Table of Contents
1. Introduction
Bitcoin has gained immense popularity in recent years, which is evidenced by the increase in Bitcoin’s usage and the number of available cryptocurrencies. In essence, Bitcoin is a digital currency that was created in 2008. It is a system that is run by peer-to-peer (p2p) technology. No single entity controls it, and it is not printed; instead, it is mined. Miners run software to find complex mathematical problems in order to solve a block and be rewarded with Bitcoins. This is a process that is quite resource-intensive, but if successful, it is intended to be rewarded with 25 Bitcoins per block. The reward will halve every 4 years until it reaches 0. At this point, there will be a maximum of 21 million Bitcoins in circulation. This is an engineered limit to avoid inflation, devaluing, or other negative circumstances. It is intended to be reached around 2140. At this point, miners are expected to be rewarded through transaction fees, which could also be an additional revenue source if Bitcoin proves to be successful. These features of Bitcoin, and many more, will be discussed in the proceeding sections, highlighting the importance of Bitcoin from a financial and economic standpoint.
1.1. Definition of 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. This sentence was the first that can be found in the white paper, written by an unknown person or a group of people using the pseudonym Satoshi Nakamoto. This is the only information that we actually have of who has created this digital currency, and the knowledge of the person is extremely limited. This characteristic of the creator is interesting because it does not set a biased context for the coin, so potential negative impacts were not sought to be created. Published on October 31st, 2008, the Bitcoin white paper is very clear and focused on the task the currency was trying to achieve. Nakamoto was left with a world with a financial climate that was suffering due to sickness caused by the sub-prime mortgage crisis and hedge funds, with Lehman Brothers’ bankruptcy in 2008 being a particularly notable moment in history. The white paper stresses the vision for a future of the world’s finance as the main driving force behind why the concept of Bitcoin should be created. The white paper has made it clear that Bitcoin (BTC) was created to act as a form of currency. It also explains that the current infrastructure of the world’s banking ecosystem is what caused the creation of a digital currency and not a proxy or a form of credit to be issued on the blockchain. He states that this is a better method of creating a form of currency than creating a central database for all the bank accounts, and it is even simpler than creating fiat because there is no requirement for the minting of coins and the printing of notes. Bitcoins can be stored in something called a digital wallet and can be stored offline on a piece of paper too. This is a global way of creating another form of money without having to convert physical forms of the currency.
1.2. Brief History of Bitcoin
This was the same time that GPUs (graphics processing units) were becoming mass-produced, and these components were much more efficient in mining compared to CPUs. The increased competition to mine and the added efficiency to mine led to a heavy increase in pollution in terms of electricity utilization (Proof of Work). In other words, the electricity consumed by the Bitcoin network represents a significant environmental impact. In May 2010, Bitcoin was used to buy the first item, which was two pizzas. The price was negotiated and agreed upon at 10,000 BTC. This transaction is well documented, and it illustrates the significant increase in the value of Bitcoin in comparison to the dollar. In essence, this is an unfortunate loss of money for the buyer, and also a loss for the supplier who could have been holding a valuable digital asset. At that time, it was impossible to predict the future success of Bitcoin.
There is no official date for the establishment of Bitcoin, but a paper was released on October 31, 2008 by an unknown person or persons using the name Satoshi Nakamoto. From there, on January 3, 2009, Nakamoto was able to mine the first block on the Bitcoin network, known as the Genesis Block. Embedded in the coinbase of this block was the text: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” This was a statement poking fun at how the government had to bail out banks by printing more money after the 2008 financial crisis. This made everyone aware of what problems were to come in the future, and this statement is highlighted on the Bitcoin Wiki in the Genesis Block article. For the first year of its establishment, Bitcoin was not well known, nor used by many, for it was only mined and held by the most tech-savvy and those who were involved in cryptography.
1.3. Importance of Studying the Impact of Bitcoin
The study of Bitcoin has largely focused on the creation of alternative economies and redistribution of power, but it is essential to consider the broader implications of Bitcoin on social, political, and economic systems. It is important to understand whether Bitcoin is a viable alternative to national currencies and whether it could play a role in affecting monetary policy, as its success could have spillover effects onto the broader global economy. If Bitcoin is to become a truly global alternative to current systems, it will fundamentally affect the way global economies and politics function. The vastly different global implications that could result from success or failure of a cryptocurrency create a situation where forecasting and planning are essential. Bitcoin has the potential to provide huge benefits for the developing world, and if the right economic and political environments exist, it could spur a strong movement away from fiat currencies and the power structures they have enforced. Bitcoin represents a significant method of value storage and transfer for its users. Used as a method of transferring traditional fiat currency throughout the world, Bitcoin will inevitably play a key role in forex markets and exchange rates. If it is successful, it will affect the way business is conducted in developed and developing countries, as the costs of forex will be unnecessary and the stability provided by the Bitcoin platform may reduce speculative business ventures. This contrasts with the volatile effects that a collapse of Bitcoin could have. In that event, the value stored in Bitcoin would be lost, but it would not necessarily store the same value in terms of fiat currencies, and an adverse exchange could prove crippling for some firms and countries.
2. Economic Impact
Once Bitcoin has gained stability in the above areas, it will start to have a significant effect on currency exchange. Due to the fact that Bitcoin is a global currency, it will create a more precise method for determining exchange rates between two strongly traded currencies and will disadvantage speculative-based currency trades (forex contracts) that are currently taking place. As it is the same people who are involved with international transactions of Bitcoin who are likely to be affected by exchange rate discrepancies, Bitcoin exchange will become integrated with other forms of Bitcoin transactions and will most probably take place in many instances for free, using market rate as the only fee. With the existence of Bitcoin, local currencies will also become stronger due to the reduction in transaction and exchange costs. This is particularly significant for countries with developing economies where borrowing and devaluation have had drastic effects on both government and individuals. These people will be able to keep more of their money safe from volatile local economies in the form of Bitcoin and convert to local currency as needed. This again represents another method of increasing economic efficiency.
Focusing on the economic impact of Bitcoin, there are several ways in which this platform is set to affect both individuals and businesses. As a truly global currency, Bitcoin will have a profound effect on the way both individuals and businesses conduct financial transactions. Due to the fact that Bitcoin operates through the internet, using a public ledger that is accessible anywhere and by anyone who has internet access, assuming they are using official Bitcoin software, this will mean that transferring Bitcoin is a much quicker process compared to the current affordability of wire transfers, ACH, SWIFT, and other methods that are currently used for transferring money across international borders. Due to the nature of these current methods, they are often costly, particularly for smaller transactions. Bitcoin transaction fees are normally around 1% of the total transferred, compared to other transaction fees which can often be 7-15% of the total amount for smaller transfers. With another service model of Bitcoin being micropayments, concrete examples of when this would be used do not yet exist, but considering the target market for micropayments and the simplicity in which they can be sent to anywhere in the world for minimal cost, this is surely an area where Bitcoin will prove to be a valuable and efficient solution.
2.1. Disruption of Traditional Financial Systems
Traditionally, banking has been the major player in global economic transactions. However, since the global financial crisis, trust in banks has declined as they are seen as risky and undesirable. This has provided an opportunity for alternative financial systems to emerge and has caused the financial services sector to begin shifting from the banking system to a broader financial system. Bitcoin is at the forefront of this innovation. In fact, one of the stated purposes of Bitcoin is to provide an “electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.” This is particularly an issue in international trade, where the efficacy of bank transactions is inhibitive and it is difficult to establish a credit relationship with someone in another country. Bitcoin can simplify the process by removing the need for forex, establishing a line of credit or a letter of credit and can potentially do for international trade what the Euro has done for Europe. This has severe implications for the banking sector so at the very least, it will be highly motivated to lobby against Bitcoin to delay its adoption. An attempt to form a digital currency within the traditional banking system has been made in Singapore and New Zealand. This was an example of the recognition of the inefficiency of the current system, but was still designed to operate within the system and thus would still have the same inherent problems. An interesting aspect that is coming under heavier international scrutiny is the near-monopoly that the US has on the global banking system and global trade due to the status of the US dollar as the world reserve currency. It is widely thought that it is destabilizing for the global economy when one country’s policy changes can have such significant and broad impact which was a prime factor in the global fiasco that was the Subprime Mortgage Crisis. Bitcoin provides an opportunity to have a global currency that is not at the mercy of any central bank and it will help to shift the global trade economy to a more stable and efficient form. This is a substantial change for the structure of global finances, but opposition from the US and powerful lobbies will likely make it a very tumultuous process.
2.2. Financial Inclusion and Accessibility
A key promise of Bitcoin is that it will enable people in emerging economies to bypass traditional banks and government currency controls and thus gain access to a financial system that would otherwise be unavailable to them. There is no doubt that financial exclusion is a massive issue globally – the World Bank Global Findex Database estimates that in 2014 over 2 billion adults did not have a bank account or access to formal financial services. The consequences of financial exclusion are severe and numerous – restricted access to credit, higher transaction costs for remittance and bill payments, lower financial security and greater exposure to crime are but some of the issues faced by those lacking access to a formal financial system. Cost is a key reason for lack of bank account ownership – many view maintaining an account to be too expensive when compared with the relative low transaction volumes and balances maintained. Bitcoin’s ability to function without a central point of control is a significant advantage for those living in economies with unstable currencies and financial systems. Due to the decentralized nature of the protocol, users can access the network from anywhere in the world and send and receive funds to and from anywhere also. The only requirement for participation is access to a connection to the global internet, something that is becoming increasingly available even in the world’s poorest and most remote locations. For those unable to open a bank account (possibly due to lack of documentation) or those who are only permitted access to localized banking services, the ability to interact with a global financial system using nothing more than a smartphone and a simple software application holds strong appeal. This potential for “banking the unbanked” is an oft-touted phrase within the Bitcoin community, and if successful could lead to significant improvement in the quality of life and economic prospects for those currently shut out of the global economy.
2.3. Potential for Financial Innovation
The controversial nature of Bitcoin as a currency could be a very interesting breeding ground for financial innovation. Since the Bitcoin blockchain provides a permanent public record of all transactions, it is possible to use this information in a way which might be very helpful for spending decisions. Imagine a credit card which is linked to the blockchain and provides an interest rate on all purchases which is equivalent to the real growth rate of the Bitcoin economy. Given that many economists believe inflation is caused by interest rates being set too low, this could be a very useful indicator of the long term time preferences of consumers. With the right user interface, this credit card could potentially influence Bitcoin users to behave in a way which is more conducive to the savings and investment necessary for economic growth.
A potential area of huge impact is how Bitcoin will affect the future of financial technology. In that Bitcoin is essentially a form of software, it seems very likely that various forms of financial technology will be built on top of the Bitcoin blockchain. Possible ideas might include building derivative or stock markets pegged to Bitcoin as a unit of account. While it is too early to say what these sorts of initiatives might look like, it seems plausible that they would be far easier to build on Bitcoin than they are with the current fiat currency system.
3. Social Impact
Empowering individuals and communities Bitcoin has many great impacts on society due to its decentralized feature. It gives hope to societies that want to move forward to better living conditions. Currently, some societies or communities still cannot access certain facilities like banks. This condition is commonly faced by small societies in big communities where banks lack infrastructure for the location. The distance between communities and the bank sometimes becomes a problem for societies to access banking services. By utilizing Bitcoin, these societies could have an alternative way to access financial services without building bank infrastructure. The cost, which may be cheaper than building a bank, can be the solution for reaching better financial services. The Bitcoin could empower individuals to have full control of their money. It provides freedom to society or individuals to be their own bank. In the conventional banking system, the account owner still requires permission from the bank for certain actions to be executed for their own account. This is due to bank policies that restrict customers for the greater safety of their money. But sometimes this kind of condition is annoying for customers because they cannot freely control their own money. With Bitcoin, the account owner has full control of their money. They are free to do any kind of transaction anytime without permission from certain parties. This can also reduce the operational cost of an account because it only requires internet access to do the transaction.
3.1. Empowering Individuals and Communities
The use of Bitcoin as a currency has allowed individuals and communities to exercise economic power. The decentralized nature of Bitcoin, in that it is not controlled by any one group, means that it can provide a level of financial autonomy to individuals who were previously reliant on cash, in particular those in the developing world. It caters to the unbanked with services nobody else can provide. As the Bitcoin economy expands and becomes more interconnected with the traditional economy, this will allow individuals and communities to route around economic embargoes and blockades. For example, the option in Cyprus to tax a percentage of all bank accounts meant that in practice people were unable to withdraw more than a set limit of money. This creates a demand for easily transferable assets which cannot be seized at the border. Bitcoin serves this purpose and as it becomes more liquid it will effect an escape valve on unfavorable national monetary policies. The ability to provide aid to foreign countries has also been empowered. Current systems of sending aid are wrought with corruption to the point where a large percentage of money does not end up in the hands it was intended for. By giving direct aid in the form of Bitcoin, the transactions can be publicly audited to ensure that they are reaching the desired destination. An example is the MPesa mobile money system which caters to the unbanked population in Kenya. By integrating Bitcoin into MPesa, users will be able to access previously untapped global markets. Finally, we cannot ignore the recent hype around so-called “Bitcoin 2.0” technologies. Mastercoin, Ethereum, Colored Coins, and others are in the process of creating new distributed financial systems which are still in their early days. If successful, such systems have the potential to grant developing communities an alternative to the unstable financial systems and high-interest loans of the past.
3.2. Privacy and Security Concerns
Nakamoto (2008) fails to elaborate on the problem that would exist if most of the world’s economic systems converted to a single currency. Bitcoin is extremely transparent in the sense that every transaction taking place can be traced back to the creation of the very bitcoin being transacted. In theory, if nothing was done, the extensiveness of this tracing would allow a seamless audit trail for every financial transaction that came to pass. It would allow governments and powerful institutions to monitor every citizen’s economic activity in a world where financial privacy is of increasing importance. It would be fair to say that the “surveillance crisis” is one of the problems that our society faces today and data is becoming the most valuable asset (Lyon, 2001). Bitcoin could potentially exacerbate this crisis, pushing people to once again revert back to cash transactions in an effort to evade the ever watchful eye of organisations to no avail. His argument that companies providing banking services act as unnecessary intermediaries is somewhat valid. Although it fails to acknowledge that not all individuals wish to manage the responsibility of their own financial security and the ultimate consequences of failure, and some who manage it do so to limited or inadequate success. This greatly impacts the potential economic efficiency of his proposed system, for it shifts the risk and burden back to the individual without aligning the increase in personal risk to the decrease in reallocated savings due to interest.
3.3. Challenges and Opportunities for Developing Countries
Companies providing Bitcoin remittances are able to keep their costs extremely low due to the nature of the currency. As a result, they usually only charge a fraction of a percent to carry out the transaction. This creates a huge potential for Bitcoin to greatly impact the standard of living for people in developing countries who rely on remittances from relatives working in foreign countries. Bitcoin also has the potential to protect the interests of the poor against inflation. Many developing countries have unstable currencies, and Bitcoin has the potential to protect people’s purchasing power. This is because, unlike fiat currencies, the number of Bitcoins in circulation will never exceed 21 million.
The remittance industry is dominated by companies such as Western Union and MoneyGram. They often charge high fees, ranging from 7% to 15%. They take between 3 to 5 days to complete a transfer and at times, they have even been known to discriminate against certain nationalities in refusing them service. Bitcoin has the potential to change all of this. A user can send the money, in any amount, anywhere in the world, at any time, almost instantaneously and at a very low cost. This is because it bypasses all third parties and authorities and is sent directly from one person to another.
The availability and cost of internet have a considerable impact on the economic structure and growth potential of many developing countries. The potential for cheap and efficient remittances can dramatically affect the lives of migrant workers and their families. “For an African migrant worker sending money home to their family, the fees on a $200 payment can be as high as $14. That’s 7% of the sum lost to middlemen. For someone looking to improve their quality of life and that of their family, that is a significant chunk of money.”
4. Environmental Impact
During the inception of Bitcoin, the creation of each new block was assigned to a central processing unit (CPU). With an increase in the difficulty to mine a block, it was obvious that CPU was no longer able to handle Bitcoin mining. In addition to the requirement of increased computing resources to mine new blocks, there is a specified limit of 21 million bitcoins that can be created. Therefore, the incentive to “mine” (i.e. process transaction data and secure the network) will be compensated by transaction fees alone, increasing CPU resources spent on mining as to not compromise profitability. In the present day, a large portion of mining is performed using Application-Specific Integrated Circuits (ASICs), which are special devices designed for a singular purpose, in this case to mine bitcoins, and operate much more efficiently than CPU or GPU mining. The global hash rate (the rate at which the currency is being mined) for bitcoin has been on a consistently positive trend for the past 5 years except a short contraction in 2018, representing the growing amount of resources being spent to mine Bitcoin. This correlation can be correlated with the popularity and growth of the value of Bitcoin. This is particularly troublesome when considering the environmental impact of such a high energy-consuming and increasingly resource-intensive task as Bitcoin mining.
4.1. Energy Consumption of Bitcoin Mining
An energy hungry industry, the majority of Bitcoin is produced as a byproduct of performing necessary computational work to mint bitcoins. Mining is an incentive system for nodes to secure the blockchain, and the fastest way to generate any currency is through direct creation (minting). Consequently, the mining activity provides the required computational work in the form of electricity consumption and also generates additional value in the form of more Bitcoin. This additional value is likely to make the electricity consumption a net loss in the long run, making it a bad investment and generally an environmentally unfriendly one. The electricity consumption can be measured in two ways. Firstly, it can be estimated based on the hashrate, a measure of the number of times the double SHA256 function can be computed per second. Given that there are efficiency differences between hardware, estimated consumption based on hardware type can be used to provide a second, more accurate measure. This energy consumption has created a severe tragedy of the commons, where the individual incentives (access to the value generated by excessive electricity consumption) are at odds with the long-term interests of the global commons. As more value is generated from mining, more money is available to invest in more efficient hardware and electricity is a tradable commodity with diminishing returns on market price. Both of these trends increase the electricity consumption per hash, and the hashrate of the network has exponentially increased as value per Bitcoin has increased despite large fluctuations. This in turn has increased competition between individual miners in a gold rush fashion, leading to the current state where there is a large gap in profitability between smallest and largest mining operations. Large operations can leverage economies of scale to generate profit and often become dedicated to locations near sources of very cheap electricity. At the time of writing, it is estimated that 69% of hashing is performed on ASICs in data centers, 24% on GPUs, and 1% on FPGAs. Each of these trends is a stepping stone towards higher energy consumption, and the end result is predicted to be a large concentration of mining operations in countries with very cheap non-renewable energy.
4.2. Renewable Energy Integration
There have been many studies showing that cryptocurrency mining is actually geared more towards renewable energy integration as the best way to maximize profits. Minehan and Malin (2) have stated that “…an electricity price of $0.065/kWh, such as excess renewable energy, it is unprofitable to use anything other than renewable energy.” What this means is renewable energy is cheaper in areas where excess renewable energy exists. This is due to the fact that the energy is sold a lot cheaper to consumers, encouraging more usage. Excess renewable energy is also a cheaper energy source relative to non-renewable energy thanks to government rebates on energy production with renewable sources. With this being said, renewable energy is most abundant in areas where excess renewable energy production occurs. An example of this would be hydroelectric power. Minehan and Malin also mention Quebec, Canada as a good place to mine due to the fact that the primary source of energy is hydroelectric. This is a great thing for the environment as it will cause less strain on non-renewable energy sources and really open up the doors to research alternative energy sources for the future.
Renewable energy is an emerging field in the world today. It is without a doubt that our planet needs to look to alternative energy sources in order to avoid the catastrophic effects of climate change. One possible option being looked at is renewable energy integration in cryptocurrency mining. Cryptocurrency is a digital form of currency that is transferred between parties. It is decentralized and relies on solving complex puzzles to validate transactions. The process used to validate these transactions is called mining and enters them into a public ledger called a blockchain. In order to add a block to the blockchain, a mining puzzle must be solved and the first person to solve the puzzle with the correct specifications may add their block to the chain. Bitcoin is the most widely used and accepted form of cryptocurrency. Mining Bitcoin can be extremely expensive as it is very competitive to validate blocks of transactions and the reward is minimal. This is relevant because fossil fuels are still one of the cheapest energy sources.
4.3. Environmental Sustainability and Carbon Footprint Reduction
In earlier sections, it has been highlighted that the Bitcoin network consumes energy, often in great quantity. However, Bitcoin mining’s carbon dioxide externalities likely result in environmental damage that is both broadly distributed and, over the long term, global in nature. For example, while the primary effect of Bitcoin mining is to reward participating miners with newly issued bitcoins, the rate at which new coins are issued is designed to decelerate over time. Thus, Bitcoin has an implicit deflation rate. A small number of bitcoins will be lost (through a subtraction of the wallet key) or destroyed, this places downward pressure on prices. Since prices are expected to fall, there is a powerful incentive to defer consumption and investment in the belief that prices will be lower in the future. This is problematic if the bulk of resources that go into consumption and investment are damaging from an emissions standpoint. In such a case, rational economic activity triggered by deflationary expectations could result in higher emissions now for lower growth in welfare. This can be thought of as a Tobin tax in reverse, with emissions being the tax and the increase in the demand for money acting as the tax base. This would be an odd sort of “Pigouvian market failure,” a too efficient movement along the wrong demand curve. Very little global consumption and investment yields a high real interest rate in terms of living units of various goods and services forgone. Bitcoin-induced deflation, on the other hand, furthers jobless growth in the sense that it increases the well-being of holders of money and decreases that of workers and entrepreneurs. The result is a relative movement of the economy toward the static state and away from full employment. Emissions from Bitcoin-induced activity would constitute a channel that pushes against the relative movement. This could lead to detrimental policy decisions regarding investment in more emission-intensive capital and a decreased accumulation of emission for skill set today’s workers and those still in the learning-by-doing phase. If we assume that the marginal abatement cost curve is upward sloping and given the irreversibility of global CO2 emissions, rational expectations of future lower prices of goods and services delivered by high emissions would shift the current optimal level of emissions. This argument is admittedly subtle, but the upshot is that even Bitcoin emissions, whose internal cost-benefit analysis is unambiguously positive, could result in less than proportional contributions to welfare. This is a particularly important consideration given the public good nature of global climate. A diverse group of people from all over the world and with varying interests and capabilities will demand climate change mitigation and remediation. Yet many of their valuations of affected areas are revealed only after a marginal increase in the amount of pollution. Suppose one of these people has perfect information about the present and future stream of Bitcoin emissions and is willing, if it is the case, to change the current state of emissions by an infinitesimal amount at every t. Then a Lindahl equilibrium will exist for Bitcoin emissions. However, any deviation from that price trajectory will change the marginal valuation and at some point impose a higher price on one who values the cleaner climate less. The price will necessarily fall on the person who bought the bitcoins. Since the bitcoins will not change into a different state of being as is the case with, say, the purchase of an energy contract that will be immediately consumed, the effective supply of the above-mentioned emissions service is the future stock of bitcoins. The marginal cost of decreased emission for Bitcoin consumers may be much less than their marginal valuation of a cleaner climate. This implies that they are free riders on other climate changers and, in the extreme case, the operations of Bitcoin pools and wallets could represent a huge coincidence of over-efficiency at the wrong demand curve. And the result is a tragedy of the commons.
