Since its groundbreaking introduction by Satoshi Nakamoto in a paper entitled: ‘Bitcoin: A Peer-to-Peer Electronic Cash System,’ on October 31, 2008, the term Bitcoin has nearly become a household name. In the ensuing nine years, this cryptocurrency has maintained nearly an upward trajectory – culminating in its price reaching $19,783.21 – a week before Christmas 2017. During this period, it has been praised by many and vilified by a few. It has been grudgingly accepted by Wall Street – who introduced Bitcoin futures late last year, and rejected by many. The Crypto lexicon has also found some new terms, such as, Ethereum, Ripple, and Cryptonnaire that define various Alternate Coins and a Crypto Millionaire, respectively.
Evidently, an ‘idea,’ resulting in such spectacular monetized returns merits a closer look from the crypto currency traders in order to gain its better understanding for profits. Thus, at Platinum Trading Institute (PTI), in addition to providing Crypto and FX trading education, we have also embarked on a journey to provide Block chain education and training.
- Thus, a prime objective of this five-part white paper is to dissect the Bitcoin myth, though more importantly it is to simplify the understanding of the underlying BCT.
- In addition, an attendant objective is to draw the traders’ attention to several other investment opportunities in BCT technology, and ALTCOINS that yield equally spectacular returns.
This series is organized so a newcomer to Cryptocurrency Trading (CCT) can gain an enhanced understanding of the Bitcoin myth – what drives its price, and acquire appreciation for the underlying disruptive BCT technology.
The discussion will be carried out in five parts:
- Bitcoin Myth and BCT, (Article Dated: 02/13/2018).
- Inner Workings of Blockchain Technology (BCT), (02/15/2018)
- Economics of Cryptocurrency Transaction (Topic of the Current Article)
- Current Applications of BCT, and What Lies Ahead,
- How Can a Cryptocurrency Trader Leverage Knowledge of BCT,
Recommendations – Food for Thought.
Economics of Cryptocurrency Transactions:
In the previous parts, we have discussed the micro-structure transaction process underlying a cryptocurrency transaction, mainly the Bitcoin. That process assures the immutability, integrity, veracity, and the uniqueness of a cryptocurrency transaction. In this article, we will analyze the macro-economic view of the cryptocurrency based financial system, in particular we will focus on various Block chains, and their impact on Global finances. This section will cover the impacts of the following factors on Cryptocurrency transactions.
- Energy Costs, and fees,
- Local and/or Global economies, and
- Socio-economic factors.
2.1 Energy Costs and Fees: By the most conservative estimates, power consumed by a Bitcoin network in 2017 was as much as 60 TWH (Tera Watt Hour). To put that in another perspective, the figure above shows one of the largest power plant with the power generating capacity of about 5597 MWH. Thus, it would require a few thousand power plants like that to meet the energy needs of a Bitcoin Block chain operation for a year. Interestingly, this type of power needs has made the Bitcoin miners to look at sources of cheap energy, for example, State of Oregon’s cheap Hydro power. In particular, recently hundreds of these 21st century miners have flocked to Oregon – giving a new meaning to the term ‘Oregon trail.’
Some of the Coin Metrics statistical data above suggest that the average Bitcoin transaction fee jumped from about $0.25 in January 2017 to about $38.00 in Dec. 2017. Since then, the fees have been declining steadily over last few months in 2018. A simple non-technical reason for a sharp rise in fees from Mid-November to December 2017 can be attributed to wild rise in Bitcoin price – that nearly tripled during that period. The novice Crypto investor had actually no idea of the associated fees, or did not care as long as they could buy a Bitcoin. However, most likely, the fees are dropping due to the fortunate confluence of the following factors.
Since its stellar rise during last two months in 2017, the price and number of Bitcoin transactions have been steadily declining. At the same time, the average Bitcoin block mining rate has increased by about 15%, from about 145 blocks per day to about 165 blocks per day during January 2018. In addition, the miners have also become smarter. They have introduced several innovative solutions in order to increase the mining efficiency. Among them, two notable innovations include; (a). Introduction of parallel channels – SegWit or a Soft Fork. I would call this process a ‘Parallel Mining,’ that allows the users to distribute funds to multiple, predetermined parallel locations.
Once this has been adequately accomplished, the ‘Final Transaction,’ is eventually transferred to the main Bitcoin Blockchain. One example of such a parallel protocol or algorithm is the ‘Lightening Network,’ that is being increasingly adopted by Bitcoin and Lite coin Block chains. (b). Similar to ‘Parallel Mining,’ another invention include combining or Batching multiple transactions, and submit a ‘Batch,’ to the Bitcoin chain for processing. ‘Shape Shift,’ is one Exchange that has announced the introduction of this technology into its Bitcoin processing.
2.2 Global and Local Economics:
In this Section, we define Global Economics as the macro-parameters that impact the assets and their values over a Global event. For Local Economics, we will review the impact of local Government’s regulations and economic policies on the crypto markets.
A classic example of a Global macro event is a recession, where the equity prices tumble, and people lose faith in sovereign currencies like US dollar. We have seen two recent examples, such as the dot com bubble, circa 1995-2001; and the Great recession of 2007-2009. In particular, the Great recession of 2007-2009 was painful as during that period not only more than 100 banks failed in US, but Brokerage giants like Lehman Brothers went bankrupt, while Meryl Lynch, AIG, and CITI Bank had to be rescued by the Obama Administration. Both the major Wall Street indices, Dow Jones and S&P 500 lost almost more than 50% between the periods June 2007 to April 2009.
As Bitcoins were introduced into the economy post 2009, one may analyze another hedge-asset, Gold for some guidance into possible behavior that Bitcoin might exhibit under similar circumstances. As one analyzes variations in DOW and S&P indices, and compare them with Gold prices during the same 2007-2009 period, it becomes evident that as the major indices dropped, the Gold price soared as a possible hedge asset. During that period, the equities dropped by as much as 36%, while Gold soared by about 15% or more. Then two questions arise.
- Do Gold and Bitcoins have similar traits that would make Bitcoin to behave as a possible hedge asset against equities? In other words, is their behavior correlated?
- How does Bitcoin stack up against prime fiat currencies e.g. US dollar, Euro, and GBP. In particular, during the times of intense volatility in fiat currencies, how do cryptocurrencies behave?
2.2.1 Gold and Bitcoins: To some extent, to treat Bitcoins as Gold – hedge against fiat currencies is misleading. Albeit, there are similarities: (1). Fixed supply, (2). Attendant prices impervious to vagaries of any Nation’s leaders, and (3). Ease of transport, storage, and
Individual ownership. However, beyond that truly no correlation exists between the two as shown by the graph shown in the inset. At times, they both move in unison, while other times, they diverge. So, during the times of weak fiat currencies – decreasing stock market – the tendency is for the investors to turn to Gold as a hedge against other equities losing their value. Then the question remains, could Bitcoin replace Gold as a choice of investment also replacing Gold. Unfortunately, the current statistical data do not support that theory.
Another way to evaluate Bitcoin’s strength as a hedge against volatility in FX markets is to evaluate their respective volatility behavior. As the chart below shows, there is really no strong correlation among the volatility indices for Gold, DXY, S&P 500, and Bitcoin. Once again, the impact of Global economy on Bitcoin volatility is rather nebulous.
- Local Economics: The impact of various Government regulations on Bitcoin price is difficult to evaluate. There have been instances, when China and Korea have put dire restrictions on trading in crypto currencies, though neither the price nor the trading volumes were significantly affected. For example, in Sept. 2017, China threatened to close down crypto exchanges, put restrictions on ICO offerings, and in general issued dire warnings against the Crypto currencies. Though, in the ensuing three months since then, the Bitcoin price surged to more than 300%. Similarly, the Korean restrictions against the Crypto currencies were short-lived.
The short discussion above clearly delineates the uncorrelated nature of Bitcoins either with Gold, or any fiat currencies, or even Government mandates that they are often contradictory. Hence, if one were to evaluate Bitcoins and Block Chain Technology as an investment alternative, then they offer that uncorrelated option that is almost a must for efficient portfolio in any investment strategy.
- Socio-Economic Factors: The Block chain technology is in its infancy. Benefits stemming from neither the technology nor its applications have permeated sufficiently to realistically evaluate their impacts on the society. Although, even with these limitations the Block Chain Technology’s disruptive force has made small differences in Social, and Economical, and Environmental aspects of the society. We will briefly evaluate those impacts in the following paragraphs.
- Social Aspects: Even a cursory study of Block Chain Technology reveals that it is a disruptive technology with far-reaching social implications. For example, the primary underlying features of the Block Chain Technology are: distributive, open ledger system, verifiability, and transparency. These have attracted attention from the business sectors as diverse as banking – to – medical –to – utilities. Even the Non-Governmental entities like United Nations (UN), is also evaluating the technology as a means to develop a sustainable micro-lending program in developing countries.
Another major social influence wielded by Block Chain Technology is in the eco-political area. The Democratic Liberal end of the Geo-political spectrum would love to get the Government out of people’s lives, and particularly the finances. Bitcoin offers exactly the recipe, where the Central Governments can hardly exert any influence on Crypto investments.
The Cryptocurrencies have begun impacting the social causes in numerous ways. For example:
- The Red Cross, United Way, and Save the Children all accept bitcoin donations. In addition, the crowdfunding site, Bithope will only accept donations in Bitcoins,
- Coin base does not charge the processing fees for the transactions by non-profit organizations, such as, 501-C(3), and
- Recently, United Nation’s World Food Program (WFP) provided Syrian refugees in Jordan with Cryptocurrency vouchers to purchase food items in the local markets.
2.3.2 Economic Aspects: While evaluating economic aspects, there are two factors that need to be considered. First, the Bitcoin mining capacities of the mining computers, attendant energy costs, and the speed at which transaction validation is accomplished in addition to albeit, the hash rate. Parallel computing, first introduced in Engineering to perform Massively Parallel Computations (MPCs), was introduced in the field of mining, and used successfully to increase hash rates to up to 1013 hash/J, with attendant improvements in energy efficiencies. Another factor is the possible unchecked growth of the Bitcoins in the circulation. That may exert inflationary pressures on the economy. In order to mitigate this risk, the Bitcoin algorithm is designed to lower the rate at which the Bitcoin is mined as the Bitcoin supply (Money supply) is increased. This feature in the Bitcoin algorithm is akin to Milton Friedman economic theory that prods the Central bank to increase the monetary supply at a predetermined rate annually. Thus, the inherent deflationary bias built into the Bitcoin algorithm will attempt to maintain inflation at a constant rate.
2.3.3 Environmental Aspects: The environmental impacts of Crypto-coin production, and underlying Block Chain Technology are counter balancing. Undoubtedly, the energy consumption for Cryptocurrency production is huge, for example – typically annual energy consumption for Bitcoins is about 30 TWH, equivalent to power a major industrial state. The attendant electricity costs are higher, and will continue to grow as algorithms for solving a Bitcoin puzzle tend to be more and more complex. For example, as the Figure shows the Bitcoin Energy Consumption Index (ECI) has almost grown by 17% between January and February, 2018. In addition, growth rate is almost linear signifying unchecked power demand by the Bitcoin production.
This high demand for energy requires power plants, either gas, coal, or oil fired – they all produce noxious emissions ranging from NOx, to CO, to CO2, and a host of other deadly gases. One of the byproducts of these plants, Sulfur Dioxide can dissolve in rain water, and come down as Sulfuric Acid causing serious health problems for the recipients. So, from the Cryptocurrency mining stand point – the Bitcoins create hazardous environment for the society.
On the other hand, Block Chains offer solutions for the betterment of the environment, and the society. Block chains can impact the society in any one of the following ways or cumulatively. For example:
- Supply Chain Management. In one of its form, the Block Chain FOOD TRAX is tracking food from its individual growers to the individual sellers through food storage, distribution, and finally the sales chain. This Block Chain can increase efficiency, reduce waste, and can make the market equitable to everyone in the food chain.
- Recycle-To-Coin is another Block Chain that rewards people with Crypto coins for recycling the plastic containers. It encourages recycling, increases environment awareness, and also helps poor people to make a living,
- Global Environmental Treaties, Carbon Trading etc., could be well served through Block Chain Technologies due to their inherent transparency, and immutability features.
- Finally, environmental non-profit organizations can have their funds properly collected, accounted for, and distributed due to Block Chain’s inherent character of transparency, and immutability.
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