Bitcoin has enjoyed varying degrees of interest over the last decade. During that time, when it receives the most attention it is usually during fantastic rallies or slumps. Here I will lay out an analysis of the most common criticisms of bitcoin. This is not an analysis of whether bitcoin should be considered as an investment in your portfolio. Full disclosure: I own ~.045 bitcoins.
Bitcoin volatility makes it a poor choice for buying goods and services
Critics argue bitcoin fails to live up to the standards of fiat currencies. This is especially true when using bitcoin to buy or compare common goods and services. The dollar for example, is a very stable currency with only minor fluctuations in value. A common question from this viewpoint is, “Why would buy anything with a currency that could double or halve quickly? And if you’re a merchant, why would you accept such a currency?”
A common counter to this argument is that bitcoin will not replace fiat currencies, especially in day to day transactions. Bitcoin’s value is not in the purchasing of goods but as a store of value across time, or facilitating international transactions. This is similar to a parent who wouldn’t buy diapers with gold coins; people just don’t use gold that way.
The Bitcoin network is slow and inefficient
Critics argue that consumers and merchants are reluctant to accept bitcoin for goods is settlement times on the network. Indeed, the Bitcoin network can process roughly 4.6 transactions per second while Visa can process nearly 2,000. The reason for this is that the blockchain technology that bitcoin is built on is not built for speed but rather built for trust  . The bitcoin ledger acts as an immutable record of all previously verified transactions. The ledger is secured and verified by complex algorithms preventing corruption. Since bitcoin is an open-source technology with no company in charge, it relies on this decentralized, trustless mechanism for security. Visa, being a trusted third party can avoid the need to implement a “trust-less” solution like the blockchain. It would be less efficient for Visa to attempt to utilize a blockchain to verify it’s payments.
There are a couple answers to these criticisms. The first one, like the one explored under point number 1 is bitcoin’s long term value is not facilitating everyday transactions. Instead, bitcoin’s long term value is as a digital store of value. The second is that there are applications being built on top of the bitcoin network to increase its efficiency. These applications are exploring ways to settle small transactions off the blockchain before submitting them to be verified on the blockchain. This could allow for quicker transactions but also invites the corruption that the blockchain seeks to prevent. It remains to be seen whether these applications will be successful or relevant in the future.
Bitcoin is too new to be trusted
Critics have argued that the novelty of bitcoin makes it difficult to meaningfully extrapolate its behavior into the future. I agree with this criticism; bitcoin is too new to say with much certainty what the future looks like for the digital currency. We are welcome to look at it’s short history and note it’s risk-adjusted performance, but whether we should draw any conclusions from such an analysis is not so clear. This makes bitcoin like many new ventures very speculative for now. A lack of understanding surrounding the new technology doesn’t help matters either. And there is always the possibility that governments could start imposing regulations that lessen the value of bitcoin, although it’s hard to say what those regulations might look like. These are among the biggest risks for bitcoin.
Bitcoins supply isn’t technically “fixed”
Critics using this argument say that while bitcoin has a future fixed supply of 21 million coins, the bitcoin mining community could collaborate to increase the total supply of coins. Indeed, the only way bitcoin’s supply could be increased is if a majority of the mining community decided to change the protocol to increase supply.
It should be noted that miners have strong incentives not to increase supply if such a move were to destroy bitcoin’s value. This is because bitcoin miners have a very strong vested interest in maintaining or increasing the value of their coins. So while it could happen, it would probably happen in a world where such a move somehow increased the value of bitcoin. One such world is when all 21 million bitcoins have been mined. Some have theorized that this could lead to miners, who at that point will rely on transaction fees for compensation, to vote to increase the supply of bitcoin. Since we don’t inhabit this world currently, I have found little value in drawing firm conclusions about the likely outcomes.
Even if the supply is fixed, it’s easy to create a million other currencies with the exact same fixed supply and other characteristics of bitcoin
This another very true criticism of bitcoin. The code backing bitcoin is totally open source and free for anyone to copy, change, and use as they see fit. There are already many instances of bitcoin’s code being used to create different so-called “alt coins”. If bitcoin is to overcome these newcomers, it will be because of its larger (and therefore safer) network, its first mover status, and it’s superior liquidity.
Supporters say that “network effects” will create an increasing incentive for more people to join the bitcoin network vs. a competing network. Similar to the way a social network (like facebook) or a cell phone network is more valuable when more people join, bitcoin becomes more valuable as more people join; this in turn causes more people to join, and so on. Whether the network effects result in the long term success of bitcoin remains to be seen.
Bitcoin doesn’t generate cash flow like a traditional investment
This is an accurate criticism. Others commonly argue back by pointing to gold or any other commodity. Strictly investing in gold will not result in any cash flow but that hasn’t kept people from buying gold. The market capitalization of gold today is over 11 trillion dollars. The reason gold remains so valuable is that mostly all of gold that has ever been mined is still held today; which means the proportion of gold entering the market that is “new” gold gets lower and lower over time. The “stock to flow” (S2F) model of valuation captures this, and bitcoin and precious metals like gold share this feature. The “stock” or existing supply of cheaper commodities can grow by increasing their “flows” or production of new stock. For example, if there was a sudden demand for plastic forks, price would increase incentivizing plastic fork manufacturers to quickly flood the market with plastic forks so they could take advantage of higher prices. More expensive commodities like gold, have flows that cannot rapidly expand to replenish stock shortages should they occur. The supply of new gold has been very low and stable for a long time regardless of the price of gold. With no expanding supply to absorb increased demand, the prices of such commodities increase over time.
What is true for gold from a stock to flow perspective is even more true for bitcoin. Bitcoins new supply decreases by half roughly every 4 years before asymptotically reaching 21 million coins around the year 2140. This means that bitcoins rate of new supply decreases to a point where there’s no mining of new bitcoins and any increase in demand can only be met with an increase in price.
Bitcoin isn’t “backed” by anything
This argument says that since there is no government authority backing bitcoin then it’s value is dubious. It is true that bitcoin has no sovereign backing like the dollar. In fact, that attracts some long term holders of bitcoin. They argue that the government resorts to debasing currency in the long run to stimulate short term economic growth. So while governments don’t back bitcoin, at least that means that no government can just “print” more bitcoins to stimulate the economy.
Historians argue that one of the main reasons most countries left the gold standard during the 20th century was its inability to make money more or less readily available during times of economic recession and expansion respectively. For example, during the Great Depression, the Federal Reserve couldn’t step in and cut interests or buy bonds from banks to increase the money supply; if they wanted to increase the number of dollars they could only decrease the value of the dollars pegged to gold, or go commandeer more gold. Fiat dollars have no such restrictions on their creation and have given central banks the world over more flexibility in fighting recessions. This is also a good way to illustrate why a deflationary currency would not make for a good primary medium of exchange in an economy. This is because with a deflationary currency, the incentive for consumers is to hoard as much currency as they can while it appreciates; this in turn causes economic growth to stagnate and resulting in more hoarding and more stagnation.
Miners and Mining equipment manufacturers are becoming more concentrated in China
This is a more recent development. A major strength of a decentralized currency backed by a cryptographically secured blockchain is that the validity of it’s transactions can not be called into question; i.e. it’s very hard to spend fake bitcoins. This security depends on the decentralization of the miners who verify the transactions. Yet China accounts for 65% of all bitcoins currently mined. Not only that but the largest companies that manufacture the computers that make bitcoin mining possible, reside in China.
Some have argued concentration of miners is less concerning because their interest is in the value of the coins they mine. There is nothing to suggest that the 65% of miners, co-located in China, would somehow find it in their interest to collaborate to destroy the source of their wealth. On the other hand, the Chinese government could pressure the manufacturers to implement less friendly measures. But if miners were to catch wind of such moves, it would theoretically incentivize them to find a new source for their computers.
- Saifedean Ammous. The Bitcoin Standard. Wiley, 2018.
Erik Goodge is a CERTIFIED FINANCIAL PLANNER™ and the President of uVest Advisory Group. He holds a B.S. in Economics and Cognitive Science from the University of Evansville. Erik is a Marine Corps veteran of the Afghanistan campaign and Purple Heart recipient. He is from Evansville, Indiana, and currently lives in near-by Newburgh with his wife and daughter.