Does Bitcoin have a bright future, or is it only a transitional proof of concept? In their March 2018 paper entitled “Bitcoin: A Revolution?”, Guillaume Haeringer and Hanna Halaburda review incentive mechanisms that make Bitcoin work and discuss current and potential uses of Bitcoin and related technologies. They view Bitcoin as the first successful digital medium of exchange without a trusted third party based on combining cryptographic tools and incentive systems that prevent double-spending. They define a Bitcoin user as any entity holding or receiving Bitcoins and a Bitcoin miner as any entity recording and validating transactions. From the perspective of users, the Bitcoin system is similar to an online banking system that supports only deposits and transfers. From the perspective of miners, the Bitcoin system is a source of rewards from adding new blocks to the blockchain (the only source of new Bitcoins) and from transaction validation fees within their blocks. Based on the body of information about Bitcoin, they conclude that:
- The block addition reward declines over time from 50 Bitcoins at inception to 12.5 Bitcoins in 2018, to 6.25 Bitcoins around January 2020 and zero Bitcoins around May 2140. After this date, miners will have created all Bitcoins, and their only source of income is transaction validation fees.
- As of the end of 2017, Bitcoin mining consumes roughly as much energy as Denmark. Since only the first miner to find a specific new block gets the associated new Bitcoins and fees, there is a race for computing power among miners, amplified by increases in Bitcoin price. The wasted energy of Bitcoin miners who lose a race is arguably the cost of achieving system security without a trusted third party.
- Bitcoin limitations include:
- High volatility of value relative to conventional currencies.
- Severely limited network capacity (maximum seven transactions per second), with potential for significant delays in processing transactions.
- Related to the capacity limitation, a fairly high transaction fee of $30 as of the end of 2017.
- Susceptibility to user identification via careful analysis of the blockchain and cross-referencing of blockchain information with other sources.
- Unrecoverable, and therefore uninsurable, loss of Bitcoins (Bitcoin address and private key in a digital wallet). Users have lost about four million Bitcoins since 2008.
- A deflationary dynamic due to the fixed number of total possible Bitcoins.
- Potentials of Bitcoin include:
- Evolution of its software to support high transaction flow. However, Bitcoin protocol modifications require near unanimity of miners, which is very difficult to obtain.
- A role in crypto-contracts (smart contracts), sets of instructions that execute automatically after satisfaction of some user-determined conditions. For example, a smart contract could support sale of a house without intermediaries such as brokers, notaries and lawyers via blockchain technology. Bitcoin currently supports rudimentary smart contracts, but competitor Ethereum already offers more robust smart contract capabilities than Bitcoin.
In summary, Bitcoin currently has significant limitations as a currency that may mean obsolescence, but it could evolve to overcome some limitations.
Cautions regarding conclusions include:
- The success or failure of Bitcoin may lie beyond the performance horizons of many investors.
- Despite limitations, Bitcoin appears to have first-mover advantage as an intermediary for other crypto-asset systems.
