencephalography (a.k.a. EEG) and functional Magnetic Resonance Imaging (fMRI).
EEG involves a head-mounted device involving electrodes that is placed on the participant’s scalp and track the electromagnetic activity collected from all electrodes in a non-invasive way. The cost of a quality research-lab quality EEG set (between 32 and 128 electrodes): about $25,000. The cost of the equipment in use: electricity and gel costs per participant are negligible.
On the contrary, an fMRI setup involves a massive scanner producing gradient magnetic fields. It usually occupies the whole room, covers the whole participant like a coffin, and scans the brain layer by layer. The 3T-Siemens fMRI Magnetom-Skyra scanner that is now a popular choice in academic institutions. And it costs $500K+ a piece. The fMRI scanners are also costly to maintain, as they need to be cooled down with liquid nitrogen during the scanning. Therefore, the cost of one hourly scanning session oscillates around $500.
EEG vs fMRI
Then the question arises. Why do we use fMRI scanners in the first place? Every hospital conducts hundreds of MRI scans daily. Every research facility conducting research in neurology or cognitive neuroscience runs a few fMRI scanners all year long. The PubMed database lists about 40,000 new publications with the key term “fMRI” per year. Well, fMRI scanners are in use because of the unique qualities and features they provide. Namely, they can detect changes in the brain with high spatial resolution. With EEG, you will approximately brain waves in the cortex. But, you won’t notice a tumor or a neurodegenerative disease. With an fMRI machine, you will.
So, is Bitcoin’s safety worth so much hassle and expenditure? Well, when you make transactions such as buying a coffee or a beer, perhaps it’s not. However, when you buy a house or store your life savings, is the safety of your transactions not essential? We need to have at least one worldwide financial system that is safe, inclusive, and not inflationary. Perhaps it is worth investing energy into the quality that the Bitcoin network offers — as means of the common good.
A Note on Sustainability
Lastly, talking about the energy cost related to Bitcoin. Perhaps, instead of asking, “do we need Bitcoin at all?”, we should ask another question. Namely, how to make the Bitcoin network more sustainable by moving the mining process to green, sustainable sources of energy? This week, the president of the South American republic of El Salvador, Nayib Bukele, not only proclaimed Bitcoin a legal tender in the country (approved by the country’s congress with 62 votes out of 84) but also announced the following on Twitter:
“I’ve just instructed the president of @LaGeoSV (our state-owned geothermal electric company), to put up a plan to offer facilities for bitcoin mining with very cheap, 100% clean, 100% renewable, 0 emissions energy from our volcanos.”
And that’s the spirit!
A Note on Redundancy
There is one more question worth answering. As mentioned before, we currently have almost 10,000 crypto-projects on the market. Are all of them necessary? Most likely not. Many projects are forks from one of the major protocols with literally one parameter (such as the block size) changed, or tokens built on major protocols such as Ethereum which are in fact private businesses who don’t offer any new value in a technological sense. It makes them redundant in the long run. Many of these redundant protocols also run on PoW and other energy costly protocols.
Therefore, the question should be the following. Which protocols offer any novelty, or qualitative advance compared to other projects? Versus which protocols offer no extra value and should be abandoned? Furthermore, even the protocols that are qualitatively different from Bitcoin, are not necessarily as energy-efficient as they were initially meant to be. For instance, Ethereum was built to be energy-efficient. Yet now, as of 2021, the associated energy cost is going ballistic. Ethereum is already in the range of 50% of the Bitcoin network. Therefore, instead of asking, “How to get rid of crypto?,” perhaps it would be better to focus on a limited number of original crypto projects. And, help them in maintaining their infrastructure in a sustainable way.
Lastly, mind that talking about energy in the media is often a scapegoat. This subject comes back over and over again to stir debate in the public and induce hate. And it leaves society without any viable solutions. Remember the worldwide discussion about the carbon footprint in the summer of 2019? A wild debate ignited, lasted for 2-3 months, and then cooled off. And what are the conclusions from this debate? What has changed since then? Nothing. The only change is that this year, the activists turned their attention to crypto. The next summer they will attack someone else. Most likely, with no viable solutions again. And every time it goes the same way: the journalists get their clickbait content and their pay, we are only left with anger.
2. Four Other Reasons Why I Believe In the Bitcoin Value
These are not the only reasons why I feel confident that the Bitcoin value is intrinsically high. I’d also like to list a few other reasons below.
i. Not Agile
Agile, as a philosophy of managing projects, rocked the IT industry — and in many applications, with great success. Most IT companies today work in the agile mode by default. They first list the essential features for their product. Then, they summon teams and distribute the work to develop every feature in parallel. They put together version 1.0.1 as quickly as they can. And then, as soon as the crippled project starts working, they iteratively mold and improve the various parts for as long as it takes to achieve the market-ready version.
In the blockchain industry, agile also became hot. Many projects kicked off by promising extraordinary new features in their white papers. And then, they quickly built buggy and dysfunctional platforms which they are trying to improve until this day. The issue is: when you are building a new, worldwide financial service, you shouldn’t ever release any product that is not seamless. A product that is in any way, shape, or form hackable or dysfunctional.
How Did Bitcoin Develop?
Unlike many other blockchain projects, Bitcoin is not developed in an agile way. It started humbly: from building a system for peer-to-peer transactions. Nothing more, nothing less. The contributors to the Bitcoin protocol didn’t aim to build internet 2.0, connect governments to medical institutions, build a system to digitally certify documents, or even provide smart contacts to the users. Payment system – that was all. BUT, the system was seamless.
And only after this system started working perfectly fine, they started building on top of that. The Bitcoin value infrastructure is being gradually built like a multi-floor house. Every floor has a different purpose. On level 2, the lightning network, users can send fast and cheap microtransactions to each other. On level 3, which is under development right now, the users can create tokens with any customizable features. For instance, they can create custom certifications and non-fungible tokens. While the grounds are seamless and work well, the upper layers are in progress. This makes the whole house firm and steady. It feels safe to live in such a house. Much safer than living in a hut quickly wrapped up from clay by a bunch of enthusiasts hoping that they will somehow make it stand before the ceiling falls onto your head.
Some Bitcoin skeptics mention that this is an ancient, outdated protocol. Except that it was created in 2008/2009. It was just 12 years ago! Later than Google, Facebook, and the vast majority of today’s leaders of the IT industry. And Bitcoin was developing and improving its performance ever since.
I don’t need to explain much here. We all know that inflation is a huge problem in the today’s world. It has become obvious especially after billions and billions of new digital dollars were minted and pumped into the American economy in the times of the pandemic. Some of the blockchain projects are also inflationary, as they mint new coins without any upper limit. Bitcoin is, however, deflationary. The upper limit was predefined from the start and new coins cannot be added to it. They can only be lost or burned. Gold has become the store of value for exactly the same reason. Yes, you can mine it but the gold supplies in the Earth’s crust are limited. And, creating new gold in a laboratory is too complex and expensive to pay off.
iii. Common Good
Now, I would like to look at the Bitcoin value more from a sociological point of view. Could a digital asset managed by a private company or with an official founder/developer, ever become a store of value? To my mind, it can’t. Gold wouldn’t become a store of value if it was created and sold by a company or an institution. Gold has become gold because it was bred by Mother Earth.
The fact that Satoshi has never stepped forward to introduce himself/herself, is probably the smartest decision in the history of Bitcoin. Even the most capable leaders such as Vitalik Buterin or Charles Hoskinson, are still mortal individuals like any of us. For this reason, they cannot become patrons of the official worldwide system of storing value for all individuals. To achieve that, you need to have a system created by an almost mythical figure. Someone who built a great concept for humanity yet never took credit for it.
iv. Common Sense
Lastly, let’s look at the Bitcoin value strictly from a business developer’s point of view. So, Bitcoin’s case always reminds me of the success story of Apple. Namely, Apple has become and remains a market leader mostly because they remember their “why.” And, they focus on surpassing themselves and becoming the better version of Apple. While every other company in the sector is focused on competing with Apple.
Last Words: Can The Bitcoin Value Ever Be Determined?
As we all know, Bitcoin’s price is dependent on the Bitcoin news. Is Bitcoin in a bubble right now? It is always a difficult question. However, one should remember that in the beginning, gold also had explosive price dynamics. The same holds true about any store of value in its beginnings. The price will highly fluctuate for a long time before the public opinion finally sets on some commonly agreed value. Of course, we should remember that, unlike gold, Bitcoin is a human creation. In that sense, it can be potentially replaced, which makes the two incomparable. However, I still believe that Bitcoin value is high, and that it has a future.
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