The World Of Bitcoin Economics
You may have heard of Bitcoin, the virtual cryptocurrency created by programmers to disrupt and decentralize our current banking system and provide security for monetary transactions. Since the virtual currency was created eight years ago, it seemed to stay in the hands of high-tech communities. But recently the cryptocurrency has been gaining worth. This summer the value of one Bitcoin jumped up to $5,000.
Economist Garrick Hileman from the Cambridge Centre for Alternative Finance at University of Cambridge breaks down what caused this increase in Bitcoin’s value, and what role the currency might play in future markets. Plus, journalist Morgen Peck visited a virtual Bitcoin mining facility in Inner Mongolia, and joins Ira to talk about why Asia has become a hotspot for the cryptocurrency.
How do blockchains work? Peck explains the technology behind Bitcoin on IEEE Spectrum.
Garrick Hileman is a research fellow in the London School of Economics and Senior Research Associate at the Cambridge Centre for Alternative Finance, part of the University of Cambridge in Cambridge, England.
Morgen Peck is a science writer based in New York City. Her work has appeared in Slate, IEEE Spectrum, and Scientific American, among other publications.
IRA FLATOW: This is “Science Friday.” I’m Ira Flatow. You’ve probably heard of Bitcoin. It’s the virtual currency that’s supposed to be more secure and decentralized and disrupt how banking is done.
Bitcoin has been around for eight years. But so far, it seems like it’s only in the hands of programmers and hackers, and not the deli owner down the street. But cryptocurrency is making its way into wider circles. For example, if you go on Yelp, you can search for restaurants that take Bitcoin. There are even places in Asia that have become virtual minds working around the clock trying to dig up the coins.
And some investors are taking it very seriously. This summer, the value of one Bitcoin jumped up to nearly $5,000.
But what is a Bitcoin? Where does it get its value from? How does it work technologically, economically? And you’ve probably heard about the other B word, blockchain. What’s that have to do with Bitcoin?
My next guest is here for a Bitcoin breakdown and to tell us how the cryptocurrency might be used in the future. Garrick Hileman is a senior research associate at the Cambridge Center for Alternative Finance at the University of Cambridge in England. Welcome to “Science Friday.”
GARRICK HILEMAN: Thank you for having me, Ira. It’s a pleasure to be here.
IRA FLATOW: You’re welcome. I want to tell our listeners that if they have a question about how Bitcoin or blockchains work, give us a call. Our number– 844-724-8255. Of course, we always like to hear from you on Twitter, @SciFri.
Can you give us a brief history of why Bitcoin was invented. What were the programmers who created it trying to do?
GARRICK HILEMAN: So, yeah, Bitcoin came out of the cypherpunk movement, which actually goes back quite a ways. You know, in the 80s and 90s, many technologists were concerned about privacy, particularly communication privacy. And so tools like PGP, pretty good privacy, were developed to ensure that emails were confidential, that governments or businesses or spouses couldn’t read communication between one party and another.
But a group within that community was also interested in financial privacy. And that’s really what led to the creation of Bitcoin, is this desire to also have private financial transactions where we’re not necessarily revealing everything about the transaction or who we’re transacting with, or even how much we’re transacting.
IRA FLATOW: So it is a currency, because people have decided it has a value, right? But there’s no silver or gold backing it like a real coin.
GARRICK HILEMAN: That’s absolutely right. It’s in some ways similar to the fiat currency that many people in the Bitcoin community criticize or don’t think will hold value much over time. What gives Bitcoin value is its scarcity, the fact that there is going to be a limited number of these, 21 million, and also with utility, its usefulness, what you can do with the Bitcoin itself.
IRA FLATOW: And what can you do with it? I mean, why is it making headlines?
GARRICK HILEMAN: Right. Well, there’s a number of limitations that our current money and currency system have, or issues. One is it can be quite expensive to transfer money across borders, so for example, if you want to send funds to sub-Saharan Africa, the average cost for a transaction like that will be at least 12%, sometimes 20% or more. You can send a value through the Bitcoin network for much, much less than that.
Micro-transactions are another possibility. Bitcoins have eight decimal places. So you can send tiny fractions of value that you cannot easily do with, say, the dollar, which only has two decimal places. You can also use the Bitcoin blockchain as a database. So it can be used for actually storing information. And we can talk more about that later in the more general uses of blockchain, but it has a lot of really interesting, novel applications.
IRA FLATOW: So this way, as you say, if I want a transfer of funds, I don’t have to pay a middleman like my credit card or my bank or anything like that. And I avoid those fees. That seems to be something desirable.
GARRICK HILEMAN: Yes and no. There can be fees associated with using Bitcoin. In the beginning, it was effectively free to use, and it was advertised as such. But actually, as Bitcoin’s become more popular over time, its become a lot more crowded. And the cost of actually using Bitcoin has gone up for users. In fact, it’s been as high as $5 a transaction, which if you’re trying to send a micro-payment, doesn’t make a lot of economic sense.
So that’s been a lot of what the debate in the last few years has been about, is how to scale the network to drive down transaction fees to levels that are more reasonable.
IRA FLATOW: Now if I make a transaction with my credit card and it goes badly, I can always call my credit card company up and say, hey, would you reverse that? That’s not something that I wanted. They gave me the wrong thing. Can you do that with Bitcoin?
GARRICK HILEMAN: You cannot do that. That’s a very important point to make. So Bitcoin is a lot like electronic cash. Once you spend it, it’s effectively out of your hands. And just like if you hand cash over to a business, not so easy always to get that back. Nearly impossible to have a Bitcoin transaction reversed back to you.
IRA FLATOW: Now, the federal government controls the amount of US dollars that are out there. It can print more money if it needs to based on how the economy’s doing. So where do more Bitcoins come from? And how is it determined how many coins are out there?
GARRICK HILEMAN: Right. Well, actually, just on that point, so a lot of– this is actually a common misconception. Most of the money in existence is not central bank notes and coins. It’s actually bank money. Commercial banks like Bank of America, when they make a loan, that’s actually where most of our money comes from is through the making of loans. Now of course, Bank of America and Chase and so on, you know, have to abide by interest rate policy and are affected by monetary policy and so on, so the central bank and the government do have a hand in how much money is circulating, but it’s not as driven by the government as I think a lot of people think.
Bitcoin, in contrast, is basically governed– the number of Bitcoins is governed by an algorithm, by basically a protocol, software protocol. And those rules can be difficult to change, as we’ve seen with Bitcoin in the last two years. But it’s not impossible to change them, either. If someday down the road a group came together and said, OK, we want to increase the total supply of Bitcoin from 21 million to, say, 42 million, if we want to double it, that’s certainly possible.
IRA FLATOW: In fact, although there isn’t a machine stamping out more Bitcoins or some company pulling more Bitcoins out of the ground like gold, they still need to come from somewhere. And they’re called virtual Bitcoin mines, giant banks of computers burning a lot of electricity, churning away at the code to make more of these coins. And you might be surprised where a big number of these mines are popping up.
I want to bring on another guest who has visited one of these mines. Morgan Peck is a journalist for the IEEE Spectrum, and the latest issue of that magazine is all about Bitcoin. Welcome to “Science Friday.”
MORGAN PECK: Thanks. Great to be here.
IRA FLATOW: Well, we’re talking– you visited one where, in Mongolia?
MORGAN PECK: Yeah, it was inner Mongolia, about a one-hour plane ride from Beijing, sort of in the middle of nowhere. And–
IRA FLATOW: So why would that be in the middle of nowhere? Why is that a good spot, then?
MORGAN PECK: Well, there’s actually only one reason they’re there, which is that it’s close to very cheap electricity. So the operators of this particular mine, I believe they pay $0.04 per kilowatt hour, which is extremely low.
IRA FLATOW: And why is that important for making a Bitcoin?
MORGAN PECK: Because basically, all these machines are doing is taking electricity and turning it into money.
IRA FLATOW: And when you say they’re machines, are these, like, supercomputers that eat up a lot of electricity?
MORGAN PECK: So they’re computers that are based on an ASIC chip, which is a chip that is specifically made to do one type of calculation. And in this example, it’s the calculation that runs the Bitcoin network, which is called– which is a hash function.
IRA FLATOW: So there are not a lot of people in hardhats sitting around mining anything.
MORGAN PECK: Tell us what you actually saw, how it works.
MORGAN PECK: Sure. It was nine warehouses, and inside each one of them, there’s just racks and racks and racks of computers that are gobbling down energy 24/7. And the only other things, really, in the facility are fans to keep it cold, because that’s your other problem, is that these machines are working so hard they’re filling the place up with heat. And you’re already actually in a very hot environment. When I was there it was 102 degrees, I think, and–
IRA FLATOW: No air conditioning.
MORGAN PECK: –that’s not– yeah, and that’s pretty normal, I think.
IRA FLATOW: Just fans.
MORGAN PECK: Just fans. Well, they’re fans made out of twisted metal, and then they have water dripping down them, so it’s an evaporative cooling technique. And then it throws the– then they have some huge industrial fans that pump it out of the warehouse. But yeah. It’s just a bunch of– just a bunch of machines.
IRA FLATOW: Well, I understand that China is seeing a surge in the use of Bitcoin. What is being used there? What are they doing with that? Why China?
MORGAN PECK: I think it’s been a big locus for speculation, actually, is everything that I’ve heard. And actually, the big news coming out of China is that there’s been a ban placed on the Bitcoin exchanges there. So that’s kind of tamped down on the activity in China in the last– I think that happened a month ago, about a month ago.
IRA FLATOW: When you say speculation, that means people are– like the stock market. They’re driving up and down the price of a Bitcoin.
MORGAN PECK: Yeah, it’s
IRA FLATOW: Trying to make money just on the price.
MORGAN PECK: Right. It’s just trading. And Bitcoin’s not only the only currency, so it’s not just trading back and forth between fiat and Bitcoin. They’re also trading between other coins that are out there now. So it’s a big– it’s just a big casino.
IRA FLATOW: Garrick, how are other countries approaching Bitcoin. Is there government support in any place?
GARRICK HILEMAN: Yeah, you know, it’s mixed. Early on, we saw some countries like Ecuador and Bolivia actually, you know, outright ban, make illegal Bitcoin. More recently, we’ve seen Japan, just this year, formally recognize, so legalize, Bitcoin, which has certainly driven much greater adoption across– not just for exchange trading, but we’re seeing also a lot of merchants in Japan starting to allow Bitcoins as a means of payment with formal recognition from the government.
IRA FLATOW: I have a tweet here coming in from Karen, who says, “Bitcoin miners in Venezuela are persecuted horribly.” You know about that at all?
MORGAN PECK: I–
GARRICK HILEMAN: Well–
MORGAN PECK: Go ahead.
GARRICK HILEMAN: Morgan, do you have– I only know what I read in the press, but Morgan–
IRA FLATOW: You have any idea, Morgan?
MORGAN PECK: I’ve only heard– yeah, I’ve heard that that’s true, but I don’t have any more information on that. Sorry.
GARRICK HILEMAN: I mean, I can speak to what might be driving that, which is that Venezuela’s economy is in tatters right now. Inflation is running wildly out of control, and people are desperately looking for alternatives to kind of store value and protect themselves financially. And so we hear reports that there’s some evidence of [INAUDIBLE], you know, growing interest in Bitcoin and other cryptocurrencies in Venezuela, which makes sense. I mean, when I looked at what factors could drive adoption of something like a digital alternative currency, it’s countries that have financial crises, high inflation, financial repression. Venezuela ticks all those boxes.
IRA FLATOW: Let me go to the phones to Frederick, Maryland. Hi, welcome to “Science Friday.” Go ahead. Can you hear me? Yeah, I hear your phone? No?
SPEAKER 1: [INAUDIBLE]
IRA FLATOW: Oh. I guess he’s gone. Let’s see. Let’s go to San Francisco to– well, let’s go to Fernando in San Francisco, California. Hi, Fernando.
FERNANDO: Hi. I recently changed a very small amount of US dollars to Bitcoin and it has since quintupled in price. So I was wondering, what are the big factors that are likely to make litecoin, for example, explode in value in the future, because a lot of people are interested in speculating on these? Is it a matter of widespread adoption by the public or major financial institutions accepting the currency and using it? And also for your second guest, or either of your guests, I wonder if they could comment on the effects of Bitcoin in the Venezuelan underground economy, which I remember reading something about. Thank you.
IRA FLATOW: OK. OK, so what is driving it? Garrick, why is it fluctuating like that?
GARRICK HILEMAN: Right. Well, I think a number of things drive the price. I mean, speculation of course, but also, there’s further adoption by exchanges and wallets. So the more wallets and more places you can use a currency– and we’ve seen litecoin and some of the other, you know, alternatives to Bitcoin increase in their levels of adoption– the more places you can use it, the more utility it has, and so the value potentially could respond to that.
At the same time, as I mentioned, you know, Bitcoin innovation has really stagnated over the last couple of years. There’s been this gridlock over how to scale the protocol. And so that’s really, I think, created space for alternatives like litecoin and others to increase in value.
IRA FLATOW: This is “Science Friday” from PRI, Public Radio International, talking about Bitcoin with Morgan Peck and Garrick Hileman. So how– what’s to stop other people from coming up with their own kind of currency? A competitor to Bitcoin? Morgan, you’re smiling.
MORGAN PECK: Yeah, because absolutely nothing. And it’s happened many times. There are thousands out there, actually. And many of them are being traded against each other.
What Bitcoin is is a protocol that everyone is running. And that’s what defines a currency, is that everyone who wants to use it is using the same protocol. So all you have to do to make a new one is start your own, you know, software.
IRA FLATOW: So when I buy either Bitcoin or litecoin or other, I’m speculating, then, that this is going to still be around tomorrow and then that’s not going to fall to some other cryptocurrency [INAUDIBLE].
MORGAN PECK: Sure. Yeah. But I mean, Bitcoin does have quite an advantage of being the first one out there, and there’s– I would say that, yeah, there is– it would be very hard to surmount that that network effect at this point. Do you think so, Garrick?
GARRICK HILEMAN: It definitely has a huge advantage in terms of adoption, brand recognition, infrastructure, and so on. Absolutely. It’s not– I wouldn’t say it’s impossible for Bitcoin to be toppled, but it definitely has a major edge on the others.
MORGAN PECK: Well, one of the things to point out is that a lot– I mean, I said there were thousands of coins out there. Most of those are purely just clones of Bitcoin itself or clones of other ones. But there are a few coins that actually add functionality, and that was the reason they were made, not just as–
IRA FLATOW: I have a tweet from Milo, which I think reflects a lot of what people are saying. “I just don’t get why Bitcoin is so valuable. It’s nothing, ’cause nothing is backing it. It’s just nothing, like a piece of data.” You’re laughing, Garrick.
GARRICK HILEMAN: Right, well, this comes up a lot. And it is mind-boggling. I mean, for the first year plus that Bitcoin existed, it was worth nothing. And then someone decided to say, hey, if someone buys me a pizza, I’ll send you 10,000 Bitcoins. A gentleman in Florida back in, I believe, 2010.
And all of a sudden, Bitcoin could be used to buy pizza. And then people said, well, what about alpaca socks? And maybe we should start trading this for dollars.
And what’s happened over time is people have found more and more uses for it. Now, some of these are less legitimate uses than others. Of course, famously, Bitcoin is widely used in the online dark web and more recently for ransomware, which is definitely a concern. But at the same time, you know, US dollars and other national currencies are used for crime, too, so you know, there are legitimate uses for Bitcoin, as well. It can be a fast, cheap way to send money across borders, like I mentioned. And that’s a good thing.
IRA FLATOW: I only have about a minute to the break, but I wanted to ask this question. Can I call up my broker and say, sell my stock and put it in Bitcoin? Or take whatever I have in Bitcoin in my IRA or whatever it is? Is that– is it that easy yet?
GARRICK HILEMAN: No, it’s not that easy. There’s been some high-profile efforts to have exchange traded funds operating on US exchanges. And those have actually been rejected so far by the Securities Exchange Commission for various reasons.
IRA FLATOW: All right.
MORGAN PECK: One–
IRA FLATOW: Well, why don’t we take a break? When we come back, we’ll have plenty more time to talk about it. A lot of people want to talk about Bitcoin. We’re also going to talk about blockchain, the math and the algorithms behind Bitcoin, and other things that people are using blockchain for.
So stay with us. 844-724-8255. Also, Tweet us @SciFri, S-C-I-F-R-I. Lots of interest in this subject. We’ll be right back after the break.
I’m Ira Flatow. This is “Science Friday.” We’re talking this hour about Bitcoin– how it works, what it might be used for in the future– with my guests, Morgan Peck, journalist for the IEEE Spectrum, Garrick Hileman of the University of Cambridge in England. Our number– 844-724-8255. You can also Tweet us @SciFri.
Now, when we talk about Bitcoin, there’s another B word you hear a lot about, and that is blockchain. Blockchain is the new algorithm. It’s a technology that people always name drop, but who really understands in our audience what it does? Garrick, can you give us a simple explanation of what blockchain is and how it works?
GARRICK HILEMAN: Yes, well, blockchain was invented alongside Bitcoin by Satoshi Nakamoto. Today, blockchain has come to mean lots of things, but simply put it, you can think of it as the database that keeps track of the Bitcoins and who owns what. And people realized, wait a minute, I can take that database technology, and I can use it to do other things that have nothing to do with money or Bitcoin. For example, I could use it for electoral voting to give people privacy, but also give them the ability to audit to make sure their vote was counted, and so on. So it’s come to be viewed as a really innovative technology in itself, separate from Bitcoin.
IRA FLATOW: And Morgan? Yeah, I would say the blockchain does two things. It’s a place that stores previous transactions on the Bitcoin network, but it’s also the place that does those transactions, which is an actual execution of that transaction, which has to follow the rules that Bitcoin has set up. And so people have looked at the blockchain and said, can we generalize the functionality of storage? And can we generalize the functionality of how you execute a transaction?
And if you make both of those more complex, you can build some really interesting things. You can have transactions that are not only– where it’s not just a simple– simply me saying, I want to give money to Ira, but you can add different rules to that transaction, such as I want to give money to Ira only when, let’s say– on a certain date in the future, or when the temperature outside is 70 degrees Fahrenheit, exactly. You can add to that complexity.
IRA FLATOW: So it is a chain of commands and things. There’s a block, and it hooked to the chain of other commands, things like that.
Garrick, you said something very interesting about voting. And you said that this would be a safe way and a way you could check if your vote counted or not. How safe is it? Is it really much safer?
GARRICK HILEMAN: Good question, and there are definite concerns here. I mean, any blockchain system is potentially vulnerable. It’s something that’s not 100% secure. There are known ways to attack the Bitcoin blockchain and any blockchain. But it does have some advantages– its resiliency, which we’ve talked about, the cryptography that they employ, and so on. So it could be a useful way for putting out public information in a transparent fashion that’s still secure.
IRA FLATOW: Morgan, there’s a company called Ethereum that is a global computer network that has created its own virtual currency. And how does it approach the idea differently than from, let’s say from Bitcoin?
MORGAN PECK: So like I was saying, you can generalize the two functions of a blockchain, which is to store data and to execute transactions. They want to generalize that beyond what anybody has previously imagined and say, instead of just doing a transaction, which is a little bit of code that miners on the network are running, we’re going to let them run any code they want, not just code that says, take this money and put it over there. We’re going to let them run whatever code they want.
It could even be, you know, a complex software program. It could be a game. It could be anything. And so what you have once you give miners that functionality– I know we haven’t talked about miners, but they’re just the ones that are keeping– that are building onto the blockchain. Once you give them that functionality, you can basically take what was a distributed currency and turn it into a distributed computer, is what they’re calling it.
IRA FLATOW: Right–
MORGAN PECK: And so you can have computer programs executed in a distributed fashion on this network.
IRA FLATOW: Wow. I have a tweet from Jim, who says, “It is as easy as downloading apps to your phone to get cryptocurrencies.” Is it that easy? Is there an app you can download?
MORGAN PECK: Sure. It’s called a wallet, and basically it’s a client that is communicating with the blockchain. That’s really all you need, is some way to interface with the blockchain, which is the repository of all of the transactions that have had happened in the past.
IRA FLATOW: Garrick, does any of this make you fearful at all?
GARRICK HILEMAN: Well, I wouldn’t I wouldn’t say so. I mean– but I tend to be a bit of an optimist when it comes to technology. There’s definite risk factors involved with all this, and I think a lot of hype has surrounded the space. And so these technologies are vulnerable at the same time. I mean, Bitcoin is nothing short of an engineering marvel.
It’s been running for almost nine years without, you know, really a nanosecond of downtime, the most powerful computing network in history. And how many other IT systems that you know of are that resilient? I mean, it’s quite an impressive accomplishment.
IRA FLATOW: Now, you conducted a study to see who was investing and using Bitcoin. And what did you find?
GARRICK HILEMAN: So yeah, we have some data on this. And really, what we’ve learned is that Bitcoin is a currency. It is being used to buy things. But actually, it’s more today an asset.
So you know, cryptocurrency is a little bit misleading. I think cryptoasset might be a more appropriate term for how it’s being used today. It’s an alternative store of value.
People in Venezuela are looking to use it for the reasons we discussed. People in South Korea, which has been one of the hot markets, may be looking to use it as a hedge against geopolitical risk. And so that seems to be the primary thing people are using Bitcoin for today.
IRA FLATOW: There’s something called small contracts, Morgan. How do these work?
MORGAN PECK: Oh, smart contracts.
IRA FLATOW: Smart contracts, yeah.
MORGAN PECK: Yeah. That’s actually that’s what I was describing before, which is ways in which you can make transactions more complex and follow more complex rules. People like to use the term programmable money. You can program a transaction to do very unique things. So–
IRA FLATOW: It’s like you can make it run an algorithm.
MORGAN PECK: Exactly.
IRA FLATOW: If it costs too much, do that. If it is too less, do this. If you want to buy that and that’s not available, buy this. That sort of thing.
MORGAN PECK: You can have whatever rule sets you want determining how a transaction goes through, when it goes through, who it goes through to, yeah.
IRA FLATOW: That’s quite interesting. We’ve run out of time. I’d like to thank my guests. We’ll have to do this again.
Morgan Peck, journalist for IEEE Spectrum. Garrick Hileman is a senior research associate at the Cambridge Center for Alternative Finance, University of Cambridge in England. Thanks, Garrick, for staying up late with us.
GARRICK HILEMAN: Thank you for having me.
MORGAN PECK: Thanks, Ira.