Summary ->> Contemplation ->> Closing
CONTEMPLATION: SEEKING EVOLUTION OVER REVOLUTION
The challenges the technology is facing internally and externally seem no small matters and, in certain aspect, it appears limitations far outweigh the potentials. In my opinion, there are a few fundamental issues that need to be addressed and cleared as “prerequisite conditions” before moving forward to the next stage.
The new world the authors envisage is apparently beautiful and ideal. However, we need to be cautious and patient in discussing these far-reaching subjects. I believe certain aspects can be realized sooner but other discussions can end as ideal wish rather than reality.
So what’s my justification for this claim? It comes from the money aspect of this new technology. If the Internet of Value, as the authors call it, is to be realized, we need to have a clear definition on the money that Bitcoin – let alone other cryptocurrencies – functions in the virtual space. Surprisingly, throughout the book, I couldn’t find the authors’ clear stance on this matter. This may create ‘confusion’ for readers. That means Bitcoin as global payment solution can appear as panacea in the future replacing ill-functioning and deemed incompetent governments, which is illusionary.
In this Contemplation section, I will develop my discussion firstly with ‘what are the prerequisites’ for the technology to survive and thrive. Under this subject, four major aspects will be extensively covered. Secondly, through SWOT analysis, I will elaborate on where potential opportunities can be found. Lastly, I will compare the technology as it is to its promise, considering today’s fast evolving nature of the blockchain technology space.
1. PREREQUISITES FOR THE SUCCESS OF THE BLOCKCHAIN TECHNOLOGY
So what are the prerequisites for the blockchain technology not to end as a one-time fad but to leap up as the next foundational technology following the Internet? 4 The answer is clear. The new technology should reach a state of true innovation that far exceeds the strengths of existing technology and complements its weaknesses, with such characteristics of mass scalability, security, efficiency, lower cost, simplicity, and practicality rather than unprecedented novelty, without causing environmental cost.
I have narrowed down diverse features and challenges of the technology into four major categories: Private money; Leadership; Technology; and Frictions. I believe, unless deliberate efforts are made to clear these issues, the technology space may face existential pressures both internally and externally.
(A) Private Money Issue
What the authors fail to address but nevertheless is the most substantial is that “stateless” Bitcoin and other cryptocurrencies(i.e. altcoins) are functioning as private money that challenges or competes with sovereign fiat currencies. In fact, they want to replace fiat currencies and become the future global payment solution. In my opinion, this aspect has to be clearly defined so as not to mislead people into believing there’s no problem.
■ Currency with No Legal Tender
Most of all, Bitcoin (and cryptocurrencies in general) as private money that has no legal tender contains the biggest uncertainty in itself.
Bitcoin resembles physical cash in a way it can be exchanged peer-to-peer without the need for a trusted intermediary and it lets transactions be anonymous. But whereas physical cash is the liability of a government, with a central bank controlling its value, bitcoin is a liability of nobody. This is its fatal flaw as a currency. There’s nothing to stop its value from falling to zero. 5
■ Deflationary Monetary Policy
Bitcoin has its own anti-inflationary monetary policy with fixed supply of 21 million coins designed in the system. Its anonymity or pseudonymity clearly defines bitcoin as stateless cash in a digital version. As David Yermack indicates, it has clear political agenda from the onset. 6
This being said, what problems can be expected? Three issues can be discussed.
The first stems from anonymity. The function cash mainly serves in the real world in a negative sense, such as money laundering and tax evasion, is amplified naturally in the borderless virtual space where no state authority can exert influence due to its unprecedented stateless quality as of today.
Secondly, the appreciating value that this virtual currency aims to achieve under fixed supply scheme – similar to gold – can mislead people. Especially so, if cryptocurrencies indeed aim to replace fiat currencies. We may need to remember why the gold standard had to be abandoned in the first place and replaced by fiat currencies. The common view is that the gold standard contributed to the severity and length of the Great Depression in the US because the very illiquidity of gold hindered expansionary economic policy during the downturn. Bitcoin carries the same problem. 7
Furthermore, as Rubini points out, if a steady-state supply of bitcoin really did gradually replace a fiat currency, the price index of all goods and services would continuously fall. By extension, any nominal debt contract denominated in bitcoin would rise in real value over time, leading to the kind of debt deflation that economist Irving Fisher believed precipitated the Great Depression. At the same time, nominal wages in bitcoin would increase forever in real terms, regardless of productivity growth, adding further to the likelihood of an economic disaster. 8
Also, reality is, while bitcoin is claimed not to be debased based on the fixed supply, it has already forked off into three branches: Bitcoin Cash, Litecoin, and Bitcoin Gold. Besides, hundreds of other cryptocurrencies are invented every day, alongside “ICO(initial coin offerings),” creating money supply and debasing it at a much faster pace than any major central bank ever has. 9
The third is the fact that most bitcoin advocates promote Bitcoin as a future currency that can fulfill three core functions of a fiat currency: a unit of account, a medium of exchange, as well as a store of value. This is misleading because Bitcoin is not. The current volatile and fluctuating market price that once hit almost $20,000 demonstrates bitcoin can serve neither as a medium of exchange nor as a store of value because holders of bitcoin are incentivized to hoard in expectation of rising price and this unrealistically high price again makes bitcoin hard to be used as a medium of exchange.
Advocates contend the criticism with bitcoin’s divisibility down to 8 decimal place, but this is incredibly impractical as a unit of account as well. We may have to pay 0.00000002 or 0.00000015 bitcoin to buy a cup of coffee at Starbucks depending on the changing market value of Bitcoin. Practicality aside, technologically speaking, this is not an innovation either. In the same context, highly fluctuating nature of the currency doesn’t serve as a good store of value. This applies to other thousands of cryptocurrencies as well that follow trails of Bitcoin with the same fixed coin supply logic as of today.
Most of all, if Bitcoin – a payment alternative and private money – is to be heavily regulated or even banned – such as in China – by governments for above stated reasons, it can cause negative ripple effects in the blockchain technology space. The almost 40% fall of Bitcoin price was due to Asian governments’ regulatory measure (or expectation of it). The promise of revolution in many areas based on the bitcoin blockchain model as per the authors may have to be re-considered.
■ Historical Lessons
Historical insight from the free banking period in the US in mid-nineteenth century provides us with a lesson that when banknotes were issued by private banks and not central government, there was the possibility that the owners of banks would issue too many notes, invest in risky assets and, if necessary, shut down the bank and disappear – i.e. bank runs. It was depositors who suffered as a result, because there was neither a central bank as a lender of last resort nor a deposit insurance such as FDIC. 10 Current proliferation of cryptocurrencies involve similar traits.
Kenneth Rogoff similarly argued in his article: “The long history of currency tells us that what the private sector innovates, the state eventually regulates and appropriates – and there is no reason to expect virtual currency to avoid a similar fate.” 11
■ Invitation of Central Banks into Competition
Central bank’s involvement into the blockchain technology space can be two fold.
First, ironically, as the market capitalization of cryptocurrencies became sizeable, hence potentially increased systemic risk on the economy, central banks – the very institution cryptocurrencies aim to bypass – have begun to research blockchain-based currencies and impose regulations on exchanges. 12
Interestingly, given the additional control and policy effectiveness that digital currencies could provide, central banks have good reason to adopt digital currencies in the coming decades. Those currencies would be “legal tender,” legally recognized forms of payment for all debts and charges. 13
If this becomes the case, cryptocurrencies will face existential dilemma, since people may have to choose between bitcoin and a blockchain-based dollar, for example, to have in the digital wallet.
Also, considering the fact that not all cryptocurrencies necessarily are tied to the value of blockchain applications that may improve the cost, speed, and security of executing transactions or contracts, there is a likelihood that, as innovation quickens and competition increases, the majority of networks (and their associated cryptocurrencies) may be rendered obsolete, leaving many cryptocurrencies like tulip bulbs in 17th-century Holland—soaring to incredible heights before the speculative bubble pops. 14
Second, if this happens, while the state has no role in managing cryptocurrencies, it will be responsible for cleaning up any mess left by a burst of bubble. Depending on where and when a bubble bursts, the mess could be substantial. This presents a challenge to central banks again requiring them to intervene. This especially can be challenging to central banks in emerging economies, since, unlike advanced economies with reserve currencies, they may not be able to mitigate the damage. 15
This is so, because demand of cryptocurrencies is related to mistrust of conventional stores of value, if people fear that excessive taxation, regulation, or social or financial instability places their assets at risk, they will increasingly turn to cryptocurrencies. This is highly likely in countries that are subject to political uncertainty or social unrest, where cryptocurrencies thereby can offer an attractive mechanism of capital flight, exacerbating the difficulties of maintaining domestic financial stability. IMF report in 2016 indicated that they have already been used to circumvent exchange and capital controls in China, Cyprus, Greece, and Venezuela. 16
■ Speculation of Possible Ponzi Scheme
Cryptocurrencies have no intrinsic value with no legal tender but instead, they function based on demand – i.e. the willingness of people engaged in transactions to treat them as valuable. With the value of the proposition depending on attracting more and more users, some claim cryptocurrencies take on the quality of a Ponzi scheme. 17
Also, two mathematicians argued in their paper published lately, “The cryptocurrencies may simply be a mechanism for a transfer of wealth from the late-comers to the early entrants and nimble traders.” 18
It is notable that unlike traditional currencies, bitcoin isn’t used to buy goods and services in much of the world. Most owners are holding it as an investment, hoping for price appreciation. The digital currency’s value increased 14-fold in 2017, before crashing by 44 percent so far early this year. Furthermore, bitcoin is owned by a few, who have a huge sway over the cryptocurrency’s price. About 1,000 people own 40 percent of all bitcoin. 19
Then there’s also Satoshi Nakamoto who could be one person’s name or a pseudonym for a group of developers, which no one appears to know for sure. But Nakamoto holds one million bitcoins, or the equivalent to $1.1 billion (at market value of $1,100). At previous peak market price of $20,000, his(her, or their) value amounted to $20 billion. That has led some to speculate that the whole thing could be a giant Ponzi scheme, though there’s no evidence to indicate that. 20 The issue about Satoshi Nakamoto’s identity will be discussed again in subsequent subjects.
(B) Leadership and Governance Issue
As the authors highlighted, specifically for the bitcoin community, current absence of leadership and governance leaves an implication that compromise of the bitcoin network integrity can happen anytime through intermittent forks, as had happened before.
The myth of Satoshi Nakamoto has to be discontinued for the bitcoin network. In my opinion, as long as the network prefers the system that way, – i.e. without leadership – its progress is highly likely to be hampered.
Many agree that the revealing of Satoshi’s true identity could help push bitcoin technology beyond its current borders. For Bitcoin to continue to provide secure, pseudonymous transactions for a growing user base, it needs a leader or small steering committee to make decisions. 21
Governance issue also applies to the blockchain technology ecosystem as well. Without self-regulating oversight bodies, the progress will be slowed down undoubtedly. As of today, we see about 1,500 altcoins that proliferated so far. By facilitating standardization of the technology and by representing collective voices toward and cooperating with regulatory bodies on various impending issues, they will be able to make faster, cohesive, and positive progress. And this will benefit everyone.
In this context, I consider any blockchain application or platform that holds a strong management and leadership capability with clear vision will thrive and ultimately lead the space. Vitalik Buterin, a 21 year-old prolific young man, as the authors state, who has vision, honesty and courage – enough to admit in the public space that cryptocurrencies’ value could drop to near-zero at any time – can be a good example. 22
(End of Part 4. To be continued in the next article)