by Ilya Pestov

The Antinomy of Bitcoin


There are a huge number of articles about cryptocurrencies. Earlier, geeks and people associated with the technology spoke about it. But now, ordinary internet users are talking about it. The most disturbing fact for them is that New Liberty Standard, the first Bitcoin exchange, set the rate of 1 Bitcoin (BTC) equal to US $ 0.0007 on 5 October 2009. Bitcoin has since multiplied over a million times.

Many people remember (with irony) the story of the person who bought two pizzas for 10,000 BTC in 2010. But, economy is a science of balances. If there were no such people who changed BTC to pizza, Bitcoin wouldn’t cost what it does today. And believing in unsecured labor earnings becomes more and more. The fact that the annual profitability of a venture is about 20% isn’t capable of forcing them to doubt the stability of the success of any ICO. Only the worlds best investment funds have made 100X a return on their investment. But, it is due to the Unicorns within their portfolio, and not the entire portfolio.

It’s well known that Blockchain is the next big thing. And that cryptocurrencies have already changed and continue to change the world. But, what would the future of Bitcoin exactly be?

There are prominent financiers like Jamie Dimon, the CEO of JPMorgan (US$ 2.5 trillion of assets under management) who calls Bitcoin a fraud. The CEO of BlackRock (US$ 5.7 trillion of assets under management) said “Bitcoin is an index of money laundering”.

There are a lot of skeptics, but a lot more followers of crypto currencies. Many people know how to play with risks, but prize-winning places are not for all. By analogy, only about 5% of poker players actually win in the long term.

So is Bitcoin a bubble or not?

There are so many opinions about Bitcoin already. Why would one more piece from an unknown person like me be interesting to you? This article isn’t my opinion, because I’ve tried to use only facts and numbers. This will be meaningful for you to make your own conclusion. This article is not a statement, and is rather a question to the reader.

An article in recently revealed that Bitcoin mining utilizes an average of 215 kilowatt hours (kWh) per transaction. Assuming the average price of 1 kWh to be 9 cents (electricity cost in China). That would need US$ 19.35 per transaction. Having this value in hand, it became interesting to project this on the activity of Visa. In 2016, Visa processed more than 83 billion transactions and gained US$ 6.7 billion in revenues.

Yesterday, there were 274,858 transactions in the Bitcoin network. I made simple calculations with an Excel sheet. It turns out that last year there were 100,444,450 Bitcoin transactions. It follows that about US$ 1.9 billion per year in electricity costs are needed. This is just for sustaining transactions within the Bitcoin network. If the number of Bitcoin transactions equal those processed by Visa, then more than US$ 1.5 trillion per year would be required. Just to sustain the Bitcoin network. The anomaly of this sum is visible.

But, the Bitcoin network is restricted to a rate of 7 transactions per second. This is due to a protocol block size restriction of 1 MB set by Satoshi Nakamoto. This provides protection against hacker attacks.

An average number of operations last year required a speed of ~3 transactions per second. There was a plan called SegWit2X, which attempted to increase the block size. These plans are suspended.

The daily amount of confirmed transactions in the logarithmic scale for the last 2 years

The fact is that Bitcoin was intended for low-frequency operations with impressive sums. It isn’t capable of reaching the globalization level of Visa. Capitalization of Bitcoin has exceeded US$ 100 billion recently. The amount of daily transactions at that time was more than US$ 900 million.

I wanted to analyze the relation of data for the estimated transaction volume to market capitalization for the last two years. As a result, the average value is equal to 1.79% (the median — 1.7%). What conclusions can be made from the obtained results?

  • Only ~1.8% of Bitcoins are circulating on the network. The remaining 98.2% are lying in accounts in anticipation of growth.
  • BTC growth is not in accordance to the law of supply and demand. For comparison, Visa’s total volume — $8.9 trillion, payments volume — US$ 6.3 trillion (this is 70% of total number).
  • The growth of cash transaction volume is proportional to the growth of market capitalization. And this does not increase in percentage.
The ratio of the transaction volume and market capitalization for the last 2 years

Earlier, I was convinced that the growth of BTC occurs because of the growth of cryptocurrency distribution. But it’s not so.

My previous statement, “If there were no such people who changed BTC to pizza, Bitcoin wouldn’t cost what it does today”, didn’t make sense. I want to emphasize that I didn’t wonder what exactly was the proof of the current BTC exchange rate. I was curious to find the cause. And the correlation between capitalization and level of difficulty is clear.

Difficulty and market capitalization charts of the entire Bitcoin history

Thus, we got surprising regularity. On one hand, the cost of transactions (difficulty) grows according to the monetary volume of these transactions. This increases together with the market formed by and large by miners. But, this “balance of payments” is provided by only 1.8% of total Bitcoins in number. And if capitalization was comparable to Visa, then an operation of US$ 1 requires US$ 1,400 worth of electricity. US$ 19.35 * Visa’s total volume / market cap of Bitcoin. Furthermore, there are fees in Bitcoin — the cost of Internet, equipment, etc.

The difficulty of Bitcoin mining is regulated artificially. And it is directly proportional to the cumulative computing power of the network. In statements that Bitcoin is a bubble, you certainly heard my previous arguments. Yes, if all nodes are disconnected from the network, except one old computer, it will get Bitcoins with the same speed of the whole network today. And “if all nodes are disconnected”, someone will begin to compute blocks in the opposite direction and the network will be hacked.

It is known that the speed of Bitcoin mining is constant and doesn’t depend on the total volume of computing capacities. Therefore, I wanted to look at the changing of difficulty level and revenue of miners. But as nothing was available, I have created the chart reflecting how many units of difficulty matched to US$ 1 throughout all time. There has been an almost exponential growth of computing power. This has led to the increased profitability of Bitcoin mining in recent times. This is due to the amazing growth of BTC price, of course.

Dependence of difficulty level and miners revenue in logarithmic scale

With such a market, the irrationality of operating where the sum made is less than the cost of operation becomes prevalent. But how long and quickly will these capacities increase is unknown. And don’t forget that Block Reward Halving comes nearer every day.

There are no doubts that electricity cost of the transactions has a limit. And if miner farms begin to close, then computing capacities will begin to decrease. In consequence, the cost of the transaction will lower to a certain norm, when it will stop to seem irrational.

But when all this happens, will the BTC exchange rate fall?

I think an attentive reader will say “Yes”. We have defined correlation of capitalization with miners and have revealed this vicious circle. Yes, but it doesn’t mean that BTC exchange rate will fall. We learned that contradiction with the law of supply and demand doesn’t prevent Bitcoin growth. Payment balance doesn’t allow adhering to that 20%, described by the economist Adam Smith. So why does our regularity have to remain? Bitcoin would cost as much as the market pays for it. And the economy, as George Soros had once mentioned, can’t be objective because the subjective human will always be its last element. Bitcoin exchange rate is our empirical understanding of cryptocurrency. But, it’s surprising how contradictory this idea is.