Gadfly

Bitcoin Plunge Exposes a Fundamental Flaw

It's not the environmental cost of crypto that should worry investors. It's the politics.
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Photographer: Qilai Shen/Bloomberg

Virtual currency's threat to the human environment has been hitting the headlines recently. The race to mine new Bitcoins, exacerbated by rules that make the process use more computer power as time goes on, threatens one day to consume as much power as the whole of Japan, according to Citi. Already, Bitcoin mines stacked high with customized machines whir away in Inner Mongolia, hinting at the crypto-currency's "Mad Max" problem, as ING's Teunis Brosens puts it.

But this is a problem only as long as people are desperate for new Bitcoin, and only as long as its rules remain fixed. The dramatic events over the past three days have shown us that neither is guaranteed. The tumble in value of the granddaddy of crypto-currencies, from about $7,300 to just more than $5,600, is testament to its biggest sustainability problem: An inability to evolve as a piece of code without tearing itself apart.

The root cause of the recent price drop is a long-running conflict over Bitcoin's failure to fix its most obvious flaws.

Although Bitcoin was designed to be a functional payments network, it has failed to live up to those expectations. A boom in transaction activity, worsened by the crypto-currency's speculative price bubble, has led to intense network congestion.

Each entry in the Bitcoin payments ledger—or, in crypto-parlance, each block in the blockchain—is capped in size, and transactions are slow to process. Transaction fees have blown past $10. Given the obstacles to spending Bitcoin like a currency, the incentive has been to hoard it like a commodity.

If this were Microsoft Corp. or Apple Inc., it would only take a nod from the CEO to deliver a system upgrade or patch to improve the network. But this is crypto-land. An issue as trivial as increasing capacity ended up kicking off a civil war among developers, miners and evangelists that has raged for several years. Those who want to keep transaction batch sizes small are accused of being nostalgic cyber-idealists, while those who want to ramp them up are accused of wanting to centralize power among wealthy vested interests.

In protest, a new crypto-currency with bigger block sizes, Bitcoin Cash, was launched in August. As for Bitcoin, a compromise solution intended to launch last week failed to get off the ground. Bitcoin remains Bitcoin.

These events have triggered a step-change in how markets view Bitcoin—just as Wall Street was starting to get comfortable with trading it. Bitcoin's price is falling while that of Bitcoin Cash is gaining. The computing power of the miners is switching away from Bitcoin to its would-be successor in search of more dependable profits. If this continues, Bitcoin's already clunky network will suffer as transactions are delayed and fees rise. Assuming this isn't just a temporary power grab, optimists reckon Bitcoin Cash has a shot at becoming the new Bitcoin—one that's actually a bit better at the whole payments thing.

Regardless of which side has more merit, investors will no doubt be scratching their heads at a far more fundamental question. If every developmental fork in the road for Bitcoin leads to a new currency branching off, how sustainable can its price boom be?

True believers who think it to be as rare and precious as a digital version of gold may soon face the grim reality that it's just one flawed crypto-currency among many. A commoditized technology, in other words, rather than a technological commodity.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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