Bitcoin

All italic text is AI-generated, but fact-checked by us. If necessary, additional commentary is provided.

Introduction to Bitcoin

In the fast-evolving landscape of finance and technology, one term that has become synonymous with innovation is Bitcoin. Born out of the aftermath of the 2008 financial crisis, Bitcoin has captured the imagination of individuals and investors alike. In this blog post, we will delve into the fascinating world of Bitcoin, exploring its history, purpose, usage, development, and the regulatory landscape it navigates.

The History of Bitcoin

To understand Bitcoin’s genesis, we need to rewind to 2008 when a mysterious figure known as Satoshi Nakamoto introduced a whitepaper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.” This document outlined the concept of a decentralized, peer-to-peer digital currency, aiming to eliminate the need for intermediaries like banks. Nakamoto’s identity remains unknown to this day, adding an extra layer of intrigue to Bitcoin’s narrative.

Although people have claimed to be Satoshi Nakamoto [1], it’s unclear who he or she is. Better said, we don’t even know if it’s only one person. Considering the complexity of the Bitcoin system, it’s perhaps more likely that Satoshi Nakamoto represents a group of people as opposed to just one. [2]

The motivation behind Bitcoin’s creation was rooted in the scepticism towards traditional financial systems. The 2008 financial crisis exposed the vulnerabilities of centralized banking,* 

prompting Nakamoto to envision a currency that operated independently of government influence and banking institutions. Bitcoin, as a decentralized digital currency, aimed to provide a transparent, secure, and censorship-resistant alternative to traditional fiat currencies.

* The Bitcoin white paper does reference this, but the phrasing doesn’t quite cover what happened during the 2008 financial crisis. Crypto-evangelists (starting with Satoshi) often tend to be overly negative of the traditional financial world (TradFi). For more information on what exactly happened in the 2008 financial crisis, we recommend that you read this article: An Analysis of the Financial Crisis of 2008: Causes and Solutions.

It’s therefore fair to say that bitcoins were never intended to become a means of investment but rather a means of exchange. Its primary objective was “disintermediation”. [3] It’s debatable if Satoshi would be happy with the way things turned out since bitcoins are mostly seen as investments due to large volatility against the US Dollar. [4]. In line with that, you may even argue that Bitcoins have failed to replace fiat entirely because the only way for us to understand the value of a bitcoin is by expressing that value in US Dollars. It’s somewhat of a paradox. Then again, the history of Bitcoin is still fairly short and more time is needed to see if Bitcoin can live up to its creator’s vision.

How Bitcoin Works

At its core, Bitcoin is a digital currency built on a technology called blockchain. The blockchain is a decentralized ledger that records all transactions across a network of computers. This ensures transparency** and prevents the double-spending problem,*** where the same Bitcoin is used for multiple transactions. Miners, individuals or groups of people who use powerful computers, validate transactions and add them to the blockchain, receiving new bitcoins as a reward.

** Ensuring transparency is a bit much. All transactions and addresses are indeed publicly available (more transparent compared to TradFi), but we don’t know who owns or makes the transaction (less transparent compared to TradFi). It’s best to regard the Bitcoin blockchain as “pseudonymous”.

*** Even though it’s very difficult and expensive to accomplish, double-spending is (at least in theory) still possible.

Furthermore, the Bitcoin blockchain does so in a decentralized manner. At its core is a consensus mechanism that makes sure that all transactions are correctly recorded. Learn more about consensus mechanisms here.

Development and Maintenance of Bitcoin

Bitcoin’s development is an open-source process, meaning that anyone can contribute to its improvement.**** Changes are proposed, discussed, and, if agreed upon, implemented. The process is deliberately slow to maintain the stability and security of the network.***** Major changes require widespread agreement among the Bitcoin community.

**** Although this is true in theory, the Bitcoin core development team consist of just a handful of people. Where Bitcoin is indeed more democrat compared to TradFi is the fact that users of the network can vote on the upgrades the team should develop.

***** Deliberately slow is a misconception. There are a lot of Bitcoin nodes these days (about 55.000 full nodes at the moment of writing [5]) and it takes time for all of them to, firstly, consider the proposed updates and discuss them and, second, when they agree to execute the update. In other words, it’s more accurate to state that the process is deliberately thorough and, as a result, slow.

In more detail, all users of the Bitcoin network (Nodes) are free to use the software they use, but for the nodes to be able to communicate, they all need to use the same version of the software. Hence, software developers can propose new updates to the Bitcoin software and each node has to choose to update or not. [6] It has happened in the past that a group of nodes disagreed with a direction the majority of nodes wanted to go in and they decided to continue in a different direction (a so-called “hard fork”). The first to “fork” from the Bitcoin blockchain was Bitcoin Cash. [7]

Blockchain’s Consensus Mechanism and Environmental Impact

Bitcoin’s consensus mechanism, known as Proof-of-Work (PoW), involves miners solving complex mathematical puzzles****** to validate transactions and create new blocks. While PoW ensures the security of the network, it has garnered criticism for its energy consumption. The environmental impact of Bitcoin mining has sparked debates about its sustainability, leading to discussions on alternative consensus mechanisms.

****** The puzzle is not complex at all. Miners try to find a number that results in a hash that starts with a predefined number of zeros. The only way to do so is through trial and error. In other words, trying trillions of different numbers. Learn more about PoW here.

Bitcoin purists (people who believe that Bitcoin should stay as close as possible as Satoshi designed it) strongly oppose any changes to PoW consensus mechanism because they argue that PoW offers far greater security as compared to other models, such as Proof-of-Stake (PoS). [8] However, energy use is not so much a byproduct of the PoW, it’s a fundamental part of it. Without the costs of energy (work), the incentive for miners to be honest will diminish. This means that the Bitcoin blockchain cannot change its huge power consumption without switching to another model. To put this into numbers, at the moment of writing the Bitcoin blockchain uses about 149 TWh of energy per annum. [9] This is more than 4x the energy consumption of Denmark, [10] a country of nearly 6.000.000 people. [11]

Bitcoin’s Use in Various Sectors

Bitcoin is not just a digital currency; it has found applications in various sectors. Some businesses accept Bitcoin as a form of payment, and individuals use it for remittances or as an investment vehicle. Its borderless nature and potential for quick and low-cost transactions make it an attractive option for those looking to transfer value globally.

That being said, in reality, bitcoins are mostly used as speculative investments and the share of businesses that accept them as payment is very low. Deloitte estimated that about 2352 businesses in the US in 2022 accepted bitcoins or another cryptocurrency as payment. [12] It’s thought that reluctance to consider bitcoins for payments is due to the high price volatility. [13]

The same is true for remittance. Yes, people use bitcoins for remittance, but not often. A key problem in this regard is an inadvertent result of the lack of options to pay with bitcoins. Because, in order to spend your “money” you first need to convert your bitcoin to your local currency, which can be quite expensive. Especially if you’re from a developing country with an unstable currency. In other words, the remittance itself (sending bitcoins from one address to another) might be cheaper, but if you have to spend 10%, sometimes 20% to exchange it for fiat, the “cheapness” rather vades. Bitcoin can be part of the solution to make remittance cheaper, but if you still have to exchange it for cash, it doesn’t provide much solace. [14]

Another use (one that our AI generate content mist) is that of financial including (you may have heard the phrase “banking the unbanked”). Cash is still king in most developing countries and people struggle to gain access to the traditional financial system. [[15] However, solving this problem with the idea giving people of giving people a Bitcoin wallet runs into the same problems as mentioned above.

If we want to know if Bitcoin can function as Satoshi intended, we have to look at the biggest Bitcoin experiment the world has ever seen. In 2021 El Salvador announced that bitcoin would become their new legal tender. [16] The first signs, however, are not scoring many points for “Team Bitcoin”. A survey showed that most El Salvadorians only downloaded the Chivo App (the official state-sanction wallet) because of $30 in free bitcoin. After spending the free bitcoin, most abandoned the app. Equally so, although mandated by law, most businesses in El Salvador refused to accept payments in bitcoins and, if they do, convert the bitcoins into US Dollars. [17]

Bitcoin and Illicit Activities

While Bitcoin’s decentralized nature brings many advantages, it has also been associated with illicit activities. The pseudonymous nature of transactions on the blockchain has led to concerns about its use in money laundering and other illegal activities. However, it’s essential to note that the majority of Bitcoin transactions are legitimate, and various measures are being implemented to enhance regulatory compliance.

That being said, the value of illicit transactions is substantial enough to matter. It’s estimated that 20.3 billion US Dollars worth of “on-chain” transactions (cryptocurrency transactions happening from one wallet to another) are illicit. Meaning that these transactions are known to come from wallets that have been involved in a crime. This figure has been rising for the third year in a row but it still only represents 0.24% of all crypto-transactions. [18]

However, the number stated above only includes so-called “crypto-native crimes”. Crypto-native crimes are crimes, such as hacks, scams and other illicit activity that happen within the crypto industry. For example, the hack of a major exchange. It does, however, not include the use of crypto-assets in non-crypto-native crimes. [19] In other words, it does not include the use of bitcoins in money laundering schemes and the use of bitcoins on the dark web.

Due to a lack of regulations and, with that, oversight, Bitcoin become a favourite of money launderers and illicit dark web marketplaces. Bitcoin and other cryptocurrencies provide an easy, almost instant way to transfer value across the globe without ever having to reveal one’s identity. [20] For this reason, the Financial Action Task Force (FATF) already published a report on the potential of crypto-assets for illicit purposes back in 2014. [21]

Thanks to the efforts of the FATF and other standard-setting bodies, regulators across the globe have (started) to include Bitcoin and other crypto-assets in their respective laws. One of the first major steps in the European Union (EU) was including crypto-assets services in the Anti-Money Laundering Directive (AMLD). [22] This was rather necessary considering the number of instances where bitcoins were used by criminals to launder money [23] or pay for drugs, stolen items and even guns or murder-for-hire on the dark web. [24]

To conclude about bitcoin’s illicit use. Is Bitcoin used for crime, yes. However, the same can be said for cash or the TradFi banking system. So, to simply state that Bitcoin is bad is rather simplistic. However, to simply state that Bitcoin is nothing but good is also rather simplistic since there is clear evidence that Bitcoin has been used as scale in criminal activities. However, be outrightly stated is that proper regulations can make sure that good use of Bitcoin can be fostered and the criminal, illicit use can be countered.

Regulatory Landscape: EU, US, and Global Perspectives

Bitcoin operates in a complex regulatory landscape that varies from country to country. In the European Union (EU), regulatory authorities are working towards establishing a framework that ensures consumer protection and prevents financial crimes. 

This framework consists of a few different laws. The main one is the Markets in Crypto-Assets (MiCA) Regulation. [25] Its main goals are to ensure that the crypto industry doesn’t interfere with financial stability in the EU [26] (e.g. Meta’s Diem project [27]) and to protect consumers from misinformation, abuse and loss due to bankruptcies (e.g. FTX [28]). Crypto-Asset Service Providers (CASPs) that offer services with regard to Bitcoin (such as trading) have to comply with what’s written in MiCA.

MiCA applies to all crypto assets (cryptocurrencies, stablecoins and NFTs) that are not excluded from its scope. This may sound confusing, but it’s a clever way of regulating the market. For example, a crypto asset (because it’s developed as such) might very well be a financial instrument (such as a security). And when a crypto asset is a financial instrument, the EU regulators want it to be regulated as such. What MiCA does is “fill the gap” within current EU financial laws. If a crypto-asset (by the way it’s designed) doesn’t fall within the scope of existing EU law, MiCA steps in. [29]

Other laws that apply to crypto assets in the EU are the Transfer of Funds Regulation (TFR) [30] and the Anti-Money Laundering Directive (AMLD) [31]. Both are designed to combat financial crimes and the funding of terrorism and other criminal organisations. The reason that both now include crypto assets is that bitcoins and other cryptocurrencies (and sometimes also NFTs) are used to launder money [32] and funnel money to illicit organisations [33].

Bitcoins themselves are not regulated by MiCA, TFR and AMLD. The reason is that MiCA excludes crypto-assets and crypto-asset services that are fully decentralized. This means that bitcoins directly are not regulated by these laws. However, services related to bitcoins are regulated by MiCA. For example, the Bitcoin blockchain is fully decentralized and “out of scope” but an exchange allowing you to trade bitcoins is “in scope”.

United States

In the United States (US), various regulatory bodies, including the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), are actively monitoring and regulating aspects of the cryptocurrency space.

In more detail, it’s fair to emphasize “aspects”. In contrast to the EU, the US doesn’t have a law similar to MiCA. The US has (for now at least) opted to regulate crypto assets based on their nature. In other words, how they are used. Bitcoin, being the largest cryptocurrency by market capitalisation [34], has been at the centre of the debate. The CFTC won this debate. Bitcoin was classed as a commodity so the CFTC has jurisdiction. This also goes for bitcoin derivatives, such as bitcoin futures. In a broader sense, all crypto assets that are classed as commodities will be supervised by the CFTC. [35]

So, what about the SEC. The SEC supervises securities. But since bitcoin is regarded as a commodity in the US, trading of bitcoins doesn’t fall under their umbrella. This, however, changes when someone designs some kind of security that involves bitcoins. The SEC is still not supervising Bitcoin, but it does supervise the security that involves bitcoins. A good example is a Bitcoin Exchange Traded Fund (ETF). An ETF falls under the supervision of the SEC. [36] So anyone who wants to offer a Bitcoin ETF must comply with financial regulations and falls under the supervision of the SEC. [37]

Global

Globally, countries are taking different approaches to Bitcoin regulation. Some embrace it, recognizing its potential benefits, while others are more cautious, citing concerns about consumer protection and financial stability. Striking a balance between fostering innovation and safeguarding against potential risks remains a challenge for regulators worldwide.

SOURCES

1. Cointelegraph: 7 people who could be (or not) Bitcoin creator Satoshi Nakamoto | Author: Alice Ivey
2. The Wall Street Journal: Who Is Bitcoin Creator Satoshi Nakamoto? What We Know—and Don’t Know | Author: Paul Vigna
3. The Block: Why was Bitcoin created? | Tim Copeland
4. DataScientiest: Bitcoin: How it works, its advantages and limitations
5. Bitcoin.org: Frequently Asked Questions – What is Bitcoin?
6. Cointelegraph: What is Bitcoin Cash, and how does BCH work? A beginner’s guide
7. Bitnodes: Global Bitcoin Nodes
8. Bitcoin Magazine: PROOF OF WORK VS. PROOF OF STAKE: WHY BITCOIN WON’T CHANGE | Author: NAMCIOS
9. Cambridge Bitcoin Electricity Consumption Index: Bitcoin Network Power Demand
10. Enerdata: Denmark Energy Information
11. WorldoMeter: Denmark
12. Deloitte: The use of cryptocurrency in business. Why companies should consider using cryptocurrency
13. The Conversation: Almost no one uses Bitcoin as currency, new data proves. It’s actually more like gambling | Author: John Hawkings
14. Medium: Bitcoin Doesn’t Make Remittance Cheaper | Author: Luis Buenaventura
15. The World Bank: The Global Findex Database 2021: Financial Inclusion, Digital Payments, and Resilience in the Age of COVID-19
16. Reuters: In a world first, El Salvador makes bitcoin legal tender | Authors: Nelson Renteria, Tom Wilson & Karin Strohecker
17. NBER.org: El Salvador’s Experiment with Bitcoin as Legal Tender | Authors: Fernando E. Alvarez, David Argente & Diana Van Patten
18. Chainalysis: 2023 Crypto Crime Trends: Illicit Cryptocurrency Volumes Reach All-Time Highs Amid Surge in Sanctions Designations and Hacking 
19. Idem.
20. IMF: THE TRUTH ABOUT THE DARK WEB | Authors: Aditi Kumar & Eric Rosenbach
21. FATF: Virtual Currencies: Key Definitions and Potential AML/CFT Risks
22. European Council: Anti-money laundering: Provisional agreement reached on transparency of crypto asset transfers
23. AMLC: Witwassen van virtuele valuta | Author: Mr. R.A. Regering
24. Complex: 15 Things You Could Have Purchased on Silk Road
25. Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in crypto-assets, and amending Regulations (EU) No 1093/2010 and (EU) No 1095/2010 and Directives 2013/36/EU and (EU) 2019/1937
26. ESMA: Markets in Crypto-Assets Regulation (MiCA)
27. The Verge: Zuckerberg’s dream of launching a cryptocurrency is officially over | Author: Alex Heath
28. Investopedia: The Collapse of FTX: What Went Wrong With the Crypto Exchange? | Author: Nathan Reiff
29. ESMA: Markets in Crypto-Assets Regulation (MiCA)
30. Regulation (EU) 2015/847 of the European Parliament and of the Council of 20 May 2015 on information accompanying transfers of funds and repealing Regulation (EC) No 1781/2006
31. Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC
32. FATF: Virtual Currencies: Key Definitions and Potential AML/CFT Risks
33. CoinDesk: ISIS Allies Used Crypto to Raise Millions: TRM Labs | Author: Anna Baydakova
34. CoinMarketCap: Bitcoin
35. CFTC: Digital Assets
36. Investor.gov: Exchange-Traded Fund (ETF)
37. Reuters: U.S. SEC has 8-10 filings of possible bitcoin ETF products | Authors: Bansari Mayur Kaqmdar & Douglas Gillison