Bitcoin is an archive that stores nothing, says economist Jorge Soria – why do people pay exorbitant prices for it?

Some people think bitcoin is the currency of the future. Others think it is an online casino that wastes natural resources.

This article was published in Yliopisto-lehti on 4/22.

In February this year, around $44,000 was paid for one bitcoin. A reporter for the financial journal Forbes wrote in April 2021 that a digital gold rush is underway. The most successful crypto currency investors have become billionaires.

Enthusiasts predict that crypto currencies are the money of the future. Critics think they are a digital casino that is wasting the energy reserves of our climate crisis ridden planet. The strangest thing is, bitcoins kind of do not exist.

What if someone doesn't want apples but clothes?

Let us imagine that economist Jorge Soria has milk and his friend has some apples. Soria wants to have some apples and his friend wants milk.

– We can swap them, making a trade-off. The challenge is that we both should want to have what the other one has. It may be that I want some milk, you clothes, and a third person apples, says Soria.

Primeval people invented a smart solution; they started to trade with things that everyone values. Beautiful, rare, and non-rusting precious metals became the most popular means of exchange.

– They are easy to divide and combine by melting. They retain their value.

But the problems continue. If you wanted to buy a castle, you had to transport hundreds of kilograms of gold, Soria says.

The next leap of faith: inventing paper money

The solution to this problem was the discovery of paper bonds that gradually developed into banknotes.

– Banks were developed to store valuables and, in return, gave out a note saying Jorge is entitled to receive this much from this bank.

The owner of the note had to make sure that he would receive the correct amount of precious metal in return for the note. The next leap of faith occurred when one state after another abandoned the gold standard in the 1900s. There was no longer so much gold in the vaults of the central banks that every money owner could have exchanged their banknotes for precious metal.

– Today, the countries just say that the currency they release is valuable. 

The central banks started to regulate the values of currencies by e.g. deciding how much money they would release. That gave rise to the question, can you trust the financial policies of nations?

A list of assets that catalogues itself

In 2009, an inventor using the pseudonym Satoshi Nakamoto published the first crypto currency, the bitcoin. One of their primary motives was to free themselves from institutional power.

– You are no longer dependent on how the European Central Bank or Venezuela handle their financial policies, says Soria.

Soria has been studying bitcoin for years. He is preparing his doctoral thesis at the University of Helsinki. The thesis in the field of economics studies trading with crypto currencies

Bitcoin is called a crypto currency, but it is really a public accounting system that shows how many units there are in each virtual wallet. How many units of what? Well, bitcoins.

Soria says bitcoin can be called a list of assets that catalogues itself. It is an archive that archives nothingness. There is no one who will guarantee that one bitcoin can be exchanged for gold, a Euro, or an apple.

So why does bitcoin have a value? Among other things, because it is practically burgle-proof.

– No one can claim to own bitcoin that they do not own. Ownership only means that a list says that Jorge owns this. But it is set in stone – and it is valuable.

Bitcoin is not necessarily better than its competitors

When bitcoin was published, the rules of the game were nailed down. The system does not contain an authority that can change the rules for others. In principle, anyone could change the rules of bitcoin, but that would mean establishing a new competing crypto currency. Since bitcoin was published, thousands have, indeed, been developed. None of them have gained as much popularity as the first one.

At the start of March, the total value of all bitcoins on the market was 739 billion dollars, while ethereum came in second with a total value of 310 billion.

Bitcoin is not necessarily better than its competitors technically speaking. It has just consolidated its status.

– The value of a currency is directly related to how many people are using it. If you own the only phone in the world, it is a useless product, says Soria.

The most expensive pizza in history

Bitcoin gradually rose in value. In 2010, Florida man Laszlo Hanyecz bought two pizzas for 10,000 bitcoins. On the web page Bitcoinpizzaindex, there is a counter that shows how many dollars Hanyecz could get for his pizza money today. Quite a few.

How much money has the developer of bitcoin made to date? Satoshi Nakamoto has remained unknown to this day. Little bits and bobs of information have revealed that it seems to be a person or group of people acting in the USA.

In the early stages of their crypto currency venture, Nakamoto amassed hundreds and thousands of bitcoins. If they have looked after their assets – and if they are still alive – they are stinking rich.

Power and electronics guzzler

In the early years, it was easy to mine bitcoins on your home computer. As the mining has become more difficult, the virtual miners have banded together to form mining communities that share the profits.

Mines have been established around the world, full of computers developed for mining bitcoins. The most popular location is Siberia: there, the servers can be cooled by opening the window and the electricity is cheap.

The thing is, mining bitcoins uses up lots of power and electronics. The mining of crypto currency is one of the reasons that there is a global shortage of semiconductors, meaning that there are not enough screen drivers, game consoles, mobile phones, and cars to meet demand.

Bitcoin may not be a good currency

There are currently nearly 19 million bitcoins in the world. That is over 90 per cent of the whole amount that will ever be available. When 21 million units have been mined, that is the end of it.

The system decreases the rewards for mining gradually so that the last unit will not be released until around 2140.

That is another answer to the question why bitcoin is valued so highly. There is a finite amount of the currency.

– This is a first attempt to create a completely deflationary currency, Jorge Soria explains.

When the central bank of the US prints more dollars, the number of existing dollars rises, which cuts the value of one dollar. Bitcoin strives for the opposite. If there is no more production of something people want, its value usually rises.

The expected rise in value may mean that bitcoin is, in fact, not a good currency. If the value of money is expected to rise, people would rather squirrel it away than use it.

The wild west of the crypto market

The central banks try to keep the value of currencies stable, but there is no captain on the bitcoin ship. The fluctuation attracts speculators, which makes the exchange rate fluctuate even more.

– If you're not too greedy, you can earn several per cents in one morning by trading in bitcoin. If you continue with that every day, you can make a lot of money, says Soria.

Crypto currencies may also be extra susceptible to market manipulation. The CEO of the manufacturer of electric cars Tesla, Elon Musk, for example, has caused the exchange rates of bitcoin and dogecoin, originally developed as a joke, to fluctuate with his tweets.

In principle, it is possible that Musk has exploited the fluctuations he himself caused to schedule his own crypto acquisitions.

Using insider information when trading in shares can be a crime. However, the same rules do not necessarily apply on the crypto market. In many countries, the lawmakers are only now coming to realize they need to consider how to handle this new phenomenon.

Is a crash or a new rise on the way?

In March 2020, the lowest price for a bitcoin was less than $5,000. In one year, there was an explosive increase in value, and in March 2021 it was over $61,000 at its highest. The top price, over $68,000, was reached in November 2021. Since then, the value of bitcoin has been falling, and in May 2022 it went under $30,000. Many investors are expecting another rise. The price is changing, but in which direction?

– Either the value multiplies itself many times over, or people decide that the problems with bitcoin are too great, which means the value will crash, says Soria.

"We can't yet imagine"

All experts are not excited about crypto currencies. Technical researcher Jarmo M. Korhonen, for example, thinks that bitcoin is an online casino that wastes power and electronics. 

Since it is hard to monitor users of crypto currencies, they are popular among criminals. The drug market on the Dark Web mostly uses bitcoins.

Soria wants to remind us that cash is still the most popular currency among criminals.

A considerable part of bitcoin owners just think of crypto currencies as an investment, not as a replacement for traditional currencies.

Soria thinks that the 2020s will be the decade for crypto currencies like the 1990s were for the internet.

– Something will emerge that we can't even imagine yet. Money will not be where it is now.

How bitcoin works

Bitcoin is like an accounting system consisting of pages called blocks. The latest block is the most current page of accounting. The blocks describe how ownership has changed since the last updated block.

Each block contains a 64-character string of code, which constitutes a locked door, as it were, to the next block. The code is encrypted with an encryption system called SHA-256 that compresses any character string to 64 characters, i.e. a hash.

You cannot deduce from the hash which character string it represents, but in practice, only one character string can lead to each hash. This character string is the key to a new block. The only way to find the key is to try random character strings. This is called mining for bitcoins.

The miners compete for who will be the first to find the key to the next block. The fastest gains new bitcoins; the system rewards the finder of the key by registering the reward in their virtual wallet. The more bitcoins are mined, the smaller the rewards are. At the start, the reward was 50 bitcoins, now it is 6.25.

One of the miners finds a new key every ten minutes, at an average. The mining does not get faster though computers get more efficient, because the system hides the key in ever more hard-to-find ways. This is why the mining requires more power year by year.

Bitcoin is constructed so that mining should always be more rewarding than trying to fool the system. If one of the miners managed to overtake more than half the processing power of the bitcoin network, they could use the same bitcoins twice. Such a scam would require such an enormous number of computers that the risk is very small.

Bitcoin units only change hands when a new block is written. Only a limited number of transactions can be entered into one block, so smaller transactions may be left hanging for a long time. That is one reason why bitcoin is not a very handy currency.

Users of bitcoins may pay the writer of a new block small rewards to process their transactions faster. This raises the total reward for the writer of a block to nearly seven bitcoins.