Friday, January 3, 2014

Bits about Bitcoin


About a year ago I revisited the whole "Bitcoin" thing, the first time I heard of it, I tried to get started but it was technically over my head and new enough the help wasn't helpful enough for my simple mind.  However I learned enough to realized I didn't know jack about cryptography or economics.  After doing some Google-study I eventually learned enough to become more comfortable with the concept.  Unfortunately I began mining with my old GPU in the early part of 2013, just as things were heating up.  I didn't trust any existing exchange with my USD money, yet.  As you likely know, 2013 was a good year for Bitcoin, as well as the dozens of sister-crypto-currencies out there.  I kept my ear to the ground on any articles written on the subject.  At first they were confused, then dismissive, then there was a good flow of Pro and Con.  They all had the obligatory "history of bitcoin" which got pretty tedious after the 100th time.

I'm an engineer/hacker/nerd and as interesting as economics are, I won't pretend to comprehend the models used in the subject.  As a software hacker I prefer to write my code to function with as little user input as possible, people are dirty nasty things that foul up every system. Economists are pretentious enough to presume they can model people, so I remain suspicious of anything "known" to the school of economics.

That said, the "why" I'm want to write this, is I'm a little tired of all the flawed models (straw men) presented in many Anti-Bitcoin articles.  I guess it's understandable, a debate over currency has never been so lively, but I'll try all the same.


The technology behind Bitcoin is pretty solid.  There are theoretical vulnerabilities, but when compared to common money, it’s pretty much uncounterfeitable.  It’s designed to be anonymous but it’s generally not practiced that way.   The “mining” of bitcoins is a reward system for perpetuating the Bitcoin transaction network.  The miners act as a distributed “bank” validating a transaction just like when you swipe your card at check-out.  It was designed to reward more early and reward less later on when they could be worth more.  Additionally, a optional transaction fee (think tip) for a BTC transaction is incentive to the mining network to process your transaction now.  A safeguard to the network restricts a new block to 1MB which will include a finite number of transactions per block.  


To reiterate, I'm not an economist or a writer, but as an engineer, economies look like systems where goods/services flow in one direction and money flows in the other.  There are good money-systems and there are bad ones.  If you don't see the point of Bitcoin then you likely regard your money-system as a good one.  Likewise if you think "hey I should get my money out of the bank and get some BTC" then you're probably in a bad money-system.

If you live/work in a good money-system, you’ll buy and pay taxes with the same money you are paid.  Within that system, you won’t notice the relative volatility because everyone is gaining and losing absolute value at the same rate.  Unless you trade with another country or money, then you’ll notice the volatility.  These effects will slowly change the price within your local money-system like higher/lower prices on imports.  If you have bad money-system, your money will loose value so fast you’ll notice immediate effects within your money-system.
In a “good” money-system, there is little need/reason to adopt crypto-currency, in fact a hybrid money-system would cause the normally insulated money-user to feel the relative volatility between currencies.


Where things get spirited is the philosophy.  The BTC and the USD run in bipolar economic models.  As an engineer I see the USD working like this.  Greatly simplified:
1.       Source: The USG prints USD and spends them
2.       System: USD circulate in the US economy
3.       Sink: Taxes remove USD from circulation.

This might look weird; because taxes don’t pay for public services, taxes simply restrain inflation.  The USG is effectively outside the money-system, while we lowly people are stuck keeping to a budget.

This money-system is designed to devalue over time, just enough to motivate the individual to consume now as each USD will be worth less later.  According to Keynes, an economy works better when people consume more now instead of saving for later.  Most economists, banks and governments agree with Keynes.

Bitcoin (and many, but not all of the other cryptocurrencies) are engineered in a different way.  First there is a cap on the number of BTC.   Second the production is prescribed by mining.   Another overlooked fact, there is a network cap of 21 MBTC, but for every lost wallet, those BTC are also lost.  I suspect that many of the early miners generated hundreds or thousands of BTC each and eventually deleted the wallets when they moved on to other hobbies, one poor guy threw is hard drive out.  Fortunately, as an infinitely divisible money-system, the whole global economy could fit under any fraction of the total BTC pool.  

If the USD was run like BTC, things would be different, instead of a source-system-sink model; the government would be on equal ground with any other user in the money-system.  Meaning to spend money on public services, the USG would need to collect taxes or other revenue; you have to have BTC to spend BTC.  It is obvious why a government wouldn't care for this burden, so I doubt an entrenched political class will make a move to Bitcoin.


A pet peeve of mine is listening to persuasive arguments that make heavy use of logical fallacies.  If you listen, they saturate our media, so much that I'm sure I've learned to be as just as guilty in habit, but I try to be better.
One particular problem I see recurring is attacks against BTC/USD volatility.  One annoying example was a theoretical BTC-mortgage.  You buy a house with a BTC mortgage, when 1BTC=1USD.  Then the value jumps to 1BTC=100USD.  Your mortgage just jumped two orders of magnitude!  This argument assumes a mixed-money system where you, the home-owner, are paid in USD but then convert that to BTC to pay your mortgage.  In a good money-system there is no reason to pay your bills using BTC if your wage is USD.  If you are in a bad money-system, you might stash your wage in BTC to save it's value, but a mortgage in a non-native currency would be risky.  If you are in a Bitcoin money-system, your wage in BTC would pay your mortgage in BTC just like it can in USD.  No problem. 

What's it Worth?

Everyone is struggling with this one, but I think I know the answer, and with all answers in engineering, it depends.  It depends on how big the BTC money-system is, not the commodity price.  
If the only country using Bitcoin was the country Galt, and Galt  was as productive as California ($2T in 2012) then the value would be 1BTC = $95,238.  Basically, as more groups adopt one finite resource the unit-value will go up, just as if Canada decided to switch to USD, we’d either have to print more money (increase the supply) or the demand/value would jump by 12% .  The problem with stating this way is it betrays a value-bias to the USD, but since it is a familiar valuable object so I think it works. 


I don't know why it matters, but I figure someone may care.  I still have not traded USD for BTC.  I don't like to think of Bitcoin as a commodity.  I chose to invest lightly in ASIC miners.  The hardware business of Bitcoin is a whole other monster, perhaps another post.  I bought my first ASIC from BFL, I fretted over BFL using my money to build my ASIC and then mine BTC with it while difficulty was still low and I waited for my product.  It did eventually come.  Later in a post $266/BTC to $70 slump the price of ASICs went down and I grabbed a few more before the meteoric rise to $1200/BTC.  Now the $/GH has created a chasm between hobby miners like me and serious investors.  If you have the resources you can buy $4-5/GH.  If you want more modest hardware you will pay $40-50/GH.  

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