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I wrote this post about Bitcoin in order to avoid writing yet another long comment on Hacker News. Next time other commentators ask me for details on my views, I will point them to the relevant section.
I knew about bitcoin since it first came out, in 2009, but didn’t take an interest until 2013. I started monitoring bitcoin closely when the price for 1 BTC turned to 20 USD, until it reached 1000 USD.
For about three months I studied currencies. I had a grasp of economics which helped me, but not much. Some concepts are hard to grasp at first, but apart from terminology - as it often happens - there’s nothing fancy going on under the hood. Once you understood some dynamics, everything seems natural.
I’m not an economist1. I have owned small amounts of bitcoins in the past. I sold everything when the price doubled. I never owned any bitcoins ever since although I’m still interested in bitcoin, mostly the protocol though.
The views stated here, are not mine. You won’t find any original content, as all these views can be find elsewhere. I endorse the views stated in this article. If my views change, I will just update the relevant section add or subtract material.
A currency is an exchange medium. Instead of exchanging apples to potatoes, we use currencies to facilitate transactions. Currencies are flexible and allow us to put accurate price tags on products. Prices are fixed by governments or regulated by the markets through supply and demand mechanisms.
Currencies are rarely adopted since their only true purpose is the exchange for goods. Currencies are enforced to populations by their governments. The most usual way to enforce a currency to a given populace is through taxes. A state accepts taxes and issues pay-backs using a specific currency, thus enforcing the use of this currency, turning any other exchange medium or currency dysfunctional.
Of course the above situation can work out in regular or even stagnant economies. In troubled economies, where inflation can reach extraordinary levels, people will search for an alternative currency.
The generally accepted economic theory states that every currency should be inflationary in order to promote the exchange of money for goods. When the consumer knows that his money will retain less value in the future, the consumer has an incentive to spend more money today, helping the economy to grow.
So if a currency is deflationary, consumers will spend only what is needed most and try to hoard as much as possible, leading to a stagnant economy.
Of course both inflation and deflation must be adjusted in minimal levels to avoid situations where people are either massively dumping the currency or massively hoarding the currency.
In order to avoid financial crisis, governments created central banks. The central bank’s main objective is to stabilize the economy through money supply (inflation) or lack of money supply (deflation).
Currencies are issued by central banks2. Central banks are following guidelines and policies issued by the ministry of finance.
Currencies from different countries are exchanged using exchange rates defined either by the governments, in case of fixed exchange rates, or by the market in the most standard case of floating exchange rates.
The biggest market in the world is dealing with currency exchange and it’s called FOREX (Foreign Exchange Market). It’s a decentralized system, for currency trading where huge amounts of money are moved every day. To give an idea of the amounts, the average daily turnover at FOREX is estimated to be around 4 trillion USD.
Central banks try to protect their financial systems from external currency attacks taking place in FOREX, some times without success3. Central banks the power to suspend operations for hours or days if needed (e.g. to stop devaluation or revaluation of their currency).
It must be noted that economic policies of governments and central banks are subject to long term, mostly unresolved debates.
Once upon a time, currencies were backed by the amount of gold a state had in his vaults. That sort of god-backed economy was called the gold standard.
Today no major economy relies on the gold standard. However every time a country is trying to invest in substantial amounts of gold - this is true mostly for military powers such as China or Russia - unrest spreads quickly4. This happens because to investors, gold has a proven universal value over time. Hence a gold backed currency, is easier to be accept by third parties, compared to any other kind of currency.
A successful currency must promote the exchange of goods while for an investment to be successful it must at least retain it’s original value if not gain more value over time.
So currencies and investments have different goals, although more often than not overlap each other, especially in FOREX where buying and selling currencies is seen as a form of investment.
The most common forms of investment are:
1 Gold: Although the last three years lost value by 23%, in 2013 got up 5% and counting. It is still considered the most stable asset for the long run.
2 Land: Especially before the housing bubble exploded in the US and EU (Spain mostly IIRC), land was the most well known form of secure investment.
Other very well known form of investments include:
Bonds: The most prominent example are government bonds.
The bitcoin protocol was a significant leap forward in many areas, as it managed to solve the double spending issue in an acceptable, decentralized way. It has a series of weaknesses which I hope will be addressed in time.
The bitcoin protocol can be used for many interesting things such as:
DNS: A decentralized uncensored Domain Name System is needed today more than ever. The bitcoin protocol can do that!
Time-stamp verification: We don’t really need a third party authority to sign a paper, discovery or contract. We can use bitcoin’s public ledger to ensure ownership and copyright.
Voting system: A new digital voting system in which we can count votes and every single one of us can go to the public ledger and ensure that his vote was not tampered while retaining privacy.
These are just a few possible uses, there are thousands more that we can’t even start to think about today!
The bitcoin protocol is a technological revolution, which will enable us to decentralize systems that now are tightly controlled and could easily be abused. Bitcoin could render these systems more secure and less prone to errors.
So if we put the bitcoin protocol in to the right perspective, it is as revolutionary as it gets! I firmly believe that it will be proposed and adopted at international level by governments to tackle many technical issues that require transnational cooperations.
Bitcoin was introduced to the general public as a cryptocurrency in 2009. Apparently bitcoin was introduced as an alternative to FIAT currency for online payments.
But there is a fundamental design decision that makes, bitcoin as a currency, contradictory: bitcoin is deflationary by design. There can only be produced 21 million bitcoins.
Initially I thought that Satoshi5 made a mistake. But given the genius that takes to create the state-of-art cryptographic protocol that bitcoin is, a mistake from Satoshi was hard to digest.
So my bet is that Satoshi had a deep understanding of macro-economics and consumer’s psyche. He knew that mainstream consumers wouldn’t have any incentive to own a currency that is inflationary with no inherent value, backed up no one. Since there was no other to way to force someone to own bitcoins - Satoshi was not in a position to force the proliferation of bitcoin - the only way turn bitcoin mainstream was to make it deflationary, to give bitcoin users something to aspire on, a good return on investment.
Hence I believe that this was a kind of forced decision, to make bitcoin acceptable by the masses and it was a successful decision in my opinion, otherwise bitcoin might had never took off.
I can’t tell if my theory is correct of course. But if it is correct, it paid off.
Bitcoin, in my view, was never meant to be a currency. It was never meant to be used at least directly, for online micro-payments, as the original paper states.
If an average consumer has reason to believe that bitcoin will raise it’s value, the consumer will probably choose to hoard and not spend bitcoins when he can spend USD which is an inflationary currency.
And there is a very good reason to believe that bitcoin will continue to go up in the long run. The reason bitcoin’s scarcity. Of course prices don’t go up for ever, but no one can tell for sure when prices will go down. So even when in doubt, most consumers will choose to spend an inflationary currency.
So in my opinion, bitcoin is a failed currency. It was meant to fail. It was meant to be used primarily as value storage medium and only in lack of other options as an exchange medium.
Of course for bitcoin to be considered an option for medium to big investors, the price needs to stop fluctuating so much. It is a common pattern for new currencies to fluctuate, but since bitcoin’s characteristics are way more similar to gold than FIAT currency, I think that it’s clear by now that bitcoin should be considered an asset (investment) and not a currency. We will see in a couple of years how this will play out, but I don’t think this will change.
Bitcoin has some really interesting innovations (properties) which make it useful in many ways, for situations that traditional currencies might not be suited:
Speed: Using bitcoin, someone can send any amount of money from the Antarctica to China in less than 1 hour6 . There’s no way for average Joe to do that without spending a substantial amount of money in services like Western Union.
Anonymity: If used with appropriate policies, Bitcoin transactions can assure an unprecedented level of anonymity for everyone who has the knowledge to use technologies like Tor in conjunction with bitcoin.
Form Factor: Using bitcoin we are able to transfer 1 billion USD from the US to China and back without anyone really noticing, since you can print your wallet into an A4 paper or carry it inside a USB stick.
Of course all these are theoretical approaches because in practice is very hard to cash out large amounts of bitcoins into any FIAT currency without getting noticed at a small time-frame. Since reality is what really counts most of these options should be taken with a grain of salt when discussed.
Especially in the USA, many people have grown to believe that markets if let alone, free of any constraint will automatically reach a state of optimal equilibrium. I don’t believe that.
There’s an excellent reading on Daily Kos on markets absolutely not regulating themselves. There are books and articles about from economists like Joseph Stiglitz and Paul Krugman
Even if you assume that all market players are ethical, when a player turns big enough, his moves cause market disruption.
I believe that there must be some kind of regulation for the general good of the society. High levels of inequality lead to social degradation7 and it’s my belief that an advanced society should promote peace and ensure welfare to it’s citizens according to the Universal Declaration of Human Rights. In order to achieve this, in my view, the state must regulate segments, parts or entire markets depending on a case by case scenario.
Bitcoin doesn’t have a central authority. The bitcoin supply can be predicted, we can all access the public ledger and see all transactions taking place and all the mining power used by the grid.
Theoretically, accurate predictions can be made using complex algorithms, for the deflationary or possibly inflationary behavior of bitcoin in the next years, but in practice it’s impossible since bitcoin’s price is tightly connected to external events.
So we can accept the fact that bitcoin is decentralized, but we must accept also the fact that bitcoin is unpredictable.
What happens when a bitcoin owner accumulates large amounts of bitcoins? Say a single owner accumulates 15% of bitcoins in circulation. Now he can use his position of power to drive the price of bitcoin down by dumping large amounts of bitcoin at once. Then he could buy back more bitcoins for the same price. That’s just a hint of what such a player can do.
I am pretty sure that exist early adopters who have more than 15% of bitcoins in their wallets and apparently I am not the only one. Adi Shamir, the famous Israeli cryptographer, who co-invented the RSA Public Key Cryptography algorithm, in a paper released 20128, state that 98% of bitcoins belong to 2% of portfolios.
That’s the danger of any non-state controlled currency. You are facing imminent havoc at any time. No state can design a monetary policy that fits the needs of it’s population9, if it doesn’t control the currency. Not having tight control the currency, is deeply undemocratic and ultimately dangerous.
I consider the current FIAT system, with central bank policies chosen by elected governments, democratic and secure compared to a decentralized anonymous currency. Here are the reasons:
- Power to influence: The majority votes the government, who choses the central banker and defines the policy. Democracy is just that: accepting the majority’s choice even if you are not supporting the majority’s views.
- Accountability: I know who the central banker is and from whom (government and individual ministers, prime minister, etc.) he was chosen. If I don’t agree with this choice, with tha banker’s stance towards economy or I consider his actions immoral, I can make a different choice in the next elections. Write a blog post about it and so on. If the central banker, or the minister of finance did something illegal there is always the chance that he will be punished.
- Publicity: Extending the above argument, a central banker is a public figure. He has at least some motivation to act morally, since he will face public scrutiny for his actions, which might lead to public outcry. For example in Greece, there is a huge outcry for the central banker, Mr. Provopoulos, for allowing short-selling on Greek bonds which led their prices sky-high. The story is known as “T+10” and Mr. Provopoulos is known ever since as “Mr. T+10” in the financial circles.
Bitcoin on the other end, lays an anonymous framework upon which big players can do whatever they wish without any kind of scrutiny. So it’s not democratic, it’s the exact opposite actually, totally undemocratic.
By adopting bitcoin instead of FIAT a country or group of people will put literally their faith in the hands of an unknown group of investors/owners who can not be held accountable in any way. That looks more like a jungle than freedom to me, but being a Greek I know that Gorgias would be proud.
I consider the bitcoin protocol a huge innovation. I think that crypto-currencies are here to stay and I’m eager to see how all these variations will evolve in the future.
Bitcoin has some unique properties that fill important gaps but in no way, cryptocurrencies are a solution to our current corrupted, unregulated and highly inefficient financial system.
I believe that as with other topics adjustment must be done at political level mostly. The technology can buy us time, but won’t get us far if laws that prohibit this or that get passed all the time uncontested. Financial deregulation is what brought the entire world to it’s knees.
I believe that large amount of the population lacks political knowledge and judging skills. I consider myself among the ones lacking judging skills. If we can train ourselves to make more sensible choices and promote the virtuous over the corrupted, I assume that we will see better days.
I’m not referring to any political spectrum in particular, I believe that there are virtuous and corrupted politicians, bankers, doctors, etc. All over the political spectrum.
All the arguments stated above are just my views. They are not and should not be accepted as universal truths. I’m open to other views as long as they come with rational arguments and food for thought.
I don’t believe that economics are a science but I reckon that you need some reading in order to get familiar even with basic concepts.↩
There are few notable exceptions to this rule, but are out of scope of this post.↩
The limit for a transaction to be generally accepted as secure is 7 signatures. This depends on the network nodes speed, could take from 5 minutes to 1 hour.↩
Greece, Italy and Spain are good examples: They can’t devalue and boost their exports because of the Euro, so they are caught in a vicious circle.↩