Bitcoin is a digital blockchain platform powered by software and cryptography. It was launched in 2008 as a solution to allow anyone around the world to interact with money in a decentralized manner.
This implied that users can participate in financial systems without going through third-parties like banks or governments.
The Bitcoin blockchain is inefficient since it runs a Proof of Work consensus algorithm. This algorithm is used to add and validate transactions to its Blockchain. The consensus mechanism is expensive and resource intensive. The main purpose of this algorithm is to prevent network centralization so that people can send money around the world without having to trust anyone in the network.
When the algorithm was initially developed, it was not designed with hardware in mind. The creators of the Bitcoin blockchain did not consider how the algorithm would perform if the Bitcoin was used at scale.
With this algorithm, network maintainers (also known as miners) compete against each other to find the next block (set of transactions to be added to the blockchain) to get rewarded. This algorithm has huge costs because there are several network maintainers competing for the next block, but only one miner will be rewarded for a correct block.
The miners try to solve a complex mathematical equation to create the next block. Simply put, all miners run resource intensive hardware that uses an immense amount of electricity.
When one miner solves the equation, the solution is then propagated to all the other network validators, implying that all the work the other miners did is then deemed useless (i.e. the electricity that was used to try and solve for the complex solution is now wasted forever).
The second reason that Bitcoin is overvalued is because of its lack of price stability. As a technology that is looking to be the currency of the world, the volatility of the currency is unattractive to the average consumer.
For financial assets, consumers can rely on certificates, bonds, stocks, and bank deposits. With these proven and validated financial services, users do not need to worry about the daily volatility of the fiat currencies (e.g. USD or GBP) that back the said financial assets.
Contributing factors to bitcoin price volatility include bitcoin whales that have astronomically more bitcoin than the average bitcoin owner (at least 1000 – 10000 times more) and laws and regulations from 200 countries around the world.
Since all of the transactions on a Bitcoin blockchain are public, people can monitor the flow of value in a transparent manner. When bitcoin owners are selling / buying bitcoins at a large volume, the price is significantly impacted and there is currently no way to control this.
Another factor that contributes to volatility is around the stance that countries and leaders are taking on blockchain and cryptocurrency in general. The countries are working diligently to understand and implement a type of cryptocurrency, laws around tax, ownership, buying, selling, etc. are still undetermined at large around the world, and due to this, the volatility of this technology will persist.
The final reason that Bitcoin is overvalued is because the software is becoming more centralized as time progresses. This is the opposite of what the technology intended to achieve.
Due to the complex nature of bitcoin, there are organizations around the world that are spinning up blockchain accounts for the average consumer. Though the average consumer is being introduced to bitcoin and owning bitcoin, the user’s access to the bitcoin is still with the organization that spun up the wallet.
If the organization is compromised or decides to go rogue, the user will lose access to all the bitcoin that they had access to.
Another factor that is contributing to the centralization of Bitcoin is due to the high price of becoming a network validator / miner. To be a miner, expensive hardware devices must be purchased and installed in regions that have cheap electricity.
Though there is an eventual payout of validating transactions for the bitcoin blockchain, there is a high and expensive barrier for the average consumer to start mining Bitcoin. This means that there are a few people that are validating the transactions on a bitcoin blockchain.
With the Bitcoin Blockchain’s inefficient consensus algorithm contributing to high electricity waste, volatility, and gradual shift towards centralization, the blockchain is overvalued.
Mehran is a product lead at UNICEF Innovation. Prior to his current role, Mehran helped scale Deloitte's blockchain delivery team. He's been working in the blockchain space for 4-5 years. To learn more about the work he's doing in blockchain, follow him on Twitter: @mehranhydary.
(Originally Published here)
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