BITCOIN EXPLAINEDBy MARY LYNNE DAHL , Certified Financial Planner ™
April 20, 2021
(SitNews) Ketchikan, Alaska - Have you thought about investing in a cryptocurrency, like Bitcoin or something similar? Enough people are doing this that it is now being used as an investment. I have done a previous column about cryptocurrencies (also called digital currencies) such as Bitcoin in prior issues of MONEY MATTERS, which I recommend that you read, but it has been long enough in the past that much has changed and now is a good time to revisit the subject, so here goes.
Bitcoin, like all digital currencies, is controversial. It is interesting, however, because it is based on rapidly changing technology that some people believe is capable of eventually replacing “reserve currency”, like the US dollar. Those who agree with this are generally technology experts while those who disagree are generally financial experts, which does explain the controversy to some extent. Regardless, there are definite pros and cons to the concept of digital money, or cryptocurrency.
First, however, it is helpful to understand just what it is and how it works. Bitcoin is just one of thousands of cryptocurrencies to be invented in recent years. It is based on algorithms that rely on math to function. There is no real asset behind it, and there are not paper records on it. It is not a credit card or regular (reserve) currency that is valued in dollars or yen, or Deutsche marks, or krona, or any national reserve currency. It is a digital currency that is created and stored in what is called “block chain”.
“Block chain” is a mathematical system in which bits of data are stored in a chain of separate “blocks” of computer code that is so vast that each block is supposedly impossible to track. This is one reason why it was invented; it allows the owner to keep his or her account of transactions (data) and value (more data) a total secret. This means that it cannot be traced, or taxed or identified as to owner, except by the actual owner. An account is password protected, of course, and digitally secure via sophisticated security systems that are very difficult to hack, although not 100%, according to researchers on the subject.
Originally, block chain was invented to provide this financial secrecy, but it was also supposed to “democratize” wealth by making it possible for ordinary people to have a currency and value that was not controlled by big banks, as sort of a statement against the big banks themselves. Bitcoin is not safekept in bank vaults, in fact, but on a vast network of computers worldwide, so the originators of it and other cryptocurrencies believed that they were pretty clever to have created a way to save, spend and invest without the banking system getting a piece of the action.
How it works is that anyone, referred to as a “miner”, can create Bitcoin by a method called “proof of work” computer calculations. Miners do this with multiple computer servers, using algorithms to guess the combination to a digital “lock” which is a very long string of digits/numbers. The first minor to unlock the combination is rewarded with newly created Bitcoin, which is credited to their account. Once that happens, a new combination is locked and the contest starts again. A new combination is offered every 10 minutes, so the contest to unlock it goes on continuously.
To do this efficiently and have any chance of being the winner of new Bitcoin, a miner needs a lot of computer servers working all of the time, 24/7/365. Successful mining now requires one miner to have warehouses full of computers, all outfitted with special software and computer chips designed for mining. Eleven (11) years ago, in the early days of mining, a miner could operate with just a laptop computer but competition and a huge increase in the difficulty of guessing the answer to unlocking the combination has resulted in the need to use an immense army of very sophisticated computer servers with specialized hardware and software in order to succeed at mining.
In addition, successful mining also requires that a miner have a place to house his or her army of servers, and to purchase upgrades in computer chips at least annually, for increased efficiency. The net result is that it has become expensive to be a miner, and today, most mining for Bitcoin is no longer in the hands of individuals. It is in the hands of large corporations. According to research by the academic journal, The Conversation, 75% of global mining is now controlled by as few as five (5) organizations, which defeats the supposed original purpose of “democratizing” or decentralizing currency transactions.
The problem is not just that mining is expensive and no longer decentralized, it is also not green or ecologically sustainable, eating up a lot of energy worldwide. It has become an ecological problem of overconsumption and waste. It now requires so much electricity that miners are willing to move to any country to secure the space and cheap electricity that they need to run their warehouses full of computer servers day and night.
Australia offers miners cheap electricity from coal production, so miners have flocked to that country to set up their mining operations. The demand for coal-fired electricity by cryptocurrency miners is now so great that these old Australian coal plants have been reopened and are supplying electricity from coal to the currency mining industry. In the Democratic Republic of Congo, there is a hydroelectric power plant that was intended to provide cheap hydro power to stop poachers from cutting down the forests for wood fuel, but currency miners have gotten access to this cheap electricity instead of the local population that it was intended for. The locals have basically been outbid for the hydro power that they need to survive and the miners have a great source of cheap electricity. Overall, it is estimated that over 60% of global currency mining is produced from fossil fuels, not green energy. Miners will, however, use any cheap energy source that they find, and move anywhere on earth to get access to that electricity.
Estimates are that mining now consumes as much electricity as several nations. In addition, it produces a lot of CO2 (carbon), with estimates of more than 37 million tons per year being spewed into our air. On top of hogging a lot of electricity and emitting a lot of pollution into our air, mining hogs much of the world’s computer chip production, because it uses a specialized hardware known as Application Specific Integrated Circuits (APIC). These circuits must be replaced yearly, with the old/used circuits being thrown away because they are not easily adaptable to reuse, creating about 12 million tons of computer waste annually for cities to deal with.
For example, near the end of March 2021, Ford Motor Company reported that they will stop production at six (6) of their plants in North America until June due to a shortage of semiconductor chips. Plants in Dearborn, Michigan and Kansas City will stop production while plants in Illinois, Ohio, Kentucky and Ontario, Canada will cancel overtime shifts. Ford estimates the loss to the company will be $1 billion to $2.5 billion in 2021 as a direct result of not being able to obtain the computer chips that they need to produce components for vehicles. Ford has already cut production of it’s top-selling vehicle, the F-150 truck as a result of the chip shortage. General Motors has announced a similar situation and production cuts to its plants as well.
Taiwan Semiconductor and Samsung are experiencing a global demand from Bitcoin miners that has created such a shortage of chips that not only the auto industry but also the smart phone industries are unable to get the supply of chips that they need for their own products. This plus carbon emissions that are a result of mining have caused a few countries and cities to enforce a ban on mining or enactment of plans to restrict it. Mongolia was the first country to ban it entirely but will probably not be the only one to do so.
Proponents for mining say that the business of producing Bitcoin will get better, will use less energy resources and be greener as time goes by, but opponents counter that this is not likely. There is no evidence to date to support the claims that mining will, in fact, use less electricity over time, nor is there any evidence that the consumption of chips will decrease.
Instead, opponents claim that consumption and pollution will increase because there is a basic weakness in the technology used to create Bitcoin. The weakness is that the higher the price of the currency, the more electricity it requires to produce it. Bitcoin miners want the price of it to go up. For the price of Bitcoin to go down, it has to use less electricity and computer chips and miners do not want the price to go down, so they keep mining and driving up the price.
Bitcoin has another problem that reduces its practical use. It is very volatile. In order for it to replace dollars and credit cards as a way to transact financial business, it cannot be as volatile as it is. Banks provide stability without wild swings in the value of the US dollar for the dollar transactions that they record. And if it is going to become less volatile, it has to be inflationary, which will only happen if the price of it goes down over time. Instead, the price has gone steadily up in spite of wild swings of volatility, sometimes in just one day.
The higher the price of Bitcoin, the more attractive it is to miners who want to cash in on the money train, which in turn attracts more miners. In 2017, the price of Bitcoin was around $1,000. Today, in April of 2021 the price is around $63,000 US dollars. Financial experts, however, warn that Bitcoin’s excessive volatility could cause it to crash by as much as 90%, possibly more, calling both the price of it and the continued production of it “unsustainable”. Whether the price trend is unsustainable or not is debatable, but the use of so much of the world’s resources to produce it is not. At some point, that will stop.
Because Bitcoin and most other cryptocurrencies use the technical system called “proof of work”, experts predict it will fail at some point, with the energy consumption and pollution that produce nothing more than a form of money as the main reason why it is not sustainable. It pollutes, wastes and is definitely not a green industry. Is there an alternative? Yes, there is.
The alternative cryptocurrency uses a different system called “proof of stake”. It does not use massive electricity, nor does it hog the market for computer chips and it does not spill carbon into our atmosphere. It is technically viable, but Bitcoin miners would be unlikely to give it a try because they already have so much invested in the system they use. Their computer network, the hardware and software investments, the real estate acquisitions, the energy resources they have lined up and the global network that they have built would become useless. Unless miners worldwide were willing to use the alternative system of “proof of stake”, it will be hard to get it off of the ground.
So, as you can see, the upside to Bitcoin is limited by how much longer nations, states, cities and other corporations are willing to allow the currency mining industry to gobble up so much of the global energy. It is only a matter of time before the amount of carbon emitted by the mining industry becomes an ecological danger that will not be permitted. It is also only a matter of time before nations figure out how to tax the profits and investment gains of Bitcoin and others. Once that happens, the advantages of these cryptocurrencies will evaporate.
Oh, and currency mining is vulnerable to failure in more traditional ways. For example, according to Coinopsy, a company which tracks cryptocurrency start-ups, over 1,085 of them have failed and gone down the financial rathole. One such failure was a Ponzi scheme called OneCoin. This scam promised to pay a guaranteed return of 300% but of course it did not. Like all traditional Ponzi schemes, it used investor dollars to pay the “returns” but by the time this fraud was discovered, the funds invested by real people had only produced losses, estimated to be around $20 billion, perhaps more.
Another problem is that an investor with an account in Bitcoin and other cryptocurrencies has to rely on the founder of the currency to have access to the transaction records kept by that digital currency, such as Bitcoin or any other cryptocurrency. When Gerald Cotton, who invented a cryptocurrency currency called Quadriga, died in 2018, his clients with accounts could not access their accounts. Mr. Cotton had a password to get access to the transaction records but he never shared it with anyone. At his death, the accounts were locked up and unavailable. Eventually, the password was figured out by a court-appointed hacker and the client accounts became accessible, but by that time, all of the funds had been sold without the account owners’ knowledge or consent.
A classic problem with digital currencies is the potential for being hacked. The most famous case of exactly this was the Mt. Cox hack in 2014. Somehow, a hacker managed to steal over 850,000 Bitcoins. They have never been found. There have been other hackings as well, estimated to have cost investors millions of dollars in losses.
The bottom line? The risks are great. The rewards are mostly only for a few people at the very top of this food chain. The business of mining is wasteful, heavily dependent on excessive consumption that will probably be prohibited or restricted. The original goal of providing a decentralized cryptocurrency that does not depend on big banks is laughable, because it is Wall Street banks that are the biggest owners of most cryptocurrency companies today. And to add insult to injury, it is clear that governments worldwide are determined to get tax dollars out of all of this so-called cyber “wealth”, sooner or later.
This is not something most people would consider for an investment, but as interest rates remain low, some investors will give it a try. Most will lose money, regardless of the soaring price of their cryptocurrency. It may go on for a while, but my hunch, and common sense, is betting that it will not end well.
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