Authors: Philipp Sandner, Constantin Lichti
Bitcoin is much more than interconnected processors. Far too often, Bitcoin is explained from a technical point of view. Attempts are made to make a significant invention understandable solely through technical terms such as nodes, hash functions, or nonces. Of course, technology is the foundation. Bitcoin is not an app on a smartphone that you can install, use and delete again. Bitcoin consists of nearly 10,000 global nodes that are interconnected and mutually synchronize with each other. This makes Bitcoin the global network that issues a new block every ten to twelve minutes and attaches it to the so-called blockchain. Every ten to twelve minutes. Viewing Bitcoin as such, it quickly becomes clear that it does not matter to this global network whether some computing nodes drop out of the network. Even if individual countries were to prevent the operation of computing nodes and these nodes had to be shut down, the overall network would always survive. This leads to the conclusion that Bitcoin has now reached the point where – technically speaking – it can no longer be shut down by anyone. The conclusion is that Bitcoin will continue to exist for the next few years – and probably even decades. However, this goes hand in hand with outrageous power consumption.
Certainly, the technology is important, but other explanations are better suited to illustrate the significance of the invention of Bitcoin. In any case, it is not just hype, not just speculation, but the beginning of something bigger.
Bitcoin as a “digital commodity”
With Bitcoin, a new kind of commodity has been discovered. No commodity you could touch, like chemical elements known as gold, silver, platinum, or even uranium. Instead, Bitcoin is a kind of digital commodity, generated by computers and partly made for computers. Mankind has a history of significant inventions. In history books written in the future, Bitcoin will be listed as one of these. That said one thing at a time for now.
How does gold actually work? The essence of gold is its scarcity and the belief of hundreds of millions or even billions of people in its value. Gold is mined in gold mines using excavators, heavy equipment, workers, and chemicals. The extraction of gold results in operating costs for the gold mine. Mined gold can be sold at the market price and the gold mine makes a profit. As long as the gold mine is making profits, it will invest resources to produce more gold. But: Eventually, mining will become so expensive that selling gold on the market will no longer be profitable. This illustrates the scarcity: It is not possible to mine an unlimited amount of gold.
It is precisely because of this scarcity, and essentially because of the belief of millions of people in this scarcity, that gold has acquired a certain kind of value. Of course, gold is physical and can be touched. It can be manufactured into jewelry and used in microelectronics. But the core of gold is its scarcity and the associated function of storing value. It is important now to recognize that gold jewelry is a result of this value. Because gold is valuable, we wear it as jewelry. If it were not valuable, we would not wear it. So scarcity comes first, then value. Scarcity is the core.
Now let’s turn to Bitcoin. Bitcoins are generated by computers. Resources such as processors, electricity, buildings, and personnel are used. The Bitcoin algorithm is programmed in a way that it invariably generates new Bitcoins day after day, but fewer as time goes on. Currently, about 900 Bitcoins are generated per day, down from 1800 Bitcoins per day a year ago. Investing more resources does not result in more Bitcoins being generated. This is how Bitcoin is programmed: There is a fixed supply function that cannot be deviated from. Thus, Bitcoin is scarce and this scarcity cannot be changed. So, while excavators and chemicals are used to mine gold, Bitcoin uses electricity and processors. The mechanism is the same, nonetheless: both are scarce. However, there is one major difference: gold has been known to mankind for thousands of years, whereas Bitcoin has only been around for a little over 10 years, and there are still relatively few people who understand the mechanics of Bitcoin.
Bitcoin and gold are subject to scarcity
Gold is physical, you can touch it. However, the value of gold is not determined by its materiality but by its scarcity and the belief in it. This means that the materiality is not decisive for the value of gold.
Bitcoin is scarce but it is immaterial. The scarcity is similar to gold, but you can not touch Bitcoin. Often this is taken as a criticism, but instead, it is the essence: Bitcoin is “dematerialized scarcity”. Relatively few people are aware of this. And exactly this is changing right now. That’s why the price of Bitcoin is currently surging.
Does Bitcoin benefit anyone?
What is actually the benefit of Bitcoin? Bitcoin is a store of value and an intangible store of value at that. This means that value can be transported without physical matter to any conceivable place in the entire world. Nobody can prevent a Bitcoin owner from carrying his value bound in Bitcoin – provided that one does not keep his Bitcoins at a financial service provider like the Stuttgart Stock Exchange or PayPal
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Furthermore, Bitcoin enables “transactions” that cannot be prevented by anyone. Anyone who wants to transfer value tied up in Bitcoin can do so worldwide in minutes and no one can stop him or her. By comparison, PayPal could block a transaction, or even the state or a government agency could stop transfers. Thus, Bitcoin is censorship-resistant.
These two points – unconditional value ownership and unconditional value transfer – cannot really be valued in a country with well-functioning institutions like Germany. Therefore, these advantages come to the fore when one imagines millions of people living in countries that are not democracies or where institutions do not function as well as they do almost everywhere in Europe.
For all time, the price has been determined by supply and demand. With Bitcoin, the supply is fixed and is also reduced over the years. That is how the algorithm is programmed – and it is unalterable. On the demand side, there have been private investors all over the world for years. Mostly tech-savvy, young, and male. The group of private investors is now gradually expanding because companies like the Stuttgart Stock Exchange and PayPal are making it as easy as possible for their customers to invest money in Bitcoin. This is gradually increasing Bitcoin’s demand.
Now, moreover, two new types of investors are entering the scene: First companies in the United States, e.g., Tesla or Microstrategy
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The understanding of Bitcoin is growing
Bitcoin is now increasingly understood as a “digital commodity” and is expanding slowly. Just as other inventions were also first discovered and then spread. A suitable comparison is the smartphone: In 2006, there was neither an Apple iPhone nor an Android phone. Now, in 2021, almost everyone owns a smartphone. It has taken 15 years to go from zero to near 100 percent penetration. In those 15 years, tens of billions of smartphones have been produced and sold. This is called market penetration.
Will Bitcoin continue to spread? There are many arguments in favor, but also some against: Even though Bitcoin has been running as a computer network for more than ten years, the question naturally arises whether there might be technical problems in the years to come. Hacker attacks could damage Bitcoin as they have in the past. And even though regions such as Europe and North America are increasingly enacting laws and regulations that are fundamentally Bitcoin-friendly, the question arises whether this will continue to be the case in the future. Nonetheless, Bitcoin is in a long-term uptrend. If you look at the short-term price trend over the course of months, you can see ups and downs. However, if you look at a longer period of time – for example since 2013 until today – the upward trend is still recognizable. However, a capital market expert only acknowledges this when a logarithmic price axis is considered. Thus, the legitimate question then arises whether Bitcoin will ever fall below the $20,000 threshold again. Probably not.
When it comes to the assessment of Bitcoin, opinions differ: Young and tech-savvy digital natives are curious about Bitcoin and try to understand it. Older generations wave it off dogmatically. However, caution is advised here: An assessment of Bitcoin can only succeed and is only “fair” if one has dealt with the matter in depth. People who have studied Bitcoin and the underlying blockchain technology in-depth usually develop a positive opinion. Conversely, it can be seen that Bitcoin and blockchain skeptics are people who have mostly not dealt with the matter sufficiently.
And now the proof: It is hard to find people who are skeptical about Bitcoin and blockchain and have sufficiently studied the matter. Expertise enlightens. Those who are familiarized will sooner or later recognize the brilliance of the technology. It is worth getting to the bottom of it.
Authors
Prof. Dr. Philipp Sandner has founded the Frankfurt School Blockchain Center (FSBC). In 2018 and in 2019, he was ranked as one of the “top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. Further, he belonged to the “Top 40 under 40” — a ranking by the German business magazine Capital. Since 2017, he is a member of the FinTech Council of the Federal Ministry of Finance in Germany.
Constantin Lichti is a research associate and project manager at the Frankfurt School Blockchain Center, and doctoral candidate (PhD) at the Johannes Gutenberg University Mainz. His research area is the individual adoption of blockchain technology. You can contact him via LinkedIn and email (constantin.lichti@fs-blockchain.de).
