Bindseil, Ulrich. et al. The encrypted threat; Bitcoin’s social cost and regulatory responses

on Tuesday, May 10, 2022

This paper, authored by By Ulrich Bindseil, Patrick Papsdorf and Jurgen Schaaf of the European Central Bank, digs into the social impact of Bitcoin and the regulatory decisions that are being made by state and international bodies in relation to this crypto asset.

  • Citation: Bindseil, Ulrich et al. ‘The encrypted threat: Bitcoin’s social cost and regulatory responses’ SuERF Policy Note, Issue No 262, January 2022
  • Wiki topic: Bitcoin


  • Key points:
    • Bitcoin technology is inefficient and vulnerable.
    • Bitcoin is not a currency (it is too volatile to fulfill the classic functions of money: unit of account, means of payment, store of value).
    • Bitcoin has not been uptaken as a means of payment outside of niches due to long settlement times and high fees.
    • Bitcoin is unsuitable and unsustainable as an investment asset.
    • The market valuation of Bitcoin is purely based on speculation. The Bitcoin hype has all the characteristics of a speculative bubble along the so-called greater fool theory.
    • The vision that Bitcoin can be a liberatory force is an illusion. Bitcoin neither empowers, nor relieves the sovereign individual from the state.
    • Illicit activity and Bitcoin are deeply entwined. Manipulation has been the cause of booms and Bitcoin is also popular for financing criminal activities.
    • Bitcoin is a negative sum game. It generates no value for society and comes with significant private costs in the form of high energy and hardware consumption of the Bitcoin network.
    • Regulators have been slow in addressing the societal impacts of Bitcoin. Why?
      • The potential development of social risks may have been underestimated.
      • Bitcoin raises multi-facetted threats and involves multiple actors. Regulatory responsibilities for Bitcoin are therefore fragmented. And the different risks to different sectors are continually changing and evolving.
      • Many aspects are new and do not fit into existing regulatory frameworks.
  • The threats are beginning to be recognized and a number of jurisdictions have taken or are preparing measures to regulate Bitcoin alongside other crypto-assets.
    • However, stances vary between authorities due to differing assessments of the value of crypto-assets.
    • Some bodies are introducing measures which legitimize Bitcoin and facilitate investment flows and the integration of Bitcoin into traditional financial systems.
  • Public authorities should:
    • Firstly, treat the Bitcoin network as rigorously as the conventional financial industry in terms of prevention of illicit payments, money laundering and terrorist financing.
    • Secondly, address the negative externalities of Bitcoin’s energy consumption.
    • Thirdly, deny recognition of Bitcoin as an investment and not allow it to become incrementally part of the regular financial system without strictest safeguards. Authorities should: strengthen global implementation of AML/CFT standards and broaden measures to stop Bitcoin being a vehicle for illicit purposes; and avoid measures that invite additional investment flows into Bitcoin.


1. Introduction

  • In November 2021, the market capitalization of crypto assets exceeded USD 3 Trillion for the first time, of which around USD 1.3 trillion were contributed by Bitcoin.
  • Summary of the underlying technology and the conceptual set up:
    • There is no central authority, but a global network of computers controls, monitors, and stores the system information. New Bitcoins are coined by decentralized “mining” by users and their computers. New data packets are added to the blockchain every few minutes. The maximum total number of Bitcoins is technically limited to about 21 million, of which just under 19 million are already in circulation. When this limit is reached the transaction fees become the only source of income for the miners, on whose existence Bitcoin depends in the long run. To prove the correctness of the entire blockchain and its extensions, computers must solve a mathematical puzzle for each block. The so-called miners validate the transactions by entering them into a public ledger. Currently rewards are the market value of a bitcoin minus the mining costs.
    • This proof-of-work method has a scalable difficulty level and aims to keep the incentive for miners to keep running the system sufficiently high. With a higher Bitcoin price, more producers are incentivised to compete for new coins. This in turn requires the encryption puzzle to be more difficult. By consequence, the miners will require more electricity to solve the puzzle and will consume more electricity and increase carbon emissions.

2. Vulnerability and inefficiency of the Bitcoin technology

  • Several authors have raised serious doubts concerning Bitcoin’s underlying technology and concept.1
    • The proof-of-work concept is generally recognised as cumbersome and slow.2
    • Slow and opaque pricing networks have traditionally attracted predatory high frequency algorithm traders and are vulnerable to related market stress (see the flash crash of 6 May 2010).
    • Bitcoin uses the secure hash algorithm (SHA) which is more than twenty years old. The U.S. Department of Defense and many leading IT firms like Microsoft found the SHA-1 standard too weak for cyber-protection and decommissioned its use in the early 2010s. In the absence of a central legitimized management it is hard to see how the fundamental security technology can be replaced in light of technological advances.
    • The Bitcoin network is prone to a so-called 51 percent attack, which occurs when miners (potentially malicious) gain control of more than 51 percent of the network's hash-rate: they could then issue coins twice.3
    • The Bitcoin network is already increasingly run by supercomputers and server farms and the incentive structure of retail miners might take a hit once all Bitcoins are minted and the reward system will rely on fees only. The hash-rate is consequently likely to be increasingly concentrated in the hands of a few.
    • Due to its reliance on proof-of-work, it wastes power and is an immense environmental polluter. The consumed energy further results in 95.9 metric tons of CO2, comparable to the carbon footprint of metropolitan London. The more energy the Bitcoin network uses, the more secure it is.

3. Bitcoin is not a currency

  • There is a broad consensus that Bitcoin fails in its original objective of being a currency.
  • Bitcoin is too volatile to fulfill the classic functions of money: unit of account, means of payment, store of value.
  • Moreover, the system is too slow and expensive to compete with established payment systems and currencies.
  • The lack of acceptance by merchants due to long settlement times and high fees (currently between USD 2.5 and 4 per transaction) already shows that Bitcoin cannot be understood as a means of payment outside of niches. Therefore, Bitcoin's business model as a global means of payment is not plausible.
  • On 7 September 2021, El Salvador tried to introduce Bitcoin as a second legal tender alongside the US Dollar. The launch was bumpy largely because there was no popular acceptance of the new means of payment. On the day of introduction, the Bitcoin exchange value plummeted by 15 percent, accompanied by protests targeted against President Nayib Bukele.
    • Important to note that payments through the Chivo Wallet are actually layered and not settled in the Bitcoin network. Instead, they are just internally settled by the wallet provider, who acts as custodian. Therefore, at best, the Chivo Wallet is a payment system backed by Bitcoin, but fully betrays the fundamental idea of overcoming the dependence of payments on centralized intermediaries.
    • President Bukele has launched new plans to push Bitcoin’s use and mining in El Salvador with a new city built around a Bitcoin industry. The construction financing and maintenance of the “Bitcoin City” would be based on new Bitcoin bonds; and the required energy taken from a volcano in the proximity.

4. Bitcoin does not appear to be a sustainable investment

  • One of the most popular arguments among Bitcoin supporters is that the limited supply of Bitcoin would make it a great asset to protect investors against inflation, while fiat money, which can be multiplied at will, would increasingly lose value.
  • Even if one were to assume that Bitcoin could become the new global money, its technically fixed “money supply” would lead the world into a deflation trap in a growing economy. In a deflation, falling prices of goods and services tempt citizens to postpone less urgent purchases into the future → aggregate demand suffers which slows down the economy.
  • The advocates of gold as a weapon against inflation – and those who praise Bitcoin for the same as reason as the new gold – should remember the reasons for the abolition of the gold standard. In 1931 major currencies gave up the gold peg after years of painful recession, deflation, and financial instability.
  • The often-used comparison to gold also fails for more basic reasons.
    • Gold is both used industrially and has been appreciated as jewelry for centuries before it became a store of value, an investment asset, or a reserve currency.
    • It does not degenerate over time and retains its value even in chaotic or degenerative states of the world like natural catastrophes or in the case of failure of the electric or digital infrastructure.
  • The objection that the fiat money of modern central banks also has no intrinsic value falls short: because in deliberately moving away from the gold standard, sovereigns and central banks have put in place clearly defined mandates, legal guarantees, institutional and operational arrangements (independence as well as loans against collateral) to be able to release the gold brake without losing stability.
  • The alternative of Bitcoin as a store of value is not predominantly central bank fiat money, but the financing through equity and/or debt of real economic projects which serve needs of society and generate a cash flow which allows positive yields to be sustained, anchoring the value of the investment assets in its real productivity.

5. Mounting doubts about the sustainability of Bitcoin

  • Bitcoin has no intrinsic value and does not generate a cash flow or dividends. The market valuation of Bitcoin is purely based on speculation. The Bitcoin hype has all the characteristics of a speculative bubble along the so-called greater fool theory.
  • Market interest has grown for newer blockchains that use smart contracts and aim to solve the challenges of earlier blockchains by introducing features to ensure scalability, interoperability, and sustainability. The biggest among the newer crypto-assets is Ether, which surpassed Bitcoin trading volumes earlier in 2021.

6. The illusion of liberation

  • Bitcoin is envisioned by some as a method of restoring freedom from government control and from centralized entities that abuse their power. This is an illusion:
    • Mechanistic rules, as Bitcoin appears to create, are not an appropriate solution for a changing world.
    • Bitcoin is by no means as grassroots democratic as its community may have believed in the early days. It is shaped by financial interests and powerful shareholders and the exposure to concentration risks, given its large reliance on a few entities, like custodial wallets and exchanges (for example, Binance handles more than half of trading volumes). 75 percent of the addresses holds just over 0.2 percent of the market share; the hundred largest Bitcoin shareholders hold more value than the smallest 38 million combined.4
  • Bitcoin offers a vision of a global means of payment without national jurisdictions. People could send value across borders for free and unhindered to anyone with a Bitcoin wallet.
    • This view ignores that the high cost of conventional cross-border payments is significantly due to costs of market and liquidity risk management and regulatory requirements to combat money laundering and terrorist financing. However, the cost of complying with these requirements, and provisions for legal and exchange rate risks only affect the regulated financial sector. The fact that some Bitcoin transactions, e.g. like peer-to-peer, have been able to escape this entirely so far is a regulatory gap, not a technological achievement.

7. The use of Bitcoin for illicit activities

  • The first bubble in 2013 was fuelled by the Mt Gox exchange which hosted about 70 percent of Bitcoin trading. The exchange lost 650,000 Bitcoins of its users and went bankrupt. Research suggests that the first boom – a rise from USD 100 to USD 1,000 in just two months - was due to manipulation of a trading software.5
  • The second and third booms were associated with the launch and rise of Tether. Tether is a so-called stablecoin, i.e. a type of crypto-asset that aims to maintain a stable value by being backed by fiat currency or other assets. Tether is nominally pegged one-to-one to the US Dollar and is backed entirely by cash-like assets. Investigations during the 2017 boom suggested that 50 percent of the sharp price increase was due to manipulation with Tether.6
  • Bitcoin has also been popular for financing criminal activities. Bitcoin is one of the main crypto assets used in the Darknet (65 percent in Q1 2020).
    • Bitcoin’s design attracts illicit usages as it allows to hide identities, to transact entirely within the darknet or on-chain without reliance on regulated entities, to use mixing services to obscure the trail of a transaction or to use exchanges that have not yet adopted the AML/CFT standards of FATF.
    • Bitcoin’s set-up can support forensic analysis in tracing illegal activities as transactions never disappear from the blockchain. However, it is complex and time-consuming.

8. The high private and social cost of the Bitcoin network

  • The longer the boom lasts and the more money flows into the system, the higher the risks and costs for invested individuals and society at large.
  • If it is true that Bitcoin is eventually unsustainable and will not persist, and will not have generated value for society, then these private costs will have represented a net loss for society → Bitcoin comes with significant private costs in the form of high energy and hardware consumption of the Bitcoin network and is therefore a negative sum game.
  • Are the negative externalities of energy consumption priced in through adequate taxes? Geographical arbitrage of Bitcoin mining will lead to a further concentration of mining in locations where this is least the case.
  • Some have argued to locate Bitcoin mining to locations where energy is quasi free and therefore leaves no CO2 footprint: “Bitcoin City” close to a Volcano in El Salvador; Iceland attracted mining operations with its abundance of cheap geothermal energy – before its national energy company decided in December 2021 to cut power to new Bitcoin miners.
    • The energy consumption of the Bitcoin network is inversely proportional to the cost of energy. This means that if mining farms move massively to areas where energy is cheaper, then the logic of the proof of work mechanism requires that more energy will be consumed in mining for a given price of Bitcoin.
  • The high social cost of Bitcoin and its negative net social value is currently not perceived by Bitcoin investors who believe them to be covered by current and future speculative gains. However, pure speculative gains are not a basis for sustainable price increases.
  • Additional social cost: when people realize that they lost hard-earned savings for the benefits of smarter Bitcoin investors it will make them question the functioning of society which permitted such unfairness to happen.

9. Regulatory mindset is changing

  • The broad use of Bitcoin for illicit activities was recognised early.
    • Darknet marketplace Silkroad shut down in 2013 - Bitcoin was used extensively.
    • In 2014, the money laundering and terrorist financing by crypto assets started to be picked up by the FATF - issued guidance in 2019 for a “Risk-Based Approach for Virtual Assets and Virtual Asset Service Providers” demanding national implementation and enforcement, making the illicit usage of Bitcoin much more difficult.
  • Despite this, regulators have been slow in addressing the above-mentioned societal problems of Bitcoin. Why?
    • The potential development of social risks may have been underestimated because of the relatively small size and unleveraged nature of the crypto assets market, which was assessed to not represent a fundamental threat to global financial stability.
    • Regulatory responsibilities for Bitcoin seem fragmented - raises multi-facetted threats and involves multiple actors. And the different risks to different sectors are continually changing and evolving (money laundering and terrorist financing, to ransomware attacks to consumer and investor protection concerns).
    • Many aspects of Bitcoin are fundamentally new and difficult to comprehend. They do not fit easily into existing regulation and raise regulatory challenges:
      • Borderless, does not have a national anchor. Global cooperation amongst regulators is of importance to avoid regulatory gaps and arbitrage → time-intensive process.
      • Was not perceived as a legal entity that could be addressed by regulation and incrimination.
      • Regulators need to seek suitable design of financial regulation to address risks and avoid gaps as well as unintended consequences, like stifling innovation.
      • Not atypical that once a need for regulation has been identified, it can take years until regulation is finalized and applied.
    • The vested interests of large Bitcoin holders and financial intermediaries seeking investment and business opportunities might have led to increased lobbying activities.7
  • The threats, however, are increasingly being recognised and more accentuated calls for addressing the risks of crypto-assets are being made. A number of jurisdictions have taken or are preparing measures to regulate Bitcoin alongside other crypto-assets.
    • Some jurisdictions have banned Bitcoin (and similar crypto-assets).
      • In December 2021, the Indian government considered prohibiting crypto-asset activities of individuals including use as store of value, unit of account or means of transfer.8 Violations by individuals could possibly be sanctioned by arrests without bail options. Reportedly the Bill would also include non-custodial wallets, an area of the Bitcoin network that is largely unregulated. However, the Bill has not yet been presented to the Parliament.9
    • In November, the religious leaders in Indonesia, the National Ulema Council (MuI), have forbidden Muslims (almost 90 percent of the population) to use Bitcoin and other crypto assets. The MuI deemed crypto assets as “haram”, i.e. banned, as it had elements of “uncertainty, wagering and harm”.10
    • In June 2021, the Chinese central bank announced that all transactions of crypto-assets were illegal, effectively banning Bitcoin and other crypto-assets entirely.11
    • In November 2021, Sweden proposed an EU wide ban of proof-of-work crypto assets like Bitcoin due to their energy consumption.
    • The UK’s FCA (2021) prohibited activities of crypto-exchange Binance and issued a warning to consumers.
    • December 2021, Australia introduced a draft legislation aiming at licensing crypto-exchanges and activities in crypto-assets.12
    • The US:
      • The President’s Working Group on Financial Markets, comprising the Secretary of the Treasury and the Heads of all the key US financial regulators, called to speed up efforts on regulation and guided federal agencies to use their existing powers (2021). The group of legislators called for more federal oversight of custodial wallet providers, i.e. firms that offer products that allow users to hold their crypto tokens.
      • The SEC has rejected a bitcoin-based exchange traded fund (ETF) in November 2021 due to concerns of possible price manipulation.
      • The U.S. Infrastructure Bill of November 2021 called crypto exchanges to notify the tax authority of crypto asset transactions.
    • The EU:
      • The European Commission (2020) proposed the regulation for Markets in Crypto-Assets (MiCA). In the absence of a central issuer, MiCA will not regulate Bitcoin and other crypto-assets, but target intermediaries, offering services in crypto assets (crypto asset service providers).
      • The European Commission (2021) presented a draft legislative proposal to enhance the EU’s framework for AML/CFT. Like MiCA, it requires intermediaries to apply AML/CFT measures and forbids the opening of anonymous crypto asset wallet accounts.
  • These regulations, once they apply, will likely address several of the societal issues related to Bitcoin – but not all of them. The rules will not cover Bitcoin transactions that happen without any regulated intermediaries, namely using non-custodial wallets or on-chain peer-to-peer transactions, or if service providers and countries with low compliance levels are used.
  • These examples indicate that regulators are progressing in addressing the risks posed by Bitcoin and crypto assets. But we can still see that regulations, apart from those criminalizing Bitcoin, face limits due to Bitcoin’s decentralized and global set-up and that stances on policy differ because of different assessments of the value of crypto assets for society.
  • To forestall or limit global regulatory gaps and arbitrage, international cooperation on crypto assets amongst regulators is important, as the IMF called for.13
    • International bodies have amplified their efforts in addressing the risks posed by crypto assets over the last years. Some of those international actions have guided national implementations.
      • FATF - issued global, binding standards to prevent the use of crypto assets for money laundering and terrorist financing. FATF focuses on the providers offering crypto asset services to apply the same safeguards as the financial sector. However, in its progress report of July 2021, FATF indicated deficits in the implementation in jurisdictions, concluding “there is not yet a global regime to prevent the misuse of virtual assets and VASPs for money laundering or terrorist financing.” Also acknowledges that a significant value for peer-to-peer crypto-asset transactions may be operating outside the FATF standards.
      • The G7 - raised concerns that ransomware payments are regularly made in crypto-assets and demanded the implementation of the FATF standards.
      • The Basel Committee on Banking Supervision (BCBS) (international standard setter) consulted on a preliminary proposal for the prudential treatment of banks' crypto asset exposures, distinguishing crypto assets that may be generally eligible for falling within the current Basel requirements, and other crypto assets, such as Bitcoin, that would require a more conservative prudential treatment.14
  • While there has been significant progress towards a consistent and effective regulation of crypto assets, Bitcoin prices and market capitalization have still reached new peaks in November 2021.
    • Some measures by public authorities may have contributed to these new peaks by supporting renewed investment flows into Bitcoin.
      • The US SEC in 2021 gave the green light for a first futures-based Bitcoin ETF (while it has repeatedly rejected Bitcoin spot market ETF).
      • The German legislator has adopted in July 2021 a “Fondstandortgesetz” which allows German investment funds for institutional investors (“Spezialfonds”) to invest up to 20 percent into crypto assets.
    • Such public measures seem to legitimize Bitcoin without necessary safeguards. Moreover, these measures facilitate investment flows and the integration of Bitcoin in the traditional financial systems.

10. Conclusion

  • If Bitcoin eventually collapses, the net social cost of the Bitcoin life cycle will be very large. And it will be the larger the longer it lasts, and the higher Bitcoin’s maximum market capitalisation will be.
  • Public policymakers have not been fast to address all problems related to Bitcoin.
  • Although its usage for illicit payments has been noted early, slow global implementation and enforcement of AML/CFT rules for Bitcoin based payments has undermined the efforts made to prevent illicit payments through regulated industries and allowed regulatory arbitrage by criminal actors.
  • Moreover, Bitcoin has become an asset class that everyone can now easily invest into, that is not regulated as a security and that lacks a plausible underlying contribution to society justifying its valuation.
  • More recently, many public authorities have taken or plan to take strong measures against Bitcoin, after concluding that its societal value is negative.
  • Also, regulators of advanced western economies have launched significant implementation measures to fight the reliance on Bitcoin for illicit purposes, although the non-intermediated use of the Bitcoin network is still largely out of regulators’ actions. Further regulatory efforts are therefore needed that effectively address all kinds of illicit payments through Bitcoins.
  • Legislators and authorities need to be careful to not at the same time contribute to renewed momentum of investment flows into Bitcoin that will contribute to increase the market capitalisation of Bitcoin and to the scale of the eventual cumulated social cost of the Bitcoin network.
    • The spike of Bitcoin valuations in November 2021 is likely attributable to investment inflows that were supported by such measures.

References and Notes

  1. Taleb, N (2021), “Bitcoin, currencies, and fragility”, published online: 22 Jul 2021:; Avoca Global Advisors (2021), “Bitcoin: a trojan horse”, wcg avoca 14 Oct 2021, available:; Acemoglu, D (2021), “The Bitcoin Fountainhead”, in: Project Syndicate, 5 Oct 2021, available:; Kolbert, E (2021), “Why Bitcoin Is Bad for the Environment”, in: The New Yorker, published 22 April 2021,
  2. It can only handle seven to ten transactions per second, whereas the Visa network is said to be able to process an estimated 24,000 transactions per second. Avoca Global Advisors (2021), “Bitcoin: a trojan horse”, wcg avoca 14 Oct 2021 at 4
  3. While Bitcoin is in principle less exposed to the risk of a 51 percent attack because of its vast network of 1,000 nodes, in June 2014, the mining pool GHash.IO reached a share of about 55 percent of the Bitcoin hashrate over 24-hours. Although a month later GHash.IO's share of the network's hashrate had dropped to just over 38 percent, the risk remained that a single miner or mining pool could again take control. GHash.IO voluntarily committed to stay far below 40 percent.
  4. Dunn, W (2021), “Bitcoin’s gold rush was always an illusion”, in: The New statesman, 20 July 2021,
  5. Gandal, N, JT Hamrick, T Moore and T Obermana (2018), “Price manipulation in the Bitcoin ecosystem”, Journal of Monetary Economics, Volume 95, May 2018, Pages 86-96,
  6. Griffin, JF and A Shams (2019), “Is Bitcoin Really un-Tethered?”, (October 28, 2019); or
  7. The Economist (2021), “Crypto lobbying is going ballistic - As regulators toughen up, companies hope to influence where the rules end up”, 12 December 2021;
  8. Reuters (2021)a, “Proposed India bill banning crypto payments could mean jail for violations”, published on 7 December 2021,
  9. Business Insider India (2021), “India ends Winter Session of Parliament with no crypto bill in sight”, published on 23 December 2021,
  10. Bloomberg (2021), “Crypto Is Forbidden for Muslims, Indonesia’s National Religious Council Rules”, published 11 Nov 2021,
  11. BBC News (2021)a, “China declares all crypto-currency transactions illegal”, published 24 Sept 2021,
  12. Reuters (2021)b, “Australia proposes new laws to regulate crypto, BNPL Proposed India bill banning crypto payments could mean jail for violations”, published on 8 December 2021,
  13. IMF (2021), “The Crypto ecosystem and financial stability risks”, in: Global Financial Stability report, Chapter 2, October 2021.
  14. BCBS (2021), “Prudential treatment of cryptoasset exposures”, published on 10 June 2021,