What is Bitcoin actually used for? Is it actually used as a payment system for goods and services—or are people just investing in it? If it’s used as a payment system, is it mostly for drugs and other illicit activity?
These are important questions. People wonder whether to buy Bitcoin. Regulators struggle to understand it and how to regulate it. Industry leaders and entrepreneurs want to know whether to build technology on top of it.
But answering these questions isn’t easy.
What is Bitcoin hypothetically used for?
Broadly, bitcoin transactions can be grouped into the following categories, based on transaction type.
- Trades: exchange between two parties for other assets, such as fiat currencies or digital currencies. Many trade exchanges exist to allow people to trade bitcoins for other currencies, similar to how people trade stocks. In these transactions, bitcoin functions like a security, such as gold or a stock.
- Commerce: exchange between different parties for goods or services. This commerce can be legal (a bagel sandwich) or illegal (drugs on a drug marketplace). In these transactions, bitcoin functions like circulated money.
- Mining: whenever a block is generated, it includes a transaction that rewards the miner or pool operator. If a mining pool receives this transaction, it then distributes the amount to its constituent miners, resulting in more transactions. In these transactions, bitcoin functions like newly printed money.
- Residual Transactions: there are multiple types of transactions that show up on blockchains that don’t involve money changing ownership. There are many ways that bitcoins get transferred between two addresses owned by the same person. These get recorded on the blockchain, but they don’t signify an economic use of bitcoin. In these transactions, bitcoin functions like money withdrawn from an ATM.
We know bitcoin gets used in all of these, and while we have some information on specific areas, we don't have a full picture.
The blockchain is transparent, but...
In theory, all confirmed transactions are transparent to the network because the blockchain is available. This, however, does not provide either a clear or a full picture, for a variety of reasons.
Transactions are pseudonymous and don’t specify purpose: A typical receipt today would include recognizable information, such as the business name, the customer, the product purchased, the amount, and the date/time. A bitcoin transaction, however, just includes the sender’s pseudonymous address, the pseudonymous address(es) of the recipient(s), the time, and the amount of bitcoin involved. Nothing about the purpose of the transaction or the identities of the real people.
Many transfers on-chain aren’t very important: The blockchain records whenever bitcoins get transferred between two addresses, including transfers that don’t signify bitcoins changing ownership. Transfers between two wallets one person owns. Transfers from wallets to exchanges for the purpose of trades (but not the trading itself). Transfers for the purpose of mixing bitcoins up or distributing them to a broader portfolio of addresses. All of these end up on the blockchain, but they don’t signify a ‘use’ of bitcoin.
Many important transfers happen “off-chain.” When people trade bitcoins on exchanges, the exchanges typically store some bitcoins in secure addresses and store some in certain wallets they use for trading. The exchange typically packages up multiple trades between users and settles them periodically using their trading (or “hot”) wallets. There are many other instances in which a bitcoin holder ‘uses’ bitcoin to trade or conduct commerce but the blockchain doesn’t record the transfer itself.
Most transactions include “change”: when bitcoins get spent, the balance of the entire address gets spent. If someone has an address with 1 bitcoin and wants to buy something with .75 bitcoin, they spend the entire 1 bitcoin: .75 to the merchant and .25 to themselves. This shows up as 1 bitcoin spent on the blockchain, and because addresses are pseudonymous, it’s not usually obvious which went to the merchant (was ‘spent’ as commerce) and which went back to themselves.
All this means the question can’t be answered through a straightforward analysis of the blockchain.