Tag Archives: Economics

Significant Day for Crypto

13 Mar

I haven’t posted in quite a while, but the news this morning seemed significant enough to stir me to start typing.

The first thing I saw on my phone this morning was that ether, the token (or crypto-currency) of the Ethereum Blockchain, was trading at $27. When I yelled this news to my wife, she responded with “twenty eight forty three”. Thus far the high on the Kraken exchange has been $29.98 but right now fallen back below $29.85. This is a 100 to 1 increase in valuation, from $.29 in August 2014.

This certainly got me excited, so as I sat in front of CBS Morning while reading Ethnews.com on my phone I saw this headline: New Gold Backed Cryptocurrency Introduced (https://www.ethnews.com/new-gold-backed-cryptocurrency-introduced).

The story reports that a new crypto-coin, OZcoinGold, is being launched on the Ethereum blockchain, but rather than a mined coin, it is a limited edition of tokens, 100 of which grant ownership in 1/3 oz. of 24 karat gold in a vault at the Perth, Australia mint, and 2/3 oz. of gold in certified reserves in a gold mine regulated by the Australian government. The issuer of the coin is backing it with 100,000 oz. of gold, at the mint and in reserves at the mine. After March 1st, 2022, holders of the tokens will be able to redeem them for certificates from the Perth mint, which are then exchangeable for gold at gold dealers throughout the world.

The coin was launched at SXSW on March 10.

This means that with only two more pieces of the puzzle in place, the unregulated free market in ideas will have provided the world with an unshakable gold standard. It will then be up to the market in currencies to use this mechanism to supplant the corrupt central bank/creeping world bank fiat money regime that siphons our wealth to fund the eternal war.

I plan to write further on what the two remaining pieces of the puzzle are, but I am also thinking about starting a new blog under a pseudonym. If you are reading this and would like to know where to find my future posts (if that change does come to pass), please email me at gmautry@gmail.com and I’ll reply with a link to the new blog. And please let me know if you found anything on this blog useful or interesting.

Government’s Role in the Bitcoin Universe

19 Nov

With bitcoin hearings before a Senate committee underway today, plenty is already being written about what the government is or is not likely to do and how its actions could affect the future of bitcoin. That is not what I want to discuss. This post is about what the government should or should not do, and how its actions will impact the world economy and the prosperity of its citizenry.

I will make clear at the outset, that my own intellectual bias is Austrian (primarily relying on the work of H.H. Hoppe), anarcho-capitalist, and post-statist. In my view, the best thing the government could do would be to shut up shop, abandon all of its assets to homesteaders, and sink into the ash-heap of history. However, I am also a realist. I recognize that the solutions I will propose herein represent a compromise with evil, and I hope that my fellow anarchist readers can forgive me for that. I would not propose them if I did not believe them to be within the realm of reasonable possibility, and that if enacted, they would shift the balance of power within society away from the political and toward the economic means.

To begin, I wish to establish a few points of agreement with my readers. If the following statements strike you as false, you should probably not waste your time reading further.

1. If government has any legitimate functions, one of these functions is the protection and restoration of justly acquired property.

2. Bitcoin is property. All bitcoin acquired through mining is justly acquired, as the means of production may be freely obtained by anyone (freely in the sense of being without arbitrary restriction such as patent or licensing law, rather than of being without investment cost). All bitcoin acquired through voluntary, honest exchange, like any other good so obtained, is also justly acquired.

3. The existence of property in bitcoin resides in the physical integrity of the bitcoin network.

4. Ergo, it is the duty of government to protect the physical integrity of the bitcoin network, and to work to restore bitcoin obtained by force, theft, or fraud to the rightful owner.

5. It is not the duty of the government to protect the value of bitcoin, but any government policy explicitly intended to decrease or destroy the value of bitcoin, such as a ban on bitcoin software, or confiscation or punitive taxation of bitcoin balances, would constitute a crime.

These points summarize what I believe to be the level of consensus today between the actors in the bitcoin community, the broader financial community, and the American federal and state governments. The more extreme stance taken by the law enforcement and anti-terrorist elements of the federal government, that bitcoin is a threat and should be actively suppressed, does not seem to be gaining a critical mass of support. At the same time, most of the major players in the bitcoin economy seem to be advocating detente with the regulatory state rather maintaining the radically anarcho-capitalist position of the early years.

Here is how I see the concerns and objectives of the key interests:

The government’s largest concern is how to tax the bitcoin economy, and it should be assumed that all proposals coming from that side will have tax enforcement as the primary goal but will be couched in terms of anti-terrorist and anti-fraud protections in order to muster public support.

The largest concern of the banks and Wall Street is the protection of the ability to manipulate credit through the fractional reserve system anchored in the Federal Reserve. They will maintain a publicly neutral stance but will covertly and frantically lobby against any proposal (such as the one that I offer) that threatens their corrupt power.

The core concerns of the bitcoin community are the maintenance of the physical integrity of the bitcoin network and its surrounding infrastructure, including enhancement and maintenance of security measures to deter theft, and continued viability of the software as the network scales upward. There are also significant concerns arising from externalities, such as the public perception of bitcoin and the policies of the regulatory bureaucracy. These include raising public awareness and understanding of the bitcoin economy with the aim of deterring fraud, and defense against unwarranted restrictions on the free production and exchange of bitcoin.

And finally, the key concern of the public at large is to be secure in their private property rights, that is, the right to justly acquire, exchange, or use for any peaceful and honest purpose, any property, including bitcoin.

My proposal provides what I believe to be a reasonable compromise between the competing concerns of the government, bitcoin community, and the public, which although not fully just (as involuntary taxation is never just), is at least as just as the current regime. (I can find no way to reconcile this proposal with the interests of banks and Wall Street, nor do I wish to do so.)

Here is the proposal:

1. Congress should enact the Fair Tax Act of 2013 (HR 25, Wikipedia, http://www.fairtax.org) This measure repeals all federal income taxes (personal, estate, gift, capital gains, alternative minimum, Social Security, Medicare, self-employment, and corporate), replacing them with a single broad consumption tax collected on the sale of new end-user goods. The tax rate is revenue neutral. A monthly “prebate”, in the amount of the tax that would have been paid on expenditures equal to the federal poverty level, is remitted monthly to each registered family. The clause in this bill relevant to bitcoin is Section 103 paragraph (d), “Barter Transactions- If gross payment for taxable property or services is made in other than money, then the person responsible for collecting and remitting the tax shall remit the tax to the sales tax administering authority in money as if gross payment had been made in money at the tax inclusive fair market value of the taxable property or services purchased.”

The enactment of this bill would satisfy the government’s objective of facilitating tax enforcement by eliminating the need to track bitcoin incomes or capital gains and instead to simply collect the sales tax in dollars on items purchased with bitcoin. The capability of calculating the tax based on the exchange rate at the time of the transaction would be a trivial addition to the functionality of already available bitcoin payment processing platforms. This single step would eliminate a huge source of uncertainty on the part of both the government and users of bitcoin. Step two would extend this benefit even further.

2. Congress should enact legislation authorizing the optional distribution of any portion of Fair Tax prebates in BTC. Taxpayers should be permitted to designate the portion to be remitted in BTC at any time more than one month prior to receiving a prebate. The prebate amount would be denominated in dollars, and the exchange rate for determining the BTC amount would be the Average Federal Bitcoin Acquisition Rate (AFBAR) for each monthly period, where AFBAR is defined as the sum of the cost in dollars of BTC purchased by the federal government during the month plus the amortized value of the GH/s employed by the government to mine BTC during the month, divided by the number of BTC distributed in prebates at the end of the month. The government would be prohibited from acquiring more, during each month, than 105% of the BTC required for the next prebate. In order to smooth the impact on market exchange rates, it would be required that purchases or sales of BTC or GH/s to make up any projected shortfall or overage in mining production be made in nearly equal daily increments, such that the total bitcoin surplus after each monthly prebate distribution would not exceed 5% of the amount distributed.

This part of the proposal is (I believe) being set forth here for the first time, and deserves some explanation. The purpose is twofold – to facilitate the acceptance of bitcoin as an alternative currency, by establishing a mechanism for widespread distribution of bitcoin throughout the populace; and to achieve rapid equilibrium in the market exchange rate between dollars and bitcoin, with minimum volatility, by making a significant fraction of the demand for bitcoin highly predictable and constant. It makes the government a significant stakeholder in the success of bitcoin, is neutral from a taxpayer perspective, and moderates the concentration of bitcoin wealth, reducing the attendant risk of market manipulation, bubbles and crashes.

Assuming these two measures are implemented while the bitcoin price in dollars is still rising, I predict the following results. Initially, few households will opt to accept the prebate in BTC, both due to unfamiliarity and to the risk that the exchange rate on the date of the prebate will be lower than AFBAR. My analysis of price data from the MtGOX exchange beginning on July 10, 2010, shows that this was the case 45% of the time. Thus, risk averse families who do not intend to save a large percentage of the prebate would be very unlikely to opt to collect in BTC. However, the data also show that if the prebate is held in savings, the risk of a negative monthly return by saving bitcoin versus dollars decreases as the period that the savings are held increases. At 22 months, the risk of a negative return by choosing bitcoin vanishes.

Under these conditions, within a few months, most families will have adopted a strategy of collecting increasing percentages of the prebate in BTC, selling BTC for dollars immediately if the exchange rate is favorable, and holding BTC in savings in the months when the rates are unfavorable. Within another few months, the most common strategy will shift to collecting 100% of the prebate in BTC, and holding these as savings as long as possible. This means that the quantity of BTC that must be acquired by government monthly will steadily increase toward a maximum, and that citizens will have a highly liquid market for selling their bitcoin prebates, at a steadily rising price.

If these measures are enacted, the economy will experience a short period, three to five years at most, of a dual currency regime. Every family will have a small, guaranteed income in a relatively deflating currency, which will significantly increase their ability to discharge debts and increase savings. At the same time, a moderately inflating currency will continue to provide the unit of account. This will moderate the shock of the transition to a truly stable currency, as dollar denominated prices and wages remain relatively steady.

In my next post, I will describe the end state of this scenario…

Gresham’s Law and Bitcoin

14 Nov

“The course our city runs is the same towards men and money.
She has true and worthy sons.
She has fine new gold and ancient silver,
Coins untouched with alloys, gold or silver,
Each well minted, tested each and ringing clear.
Yet we never use them!
Others pass from hand to hand,
Sorry brass just struck last week and branded with a wretched brand.
So with men we know for upright, blameless lives and noble names.
These we spurn for men of brass…”

Aristophanes, “The Frogs”, circa 405 B.C.E.

Gresham’s Law states that “bad money drives out good”. When the price of a currency is artificially constrained, for example by a legal tender law, then the constrained price may be higher, the same, or lower, than what its price would be on a free market. If the currency’s constrained price is lower than it would be on a free market, it will tend to be exported to be resold where the constraint does not operate, and thus will disappear from circulation. If there are competing currencies in the constrained market, the currencies that are relatively undervalued will also disappear from circulation. This will be true, even if the constrained price of the most undervalued currency is still greater than or equal to its true free market price. If creditors are compelled under legal tender laws to accept one or more currencies at a fixed price, debtors will always tend to pay with the cheapest currency available, that is the currency whose constrained price has the greatest positive (or smallest negative) spread from the free market price. The currencies with a narrower spread, even if they cannot be resold on a foreign market at a profit, will tend to be retained as savings.

What does this have to do with Bitcoin? Bitcoin actually does trade on a truly free and global market. Thus its spread is, by definition, zero. No national fiat currency can make this claim, at least in its home country. Thus, by applying Gresham’s law, we can see that given a choice, debtors will tend to pay their debts with their national currency, and retain any Bitcoin that they acquire as savings. They will exchange their Bitcoins for other currencies only if they have no other means of paying a debt or purchasing a necessity.

This means that the adoption of Bitcoin for commerce directly will be slow, or in other words, even if Bitcoin becomes commonly used as a payment system by merchants, prices for consumer goods and interest rates on loans will continue to be denominated in the national currency, and will be quoted in Bitcoin at the prevailing free market exchange rate at the time of payment. During the current phase of Bitcoin’s adoption, as it becomes increasingly clear that demand continues to rise steadily, I would actually expect that Bitcoin prices will be quoted at a discount to the instantaneous exchange rate.

So, as a unit of account, Bitcoin will not become the standard anytime soon, although it probably will at some point in the future, when demand for Bitcoin reaches equilibrium with other currencies, and in particular, gold and silver bullion, which also trade globally on a fairly free market. However, as a store of value, I believe that it is already the standard.

In my next post I will explain at what price I expect that equilibrium to occur.

What backs Bitcoin?

12 Nov

In several earlier posts, I implied that the Imperial Government of the United States might be actively hostile to Bitcoin, which could certainly tend to complicate its widespread adoption. In this, I believe I was in line with the conventional wisdom (a position I have seldom fitted into comfortably). However, in the interim, several indications have arisen which suggest that the IGUS is maintaining a neutral stance vis-a-vis Bitcoin. Most notably; last month’s Federal bust of Silk Road was not accompanied by a frenzied government call for the abolition (as if that were even possible) of Bitcoin, and last week, François R. Velde, senior economist at the Federal Reserve Bank of Chicago, published Bitcoin: a primer in the Chicago Fed Letter. This is a balanced piece which includes a good technical explanation of Bitcoin. It concludes with the statement that, “[Bitcoin] represents a remarkable conceptual and technical achievement, which may well be used by existing financial institutions (which could issue their own bitcoins) or even by governments themselves.” I have long believed that the most rational response of the state to Bitcoin would be to embrace and profit from it along with rest of us, and this paper suggests that at least one of the court intellectuals agrees.

However, Dr. Velde makes a common mistake when he states “Fiduciary currencies” (including Bitcoin) “—in contrast with commodity-based currencies (such as gold coins or bank notes redeemable in gold)—have no intrinsic value…”. This touches directly on a criticism I answered briefly in a previous post, which is that “Bitcoins are backed by … well … nothing. It’s fiat money issued by ‘the market’…”. In that post I addressed the mischaracterization of Bitcoin as fiat money, since this designation requires the imposition of a state fiat or decree to support the value of the currency. Dr Velde correctly points out that fiat money, including the US Dollar and all other major national currencies, is also a fiduciary currency, and has no “intrinsic value” derived from its status as a commodity.

So what is the error that Dr Velde has made? You might expect that I would argue that Bitcoin has some sort of “intrinsic” value, perhaps deriving from the fact that it requires an input of energy to create new Bitcoins. I have seen this argument before, in Bitcoin forums and articles. Dr Velde alludes to this when he remarks that “The term ‘mining’ may lead one to think that bitcoin is not fiduciary.” However, this is nothing more than the Marxist labor theory of value, and holds no water in a serious economic discussion.

My argument is not that Bitcoin has intrinsic value. It is quite the opposite – I maintain that no form of money, fiduciary or commodity-based, has intrinsic value. In fact the term “intrinsic value” is an oxymoron. Things have intrinsic characteristics; gold is dense and malleable, Bitcoin is decentralized and cryptograpic, water is wet, etc. One of the intrinsic characteristics of the concept of value is that it always and everywhere is a subjective ranking reflecting the goals of a human actor and the options available to him for achieving those goals. To argue that gold has intrinsic value is to assert that there is some minimum level in the rankings assigned by every living human to every option available below which gold (in some specified quantity) can never sink. This is clearly ludicrous. A drowning man in possession of a kilogram of gold will be more likely to find positive value in letting it sink to the bottom of the sea than in maintaining his hold on it.

What is really being said by incorrectly applying the adjective “intrinsic” to the value of gold is that gold has a long established history of being relatively highly valued by many if not most people. In fact, it is so highly valued that its market price cannot be even remotely accounted for by its utility as anything other than as (primarily) a store of value and (secondarily) a medium of exchange. This explains why the vast majority of the gold currently in the hands of humanity consists of bullion bars or coins, or chains, rings and amulets that may also be used for exchange in a pinch. Only a tiny fraction is employed in such uses as decorative gold leaf or as an electrical conductor.

To quote Dr. Velde again, “a currency that has value only because of the belief that it will have value may have no value at all (for instance, if I believe that no one will accept it, I will not accept it either)”. Quite true, and applicable to gold as much as to any other thing on earth. What is at issue here is not some intrinsic value that gold can never lose, but rather the strength of the belief that gives gold as well as Bitcoin its value. I am certainly not suggesting that the strength of the general belief in the exchange value of gold is likely to be diminished anytime soon. I am merely asserting that the fact that Bitcoin is not “commodity-based” or “gold-backed” has no rational bearing on its value whatsoever.

The only difference between Bitcoin and gold, or any other currency, is that the demand for Bitcoin is 100% derived from its utility as money (that is, a medium of exchange, a store of value and a unit of account), whereas there does exist some modest demand for non-monetary gold. Gold has a history of demand spanning 5 millennia, Bitcoin has a history of demand spanning 5 years. But based on that brief history, there is no reason to think that the belief in the value of Bitcoin is in danger of vanishing.

Bitcoin critic’s top ten list

11 Nov

Well, the nice weather has continued for some considerable time, but at last I return to the task of refuting the top ten objections to Bitcoin posited by my skeptical friend, starting in my April 8 post, which you can find here.

But first, I would like to update a pertinent fact from an earlier post which supports my overall thesis. On April 2, 2013, I wrote that my initial investment of $100 in Bitcoin was worth $1,272, or an annualized 776% gain. That investment is now (4:43 pm EST, 11/11/2013) worth $4227, or 1,933% annualized. BTC continues to be the most lucrative investment of the millenium.

So, on to the top ten objections to Bitcoin…

4. The transactions are supposedly “safe” because, because they’re public record. We’re supposed to believe in this safety despite the fact that major data portals like Facebook, Google, Bing, Twitter, etc. can now deduce or infer with high probability incredible amounts of information about your career, sexual orientation, political views, etc by just the kinds comments you make on your Facebook profile and news feed. Yet, somehow, we’re supposed to believe that there isn’t enough processing power in the world to deduce who is associated with which transaction in a bitcoin log.

I must admit, I find this statement of objection somewhat confusing. It appears my friend means “anonymous” when he says “safe”, and yet he believes that the proponents of Bitcoin are promoting the completely transparent character of the Bitcoin blockchain as a source of anonymity. If this were true, I would agree that this is a ridiculous assertion. In reality, there has never been any claim by anyone who understands Bitcoin, that transactions on the Bitcoin network are guaranteed to be anonymous. It is well known that every Bitcoin transaction that ever has or ever will occur, can be easily traced from the recipient to the sender, back to each previous sender, and ultimately to the miner who first created the Bitcoin, through the Bitcoin addresses recorded in the blockchain. In this regard, Bitcoin transactions are far less anonymous than cash transactions wherein the payer and payee are unknown to each other and no written record is kept. On the other hand, Bitcoin transactions can easily be initiated without revealing any personal information about the participants other than the IP address of the payer. Thus if a payer takes care not to disclose his or her ownership of a specific Bitcoin address, it is far from trivial to deduce his or her identity. It may in fact be impossible, for example if the payer initiates the transaction on the WiFi network of a McDonald’s restaurant. In this regard, Bitcoin transactions are far more anonymous than bank-mediated transactions, such as credit or debit card or PayPal charges, where detailed personal information is always collected and stored by the bank holding the payer’s account.

On the other hand, if my friend is questioning the safety of Bitcoin with regard to the integrity of the transactional history and the protection against fraudulent double spending, I can only say that the “public record” of Bitcoin transactions is exactly what guarantees their safety. It is a fact that the entire history of Bitcoin transactions is recorded on each and every one of the tens or hundreds of thousands of active nodes in the Bitcoin network, and that the validity of each and every one of the hundreds of millions of transactions that have ever occurred on the Bitcoin network has been agreed to by a majority of those nodes.

The safety of BTC balances from theft or fraud is an entirely different subject which does not seem to be germane to this discussion, but which I will probably address in future posts.

5. While there are ways to cash into bitcoin, it’s extremely difficult to cash out of it.

Actually, it is really the other way around, although I would not characterize the transaction on either end as “extremely” difficult. There are several competing exchanges which mediate trades between BTC and at least 35 major world currencies. Opening an account on these exchanges can be accomplished on-line by anyone with a computer and an Internet connection. Transferring funds to one’s account can also usually be achieved with either an Internet link or a phone, although depending on the regulatory regime of the user’s home country, the process may be involved and may require up to a week, and may involve transaction fees on the order of 3-5% of the amount transferred. Cashing out can also be accomplished on-line or by phone, and usually involves a simple wire or ACH transfer of funds from the user’s BTC exchange account to his or her bank. Again, there will probably be transaction fees.

In addition, many, if not most, people who have managed to acquire BTC actually have no interest in cashing out. The purchasing power of BTC, as well as the number of merchants accepting BTC for purchases are both rising. Unless a BTC owner lacks sufficient USD or other national currency income to meet his or her needs, why would he or she want to exchange BTC for a fiat currency?

Finally, “cashing in”, while currently more difficult through an exchange, may also be accomplished by selling one’s products or labor for BTC. Currently, selling products for BTC can be as easy as downloading a smartphone app, but finding a customer with BTC to spend can be very difficult. Convincing your employer to pay your wages in BTC can also be very difficult, but again, the incentives tend to favor an increase rather than a decrease in merchants accepting BTC in payment and employees demanding a wage paid in BTC.

6. Even if you buy the theory that there will never be more than 21 million bitcoins (because you were promised that, right?), that quantity is nowhere near large enough to actually serve as a viable currency in a world economy consisting of over 7 billion people. We’re supposed to believe that this will be accomplished by subdividing bitcoins into subunits called “satoshis” (named for the fictional creator of bitcoin), although no one has actually been able to figure out how to accomplish this subdivision.

This one has me shaking my head in disbelief. First, there will never be more than 21 million BTC. This is not a promise, it is a fact. If you do not believe it, and don’t wish to take my word for it, you can download and examine the Bitcoin source code, and use your own mathematical reasoning ability to confirm it in your own mind. If that fails, it is because your mathematical reasoning ability is at fault.

As to the question of “Satoshis”. I don’t know what source of misinformation convinced my friend that “no one has actually been able to figure out how to accomplish this subdivision.”  In fact, the Bitcoin protocol is designed to accept 8 digits to the right of the decimal in all BTC calculations. That is, 1 BTC = 100,000,000 Satoshis. My investment of $100 bought 1.25 million Satoshis. 21 million BTC = 2.1 quintillion Satoshis (roughly the same as the number of US pennies, depending on which measure of money supply you favor). If this quantity of currency units ever becomes too small, the Bitcoin protocol can be modified (it’s only software), and if adopted by a majority of the active network nodes, will become the new standard.

If any of my readers still think “Satoshis” are a figment of the imagination, please email your Bitcoin address to gmautry@gmail.com, and I will send you one.

7. Supposedly, only the last bitcoin gets subdivided (according to Wikipedia). That’s just plain wacko!

I generally trust the accuracy of Wikipedia, but this statement is simply false. If it actually appear(s/ed) in Wikipedia, I agree it is/would be “just plain wacko”. But it is not true. Again, if you don’t believe me, download and analyze the code (or email me for a Satoshi which was not subdivided from “last bitcoin”).

8. Bitcoins are backed by … well … nothing. It’s fiat money issued by “the market”, which of course is why we’re all supposed to say, “Oh, what a wonderful idea!” … even though it’s a crackpot idea.

A full answer to this objection deserves an entire post of its own, which will be forthcoming. For now, I will simply point out that “fiat money” is money whose “value” is backed by state government decree. It is, by definition, backed by coercion. Any money which derives it value from free market transactions is, by definition, uncoerced, the opposite of “fiat”.

9. No one seems to have thought about how people will track all the public transactions associated with bitcoin if it somehow managed to become a popular, world-wide currency despite all the strikes against it. I suppose we’d all have to end up carrying around storage arrays so we can make sure we aren’t being cheated, right?

Just like we all carry around storage arrays now to make sure we are not cheated by Bank of America and JP Morgan? (Oh, right, we are cheated by those guys.) Actually, I have the last 5 years worth of Bitcoin transactional data on my laptop as I write and it takes up all of 22.4 Gigabytes. Suppose the traffic on the Bitcoin network doubled every year until it had completed replaced Visa and MasterCard, then leveled off. In that case, it would fill up one of my 1 Terabyte external drives sometime in 2017, and then I would need to add another Terabyte every year or two thereafter. But wait, I forgot about my wallet on Blockchain.com. That gives me access to the entire Bitcoin blockchain in the cloud, on my smartphone, so I don’t even need to run the Bitcoin client or store the blockchain on my laptop at all.

I don’t mean to be too dismissive of this question, because frankly, this is something that has concerned me as well. It just seems that a currency which is utterly dependent on every user having access to a complete record of the transactions conducted in that currency is bound to become fatally unwieldy in the course of time. However, having done the math, it is apparent to me that the existing protocol will not be defeated by this weakness within the next decade, and I believe that a decade is more than enough time for the problem to be solved. This is where I surrender to faith.

10. I could go on, but why bother? The whole concept is a nut job.

I could go on as well, but why bother? My friend, the critic, is sadly misinformed.

Sorry for the interruption

21 Apr

Saturday 4/20/5

The nice weather has completely sidetracked my plans for posting articles on this blog.  However, I have had a long article on the mechanics of Bitcoin prepared for some time.  I will post it now  and then try to finish the other two two threads I’ve already started.

Chapter One – A Brief Introduction to the Future of Money

 On November 1, 2008, the following message was posted on an internet mailing list devoted to the topic of cryptography;

“I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party.

The paper is available at:

http://www.bitcoin.org/bitcoin.pdf

 The main properties:

– Double-spending is prevented with a peer-to-peer network.

– No mint or other trusted parties.

– Participants can be anonymous.

– New coins are made from Hashcash style proof-of- work.

– The proof-of-work for new coin generation also powers the network to prevent double-spending.”

 The message continues with an abstract of the paper, titled Bitcoin: A Peer-to-Peer Electronic Cash System, and is signed, “Satoshi Nakamoto”.

 Over the next year and a half, Satoshi Nakamoto largely implemented the protocol for the “electronic cash system” proposed in his paper, making his work freely available to the open-source software community. Contacts among the members of this community typically take place electronically, and this was entirely the case with Nakamoto. No one knows the actual identity of the person or group using this name, and it is widely assumed to be a pseudonym.

Other members of the community took on an increasing role in the development and refinement of the software. The first functional Bitcoin network began operating in 2009. In 2010, messages from Satoshi Nakamoto began to grow less frequent, and he (or she, or they) finally vanished completely from the message boards by the last half of the year. But the work that Nakamoto started has taken on a life of its own. His “Peer-to-Peer Electronic Cash System” has grown into a network of thousands of highly specialized nodes which enable more than 160,000 cash transactions daily.

 But what exactly are Bitcoins, and why should anyone care about them? Simply stated, Bitcoin is an entirely new form of money. It is not the intent of this work to delve too deeply into the technical details behind Bitcoin. For interested readers of a technical bent, copious documentation right down to the open-source code implementing this technology is available on the internet. A good starting point is bitcoin.org. What follows is a very high level introduction, provided in the hope that readers at all levels of technical proficiency will be able to appreciate the basic Bitcoin concept.

Bitcoin was created as a form of currency, meaning that Bitcoins (abbreviated as BTC) can be spent by a buyer to purchase a good from a seller. In this sense, BTC are exactly the same as gold or silver coins, or paper dollars. BTC differ from these earlier forms of currency in the fact that they only exist digitally, as electronic records in cyberspace. (In the remainder of this monograph, I will use “Bitcoin” to refer to the Bitcoin software and the network of processors and communications links that runs the software and enables the Bitcoin currency. I will use BTC to refer to the unit of currency. I will also use the term “Satoshi” to refer to the smallest unit of the BTC currency. 1 BTC = 100,000,000 Satoshi.)

Of course, there are already many electronic payment systems in existence, which record and track transactions denominated in an existing currency. For example, whenever I purchase a song from iTunes, some third party, a credit card company like Visa or a payment processor like PayPal, debits an account in my name, and credits the iTunes account in whatever bank iTunes uses. If I use a Visa account, I will have a debt, which I may pay in part or in full when my monthly bill comes due, by authorizing the transfer of dollars from my bank account. If I want to use Paypal, or a debit card account, I must make that transfer before I buy the song on iTunes. In any case, the transaction involves the transfer of some amount of USD (dollars) between bank accounts. The transfers occur digitally, in cyberspace, and result in records of amounts deposited in or owed to various banks. These records are kept by each bank involved in the transaction. So if BTC are simply electronic records, what makes them fundamentally different from these established payment systems?

 First, records of Bitcoin transactions do not refer to any other currency. If I want to buy something from a merchant with BTC, I will pay the BTC, not the USD, price. In other words, Bitcoin is not a system for maintaining records of purchases denominated in any existing currency. Instead, it is a system for enabling transactions in a new currency. Bitcoin stands as an independent currency, on a level playing field with the dollar, euro, yen, or even gold.

Secondly, and most importantly, Bitcoin does not depend on banks. Much of the remainder of this monograph will be devoted to explaining why banks were (until now) a necessary evil. Bitcoin is designed in such a way that anyone who owns a at least a smartphone may become a keeper of the complete record of all BTC transactions. Right now, the entire history of BTC transactions exists on thousands of computers across the globe. If all but one of these were to be destroyed tomorrow, Bitcoin, and all BTC balances, would survive.

So, as to how Bitcoin works – As mentioned, Bitcoin is a distributed network of independent computers, connected by the internet and each running special software. There are two types of software on the network, the Bitcoin client and the Bitcoin miner. Most users of Bitcoin will only ever interact with a client, so let’s look at it first. Anyone can download a Bitcoin client from the internet for free, and install it on their laptop or mobile device. The software lets the user create a Bitcoin wallet, which can be locked (encrypted) with a password. The user can create Bitcoin addresses within the wallet. These addresses can be thought of as account numbers, and once an address has been created, the wallet owner can begin accepting deposits in the account. The wallet owner can create as many addresses he wants. This is useful, for example, if he wants to keep track of where deposits came from, by sending a different address to each person who he expects to send him BTC.

 You can use the client to send an email request for payment, with the amount requested and the address to send it to. If you have BTC in your wallet, you can send any fractional amount down to 1 Satoshi to another address. In a face-to-face transaction, a mobile device app can display the address of the receiving party as a QR code. The sending party scans the code with his mobile device, enters the number of BTC, and sends.

There are multiple versions of the client software available. Some store your wallet, as well as the entire Bitcoin blockchain (more on this in a moment), on your own computer. There are also web -based services that create your wallet in the cloud. In the coming months and years, users will undoubtedly encounter numerous other client interfaces for sending and receiving Bitcoin payments, as more and more merchants begin to accept payments in this new currency.

The second type of software is the Bitcoin miner. This software provides the core functionality of the network. Just like the client, the source code for the miner software is open source, and can be downloaded by anyone from the internet. The miner software maintains the database of Bitcoin transactions, and validates new transactions. Whenever a user sends BTC from his wallet to an address in another wallet, the message is sent across the Bitcoin peer-to-peer network of miners.

Each miner maintains a ledger of valid transactions, which are collected into blocks, which are linked in a chain. The chain begins with the block containing the first valid transaction, a transfer of 50 BTC (5,000,000,000 Satoshi) to the address of an undisclosed early adopter of Bitcoin. There is no address of origin, in other words, 50 new BTC simply became available that were previously unavailable thanks to the unassailable mathematical logic of thoroughly peer-reviewed and tested open-source (i.e. freely transparent to the technically literate) software code.

Each time a new block is added to the chain, another BTC deposit comes into existence, and is unfailingly added to an automated ledger with strict business rules, instantaneously backed-up to thousands of network peers, to the account of the owner of the cybernetic machine that performed the computational load of encrypting the new block. Much of the computational load is necessary for the successful maintenance of the integrity of the ledger against falsification, through virtually unbreakable cryptography.

Each miner competes in a lottery for the right to add each new block, where the drawing is the random numeric output of each peer’s execution of the encryption algorithm that seals the block and links it into the chain, and the prize is 50 BTC, awarded every ten minutes for four years, then 25 BTC every ten minutes for four years, and then 12.5 BTC…

Every other peer on the network can instantly verify the authenticity of each block, or of any other block in the chain, right down to the anchor block, by verifying that its public key decrypts a ledger of transactions identical to the relevant section of transactions in the full ledger maintained by each independent miner. This also implies that any node may freely join or leave the network at any time. If newly joined, the node will receive the entire valid block chain in a matter of hours, verified at each step by at least eight other independent/co-dependent nodes. Or the node may elect to download a validated archived copy of a recent state of the block chain from a trusted source, taking only minutes or even seconds to reconstruct a local copy of the block chain up to the present instant. At that moment it is woven into the network, monitoring the transactional traffic stream in real time, sending its own messages into the stream, messages that will instantaneously and reliably and with only a tiny amount of entropic leakage, balance and coordinate the wants and offerings of the node’s human owner with the production and distribution of goods by hundreds of thousands of capital owners, supervisors, and laborers. And this will be done in such a way that each of these people receives exactly the greatest amount of satisfaction in life that they are capable of attaining by their effort, thought, good will, and honesty.

For that is exactly what money does.

Unfortunately, there is something else that money must do. In addition to facilitating the production of goods and services, in short, of satisfactions, money must enable the building of safeguards and the execution of restraints against those who by their brutality, cunning, evil intent and soulless condition, seek to possess that which they have not produced, nor honestly traded for, nor were freely given out of love, or even out of pity.

The resources and human effort required to build and man these safeguards and constraints must be paid for with money. One of the advantages of a digital currency is that safeguards can be embedded in the design of the enabling software system, so that the resources and human effort required for ongoing protection are minimal. A digital cryptographic currency achieves these safeguards with crytography, a computationally expensive technology. The most computationally efficient implementation of a digital cryptographic currency would simply put the fastest machine available on the job, adjusting the rate of production by command and control. One of the most brilliant design aspects of Bitcoin is the metering of the production rate coupled to a software feedback loop which controls the difficulty of successfully encrypting and publishing a block. The control mechanism is the adjustment upward or downward of a threshold number. The first peer to perform the encryption using a private key which produces an output value below the threshold number is authorized to publish the new block. The output value cannot be predicted from the private key in advance, and thus the output values generated are random, and each execution of the encryption algorithm stands an equal chance of producing a value below the difficulty threshold.

Without this difficulty control, on any kind of distributed network where nodes compete to complete a task and be compensated with rewards, the probability of the fastest node receiving all of the rewards is .99999999… Thus, little incentive exists to design such a network at all, rather to design for a Fast Central Server, with communications only sufficient to receive customer orders, and to transmit data backups to a few secure distributed vaults.

Until now, the model of central command and control of the production of money, and the interposition of banks and regulators between traders, is the only model that has really been tried outside of the small villages and towns of the pre-industrial world. It is the model of the bank, and in its mid-twentieth to early twenty-first century incarnation, the model of the credit card and of PayPal. If the minions of the state, against all likelihood, had been first to perceive the potential value of a new digital, cryptographic, global currency, this is the pattern they would have tried to build to. Even if they could conceive of the brilliant design concept embodied in Bitcoin’s difficulty controller, they would not dare to implement it, knowing full well it could destroy the illegitimate basis of their power.

With the difficulty control in place, even the fastest computer on the network will only be successful in the lottery to the extent that its processing power has contributed to the overall activity of the network. Every node, no matter how slow, has a calculable chance of being the winner in each new lottery. Much of the activity is ultimately useless in the production of BTC and maintenance of the integrity of the financial ledger of BTC transactions, but is incredibly valuable in providing the perfect incentive structure for the growth and protection of a self-organizing network. Thus, if the network can be freely joined, and if anyone with a computer and an internet connection can freely download both the executable and source code, and in fact even the record of all modifications and configuration changes ever made to the code, then some people will be incentivized to participate in the network by the prospect of receipt of 5 billion Satoshi even if no one else in the world can perceive the potential real value of that ledger entry, or of the ledger itself which actually encompasses the globe with a virtual omnipresence of utterly reliable and honest financial transaction data, guarded by exhaustively proven mathematical locks and keys and regulated by its unalterable control logic.

Admittedly, only technically competent individuals with their own ideas, interests, and pursuits in the somewhat arcane field of digital cryptography and the even more arcane field of anarcho-capitalist monetary theory, were likely to, and in fact did, see the hidden value of this new technology in its infancy, and to understand that it possesses the potential to render banking and the state obsolete relics of a past barbarous age, while preserving and even greatly enhancing the ability of free people to trade freely and honestly with one another, and so secure prosperity for the deserving, generous charitable provision for the unfortunate, adequate consideration for the undeserving, and just restitution from the justly proven transgressor. These individuals, starting with Satoshi Nakamoto, brought the Bitcoin network into existence and made its benefits freely available to the world. In return, some of them now likely own thousands or even hundreds of thousands, of BTC. For this, these people have been criticized as the authors of some sort of fraudulent scam, by critics envious of their success and too unimaginative or lazy to understand how it has been achieved. Since they have clearly profited by their actions, the builders and early adopters of Bitcoin have been decried as charlatans and hucksters, simply because they have, through their own foresight and reason, brought into the world an invention of incalculable value, making it freely available to the entire world, and then honestly competing with anyone else willing to invest capital in the production of the goods their invention enables. Their share of the harvest they have stored until it could be exchanged at a freely bargained price acceptable to themselves and to their willing customers. Yet they are accused of dishonesty for the creation of a wonder which anyone who wishes to examine can clearly see was designed to make dishonesty impossible within the limits of its workings.

If you encounter these criticisms, I hope you will take them for what they are.

Dialog with a bitcoin critic

8 Apr

A friend of mine left the followiong comment on Facebook when I announced my new blogs:

“Let’s count all the ways bitcoin is a terrible idea.”

He then gives his top ten list of the reasons why bitcoin is a crackpot scheme that will steal all your money if you are foolish enough to get involved. I’m not sure if he is pulling my leg, but his list contains a shocking lack of literacy on the technical foundation of bitcoin in every item. Since this is a sterling opportunity to correct each of these misconceptions, which are certainly widely held by those only vaguely familiar with the concept embodied in the bitcoin network, I will respond to each of his ten items individually. In this post I tackle numbers 1 through 3…

“1. It’s a plan written by a phantom person no one has ever been able to track down in the real world.”

It is a plan, written entirely in the open and freely available for anyone to criticize or improve, by a man or woman who knew he or she could potentially be a target of suppression by the federal government to protect the Federal Reserve Bank’s monopoly on money creation, and was appropriately careful of privacy, to the point of anonymity.

Incidentally, this person only started the design and implementation of the bitcoin software. It is now the product of hundreds of independent designers, coders, testers, bug reporters, debuggers, each participating on a voluntary basis, and each having full access to the code base. Yep, that phantom person must have been real darn cagey to figure how to hide the plans for his nefarious Ponzi scheme right out in plain sight like that!

“2. It sets a “limit” on the quantity of units based on how many “puzzles” have been hidden somewhere on the net for people to “mine” … with the incredible, unimpeachable assumption built in that the creators wouldn’t DARE create more than they promised they would create.”

 There is a basic misunderstanding of the operation of bitcoin apparent in this assertion. The limit on the amount of currency to be created does not depend on computers solving “puzzles” that have been “hidden” on the web by the crafty bitcoin masters, so there is no way for them to create new “puzzles” to “hide”. The limit is purely algorithmic, and cannot be changed by any single person, although any person willing to learn a computer language can examine the source code and verify the function of the algorithm controlling the rate of bitcoin production. The “hidden puzzles” idea is like telling a child that babies are brought by the stork. It is just a dumbed down version of a process that is difficult for most people to understand. There are many clear explanations of the bitcoin mining algorithm freely available on the web. Probably the best from a technical standpoint is the original paper published by that phantom person, Nakamoto Satoshi, and available here:http://www.bitcoin.org/bitcoin.pdf

 I have also written an explanation of bitcoin, which I will post in the next few days.

“3. Bitcoin is currently in heavy use by drug cartels and organized crime, which is why the Federal Government just announced anti-money laundering regulations specifically for bitcoin.”

The dollar is currently in heavy use by drug cartels and organized crime, which is why the Federal Government created money laundering regulations in the first place. The Federal Government just announced guidance for how it believes its existing regulations apply to various actors in the bitcoin economy. You can access the guidance document here.There were no new regulations specific to bitcoin announced.

Here are numbers 4 through 10. I will leave it as an exercise for the reader to come up with a response to each of these statements, and I will give you the correct answers in subsequent posts.

“4. The transactions are supposedly “safe” because, because they’re public record. We’re supposed to believe in this safety despite the fact that major data portals like Facebook, Google, Bing, Twitter, etc. can now deduce or infer with high probability incredible amounts of information about your career, sexual orientation, political views, etc by just the kinds comments you make on your Facebook profile and news feed. Yet, somehow, we’re supposed to believe that there isn’t enough processing power in the world to deduce who is associated with which transaction in a bitcoin log.


5. While there are ways to cash into bitcoin, it’s extremely difficult to cash out of it.

6. Even if you buy the theory that there will never be more than 21 milliion bitcoins (because you were promised that, right?), that quantity is nowhere near large enough to actually serve as a viable currency in a world economy consisting of over 7 billion people. We’re supposed to believe that this will be accomplished by subdividing bitcoins into subunits called “satoshis” (named for the fictional creator of bitcoin), although no one has actually been able to figure out how to accomplish this subdivision.

7. Supposedly, only the last bitcoin gets subdivided (according to Wikipedia). That’s just plain wacko!

8. Bitcoins are backed by … well … nothing. It’s fiat money issued by “the market”, which of course is why we’re all supposed to say, “Oh, what a wonderful idea!” … even though it’s a crackpot idea.

9. No one seems to have thought about how people will track all the public transactions associated with bitcoin if it somehow managed to become a popular, world-wide currency despite all the strikes against it. I suppose we’d all have to end up carrying around storage arrays so we can make sure we aren’t being cheated, right?

10. I could go on, but why bother? The whole concept is a nut job.”

to be continued…