Wiremodal

Why I Like Bitcoin

Note to reader: What follows is my current thinking on the broad topic of Bitcoin. I expect that I'll revise it periodically as I learn more. It's fairly long but not nearly exhaustive; each section only scratches the surface of what could be written about the topic. If you have a correction or want me to expand on something, add a comment or write me an email.

This post is prompted by the following:

I previously presented the background information necessary for understanding how Bitcoin works. The purpose of this post is to concisely present why I think it's an important monetary technology for the world. I'll also discuss some of the risks and detractors.

A note on politics

Bitcoin and cryptocurrency are politically associated with the libertarian right. In Canada, Conservative party leadership candidate (and front-runner) Pierre Poilievre has been a vocal proponent of Bitcoin, while also being critical of the Bank of Canada. This is not an uncommon position among "Bitcoiners"; fundamentally, Bitcoin is a decentralized monetary system with fixed issuance determined by an algorithm and not a central bank. If you believe that Bitcoin is a better system, then it generally follows that you dislike central banks. Austrian economists and libertarians are the most vocal proponents of Bitcoin for this reason.

This is an uncomfortable position for me because I consider myself to be politically moderate. I am sympathetic to some libertarian arguments, but I don't agree with their full world view. Because Bitcoin has this political association, those from the left are eager to attack it using any means possible. They cite its price volatility, use by criminals, and energy consumption as reasons why it should be banned, or barring that, shunned into irrelevance.

I think both sides miss the mark. Bitcoin is a new money in the market of monies. I believe it's better than most other kinds of money, but that doesn't mean that central banks and fiat currencies are obsolete. Common criticisms like its usage by criminals and environmental impact are parroted by many who don't fully understand the system. I don't see these as major risks or detractors, for reasons I'll discuss later.

Bitcoin is inherently apolitical but coloured by the views of its loudest proponents. This colouration can be blinding to newcomers and casual observers. It's also a difficult subject to understand well, and like other difficult subjects, if an observer can't (or won't) learn about it for themselves, they adopt the crude understanding associated with their political tribe. In the case of Bitcoin, the default political mob understanding is that either Bitcoin fixes everything, or it's at best a scam, at worst the root of all evil. Like all politicized topics, neither pole has it right.

I think Bitcoin can be a very powerful tool for marginalized people who have historically been left out of the financial system. I think the financial inequality and inflation we see now is driven by a monetary system that favours the powerful and well-connected and that fixing the money fixes part of the incentive structure that drives these social problems. Politically, these views are probably left of centre and completely consistent with the Bitcoin ethos.

What is it good for?

Peer-to-peer financial network

Fundamentally, Bitcoin is a final settlement layer for financial transactions that occur on a peer-to-peer network via the internet. The novelty is that no single entity controls the network and thus it can be accessed and used by anyone with an internet connection. The closest analog is physical cash, where two people settle a transaction peer-to-peer in the physical world. Digitally, interbank financial networks (e.g. Fedwire in USA) are a good comparison, however they are centralized services operated by central banks and the only participants are nationally charted banks. Visa, Mastercard and other online payment networks are poor comparisons for Bitcoin because transactions that occur there do not permanently settle for weeks or months, allowing participants to dispute charges and increasing the cost of using the network. Satoshi Nakamoto cites this cost as a primary impetus for creating Bitcoin. I raise this last point not to diminish credit card networks. They are useful and Bitcoin is unlikely to replace them. However, some detractors like to compare the Bitcoin network transaction throughput to that of Visa. It's a meaningless comparison as both networks accomplish different things.

Bitcoin is also a storage mechanism for monetary value. Much like anyone can store a pile of cash at home, anyone can take ownership of bitcoin and know that it will be safe as long as they have their cryptographic keys. The proof-of-work mechanism is like a mountain; old transactions are buried deep inside and cannot be reneged.

So Bitcoin is a global, open, free (as in speech), monetary network where two pseudonymous parties can exchange value and know that the transaction will be final. It's also a decentralized, maximum-security bank. The set of people in this world who have a smartphone with internet access and yet are unbanked (i.e. relying on cash or other physical monetary assets) is enormous, likely in the billions. I believe that Bitcoin can be incredibly valuable to them.

Even those that do have access to a reliable banking and financial system may chose to save some amount of money in bitcoin as an insurance policy against major dysfunction in financial markets. Depending on your opinion of its monetary qualities, thanks to its scarcity it may be a more durable long-term saving device than dollars. This brings us to the next discussion:

Zero-utility savings

People can do three things with money: spend, save, and invest. We spend what we need to survive and maintain our lifestyle. Whatever is left over can be saved for the future, or invested in the hope of earning a good return.

I'll define saving as a nearly risk-free way to transmit value from the present day to the future. Because inflation of the money supply is consistently positive, and because interest rates are low, the real return on a dollar held in a savings account is negative. In this environment, saving (in dollars) is discouraged in favour of spending or investing.

Instead of saving money, we buy and hold assets. We invest in stocks and bonds because they have a better chance of a positive return; or, at least, negative return is not guaranteed. Of course, this comes with a large risk of ruin that is mostly ignored due to historical results. Buying houses has an aspect of spending, saving, and investing; the spending component is the utility value of the house. If you're able to rent out part of the house, it has investment value. Over time, you hope that the price appreciates which makes it useful for saving.

The current macroeconomic conditions (low interest rates and high money supply) cause inflation in goods and assets. Consumers are incentivized to have a high time preference due to the constant devaluation of their money which drives demand for goods and services. Whatever they can't spend is ploughed into assets, driving up their market prices through a monetary premium. The stock market reaches record highs alongside the housing market. The utility value of housing is dwarfed by the saving and investing value. Investing returns for the propertied class comes from the pockets of those who can't afford to store value in housing. The end result of this vicious cycle is that poor people are forced to accept lower standard of living.

A common criticism of bitcoin is that it has no utility. We're used to saving money in hard assets that have utility value such as houses. We assume that a property needs to be used for something in order to be valuable. But we stop there and don't take the next logical step; if a useful asset is bought and held and the market rewards such behaviour, we are actually destroying utility. The second-order effect is the impact on social cohesion when one group of people increases their wealth by destroying utility value for another group. If food were money (and in certain circumstances, it can be), one group could become wealthy while literally starving the others.

I can't build a house with bitcoin, nor can I feed my family with it. But I think that's a good thing. Bitcoin can play the role of a neutral savings vehicle with no utility value. Bitcoin is an infinitely divisible digital property that can't be created. If more people saved money in neutral assets like bitcoin, the monetary premium of useful assets like houses should decrease.

The freedom to transact

Transactional freedom has been taken for granted in the past because cash-based transactions are very difficult to control or stop. However, most of our financial transactions now are digital and are subject to control by an intermediary (e.g. bank, credit card processor). With a centralized chokepoint, we have to assume that the freedom to transact is not a given.

There's a compelling argument that all freedoms held sacred in a liberal democracy are ultimately downstream from the freedom to transact. Free speech requires access to a means of distribution, which in turn requires free transactions. Free press requires that a news organization can transact with patrons. Free assembly requires attendees to have a means to travel, which usually requires a financial transaction. Laws and regulations that infringe on this transactional freedom, even if made with good intentions, have a negative impact on a liberal democratic society.

Bitcoin removes this chokepoint, while retaining the convenience and connectedness afforded by the internet. This promotes use by activists and marginalized communities, especially in countries that are heavily sanctioned by the current financial system (ironically, a system dominated by "liberal" Western democracies).

Important qualities

Issuance

Bitcoin's most famous quality is that there's a fixed issuance of 21 million bitcoins, each of which can be subdivided into 100 million satoshis (or sats). No one knows for sure why the limit is 21 million, but the fixed issuance is likely due to Nakamoto's wish for money free from (monetary) inflation and centralized control. He could have programmed a 2% annual inflation rate but he had enough sense to realize that no one knows if that is an ideal inflation rate for money. It also could serve as a point of dispute or temptation to change in the future.

Bitcoin's fixed issuance makes it a scarce resource and has lead to it being considered "digital gold". The main use case so far is as a store of value asset, much like gold. For now, it's still far too volatile to convince most companies or banks to diversify their treasuries into Bitcoin. As it monetizes and gains more users, I expect that the volatility will level off.

Bitcoin's issuance is also fair. The only people who can get new bitcoin are the ones who are willing to expend energy to do so. There is no mint, there was no "premine" (some later cryptocurrencies generated tokens to reward its developers before the protocol was released for use to the general public; not the case with Bitcoin). Thanks to its decentralization and proof-of-work consensus algorithm, miners do not receive special privileges other than the ability to turn energy into bitcoin.

Some Bitcoiners imagine a world of "hyperbitcoinization", that is, a world where the only money is bitcoin. All economic value is funnelled into the Bitcoin network. Workers get paid in bitcoin and buy their groceries in bitcoin. If this world is in our future, this means that bitcoin currently trades at an incredible discount. The present day purchasing power of 1 BTC in a hyperbitcoinized future is likely above $10 million (currently about $20,000). Understandably, this is an exciting proposition for holders (or "hodlers") of bitcoin.

I don't fully subscribe to this view. I believe that the future is promising for bitcoin primarily as a safe savings vehicle for most people around the world and thus there is still considerable upside for it as a speculative investment. I think it will capture some of the monetary premium of useful assets that are currently used as a store of value, which is a good thing. But a world where all economic output is funnelled into a fixed supply asset is far from a utopia. This world is extremely pessimistic about the future. Credit would be expensive, making the risk of failure for a new business very high. This slows growth and productivity. Some amount of credit is a good thing; it becomes dangerous when the global monetary system is based on it.

Proof-of-work

Bitcoin's blockchain is secured though a mechanism called "proof-of-work". Through proof-of-work, a large amount of energy, computation, and time is required to settle transactions. Briefly, for a transaction to be considered settled on the network, it requires proof that the transaction is located in a block of transactions, and that the information in that block has been linked to a previous block through a cryptographic hash algorithm. The difficulty (in computational resource terms) of linking blocks can be adjusted based on the amount of computational power on the network (miners) such that each block takes on average 10 minutes to "find".

Bitcoin's proof-of-work algorithm is contentious to people outside of the Bitcoin ecosystem thanks to its energy use and slow block time. Within Bitcoin - among advocates, developers, and miners - there's no contention; proof-of-work is the only viable, decentralized mechanism to secure the network. The most common alternative used by other cryptoassets is proof-of-stake, whereby a small group of validators is chosen to validate transactions based on the amount of coins they have staked into a smart contract. This mechanism is quoted as faster and far less energy-intensive than proof-of-work.

The main criticism of proof-of-stake is that it centralizes the validation role to a small group of elites. The people who can afford to put up a big enough stake to act as a validator are often those who have the most to benefit from exercising greater control over the protocol. This is a political incentive and an enormous cost that is socialized to the users. The blockchain protocol can be controlled by a small cartel and there's nothing that the average user can do to prevent it.

In proof-of-work, miners have very little control over the protocol. Their incentive to defraud the network is severely limited because they must constantly expend resources in real time. Only if one miner were to control a majority of the network hash power (requiring tens of millions of dollars of capital investment) could they have a good chance of reversing transactions. If you've ever played Hearts, the trade-off is a bit like shooting the moon; if you go for it you need to go hard and not miss, otherwise you'll be left holding the bag.

Security is the paramount concern to Bitcoin advocates. If you want to create a new form of money, you need to ensure that it can't be tampered with. You do this by creating a system where there is a high, time-bound cost for unilaterally editing the ledger. Proof-of-work fills this role.

Decentralization

A Bitcoin node - a computer that validates all transactions and maintains a full copy of the blockchain ledger - can be run on a tiny RaspberryPi computer with an external hard drive. I've built a Bitcoin node and can attest that the components cost only a couple hundred dollars. It also requires a moderate internet connection, speed being less important than bandwidth. Note that a node is not a miner; the node simply double-checks each block to verify that it was created according to the Bitcoin Core specifications. As discussed in the Bitcoin Whitepaper review, Bitcoin blocks are hard to create but easy to verify. This minimal requirement to run a node is by design, as quantity and distribution of nodes define the network's decentralization. A node should be as easy to run in Canada as it is in Cameroon.

There is a trade-off for this decision, primarily regarding transaction throughput. Because Bitcoin nodes are designed to use minimal internet and computing resources, there's a limit to how many transactions they can collect and verify. A block is created every 10 minutes, on average. Each block contains a couple thousand transactions. On a given day the Bitcoin network may process a few hundred thousand transactions. Other blockchains are in the millions, and centralized payment networks like Visa are in the hundreds of millions per day.

Trying to increase transaction throughput would require at least one of two things to happen: Bitcoin increasing its block size (the number of transactions collected in a block) or decreasing its block creation time. Both of these would require nodes to increase their internet bandwidth to receive the additional transaction data, increase their processing power to verify the transactions, and increase the hard disk storage needed to maintain the ledger. Increasing block size was tried in the past. A group of Bitcoin companies (mostly exchanges) and miners tried to push a software upgrade through; ultimately it was rejected by most of the nodes and therefore the upgrade was abandoned. The miners were forced to continue running the unmodified version of the Bitcoin software.

In my mind, Bitcoin's transaction volume is a non-issue. Because I see Bitcoin as a global, decentralized, financial settlement system, I'm fine with waiting an hour for a transaction to settle. It beats two or more days for a wire transfer. I prefer for the developers to prioritize node decentralization over transaction throughput.

Criticism and risks

Use by criminals

I sometimes hear this argument made against Bitcoin, along the lines of: "Hackers and drug dealers use bitcoin to extort and addict innocent people. It's a technology for criminals and should be banned." This has never been a compelling argument for me primarily for the following reasons:

Where bitcoin differs from cash and other currencies is that it allows a hacker in Russia to extort an unsuspecting person in Rhode Island. Bitcoin can be transmitted via the internet which means that the slimy tentacles of the dark web can reach farther than they ever have. Because bitcoin has no issuer and all transactions are final settlement, there's no way for the victim to recover their asset unless the perpetrator is caught. Even then, a committed criminal can take their bitcoin to the grave if they choose.

I don't want to understate the scale of this problem. It's unfortunate that these scams run every day and we should do everything that we can to stop them. However, this is less a problem of the money and more a side-effect of billions of people worldwide interacting with the same computer network. The price we pay for internet connectivity is the risk of exposing important data to attack and extortion. The irony is that most of us freely give important data away to internet companies and attackers by using Google, Facebook, and other social media giants. We willingly increase our personal risk for some nice convenience and dopamine hits. If we're worried about getting caught up in cybercrime, we need to get serious about personal online security and privacy. A pseudonymous, peer-to-peer internet money is the least of our worries.

Transaction throughput

As I mentioned earlier, the transaction throughput of the Bitcoin network is a common criticism against its use as a currency. This is absolutely true. I don't recommend using the Bitcoin network to buy a coffee. It's slow and expensive.

But again, is this a fair comparison? As a general rule of thumb, a Bitcoin transaction can be considered final after six blocks have been created "on top" of the block in which your transaction resides. At this point, the computational power required to double-spend this bitcoin is so great as to be nearly impossible. On average, it takes about an hour to reach six confirmations. Depending on the time of day, the transaction fee is a few cents or at most a couple of dollars. If you're moving $5 of bitcoin this isn't a great bargain. However, if you're moving thousands or millions of dollars around the world, this can't be beat. No other financial network can promise quicker settling time for a lower fee.

Of course, a lot of people want Bitcoin to be a global currency, and it still could be by using what are known as "Layer 2" technologies built on top of the Bitcoin network. Currently, the Lightning Network is the most mature and well adopted of the layer 2 technologies for facilitating rapid bitcoin transactions. This network is used in El Salvador to buy coffee using bitcoin, while still maintaining the decentralized, permissionless, and non-custodial ethos of Bitcoin. Running a Lightning node has similar computational requirements to the Bitcoin blockchain node, meaning it should be possible to have a fairly large, decentralized, global network. There's still a lot to be done to make this more accessible and user-friendly, but the Lightning Network has a bright future.

Energy use

I agree with scientific consensus that human fossil fuel use is causing climate change and that we should work to reduce our use of fossil fuels in order to reduce or reverse the effects of climate change. Bitcoin mining uses a lot of energy, much of it derived from fossil fuels. Therefore, I should not support Bitcoin until either a) the mining network switches to all renewable energy or b) proof-of-work is discarded for a less energy-intensive mechanism such as proof-of-stake.

This was one of the biggest sticking points for me as I first explored Bitcoin. Most of what I had previously read about Bitcoin emphasized its energy use and the associated environmental cost which also includes the electronics waste from obsolete mining computers. I seriously questioned whether I should take part in the network for this reason alone.

I held these thoughts in tension with a more fundamental understanding that energy use is generally good for humanity. The increase in energy generation and consumption by humans correlates almost perfectly with poverty reduction and increased life expectancy. The question around Bitcoin's energy use then is essentially a normative one: is it a waste or does it contribute to the advancement of humanity?

As the title of this piece reveals, I eventually landed on the latter. As I learned more about how Bitcoin works and what it means for people, I realized that it can be an improvement over the existing system in terms of environmental impact. If you think that Bitcoin can play the role of gold as a store of value asset, is it not better to "mine" bitcoin using waste methane from an oil well in Alberta than to bribe politicians in Papua New Guinea, clear out a jungle, and exploit local workers to mine gold? If you think that bitcoin could one day become the world's first totally neutral reserve currency, what then is the environmental cost of the banking, political, and military systems in the United States that protect the current reserve currency?

Further, bitcoin mining plays a potentially important role in energy markets. Bitcoin miners seek the cheapest electricity that they can find, and they're globally competitive. They can locate almost anywhere in the world as long as they can find a stable internet connection. Thus, they're uniquely positioned to monetize remote or stranded energy. Methane from oil wells, that otherwise would be flared, is a good example. There is a company that is capturing methane from US landfills and using it to run bitcoin miners. For many landfills, there is a low incentive to generate power from methane since they are usually far away from urban areas and the transmission costs to the grid are too high. Similarly, capturing and refining it into natural gas is only cost-effective for very large landfills. Instead, it's flared, or worse, released directly into the atmosphere (methane has about 80 times the greenhouse effect in the atmosphere than carbon dioxide). Bitcoin mining incentivizes them to at least burn this harmful gas.

Bitcoin miners also incentivize renewable energy investments by providing a baseload to utilities that is 100% responsive to peak demand. That is, a utility could justify investing in a renewable power station knowing that they can sell a certain percentage to a Bitcoin miner at a low rate. They also know that, if they adjust the rate higher in response to a peak load demand, this miner baseload will go completely offline in order to conserve power for other customers simply because it becomes unprofitable to mine bitcoin at higher energy prices.

I think over the next five to ten years, most mining hash rate will migrate to renewable or low-carbon energy sources. Over the long-term, they have the lowest operating costs and therefore will be the cheapest on a kilowatt-hour basis. I'm hopeful that smart carbon taxes coupled with sane nuclear regulations will drive more investment into renewable and nuclear power generation. I think bitcoin miners can also play a crucial role in driving this investment.

Privacy and fungibility

I'll end this section with what I believe to be one of the biggest risks for bitcoin's widespread use and adoption.

Bitcoin's blockchain is open and can be viewed by anyone with an internet connection. It's fully auditable and anyone can add up all of the existing bitcoin and verify that supply has not been changed. This is by design: it's part of Bitcoin's trustless model for every participant to be able to verify that the protocol is following the rules that they expect it to. However, this openness has implications for personal privacy and fungibility of the currency.

Most people who own Bitcoin have at some point interacted with a centralized exchange (e.g. Coinbase), a company that is required by law to "know your customer" (KYC). This means that, when a person buys bitcoin on Coinbase and withdraws it to their own wallet, the company can link the withdrawal address to the individual. Pseudonymity is broken. This information could be leaked or seized by a regulatory authority. Since a "bitcoin" is essentially a chain of digital signatures, it's easy to trace where that bitcoin went.

Tools exist to re-pseudonymize transaction outputs. CoinJoin is a common one. To understand this, it's important to know that a bitcoin wallet is essentially a collection of loose change called "unspent transaction outputs" or UTXOs for short. While my wallet balance may say "1 BTC" that value likely came from dozens of different addresses in different amounts. These outputs are not rolled into one whole coin - they remain a distinct chain of digital signatures. To do a CoinJoin, a set of users create a transaction where each contributes the same amount of bitcoin (input) and withdraws the same amount of bitcoin (output), minus transaction fees. No one knows who participated in the CoinJoin and the output UTXOs are again pseudonymous. If you use CoinJoins, you should also use a wallet that allows you to easily see which UTXOs are pseudonymous and which are (potentially) still linked to your identity. Sparrow Wallet is a good option.
This is a good tool, but it's beyond the technical competency of a lot of people as it currently exists. Most people interact with bitcoin naively, using only centralized exchanges thus tying UTXOs to their identity.

One can imagine a future (or present) where a government wants to block an individual's ability to transact with bitcoin. If you self-custody on your own wallet and use CoinJoin, this is difficult for any government to achieve. However, if you keep bitcoin on a centralized exchange that is beholden to various regulations, censorship is trivial. Even if you hold your bitcoin on your own wallet, if it came from a centralized exchange and hasn't been pseudonymized, the UTXOs are still linked to your identity. If you wish to convert back to dollars, the exchange may block the transaction.

This leads to the question of fungibility. Ideally, each unit of bitcoin is interchangeable with any other. In the example above, a blacklisted bitcoin cannot be used in the same way as any other. One can imagine secondary markets crop up for these tainted coins, effectively setting a secondary exchange rate for bitcoin. This is bad for bitcoin adoption.

Fortunately, a lot of effort is being expended to improve bitcoin privacy for the average user. I have not researched these projects in depth, but mobile wallets like Samourai (Android) make it easy for any user to participate in CoinJoins. Fedimint is still in development but is essentially a community-run "bitcoin bank" which is somewhere between third-party custody (central exchange) and full self-custody (private CoinJoins to an individual wallet) on the custody scale. This could be a good option for most people who don't have the technical savvy to self-custody bitcoin privately but don't want to be subjected to the KYC rules of a centralized exchange. Fedimint hopefully will deliver a high level of privacy for a minimal amount of trust.

Final thoughts

I didn't want to like bitcoin. When I first heard of it in relation to Silk Road around 2013, I dismissed it as fringe and dangerous. When it went on a big bull run in 2017, I latched on to the "tulip mania" narrative, likening it to a speculative bubble inflated by hype and nothing else. I nodded my head to the "blockchain not bitcoin" line spouted by experts who had to acknowledge that there was some importance to the technology, but held that it was packaged within a dumb and wasteful protocol.

I began my serious individual investigation in 2020 at the start of the coronavirus pandemic, ramping up in early 2021. All along the way, I've tried to break away from bitcoin. I've tried to ignore it and forget about it. I've vacillated between thinking "this is the stupidest idea ever" to "this is one of the most important technologies today" more times than I can count. Part of me wants to go back to a time when it occupied no space in my brain, when I was mostly oblivious to our financial system and eager to participate in the status quo.

I think I've had this tension along the journey because believing that bitcoin is important almost requires you to disbelieve the importance of the existing financial system. I said at the top that I don't think that Bitcoin displaces governments and central banks. However, going down this rabbit hole forces you to confront the failures and inadequacies of our current system. My understanding of our public monetary institutions has increased and my criticism of them is more sharply focused.

This article is a distillation of hundreds of hours of research and reflection. I won't claim that it's all original thought, but I also haven't rigorously cited the work because a) I don't have the time, and b) it doesn't matter in the end. I'm not trying to convince anyone of anything other than that I'm not a weirdo for liking bitcoin.

Recent posts