What is the downside of Bitcoin

Bitcoin: 8 problems of the most famous cryptocurrency

Bitcoin is currently the most well-known concrete application of blockchain technology and is being promoted by some as the “payment method of the future”. In fact, however, the cryptocurrency has some significant drawbacks as a potential means of payment. This also applies in comparison to some other cryptocurrencies, which already solve some of these problems better. Aside from the question of means of payment, there are still some big issues open to Bitcoin. Raiffeisen Research analysts identified eight major pain points within a larger Bitcoin analysis. The incubator added critical comments to some of them.

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1. Extremely high volatility

It is questionable how far a means of payment can gain acceptance that has fluctuations in value of 10 to 20 percent within a day. Who would give it in exchange for goods if the price of Bitcoin could be 20 percent higher in just a few hours? (And you would have paid 20 percent too much for the goods, converted into euros?) And who would accept it in exchange for goods if they fear that the exchange rate could be 20 percent lower in a very short time?

Editor's note: This could also be a chicken and egg problem. Theoretically, volatility would decrease drastically if Bitcoin were used across the board as a means of payment. Because then prices for goods and services, as currently in euros, would be defined in Bitcoin. And these would not be continuously changed. Accordingly, there would then be volatility in relation to other currencies, but not in terms of purchasing power. However, the volatility in purchasing power is the one that is decisive for suitability as a means of payment.

2. Can a purely speculative object have long-term value?

The question is of course related to point 1. The strong price increase recorded so far makes Bitcoin more of an object of speculation. Something that is hoarded for price increases but not used to pay. However, its use as a large-scale means of payment would be a prerequisite for Bitcoin to hold any value in the long term.

Editor's note: Firstly, due to the reasons given above, it has not yet been excluded as a means of payment. Second, what is probably the oldest of all speculative objects stands here as a counterexample: gold. In the past few decades, the precious metal has actually received a usability value as an important raw material in the electronics industry. Until then, however, its value had only been generated over millennia through its property as an object of speculation.

3. Reversal of payments not possible.

Erroneous / erroneous transactions cannot be reversed, as there is no central authority to appeal to and to intervene in the transactions.

4. Limited multipliability of Bitcoin

Related to point 2. Bitcoin is programmed in such a way that a maximum of 21 million pieces can be produced (with divisibility up to 1 / 100,000,000 Bitcoin [= 1 Satoshi] for smaller payments). 16 million of these have already been produced. For speculative price increases, this limited multipliability is an advantage, because the artificial scarcity stimulates the price imagination. As a widely used means of payment, it would mean continuous deflation for goods and commodity prices (expressed in Bitcoin
Goods prices fall because their quantity increases (economic growth), but the number of means of payment can (shortly) no longer be increased. In the past 200 years, however, the deflationary environment has had rather bad experiences, which is why most central banks are aiming for slightly positive inflation.

Editor's note: The comment “in brief” is not entirely true. Due to the algorithm, it will take several decades until all bitcoins are issued. However, the amount dispensed is also continuously decreasing. Another problem with this topic is the high concentration of the cryptocurrency on a few large owners. The Bloomberg news agency recently released one Estimate, According to which 40 percent of Bitcoins are in the possession of only 1000 people. Of course, there is also an unequal distribution of wealth in the current standard currencies. A non-growing money supply and the associated deflation make changing this situation even more difficult.

5. Relatively high transaction costs

Due to the high computing effort behind it, the transaction costs for Bitcoin are relatively high (currently several USD / payment), which makes it uninteresting for small payments for daily needs in its current form.

Editor's note: The transaction costs work according to a kind of auction system. You can also pay lower transaction costs, but will then be ranked behind those users who pay more. It can then even take several days for a transaction to be carried out. The "queue" is getting longer and longer due to the slow processing (see point 6).

6. Relatively slow to process

An advantage is mentioned that with cryptocurrencies no external settlement is required, which is often the case in the banking sector
Can take days. In this respect, the blockchain accelerates and simplifies payment transactions. However, it can currently take hours for both contracting parties to be certain that the payment has actually been carried out in the case of a specific Bitcoin payment (while with an ATM payment there is legal clarity in this regard within seconds. So there is still a lot of room for improvement here, too.

Editor's note: With Bitcoin, theoretically (currently) only up to seven transactions per second can be processed worldwide. In fact, the number is below that. For comparison: credit card companies come up with a six-digit number. With further expansion, the transaction queue for Bitcoin will become even more difficult. However, work is also being done to improve the system. That led to the "soft forks" of the last few months - these are updates in the system. The hard forks from Bitcoin Cash and Bitcoin Gold were partly justified by an increase in the number of transactions.

7. No public authority that can intervene in the event of problems

Closely related to point 3. But also means that in the event of major problems or changes in the payment network, there is no possibility of central action. Rather, all computer operators involved would have to come to an agreement for further developments. In practice, this means that there is often no consensus, and the currency splits into two clones (called "hard fork"), which remain as the old and new versions of Bitcoin (e.g. Bitcoin vs. Bitcoin Cash).

Note: On the other hand, the fact that no central player can intervene is also one of the biggest arguments in favor of crypto currencies. It is precisely the control by central authorities that is supposed to be switched off by using blockchain technology. One advantage is that corruption within the system is made impossible.

8. Extremely high electricity consumption for processing payments (proof of work)

The computing process behind the processing of transactions via Bitcoin is deliberately designed to be very complex in order to prevent manipulation. This leads to high power consumption by the computers involved. Accordingly, the "miners" (long since large specialized server farms, a large part of them in China with access to cheap electricity), who make their computers available for the computing process, also have to pay for their computing effort (during the "mining", i.e. the process of processing the transactions), newly created bitcoins and transaction costs are rewarded. This electricity consumption has meanwhile become a considerable cost factor: According to digiconomist.net, the Bitcoin payment system (including its clone Bitcoin Cash) in its current dimension already consumes over 30 TWh of electricity per year - that is more than Ireland's electricity consumption. A single Bitcoin transaction in its current form consumes electricity that could meet the daily needs of 9 US households.

In other words: The VISA payment network processed 82 billion transactions last year (compared to around 100 million annualized transactions for Bitcoin). Its data centers used an amount of electricity that corresponds to the annual requirements of 50,000 US households. In contrast, the Bitcoin computer network in its current rudimentary form devours the electricity consumption of almost 3 million (!) US households on an annualized basis, and consumption continues to rise with the growth of the transaction volume and the value of Bitcoin. In order to replace other means of payment, this approach is hardly realistic, the technology would have to be further developed - either within Bitcoins or in the form of another crypto currency (for professionals: e.g. Proof-of-Stake instead of Proof-of-Work protocol).

Note: In fact, Ethereum is currently working on a step-by-step implementation of the Proof of Stake concept. Other cryptocurrencies, such as the latest addition to Cardano, only use the significantly more energy-saving concept. In addition, further distributed ledger technologies are currently being presented that use other (more energy-efficient) systems. If Proof of Stake or one of these systems prevails, that also means the end of crypto mining.

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⇒ To the Raiffeisen Research page