Bitcoincerns — as in Bitcoin concerns! Get it? Hahaha.
Despite having an interest in ecash, I haven’t invested in any bitcoins. I haven’t thought about it any depth, but my intuition says I don’t really trust it. I’m not really sure why, so I thought I’d write about it to see if I could come up with some answers.
The first thing about bitcoin that bothered me when I first heard about it was the concept of burning CPU cycles for cash — ie, setup a bitcoin miner, get bitcoins, …, profit. The idea of making money by running calculations that don’t provide any benefit to anyone is actually kind of offensive IMO. That’s one of the reasons I didn’t like Microsoft’s Hashcash back in the day. I think that’s not actually correct, though, and that the calculations being run by miners are actually useful in that they ensure the validity of bitcoin transfers.
I’m not particularly bothered by the deflationary expectations people have of bitcoin. The “wild success” cases I’ve seen for bitcoin estimate their value by handy wavy arguments where you take a crazy big number, divide it by the 20M max bitcoins that are available, and end up with a crazy big number per bitcoin. Here’s the argument I’d make: someday many transactions will take place purely online using bitcoin, let’s say 75% of all transactions in the world by value. Gross World Product (GDP globally) is $40T, so 75% of that is $30T per year. With bitcoin, each coin can participate in a transaction every ten minutes, so that’s up to about 52,000 transactions a year, and there are up to 20M bitcoins. So if each bitcoin is active 100% of the time, you’d end up with a GWP of 1.04T bitcoins per year, and an exchange rate of $28 per bitcoin, growing with world GDP. If, despite accounting for 75% of all transactions, each bitcoin is only active once an hour, multiply that figure by six for $168 per bitcoin.
That assumes bitcoins are used entirely as a medium of exchange, rather than hoarded as a store of value. If bitcoins got so expensive that they can only just represent a single Vietnamese Dong, then 21,107 “satoshi” would be worth $1 USD, and a single bitcoin would be worth $4737 USD. You’d then only need 739k bitcoins each participating in a transaction once an hour to take care of 75% of the world’s transactions, with the remaining 19M bitcoins acting as a value store worth about $91B. In the grand scheme of things, that’s not really very much money. I think if you made bitcoins much more expensive than that you’d start cutting into the proportion of the world’s transactions that you can actually account for, which would start forcing you to use other cryptocurrencies for microtransactions, eg.
Ultimately, I think you’d start hitting practical limitations trying to put 75% of the world’s transactions through a single ledger (ie hitting bandwidth, storage and processing constraints), and for bitcoin, that would mean having alternate ledgers which is equivalent to alternate currencies. That would involve some tradeoffs — for bitcoin-like cryptocurrencies you’d have to account for how volatile alternative currencies are, and how amenable the blockchains are to compromise, but, provided there are trusted online exchanges to convert one cryptocurrency into another, that’s probably about it. Alternate cryptocurrencies place additional constraints on the maximum value of bitcoin itself, by reducing the maximum amount of GWP happening in bitcoin versus other currencies.
It’s not clear to me how much value bitcoin has as a value store. Compared to precious metals, is much easier to transport, much easier to access, much less expensive to store and secure. On the other hand, it’s much easier to destroy or steal. It’s currently also very volatile. As a store of value, the only things that would make it better or worse than an alternative cryptocurrency are (a) how volatile it is, (b) how easy it is to exchange for other goods (liquidity), and (c) how secure the blockchain/algorithms/etc are. Of those, volatility seems like the biggest sticking point. I don’t think it’s unrealistic to imagine wanting to store, say, $1T in cryptocurrency (rather than gold bullion, say), but with only 20M bitcoins, that would mean each bitcoin was worth at least $50,000. Given a current price of about $500, that’s a long way away — and since there are a lot of things that could happen in the meantime, I think high volatility at present is a pretty plausible outcome.
I’m not sure if it’s possible or not, but I have to wonder if a bitcoin based cryptocurrency designed to be resistant to volatility would be implementable. I’m thinking (a) a funded exchange guaranteeing a minimum exchange rate for the currency, and (b) a maximum number of coins and coin generation rate for miners that makes that exchange plausible. The exchange for, let’s call it “bitbullion”, should self-fund to some extent by selling new bitbullion at a price of 10% above guidance, and buying at a price of 10% below guidance (and adjusting guidance up or down slightly any time it buys or sells, purely in order to stay solvent).
I don’t know what the crypto underlying the bitcoin blockchain actually is. I’m surprised it’s held up long enough to get to where bitcoin already is, frankly. There’s nominally $6B worth of bitcoins out there, so it would seem like you could make a reasonable profit if you could hack the algorithm. If there were hundreds of billions or trillions of dollars worth of value stored in cryptocurrency, that would be an even greater risk: being able to steal $1B would tempt a lot of people, being able to destroy $100B, especially if you could pick your target, would tempt a bunch more.
So in any event, the economic/deflation concerns seem assailable to me. The volatility not so much, but I’m not looking to replace my bank at the moment, so that doesn’t bother me either.
I’m very skeptical about the origins of bitcoin. The fact it’s the first successful cryptocurrency, and also the first definitively non-anonymous one is pretty intriguing in my book. Previous cryptocurrencies like Chaum’s ecash focussed on allowing Alice to pay Bob $1 without there being a record of anything other than Alice is $1 poorer, and Bob is $1 richer. Bitcoin does exactly the opposite, providing nothing more than a globally verifiable record of who paid whom how much at what time. That seems like a dream come true for law enforcement — you don’t even have to get a warrant to review the transactions for an account, because everyone’s accounts are already completely public. Of course, you still have to find some way to associate a bitcoin wallet id with an actual person, but I suspect that’s a challenge with any possible cryptocurrency. I’m not quite sure what the status of the digicash/ecash patents are/were, but they were due to expire sometime around now (give or take a few years), I think.
The second thing that strikes me as odd about bitcoin is how easily it’s avoided being regulated to death. I had expected the SEC to decide that bitcoins are a commodity with no real difference to a share certificate, and that as a consequence they can only be traded using regulated exchanges by financial professionals, or similar. Even if bitcoins still count as new enough to only have gotten a knee-jerk regulatory response rather than a considered one (with at $500 a pop and significant mainstream media coverage, I doubt), I would have expected something more along the lines of “bitcoin trading is likely to come under regulation XYZ, operating or using an unregulated exchange is likely to be a crime, contact a lawyer” rather than “we’re looking into it”. That makes it seem like bitcoin has influential friends who aren’t being very vocal in public, and conspiracy theories involving NSA and CIA/FBI folks suggesting leaving bitcoin alone for now might help fight crime, seem more plausible than ones involving Gates or Soros or someone secretly creating a new financial world order.
The other aspect is that it seems like there’s only really four plausible creators of bitcoin: one or more super smart academic types, a private startup of some sort, an intelligence agency, or a criminal outfit. It seems unlikely to me that a criminal outfit would create a cryptocurrency with a strong audit trail, but I guess you never know. It seems massively unlikely that a legitimate private company would still be secret, rather than cashing out. Likewise it seems unlikely that people who’d just done it because it seemed like an interesting idea would manage to remain anonymous still; though that said, cryptogeeks are weird like that.
If it was created by an intelligence agency, then its life to date makes some sense: advertise it as anonymous online cash that’s great for illegal stuff like buying drugs and can’t be tracked, sucker in a bunch of criminals to using it, then catch them, confiscate the money, and follow the audit trail to catch more folks. If that’s only worked for silk road folks, that’s probably pretty small-time. If bitcoin was successfully marketed as “anonymous, secure cryptocurrency” to organised crime or terrorists, and that gave you another angle to attack some of those networks, you could be on to something. It doesn’t seem like it would be difficult to either break into MtGox and other trading sites to gain an initial mapping between bitcoins and real identities, or to analyse the blockchain comprehensively enough to see through most attempts at bitcoin laundering.
Not that I actually have a problem with any of that. And honestly, if secret government agencies lean on other secret government agencies in order to create an effective and efficient online currency to fight crime, that’s probable a win-win as far as I’m concerned. One concern I guess I have though, is that if you assume a bunch of law-enforcement cryptonerds build bitcoin, is that they might also have a way of “turning it off” — perhaps a real compromise in the crypto that means they can easily create forks of the blockchain and make bitcoins useless, or just enough processor power that they can break it by bruteforce, or even just some partial results in how to break bitcoin that would destroy confidence in it, and destroy the value of any bitcoins. It’d be fairly risky to know of such a flaw, and trust that it wouldn’t be uncovered by the public crypto research community, though.
All that said, if you ignore the criminal and megalomaniacal ideas for bitcoin, and assume the crypto’s sound, it’s pretty interesting. At the moment, a satoshi is worth 5/10,000ths of a cent, which would be awesome for microtransactions if the transaction fee wasn’t at 5c. Hmm, looks like dogecoin probably has the right settings for microtransactions to work. Maybe I should have another go at the pay-per-byte wireless capping I was thinking of that one time… Apart from microtransactions, some of the conditional/multiparty transaction possibilities are probably pretty interesting too.