The economic stakes of bitcoin

A cryptocurrency such as bitcoin has value only if it is considered a currency by all participants in the monetary system. It therefore needs to be rare, in the sense that it can not be easily copied (a problem equivalent to that of counterfeit notes, for traditional currencies).

This property is satisfied by the Bitcoin network, which guarantees the absence of double expenditure. In addition to this value related to acceptance, bitcoin has value through various economic mechanisms related to the supply and demand analysis of bitcoin_s_.

The supply of bitcoins
The issuance of money on the primary market

The creation of bitcoins is determined by a mining process . Each mined block generates bitcoins. It is expected that the amount per block mined be divided by 2 every 210 000 blocks to arrive at a total of bitcoin_s_ in circulation (except those lost) of 21 million. This monetary rule is controlled by an editable protocol by the Bitcoin Foundation consortium , as we will see later. The monetary rule can therefore be modified to respond to fluctuating market conditions, at the risk of a hard fork .

Electricity is the main component (over 90% according to current estimates) of the total cost of a mining farm. In 2015, Böhme et al. (2015) estimated the consumption of the bitcoin network at more than 173 megawatts of electricity on an ongoing basis. This represented about 20% of the output of a nuclear power plant and $ 178 million annually (at the price of residential power in the United States). This amount may seem important, but Pierre Noizat estimates that this is not more than the annual electricity cost of a network of ATMs (ATMs) worldwide, estimated at 400 megawatts. If we include the cost of making and putting into circulation the currency and bank payment cards, the electricity cost of the Bitcoin network is to be put into perspective.

However, this cost can be increased significantly as the network grows. There is indeed a negative externality of mining: each miner, when he invests in new equipment, increases his marginal income, but it also increases the overall cost of mining, because the difficulty increases with the number of miners and with their capacities calculation (hash-power).

Thus, for the bitcoin network, the difficulty of the cryptography problem to be solved validated by a consensus of proof-of-work increases with the overall hash-power of the network. There is therefore a risk of over-investment in mining capacity, as individual miners do not take into account the negative effect on the entire network.

It is important to note that increasing the difficulty of mining reduces the incentives to mine and increases the verification time, and thus the blockchain itself. This mechanism is reminiscent of the tragedy of the commons, where shared resources (in this case, the hash-power ) decay and are maintained by only a handful of farms and pools, thus canceling the very principle of the public blockchain, which wants to be decentralized.

There is therefore a risk that the mining capacities are highly concentrated in the hands of a small number of actors, making the principle of the blockchain obsolete. This trend is already perceptible today.

In the end, the supply of bitcoins and therefore the monetary creation on the primary market depends on the cost of electricity and the difficulty associated with the mining process as well as governance rules on the amount of Bitcoin generated per mined block.

The value of bitcoin on the secondary market

Bitcoin can also be bought and sold on a trading platform. The value of the bitcoin is then closer to that of a financial investment whose actors anticipate earnings prospects and factors that may lead to an appreciation of bitcoin.

The demand for bitcoins
The demand for cryptocurrency comes from several user concerns that we detail below, starting with the positive factors and ending with the risks.

Financial privacy

Governments are increasingly limiting the use of cash to show their fight against money laundering and the development of black markets. The cash is the only means of payment 100% anonymous. Bitcoin and other crypto-currencies come second. Indeed, the pseudonym system used by the bitcoin protocol makes it possible to mask the identity of the persons carrying out transactions. In addition, some cryptocurrencies, like Zcash, go further and hide all the metadata of a transaction.

Why use an anonymous payment method? There are many reasons.

Firstly, the use of a means of payment avoids leaving traces that can be used for surveillance purposes by the state, employers and some companies (especially banks and insurance companies) . Thus, companies and banks practice price discrimination strategies that can sometimes turn against consumers. Keeping track by payment can also push companies to solicit more customers on new commercial offers and the distribution of targeted advertisements that can be considered nuisance by some.

Secondly, paying with an anonymous method of payment also limits under-supervision (or reverse supervision) by relatives. This will be the case for a payment made from a joint account.

Third, pseudonymous payment also helps preserve business secrecy.

Fourth, just like privacy, the anonymity of certain transactions (for example health products or hospital consultations) helps to maintain trust in society and therefore has economic value. Bitcoin, by allowing the pseudonym, thus generates value by these various biases.

Bitcoin works in times of crisis and therefore avoids control of capital

Bitcoin emerged just after the 2008 financial crisis. This period witnessed the power of governments and central banks to control cash withdrawals and outstanding capital. There are very few ways to escape these two institutional constraints. Bitcoin is one of them. Indeed, even if cash withdrawals are prohibited, owners of bitcoins can still pay using their private key.

Bitcoin helps to discipline governments

Bitcoin (the same goes for other cryptocurrencies) can be considered as an alternative currency not controlled by a central bank. Some economists, like F. Hayek, consider that these alternative currencies that compete with the official currency can discipline governments that would be tempted to finance their debt by inflation. In this case, consumers and investors would turn away from the official currency to buy the alternative currency and thus create a deflationary pressure on the official currency.

Network externalities related to security

The level of security increases with the number of nodes of the network, because it requires all the more computing power to compromise the security of the blockchain (through a 51% attack, double spending or denial of service (DOS). moreover, a DOS attack is all the more difficult to achieve because it is difficult to guess who is the beneficiary, so there are positive network externalities: the value of bitcoin increases with the number of nodes participating in the network.

Indirect network externalities linked to the payment method

Bitcoin is a means of payment, as are cash, bank cards or Visa / Mastercard / American Express cards. Bitcoin can therefore be apprehended by the theory of multi-slope markets that models situations in which two groups of economic agents benefit from positive cross-externalities. Indeed, when a consumer chooses a means of payment, it will be all the more satisfied that the latter is accepted by the merchant with whom he makes a transaction. Conversely, for a merchant, it is all the more interesting to offer a method of payment that there are customers who own it. As a result, the dynamics of multi-slope markets result in virtuous cycles that may experience a slow start phase followed by a very rapid deployment phase.

A bitcoin bubble? duncan on Visual Hunt , CC BY-NC
The risks

Among the factors that reduce the demand for bitcoins, risks related to regulation and regulation stand out. On the one hand, a State could require the declaration of capital gains generated by the purchase and sale of bitcoins. In addition, bitcoins can be used in regulated sectors (such as insurance or banking) and their use could also be regulated. Finally, there is always the risk of losing the data of the hard disk on which the private key is stored, and thus losing the associated bitcoins, or that a state imposes its access to private keys for a security issue.

However, the biggest risk is the governance of the Bitcoin network.

Indeed, in case of disagreement on the evolution of the communication protocol, the network may be divided into several networks ( hard fork ) with currencies incompatible with each other. The most important question is related to the choice of the consensus rule for the validation of new blocks. Consensus must be reached on consensus, which technology alone can not provide.

Conclusion
The economic value of bitcoin depends on many positive economic factors that can bring the cryptocurrency to a phase of sustained growth that would justify the soaring price on the exchange markets currently. However, the risks associated with the governance of the network should not be neglected because trust in this new currency depends on it.