Cryptocurrency seems to serve two functions: it facilitates money laundering, and it provides a speculative investment. It is an extreme example of the absurdity of having a form of money be a tradable asset. The whole idea that a single Bitcoin, whose value was set at 30¢ in 2011, could have a market value of over $68,000 in 2021 is preposterous.

What exactly is cryptocurrency and why is anyone interested in it other than as a way to hit the jackpot? Theoretically it is a medium of exchange, but paying someone with cryptocurrency is so inconvenient and even expensive that it is not yet a practical way to pay for everyday expenses. It is possible to use Bitcoin these days to buy a car, but the main use for cryptocurrency as a medium of exchange has been international transfers of very large amounts of cash where the real benefit seems to be that the transactions are untraceable for all practical purposes.

Bitcoin was not the first cryptocurrency, but it is certainly the most prevalent one at present, and the “Bitcoin White Paper” written by the creator of Bitcoin may be a good place to start in evaluating its potential. To some extent cryptocurrency seems like a solution in search of a problem, but the most important characteristic of Bitcoin is that it is, as the title of the white paper says, “a peer-to-peer electronic cash system.” The idea of electronic or digital “cash” is not new, but most forms of electronic cash transactions require an intermediary such as a bank or credit card company not to mention a large infrastructure behind the money and some institution supporting it.

The object of Bitcoin is to enable one individual to pay another in a secure manner without an intermediary. Much of what is written about cryptocurrency focuses on how the transactions can be secure rather than why it is advantageous to eliminate the intermediary. Part of the reason that Bitcoin became so popular after it was introduced in 2009 was the 2007- 2008 financial crisis. Many people became convinced that there was something fundamentally wrong with the current financial system, and it seemed natural to blame the government and the large banks that controlled the supply of money. Cryptocurrency offered a way to take the monetary system out of their hands.

One way to understand the point of cryptocurrency is to view it in the context of how money has evolved. When money consisted of coins made from “precious” metals, it was possible when someone paid you to verify that you had in fact been paid. The metal used for the coins was considered valuable in itself and its weight and purity could be tested. The term “acid test” derives from one method of testing the purity of gold. Gold is also soft enough that one can test a coin by biting it.

Once paper currency replaced precious metal coins, an element of trust was required for transactions. Paper currency may have unique serial numbers and elaborate engraving techniques to make it difficult to counterfeit, but the institution issuing the currency must be trustworthy and have the means to enforce the use of the bills as “legal tender.”

With cryptocurrency the object is to make the currency self-verifying by having it contain a record of its provenance and transaction history. This would prevent someone from using the same Bitcoin in different transaction or just generating counterfeit Bitcoins, and it is achieved with blockchain technology and a network of computers. This is not the place to explain blockchain technology. Suffice it to say, blockchain is a method of encrypting data which requires a lot of computing power distributed over a network of computers. Elements of the theory had been available for 25 years, but Bitcoin was the first application of it to a decentralized network. The network is an essential element in the security of Bitcoin, and the number of computer processors verifying the validity of a transaction needs to be greater than the number of computers trying to hack the system.

The creation of a new Bitcoin is the first transaction stored in it and requires similar computing power to the verification of later transactions. Anyone with sufficient resources can create Bitcoins which they then own, although there is an algorithm embedded in the scheme which limits how fast the number of Bitcoins can grow. Anyone who puts their computers on the network to verify transactions may also received transaction fees in Bitcoin. Both creation and verification are referred to as “mining” in a comparison to gold mining where anyone who extracts gold from the ground or a stream is the owner of a form of money. The resources required for Bitcoin mining are computer hardware and enough electrical energy not only to run the computers but to keep them cool. Computer installations devoted to Bitcoin mining can consume enormous amounts of electricity, and, even though computer processors are always becoming more efficient, the difficulty of verifying a cryptocurrency transaction grows as the cryptocurrency becomes more widely adopted.

If we ignore any technical obstacles, what are the reasons for adopting a self-verifying digital currency? It seems to me that the only conceivable reason is that it severs any connection between the currency and a government or some other centralized authority. Whether this is advantageous is a matter of debate. The main argument against having a government issue and regulate money is that the government cannot be trusted to maintain the value of the money rather than simply increasing its supply to pay for wars or for institutions designed to subjugate the population. Control over money gives the government too much power, and individuals in the government can use monetary policy to increase their own power.

Crptocurrency involves what is called a “decentralized autonomous organization” (DAO). Verification of transactions is not done by a centralized process but requires the involvement of many computers on a network operating independently of any human intervention. It is difficult to appreciate the significance of this. A credit or debit card authorization also involves a large network of computers and any given transaction is authorized without any human intervention. One can easily imagine that no human hand touches anything between the time one swipes or inserts or taps a card at the grocery store checkout counter and the time when one receives a monthly statement. It is certainly hard enough to speak with a human being when questioning a transaction on a statement.

Does the fact that every Bitcoin contains a unique record of its provenance make a given transaction any more secure than one using a credit card or debit card? It prevents “double spending” of the Bitcoin. In fact the prevention of “double spending” seems to be the principal justification for Bitcoin.

A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending. We propose a solution to the double-spending problem using a peer-to-peer network.

Trying to eliminate trust from social interactions is as self-defeating as the attempt to eliminate risk from investing. One can understand why individuals do not trust large institutions that use their power to benefit a small group of people, but perhaps the solution is to regulate the institutions rather than eliminate the need for trust. This of course requires trust in the government that must enforce the regulations.

Why would one trust the security of a cryptocurrency transaction more than a credit or debit card transaction? The problem with banks and credit card companies is not that their involvement in transactions makes them less secure, but that their other activities can have devastating effects on the economy and often benefit only the extremely wealthy. If cryptography can provide a way to securely embed the provenance of a given amount of cryptocurrency, surely it can provide an equally effective method for insuring the security of credit and debit card transactions and bank accounts. The issue of “double spending” is a problem introduced by a digital currency for peer- to-peer transactions. Solving that problem is not a justification for adopting a digital currency capable of peer-to-peer transactions. The critical lack of trust lies in the method for creating and regulating the currency itself.

Cryptocurrency is created by “mining,” and the system design includes some method for limiting the rate at which the amount of currency in circulation can grow. Someone or some group has to determine the appropriate rate for the currency to grow if its purchasing power is to be stable.

When Satoshi Nakamoto created Bitcoin, he installed a strict limit on the number of Bitcoin that could ever exist. There will never be more than 21 million bitcoin. This limit, known as the hard cap, is encoded in Bitcoin’s source code and enforced by nodes on the network.

Bitcoin’s hard cap is central to its value proposition, both as a money and an investment. Like gold and real estate, Bitcoin is a successful store of value because it is difficult to increase its supply. Thanks to the halving, bitcoin becomes more difficult to produce every four years, and eventually, it will become impossible.

According to coinmarketcap.com there were 19,013,687 units of Bitcoin circulating on April 16, 2020. The limit on the number of Bitcoins in circulation may be an essential element in its value as an asset, but it does not means that its purchasing power can be stabilized. Bitcoin rapidly became an extremely speculative asset for investors. Apparently the earliest use of Bitcoin to purchase something was in 2010 when an early adapter persuaded his local Papa Johns pizzeria to sell him two pizzas for 10,000 Bitcoins, which he regarded as worth $40. By 2021 those Bitcoins would have been worth $680,000,000. On the other hand an investor who watched the trading value of Bitcoin rocket from $1 in April 2011 to $29.60 in June could have bought it only to see its value plummet to $2.05 in about five months. Some advocates of cryptocurrency, of course, say that it will gradually stabilize, but it is worth noting that the investors in Bitcoin who have made fantastic amounts of money have done so by selling the cryptocurrency for dollars or some other established currency. The idea that a cryptocurrency can function as a store of value because it is a scarce resource seems undermined by the fact that it is a tradable asset whose value is determined simply by a market created by speculators. The success of Bitcoin seems also to have given rise to the “nonfungible token” (NFT) which uses the same technology to create a unique digital object whose only value is that it is a tradable on a market comparable to the market for collectibles like baseball cards.

The number of Bitcoin in circulation may be limited, but there is nothing to stop other cryptocurrencies from being created.

Since the 2008 invention of the first cryptocurrency, Bitcoin, cryptocurrencies have proliferated. In recent years, they experienced a rapid increase and subsequent decrease in value. One estimate found that, as of March 2020, there were more than 5,100 different cryptocurrencies worth about $231 billion.139

Wikipedia lists only 180 currencies recognized at legal tender by nations or their dependencies. Bitcoin is one of these since it has been recognized as legal tender by El Salvador. Wikipedia also says there are another 300 “complementary” local or regional currencies. One has to wonder what the economic impact would be if there were 5,000 different currencies used globally.

Among the commonly cited benefits of cryptocurrency are

1. Transaction speed

2. Transaction costs

3. Accessibility

4. Security

5. Privacy

6. Transparency

7. Inflation protection

Transaction speed. Comparisons of the speed of a cryptocurrency transaction are often made to the speed of a wire transfer, which can sometimes take several days to go through. Often a check issued electronically by Quicken can take three or four days to be fully processed as well. Other forms of electronic payment, however, seem virtually instantaneous to the payer. If you buy something online using a credit card, you only have to wait few seconds for the payment to be verified, and, if you authorize a bill to be paid by supplying my bank account information to the payee, it seems to be credited the same day.

It seems as though the verification of a Bitcoin transaction can take anywhere from 10 minutes to 7 days, depending on how many other transactions are waiting to be verified and how much of a transaction fee the sender is willing to pay. The computational difficulty of the verification of a Bitcoin transactions is systematically modified with a view to keeping the time required around 10 minutes.

Transaction costs. Transactions costs are paid by the spender, and generally someone initiating a cryptocurrency transfer has the option of increasing the transaction fee to secure a higher priority in the cue of transactions waiting to be processed by the computer network. Transactions costs for Bitcoin transfers have varied dramatically over the years, rising as high as $54 in 2017 and an all time high of $62 in April 2021. As of April 18, 2022, the Bitcoin average transaction fee was $1.04.

Transaction costs in other forms of electronic payment are often paid by the merchant rather than the customer, though the cost of the transaction may affect the retail price of the good. The Dodd-Frank Act included a provision for limiting the transaction fees charged to vendors when a purchase is made with a credit card. Generally these fees range between 1.5% to 3.5% of the purchase amount. Banks charge the sender for wire transfers, and they may charge a monthly fee for processing electronic checks from Quicken, but they do not seem to charge a transaction fee for bill-paying when it is done directly with the bank.

With cryptocurrency the transaction fee is the incentive for “miners” to put their computers on the network to verify transactions. According to Statista.com “The average energy consumption for one single Bitcoin transaction in 2022 could equal several hundreds of thousands of VISA card transactions. “ Another source estimates the average amount of electrical power required to verify each Bitcoin transaction as 1,173 kilowatt hours, an amount comparable to the power consumed in about 6 weeks by an average household. It is difficult to see how earning a transaction fee of $1.04 every ten minutes provides sufficient incentive. Other forms of cryptocurrency require significantly less power to verify transactions. Ethereum is said to require 87.29 kilowatts per transaction, and its average transaction fee as of March 10, 2022, was $15.

Accessibility. Motley Fool describes the accessibility of cryptocurrency as an advantage for people who do not or cannot deal with a traditional bank in managing their money:

Anyone can use cryptocurrency. All you need is a computer or smartphone and an internet connection. The process of setting up a cryptocurrency wallet is extremely fast compared to opening an account at a traditional financial institution. There’s no ID verification. There’s no background or credit check.

Cryptocurrency offers a way for the unbanked to access financial services without having to go through a centralized authority. There are many reasons a person may be unable or unwilling to get a traditional bank account. Using cryptocurrency can allow people who don’t use traditional banking services to easily make online transactions or send money to loved ones.140

Sending money to loved ones conjures up an image of refugees or undocumented workers sending money back home to support their family, and in fact there is some indication that this is a growing use of Bitcoin.

Security. There are two aspects to the security of a cryptocurrency. One is the difficulty of generating false transactions because of the nature of the network involved in verifying transactions. The larger the network becomes, the more difficult it is to hack it and the more secure the currency transactions are. The other factor affecting the security of a cryptocurrency is how the owner of the currency stores it in his digital “wallet.” He has a private “key” which gives him access to his own currency and which is distinct from the public key employed when the currency is involved in a transfer. If someone else discovers what your private key is, he or she can access your currency as easily as you can. If you lose or forget you private key, you lose your money. Some people apparently write their private key down somewhere rather than store it on a digital device.

Privacy & Transparency. There is something incongruous and ironic about the way in which proponents of cryptocurrency tout both its privacy and its transparency. Cryptocurrency transactions are said to be transparent because anyone can see all of the transactions for a given currency. For example, there is a website called blockchain.com which updates information about Bitcoin transactions in real time. As I write I can see there there is a transfer of $76,724,684.46 initiated a couple of minutes ago and still waiting for verification. During the time it has been waiting to be confirmed the value of the Bitcoin involved has apparently increased by $45,667.51. I can see the “address” of the sender (a 64-character string) , but I cannot see any real information about the person or company behind that address. This is because of the main source of privacy with cryptocurrency: the sender is always using a pseudonym and may in fact use a different pseudonym for every transaction.

Inflation Protection. The design of Bitcoin includes a hard clip limiting the number of Bitcoin that can be created to 21 million. While there is a convoluted process by which this limit could be altered, the prevailing attitude at present seems to be that it will not because having a fixed limit on the amount of Bitcoin in circulation is protection against inflation. Most economists will say that excessive supply of money is a major cause of inflation. One the other hand if productivity increases while the supply of money remains constant, the money becomes more valuable in terms of its purchasing power. Ideally, of course, the supply of money should somehow track with fluctuations in productivity so that the purchasing power of the money remains constant.

Apparently not all cryptocurrencies are designed with this type of limit on the supply of currency, and obviously the main appeal of cryptocurrencies so far is not that they are form of money whose value is stable, but rather that they are a type of financial asset whose market value is highly volatile.

Any argument that cryptocurrencies are better at preventing inflation would also have to factor in the way in which any number competing currencies can be created.

To my mind, the only coherent justifications for cryptocurrency are the separation of money from government or large banks and the supposed elimination of the need for trust in financial transactions. It is unclear to me that current forms of cryptocurrency can even achieve these goals. Their use depends on the ability to exchange the cryptocurrency for whatever currency is regarded as legal tender and accepted in the society in which one lives. One might even say that the elimination of a trusted intermediary is an illusion since the currency seems to rely on large installations of dedicated computers mostly owned, operated and maintained by a relatively small number of individuals or companies seeking to make a profit off mining and transaction fees.

Some advocates of cryptocurrency are very enthusiastic about the concept of decentralized autonomous organizations in general and the descriptions of how such organizations function sounds very much like the functioning of a cooperative or even a democratic or representative form of government. For some reason it seems to be easier to put ones trust in an anonymous “node” of computer processors than in the person owning it. There may be a lot to be said in favor of decentralizing many aspects of how a society is organized and, as the example of Sardex illustrates, there are clearly some advantages to localized currencies. The problem with cryptocurrencies, though, is that they designed to be global and are not in any way connected to a local economy.

Aside from the waste of energy resources involved in supporting a cryptocurrency, the biggest objection I have to the concept is that is repeats the mistake of assuming that money itself can be an asset that trades on an open market. While there may be nothing inherent in the concept of a cryptocurrency that requires it to be a tradable asset whose value is determined by a market, all of the current implementations seemed to be designed to encourage that. Money can function as a store of value without being a tradable commodity. The techniques involved in cryptocurrency could conceivably used to facilitate international transfers of money without having the currency itself be an “asset” whose value fluctuated according to the expectations of speculators. Whether the degree of secrecy (aka “privacy”) currently possible with cryptocurrency transactions is desirable is another matter.

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