Analysis on the Financial crash of 2008 and Bitcoin:
A Peer-to-Peer Electronic Cash System
Wasi Imrose
Inquiry Based Research Essay
English 11000
Professor Joseph Furlong

Abstract

One of the main motives that had driven the creation of Bitcoin was to eliminate the
need for financial institutions so that transactions are direct among individuals. The blockchain
technology provides a decentralized network that achieves this goal. We examine what bitcoin is
and its efficiency. We identify the inefficiencies in our banking system through the speculation
of the Financial Crisis of 2008. We acknowledge how Bitcoin can play a role in transforming the
system or potentially replace the majority of it.

1. Introduction

Bitcoin has been a common element of discussion among news and media this year. From
excessive volatility to various business ventures such as HIVR, a bitcoin social media app, and
HTC’s new blockchain smartphone purchasable through bitcoin and Ethereum, the heat of
virtual currency seems unlikely to fade away in the years to come. Ever since Satoshi Nakamoto
had published his white paper and introduced the world to Bitcoin and the Blockchain
technology, cryptocurrency has been a subject to extensive analysis due to its impressive
estimated potential. Tech giant, Bill Gates once quoted,“Bitcoin is exciting because it shows how
cheap it can be. Bitcoin is better than currency in that you don’t have to be physically in the same
place and, of course, for large transactions, currency can get pretty inconvenient.”After the
financial crisis of 2008, the efficiency of our current financial system was a case of speculation
and other alternatives were acknowledged. Such a case can lead us to ask the question, “ Is
Bitcoin and blockchain technology a viable alternative to the American dollar and our current
financial system?”

Bitcoin and Blockchain Technology

According to the white paper published by Satoshi Nakamoto, Bitcoin is a peer to peer cash
which can can be sent directly from one party to another without the involvement of a financial
institution, namely the banks. The entire process is initiated electronically without the use of any
physical entity. Although conventional currencies such as Dollars and Euros can also be traded
electronically, Several factors differentiate Bitcoin from them. One of the major characteristics
of Bitcoin is that the underlying technology of the currency is the Blockchain.It is a form of
database where the financial transactions that occur involving Bitcoin are grouped into blocks of
data and “chained” together using sophisticated cryptography. This makes the record permanent
which makes it near impossible to go back and rewrite the older data. Furthermore, the most
important aspect of the Blockchain technology is that it surpasses the need for a central authority.
As the the database is shared with any device that is involved, the system is completely
decentralized. If ,for instance, a computer is hacked, the other computers in the system is able to continue and hold the
records. This prevents a central institution such as banks to hold excessive power and control
over the money. Although the system is accessible from anywhere, the transactions that occur are
completely private and are secured by keys that only the owner owns. The keys are bound by
extremely sophisticated cryptographic mathematics that ensures safety.

3. Financial Crisis of 2008

The failure of our banking system can be represented by one of the biggest events in the history
of finance: The Wall street crash of 2008. The 2008 financial crisis has been deemed by many
economists as the worst financial crisis since the great depression according to the Anatomy of
Financial Crisis staff report. The report provides an in depth analysis of the reasons behind the
crash. The main reason for this crisis can be attributed to what is known as subprime mortgage
bubble which refers to the housing mortgage loans granted by the banks to borrowers with poor
financial credibility. This lending was encouraged due to the low interest rates. When an
individual intends on buying a house he often borrows the money needed from the bank in the
form of an agreement known as a mortgage. If the borrowed money is not repaid with interest on
monthly intervals the bank has the right to own the property. Banks often sells the mortgage to a
third party to further profit from it. Hence, in regards to exploration for lower risks and higher
profits, investment in the housing markets can be considered a profitable venture. After the year
2000, banks had invested in a new form of financial entity known as the Mortgage backed
securities. These were essentially a pool of multiple mortgages instead of individual ones that
were sold to third parties in order to gain higher profits. The mortgage backed securities were
deemed as a financial innovation. Extensive profits led investors to buy more mortgage and
eventually led money to individuals with poor credibility who had a lower chance of repaying
their loans. These were known as subprime mortgages. As the subprime mortgages increased,
financial investments became much more riskier. Additionally, large amounts of investments led
to the prices of houses to rise exponentially creating what was known as a bubble. The higher
prices caused the poorly credited individuals to be unable to pay their mortgages which caused
the houses to be put on sale again. However a large mass of indebted people could no longer buy
the houses. The demand was low which caused the prices to drop drastically. The large
institutions as well as the people were caught in excessive loans. Several institutions had
declared bankruptcy and unemployment and recession was unconventionally high causing a
global panic. The federal reserve, in an attempt to recover from the collapsing economy initiated
the TARP (Troubled Assets relief program) which bought the mortgage backed securities that
had not been liquidated yet so that the debt could be reduced and the economy could be
stabilized. Furthermore, the government had established a form of regulation to stimulate
transparency among the banks in order to ensure safer investments. This was done by the passing
of the Dodd Act law in 2010. While such actions had aided in stabilizing a collapsing economy.
Regardless of the measures taken, it can easily be noticed that the unregulated financial
institutions had profited from risks through the money of the people and this lack of transparency
had led to a devastating economy.Furthermore, recovery measures cannot not strongly ensure the
prevention of future crisis. Hence it is essential to look for alternatives to the entities of our
current financial systems.

4. Benefits of Bitcoin and Blockchain technology

Satoshi Nakamoto had had elaborated on his own perspective on his online Bitcoin forum. In the
post published on February 2009 called “Bitcoin Open Source Implementation of P2P
Currency”, Satoshi emphasizes on the problem of trust among financial institutions. The central
banks have to be trusted in order to perform financial transactions. However, Satoshi implies that
the trust had been breached multiple times with the financial crash of 2008 being the biggest
outcome. Although the post loses its credentials due to being a non-academic source, it provides
us with an extension of Satoshi’s claims. Its credibility is quite similar to the White paper itself
which was published anonymously. However, the paper introduced us to the novel invention of
Bitcoin and its technical elements that were stated by Satoshi. Hence, it is essential for us to
acknowledge his point of view even if they are not supported by valid credentials. The post on
the online forum and the white paper have different target audiences. The contents of the post is
primarily qualitative for easier comprehension among non-experts while the white paper consists
of quantitative analysis, technical terminology and computer code which makes it a tool for
professionals who can make effective use of it. Regardless of the different audiences, both the
genres serve the same purpose. Satoshi strictly emphasizes on the elimination of the need for a
third party such as banks for financial transactions among individuals. This can be efficiently
achieved by the decentralized nature of the Blockchain technology. In this case, all individuals
operating in the system will have equal access to the records in the system which would provide
an enhanced scale of transparency. This transparency was not present during the the rise of the
subprime mortgage bubble where the individuals were unaware of the risk of a potential crash.
While the government reports cited have not considered the elimination of central institutions,
lack of transparency was a main factor in all of them. Therefore, the Bitcoin and the blockchain
technology will exponentially increase
transparency which would yield a safer financial system . According to an article, The Bitcoin
Boom: In Code we trust”, published in the New York Times, people’s trust are gradually shifting
from authorities towards technologies. The author states that the banks that had been backed by
powerful governments were treated as symbols of financial trustworthiness. Ironically, however,
the banks have been reckless and “drunk on people’s money”, according to the article. Therefore
these factors provide a solid ground for the existence of Bitcoin and blockchain and their
benefits. The article is authored by Tim Wu who is a Law professor at Columbia University. His
stance builds up on the claims of Satoshi Nakamoto and provides a strong credibility. However,
his purpose in the article was to analyze and determine the significance of Bitcoin. Regardless of
this differentiation, Tim Wu’s article achieves the same conclusion as Satoshi does in his
publications.

5. Negative aspects

One of the major concerns involving the implementation of Bitcoin had been the volatility of the
intrinsic value of Bitcoin. Therefore, an investment in Bitcoin has been considered an immense
risk. A publication in the Journal known as Physica A authored collectively by faculty from the
University of Zagreb, Boston University and Luxembourg School of Business makes effective
use of quantitative analysis in order to examine the levels of volatility among Bitcoin
transactions. The Bitcoin exchanges analyzed were Mt.Gox, Kraken, BTC-e, Bitstamp and and
Bitfinex between the years of 2010 and 2017. According to calculations, the fluctuations that had
been identified had been present in several time intervals and multiple exchanges over the 80
million trades analyzed. This suggests that the tendency to fluctuate is a convention exhibited by
the currency and the technology itself. Moreover, the fluctuations, in comparison, seems to be
more frequent than the US Stock market. The journal had also used the term “Bubble” to
describe Bitcoin which refers to the value of the entity being excessively higher than its intrinsic
value. Due to this, the large amounts of panics that had been witnessed among individuals is
unlike any other market in the US including stock, currency and commodity markets. However,
Satoshi Nakamoto had introduced the technology on October 2008 which still implies that
Bitcoin is still in its developmental stage and will require more time in order to achieve stability.
The amount of time required,however, is still a matter of speculation. Although it is typical to
claim that Bitcoin investment is a risk, further analysis over a longer period of time should be
initiated in order to validate such a claim.

6. Viable alternative

According to the journal, “Economics Letters” published at the University of Sydney, Australia,
Bitcoin is “highly investible” at the retail level. The respective authors of this journal provide a
detailed and comprehensive assessment of the costs of transactions and liquidity, also referred to
as the availability of cash, at the major Bitcoin exchanges in the US. This effectively provides a
further clarification of the useful implications and significance of Bitcoin. The authors focus on
the individual trades that occur on a daily basis and conclude that although the Bitcoin
blockchain operates under complex algorithms, the volatility in the value of Bitcoin occurs only
during trading hours. This implies that the volatility are caused by traders themselves and that
Bitcoin as an independent currency impose no such threat of volatility. This directly contradicts
the publication by Physica A which concludes through statistical analysis that the volatility that
exists in the values of Bitcoin are much higher than that of currencies conventionally used.
However, the paper also identifies the fact that the time period used to analyze the Bitcoin
exchanges was an interval of mere 7 years which undermines its comparison with traditional
currencies as they have existed for decades. The authors in Economic Letters state that, due to
the value of Bitcoin being dominated and influenced by retail investors, Bitcoin is highly
investible at the retail level.
At this stage, whether Bitcoin is a viable alternative to the American dollar and our financial
systems still remains a matter of debate.

Reference

[1] Bitcoin: A peer-to-peer cash system, Satoshi Nakamoto, https://bitcoin.org/bitcoin.pdf , 2008
[2] Bitcoin Open Source Implementation of P2P Currency, Satoshi Nakamoto,
http://p2pfoundation.ning.com/forum/topics/bitcoin-open-source , 2009
[3] The Bitcoin Boom: In Code We Trust, Tim Wu, The New York Times,
https://www.nytimes.com/2017/12/18/opinion/bitcoin-boom-technology-trust.html , 2017
[4] The Wall Street and The Financial Crisis: Anatomy of a Financial Collapse, Permanent
Subcommittee of Investigations, United States Senate,
https://www.hsgac.senate.gov//imo/media/doc/Financial_Crisis/FinancialCrisisReport.pdf?attem
pt=2 , 2011
[5] The Financial Inquiry Report, The Financial Crisis Inquiry Commission,
https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf , 2011
[6] How Investible is Bitcoin? Analyzing the Liquidity and Transaction Costs of Bitcoin
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[9]HTC launches its blockchain-focused phone, but you can only buy it in cryptocurrency,
CNBC,
https://www.cnbc.com/2018/10/23/htc-launches-blockchain-phone-exodus-1-to-be-sold-in-crypt
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