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What Would Happen to Crypto In a Global Market Meltdown?

Michael J. Casey is the chairman of CoinDesk’s advisory board and a senior advisor for blockchain research at MIT’s Digital Currency Initiative.

The following article originally appeared in CoinDesk Weekly, a custom-curated newsletter delivered every Sunday exclusively to our subscribers.

A common thought experiment in the crypto community is to ponder how cryptocurrencies would fare in the event of another global financial meltdown.

It is not an idle question. There is a host of troubling developments in the global economy: the threat of a trade war, jitters in Italian debt markets, problems at Deutsche Bank and new emerging market crises in Turkey and Argentina.

Meanwhile, central banks, led by the U.S. Federal Reserve, are tightening or signaling tighter monetary policy. That’s putting a brake on the huge gains that low interest rates and quantitative easing had bestowed on global markets in the eight years since the end of the last crisis.

With this combination of risk factors already in play, there’s always a chance that some unforeseen trigger could set off another terrified rush for the exits among global investors.

What would the impact be on bitcoin and other cryptocurrencies? Would their reputation as independent assets see them benefit from safe-haven inflows? Or would the market-wide reduction in risk appetite spread wide enough that crypto assets get caught up in the selloff?

Opposing scenarios

Some crypto hodlers salivate at the idea of market panic.

They contend that, unlike the 2008-2009 collapse, when Satoshi Nakamoto’s newly launched cryptocurrency was essentially out of sight and unavailable to the hordes seeking a haven from the fiat world’s chaos, bitcoin is now widely recognized as a more versatile alternative to traditional flight-to-safety assets such as gold.

In a crisis, they say, bitcoin could shine – as might other cryptocurrencies designed as alternatives to fiat cash such as monero and zcash. Unaffected by future monetary policy responses, immune from draconian interventions such as the Cypriot bank deposit freeze of 2013, and easily acquired, they could prove their value as digital havens for the digital age in such a moment. Accordingly, the bulls’ argument goes, their prices would surge.

On the other hand, if there’s enough of a market-wide departure from risky investments, it’s hard not to see this sector being swept up in it.

Just as the most extreme gains in crypto prices in the latter part of 2017 were inextricably linked to the rapid “risk on” uptrend seen in stocks, commodities and emerging-market assets, so too a major selloff could easily infect these new markets.

Cryptocurrencies and tokens are perceived by most ordinary investors as high-risk assets – you buy them with money you can afford to lose when you’re feeling upbeat about market prospects. When the mood sours, this class of investment is typically the first to be retrenched as investors scramble to get cash.

At $300 billion, according to Coinmarketcap’s undoubtedly inflated estimates, the market cap of the overall crypto token market is more than three times its value of a year ago (even though it’s down more than half from its peak in early January).

But it’s less than 1 percent of the end-2017 market cap of $54.8 trillion for the S&P Global Broad Market Index, which includes most stocks from 48 countries. If risk-hungry investors are panicking and looking for things to dump – or for that matter if they’re looking for something safe to buy – it won’t take much of their funds to move the crypto markets, one way or another.

Low correlations

Backing the bitcoin bulls’ argument is the fact that correlations between cryptocurrency and mainstream risk assets – the degree to which prices move in tandem with each other – are quite low.

A 90-day correlation matrix compiled by analytics firm Sifr put bitcoin’s correlation with the S&P 500 index of U.S. equities at minus-0.14. That’s a statistically neutral position since 1 represents a perfect positive correlation while -1 is a perfectly negative relationship.

But they say that in a crisis “all correlations go to 1.” The panicked state of the crowd, with investors selling whatever they can offload to cover debts and margin calls, means that everything could go out with the flood.

Intellectually, too, that sort of wholesale downturn would comfortably stand as a logical counterpoint to the conditions seen last year when market valuations reached excessive levels. We cannot separate the flood of money that flew into crypto at the end of the year from the fact that eight years of quantitative easing had driven a “hunt for yield” in once-obscure markets as the return shrank on now pricey mainstream investments such as corporate bonds.

With bond funds paying little more than, say, 2 percent for years, bitcoin looked attractive to mainstream investors. When that artificially-stoked liquidity disappears, the reverse could happen.

Despite all of this, I do believe a global financial crisis could be an important testing moment for crypto assets.

Perhaps there’ll be a two-phase effect. In the immediate aftermath of the panic, there would be a selloff as every market is hit by the liquidity squeeze.

But after things settle, one can imagine that the narrative around bitcoin’s uncorrelated returns and its status as a hedge against government and banking risk would gain more attention.

Just like the mid-2013 surge in bitcoin that accompanied the Cypriot crisis’ lesson that “they can come for your bank account but not for your private keys,” so too a wider financial crunch could spur conversation around bitcoin’s immutable, decentralized qualities and help build the case for buying it.

The wider point here is that, whether it’s as an aligned element that rises and falls in sync with the broader marketplace or as a contrasting alternative to it, cryptocurrencies can’t be viewed in isolation from the rest of the world.

Image via Shutterstock

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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How To Diversify Away Risk In A Crypto Portfolio: Correlation And Variance

Disclaimer: This article does not contain investment advice or recommendations. Every investment and trading move involves risk, you should conduct your own research when making a decision.

Observations of the crypto market give impression that “when Bitcoin sneezes, the cryptocurrency market catches a cold”, – in traditional stock markets this would not be the case. Although there are public companies whose stock movements have strong correlations due to those doing similar work in the same industry – oil companies, for example – investors are still capable of diversifying away risk in an equally weighted portfolio by adding stocks with negative correlations to the portfolio.

Technically, diversifying away risk in a crypto-only portfolio could be difficult. Creating a two-asset portfolio with highly correlated stocks gives an investor a greater risk of losing more wealth. When two assets have a strong correlation coefficient they tend to move in the same direction. If  two assets in the same portfolio move in the same direction then your gains in wealth will be greater and your losses more severe. That could be the reason why investors try to create portfolios with negatively correlated stocks.

If one asset is declining in a portfolio consisting of two assets that are negatively correlated, then the other asset in the portfolio should be increasing. This should in effect diminish the maximum amount of wealth that can be lost in a portfolio.

Just from checking out the digital asset prices on a cryptocurrency exchange, one can see that they are highly correlated with one another.  If Bitcoin is in the red for the day, nearly every cryptocurrency on the homepage will be in the red, if Bitcoin is in the green, – so would be the others. That is why people say that “even the most unseaworthy boats will float when the tide rises”.  

Correlation of cryptocurrencies

Economic researcher Vasily Sumanov told Cointelegraph the cryptocurrency market is highly correlated because most altcoins are bonded to Bitcoin:

“The market is very small [market cap] and has low-liquidity, a majority of the trade volume is provided by algorithmic traders using bots. There are only a few exchanges who actually establish prices but prices at these exchanges are connected to arbitrage bots also. All digital assets are really bonded to the BTC market – besides stable coins like USDT – so every change in the market is immediately mimicked by other assets.

When BTC/USD is falling, all digital assets/USD are falling because the price of a majority of digital assets is being calculated via the USD/BTC price.  For example, when BTC is falling, traders could sell altcoins for BTC. Afterward they could immediately sell Bitcoin, and receive dollars and then buy back their BTC at a lower price. Then they could buy cheap altcoins with their Bitcoin.”

It could be well illustrated by this winter fall of the crypto market. Here is what it looked like, for example, on Feb. 2, 2018. While Bitcoin lost 15%, Ripple lost 30% –  XRP could have become cheaper due to the algorithm used by a majority of traders.

Image source: Coinmarketcap

In a correlation matrix created from the yearly returns of Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), and Ripple (XRP), there are seven out of ten digital asset pairs that are perfectly correlated; BTC-BTC, BTC-ETH, ETH-ETH, ETH-LTC, ETH-XRP, LTC-LTC, and XRP-XRP. The three other pairs still show strong correlation – anywhere between .7 and 1: BTC-LTC is correlated at  .934, BTC-XRP at .729, and LTC-XRP at .892.


Trading systems technology and operations consultant Tony Karim shared with Cointelegraph his opinion that digital assets are highly correlated due to investor sentiments and systematic risks:

“Mainstream crypto assets (not so much with newer altcoins) are closely correlated in their volatility due to the same catchment of underlying investors who are almost exclusively sentiment driven with similar trading motives without reviewing any of the drivers and flow of this market.”

“The recent devaluation has been due to fundamental activities and pressure be it regulators, thefts from exchanges and individuals, and other negative publicity. Therefore, when one crypto asset is impacted, this propagates to completely different cryptos using totally different technology on a bear or bull trend on the mainstream assets by market volume. Another fact is liquidity is in the hands of a few and based on the total number of crypto assets actively trading daily vs the number in circulation. There isn’t the same sense of liquidity that is present in other markets.”

If crypto-assets fall victim to high correlation coefficients, would it be possible to diversify away risk in an equally weighted cryptocurrency portfolio by adding more crypto-assets?  To answer this question we will analyse the expected returns and standard deviations (SD) from a series of portfolios constructed from Bitcoin, Ether, Litecoin, and Ripple.  All the data analyzed consists of yearly prices taken on Oct. 5, as the first day for the earliest year available.

Single asset portfolios



Bitcoin’s blockchain was launched on Jan. 3, 2009. Based on the yearly returns from 2010 to 2017, with a portfolio that consists of only Bitcoin, you can expect a 194.2 percent return on average. The standard deviation – the amount you can expect the returns to deviate from the average – associated with holding a portfolio of only Bitcoin is 168.8 percent. This means that the returns you can expect from Bitcoin could deviate 168.8 percent above or below the average return.


Ethereum was released on July 30, 2015 as a blockchain network that allows companies to create applications, contracts, or systems via programming on the Ethereum network. The data for Bitcoin and Ethereum in this article was pulled from 99Bitcoins.

If you hold a portfolio that consists of only Ethereum, you can expect a 307.29 percent return based on Ether’s yearly return data from 2015 to 2017. The standard deviation of an Ethereum only portfolio is 6.06 percent. This means that one can expect the yearly returns of Ethereum to be rather reliable and not stray too far from the average return of 307.29 percent. That being said, Ethereum has only existed for 3 years.  


Litecoin was released on Oct. 7, 2011, created from a fork in the Bitcoin Core blockchain. For that reason, Litecoin is very similar to Bitcoin, and that may be why Litecoin does not have its own white paper. Litecoin aims to solve some of the problems associated with Bitcoin such as network efficiency and transaction verification speed. The data for Litecoin in this article was pulled from Bitinfocharts.

Based on the yearly returns of Litecoin from 2013 to 2017, if you hold a Litecoin-only portfolio, you can expect a return of 136.1 percent with a standard deviation of about 163.6 percent.


Ripple was released in 2012 as a cryptocurrency and global remittance service for banks to make nearly instantaneous cross border payments for an amount lower than traditional transaction fees. The data for Ripple in this article was pulled from Coinmarketcap.

Based on the yearly returns from 2014 to 2017, with a portfolio that only consists of Ripple, you can expect a 80.3 percent return on investment. A Ripple-only portfolio has a standard deviation of about 182.5 percent.

Two asset portfolio

In a two asset portfolio the expected returns will increase in respect to every single-asset portfolio except when comparing the Litecoin-only portfolio to the LTC-XRP portfolio, the Bitcoin-only portfolio to the BTC-LTC and BTC-XRP pairs, and the Ethereum-only portfolio to the ETH-LTC, ETH-XRP, and ETH-BTC pair.


The expected return is the average of the returns from previous years. Because Bitcoin and Ethereum have relatively high expected returns in their single-asset portfolios, when you add either XRP or LTC to the Bitcoin or Ethereum-only portfolios, the lower expected return values of LTC and XRP drag down the overall expected return of the portfolio. For example: 2>1, 1+2=3, 3/2 = 1.5, 1.5 < 2.  

That is why the expected returns are lower for every two asset portfolio containing BTC, besides the BTC-ETH pair. In the BTC-ETH portfolio, Ethereum’s average return is higher than Bitcoin’s average return; so when the portfolio’s expected return is averaged, the expected return for the two-asset portfolio is higher than the expected return for the BTC-only portfolio – for example  2 >1, 1+2 =3, 3/2 =1.5, 1.5>1.

The standard deviation associated with a portfolio consisting of two assets is lower than the SD of every single asset portfolio (except when comparing the Ethereum-only portfolio to every other one containing Ethereum or the Litecoin-only portfolio to the LTC-XRP one).

The standard deviation of Ethereum is so low (6.05 percent) that when another asset is added to an Ether-only portfolio, the higher SD of the other asset raises that of the entire portfolio to a level higher than that of an Ethereum-only portfolio.

In the LTC-XRP portfolio, the standard deviation of the portfolio is 4.77 percent higher than SD of a Litecoin-only portfolio (163.6 percent). For most investors, this may be nothing to sneeze at, but it all depends on the level of risk that an investor is able to tolerate.

Three asset portfolio

In a three-asset crypto portfolio, the expected returns increase in comparison to every-two asset portfolio.

The standard deviation associated with holding a three-asset crypto portfolio will increase in comparison to every two-asset portfolio except those with LTC-XRP, BTC-XRP, and BTC-LTC, their SD will decrease when you add a third crypto-asset to the portfolio.


Four asset portfolio

In an equally weighted crypto portfolio that consists of BTC, ETH, LTC, and XRP the expected returns would decrease compared to those of every three-asset portfolio. The maximum decrease in expected return is 232.225 percent and comes from the portfolio that adds Bitcoin to the  ETH, LTC, XRP portfolio, and the minimum decrease in expected return is 119.159 percent and comes from the portfolio that adds ETH to the BTC, LTC, XRP portfolio.

The standard deviation would increase in respect to three out of the four three-asset portfolios, with the only decrease in the SD being in reference to the BTC, LTC, XRP portfolio by 4.91 percent.


So how to diversify away risk in crypto portfolios?

Although digital assets are highly correlated, it is possible to diversify away risk in a crypto-only portfolio by adding more crypto assets to the portfolio. It is possible to diminish standard deviation when you move from a single-asset portfolio to a two-asset portfolio in 3 out of the 6 possible two-asset portfolios; from a two-asset portfolio to a three-asset portfolio – in respect to 3 out of 6 two-asset portfolios, and in a four-asset portfolio – in respect to 1 of the 4 three-asset portfolios.

The reason you are able to diversify away risk in a crypto-only portfolio even though the crypto-assets are highly correlated could be because there are different types of risk, as Sumanov said to Cointelegraph.

“Diversification in a crypto-only portfolio can help with the following:

  1. Single asset risks. Risks of project failing, delisting from exchanges, ban from government, problems with team etc. Huge dump due to a major holder deciding to sell all his holdings one day and many other risks, that are connected  with holding only a single asset. For example, TenX token (ticker PAY) declined a lot in price after Wirex Company declined their contract for cryptocurrency card issuing due to EU regulator.
  2. Connection of portfolio value to average industry growing. If you invest in just single or few assets, it is like playing the lottery. Your assets can perform differently – one could grow fast, and another could just make +10 percent  and that is all. So, portfolio diversification gives you the opportunity to receive profit from the whole market growing and not depend just on having faith in one coin.
  3. You can make different portfolios (for example high-risk, average, low risk) and receive profit that will be “averaged” on risk type.”

Even though digital assets are highly correlated, it is possible to mitigate the amount of risk you are exposed to by investing in multiple crypto assets instead of only one crypto-asset. This is reminiscent of the old adage “you should not put all your eggs in one basket”. By investing in multiple crypto-assets it is possible to spread out the amount of risk you are exposed to instead of having all of the volatility of the portfolio come from one asset. By spreading the risk over several assets, it could be also possible to increase the expected returns of a portfolio while diminishing the amount of standard deviation of the portfolio.


When comparing all six two-asset portfolios to the four single asset portfolios, it is possible to increase expected returns in respect to at least one of the single-asset portfolio. Comparing the three-asset portfolios to the two asset portfolios, it is possible to increase expected returns in all four three-asset portfolios, and when comparing a four-asset portfolio to the three-asset portfolios, it seems not possible to increase expected returns in comparison to the three-asset portfolios.

The analysis shows that spreading wealth over a number of assets, instead of putting all into one, could diversify away the idiosyncratic risk that is unique to a particular digital asset, and the more risk one is able to diversify away, the better situated he could be to protect himself against losses in the cryptocurrency portfolio.

The views expressed here are the author’s own and do not necessarily represent the views of

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Lightning Network May Not Solve Bitcoin's Scaling 'Trilemma'

Frances Coppola spent many years working in banks and IT, and now writes and speaks about finance, banking and economics.

Bitcoin has proven incapable of accommodating growing demand without deviating considerably from Satoshi Nakamoto’s original vision of a “peer-to-peer electronic cash system.”

It was intended to provide a fast, secure and inexpensive means of making payments without using the traditional financial system. Today it still only manages a tiny proportion of the traffic of, say, Visa or Mastercard, yet has become cripplingly slow and very expensive.

Solving bitcoin’s scaling problem has become a principal concern of developers. But the problem has proved intractable.

Now, making a virtue out of necessity, the buzz is that bitcoin is “digital gold.” Its built-in limit of 21 million bitcoins makes it an ideal anchor for a hard-money financial system similar to a strict gold standard. A new payment system could be built on top of it.

The problem is, it isn’t possible to have full decentralization, a fixed money supply and sufficient liquidity for an efficient payments system. This is bitcoin’s “trilemma.”

Immobile money

In the gold standards of old, there was no trilemma. They were always centralized.

For example, the “classical” gold standard of the 19th century was the heyday of the British Empire, which at that time covered a third of the globe. The pound was the currency of international trade, and it was backed by gold.

Countries in the empire were forced on to the gold standard by the British government; countries outside the empire joined the gold standard, or even adopted the pound as their currency, because it made trade much easier.

In the center of the web, the Bank of England managed both the price of gold and pound issuance. It was the most centralized financial system since the Roman Empire.

But for bitcoin, the fact that it is designed as a decentralized system means something else has to give. And the clue is its rapidly rising price.

Bitcoin is becoming illiquid.

Bitcoin’s growing illiquidity is due to a toxic combination of high demand, hoarding and designed-in scarcity. The rapid price rise indicates that purchases have increased much more than sales. More and more people are buying bitcoin in the hopes of cashing in as the price rises, while those who already own bitcoins are Holding On for Dear Life for the same reason.

People are also reluctant to spend their bitcoins, because that rapidly rising price means that they face huge opportunity costs.

And although bitcoins are still being mined, the rate at which they are mined is nowhere near enough to meet demand – and anyway, miners too can HODL their bitcoins.

Meanwhile, rising transaction volumes are causing network congestion. Bitcoin has no means of adjusting capacity other than rationing verification. Miners verify transactions with higher fees more quickly than those with lower fees. Those who want fast verification (which is nearly everyone, since bitcoin’s price is rising so fast) will pay higher fees. Those who don’t want to pay higher fees must wait longer for their transactions to settle.

Bitcoin’s popularity therefore means both higher transaction fees and slower settlement times. The design feature intended to prevent it coming to a hyperinflationary end is driving it towards deflationary gridlock. As Business Insider asked, what on earth is the point of money that you can’t spend and can’t convert to anything else?

But is there a way round this problem? The clever folks working on the Lightning Network think so. Their solution is to take most transactions off-chain, and to share liquidity across the network.

Supply shortfall

Lightning is a decentralized network of pre-funded, bilateral bitcoin payment channels off the bitcoin blockchain. Lighting transactions are typically small, and most are not broadcast to the blockchain. So they should be much faster and cheaper than on-chain bitcoin transactions.

Assuming enough people open Lightning payment channels, there will eventually be a sizable bitcoin liquidity pool distributed across the network. The question is, how to enable it to be shared.

Lightning developers are designing a routing facility that identifies which network nodes have sufficient funds to make a payment, calculates the shortest viable route to the payment destination across those nodes, and sends the payment. If this works, it would resolve the bitcoin trilemma.

But it is not certain that it will work. There are two potential problems.

The first is that Lightning’s pre-funded channels tie up funds that could be used for other purposes. Because of this, people may choose to keep very low balances in their Lightning channels, topping them up frequently rather than making infrequent balance adjustments.

And the second is that channel funding changes constantly. Typically, people would fund their channel, then pay the balance down gradually. Soon after funding, there could be quite a large balance, but only a few days later, the balance might have diminished considerably.

If a lot of people fund their channels at around the same time – for example, if people fund their channels on payday, then pay them down over the next month – liquidity across the network could vary considerably. This would mean that, at times, particularly for larger payments, it could be difficult or even impossible to find a payment route.

As it stands, therefore, Lightning could prove as illiquid as bitcoin.

Lightning’s illiquidity problem could be solved by creating large payment channels kept open and fully funded at all times, so that they were always available for payment routing. But this would mean Lightning was not fully decentralized.

Such “hub” channels would be more efficient for payments, but they would be a magnet for thieves and a point of weakness in the network. If one went down, an awful lot of payments could be disrupted.

The alternative would be to allow channels temporarily to go into deficit as a payment passes through. This would ensure that payments always settled.

But since it is effectively fractional reserve lending, it would breach the “gold standard” principle of bitcoin. If gold is needed to settle payments, and you haven’t got enough gold, you can’t settle payments. That’s how a gold standard works. It is also why it fails.

Lightning is still a work in progress, of course. But at present, it is hard to see how it can resolve bitcoin’s three-pronged problem.

Neptune and trident image via Shutterstock

The leader in blockchain news, CoinDesk strives to offer an open platform for dialogue and discussion on all things blockchain by encouraging contributed articles. As such, the opinions expressed in this article are the author’s own and do not necessarily reflect the view of CoinDesk.

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Why Bitcoin Needs Fiat (And This Won't Change in 2018)

Tim Swanson is the director of research at Post Oak Labs, a U.S.-based technology advisory firm, and the former director of research at distributed ledger technology consortium R3. 

The following article is an exclusive contribution to CoinDesk’s 2017 in Review series.

Imagine a parallel universe in which the U.S. economy could only grow at $50 every 10 minutes generating a mere $2.6 million of output per annum. That due to a hard-coded economic planning computer program, every four years the income its inhabitants collectively generated divided in half. Such that in year nine, its output shrank and was $12.50 every 10 minutes or $657,000 a year.

That is to say, irrespective of how productive and skilled the labor force became or how large the labor force grew, the productive output in the U.S remained fixed and static with the only change (downward in this case) occurring just once every four years.

How many people would volunteer to live and work in that “Upside Down” world?

This situation effectively mirrors the static, internal economy of bitcoin and many other cryptocurrencies.

For instance, with proof-of-work networks like bitcoin, the marginal productivity of labor is zero. It does not matter how many more units of labor are added to the income generation (mining) process as the network will always produce the same amount of economic output.

Today, after nearly nine years of operation, the bitcoin network – better referred to as Bitcoinland – generates 12.5 bitcoins roughly every 10 minutes. Irrespective of external economic conditions, of demand, the Bitcoinland economy will generate about 657,000 bitcoins per year in its third epoch.

While comparisons with aggregate measurements like GDP and money supplies may be an imperfect analogy, the fact that economic expansion as measured in output can – with the exception of a fork and rule change – never change in bitcoin due to its inelastic coin supply is arguably detrimental to its unit of account.

The purposefully planned sameness is often extolled as a “feature not a bug,” and many cryptocurrency enthusiasts like to daydream for when regulators and financial institutions of our own world disappear, eaten up by grey goo nanites funded by bitcoins.

But before bitcoiners can reach their Upside Down nirvana state, they need to resolve the underlying omnipresent economic calculation challenge facing their security system and labor force.

The phenomenon is simple to describe: virtually no participant in Bitcoinland conducts economic calculations (such as pricing) for any goods or services in cryptocurrencies such as bitcoin.  There are many reasons for this, including chronic volatility.

Courtesy of J.P. Koning

Or increasingly high ($10+) transaction fees that result in hemorrhaging of merchants (even their very own Cobra Commander acknowledges this issue).

But for this article, let’s put aside the typical discussion of payments and merchants and instead focus on labor.

Labor force

If Bitcoinland is viewed as its own sovereign (virtual) nation-state, the only wages any native participant receives in return for any kind of service rendered is what miners are paid to solve and “vote” on a benign problem about once every 10 minutes.

From the perspective of the network: developers, maintainers, administrators, enthusiasts, Twitter sock puppets, meme artisans, flame war veterans, self-appointed thought leaders, pumpers, hat wearers, etc., are all viewed as foreign third parties and can only receive bitcoins after they are first minted by the miners.

Much like multinational corporations (MNC) with large overseas operations, miners of cryptocurrency networks as a whole do not measure the income they receive in terms of bitcoins (or other discrete cryptocurrencies), but instead they measure their income in terms of “fiat” from foreign financial markets, specifically converting bitcoins into the local fiat currency where their mining operation physically resides.

However, unlike MNCs that eventually repatriate some or all of their capital back to their headquarters, aside from a recycling of coins into ICOs, most cryptocurrency-focused companies are still dependent on what amounts to foreign domestic income (FDI), regular injections of foreign capital from venture firms in order to grow or even measure enterprise valuations.

Miners do this because the unit of account for fiat currency is typically stable and liquid, such that they can pay wages to their employees, pay rent, electrical costs, property taxes, etc. There are exceptions to stability, such as planned economies of Venezuela and Zimbabwe which have suffered from years of political chaos, but in general, most developed countries and even developing countries have relatively stable domestic currencies relative to Bitcoinland.

And because bitcoin is still not used as a unit of account, its labor force (miners), rely on a third-party reference data in order to conduct all economic calculations.  That is to say, in order for Bob the miner to accurately calculate if he should increase or decrease consumption (and investment) of capital, or to measure whether his mining operation is profitable, Bob projects future revenue based on a unit of account that is stable, in this case, currency from foreign capital markets.

During the Cold War there was a joke in academia: that the Soviet Union would conquer the world with the exception of New Zealand (other versions used Switzerland as the cut-out). New Zealand would be left alone because the Politburo needed a functioning market so that the Soviets could know what the market prices were for goods and services.

While Bitcoinland may be attracting large sums of foreign capital, miners continually still need very liquid over-the-counter (OTC) and spot exchanges denominated in foreign currencies because it is with these foreign currencies that they pay their bills.

In this case, despite their own defects and problems, the U.S., eurozone, Japan, South Korea, China and several other countries effectively stand in for “New Zealand,” such that the national currencies and prices in these countries reflect dynamic economic conditions that bitcoin miners can use as reference rates in their capital consumption projections.

Final remarks

In 2018, just as the past nine years, miners will still depend on foreign financial markets for both stable pricing and liquidity. If the existing traditional financial markets became chaotic and unstable, miners would be unable to rationally plan and allocate for future investments.

For instance, the unseen costs of hash generation for a hypothetically stable $20,000 bitcoin would be about $13 billion in capital consumed by miners in their rent-seeking race.

And that is just one proof-of-work coin. If there were dramatic bouts of volatility, or even an extended bear market, this could result in bankruptcies like CoinTerra, HashFast or KnC previously went through, though that is beyond the speculation of this article.

Ironically, despite all the bluster, because cryptocurrency ecosystems lack a circular flow of income, they will still be dependent on the very financial system they vilify for daily support and stability.

And while there have been many “stablecoin” projects announced and launched over the past year, nearly all of them are not only dependent on commercial bank accounts, but also on the economic stability of a specific economic region they aim to serve. Guess what set of entities provides that type of relative stability?

Ideological enthusiasts will likely resort to whataboutisms and respond by bitcoinsplaining: how dirty filthy statists will censor your virtuous darknet market transactions and that maintaining proof-of-work networks is worth any cost to the environment! But again, that is for a snarky article on a different day.

Empirically with proof-of-work-based blockchains, the labor force and the liquidity providers all still depend on functional, mature foreign capital markets in order to convert their coins into real money. Perhaps this will change as more hedging products, courtesy again of foreign financial markets, are brought online.

While the traditional financial markets will continue to exist and grow without having to rely on cryptocurrencies for rationally pricing domestic economic activity, in 2018, as in years prior, Bitcoinland is still fully dependent on the stability of foreign economies providing liquidity and pricing data to the endogenous labor force of bitcoin.

Too much macroeconomics for you? CoinDesk is accepting submissions for its 2017 in Review series. Email to tell us your thoughts on the year ahead.

Upside Down world image via “Stranger Things” Facebook page.

The leader in blockchain news, CoinDesk strives to offer an open platform for dialogue and discussion on all things blockchain by encouraging contributed articles. As such, the opinions expressed in this article are the author’s own and do not necessarily reflect the view of CoinDesk.

For more details on how you can submit an opinion or analysis article, view our Editorial Collaboration Guide or email

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'Wealth Effect' From Bitcoin Trading Could Boost Japan's GDP, Say Analysts

Analysts from Japanese financial holdings company Nomura have estimated that the rise in the value of bitcoin could boost Japan’s economic growth.

Analysts Yoshiyuki Suimon and Kazuki Miyamoto said on Friday that the “wealth effect” arising from the massive gains in the price of bitcoin could increase the country’s GDP by 0.3 percent, a Bloomberg report says.

According to the researchers’ prediction, gains from bitcoin trading by Japanese investors could see consumer spending increase in the range of 23.2 billion–96 billion Japanese yen ($206.5 million–$854.4 million).

A report published Friday by Yoshiyuki Suimon’s team noted:

“Moreover, the fact that the rise in bitcoin prices was concentrated in 2017 Q4 could result in the wealth effect materializing in 2018 Q1, and if that is the case, we estimate a potential boost to real GDP growth on an annualized quarter-on-quarter basis of up to about 0.3 percentage points.”

Describing the “wealth effect” as the increase in consumer spending resulting from a rise in asset values, the team further stated, “Although Japanese investors’ unrealized gains are unlikely to feed straight through to their patterns of consumption, it is common knowledge that personal consumption is bolstered as a result of increases in the value of asset holdings.”

According to a CNBC report, the Nomura team also acknowledged a statement from the governor of Bank of Japan, Haruhiko Kuroda, who said in late December that speculation has led to the rise in bitcoin price.

Nomura building image via Shutterstock

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Bitcoin No Threat to Financial Stability, Say European Economists

A group of European economists believe bitcoin is no threat to the financial stability, although regulatory oversight needs to be increased, new research shows.

In a survey published yesterday by the U.K.-based Center for Macroeconomics, 100 prominent European university economists were asked for their thoughts regarding the recent market growth of bitcoin and cryptocurrencies.

According to the results from the 50 respondents – in response to the question “Do you agree that cryptocurrencies are currently a threat to the stability of the financial system, or can be expected to become a threat in the next couple of years?” – nearly 50 percent of the respondents said they “disagree,” while another 25 percent “strongly disagree.”

Some economist argued that, even with a near-$300 billion market capitalization, bitcoin is still trivial compared to the overall financial market.

For example, Michael McMahon, professor in economics from the University of Oxford, was quoted as saying:

“Cryptocurrencies are still too small and lacking in widespread ownership, especially among large investment groups, to be a serious risk to the overall financial system.”

Similarly, Ethan Ilzetzki, assistant professor from the Economics Department Centre for Macroeconomics at London School of Economics, called bitcoin and other cryptocurrencies “a toy for a very narrow segment of investors.” Further, they are “detached” from the financial system and the “real economy,” he said.

While not recognizing bitcoin as a threat, a majority of the respondents still expressed concerns around the role of bitcoin and its challenge to traditional central bank-issued currencies. In fact, 61 percent of the interviewees either “agree” or “strongly agree” that regulatory oversight of cryptocurrencies needs to be increased.

For instance, Sylvester Eijffinger, professor of financial economics at Tilburg University, argued that cryptocurrencies are “undermining the monopoly of money creation by the central banks and [leading to] the ineffectiveness of conventional and unconventional monetary policy.”

However, as recently reported, the European Central Bank takes a somewhat different view on bitcoin. Addressing the European Parliament late in November, the president of the ECB, Mario Draghi, stated that digital currencies are “not yet something that could constitute a risk for central banks.”

Stacks of coins image via Shutterstock

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Nobel Winner Robert Shiller: Bitcoin Is Too 'Ambiguous' to Value

Nobel Prize-winning economist Robert Shiller believes there’s no clear way to put a price on bitcoin.

“I think the value of bitcoin is exceptionally ambiguous,” he told CNBC today.

The comment is perhaps notable in that it comes from a legendary economist who gained long-term credibility following his work around the 1987 stock market crash and the housing bubble in 2008. He received the Nobel Prize in Economics in October 2013.

Yet speaking to the network, Shiller argued that it’s difficult to peg the fundamental price of bitcoin, remarking:

“You just put an upper bound on [bitcoin] with the value of the world’s money supply. But that upper bound is awfully big. So it can be anywhere between 0 and there.”

That same sentiment was reflected in Shiller’s recent op-ed article for The New York Times, in which he wrote: “How can we even start estimating the fundamental value of bitcoin, with its astonishing market value of more than $275 billion? Any attempt will soon sound silly.”

Bitcoin’s price has surged in value since the beginning the year, climbing from $800 last January to a new record of almost $20,000 this weekend, according to CoinDesk’s Bitcoin Price Index.

Shiller cited a phenomenon that may explain the reasons behind such a phenomenal market rally. According to neuroscientists, he said, our brains work differently when making choices in a stressful, ambiguous environment.

“You might think people who are educated will transform the decision problem into something precise … But it doesn’t seem like the brain is doing that,” Shiller told CNBC.

Robert Shiller image via WEF/Wikipedia

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Disclaimer: This article should not be taken as, and is not intended to provide, investment advice. Please conduct your own thorough research before investing in any cryptocurrency.

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Ex-IMF Economist Kenneth Rogoff Joins 'Bitcoin Will Collapse' Chorus

Another prominent member of the financial establishment has predicted that bitcoin will crater, while still professing admiration for the technology behind it.

“My best guess is that in the long run, the technology will thrive, but that the price of bitcoin will collapse,” Kenneth Rogoff, a former chief economist of the International Monetary Fund, wrote in an op-ed published Monday in The Guardian.

Like JPMorgan Chase CEO Jamie Dimon, Rogoff based his bearish take on the assumption that the world’s governments would not allow a borderless, pseudonymous system of value transfer to grow significantly.

Calling it “folly” to assume that bitcoin would be allowed to replace money issued by central banks, he said:

“It is one thing for governments to allow small anonymous transactions with virtual currencies; indeed, this would be desirable. But it is an entirely different matter for governments to allow large-scale anonymous payments, which would make it extremely difficult to collect taxes.”

Rogoff famously advocated for phasing out large-denomination bills as a way to combat tax evasion and aid central banks in implementing monetary policies in his book “The Curse of Cash,” published this year, and struck similar notes in his op-ed.

For example, he went on to suggest cryptocurrency is even more suited to illicit purposes than the proverbial briefcases full of banknotes.

“Cash at least has bulk, unlike virtual currency,” he wrote.

Rogoff also offered his disapproval for Japan’s recognition of bitcoin as a legal method of payment.

While the government in the East Asian country has told cryptocurrency exchanges to identify customers and monitor transactions for suspicious activity, he argued that “global tax evaders” would likely attempt to acquire bitcoin anonymously and then launder it in Japan.

Perhaps unsurprisingly given this take, he concluded by expressing his hope that other countries won’t follow Japan’s lead.

“Carrying paper currency in and out of a country is a major cost for tax evaders and criminals; by embracing virtual currencies, Japan risks becoming a Switzerland-like tax haven – with the bank secrecy laws baked into the technology,” he wrote.

Kenneth Rogoff image via CNBC/YouTube

The leader in blockchain news, CoinDesk is an independent media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. Have breaking news or a story tip to send to our journalists? Contact us at [email protected].

Disclaimer: This article should not be taken as, and is not intended to provide, investment advice. Please conduct your own thorough research before investing in any cryptocurrency.

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Philadelphia Fed Chief: Bitcoin Has Yet to Be Tested

Bitcoin and other cryptocurrencies are unlikely to weaken the Federal Reserve’s influence on the U.S. economy.

That’s according to the president of the Federal Reserve Bank of Philadelphia, Patrick Harker, who issued the new remarks on the second day of a fintech event hosted by his organization, one of 12 regional institutions that today comprise the U.S. central banking system.

But while some have worried that the rise of a cryptocurrency would make it harder for the Fed to manage the rate of inflation, Harker showed that he isn’t concerned about the prospect.

Onstage, he went so far as to contend that bitcoin has yet to be tested by a real catastrophe, but that when one happens, people will be more likely to flock to government-backed money.

“The paper that’s in your pocket, that we call money, only has value because we believe it has value, because we believe the government stands behind it. It’s all trust issues,” Harker said.

He told attendees:

“And so, when cryptocurrencies and other forms of currency emerge, I think the basis of that has to be how do they create that trust?”

Trust in the government

Harker went on to acknowledge that while citizens have put varying degrees of trust in what he called the “sovereign states” that stand behind currencies today, other currency models might be possible. This includes, he said, ways in which trust might come from another “large player,” or as in the case of bitcoin, an algorithm.

But his most pertinent critique was perhaps that cryptocurrencies have not been significantly tested enough to ensure confidence.

Despite issues such as the collapse of Mt. Gox, once the bitcoin’s network’s largest exchange, or the ongoing bitcoin scaling debate, Harker argued that cryptocurrency has been largely insulated from “bad times.”

“Everything can work in good times,” he added.

This leads to the second reason Harker said he’s not concerned about cryptocurrency hamstringing the Fed’s monetary influence: If – and, according to Harker, when – things go wrong, the Federal Reserve and other state agencies will likely be asked to get involved anyway.

“When things really go bad, where do Americans turn?” he asked “Well, they’re going to come back to the government. That’s the history of the country.”

‘How do you regulate an algorithm?’

Elsewhere, Harker responded with his thoughts on cryptocurrency regulation, with his interviewer, [email protected] founder Mukul Pandya, asking directly how the Federal Reserve might assist or advise on such a strategy. (The Federal Reserve has previously noted that it does not have the authority to directly regulate the technology.)

On this point, he was inconclusive, suggesting any ideation is today in early stages.

“How do you regulate an algorithm?” he asked, drawing laughs from the audience. “I don’t know yet. The answer is we have to continue to study this.”

Still, that doesn’t mean there aren’t possible next steps.

For example, those studies might include looking more closely at how another algorithm, perhaps one created by the Federal Reserve, might ensure fairness in mathematical form, something Harker said is crucial to any potential cryptocurrency controls.

He concluded:

“Before we even think about how you regulate an algorithm, how would you even build an algorithm that would have that sense of fairness in it? It is a fairly deep technical question.”

Patrick Harker image via Federal Reserve

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The Economic Case for Conservative Bitcoin Development

Ariel Deschapell is a full-stack javascript developer teaching at the Ironhack coding bootcamp in Miami, and a recent Henry Hazlitt fellow in Digital Development at the Foundation for Economic Education.

In this opinion piece, Deschapell discusses the tensions underlying bitcoin’s scaling debate, arguing those who have approached the protocol’s design with more caution are perhaps doing so with history on their side.

The way we think about bitcoin, its use cases and its subsequent road to adoption fundamentally underlies the scaling and governance debates at the heart of forks like bitcoin cash and Segwit2x.

As an unprecedented technology, bitcoin’s refusal to fit into any predefined conceptual pigeonhole continues to give fits to regulators and traditional financial intermediaries alike. But, this presents a problem to its advocates too, who rely on their own idealistic notions and necessarily incomplete understandings of bitcoin.

Economically, the way we think about bitcoin is also shaped by the way traditional money and payment systems have evolved and developed. These systems are our only frame of reference, but in using them as such, we must make use of sound economic theory or risk many intellectual pitfalls.

At the center of these considerations is the idea of bitcoin as a new type of money. Given its use as a means of exchange in many online and in-person payment gateways, it seems to be an easy jump to call it money just like the U.S. dollar or Japanese yen. Bitcoin was originally proposed as a “peer-to-peer digital cash” after all, and its most ardent maximalists aspire to have it replace the national patchwork of fiat currencies as the primary means of exchange around the globe.

However, bitcoin is not money – at least not yet.

Believing otherwise based on its use and characteristics as a usable medium of exchange is an erroneous conclusion, and worse, it can lead to problematic and ultimately harmful implications for its future development.

To ultimately have the best chance of establishing bitcoin as money, we must understand the nature and origin of money, and in that context the technical challenges facing any cryptocurrency.

The origin of money

Long prior to bitcoin, the economist Ludwig von Mises ingeniously articulated and expanded upon the Austrian school of economic thought regarding the nature and evolution of money.

In what is known as the “regression theorem,” Mises observed that all money originates as a universally valuable commodity before it ascends to becoming a medium of exchange, and then only subsequently, money proper. This was why the first widely used mediums of exchange were metals such as gold and silver.

These commodities were valued for their unique properties, ones which would also later make them very effective means of exchange and ultimately good money.

Gold and silver were both aesthetically attractive and relatively easy to clean. However, they were also malleable, easily divisible and completely uniform. Gradually, over thousands of years, these commodities supplanted barter as a much more efficient way to stimulate trade for ancient peoples.

In turn, this gave way to more convenient “banknotes,” or claims on gold and silver in a vault, and of course, fiat money, as governments discovered the power of appropriating control of the money supply. Digital replacements for this legal tender came even later.

This evolution of money took place gradually over thousands of years – and bitcoin stands in stark contrast. From its inception, dividing and sending bitcoins to and from addresses was a fairly trivial task. Within a few years, spending it at a number of online websites and even brick-and-mortar stores was a straightforward affair.

To the casual observer, it may seem as if bitcoin disproved Mises’s regression theorem: a purely conceptual number on a ledger that spawned from nothing and became a means of exchange almost overnight.

If only it was that simple.

The money test

At this point, it’s necessary to identify what money is and why it matters.

As defined by Merriam-Webster:

“Something generally accepted as a medium of exchange, a measure of value, or a means of payment.”

Wikipedia’s definition:

“Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts in a particular country or socio-economic context.”

The common denominator here is “generally accepted,” a standard that is a bit arbitrary but nonetheless is hardly met by bitcoin today.

Yes, many goods and services can be bought with bitcoin. But this doesn’t make it money any more than the hypothetical ability to spend wheat futures digitally would make wheat futures money.

It is technically possible to accomplish this much the same way as the majority of bitcoin commercial transactions work in practice: by instantly converting what the merchant receives into fiat currency, the real money still making this exchange possible.

Confusion on this point stems from our historical experience of currency (dollar, yen) and the systems used to facilitate their transfer of ownership (debit cards, checks, bank wires) being traditionally separate.

Bitcoin meshes the two into one. The protocol both establishes a provably scarce digital good and easily facilitates changes in their ownership regardless of geographic space. Yet, while this technological property gives the token significant utility and makes it easy to spend with the use of clever software and third parties, it does not make bitcoin money.

For bitcoin to be considered money, it must be generally accepted and used within a closed loop. Merchants must not only much more widely accept it as a payment option, but also feel fully confident in holding the actual bitcoin itself.

Establishing a store of value

After establishing that bitcoin cannot yet be considered money, suddenly the regression theorem becomes far more interesting and practical. If bitcoin is not money, then what is it? The only remaining answer is a valuable commodity, which brings us to the very beginning of the regression theorem.

Like gold and silver, bitcoin possesses unique properties that are valued by individuals. The fact that it remains entirely digital is not a problem conceptually, it only makes it unprecedented and therefore harder to grasp. But physicality isn’t a necessary prerequisite for a good to have market value.

The only prerequisite is scarcity. Through the ingenuity of its blockchain architecture, bitcoins became the first provably scarce digital good.

The attractive properties of this digital good can be said to include its extreme divisibility, fungibility and its hard limit on supply. Still, other alternative currencies were created in the past with all these properties, including the Liberty Dollar and E-Gold. These attempts were quickly shuttered by governments in the interest of maintaining their monopoly on currency issuance.

Bitcoin was different for what quickly became and remains its foremost feature: its resistance to censorship.

This is the bedrock of bitcoin’s usefulness as a store of value. The ability to hold wealth outside the system and largely outside of its reach is the original killer application for bitcoin. It is tied to the protocols functions of both establishing a scarce store of value and facilitating their transfer, regardless of physical space or the objection of any single third party.

However, to take this functionality for granted betrays a massive under-appreciation, if not complete misunderstanding, of the technology involved and its very real limits.

In software as with the world, security and safety are never a permanent state of affairs. Any computer network ever devised can be attacked, and attacked successfully at a high enough cost. Bitcoin’s brilliance is that its incentive architecture and resulting infrastructure makes the cost to attack and successfully disrupt the network very high.

The fact that it has been running without interruption for close to nine years is nothing short of a software miracle that speaks to the ingenuity and brilliance of the system’s design. However, past performances are never a guarantee of future results. This is even more so when it comes to something still as new and experimental as bitcoin.

The real challenge

To see why this is the case, we have to understand basic risk and threat analysis.

Imagine a computer system that, if compromised, gives an attacker $100. Now, if the cost to compromise that system is $10, then doing so is a worthwhile endeavor. However, if the cost to do so is instead $200, it clearly is not. In this simplistic example, the system can be considered hypothetically secure only in the latter case.

To date, it can be said the cost of disrupting bitcoin has always exceeded the value of doing so, as is evidenced by its successful continued operation. While quantitatively measuring the cost of compromising the bitcoin network is tricky at best, let’s first assume that it remains fixed.

If bitcoin continues to grow and add value to its ecosystem, the potential returns to be made in disrupting it also continue to increase. If the cost of compromising it remains the same all the while, it must eventually become cost-effective for some entity of sufficient resources to indeed compromise it. By its ambitious nature, there is no shortage of large and resourceful entities which bitcoin’s success continues to threaten.

Indeed the larger and more successful it becomes the greater the size, number, and motivation of such potential adversaries.

We’ve established that to become money bitcoin must be generally accepted and used within a closed loop. This is only possible if it first becomes a stable store of value, and even this long process has a necessary prerequisite: that bitcoin continues to be a secure store of value.

For it to ever have a chance at accomplishing this demands then that it must not only just maintain its security as it continues to scale to and increase in value. It must actually increase security as the network continues to scale and increase in value.

Cart before the horse

This is the central challenge facing bitcoin scalability.

It is not enough for it to simply handle more and more transactions cheaply. It must do so while preserving its most foundational feature, that of censorship resistance. Only by accomplishing that can it remain a trusted store of value on a fundamental technical level, and only after continuously proving this with more users and more wealth can it gain enough adoption and market confidence that it ultimately becomes a stable store of value. Then only subsequently can it become money

Only by accomplishing that can it remain a trusted store of value on a fundamental technical level, and only after continuously proving this with more users and more wealth can it gain enough adoption and market confidence that it ultimately becomes a stable store of value. Then only subsequently can it become money proper.

Assuming bitcoin is money first and foremost today, and concluding that it must immediately compete with the transaction times and fees of popular money transmitter apps like Venmo, is putting the cart before the horse.

Even worse, these assumptions have led to proposals that proactively sacrifice network security in favor of cheaper fees and other such secondary concerns.

This is the reason why I’ve previously written that the trade-offs from increasing the block limit as implemented by bitcoin cash and proposed by Segwit2x are not advantageous. There is only problematic reasoning behind how such proposal increase the rate of adoption and very real long-run security concerns that remain unaddressed.

Of course, it is possible to disagree on these finer points. One can agree with the sentiment expressed here and also earnestly believe that the block size or other protocol changes won’t fatally impact block propagation, node numbers or miner centralization. Open discussion, debate and even open competition is key to finding the best way forward.

However, given the undeniable and fundamental importance of bitcoin’s censorship resistance in its value proposition, the burden of proof clearly rests on those who would change the protocol to show how such changes either do not impact the network’s distribution and security, or why such a tradeoff is otherwise desirable or urgently necessary.

Censorship resistance is simply too important to risk, especially when more secure approaches to scaling are readily available.

An issue of perspective

Bitcoin is not a short-term project or investment. Neither is its continued success a sure thing.

Make no mistake, continuing to upgrade bitcoin to handle true widespread adoption while maintaining its censorship resistance is a monumental task fraught with many risks and unknowns. Accomplishing this would be nothing short of an unprecedented feat of software engineering and human coordination, and would likely have a larger societal impact than any single previous technological advancement in history.

There exist no shortcuts through the careful and intelligent development needed to make this dream a reality.

Those who are impatient for bitcoin’s widespread adoption and use as money should look back at the history of traditional money for a sense of perspective. It took millennia for gold and silver to be established as universal means of exchange and money proper. It took centuries if not millennia more for these to be replaced by more abstract concepts such as banknotes and fiat currency.

By comparison, bitcoin is the first scarce digital good, and the first instance of a whole new asset class spontaneously appearing from the ether. With this in mind, the progress it has made in nine short years is both shocking and awe-inspiring.

Needless to say, it will take much longer than a decade for markets to fully embrace bitcoin with the same faith they have in fiat currencies today. But should it take even 100 years to accomplish this, it would remain a blink in the eye of history.

A blink, we are all lucky enough to get to see.

Disclosure: CoinDesk is a subsidiary of Digital Currency Group, which helped organize the Segwit2x bitcoin scaling proposal.

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