22 janvier 2018

Alexandre Swoboda on “Bitcoin, Blockchain and All That Jazz”

Virtual currencies and distributed ledger technologies have been mooted as disruptive forces that would fundamentally transform finance and payments. They have also been dismissed as hype, fodder for bubbles, and Ponzi schemes. On 11 December 2017, Honorary Professor of International Economics and former Director of the Graduate Institute Alexandre Swoboda held a Lunch Briefing in which he explored the two sides of the argument, assessing the potential for virtual currencies, bitcoins among others, to serve as money in a significant sense.

The idea of a currency such as the bitcoin has been around since the 1980s, when people started thinking of inventing a currency that could be universally accepted in exchange, transferred safely and without cost, and have a fixed quantity, meaning that the government couldn’t manipulate it. Additionally, this utopian currency is supposed to guarantee the anonymity of transaction and be guarded by incorruptible software. A person (or group) writing under the name Satoshi Nakamoto eventually developed this currency, bitcoin.

One has to distinguish between “Bitcoin”, which is the payment system, a peer-to-peer network of computers basically running a database, and “bitcoin”, which is the “currency” itself. Bitcoin is based on the blockchain technology, that is, a distributed public ledger – a ledger that is available to every node (computer) in the system and records every authenticated transaction of bitcoins. A new transaction can be added to the ledger only if it is verified through the solving of a computation-intensive mathematical problem. This verification is done not by the parties to the transaction but by so-called miners. Whoever solves the problem first is rewarded by an allocation of newly issued bitcoins.

The way blocks of transactions are added to the chain (the ledger) insures that the whole history of each bitcoin can be traced. The production of bitcoins is endogenous, but limited to 21 million, which are predicted to be reached asymptotically by 2040 (so far some 17 million bitcoins have been issued). Bitcoins are issued at a decreasing rate; the quarter-on-quarter growth of new issuances has decreased from 40% in 2010 to 1% today. To slow down the rate of increase and limit the supply, the system makes the mathematical problem to be solved by miners increasingly difficult, thus raising the required computation power and the attendant consumption of electricity.

Bitcoin transactions are done through wallets, with a public key and a private key known only by the owners. They differ from electronic banking in that they are conducted peer to peer without intermediary such as a bank.

The demand for bitcoins comes from different groups of individuals. There are the true believers, who believe in the Bitcoin utopia of the 1980s and want to be part of the system for ideological reasons. There is some demand for commercial transactions as bitcoins can be used to trade goods and services among the participants of the Bitcoin network. Alexandre Swoboda believes that most of the demand nowadays is of a speculative nature, however, as people are betting on an increase in the price (in USD terms) in the future. As the supply is limited, any shift in demand will lead to volatile price changes. The original idea of low transaction costs is not fulfilled anymore as the system slows down (so it takes longer) and a lot of electricity is needed for the computation of the mathematical problems. For example, one bitcoin transaction is nowadays equal to eight days of the average US family’s energy consumption, or, differently put, the Bitcoin system uses a bit less energy than Denmark.

There is a growing industry around Bitcoin, such as Bitcoin exchanges (to exchange bitcoins into real money), digital wallet services and mining pools for the computation of the mathematical problems.

Is the bitcoin actually a money or a currency in the economic sense? Alexandre Swoboda doesn’t believes so as certain requirements are not fulfilled. The bitcoin is not a unit of account as it is not widely used and accepted, nor is it a medium of exchange as it is not used to buy goods and services when the value rises, but rather stored in the hope that the value will rise in the future and it can be sold with a profit, similarly to stocks. It can be seen as a store of value of the commodity type, such as gold, but there is no alternative market for this commodity. The bitcoin is therefore not a money, and it is a currency in a very limited sense as it can only be used within the Bitcoin system.

The Bitcoin system will not remain as unregulated as it is currently for a very long time, due to various reasons. Governments will step in to regulate the market in order to protect consumers, stop illegal transactions and money laundering, and provide financial stability. The regulation will mainly target the industry around Bitcoin such as digital exchanges and wallet providers, and less the system itself. Additionally, taxation is a problem as Bitcoin is anonymous and it is unclear whether Bitcoin holdings should be treated as commodities/securities or money.

Currently the Bitcoin system doesn’t threaten monetary policy as it is running parallel to it. The question is rather whether central banks will issue their own digital currency in the future and what form it will take. The Chinese and Uruguayan central banks are working on one, and the Swedish central bank will introduce one. There might be implications for the monetary system as a digital currency might lead to a new industrial organisation of the banking systems.

In conclusion, Alexandre Swoboda believes that crypto-currencies will not remain independent as the state will take over, and that the blockchain itself will survive as a technology, but not necessarily for currencies. Blockchain technology could be combined with smart contracts, deep learning or artificial intelligence and applied in areas such as identity tracing (for example in refugee camps), land registries and health information. All these applications need permission to participate and at the same time should provide anonymity.

By Nadia Myohl, Master student in International Economics