• Hristo Piyankov

Why Bitcoin failed (economically)​

Updated: Jul 5, 2021

I should probably start this article with a clarification - I am an avid supporter of cryptocurrencies and I do believe they have a place in the future of finance. However, I also believe that constructive criticism and change are needed when something is not performing as intended.

What provoked this article​?

In all my work experience, I have worked in finance - banks and other financial institutions. Throughout this time, I've always had the feeling that the processes there were a bit too bureaucratic and were way too focused on profit (for the company) rather than actually solving problems through financial instruments. I can talk in length about how consumer loans should not exist (or at last not exist in a for-profit form), but this is beyond the scope of this article. Considering all this, you can imagine how, when I was made aware of cryptocurrencies (around the start of 2015), they spiked my interest. When I think about Bitcoin (both then and now), the following definitions pop in my mind:

  1. Store of value

  2. Digital gold

  3. Universal currency

  4. Solution to central banks printing money/QE (quantitative easing) during a financial crisis

It is a bit ironic. I've always had a good understanding of how money and banking works (having worked there for over 12 years), but it took Bitcoin to provoke my interest in understanding how they work on a larger scale. I have spent the last year reading on country/world level economy as well as any article I could find on cryptocurrency economy. Also during this last year, I have worked with dozens of cryptocurrency projects on their tokenomics and how it fits into their business models.

The result? I am now convinced that Bitcoin can never fit into any of the above four definitions.

Why not?​

I doubt an article (or even a single book) can ever be enough to cover this topic, but I will do my best to provide a couple of bullet points trying to summarize a year worth of reading (albeit in an oversimplified manner).

A fixed supply currency would be disastrous in the conditions of an economic crisis. Boom and bust cycles are built into our economic system (there is a great video by Ray Dalio about this). The reasons for this are not banks or governments or lack of regulation. The reason is that the rate at which we extend credit eventually outpaces the rate at which productivity grows. It might be tempting to think that if Bitcoin was a universal currency, or if banks did not exist or if regulation was tighter this would be a non-issue. This, however, is not the case - we have always found ways to extend new forms of credit regardless of currency, intermediaries or laws. Actually, in their current form, most cryptocurrencies are exactly this - a form of credit, created out of thin air, having value only because a group of people agree that they do. In the conditions of an economic crisis, credit contracts rapidly in order to provide much-needed liquidity. And when this happens, monetary policy decisions and flexibility are critical in order to prevent a crisis from going into a full-blown recession. If you are unsure as to why it might be good to read up on the economic conditions that helped cause World War II. Don't get me wrong, though, I am not claiming that the current financial system is perfect nor that financial crises are always handled in the best possible way. I am only saying that we are yet to see an algorithmic policy, that would be able to handle all the nuances of a crisis within a country, let alone the world.

A store of value's supply needs to grow proportionally with the economy. I believe, that if we are honest with ourselves - most of us love cryptocurrencies for the wrong reasons (at least partially). We are fascinated with the idea of getting in on the ground floor, of a new economic system. We are all for the re-distribution of wealth as long as we get a larger percentage of it than we currently have. If this is not the case, then why is the rallying cry of cryptocurrencies "HODL" and "to the moon", instead of promoting usage, spending and equal grounds for newcomers? And Bitcoin has the inherited promise of "to the moon" built-in. Given that it has a fixed supply and the world wealth ($317 trillion a year-on-year increase of 4.6%) and population keeps growing, simple logic dictates that if Bitcoin is accepted as a universal currency in any large enough domain, it will keep appreciating in value. If we are to express the world wealth in Bitcoin, owning 1 BTC (@21 million BTC in circulation) would be equivalent to owning $15 million. The problem arises when the next generation comes along, or even before that when people who were not in on the ground floor of Bitcoin come along. Why would they accept a wealth distribution which was stacked against them, when they can just as easily create a new one?

Our (Bitcoin's early adopters) virtue wasn't doing something right, it was just getting in early. In this regard, the Bitcoin (and the majority of other cryptocurrencies') club is a bit exclusive. You either get in early or just wait for the next train to come along. You could argue that FIAT money has a similar problem, however, inflation and (properly structured business) loans along with other mechanisms, tend to alleviate that. Although, as already mentioned, I don't like fully algorithmic policies, I believe that if Bitcoin's block reward doubled (as opposed to halved) every four years, it would have a much lower barrier to entry and much larger application as a currency.

Expectations vs reality​

"Did I miss something?" This was my original thought when arriving at the realizations above. So I went back to read Bitcoin's whitepaper again. I have read it multiple times in the past, so it was to my great surprise when I realized that none of the terms above, were actually present in the document. Here is the frequency at which certain (relevant to this article) terms occur in the document:

Bitcoin's whitepaper has 0 references to anything related to economics or solving any other problem apart from the settlement of payments without a middleman. The text is entirely technical and does not offer any financial justification on why was the supply of 21 million BTC chosen, why the reward halves every 4 years or why it needs to be a fixed supply. It is only assumed that eventually, transaction fees would be enough to incentivize miners, so additional block rewards would no longer be needed for this purpose. All Bitcoin was ever intended to be is a protocol, a proof of concept for transaction settlement without intermediaries.

I also tried to search online, in order to find out where did the miscommunication start. Why was mine I (and I assume others) associating Bitcoin with something it was never designed to be. I could not find a single source or a particular point in time when this happened, but I did find references to the people saying that the whitepaper is old and Bitcoin has evolved into something more than what it was intended to be.

And this is where I disagree. To evolve is to change. And Bitcoin it is pretty much the same (from an economic point of view) as it has always been. This, however, is not the problem. The problem is our perception of Bitcoin and our persistence in assigning qualities it doe not possess. On the other hand, Bitcoin is exactly what it was designed to be - a proof of concept, a technical blueprint for the implementation of the underlying technology.

Where do we go from here​

Bitcoin has to eventually die. Not because it was bad or faulty in any way, but because it has already served its purpose. Much like the very first search engines and social networks died off to make way for Google and Facebook, Bitcoin is already outdated. If anything, it is holding the crypto space back, exactly due to the persistence of people assigning it qualities it does not possess. Luckily we are moving in the right direction. There are many businesses in the crypto space launching new projects while making sure that their tokens have proper value drivers and that their figures and tokenomics add up.

In conclusion - I do believe that a cryptocurrency can be a store of value, can function as a national currency and in certain ways can help us have more adequate and transparent monetary policies, especially in times of crisis. It can also drive a business forward and can replace traditional equities and currencies in certain functions. We just need to engineer one which has those qualities and not just wish them upon it.