2011 Journal

WORDS is a monthly journal of Bitcoin commentary. The 2011 writing in the WORDS archive is too sparse for monthly issues, so it is gathered here as a single volume. For the uninitiated, getting up to speed on Bitcoin can seem daunting. Content is scattered across the internet, in some cases behind paywalls, and content has been lost forever. That’s why we made this journal, to preserve and further the understanding of Bitcoin.

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Bitcoin, what took ye so long?

By Nick Szabo

Posted May 2011

So asks gwern in a spectacular display of hindsight.

The short answer about why it took so long is that the bit gold/Bitcoin ideas were nowhere remotely close to being as obvious gwern suggests. They required a very substantial amount of unconventional thought, not just about the security technologies gwern lists (and I’m afraid the list misses one of the biggest ones, Byzantine-resilient peer-to-peer replication), but about how to choose and put together these protocols and why. Bitcoin is not a list of cryptographic features, it’s a very complex system of interacting mathematics and protocols in pursuit of what was a very unpopular goal.

While the security technology is very far from trivial, the “why” was by far the biggest stumbling block – nearly everybody who heard the general idea thought it was a very bad idea. Myself, Wei Dai, and Hal Finney were the only people I know of who liked the idea (or in Dai’s case his related idea) enough to pursue it to any significant extent until Nakamoto (assuming Nakamoto is not really Finney or Dai). Only Finney (RPOW) and Nakamoto were motivated enough to actually implement such a scheme.

The “why” requires coming to an accurate understanding of the nature of two difficult and almost always misunderstood topics, namely trust and the nature of money. The overlap between cryptographic experts and libertarians who might sympathize with such a “gold bug” idea is already rather small, since most cryptographic experts earn their living in academia and share its political biases. Even among this uncommon intersection as stated very few people thought it was a good idea. Even gold bugs didn’t care for it because we already have real gold rather than mere bits and we can pay online simply by issuing digital certificates based on real gold stored in real vaults, a la the formerly popular e-gold. On top of the plethora of these misguided reactions and criticisms, there remain many open questions and arguable points about these kinds of technologies and currencies, many of which can only be settled by actually fielding them and seeing how they work in practice, both in economic and security terms.

Here are some more specific reasons why the ideas behind Bitcoin were very far from obvious:

(1) only a few people had read of the bit gold ideas, which although I came up with them in 1998 (at the same time and on the same private mailing list where Dai was coming up with b-money – it’s a long story) were mostly not described in public until 2005, although various pieces of it I described earlier, for example the crucial Byzantine-replicated chain-of-signed-transactions part of it which I generalized into what I call secure property titles.

(2) Hardly anybody actually understands money. Money just doesn’t work like that, I was told fervently and often. Gold couldn’t work as money until it was already shiny or useful for electronics or something else besides money, they told me. (Do insurance services also have to start out useful for something else, maybe as power plants?) This common argument coming ironically from libertarians who misinterpreted Menger’s account of the origin of money as being the only way it could arise (rather than an account of how it could arise) and, in the same way misapplying Mises’ regression theorem. Even though I had rebutted these arguments in my study of the origins of money, which I humbly suggest should be should be required reading for anybody debating the economics of Bitcoin.

There’s nothing like Nakamoto’s incentive-to-market scheme to change minds about these issues. :-) Thanks to RAMs full of coin with “scheduled deflation”, there are now no shortage of people willing to argue in its favor.

(3) Nakamoto improved a significant security shortcoming that my design had, namely by requiring a proof-of-work to be a node in the Byzantine-resilient peer-to-peer system to lessen the threat of an untrustworthy party controlling the majority of nodes and thus corrupting a number of important security features. Yet another feature obvious in hindsight, quite non-obvious in foresight.

(4) Instead of my automated market to account for the fact that the difficulty of puzzles can often radically change based on hardware improvements and cryptographic breakthroughs (i.e. discovering algorithms that can solve proofs-of-work faster), and the unpredictability of demand, Nakamoto designed a Byzantine-agreed algorithm adjusting the difficulty of puzzles. I can’t decide whether this aspect of Bitcoin is more feature or more bug, but it does make it simpler.

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Alternative Bitcoins in a Market of Currencies

By Ryan Dickherber

Posted June 18, 2011

There are two classes of criticisms of bitcoin (see this Quora question, for instance): 1) The bitcoin protocol is flawed, is probably flawed, or might be flawed. 2) Some of the properties of the bitcoin system are economically poor choices. I am not a cryptographer, so I have nothing meaningful to add to the discussion of the technical merits of bitcoin. However, I can say with confidence that the second criticism of bitcoin, that, for instance, the fact that it is a deflationary currency renders it useless, is a problem that can be solved by merely creating a market of different bitcoin currencies that all use the same protocol but have different economic properties.

For instance, there may be value in having a bitcoin currency that is like bitcoin in every way, except that is not limited to 21 million coins. Let’s call this new currency infinitycoin. New infinitycoins would be generated at a rate of 50 per 10 minutes, just like regular bitcoins. The only difference would be that the production would never taper off; there would never be a time when the production of infinitycoins cuts in half, or cuts in half again. Instead, the rate will be held at a constant 50 new infinitycoins per 10 minutes forever. Bitcoins would probably always be more valuable, because they are deflationary. But infinitycoins might have a more steady value with time. Thus, infinitycoins could be used in cases where they are appropriate but bitcoins are not.

Another coin, let’s call it Fedcoin, could be run by the Federal Reserve Bank of the United States. Like infinitycoin, it would use the same cryptographic and communications protocols as bitcoin. However, unlike infinitycoin or bitcoin, the rate of creation of coins would not be controlled directly by an algorithm. Instead, the software will communicate with centralized servers controlled by the Fed in order to determine the rate of production of new Fedcoins, thus controlling the rate of inflation. The Fed would be able to control the rate of inflation of Fedcoins in a manner similar to the way the Fed controls the rate of inflation of US dollars.

These three currencies, and many more that I am not creative enough to imagine, could exist simulaneously in a market of currencies. It may be the case that one of them becomes by far the dominant currency, or it may be the case that they all exist simultaneously, and people will use all of them at different times depending on which currency they deem is appropriate. Like with biological evolution, the currencies would exist in a competition. Just like how many different species, or many different ways of life can exist simultaneously, these currencies could exist simultaneously. And again, just like with biological species, some of the currencies may die out if they are not fit enough.

Thus we see that any argument that bitcoin is flawed becuse it is a deflationary currency is itself flawed. The reason is because the economic choices of bitcoin are only one possibility; there is no technical reason why other species of bitcoins could not exist simultaneously. If any such currencies came into existence where there was in fact a market for them, they would thrive, and thus come to compete with standard bitcoin. Indeed, one would expect that such alternative bitcoins probably already exist. Some Googling reveals that they do, or at least they do at an early state of development (1,2,3).

If the bitcoin protocol is flawed, then bitcoin and all alternative species of bitcoin will fail. But if the protocol is not flawed, then different species of bitcoin will certainly emerge and be useful exactly to the extent that their economic nature makes them useful.

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The Most Dangerous Creation In The History Of Man

By Michael Suede

Posted May 26, 2011

Ask most people what the most dangerous thing man has ever created is and you will almost certainly receive the uniform response of “nuclear weapons.”

Lo, there is another far more nasty entity in existence that most people have never heard of.

The Bitcoin.

I just ran into this myself so I thought I would give it some free publicity.  Bitcoin is an electronic peer-to-peer currency that has no central server.  To hear a statist speak of it, it sounds like it could herald the end of the world (at least as we know it.)

Of course, depending on whether you believe in the State or not, the Bitcoin is either the spawn of Satan himself or it is a manifestation of the Christ.  I personally put it somewhere between the Virgin Mary and Gandhi.

Given that it is a secure currency that has no central server, it is impossible to tax, and impossible to stop.  I can see the looters frothing at the mouth and sputtering obscenities as we speak.

C4SS reports:

Jason Calacanis and his colleagues at LAUNCH describe Bitcoin as “The Most Dangerous Project We’ve Ever Seen” (May 15, 2011).  Not only is it “the most dangerous open-source project ever created,” but “possibly the most dangerous technological project since the Internet itself.”  It “could topple governments, destabilize economies and create uncontrollable global bazaars for contraband.”

The beauty of Bitcoin is that there’s no central server network to shut down. Bitcoin is traded from one desktop or mobile device to another via public key encryption. Short of catching and prosecuting end-users with harsh punishments — and we all know how well that’s worked out for proprietary content companies versus file sharers — there’s no way to stop it.

There are currently 6 million Bitcoins in circulation, with a total value of $40 million. Bitcoins are generated by a complicated algorithm, with the total to top out at 21 million. After that, increases in exchange of goods and services will be offset by appreciation of Bitcoins in value and deflation of Bitcoin-denominated prices.

I’m assuming the world will soon devolve into Mad Max beyond Thunderdome as leather clad mercenaries paid in Bitcoins deconstruct society using machine guns while hoarding oil and pig slop.

I don’t want my joking to fool you into thinking that this isn’t the most important development in human history.

It is.

When people can be paid in a currency that is impossible to trace, impossible to take, and impossible to tax – the governments of the world will all fall to the dustbin of history.

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Bitcoin Is Worse Is Better

By Gwern

Posted May 27, 2011

Abstract

The genius of Bitcoin, in inventing a digital currency successful in the real world, is not in creating any new abstruse mathematics or cryptographic breakthrough, but in putting together decades-old pieces in a semi-novel but extremely unpopular way. Everything Bitcoin needed was available for many years, including the key ideas.

However, the sacrifice Bitcoin makes to achieve decentralization is—however practical—a profoundly ugly one. Early reactions to Bitcoin by even friendly cryptographers & digital currency enthusiasts were almost uniformly extremely negative, and emphasized the (perceived) inefficiency & (relative to most cryptography) weak security guarantees. Critics let ‘perfect be the enemy of better’ and did not perceive Bitcoin’s potential. However, in an example of ‘Worse is Better’, the ugly inefficient prototype of Bitcoin successfully created a secure decentralized digital currency, which can wait indefinitely for success, and this was enough to eventually lead to adoption, improvement, and growth into a secure global digital currency.

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What is the great accomplishment of the idea of Bitcoin? In discussing Bitcoin’s recent rise to $10 in 2011, many have been wondering who is the real man under the Satoshi Nakamoto mask; a hard question—how many genius libertarian cryptographers are there? But the interesting thing is, Satoshi could be anybody, and I believe this gives us an interesting clue to how Bitcoin has been able to bootstrap itself from nothing.

Satoshi could be anybody, Bitcoin involves no major intellectual breakthroughs of a mathematical/cryptographic kind, so Satoshi need have no credentials in cryptography or be anything but a self-taught programmer!

Pre-requisites

Satoshi published the first public version of his white paper on 1 November 2008 after earlier private discussions^[bitcoin.org was registered 18 August 2008, so presumably Satoshi had been developing the bitcoin idea at least as early as 2008. He refers to working on it earlier than that, but the earliest draft of the Bitcoin whitepaper appears to have been circulated privately sometime before 22 August 2008 when he contacted Wei Dai for comments.] and the whitepaper was further edited afterwards, but if you look at the cryptography that makes up Bitcoin, they can be divided into:

• Public key cryptography^[Although Bonneau & Miller 2014 describe a cryptocurrency design using just cryptographic hash functions (with commit-and-reveal) without any need for public key cryptography and pointedly note that “Bitcoin itself is something of a curiosity from an academic standpoint in that it was discovered decades after the requisite cryptographic primitives were available. Our work shows that it was in fact possible even before the discovery of public-key cryptography.”]
• Cryptographic signatures
• Cryptographic hash functions
• Hash chain used for proof-of-work
  1. Hash tree
  2. Bit gold
• cryptographic time-stamps
• resilient peer-to-peer networks

Dates

> "So the first answer to Why Now? is simply 'Because it's time.' I can't tell you why it took as long for weblogs to happen as it did, except to say it had absolutely nothing to do with technology. We had every bit of technology we needed to do weblogs the day [Mosaic](!Wikipedia "Mosaic (web browser)") launched the first [forms](!Wikipedia "Form (HTML)")-capable browser. Every single piece of it was right there. Instead, we got [Geocities](!Wikipedia). Why did we get Geocities and not weblogs? We didn't know what we were doing." > > [Clay Shirky](!Wikipedia) (["A Group Is Its Own Worst Enemy"](http://www.shirky.com/writings/group_enemy.html), 2003)

The interesting thing is that all the pieces were in place for at least 8 years before Satoshi’s publication, which was followed more than half a year later^[The first revision in the Github repository is dated August 2009 by sirius-m.] by the first public¹ prototype. If we look at the citations in the whitepaper and others, and then order the relevant technologies by year in descending order:

1. 2001: SHA-256 finalized
2. 1999–present: Byzantine fault tolerance (PBFT etc.)
3. 1999–present: P2P networks (excluding early networks like Usenet or FidoNet; MojoNation & BitTorrent, Napster, Gnutella, eDonkey, Freenet, i2p etc.)
4. 1998: Wei Dai, B-money^[In the same vein of ‘the network is a third party which keeps a copy of all signed transactions’, you could include Ian Grigg’s 2005 paper “Triple Entry Accounting”.]
5. 1997: HashCash; 1998²: Nick Szabo, Bit Gold; ~2000: MojoNation/BitTorrent; ~2001–2003, Karma, etc
6. 1992–1993: Proof-of-work for spam^[“Pricing via Processing, Or, Combating Junk Mail”, , Dwork 1993, published in CRYPTO’92.]
7. 1991: cryptographic timestamps
8. 1980: public key cryptography^[This is Satoshi’s citation date; Diffie-Hellman, the first published system, was in 1976, not 1980.]
9. 1979: Hash tree

This lack of novelty is part of the appeal—the fewer new parts of a cryptosystem, the less danger^[In cryptography, new parts are guilty until proven innocent. Hundreds of past systems have been broken, sometimes after decades of study & use.]. All that was lacking was a Satoshi to start a Bitcoin.

Delay

But with the benefit of this hindsight, one can wonder—why this delay?³

If the idea is (relatively) easy to understand and uses basic ideas[^Laurie], if it is very far from the cutting-edge of cryptography^[One thinks of the formidable mathematical difficulties surrounding the area of homomorphic encryption where one would expect any breakthrough to be from a bona fide genius, or at least a credentialed expert.], then there’s no reason it would not be seriously tried. Certainly the cypherpunks of the ’90s were wildly creative, inventing everything from Cypherpunk/Mixmaster to MojoNation to assassination markets to data havens (memorably depicted in Cryptonomicon). We have already seen 2 of their proposed cryptocurrencies, and proof-of-work was one of the most common proposals to deal with the rising tsunami of spam⁴. Why did Bitcoin take a decade to be born? The problem of timing nags at me—similar to the historical question of why England experienced the Industrial Revolution and grew to empire, and not China, which seems better equipped in every respect[^China]. Where does innovation come from? There must be an answer. (And it may be similar to VR.[^Palmer-Luckey])

Impractical?

Is the problem one of resources? In the whitepaper, Satoshi remarks:

A block header with no transactions would be about 80 bytes. If we suppose blocks are generated every 10 minutes, 80 bytes * 6 * 24 * 365 = 4.2MB per year. With computer systems typically selling with 2GB of RAM as of 2008, and Moore’s Law predicting current growth of 1.2GB per year, storage should not be a problem even if the block headers must be kept in memory.

That’s fine to say in 2008, after many doublings. Would memory be a problem in the 1990s? It doesn’t have to be. The difficulty of bitcoin mining is adjustable, so the problem boils down to:

1. disk usage

   • With a smaller hash like SHA1^[SHA-1, as of 2011, had not been cracked in practice; it was defeated in 2017.], the 80 bytes can be shrunk
   • 10 minutes is not graven in stone; why not 20 minutes? Right there we have halved the transaction overhead
   • the hash tree can be ‘garbage collected’ and shrunk^[My understanding is that simply no one has bothered to program this functionality since 400MB is not that much space.]

   • it is only necessary to maintain a full hash tree if one is paranoid.

     In practice, like many programs of the era such as mail or Usenet clients, the default could simply be to hold onto the last n blocks/hashes (Satoshi estimates 12kb/day); this would consume a limited amount of disk space.

2. network connectivity is solvable by solutions to #1

   1. A function of the existing hash tree size
   2. And frequency of new transactions

It’s worth pointing out that it’s generally expected that at some point ordinary desktop users like you or me are expected to stop being full-fledged nodes and bitcoin miners and will instead make use of some specialist service running powerful servers of its own; in a counterfactual universe where Bitcoin was begun in the early 1990s, the changeover would simply have occurred sooner. (And with all the investment money desperately investing in the first Internet bubble, it would be quite easy to start such a service regardless of the technical demands.)

Contemporary objections

As well, few of the objections to cryptocurrencies seem to have been “computers which can run it are fantastically expensive”^[Or rather, the objections were that cryptocurrencies had to be mobile—usable on the contemporary PDAs and cellphones, with the computing power of a watch.]. In computing, applications and techniques are often invented many decades before Moore’s law makes them practically useful^[Garbage collection and most of artificial intelligence (or machine learning in particular) seem to have waited decades for sufficiently fast hardware. Indeed, I sometimes feel that Alan Kay’s entire career has essentially been sketching out what he could do if only he had some decent cheap hardware.], but this does not seem to have happened with Bitcoin. A similar objection obtains with patents or published papers; if Bitcoin was a known idea, where are they? I have yet to see anybody point out what patents might have deterred cryptography researchers & implementers; the answer is that there were none. Because there was no investor interest? Not that Satoshi needed investors, but there were a tremendous number of online payment services started in the ’90s, each searching for the secret sauce that would let them win ‘mindshare’ and ride ‘network effects’ to victory; DigiCash again comes to mind. Even in the ’90s, when the Internet seems embryonic to us of the 2010s, there were still many millions of people on the Internet who could have used a digital cash.

So if the basic idea is accessible, and it’s useful on consumer-grade hardware for the last 20 years or so, then what’s the problem?

Cryptographers’ objections

I think it’s instructive to look at Satoshi’s ANN thread on the Cryptography newsgroup/mailing list; particularly the various early criticisms:

• disk/bandwidth won’t scale^[It probably will. Some informal projections have been made of what it would take to run millions of transactions worth trillions of dollars, and they tend to come in at comparable to the existing resource use of companies like Google (which fund their own power plants or monopolize convenient hydroelectric dams to run their datacenters).]

  Satoshi’s response was that he expected most Bitcoin users to eventually become second-class citizens as they switched to the thin client scheme he outlined in the whitepaper for only keeping part of the blockchain and delegating storage to the real peers. This doesn’t seem ideal.

• proposal is under-specified (omitting all the possible race conditions and de-synchronization attacks and scenarios in a distributed system) and details available only in ad hoc code⁵
• conflating transactions with bitcoin creation requires constant inflation
• it is very difficult to achieve consensus on large amounts of distributed data even without incentives to corrupt it or attacks
• domination of the hash tree by fast nodes and starvation of transactions
• pseudonymity & linkable transactions[^Szabo] (irreversible transactions also implies double-spend must be very quickly detectable)

Nick Szabo summarizes the early reaction:

Bitcoin is not a list of cryptographic features, it’s a very complex system of interacting mathematics and protocols in pursuit of what was a very unpopular goal. While the security technology is very far from trivial, the “why” was by far the biggest stumbling block—nearly everybody who heard the general idea thought it was a very bad idea. Myself, Wei Dai, and Hal Finney were the only people I know of who liked the idea (or in Dai’s case his related idea) enough to pursue it to any significant extent until Nakamoto (assuming Nakamoto is not really Finney or Dai). Only Finney (RPOW) and Nakamoto were motivated enough to actually implement such a scheme.

As well, let’s toss in some blog posts on Bitcoin by the cryptographer Ben Laurie and Victor Grischchenko; Laurie particularly criticizes⁶ the hash-contest which guarantees heavy resource consumption:

1. “Bitcoin”
2. “Bitcoin 2”
3. “Bitcoin is Slow Motion”
4. “Decentralised Currencies Are Probably Impossible: But Let’s At Least Make Them Efficient”
5. “Bitcoin?”, Victor Grischchenko

What’s the common thread? Is there any particular fatal flaw of Bitcoin that explains why no one but Satoshi came up with it?

Aesthetics

No! What’s wrong with Bitcoin is that it’s ugly. It is not elegant[^beauty]. It’s clever to define your bitcoin balance as whatever hash tree is longer, has won more races to find a new block, but it’s ugly to make your network’s security depend solely on having more brute-force computing power than your opponents[^Szabo-power], ugly to need now and in perpetuity at least half the processing power just to avoid double-spending[^Laurie-2]. It’s clever to have a P2P network distributing updated blocks which can be cheaply & independently checked, but there are tons of ugly edge cases which Satoshi has not proven (in the sense that most cryptosystems have security proofs) to be safe and he himself says that what happens will be a “coin flip” at some points. It’s ugly to have a hash tree that just keeps growing and is going to be gigabytes and gigabytes in not terribly many years. It’s ugly to have a system which can’t be used offline without proxies and workarounds, which essentially relies on a distributed global clock⁷, unlike Chaum’s elegant solution[^May]. It’s ugly to have a system that has to track all transactions, publicly; even if one can use bitcoins anonymously with effort, that doesn’t count for much—a cryptographer has learned from incidents like anon.penet.fi and decades of successful attacks on pseudonymity^[For example, see some of the most recent research I linked in Death Note: L, Anonymity & Eluding Entropy.]. And even if the money supply has to be fixed (a bizarre choice and more questionable than the irreversibility of transactions), what’s with that arbitrary-looking 21 million bitcoin limit? Couldn’t it have been a rounder number or at least a power of 2? (Not that the bitcoin mining is much better, as it’s a massive give-away to early adopters. Coase’s theorem may claim it doesn’t matter how bitcoins are allocated in the long run, but such a blatant bribe to early adopters rubs against the grain. Again, ugly and inelegant.) Bitcoins can simply disappear if you send them to an invalid address. And so on.

The basic insight of Bitcoin is clever, but clever in an ugly compromising sort of way. Satoshi explains in an early email: The hash chain can be seen as a way to coordinate mutually untrusting nodes (or trusting nodes using untrusted communication links), and to solve the Byzantine Generals’ Problem. If they try to collaborate on some agreed transaction log which permits some transactions and forbids others (as attempted double-spends), naive solutions will fracture the network and lead to no consensus. So they adopt a new scheme in which the reality of transactions is “whatever the group with the most computing power says it is”! The hash chain does not aspire to record the “true” reality or figure out who is a scammer or not; but like Wikipedia, the hash chain simply mirrors one somewhat arbitrarily chosen group’s consensus:

…It has been decided that anyone who feels like it will announce a time, and whatever time is heard first will be the official attack time. The problem is that the network is not instantaneous, and if two generals announce different attack times at close to the same time, some may hear one first and others hear the other first.

They use a proof-of-work chain to solve the problem. Once each general receives whatever attack time he hears first, he sets his computer to solve an extremely difficult proof-of-work problem that includes the attack time in its hash. The proof-of-work is so difficult, it’s expected to take 10 minutes of them all working at once before one of them finds a solution. Once one of the generals finds a proof-of-work, he broadcasts it to the network, and everyone changes their current proof-of-work computation to include that proof-of-work in the hash they’re working on. If anyone was working on a different attack time, they switch to this one, because its proof-of-work chain is now longer.

After two hours, one attack time should be hashed by a chain of 12 proofs-of-work. Every general, just by verifying the difficulty of the proof-of-work chain, can estimate how much parallel CPU power per hour was expended on it and see that it must have required the majority of the computers to produce that much proof-of-work in the allotted time. They had to all have seen it because the proof-of-work is proof that they worked on it. If the CPU power exhibited by the proof-of-work chain is sufficient to crack the password, they can safely attack at the agreed time.

The proof-of-work chain is how all the synchronisation, distributed database and global view problems you’ve asked about are solved.

How Worse is Better

In short, Bitcoin is a perfect example of Worse is Better (original essay). You can see the tradeoffs that Richard P. Gabriel enumerates: Bitcoin has many edge cases; it lacks many properties one would desire for a cryptocurrency; the whitepaper is badly under-specified; much of the behavior is socially determined by what the miners and clients collectively agree to accept, not by the protocol; etc.

The worse-is-better philosophy is only slightly different: […]

• Completeness—the design must cover as many important situations as is practical. All reasonably expected cases should be covered. Completeness can be sacrificed in favor of any other quality. In fact, completeness must be sacrificed whenever implementation simplicity is jeopardized. Consistency can be sacrificed to achieve completeness if simplicity is retained; especially worthless is consistency of interface.

…The MIT guy did not see any code that handled this [edge] case and asked the New Jersey guy how the problem was handled. The New Jersey guy said that the Unix folks were aware of the problem, but the solution was for the system routine to always finish, but sometimes an error code would be returned that signaled that the system routine had failed to complete its action. A correct user program, then, had to check the error code to determine whether to simply try the system routine again. The MIT guy did not like this solution because it was not the right thing… It is better to get half of the right thing available so that it spreads like a virus. Once people are hooked on it, take the time to improve it to 90% of the right thing.

Guarantees of Byzantine resilience? Loosely sketched out and left for future work. Incentive-compatible? Well… maybe. Anonymity? Punted on in favor of pseudonymity; maybe someone can add real anonymity later. Guarantees of transactions being finalized? None, the user is just supposed to check their copy of the blockchain. Consistent APIs? Forget about it, there’s not even a standard, it’s all implementation-defined (if you write a client, it’d better be “bugward compatibility” with Satoshi’s client). Moon math? Nah, it’s basic public-key crypto plus a lot of imperative stack-machine bit-twiddling. Space efficiency? A straightforward blockchain and on-disk storage takes priority over any fancy compression or data-structure schemes. Fast transactions? You can use zero-conf and if that’s not good enough for buying coffee, maybe someone can come up with something using the smart contract features. And so on.

But for all the issues, it seems to work. Just like Unix, there were countless ways to destroy your data or crash the system, which didn’t exist on more ‘proper’ OSs like OpenVMS, and there were countless lacking features compared to systems like ITS or the Lisp machine OSs. But like the proverbial cockroaches, Unix spread, networked, survived—and the rest did not.[^preface] And as it survives and evolves gradually, it slowly becomes what it “should” have been in the first place. Or HTML⁸ vs Project Xanadu.

Paul Ford in 2013 has stumbled onto a similar view of Bitcoin:

The Internet is a big fan of the worst-possible-thing. Many people thought Twitter was the worst possible way for people to communicate, little more than discourse abbreviated into tiny little chunks; Facebook was a horrible way to experience human relationships, commodifying them into a list of friends whom one pokes. The Arab Spring changed the story somewhat. (BuzzFeed is another example—let them eat cat pictures.) One recipe for Internet success seems to be this: Start at the bottom, at the most awful, ridiculous, essential idea, and own it. Promote it breathlessly, until you’re acquired or you take over the world. Bitcoin is playing out in a similar way. It asks its users to forget about central banking in the same way Steve Jobs asked iPhone users to forget about the mouse.

But he lacks the “worse is better” paradigm (despite being a programmer) and doesn’t understand how Bitcoin is the worst-possible-thing. It’s not the decentralized aspect of Bitcoin, it’s how Bitcoin is decentralized: a cryptographer would have difficulty coming up with Bitcoin because the mechanism is so ugly and there are so many elegant features he wants in it. Programmers and mathematicians often speak of “taste”, and how they lead one to better solutions. A cryptographer’s taste is for cryptosystems optimized for efficiency and theorems; it is not for systems optimized for virulence, for their sociological appeal[^Ponzi]. Centralized systems are natural solutions because they are easy, like the integers are easy; but like the integers are but a vanishingly small subset of the reals, so too are centralized systems a tiny subset of decentralized ones⁹. DigiCash and all the other cryptocurrency startups may have had many nifty features, may have been far more efficient, and all that jazz, but they died anyway¹⁰. They had no communities, and their centralization meant that they fell with their corporate patrons. They had to win in their compressed timeframe or die out completely. But “that is not dead which can eternal lie”. And the race may not go to the swift, as Hal Finney also pointed out early on:

Every day that goes by and Bitcoin hasn’t collapsed due to legal or technical problems, that brings new information to the market. It increases the chance of Bitcoin’s eventual success and justifies a higher price.

It may be that Bitcoin’s greatest virtue is not its deflation, nor its microtransactions, but its viral distributed nature; it can wait for its opportunity. “If you sit by the bank of the river long enough, you can watch the bodies of your enemies float by.”

Objection: Bitcoin is not Worse, it’s Better

Nick Szabo and Zooko Wilcox-O’Hearn disagree strongly with the thesis that “Bitcoin is Worse is Better”. They contend while there may be bad parts to Bitcoin, there is a novel core idea which is actually very clever—the hash chain is a compromise which thinks outside the box and gives us a sidestep around classic problems of distributed computing, which gives us something similar enough to a trustworthy non-centralized authority that we can use it in practice.

Gwern’s post fails to appreciate the technical advances that BitCoin originated. I have been trying, off and on, to invent a decentralized digital payment system for fifteen years (since I was at DigiCash). I wasn’t sure that a practical system was even possible, until BitCoin was actually implemented and became as popular as it has. Scientific advances often seem obvious in retrospect, and so it is with BitCoin.^[Zooko, May 31, 2011 6:42 PM]

Nick Szabo thinks that the main blocking factors were:

1. ideological beliefs about the nature of money (liberals not interested in non-state currencies, and Austrians believing that currencies must have intrinsic value)
2. obscurity of bit gold-like ideas
3. “requiring a proof-of-work to be a node in the Byzantine-resilient peer-to-peer system to lessen the threat of an untrustworthy party controlling the majority of nodes and thus corrupting a number of important security features”
4. some simplification (not markets for converting “old” & harder-to-mine bitcoins to “new” & easier-to-mine bitcoins, but a changing network-wide consensus on how hard bitcoins must be to mine)

My own belief is that #1 is probably an important factor but questionable since the core breakthrough is applicable to all sorts of other tasks like secure global clocks or timestamping or domain names, #2 is irrelevant as all digital cryptographic currency ideas are obscure (to the point where, for example, Satoshi’s whitepaper does not cite bit gold but only b-money, yet Wei Dai does not believe his b-money actually influenced Bitcoin at all¹¹!), and #3–4 are minor details which cannot possibly explain why Bitcoin has succeeded to any degree while ideas like bit gold languished.

See Also

• Silk Road 1 -(use and economic philosophy of the Silk Road 1 marketplace)
• Time-lock Cryptography; Cryptographic Timestamping of Files -(a similar solution by resort to proof-of-work)
• Copyleft
• Gall’s law

External Links

• Original essay published on Bitcoin Weekly (7 comments)

  • Reddit discussion: 1/2/3
  • Hacker News discussion: 1, 2
• “Bitcoin Theory (Byzantine Generals and Beyond)”
• “Bitcoin: A Little Slice of Future Shock”
• “Squaring the Triangle: Secure, Decentralized, Human-Readable Names” (Aaron Swartz)
• “Nick Szabo: The Computer Science of Crypto-Currency”
• “Money, blockchains, and social scalability” (Nick Szabo)
• “A Prehistory of the Ethereum Protocol” (Vitalik Buterin)
• “Bitcoin—The Andromeda Strain of Computer Science Research” (Steven M. Bellovin)
• “The Eureka Moment That Made Bitcoin Possible: A key insight for the technology came to a physicist almost three decades ago at a Friendly’s restaurant in New Jersey”
• “Grow-up and grow-down technologies”
• “Bitcoin bites the bullet: Some of its most puzzling tradeoffs explained”
• “What’s Really Driving the Cryptocurrency Phenomenon?”, Dannen et al 2018

Appendix

Irreversible transactions: meta-scams {.collapse}

[The irreversibility of]{.smallcaps} Bitcoin transactions makes for some unusual dynamics in exchanges, along with the entire altcoin ecosystem (probably the most interesting altcoin scam to me was the [Bytecoin scam+anonymity innovation](https://da-data.blogspot.com/2014/08/minting-money-with-monero-and-cpu.html "Minting Money with Monero ... and CPU vector intrinsics")). I learned of an interesting example in May 2013, when a [Reddit post](https://old.reddit.com/r/onions/comments/1euxp4/so_does_this_work_or_is_it_a_scam/ "Throwaway account because I'm embarrassed to ask... http://f7tyfzd2bbqi7jaa.onion/ It claims 'double your bitcoins'") introduced me to a Tor hidden site which offers you double your money back if you send it some bitcoins. A scam, right? Well, it is a scam, but it's not quite the scam it looks like...

To start, there is a comment from someone claiming that they tried it and the way the scam worked was that it doubled your money the first time you sent it some bitcoins, but then kept anything you sent it subsequently; the idea being that the first transaction will be a ‘test’ by suspicious users, who will then send a ‘real’ transactions which can be stolen in toto. Specifically:

Oh dude. I actually tried this like 5 Days ago. I sent 0.5btc and got one back, so technically it works. However, when I sent my 1btc back (and emailed the guy about it) he kept it and didn’t respond at all. So it’s a scam, obviously, but the way it works is kind of interesting in that it actually works the first time, to lure you in and send even more. EDIT: I SHOULD PROBABLY ADD: DON’T SEND MONEY TO THIS GUY

This is reasonable enough—ponzis are careful to allow withdrawals early on, and runners of ponzis, like the classic 2006 “Currin trading” EVE Online ponzi scheme (part 1, 2), record how people would do 1 or 2 test transactions and then deposit large ‘real’ sums with the ponzi.

Except… the person claiming it worked for them is an unused account, and so are the people expressing skepticism of him! It gets more interesting when you note that the scam as claimed is trivially exploitable (or scammed) by anyone who knows how it works (send a large amount the first transaction, and never send again), and more interesting still when you remember that Bitcoin transactions are public and so the first commenter could have partially proven that the scam worked as they claimed it worked for them yet has not provided any evidence despite being challenged to do so and given 9 days’ grace, and finally, we see 2 Redditors sending in token amounts and claiming they received nothing back.

So what are we looking at here? I can’t know this for sure, but this is what I think is going on.

We are looking at a meta scam: the scam is that you think it’s a scam that you can scam, but you get scammed as you try to scam the scam. The original scammer puts up a scam website, makes 4 shill accounts to claim it works and lay out the rules—send it X it sends you 2X back, and then the second time it keeps your money when you presumably sent it 2X+Y—but actually, the site simply keeps any money sent to it, and so the people who planned to scam the scam wind up being scammed.

If we think of deception as having levels, this is a little confusing; but the site will either return your money or not. The first level is that the site works as it claims: it returns your money, it doubles any money you send it. (This is understood by anyone who can read the page.) The second level is that level 1 is a lie: it does not return your money, it simply steals any money you send it. (This is understood by anyone with a brain who has read the page.) However, then we get to a third level: level 2 is not quite right, the site will either return your money or not, depending on how many transactions you’ve done—the site is a scam which will steal your money, but it will do so only after 1 successful transaction. (Understood by anyone who reads the Reddit comments and blindly trusts them.) The fourth level, the level originally above mine until I became more suspicious, is that level 3 is a lie too, and actually, level 2 was the real truth—the site simply steals your money.

Phew! How fascinating! Honestly, I almost feel like sending the dude a buck or two just for implementing such an interesting little scam for me to think about, although he could’ve done it a bit better and shuffled some bitcoins around on the blockchain 7 days in advance to match his shill account’s claims. (He didn’t invent the meta-scam, however, since it seems to have precedents like in Runescape as the “doubling money scam”.)

An even more recent (2018) Ethereum-based scam exploits Ethereum’s ‘gas’ transaction fees and smart contracts: the scammer pretends to accidentally post publicly in a chat room his private key to an address with a large amount of some asset in it and a smart contract, but the address happens to have insufficient ‘gas’ to allow immediate withdrawal; everyone stampeding to withdraw the asset has to send some gas to the address first to unlock it… except that smart contract, which they didn’t have time to inspect closely, merely receives all gas deposits & immediately transfers them away to another account, so everyone who sends gas loses it and the original assets remain in place.

So in a way, this scam embodies the old saw “you can’t cheat an honest man”^[Which is a comforting lie scammers tell themselves and others to blame the victim—‘really, the victim deserved it, you can’t cheat an honest man!’—and which makes for funner fictional (ie. ‘not true’) stories. But I think the sordid reality looks more like simply good people being ripped off as they lose their life savings because they aren’t specialists in an area and trusted an expert. I think it’s relatively rare that you get a complicated setup like this scam, or like the Madoff scam in which people assumed Madoff was simply frontrunning the people he was trading for; although now that I think about it, only the savviest investors with Madoff understood the sheer impossibility of his returns and concluded he was scamming by frontrunning, most of the people who gave him money were just ordinary middle-upper-class folks.]. Well, of course in the real world honest men get cheated all the time, so I prefer to think of it as Nash equilibriums:

‘Nash equilibrium strategy’ is not necessarily synonymous to ‘optimal play’. A Nash equilibrium can define an optimum, but only as a defensive strategy against stiff competition. More specifically: Nash equilibria are hardly ever maximally exploitative. A Nash equilibrium strategy guards against any possible competition including the fiercest, and thereby tends to fail taking advantage of sub-optimum strategies followed by competitors. Achieving maximally exploitative play generally requires deviating from the Nash strategy, and allowing for defensive leaks in one’s own strategy.

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How To Use Bitcoin – The Most Important Creation In The History Of Man

By Michael Suede

Posted May 31, 2011

Recently I wrote an article entitled The Most Dangerous Creation In The History Of Man.  The article covered the emergence of Bitcoin; an electronic open source peer-to-peer currency that has no central banking server, is untraceable (when proper steps are taken), and essentially can not be taxed through coercive measures.  The article makes the point that if a currency can not be taxed and controlled, eventually it will topple the coercively funded fascist control grid you call the modern State.  Read more about it in this Bitcoin forum post that explains it in more detail.

I’ve received several requests for more information about how people can put Bitcoin to work for them.  Most articles on Bitcoin, and even the Bitcoin site itself, don’t give a clear top to bottom description of how common users of Bitcoin can put the currency to use.

It is a tad confusing  if you are not familiar with how currency markets work, but not to worry, it is not as intimidating as it sounds.  Bitcoins are generated on a logarithmic scale by dedicated “miners” who run software that generate the complex hash codes which make up a Bitcoin.  Bitcoins can not be artificially inflated and require real resources (electricity and time) to produce.

Here are a few reasons why I think Bitcoins are superior to gold as medium of exchange:

1.  It is impossible to artificially inflate the supply of Bitcoins in existence.  They are produced at a known steady rate, the supply of which will eventually top out.

2.  Bitcoin transactions are made for the web!  It is impossible to actually ship gold across a wire.  The best one can do is use a medium that represents gold, such as shares of GLD, and trade those as a currency.  Clearly this leaves room for inflation of the money supply by unscrupulous bankers.  When a person transacts in Bitcoins, it is the equivalent of actually sending gold across a wire.  The unreproducible currency itself is transacted with, unlike a paper currency that represents a commodity.

3.  Bitcoins can not be confiscated since the files they reside on can be replicated and hidden in USB keys or anonymous servers.

4. The peer-to-peer nature of Bitcoin makes it as impossible to stop as BitTorrents.  Governments would have to shut down the web to stop it.

5.  It is impossible to create salted Bitcoins or “shave the edges” off of them.  There are wide spread rumors that the supply of gold that central banks are holding is loaded with tungsten bars coated in gold.

6.  Obviously they are lighter, easier to transact with, and far easier to secure than gold bullion.

Let me repeat:  Bitcoin IS NOT A PONZI – it is the same as if people were digging up gold nuggets out of the ground and then trading them as money.  Any claims that early adopters are simply promoting this as a Ponzi are like claiming people who were promoting buying Apple’s IPO were promoting a Ponzi.

Bitcoins use a 256 bit public/private key encryption algorithm that has never been cracked in practice and is considered secure by the NSA.

Bitcoins CAN NOT BE ARTIFICIALLY INFLATED.

Total Bitcoin production will TOP OUT in the future meaning NO NEW BITCOINS WILL BE CREATED BEYOND A CERTAIN DATE.

If you have additional concerns, please take the time to research the answers on your own.   Don’t blindly dismiss it because of a concern that could easily be addressed with some simple research and questioning of those who are current users of the system.

Anyone who has a through understanding of Austrian economics should immediately recognize the inherent benefits of Bitcoin.  Bitcoin is the equivalent of electronic gold.  Even better than gold in some respects.

Here are a few articles that cover the economics of the Bitcoin monetary system in more detail:

• The Economics Of Bitcoin – Why Mainstream Economists Lie About Deflation
• The Economics Of Bitcoin – How Bitcoins Act As Money
• Against The Gold Standard
• The Economics Of Bitcoin – Doug Casey Gets It Wrong
• The Economics Of Bitcoin – Resource Allocation And Interest Rate Distortion
• The Economics Of Bitcoin – Challenging Mises’ Regression Theorem
• The Economics Of Bitcoin – Challenging Mises’ Regression Theorem – Prof. George Selgin Responds
• Why Do People Want A Gold Standard When History Shows Us It Does Not Last?

That said, lets go through the process of a common user setting up a Bitcoin account in an electronic bank and then purchasing some Bitcoins with US Dollars.  Then we will buy an item using the Bitcoins we just purchased.

Check out OKPay.com for a payment processing service that accepts Bitcoins and translates them directly into an e-wallet that can be accessed by a Master Card debit card anywhere in the world.  Checkout Crypto X Change for an easy way to buy and sell Bitcoins through normal bank accounts.

Step 1:  Setting up a Bitcoin wallet.

There are a few ways to set up a wallet.  One way is to install the Bitcoin client on your PC.  The client will automatically create a wallet address that you can accept payments to or send payments from.  The easier alternative is to simply visit the site InstaWallet and it will generate a wallet address for you as soon as you enter the site.

A wallet is simply a datafile that stores your currency.  Transactions to and from a wallet are sent via encrypted peer-to-peer network and are processed across the network, meaning there is no central banking server that a person needs to log in to.

The datafile that stores the wallet information is worth its virtual weight in gold.  If that datafile is destroyed or compromised, the money you had in that wallet will be destroyed.  This is why many people chose to store the file on their home PC rather than entrusting it to some other site owner’s care.  There are advantages and risks to storing your wallet on someone else’s site.   Storing it on someone else’s site opens your wallet up to possible confiscation by government or abuse by the site owner, but it does offer the advantage of easy access and the redundancy/backups that most site operators employ.  On your local PC, using Windows 7, the datafile is located in the hidden folder “AppData” that is under your user directory:

C:\Documents and Settings\YourUserName\Application data\BitCoin (XP) C:\Users\YourUserName\Appdata\Roaming\BitCoin (Vista and 7)

A good idea is to have multiple wallets and multiple backups, so if one wallet is compromised or destroyed on accident, your remaining money will not be effected.  But let’s continue on using the InstaWallet example for now.

So you’ve visited InstaWallet and bookmarked your wallet’s address.  Obviously giving out the web address to a wallet on this site would give a person total access to the wallet, so don’t do that.  On the wallet page, you’ll see a public address listed that can be used for sending payments to this wallet.

My address is: “17C3iPNMyz5dPELJUc6NbYYarSzPY6gS9M”

People using Bitcoin can send Bitcoins to that address by entering it into the “Send Payment” field on InstaWallet or by entering it into their local PC client wallet which has a tab for sending payments.

It’s that easy to create a wallet and use it!

Step 2:  Adding Bitcoins to your wallet

Getting Bitcoins to spend is a touch more complicated, but it is still a fairly straight forward process.

To get Bitcoins to spend, the most common way is to purchase them on the open market.  Since there is no central banking server or exchange, one must purchase them on a private open market exchange.  Two of the most popular exchanges are Mt. Gox and TradeHill.

Using Mt. Gox, we first create a user account on the site.  Then we need to add some funds to it in order to purchase some Bitcoins.

After you’ve created an account and logged into it, click on the “Add Funds” button.

In order to add funds to your Mt. Gox exchange fund, you have a few options.  I will be using a Dwolla account for this example.

After creating an account on Dwolla, you can add funds to your Dwolla account directly from whatever bank you chose to bank at by adding a bank account to your Dwolla account.  You’ll need to verify the bank account by entering in the amount of the penny transactions Dwolla sends to your bank to verify that you actually own the account in question.  It may take up to 72 hours for Dwolla to send the transactions and for them to show up in your bank transaction history.  Bookmark this page and return later if you don’t already have a Dwolla account.

Clicking the link that represents your account number on the Mt. Gox “Add Funds” page under the Dwolla payment method will automatically bring up Dwolla with the appropriate transaction to Mt. Gox already formatted.  All you have to do is enter in the amount you wish to add to your Mt. Gox exchange fund and complete the transaction.

After you’ve got some funds in your Mt. Gox exchange fund, you’ll be able to buy Bitcoins on the open market.

On the Mt. Gox site, click the “Buy Bitcoins” link on the main page.  The easiest and fastest way to get coins is to simply purchase them at the current asking price, which at the time of this posting was $9.28001 USD for one Bitcoin.  Mt. Gox explains how the trade transactions work here.

When buying Bitcoins, your Mt. Gox account will be debited the amount your order filled at and the Bitcoins will be sent to the address of the wallet of your choice.

Congratulations, you now have some Bitcoins to spend!

note:  It is recommended that you use a different wallet address to receive and send Bitcoins each time you make a transaction.  This is not required, but it does help maintain your anonymity by making it harder to trace your transactions through the block chain.  If a vendor knows your identity because you purchased a product from them, and you have used the same wallet address for all your transactions, the vendor would be able to see the entire transaction history for your wallet by looking at the block chain.  Look for the “New Address” button on the bottom of your Bitcoin client to get a new address.

Step 3:  Buying an item with Bitcoins

Let’s visit the site discretehydro.com and buy a bottle of fertilizer.  Once you’ve added a product to your cart and have gone through the checkout process, you’ll be directed to pay using the BTCInch checkout method.

Simply enter in the address they provide you into your wallet’s “send” field and ship them the coins they require.

Transactions through Bitcoin are non-reversible.  So make sure you enter the correct amount to the correct address.  Obviously a reputable business will refund any accidental over-payments and refund any coins for merchandise returns, but unlike a credit card, there is no middleman to complain to if you get scammed.  All transactions are final.

Step 4: Securing your wallet

Older Bitcoin clients do not encrypt the wallet.dat file.  Anyone who can access it can easily steal all of your coins. Use a file encryption program if there is any chance someone might stumble upon your wallet.  The latest version of the client has built in wallet cryptography that can be enabled by clicking the menu option “Settings” -> “Encrypt Wallet”

A good practice is to keep at least two wallets, one as a “current account” for everyday transactions and one as a “savings account” where you store the majority of your Bitcoins.

The “savings account” wallet should be backed up in encrypted form only, and all plain text copies of this wallet should be erased. In case someone gains unauthorised access to your computer (either by physically stealing it or by exploiting a system vulnerability via the internet), they will only be able to spend the coins in your “current account” wallet.

In most operating systems, including Windows, Linux, and Mac OS X, simply deleting a wallet.dat file will not generally destroy it. It is likely that advanced tools can still be used to recover the wallet.dat file, even after it has been deleted.

For Windows, the built-in command cipher /W will shred all previously-deleted files. Rwipe or CyberShredder can securely delete individual files.

If you chose to keep your wallet on your local PC, I recommend encrypting your main wallet file that holds the bulk of your savings with TrueCrypt, and keeping an unencrypted wallet file for everyday use.  I like the idea of keeping the everyday wallet on InstaWallet, and keeping your main bank on your local PC, encrypted by TrueCrypt, and backed up onto a thumb drive.  Wallet sites like InstaWallet are still fairly new and they have not had a lot of time to prove their trustworthiness.  Use them at your own risk.

Make sure your TrueCrypt password is at least 12 characters long.  8 character passwords can be cracked easily by brute force hacking attacks.

If you really want to do some super secure transactions using Bitcoin, use the Tor web browsing network that hides your IP address from online identities to do your shopping and communicating.  Tor is a free open source project.  Learn more about it here.  Then follow the directions to anonymize your transactions here.

Other Odds And Ends:

There are other ways to acquire Bitcoins as well, such as mining for Bitcoins or purchasing them directly from other holders using sites like PayPal.  You could literally put up a post on an internet forum and ask people if they will sell their coins to you for a direct transaction through PayPal.

Mining for Bitcoins is a bit more complex and your average user shouldn’t even worry about it.  For more information on mining for Bitcoins, look here.  It used to be that a single PC could effectively mine the coins, but today, it requires a collective pool of computers or a powerhouse server to be able to mine coins at an economically efficient rate.  Mining coins is a commercial enterprise that requires excessive resources, just like mining for gold does.

Anyone may freely distribute this article or use any portion of it as they see fit.  I encourage you to do so.

I have no stake in promoting this. I am not being paid to write this.  I am not receiving a commission for writing this.  I am staking my site’s reputation on promoting this because I feel the positive benefits to humanity that can arise from this currency demand that it be given public attention.

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Bitcoin is the Economic Singularity

By Ryan Dickherber

Posted June 4, 2011

Three weeks ago I discovered bitcoin. It sounded interesting enough that I decided to devote an entire Saturday to it—that was my “day of bitcoin.” My day of bitcoin evolved into my three weeks of bitcoin. In that time, I have been obsessively reading about it, writing about it, buying it, and creating businesses for it. As far as I can recall, I have never been so obsessed about anything. But the reason I am obsessed with bitcoin is simple: it is the most incredible thing to ever happen in the world. I am not exaggerating. We are presently witnessing the most disruptive change to ever happen to collective human behavior.

Although there have been other disruptive changes to human behavior in the past, bitcoin is happening much faster than those. Consider, for instance, computing. Charles Babbage invented the mechanical Analytical Engine in the 1830s. It took on the order of a century or more before those seeds of an idea blossomed into something that actually started being used on a large scale. Or consider, say, the internet, which was invented in the 1960s, but took on the order of decades before it saturated the world. That was faster than computing, but still long compared to bitcoin. Bitcoin was only invented about 2.5 years ago. And already, I have been able to ask random people about it, and they know what I’m talking about. If the growth of bitcoin continues exponentially like most widely useful technologies, it will only be on the order of years—not centuries, not even decades, but individual years—before virtually everyone is using it.

The standard term for such a rapid change is a “singularity.” Robin Hanson predicted an economic singularity. Bitcoin, as I will argue, is that singularity. (Hat tip to noagendamarket on the bitcoin forum for reminding me of Robin Hanson’s article.)

What is bitcoin?

Bitcoin is the decentralized digital currency. I say “the,” rather than “a,” because there can only be one. Since decentralized digital currencies rely on computational power to ensure security, the currency with the most computational power is the most secure. If we ever found ourselves with more than one decentralized digital currency, which ever one had more computational resources devoted to it would be the most secure, and thus more people would trust it, and thus more people would use it, and thus it would come to dominate and be the only one. Bitcoin is that currency. (Previously, I argued that there could be a market of currencies. However, I now realize that, while there can be a market of currencies, there can’t be more than one decentralized digital currency.)

Why is it gaining traction?

Bitcoin is useful for all the same reasons that any currency is useful: it is a medium of exchange. The advantage of being decentralized is that you do not have to rely on a third party for security. Thus, bitcoin is more useful than digital dollars for the same reason that digital dollars are more useful than paper dollars, or paper dollars are more useful than gold: it is just easier to pay people with them. No banks means less headaches, in the same way that no gold means there is a lot less weight you have to lug around. Bitcoin is thus a better answer to a problem humanity has been slowly solving for millenia: how do we remove barriers to payment?

There are other advantages to bitcoin too, besides being more convenient. The fact that no central party party controls the supply means no central party can inflate it to redistribute wealth in their favor. No one can debase bitcoin to pay for a war. Also, since it is deflationary (in the sense that prices reliably go down), it encourages savings, because everyone gets richer that way.

Exponential growth

Certainly, then, bitcoin is a candidate for an economic singularity, because everyone has incentives to use it, and it makes the world a better place. That’s great in theory, but the reason why it cleary actually is a singularity is because its adoption is, in fact, growing exponentially. There are at least two exponential curves we can see. One is Google Trends, where bitcoin has crystal clear exponential growth. And another is its value in USD, where again the growth is clearly exponential. Although these quantities are not the same thing as adoption, they are probably proportional to adoption. 2.5 years ago, there was one user of bitcoin. We may estimate that there are somewhere between 104 and 105 users of bitcoin at present. Thus, in another 2.5 years, there will be somewhere between 108 and 1010 users. Since there aren’t even 1010 people on the planet, we may estimate that adoption will be ubiquitous in approximately three years.

Attack vectors

This incredibly rapid exponential growth is being powered by the fact that people around the world are quickly learning about it. Thus, the exponential growth can only last until it saturates the world, at which point it will continue growing only at the rate that humanity grows (which is also exponential, but much slower). At present, there is no reason to think the growth will stop before that. There are no credible attack vectors at all; not even government (the US government or any other) can stop it, because the economic incentives are too large. A War on Bitcoin would have exactly as much efficacy as the War on Drugs: none. Bitcoin is susceptible to DOS attacks, but that would only slow its growth, not stop it. The only credible threat to bitcoin is quantum computers, because bitcoin relies on classical, rather than quantum, cryptography. But that threat is many years away. Bitcoin will be ubiquitous by then.

What will happen?

Bitcoin will take over as the currency of the internet. It will also take over as a store of value; why earn a measly, less-than-inflation interest rate in a savings account when you can have steady appreciation of value if you just keep your money in bitcoin? People will spend less and save more because they know if only they do that, they will be richer in the future. Companies will no longer produce things of no value, because no one will buy them. The world will become more efficient, because there will be less waste. Everyone will realize how much they lose by spending money on valueless things. There will be a more equitable distribution of wealth, because no one can inflate (or, to use a less charitable term, counterfeit) bitcoin at their whim.

Bitcoin will also take over any fiat currencies that inflate too rapidly (think Zimbabwe, Argentina, or any other country that presently has or will have a rapidly inflating currency). Central banks will be under enormous pressure to stabalize their currencies or become obsolete. Many banks will collapse. Many fiat currencies will become worthless. Probably, all fiat currencies will become worthless eventually, because it is only a matter of time before the central banks fall into the temptation of inflating their currencies just a bit too fast.

How to proceed

Since bitcoin appreciates in value very rapidly during the singularity phase, you should convert all of your liquid assets to bitcoin as quickly as possible. Do not keep any cash, savings, or checking beyond what you need to pay for goods and services that cannot yet be paid for with bitcoin. The more things you can buy with bitcoin, the more bitcoin you should keep.

Stop wasting money on excessively expensive meals, televisions, cars, and anything else that loses value quickly or instantly. Instead, put your money into bitcoin. You will be much richer that way. You may think having less stuff is less fun, but actually the pleasure of financial freedom far, far outweighs any losses.

During the singularity phase, you should also take out loans to buy bitcoin, since bitcoin appreciates far more rapidly than interest on any fiat currency loan. When bitcoin gets near saturation, which is the end of the singularity, you should pay off the loans, because at that point the rate of appreciation will probably be a lot closer to the interest on the loans, and you may not be able to reliably earn money that way anymore.

You may also be tempted to convert other assets to bitcoin. If you are invested in anything that is likely to be bitcoin-unfriendly, like a bank, it would be wise to convert those assets into bitcoin. However, if you are invested in companies that actually produce value, those companies will thrive after the singularity, so it is not necessarily a good idea to convert those assets to bitcoin.

If you own assets where the ownership of those assets is certified by a country that is likely to collapse after the singularity, such as if you owned land in a country where the currency is rapidly inflating, you should consider converting those assets to bitcoin, or risk losing it when your country’s government collapses.

If you own a business, you should start accepting bitcoin as quickly as possible to maximize your ownership of the bitcoin economy. If you don’t own a business, consider starting a bitcoin business. See my previous post to learn more about bitcoin startups.

Conclusion

The economy is going to change very dramatically in a matter of three or so years. You are likely to be doing a significant amount, if not all, of your economic activity in bitcoin very soon. The change will be as dramatic as, say, computing or the internet, except that it will happen much faster. The change will be for the better, since it is more convenient to use bitcoin than fiat currencies for digital payments. Fiat currencies may stick around if they do not hyperinflate; they will probably still be useful for buying coffee. The most interesting change is that we will all become more motivated and productive, since we will see very clearly how our work ethic affects how rich we are. And the world as a whole will be significantly more efficient, since it will be extremely difficult to finance huge wastes of money, like wars.

Personally, I have invested most of my savings into bitcoin, and am in the process of figuring out precisely how much more it is wise to invest. I have not yet taken out any loans to buy bitcoin, because that decision is too hard to swallow (I may yet do it if I can stomach it—Falkvinge did.) I have also begun producing bitcoin businesses which I am hoping will support me after I graduate. (My bitcoin savings alone will actually probably be enough to support me, but I will be richer if I work too.) Most of the other ideas I had about what to do with my life after graduation have gone into the toilet—I will probably do something with bitcoin.

In the future, books that summarize the history of money will have a line that says, “and then came bitcoin.” It is the economic singularity. And we are living in it now.

Donations appreciated. 1CU8KRSTcrYKyjfeGRTjpJ1S57jViwqrnh

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Libertarian Goldbugs Hating On Bitcoin – Free Market Money

By Michael Suede

Posted June 6, 2011

Let me start off by giving you a little background as to my knowledge on the subject of monetary theory.  As you can see in the header bar of this page, I’ve put together my own little online college in Austrian economics that is composed of over 150 individual lectures on economic theory by Austrian economists.

I have pretty much watched every single one of those lectures (and hundreds more), in addition to reading such works as _Man, Economy, and State, _along with numerous other books, in-person lectures, and journal articles.  I have a business school undergrad and I work as a software developer, which forces me to think logically on a daily basis (there is a reason why so many software developers are libertarians).

I feel I have a pretty damn good grasp of Austrian economic theory and its core tenants.  Thus, it was incredibly surprising to me when I set about visiting numerous libertarian forums to discuss the new peer-to-peer currency called Bitcoin and was met with wide ranging hostility.  To be fair, not everyone was hostile to the idea, but it was clear from the responses that the majority saw the new currency as some kind of a scam.

I was accused of promoting a ponzi scheme, accused of promoting a pump and dump, accused of promoting unsound currency that would eventually implode, etc.. etc.. etc.. All the while, none of my detractors actually bothered to comment on the economics of the Bitcoin monetary system.  It was like they had been brainwashed into believing the only legitimate money is gold while everything else must automatically be junk.

I suspect that many libertarians who denounce Bitcoin as a legitimate currency system have purchased large quantities of gold and silver, and are looking to recoup some of their investment by having those metals make up the groundwork for a new monetary system.  It would stand to reason that anyone who holds large amounts of precious metals would be opposed to any new currency system that is not based on those metals.

At the time I started promoting the currency I had NO HOLDINGS of Bitcoins.  Only recently did I manage to actually purchase some – AFTER they had already inflated in price.  Further, I own a good chunk of physical silver myself, and I’ve always been a strong advocate of a gold standard currency system.

That said, I want to cover the economic reasons why Bitcoin (at least in my view) is a superior currency to precious metals.  (The equivalent of shooting myself in the foot with my silver holdings).

The primary questions people should concern themselves with is;  why did the markets chose gold as a currency and what properties does gold have that make it a currency?

Let’s begin by defining what a commodity is, then I will explain why Austrian economic theory believes that real money MUST be a commodity.  Wiki defines a commodity as “a good for which there is demand, but which is supplied without qualitative differentiation across a market.”

So a commodity is typically something tangible, fungible, and divisible.  Gold would be an example of a commodity.  I don’t care which gold coin I am paid with, I simply care that I am getting a gold coin as payment.  I don’t care what shape the gold coin has, but I do care how much it weighs.

Austrian theory demands that money be a commodity for a few reasons:

It is logically impossible to have prices arise from anything other than a commodity.  If there were no money in the world, it would be impossible for a government to print up some paper notes, write some numbers on them, and then tell people to start trading them as a money.  People would have no idea how much a single unit of the currency was actually worth.

Is a candy bar worth 1 unit or 10,000 units?

Prices must be set by trading weights of one good for another.   Only after prices have been established in weights can paper notes be used to represent the actual amounts of the commodities being traded.

The dollar used to represent 1/32nd an ounce of gold.  Thus, the dollar was actually a representation of weight.  And through this, price levels in terms of dollars were able to be established.

If it is logically impossible for prices to arise any other way, then we can say markets demand that real money be some kind of a commodity (a product that is fungible, divisible, and for which demand exists).

The argument I hear from the peanut gallery is that Bitcoins aren’t actually a commodity because you can’t pick them up and hold them.  They are intangible; therefore, they must not be a commodity.  I would argue this is false because the nature of Bitcoin’s coding actually turns them into tangible goods that meet all the criteria of being labeled a commodity.

So let’s break down the dictionary definition of a commodity and compare it to the properties of a Bitcoin:

Is it a good? – yep.

Is there demand? – yep.

Fungibility? – yep.

The nature of the Bitcoin network ensures the uniqueness of each coin and completely prevents arbitrary replication of the digital product called a Bitcoin.  Bitcoins are NOT like a software product which can be installed on multiple computers while incurring almost no physical cost to replicate.  The soundness of the currency lies in the strength of its cryptography.  If the cryptography is secure, then so too is the uniqueness of each digital coin.

For example, a Bitcoin wallet file can be replicated a billion times over, but the network knows exactly how much that wallet file is worth.  No matter how many times the wallet file is replicated, the number of Bitcoins that are accessible to that file remain the same.  The file itself is a tangible product that must be physically stored at some location, either on a USB thumb drive, remote server, smart phone, or home PC.

What is the difference if I am holding a USB key that contains a file which the markets have deemed to be worth $1,600 or a physical ounce of gold?

Bitcoins are the first digital commodity to come into existence that do not require a central point of control.  The Bitcoin solves the double spending problem that has plagued digital currencies from their inception.  This is  a new class of software that is unique in its own right.  It is worthy of being branded a “digital commodity.”

I’ve recently seen arguments by supposed free market economists arguing that Bitcoins are nothing, therefore they are inherently worth nothing.  This is a fallacious argument.  To claim Bitcoins are nothing is like claiming your operating system is nothing, therefore it is worth nothing.  Clearly an inordinate amount of time and resources went into the development of your computer’s operating system.  The time and resources that went into the development of the software constitutes “something”, which is obviously more than nothing.  Software can have inherent properties that give it value in and of itself.

Let’s look at some other reasons besides the inability of fiat money to establish prices as the basis for demanding real money be a commodity.

Rothbard writes on monetary units as commodities:

Obviously, the more valuable the units of a commodity are, the smaller the size of the units used in daily transactions; thus, platinum will be traded in terms of ounces, while iron is traded in terms of tons. Relatively valuable money commodities like gold and silver will tend to be traded in terms of smaller units of weight. Here again, this fact has no particular economic signifi­cance.

The form in which a unit weight of any commodity is traded depends on its usefulness for any specific, desired purpose.

The weight of a Bitcoin is infinitesimally small, but indeed a Bitcoin does have physical weight if we consider that the digital hash which makes up a Bitcoin must reside on a physical storage medium.  The more Bitcoins you have, the more storage medium required.

So why is such an infinitesimally small digital commodity worth so much money? Because of Bitcoin’s usefulness for the specific desired purpose of measuring and storing value.

An ounce of gold is not worth $1600 today because it can be made into shiny jewelery.  Gold is worth $1600 dollars today because it is a scarce resource that can not be arbitrarily inflated, which makes it ideal for representing the value of other goods and services.  Its scarcity, fungibility, and divisibility give it properties which lend itself to acting as a measure of wealth.

In the same way gold acts as a measure of wealth, as determined by free markets, so too do Bitcoins act in the same capacity for the exact same reasons.  Bitcoins are scarce, they are fungible, and they are even MORE divisible than gold (in functional terms).  And they can be sent across a wire transaction, while gold requires expensive shipping costs and insurance to actually deliver.

So lets look at how commodity pricing comes into existence.  First, a commodity must be mined and extracted from the earth.  Then the markets must chose that commodity as a trade intermediary.  Then the miner must spend the commodity into the economy by having people freely decide just how much each individual unit/weight is worth.  As the law of supply and demand dictate, the more of something there is, the less valuable it will become.

This is exactly how Bitcoins currently operate.  Miners run specialized software that labors to produce the unique hash that makes up a Bitcoin.  The miners incur real world electrical costs and computer resource costs on producing a Bitcoin.   By being able to spend that coin into the economy first, they economically benefit in the same way a person mining for gold does.  As they spend the coins into the economy, the market then determines the value of each coin.  Bitcoin production does not differ at all from how gold comes into existence as a money.

Another way in which Bitcoins are superior to gold is that gold can be indefinitely mined forever.  The supply of gold is always increasing to some degree and always will be.  Bitcoin production on the other hand will reach a point where no new coins can ever be created.  This means that in the future, the supply of Bitcoins will never be subject to supply side economic factors.  This removes a huge layer of uncertainty when trying to gauge the future value of a Bitcoin in comparison to gold.  It also means that there will never be price inflation with Bitcoins due to an  arbitrary expansion of the money supply.

There is no government out there demanding that people transact in Bitcoins.  There is no government out there telling people that they must accept Bitcoins in payment of debts.  There is no government out there controlling the issue of Bitcoins.  The only forces that are giving Bitcoins the value they have are free people deciding on their own that Bitcoins do indeed have value as a store of wealth and as a trade facilitator.  The markets have decided that the time and labor that went into producing the Bitcoin software, along with the properties of the software itself, have real value in the real world.

Whether Bitcoins are currently experiencing a bubble in prices or not is immaterial to their efficacy as a currency unit.  They have value because the market says they have value.  And because they have value, and because they are divisible, fungible, and scarce, they ARE free market money.  If I thought there was some aspect of Bitcoin production that would throw a monkey wrench into the free market economics espoused by Austrian theory (such as arbitrary inflation, interest rate price fixing, centralized control, etc.. etc..) I would be denouncing Bitcoin at the top of my lungs.  – I can tell you that no such problems exist with the system.

Austrian economists don’t want a gold standard because they simply like shiny yellow metal.  They want a gold standard because historically when people were free to choose, they chose gold.  The markets chose gold because of its properties of scarcity, divisibility, fungibility, and recognizability.  In the same way the markets chose gold, and for the same reasons, we WILL see Bitcoins come to dominate the currency markets to the exclusion of all other currencies.

Bitcoins are free market money.

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Refuting the attacks on Bitcoin’s design

By Beautyon

Posted June 10th, 2011

Some people believe that the design of Bitcoin is flawed, and that it cannot work. David Kramer is one of them and has made an interesting post over at Lew Rockwell, about Bitcoin. Lets take a look.

I’m sure by now many of you have heard about Bitcoin. The fact that it’s called “virtual currency” gives you an idea about its actual value as a real medium of exchange.

This isn’t true; the only thing that gives you an idea about its value as a medium of exchange is what you can exchange it for. Right now you can trade a bitcoin for 26.141 Federal Reserve Notes. This is the truth about what the value of a Bitcoin is right now.

While many people who are touting it on Facebook are enamored with the fact that it was voluntarily created by the marketplace (i.e., is not forced down our throats by a private central bank), I’m afraid that those people are losing sight of how a real medium of exchange arises in a free market.

Bitcoin was developed as a way to exchange between people in a cash like fashion at a distance, without a central clearing authority. It was created because there is a need for this service, which has been recognised since the days of Dr. David Chaum’s E-Cash.

The people who work on this project were not directed to by anyone, and no one told the man who made the breakthrough that this is what he should be doing. This is yet another example of free people solving problems for themselves, and that is a good thing.

We should point out that Satoshi Nakamoto could have patented this idea but choose not to; instead, he released his idea and the software he wrote to implement it as Open Source, so that everyone everywhere can benefit from his concept. This is a noble act, and it is proper that we recognise this.

A medium of exchange arises from something that had a material use/value in the market prior to becoming a medium of exchange, i.e., it was also a good being bartered for other goods and services. Over the centuries, gold and silver won out as the two most preferred mediums of exchange�with gold holding the number one position due to it being more scarce than silver.

You could argue that the electricity and the CPU cycles that are used to generate bitcoins had a use in the market prior to their use to create a Bitcoin, but we will leave that for today.

Over the centuries, gold and silver have been settled upon as the best medium of exchange by the market, and this is still true today.

Now fast forward to the twentieth century, which is happening right now. How can I transmit gold (or any thing that I and another person want to trade) without double spending, anonymously, to a person that is half way around the world, without a central clearing authority? Before Bitcoin, this was not possible, and now it is.

Bitcoin, whilst not conforming strictly to the definition of what money is, is a very useful tool to exchange value. It takes some understanding and knowledge of mathematics to grasp exactly how it works and why it is so brilliant, but even without that knowledge, it can still be used by everyone eventually.

Mr. Kramer can use email to send and receive messages without understanding SMTP or POP syntax. He can write blog posts without understanding HTTP requests or MYSQL, and most certainly he will be able to use credit cards and buy books from Amazon whilst his transaction is protected by SSL. None of these things, these very complicated things, need to be understood fully before you can grasp their importance. SSL, upon which the entire commerce infrastructure is built, is nothing like putting a paper document in an envelope to be mailed by the government monopoly postal system and yet, it is used every day to secure documents in transit. PGP and Public Key Cryptography is used every day to sign documents in a way that means they cannot be forged; signing a document with Public Key Cryptography is not the same as putting your ‘John Hancock’ on a piece of paper, but it is a quantum leap in a different direction that has uses way beyond what signing a piece of paper can do for you.

This is what Bitcoin is all about; it is a breakthrough in sending and receiving acknowledgement of ownership.

Anyone who scoffs at this is simply not seeing the big picture.

What was Bitcoin’s prior material use/value? Zero. It is just bits in a computer.

This is a straw man argument. David Kramer’s post, and the two links in his update to Murray Rothbard’s books (one of which I have read; ‘What has Government done to our money?‘) are just ‘bits in a computer’ and yet, these bits can be used to transform the thinking of men. Bitcoins when they are stored on a device, are represented by bits, but it is what those bits represent and their relationship to other bits on other people’s computers that is important. This line of Kramer’s shows that he really does not understand what computers are, how they work and why Bitcoin is a breakthrough.

And what’s with the “fixed” amount of Bitcoins? Who determined the “proper” amount? A computer programmer?

And why not a computer programmer? This is exactly the same as�Lacy Clay saying Thomas DiLorenzo cannot talk about economics ‘because he is an historian’. For what reason are computer programmers excluded from inventing something that has a potential use in economics? Or should this be left only to the high priests? This is not a serious argument against the design of Bitcoin. Clearly there needed to be an upper limit to the number of Bitcoins in circulation, otherwise it would not be useful as a way of transmitting ‘money’. The person who designed Bitcoin, a computer programmer, set the upper limit. If the market will not accept this limit, then the system will not be used. But I digress.

Data is infinitely copyable. There is no limit to the number of times data can be copied. This means that any token in a system of exchange can be copied at will by anyone with access to the system at any level. This is where the problem of double spending comes from, and part of the breakthrough in Bitcoin is the solution to this problem, which computer programmers have been searching for for decades.

When you have even a slight grasp of how data and computers work, and you understand that the double spending problem has been solved, your first reaction would be to gasp, as the enormity of what Bitcoin is dawns on you.

Only the free market can voluntarily determine how much of a real medium of exchange is needed in the marketplace over time.

This is true, but once again, this has nothing to do with Bitcoin. By releasing Bitcoins slowly over time, by the efforts of the people who use it, there can never be a flood of Bitcoins. Satoshi Nakamoto must have grasped on some level, if not entirely, that money is a commodity, which is why he designed Bitcoin to be mined in this way, instead of starting off with 21,000,000 coins in circulation all at once. All we know about his thinking is what we see in his software and in his original proposal. We have between now and 2142 to see what the market voluntarily determines how much of a real medium of exchange Bitcoin is, and if the number of bitcoins is too small or too big. Whatever the outcome, there is nothing stopping someone else with another system from supplanting or improving on Bitcoin, by whatever means they can come up with.

While the idea of attempting to get rid of the Bankster monopoly on creating money out of thin air is commendable, Bitcoin is also money created out of thin air. Bitcoin is just substituting one bogus medium of exchange for another. http://www.lewrockwell.com/blog/lewrw/archives/89471.html

Declaring Bitcoin to be ‘Just Another Bogus Medium of Exchange’ is not an argument and is clearly false. It is also not true that Bitcoins are created ‘out of thin air’. Bitcoin is new and unique, and that is a fact; even if you believe it to be bogus, you have to demonstrate why it is bogus.

If you want to refute Bitcoin (or anything for that matter) you have to address the facts about it. Here is an example of someone who has done precisely that.

Tav addresses how Bitcoin works, acknowledges its breakthrough, demonstrates an understanding of economics, identifies what he believes the specific flaws in Bitcoin are, and explains why he concludes it cannot work, clearly and with precision. Here is another critique and another by the same author. If you want to contribute something meaningful and useful that is the way to do it. There are arguments swirling around the ‘hoarding problem’; it would be nice to read a good analysis of hoarding and how it applies to real money like gold and silver, and how those dynamics apply to Bitcoin. In any case, I don’t care much for people who refuse to think hard about subjects like Bitcoin; something that is voluntary, harmless, an exiting breakthrough and which has massive potential even if in this iteration, it fails.

We have seen the failure of other systems, like Chaumian E-Cash before. Each of these iterations causes analysis, innovation and new products to emerge. This is something to celebrate, to think hard about, to address with logic and facts and indeed, to even try out on your own computer so that you actually have a grasp of what is involved in it.

Finally, whatever happens with Bitcoin, the individual wins.

If Bitcoin becomes the de-facto way of spending money on the internet, displacing all other systems like Credit Cards and PayPal, the public wins, and the State loses. That is win.

If Bitcoin fails because the State outlaws it, hatred for the State increases. That is win. If Bitcoin fails for economic reasons, it will not be tried again in this form and the lessons learned will be folded into the next iteration. That is win. If Bitcoin fails for technical reasons, same again, the lessons learned will be used in the next iteration, which is win.

Whatever way you choose to look at it, Bitcoin is a good thing.

+++++++ UPDATE! +++++++

In a well considered article, which I linked to above, “BitCoins: All Buzz, No Substance” by Grant Babcock, the problems with Bitcoin as perceived by the author are addressed. In listing his objections to Bitcoin, he actually argues for it. Lets take a look.

A given good�s exchange value has a tendency to snowball.

This is happening with Bitcoin right now.

If I believe that a larger number of people are willing to trade for a good, I am more willing to trade for that good myself.

This is happening right now with Bitcoin.

Eventually, we expect a single good or a handful of goods to emerge as the predominant media of exchange; they are then called monies.

This may happen with Bitcoin on the internet. If enough people download the client and accept it, and websites use the simple tools needed to accept it, we can expect it to emerge as a form of money. Bitcoins, by Grant’s own reasoning, are no different to coconuts, feathers, tally sticks or cowrie shells.

Historically, goods such as cigarettes, precious metals, shells, and many others have emerged as monies.

And so why not digital certificates that cannot be forged or ‘printed’ (mined or generated) beyond a certain number (21,000,000)?

People�s willingness to treat an item as money is based on experience. They forecast that a good will be accepted in trade tomorrow because it was accepted in trade the day before and the day before that.

And so, if enough people accept Bitcoins, they will treat it as money de-facto by this definition.

If we follow this chain back in time, eventually we arrive at a point where the commodity is has not yet been used as a medium of exchange and is only wanted for its use value.

This is true of Bitcoins; digital certificates and signatures have been around for many years; they were never before thought of as money in and of themselves (though you can buy certificates for money; ask Mark Shuttleworth about how he became a billionaire by selling ‘just bits on a computer’).

The principle that the value of a currency can be traced back to a time when it was not yet a currency but just a commodity like any other is called the regression theorem, and interested parties can read more about it in Human Action Ch 17 � 4.

If you do not like tracing Bitcoins back to digital certificates, you could trace them back to the electricity used to make them. Or is electricity not a commodity because it is not physical? It is intangible, but is transmissible… hmmmm!

Typically once a commodity becomes a money, a variety of certification agencies will emerge.

Bitcoin has this, of course, in the form of its decentralized P2P clients. That is the breakthrough; no centralised certification agency.

Suppose for example that our money is gold � examples of certification might be an imprint on a gold coin stating its weight and where it was minted, or a piece of paper entitling the bearer to a certain amount of gold at a trusted repository.

A stamp on a bar of gold is meaningless, as we have seen with the tungsten centered fake gold bars. Bitcoin, in this respect, is superior to gold because each Bitcoin is absolutely certified.

This certification makes the commodity an even better money than it would have been without the certification. The certification is bundled with the commodity and traded, but is in principle distinct; the coin and the stamp in the coin are different �things.�

Indeed. As you can see, all the arguments presented here for gold as money, apply to Bitcoins as money.

Just as the computers and the internet changed the way letters and books are made and distributed and read, money is being changed in the same way.

This means that if you want to read a physical book, you still have to go out an buy one, or have it posted to you. If you want money in the real world, you should use gold and silver coins only.

If you want to read a book on your iPad, you get a PDF copy from somewhere on the internet, and then read it on your device. This does not mean that ‘PDFs are not books’ and no one with any sense says this. PDFs are for e-readers. That is their nature, its what they are for and the medium where they make sense is the computer.

If you want to send money to your cousin in Jodhpur, you take your gold coins to a shop in Manchester, turn them into Bitcoins and then send them. Your cousin can then turn them back into gold, or he can buy goods and services with them on the internet. Bitcoins are to money as PDFs are to books. Its not hard to understand, and the wow factor comes in when you understand that whilst PDFs can be copied ‘double spent’ ad infinitum, Bitcoins cannot, even though they are both digital.

That is simply incredible and its why everyone is so exited about them. Add to the mix the anonymity, the lack of central authority, the transparency in both the client software and the network, and you begin to see just what a revolution this is any why the word ‘revolution’ is appropriate.

Finally read this [excellent analysis of gold vs Bitcoin by Anthony Freeman](http://economicsandliberty.wordpress.com/2011/06/04/further-observations-on-bitcoin-digital-currencies-privacy-and-liberty/ “Further Observations on Bitcoin, Digital Currencies, Privacy and Liberty

Economics and Liberty”).

Chinese translation of this article.

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The Economics Of Bitcoin – Why Mainstream Economists Lie About Deflation

By Michael Suede

Posted June 11, 2011

As many of my regular readers know, I’ve already written a few articles on Bitcoin that explain _why_it is money.  In those articles I have addressed why the inherent properties of Bitcoin give it value as a medium of exchange.  One of those properties that I mentioned, but did not go into very deeply, is the deflationary aspect of the currency system.

Bitcoins are inherently deflationary as a currency because they will eventually top out in the number that can be produced.  Eventually total Bitcoin circulation will reach about 21 million coins, and after that, no new coins can be created.  Thus, if no new money can be created, yet if the productive capacity of the economy increases, prices will fall since there will be more goods chasing the same amount of coins.

Most people remember hearing that deflation is just as bad (or worse) than inflation from their high school or college economics teachers.  In this article I will explain why those assumptions are wrong.  Deflation is when a currency gains value over time (i.e. you need less and less of it to buy the same amount of goods in the future).

So let’s list off the reasons why crackpot Keynesian economists think deflation is bad for the economy.  Then I will address each of those points.  You are about to see a guy with a BBA in MIS smash a Noble prize winning PhD economist’s arguments using simple common sense.

Deflation is supposedly bad because:

There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow…even a zero rate may not be low enough to achieve full employment.

A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts.

Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity.

Those arguments against deflation are typical Keynesian dogma.  In fact I actually wrote out the exact same three arguments before I even read Krugman’s article, but I figured it would be better if I listed them off right from the horse’s mouth.

So let’s address the first argument that people become less willing to spend, and particularly less willing to borrow, and this somehow leads to unemployment.  There will ALWAYS be some unemployment if the economy is not in equilibrium (which it never is, since human desires change over time).  As people shift their desires from wanting notebook computers to iPads, some unemployment will result from this.  Consider that if the demand for notebooks drops while the demand for iPads increases, notebook producers will end up having to lay people off or go out of business while iPad producers will be hiring more people.  The people in transition are going to be unemployed while they look for new work.

But setting that point aside, we have to look at why money undergoes deflation in the first place!  It is not surprising that Krugman doesn’t mention the reasons why deflation occurs in a currency.  There are basically only two reasons (on a macro scale) why a currency would undergo deflation:

1.  The economy is producing more new goods and services at a rate that is above the growth rate of the money supply…. or

2.  In a fractional reserve system, debt is being wiped out through widespread bankruptcies.

Consider that in the first case, this is entirely normal and healthy!  If the money supply is held constant, yet the productive capacity of the economy increases, there will be the same number of dollars chasing more goods.  Inflation is the exact opposite of this, whereby same dollars are chasing fewer goods (or more dollars chasing same/less goods).  Clearly deflation in this sense is beneficial for consumers.  We see this taking place in the electronics industry which is largely free from government regulation and subsidies.  When competition is fierce, the productive capacity of industry over-rides the inflationary aspects of our fractional reserve economy and we see prices come down as more and more electronic goods are produced more efficiently.

Imagine if the electronics industry operated like the government subsidized and regulated healthcare industry.  You would buy all the electronics you could now, because in the future, they would be so expensive you might not be able to afford them!  So yeah, in this sense, inflation encourages spending.  But clearly this is UNHEALTHY spending caused by people fearing the loss of their purchasing power.

Inflation creates a fear based economy that motivates people to spend above their means because the future value of their purchasing power is constantly decreasing.  It would be foolish to try and save money for future expenditures in an inflationary economy, which obviously destroys savings.  People who save for their retirement by putting money in a bank would be fools in an inflationary environment.

In fact if the inflation gets bad enough and interest rates are artificially low, people would be motivated to take out excessive loans and credit card debt to try and get as many things as they could now!  Boy that sure sounds like a problem we are all familiar with doesn’t it?

Krugman’s argument that people would be less willing to spend and borrow, and this would lead to unemployment, is as ridiculous as saying that because computers keep getting better and cheaper into the future, people would be less willing to spend money on a computer today because they could simply wait and buy an even better/cheaper computer in the future.  That is obviously not how people think.  People have needs and desires that have to be met, and they will purchase things as soon as their desire for the product is larger than their desire for future earnings on savings.  That, by the way, is how a healthy economy should operate.  Notice there is no fear involved.  Electronics companies are not going out of business because their products are becoming more abundant and cheaper.

So let us look at Krugman’s second argument that deflation makes debtors worse off.  What is left unsaid in this assumption is that debt is a good thing, while saving is a bad thing.  Does this make any logical sense to anyone?  Consider that if money is undergoing deflation, SAVERS benefit.  Shouldn’t the savers naturally benefit more than someone who is putting themselves into debt?  Savers are forgoing pleasure in the moment for the expectation of even greater pleasure in the future.  This means resources that could be consumed immediately for minimal productive gains are being put aside into bigger projects that could yield even greater gains in the future.  Savings is what builds strong economic foundations.  If the US wasn’t so wildly in debt at the moment we would be in a better economic position with larger prospects for growth!

But also let us consider the impacts of deflation on interest rates.  People who lend and borrow money will know that money will be worth more in the future if the money supply remains constant (like Bitcoins) yet the productive capacity of the economy continues to increase.  This leads to falling interest rates.  Interest rates will naturally come down in a deflationary environment because savings will increase, thereby making more money available to banks to lend.  When banks have a lot of people saving money with them, they will lower rates naturally.  This is in contrast to our present situation where rates are low strictly because the Fed is artificially depressing them by paying banks NOT to lend and by buying up government bonds.

Distortion of interest rates by the Fed also has other deleterious effects on the structure of production that I will not get into here, but according to Austrian Business Cycle Theory, inflation and its distortion of interest rates is the primary driver of business cycles.  Learn more about it by watching this video by Professor Roger Garrison.

Which situation sounds healthier to you?  Low interest rates because a lot of people are saving money or low interest rates because the Fed is artificially depressing them with tax payer money?

So let us address Krugman’s final argument that wages face downward rigidity which makes it more difficult for employers to adjust to the money that is gaining in value.

Consider if you were in this situation:

Your employer gathers up all the employees for a conference and tells you that because the economy is so productive and that the value of money is going up so much, that he is going to have to furlough the workforce to deal with the appreciating currency.

From your perspective, you are getting more time off while your income remains exactly the same in terms of purchasing power.  Who doesn’t want that?  Further, consider that if you don’t get a raise every year, YOU STILL GET A RAISE!  Employers don’t necessarily have to cut wages; they can cut hours or simply not give raises yet people would still be better off than they were the year before.

But let’s say the economy is so productive that money gains so much value that employers are simply forced to cut wages – if this was the case, would anyone seriously give a damn?  We would be living in a nirvana society that had absolutely ridiculous amounts of abundance.  Women could stay home to take care of the kids, one man could provide all the income necessary to take care of his family and still retire, kids wouldn’t have to work three jobs to put themselves through school, etc… etc… etc…

Less people would need to work in such an economy (like they did in the 50s and 60s) which would relieve the need of employers to cut wages.

Oh yes, one more thing.  I suppose I should address the second cause of deflation other than increasing productivity while the money supply remains constant – and that is a deflationary default spiral that results from the unwinding of a Ponzi scheme.  This is the real reason why Keynesian economists fear monger about deflation.  Since in our crazy society, money IS debt, if debtors get themselves into a position where they are so over-leveraged that they are forced into bankruptcy, it can cause a cascading series of defaults that wipe out the banking industry (along with the government and its welfare/warfare state).  As debt gets wiped out, the money supply decreases which leads to deflation.

Keynesian economists have to continually fear monger about deflation because even a tiny amount of it could wipe out our Ponzi debt based economy, and thereby wipe out their fat government aid fueled paychecks.  To learn more about the scam that is our debt based economy, check out The Case Against The Fed.  It offers a clear picture of how the modern banking system operates and why it was created.  If you are looking for something slightly more entertaining, yet still informative, check out The American Dream.  It is gives a great overview of what fractional reserve banking is and why it is nothing more than a Ponzi scheme.

Keynesian economists like Krugman don’t have your best interests in mind when they argue against deflation.  They are far more concerned about keeping the welfare/warfare state alive and well, along with their own paychecks.

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The Economics Of Bitcoin – How Bitcoins Act As Money

By Michael Suede

Posted June 18, 2011

A video reading of this article can be found here.

I’m going to start off with a simple example of how and why Bitcoins act as trade facilitators and move forward into comparing when more complex transactions take place.  Then I will analyze the properties of Bitcoins that make them act as facilitators of trade and a store of wealth.

So let us assume the following situation:

Bob lives in California and wants to buy a widget from Frank who lives in New York.

Frank has decided to sell his widget for 100 dollars.

Bob has reviewed Frank’s product through Frank’s website and agrees to purchase the product from Frank for the agreed upon price of 100 dollars.

To facilitate this transaction, the two have agreed to use Bitcoins exchanged through Mt. Gox.

Now let us suppose that there is only one Bitcoin in existence and Frank is in possession of this Bitcoin.

Frank logs into Mt. Gox and places his Bitcoin for sale on Mt. Gox and sets his price at 100 dollars.

Bob logs into Mt. Gox and buys the Bitcoin for 100 dollars.

After this series of transactions completes, Frank is now 100 dollars richer and Bob is in possession of a Bitcoin.

That Bitcoin now has a market determined value of 100 dollars, so Bob now sends the Bitcoin back to Frank as payment for the widget.

At this point Frank ships his product after he has the confirmed payment of one Bitcoin.

So the end result is Frank is 100 dollars / 1 Bitcoin richer, while Bob is richer to the tune of one widget.

Of course, this is a very round-about way of conducting a trade, but as we can see there was no loss of value.

Now we are going to inject Larry as a third party buyer and seller of this Bitcoin.

So let us suppose that still only one Bitcoin exists and it is in the possession of Larry.

Larry has decided that his Bitcoin is worth 100 dollars and will sell it for that price, so he puts his Bitcoin up for sale on Mt. Gox at the asking price of 100 dollars.

So Bob logs into Mt. Gox and purchases this Bitcoin for 100 dollars and then sends the Bitcoin to Frank as payment for the widget.  Frank then responds by shipping Bob the widget.

So now we have Bob +1 widget, Frank +1 Bitcoin, and Larry +100 dollars.

To finalize the transaction, Frank logs into Mt. Gox and puts his Bitcoin back up for sale for the asking price of 100 dollars.

Larry sees the Bitcoin back up for sale and decides he will pay 100 dollars for the coin because he would rather hold Bitcoins than dollars, and thus, Frank is now 100 dollars richer while Larry is richer by one Bitcoin.

In this final example, Larry represents the entire free market in Bitcoins.  Larry actually represents thousands of people all willing to buy and sell Bitcoins in a constantly changing market.  As long as Frank does not decide to hold the Bitcoins over an extended period of time, his exposure to changes in market prices is incredibly small.  Frank may make a little extra money or he might lose a little money in the exchange as the market price of the coins fluctuates during the period of time he is in possession of the coin to the period of time he sells the coin back into the market for dollars, but this is a small risk he is willing to take for the ease transacting in Bitcoins and because he doesn’t have to pay any credit card fees on the transaction.

Through this example we can see that Bitcoins act in exactly the same manner as if one were exchanging physical nuggets of gold represented by electronic gold receipts.

To prove my point, lets go through this same example using a digital receipt for gold bullion we shall call a GLD.  You’ll notice that there is absolutely no difference between how the series of transactions unfolds.

Larry has decided that his GLD receipt is worth 100 dollars and will sell it for that price, so he puts his GLD up for sale on Mt. Gld at the asking price of 100 dollars.

So Bob logs into Mt. Gld and purchases this GLD for 100 dollars and then sends the GLD to Frank as payment for the widget.  Frank then responds by shipping Bob the widget.

So now we have Bob +1 widget, Frank +1 GLD, and Larry +100 dollars.

To finalize the transaction, Frank logs into Mt. Gld and puts his GLD back up for sale for the asking price of 100 dollars.

Now the only difference in all of this is that the GLD receipt represents a fixed amount of a physical commodity (gold), while the Bitcoin does not represent anything at all.   As far as the money market is concerned, this representation of a hard commodity is totally irrelevant in regards to how GLD acts as a currency.

The important question in all of this is why are people willing to use gold as a store of value?  Why do people willingly buy and sell gold in exchange for dollars?  If we can answer that question, we will also have an answer as to why people buy and sell Bitcoins in exchange for dollars.

The answer lies in the specific properties of gold that lend itself to acting as a store of value.

People buy gold with dollars as a store of wealth because of the following specific properties gold has:

1.  Scarcity – Its supply is very stable and does not fluctuate much.  There is enough gold around that everyone can get access to it, yet new sources of gold are limited enough that the supply of gold can not easily be inflated.  Thus, the supply of gold will not be increased and can not be increased at a very high rate in proportion to the existing supply of gold.  This is obviously important in a money because, as the law of supply and demand dictate, the more of  something there is, the less valuable it will become.

2.  Fungibility – All gold is uniformly the same.  Therefore, no one cares if they are getting a specific gold bullion bar in exchange for dollars, they only care about the amount of the bullion they are receiving.

3.  Divisibility – As gold’s value fluctuates, people want to know they can sell any amount of gold in the future for the same rate as any other amount of gold.  So if I take an ounce of gold and cut it up into grams, each gram will proportionately total up to the same value as a full ounce.  Let us contrast gold with diamonds to make my point.  If I divide up a diamond that weighs an ounce, each piece of that diamond will be worth faaaar less in total than what the ounce diamond would be worth on its own.   So by dividing a diamond, each piece loses a tremendous amount of value as compared to the whole.  This is not the case with gold, since gold can be melted back into a larger piece at any time.

4.  Recognizably – People need to easily be able to validate that the product they are receiving is actually the product claimed.  Gold can easily be identified by its physical characteristics and tested to ensure its purity.  This means that people can not be easily deceived into buying a counterfeit gold product.

It is important to note that anything which meets the criteria I just listed can act as a money.  People do not care in the slightest that gold can be turned into artistic jewelry pieces in their decision making process about why they are holding gold as a store of value.

The fact that gold can be turned into artistic pieces simply provides a reassuring alternative use for gold if people decided that gold is no longer of monetary value.  So this way I know that if people stop buying gold as a store of wealth, I’ll still be able to sell my gold to a jewelry shop at a tiny fraction of its current value if it came down to it.  But this reassurance that gold will always have some tiny fraction of value to jewelers in no way influences the reasons why people use gold as a money and why gold has a market determined value of nearly 1600 dollars today.

Because Bitcoins have no other use besides acting as trade facilitators, they have no such reassurances of minimal value – but this fact is totally irrelevant from a monetary perspective, just as it is totally irrelevant from the perspective of gold.

All that matters as far as the money market in Bitcoins is concerned is that they have all of the aforementioned properties that make gold a money – which they do.  Thus, Bitcoins can act in exactly the same capacity as a store of wealth as gold.  The only valid economic arguments that can be made against Bitcoin are those arguments which attempt to demonstrate why Bitcoins don’t meet the above mentioned requirements.

After thoroughly reviewing the risks involved and the way Bitcoins are created and transacted with, it is my opinion that any arguments which attempt to demonstrate why Bitcoins somehow don’t meet the above requirements are not adequate to call for its discontinued use as a currency.

For example, there is an ultra tiny fraction of risk that Bitcoins could be double spent if a person were to acquire more than 50% of the computing power of the entire network.  I find this risk to be so small that it is not really a serious threat to the stability of the currency.

In summary, Bitcoins are money because of the properties they have.  They act in exactly the same capacity as gold when used as a money.   The fact that Bitcoins are not represented by a physical commodity is totally irrelevant from the perspective of their use as a store of value.   The free  market has decided Bitcoins do have value and can be used as a trade facilitator because of the properties they have; therefore, they are free market money.

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Against The Gold Standard

By Michael Suede

Posted June 21, 2011

After reflecting upon the recent articles I have written where I have defended the new peer-to-peer currency called Bitcoin from attacks by gold standard advocates, I feel it is time stop taking a defensive role and make a few offensive jabs at the much vaunted gold standard.

In my articles I have spent a lot of time comparing the economics of how gold operates as a currency to how Bitcoin operates as a currency.  In the course of comparing the currencies, I was struck by a problem with the gold standard that was so obvious, yet so damning, I felt it deserved its own article.  I hope to hear a response from some well versed gold standard advocates on this issue.

The problem is not a new one, but it is a problem that I have never in all my years heard a satisfactory answer to.   The problem is quite simple, so here it is:

When gold is represented by something, what prevents arbitrary replication of that “thing”?

The law?  Who is the law?  Aren’t laws arbitrary creations by some governing body?  If that body has the authority to make arbitrary replication of money products illegal, then it stands to reason it also must have the power to make counterfeiting legal.

Throughout history, hasn’t that been the historic fault of the gold standard?  Hasn’t history been abundantly clear that as soon as paper receipts for gold are used as money, those paper receipts inevitably become monopolized by State actors, leading to their eventual arbitrary replication at the hands of the criminal class?

Don’t the bankers who issue the receipts have a massive incentive to cheat the system and issue more receipts than they actually have in gold reserves?  Doesn’t the State have a massive incentive to allow such legalized counterfeiting?  Has not history made it clear that those who have the power to issue money always and inevitably come to dominate the rest of society?

Baron Nathan Mayer Rothschild once said,

“I care not what puppet is placed on the throne of England to rule the Empire, …The man that controls Britain’s money supply controls the British Empire. And I control the money supply.”

Rothschild wasn’t talking about minting gold coins for use in barter; he was talking about paper receipts.  The incentive to issue more paper than specie is more massive than any other kind of fraud imaginable.  If one had the ability to manufacture paper that people treat in the same way they treat a gold coin, the urge to inflate would be more powerful than even an angel could bear.

I’m reminded of a statement Milton Friedman once made concerning greed as he was addressing Phil Donahue on his talk show.  Friedman said, “You know I think you are taking a lot of things for granted, just tell me where in the world you will find these angels who are going to organize society for us? I don’t even trust you to do that.”

I would argue that there is NO solution to this problem.  Changing the structure of government, eliminating the State, enforcement of fraud laws, and other such measures ultimately can not prevent a private bank from engaging in this kind of fraud.  Indeed, history has shown us that bankers routinely buy the law and were instrumental in creating the modern State.

Rothbard wrote extensively on the mischief caused by private banks engaged in the counterfeiting of their own notes prior to the inception of the Fed.  The Fed is simply a coordinator and cartelizing agent that allows for the even inflation of the money supply and acts to prevent bank runs, but its existence is not necessary for banks to engage in the counterfeiting of their own notes.  It was through this process that the bankers came to acquire enough power to take control of government in the first place.  It was through the power of the printing press that the Fed came to be enshrined in law.

I seem to recall, deep within the recesses of my mind, Hoppe making similar arguments at one point in time.

Dr. Hans-Hermann Hoppe writes:

And they [the power elite] realized that their ultimate dream of unlimited counterfeiting power would come true, if only they succeeded in creating a US dominated world central bank issuing a world paper currency such as the bancor or the phoenix; and so they helped set up and finance a multitude of organizations such as the Council on Foreign Relations, the Trilateral Commission, the Bilderberg Group, etc., that promote this goal. As well, leading industrialists recognized the tremendous profits to be made from state-granted monopolies, from state-subsidies, and from exclusive cost-plus contracts in freeing or shielding them from competition, and so they, too, have allied themselves to and “infiltrated” the state.

There are “accidents” in history, and there are carefully planned actions that bring about consequences which are unintended and unanticipated. But history is not just a sequence of accidents and surprises. Most of it is designed and intended. Not by common folks, of course, but by the power elites in control of the state apparatus. If one wants to prevent history from running its present, foreseeable course to unprecedented economic disaster, then, it is indeed imperative to arouse public indignation by exposing, relentlessly, the evil motives and machinations of these power elites, not just of those working within the state apparatus, but in particular also of those staying outside, behind the scenes and pulling the strings.

The ability to acquire enormous power through the fraud of counterfeiting is plainly evident.  Thus, the importance of ensuring that such fraud can not take place is paramount in selecting a currency system.  Bankers are very good at playing the role of benevolent benefactors.  Today, over half of our society calls out to the banker gods begging for more table scraps and handouts.  Bankers make society love them for their printing presses. It is impossible to get rid of counterfeiting if bankers can use the power of the printing press to make the public believe they are the beneficiaries of the fraud.  They only need to convince half of the population that they are benefiting from the fraud, then turn that half against the other to ensure their fraud continues unhindered.

Former Chairman of the Federal Reserve, Alan Greenspan once said,

“Well, first of all, the Federal Reserve is an independent agency, and that means, basically, that there is no other agency of government which can overrule actions that we take. So long as that is in place and there is no evidence that the administration or the Congress or anybody else is requesting that we do things other than what we think is the appropriate thing, then what the relationships are don’t, frankly, matter.”

Low interest rates, cheap loans, cheap credit, social welfare programs, public-private contracts that insulate corporations from competitive forces, etc.. etc.. etc.. – all act to fool the public into believing that their great benefactors are only looking out for their best interests.  And all of those things arise from the power of the printing press.   From this we can say that the urge to inflate is not limited to the bankers who control the printing presses, but also expands out to the public who ostensibly control “the law.”

I would argue that as long as the possibility exists that gold receipts can be counterfeited, they will be counterfeited.  And as long as those receipts are counterfeited, a State will exist to ensure that things remain that way.  It is a simple matter to bribe judges, law makers, enforcement agents, and even the public itself when one has a printing press.

The market has proven wholly inadequate at preventing the fraud of counterfeit bank notes, it can only react after the fact to punish the fraudsters.  But as we have seen, it is often too late.  Once the bankers have bought off the politicians and the public with their fraudulently acquired dollars they will be protected by the State.  The market has been trying to punish the fraud of counterfeit bank notes for the past 40 years and yet the State has held it at bay.

Thus we are back to my original question.  What system is to prevent the arbitrary replication of receipts for gold under a gold standard?  Unless we give up digital transactions and outlaw the use of paper receipts as a society, there is nothing that can prevent it.

If it hasn’t become clear by now, I hope you can see why Bitcoins (or another similar currency like it) are superior to a gold standard.  They simply can’t be inflated.  It can’t happen.  And further, since there is no bank issuing the notes, there is no one group of people who can use the power of the press to influence the public or political class with the bribery of free money.

This core problem must be addressed by gold standard advocates if they want to argue that gold is superior to encrypted digital currencies like Bitcoin.   Since gold can not be shoved down a transmission wire, unless the gold standard advocates want argue that all transactions must be made with physical specie, they have no possible way of getting around this one fatal flaw with the gold standard.

I never in a million years thought I would be saying these words, but the gold standard really is a relic of a by-gone era.  In today’s society where barter takes place across global markets using digital transactions, a gold standard currency that does not use the exact same mechanisms of Bitcoin to ensure replication of the digital representation of gold is impossible, is ultimately doomed to fail in the exact same manner it has already failed today.

Of course, the nature of Bitcoin is such that it is impossible to tie gold specie to a Bitcoin because Bitcoins can not be created in accordance with the minting of new gold.  But the nature of Bitcoin also begs the question as to why we even need to have such a currency tied to a commodity at all.

We don’t – and we shouldn’t.

It is a waste of resources to have men digging for gold, just to have it sit in a bank vault, when those same men could be making something useful for humanity instead.  Gold was only useful as a currency because it could not be arbitrarily inflated and met the requirements of scarcity, divisibility, fungibility, and recognizably better than any other physical commodity.   Today, in our new digital world, such monetary requirements are better suited to the digital realm, where the waste of resources on the production of money is not necessary.

I would like to end this article with some thoughts on money by Hoppe.

In a free society, the market would produce money, as all other goods and services. There would be no such thing as money in a world that was perfectly certain and predictable. But in a world with unpredictable contingencies people come to value goods also on account of their marketability or salability, i.e., as media of exchange. And since a more easily and widely salable good is preferable to a less easily and widely salable good as a medium of exchange, there is an inevitable tendency in the market for a single commodity to finally emerge that differs from all others in being the most easily and widely salable commodity of all. This commodity is called money. As the most easily salable good of all it provides its owner with the best humanly possible protection against uncertainty in that it can be employed for the instant satisfaction of the widest range of possible needs. Economic theory has nothing to say as to what commodity will acquire the status of money. Historically, it happened to be gold. But if the physical make-up of our world would have been different or is to become different from what it is now, some other commodity would have become or might become money. The market will decide. In any case, there is no need for government to get involved in any of this. The market has provided and will provide some money-commodity, and the production of that commodity, whatever it is, is subject to the same forces of supply and demand as the production of everything else.

Bitcoins are the first true digital commodity.

Bitcoins are free market money.

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The Economics Of Bitcoin

By Michael Suede

Posted June 23, 2011

Doug Casey of Casey Research recently conducted an interview where he spoke about Bitcoins to Louis James, Editor of the International Speculator. In the interview, Casey makes a few claims that had me yelling at my computer screen. It is important to remember that Casey has a vested interest in promoting a gold standard. His company, Casey Research, specializes in precious metals. So his analysis of any currency system that is not predicated on metals is obviously going to be somewhat biased.

This particular claim by Casey rubbed me the wrong way:

L: Do they have value in themselves?

Doug: There’s the rub; I don’t see that they do. Bitcoins are just an electronic abstraction. They can’t be used for anything else, nor are they made of something that can be used for anything else. They are like one of those knots in a string that disappear if you pull hard enough on the ends of the string. They are not backed by anything at all. Like government fiat currencies, they are a con game, functioning only as long as people have confidence in them, regardless of whether that confidence is well placed or not.

So Doug, what you are saying is that if gold could not be turned into jewelry, it would not be a money? What industrial uses does gold have outside of being ornamental? Sure it has some minor industrial uses such as plating for electronics or a few other obscure things such as radiation shielding on astronaut helmets, but other than that, the vast majority of gold that is actually used in some physical way is nothing more than pretty trinkets. The trinkets themselves are totally useless as far as improving the conditions of humanity are concerned.

Of course, the answer to my question “what uses does gold have besides being ornamental?” is obvious to Doug, and everyone else, its primary use is to act as a store of wealth and as a trade facilitator. The market has a need for a trade facilitator which allows the division of labor to take place. The market has a need for a medium to store wealth. These market driven needsimpart value to gold faaaaaar above what it would normally be valued at for industrial or ornamental uses alone.

Gold is not worth $1600 an ounce today because it can be turned into pretty trinkets or plate astronaut helmets.

The market imparts value to gold because of its properties of divisibility, fungibility, scarcity, and recognizability. These properties allow gold to act as a store of wealth. The market also imparts an additional tiny fraction of value to gold due to its industrial and ornamental uses, but these uses are secondary, not primary. I would argue that gold would still be worth at least $1500 an ounce today even if it had absolutely no uses outside of acting as a money.

Doug goes on to say,

Their main value seems to have been as a speculative medium. Worse, actually, in that they are – or were – based on finding a “greater fool” to pass them on to, for something of value.

Since I’m sure we can all agree that gold is not worth $1600 an ounce today because it can be turned into pretty jewelry, I have to ask why Doug’s statement shouldn’t also apply to gold? Isn’t the current price of nearly $1600 an ounce due to speculation about the dollar’s solvency? If gold is not valued at $1600 for its industrial or ornamental purposes, then what is driving its price so high?

Let me put this another way; if people had total faith in the dollar and the dollar was not being inflated, would gold still be valued at $1600 dollars an ounce? Of course, the answer would be a resounding NO. It would be NO because if people had total confidence in the dollar they would not bother looking for alternative mediums to act as a store of wealth. Thus, we can say Doug’s claims about Bitcoins being nothing more than a “speculative medium” also apply to gold in the same sense.

Casey is essentially making the claim that because Bitcoins have no uses outside of acting as a money, they are inherently worthless. I have argued against this in previous articles and I will repeat myself here. This is a fallacious argument. To claim Bitcoins are nothing is like claiming your operating system is nothing, therefore it is worth nothing. Clearly an inordinate amount of time and resources went into the development of your computer’s operating system. The time and resources that went into the development of the software constitutes “something”, which is obviously more than nothing. Software can have inherent properties that give it value in and of itself. In the case of Bitcoins, they are imbued with value by the free market because of the properties they have that allow them to act as a store of wealth and as a trade facilitator. Those properties which allow Bitcoins to act in this specific capacity are exactly the same properties that gold has which allow gold to act as a store of wealth and as a trade facilitator. Again, even if gold had absolutely no other uses besides sitting in bank vaults as ingots, gold would still be a money.

The next item I would like to address:

L: …the whole concept of barter is trading in goods and services directly, not via media of exchange.

Doug: Well, barter chits were supposed to encourage trade among those who used them. And they were also a tax dodge, since no official money changed hands. That was a major incentive for using them. But they all dried up and blew away, and the people who wound up holding them had nothing. Sort of like when the Argentine peso collapsed ten years ago. The provinces decided to set up their own currencies, but they weren’t backed by anything either, and they all dried up and blew away as well, leaving those who held them holding an empty bag.

The Argentine peso collapsed because it was inflated to the moon by a corrupt government. Comparing Bitcoins, which can not be arbitrarily inflated and are not controlled by any government, to the Argentine peso is ridiculous. I have to assume this is purely Casey’s bias rearing its ugly head. It is a straw man conjured up to demonize Bitcoins as somehow being vulnerable to the same fate.

Also, as far as I know, the barter clubs that Casey is referring to are still in business. See here, here, and even from Lew Rockwell’s own website here. In fact every report I’ve read on them says they are gaining traction. I haven’t seen an article saying club chits had suddenly become worthless. I suppose there may have been a few clubs that folded and went out of business, but that is the market making a determination about a specific club, not the chit system in general. Just like any market driven currency, the chits have value because the market says they have value.

Casey goes on to make much ado about GoldMoney, which he claims meets all the same functional requirements as Bitcoins. I disagree. GoldMoney, like e-gold, has a central point of control that can be corrupted or shut down. The gold holdings can be confiscated and the gold transactions are not anonymous. Bitcoins have no central control and are virtually impossible to shut down in the same way BitTorrents are virtually impossible to shut down. Further, Bitcoin wallets can be encrypted, duplicated, and hidden to the point where they are virtually impossible to confiscate. Further, GoldMoney doesn’t actlike a currency in the fact that you can’t directly send your gold holdings to a retailer for goods.

In summary, Casey’s arguments against Bitcoin are weak or misleading. His arguments, in many respects, can be applied to gold as well. Casey should rethink his logic before making public pronouncements about the efficacy of Bitcoins as a currency.

Disclosure:

I hold Bitcoins as well as silver. My silver holdings currently outweigh my Bitcoin holdings by a large margin, so in theory I’m shooting myself in the foot with my silver holdings by writing this. I personally think there is room for both Bitcoins and metals in this world. I foresee a day when metals are used like cash for physical transactions and Bitcoins (or another market driven electronic currency like it) are used like check-cards for electronic purchases, with currency exchanges facilitating conversion between the two.

Related articles:

How To Use Bitcoin – The Most Important Creation In The History Of Man

Libertarian Goldbugs Hating On Bitcoin – Free Market Money

The Economics Of Bitcoin – Why Mainstream Economists Lie About Deflation

The Economics Of Bitcoin – How Bitcoins Act As Money

Against The Gold Standard

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The Ridiculousness Of Demanding Government Return To A Gold Standard

By Michael Suede

June 28, 2011

Why in the world are libertarians running around demanding government return to a gold standard?  I have a couple of questions for libertarian goldbugs in the Ron Paul camp.

1.  What possible motivations would government ever have for doing so?

2.  What makes anarchists think the government would ever listen to their pleas?

The answer to the first question is obvious – it has none; therefore, it will never return to a 100% reserve gold standard.  It will simply never happen.  No amount of protesting, cajoling, rioting, etc.. etc.. will ever make the government return to a gold standard.  Historically speaking, a return to gold is only precipitated by the total destruction of the preceding fiat monetary system.  Markets can force a return to gold, but government never willingly returns to a gold standard of its own accord.

The second question is really why I’m writing this article.

By now it should be obvious to everyone, even to people who aren’t libertarians, that government never does anything that is in the best interest of the public at large.  It only serves selective special interest groups that are composed of various voting blocks.

For example, social security is robbing the youth of the nation blind while funneling all of the stolen booty into the pockets of old  people who happen make up the richest age demographic in the nation.  Social security doesn’t help the old and young, it only helps the old at the expense of the young.  Old people vote more often than young people so they constitute a special group of people that government looters pay attention to.

Since a government mandated return to a gold standard would “injure” more special interest groups than it would serve by way of providing a stable medium of exchange, is it not simply a massive waste of time and resources trying to get the government to institute a gold standard?

Let me put this another way – Is not demanding that congress abolish the Fed and return to gold the same as demanding that the Bonnano family abolish the Italian Mafia?

Could it happen?  I suppose it could happen; in the same way I could win the mega-bucks lotto.

Given that I feel the above facts are indeed facts and not opinions, it would seem to me that the proper way for libertarians to go about bringing a return to sound money is to simply start transacting in one.  If all the libertarians (which I figure make up around 10% of the US population) simply decided that they are going to start using and accepting gold as a currency in their daily transactions, it would rapidly undermine the official fraudulent currency.

This solution seems obvious to me, so why aren’t the goldbugs doing this?

What’s that?

Did I just hear you say that people have tried to create their own gold backed currency, like the Liberty Dollar, which resulted in them being attacked and looted by the Feds?

Did I just hear you say that gold is simply too difficult to use a direct medium of exchange because you can’t physically divide it up as you stand in line at the checkout counter?

Did I just hear you say that you can’t use gold for internet transactions because you can’t shove gold down an internet cable?

Did I just hear you say that as soon as you start representing gold with tokens or paper that those things suddenly become the target of counterfeiting, fraud, and a plethora of government regulatory attacks because they fall under Federal Securities regulations?

Did I just hear you say that gold backed private currencies constitute a centralized issuing authority that can be arbitrarily shut down by government or that the private issuing body could issue more notes than they actually have in specie?

Of course, you are absolutely correct on all counts, which is why people aren’t transacting in private gold backed currencies today.  I have to thank you, because you just made all of my arguments against the gold standard for me.

Hmmmmm…… so what is a libertarian to do?  I think most libertarians have come to accept the reality that laws do not actually solve any given problem within a society.  At best, they simply act as a band-aid or punishment to deter crime.  Murder laws do not solve the problem of murder.  Rape laws do not solve the problem of rape.  And government currency laws don’t actually help make the general population richer.

Only the industrious use of technology can actually solve complex social problems.  It is for this reason that one must remain open and alert for new technologies that can address the issues with gold that you just laid out for us.

It has really struck me that while libertarians make much hullabaloo about returning to a gold standard, they aren’t really interested in returning to a market driven gold standard.  They are only really concerned with with returning to a government mandated or granted gold standard, which is an utter pipe-dream.

Running around stamping your feet demanding government return to a gold standard or that government allow private mints to issue their own private currency is like demanding the mob stop robbing people.  IT WILL NEVER HAPPEN. There is only one way to affect the social change you desire, and that is by finding a way to address the issues that are preventing gold’s use as a private barter currency today through technological innovations.

What if I told you a global decentralized currency exists today that is not subject to any of the above burdens, while still retaining all of the monetary properties of gold?  Would you be interested in learning more about this currency – or would you dismiss it out of hand because it’s simply not gold?

Didn’t you just finish dismissing the gold standard in the above arguments?  I just can’t win with you people!

The reality is gold can not become a currency of the resistance.  It just can’t.  It is too difficult to spend, too easy to confiscate, and too easy to control.  The only way to undermine the current tyrannical regime is to create a currency that is better than gold.  The only way to topple the regime is by taking its ability to confiscate resources away from it through technological innovation.  Only through technological innovations that eliminate the problems with a gold backed currency can real change be effected.

Most importantly, libertarians must accept that gold is flawed.  They have to look at the arguments laid out above and really digest the fact that gold just isn’t going to cut it.  They have to acknowledge that the physical limitations of gold combined with the violence of the State act in concert with each other to prevent its return to the markets.

There is only one currency in existence today that evades all of the problems with gold while retaining all of the benefits of a commodity currency – and that currency is Bitcoins.

Let us not forget that we should ultimately not want a commodity backed currency, we should want a commodity to be the currency itself. Backing a currency implies that some issuing body is responsible for auditing the issue of whatever is representing the underlying commodity.  History has taught us this way of thinking is folly.

So this is my plea to you, my dear voluntarists, stop demanding government effect change through laws and start effecting change on your own by seeking out technological innovations that undermine the State’s ability to rob people.

I’m not going to proclaim that Bitcoins are the panacea to the problems of gold, but I am going to proclaim that if it is not Bitcoins, then it is another flavor of electronic currency that operates on the exact same principles as Bitcoin.  Only a decentralized,  peer-to-peer, unreproducible, anonymous, and secure electronic commodity can solve the problems that gold fails to address.

Related articles:

The Economics Of Bitcoin – Doug Casey Gets It Wrong

How To Use Bitcoin – The Most Important Creation In The History Of Man

Libertarian Goldbugs Hating On Bitcoin – Free Market Money

The Economics Of Bitcoin – Why Mainstream Economists Lie About Deflation

The Economics Of Bitcoin – How Bitcoins Act As Money

Against The Gold Standard

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Man From The Future Shares His Story

By Michael Suede

Posted June 29, 2011

MS:  Today I’m speaking with Dr. Hannes Alfven of the Tesla Electric Power Collective.  Dr. Alfven joins us from the future to discuss events that will soon be unfolding in our time.  Dr. Alfven please introduce us to yourself.

HA:  I’m a plasma physicist from the year 2090.  I have a doctorate in electrical engineering from Intel University.  I did my undergrad at the Tesla Electric Power Collective.  Currently I’m employed with Tesla Electric working on the development of teleportation devices, which is how I came to be speaking with you today.

MS:  Thanks for taking the time to speak with us today Doctor.  I noticed you mentioned you got your doctorate from Intel, is that the same Intel chip manufacturing company that is around today?

HA:  Indeed it is.

MS:  That seems so incredibly odd to me.  Why did Intel decide to open a college?  Were they having trouble finding qualified applicants?

HA:   Well, after the State was eliminated, private industry was forced to pick up the tab for educating their own employees.  A lot of the major high tech manufacturing organizations opened up educational facilities on their campuses to train their own workforce.

MS:  Wait a minute, back up.  Did you just say the State was eliminated?  How in the world did that happen?

HA:  In a few years from the present time, the current Anglo-European monetary empire will come to an end as the debt Ponzi comes unraveled.  The States ended up trying to print their way out of the Ponzi fractional reserve debt scheme they had created and wound up destroying the value of their money.  When they could no longer pay their bureaucrats, police forces and armies with money that had value, they collapsed.

As the fiat money of the world was devalued into worthlessness, people began looking for alternative currencies that could retain their value.  The electronic currency that was struck upon by the markets was called Bitcoins.  Basically they act like a digital commodity; so in the future, monetary transactions are conducted using what you might call “virtual gold”.

MS:  So why didn’t the populations of the world simply reconstitute new States that operated under this new monetary system?

HA:  Well, you can’t loot other people’s Bitcoins.  This makes it impossible to have a coercively funded State government.   What ended up happening was people became responsible for their own security and subscribing to their own “public” services.

So there are no police, only private security guards.  There are no “laws” per se, but most people deal with trade disputes through private “loser pays” arbitration courts.  So contracts between organizations and people define what the “law” is.   Murder, rape, and other violent crimes are basically non-existent, but when they do occur, communities typically ensure justice is swiftly dealt.   You might call it vigilantism by community consensus.   People don’t take very kindly to murders, thieves, and rapists in their neighborhoods if you catch my drift.  Since everyone is usually armed, robbing or hurting someone typically winds up like a gun store robbery today.  The person attempting the crime gets gunned down rather swiftly or driven out of town by private security.  Lord help them if they kill someone.

Private insurance companies basically deal with private property protection in the future, just as they do today.  So most people subscribe to an insurance contract which indirectly funds their local security and fire\emergency protection services.  Engaging in a crime voids your insurance protections, which typically doesn’t end well for the criminal.

MS:  Fascinating.  And the public is fine with this?

HA:  For the most part.  Since victims don’t like paying to put their assailants behind bars, the prison industry evaporated.  This left justice to be dealt with at the individual and neighborhood level.  It is important to note that reputation plays a massive role in your future society.

People don’t rob or harm others because a bad reputation can force you into total poverty.  If you become notorious, you’ll end up either getting hunted down and shot, or people will refuse to do business with you, which means you will typically end up starving to death.  A bad reputation can be more brutal than a life sentence in a prison today.

MS:  So Doctor, tell me more about this monetary system that makes it impossible to have a State.

HA:  The monetary system is an encrypted peer-to-peer electronic currency with a distributed transaction database.  Basically it is a system of encrypted tokens that are used as money.  The tokens can’t be reproduced or inflated, but they can be infinitely divided.  Because there is no central authority that can issue the coins, and because new coins can not be arbitrarily created, fractional reserve banking is impossible and the coins constantly gain value as the economic productivity of the world expands.

In my time, a full Bitcoin can buy you nearly an entire city block worth of property and merchandise.  Today the currency is still in its infancy, but its value will grow exponentially over time until all the goods and services that exist on the planet Earth are represented by the currency.  People also use gold and silver as cash substitutes or as a secure store of wealth, but the vast majority of retail transactions take place in Bitcoins because they are much easier to work with than physical metals.

MS:  Wow, that is incredible.  So what does the future look like  for us in the short term and the long term?

HA:  Well let me start off with the good news first:

Since there are no violently funded States to squander wealth in the future, global productivity in my time is so incredibly high that most people only work a few hours a week.  All of humanity’s energies are directed into private markets that serve consumer interests.  For example, since there are no shipyards building aircraft carriers for State governments, those same ship yards are now building cruise liners for the public.  With the State out of the way, people were forced once again to only produce things that individual consumers actually desire.  Obviously it goes without saying that there are no wars or military dictatorships since they can’t exist without the ability to steal wealth from the public.

The defense industry was wiped out when the States of the world collapsed, which also freed up an absolutely tremendous amount of resources for the production of consumer goods.  Raytheon is now the number one producer of plasma convection ovens in the world.  McDonald Douglas went out of business and was folded into General Electric.  Their old plants are now producing personal flying vehicles for the public.  They actually use TEPC’s plasmERG engines that I helped refine.

Consider that all of the hundreds of millions of men and women who work for military organizations, prisons, bureaucracies, defense industries, intelligence agencies, etc.. etc.. in your time today will be released into the private sector in the future.  This massive addition of highly skilled and motivated labor to the private markets drastically increased global productivity.

In your time today, the workforce of the United States is only devoting about 60% of its energies into private consumer markets, with the other 40% being controlled by State spending.  That will ultimately change to a 100% consumer market driven economy.

The elimination of centrally planned interest rates with the implosion of the central banks also drastically reduced the misallocation of resources within the private sector.  So really, the economy you are experiencing today is only a fraction of its real potential to produce wealth and an abundance of consumer goods for the masses.  In the future, following the elimination of the State, the full potential of the economy to produce wealth will be realized.

I suppose I should now move on to the bad news:

In the near term, many people will end up starving to death.  There will be massive political upheavals.  There will be much weeping and gnashing of teeth as the violent system of State sanctioned looting comes to an end.  Many of the people who have become dependent upon the redistributed stolen wealth of the State will engage in violence to protect their paychecks and handouts.  It will not be a pleasant experience.

When States hyper-inflate their currency, what they are really doing is transferring the ownership of wealth within a society to those who get the new money first.  Since printing money doesn’t actually create new wealth, all it does is change who can buy what little remains within the economy.

A State undergoing a hyper-inflationary scenario can expect that common consumer goods, food stuffs, and energy costs will skyrocket since they are necessities that everyone must purchase.  This state of affairs will continue until the money finally becomes totally worthless.  At which point society will devolve back into a barter existence like they did during the dark ages.

This is why the dark ages followed the collapse of the Roman empire, and so too will the people of the world experience a similar “dark ages” today.  However, the dark ages that will soon befall you will not last very long at all.  If you are young, you will live to see an age of prosperity emerge from the ruins of civilization.

So take heart, unless you are old and poor.  In which case you are basically SOL.  I’m sorry to inform you, but your governments already spent the money they promised they were saving for your retirement.  It doesn’t exist, and you’re not going to get any of it.  If you do get any of it, it will be in an amount that will not buy you a loaf of bread.

MS:  That is a lot for me to digest Dr. Alfven.  I’m curious about the plasmERG engine you mentioned earlier.  Could you tell us more about what future products await us?

HA:  Certainly.  The PlasmERG engine uses expanding plasma to drive pistons in the same way a combustion engine does, but it does so using a very tiny fraction of noble gases which cost virtually nothing to produce.  This is just one of many technologies that will explode on to the market in the wake of the State collapsing.

You see, a tremendous amount of innovation is stifled by patents and copyright law.  When the State collapses, people will be free to produce whatever they like by copying others.  When people are free to copy the ideas of others, it means the economy can produce more things more rapidly.

Competition will become very fierce and trade secrets will become tightly guarded.  Those who are first to market with a new idea stand to make a tremendous amount of money, which is reward enough for those who innovate.   In the future, the ability to take others’ ideas and improve upon them will become central to building a prosperous society.  It is a backwards archaic notion to think that inventors need State protection in order to come up with new ideas.  Consider that patent law is intentionally designed to create monopolies which harm consumers.

Also, an absolutely enormous amount of waste comes from the legal battles that revolve around patent laws.  With the elimination of patent laws in the future, companies will not have to worry about defending themselves from lawsuits, which means they can take that money and put it towards building better products.

MS:  Thank you Dr. Alfven for your time today.  I look forward to meeting with you again in the future! (LOL).

HA:  My pleasure Michael.

I plan on bringing Dr. Alfven back for continuous series of interviews.  Consider this part 1.

Additional reading:

If you would like more insights about the future, check out Jeffery Tucker’s work It’s a Jetsons World.  The book is free in pdf format and covers issues such as patent laws stifling growth, the miracle of free market productivity, and why the State destroys abundance.

Some lectures by economists that touch on the topics this article covers:

How Government is Unraveling Civilization by Force - Jeffrey Tucker

A Private Law Society - Hans Hoppe

Austrian Theory of the Trade Cycle - Roger W. Garrison

The Evils of Intellectual Property - Jeffrey A. Tucker

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The Economics Of Bitcoin – Resource Allocation And Interest Rate Distortion

By Michael Suede

Posted July 6, 2011

This article is in response to claims by inflationistas that Bitcoin isn’t a viable currency because the supply of coins does not inflate to counter-act deflation.

Their arguments against my previous article on this subject are as follows:

• Big building projects are FINANCED, that means borrowed money.  So the exact opposite of what you’re saying is true.  It’s deflation that hurts the business paying back the loan for the large projects.  Inflation helps the borrowing business.  As someone already pointed out, inflation/deflation arguments based on a debt are a wash. If you are stuck in such a stage where the loan amount has got the bailiffs knocking at your front door, look for an individual voluntary arrangement to stop such acts from the financial institution.
• Remember that money itself isn’t intrinsicly worth anything, it’s just a way of allocating resources. So someone that stuffs $1 million under the mattress for future use actually benefits the ecomomy far less than someone that goes $1 million into debt in order to start up a new business. Now, what you were saying would be true if savings worked the same way in a deflationary economy as in an inflationary one with the money saved being loaned out through fractional reserve banking, but they won’t – that’s why savers can benefit even though it harms debtors.
• You talk about productivity gains, but so far they’ve mostly happened through decreases in the amount of labour required to manufacture items; the raw materials and capital costs have remained substantial and often even increased. This means that wages have generally decreased far faster than the costs of items have – this is a problem even without deflation. So an increasing amount of the cost of goods and services is going to a handful of very wealthy individuals that control the resources required to produce them. While we might end up with ridiculous amounts of abundance, the vast majority of the population isn’t going to see it. What’s more, the gains don’t happen evenly: the cost of producing shiny technological items has decreased massively, but the cost of essentials like food and homes hasn’t.

The first question I have for the inflationistas is, who is to decide who gets the new funny money if Bitcoin was to be arbitrarily inflated?

Say we are to have an inflationary Bitcoin currency that is arbitrarily printed up at a rate that exactly matches price deflation (which is an impossibility, but lets say its possible to code such a mechanism).

Should the miners get it?

If the system was changed to grant miners additional coins based on CPI price levels, does that not artificially give miners control over more resources than they otherwise would have?  Money controls resources.

Those who get the new money first get the most benefit.  This is because they get it before it has circulated in the economy and driven up prices.  This is why countries who engage in money printing have highly stratified wealth distribution.  Typically bankers and bureaucrats benefit from printed money the most under fiat fractional reserve systems because they are at the top of the money spigot.  Under our current system, those who use debt leverage the most ultimately derive the most benefits.

Again, it is not “a wash” when comparing the benefits and detriments to savers and debtors.  It is not a wash because funny money distorts the structure of production.  This should be plainly evident from the preceding paragraph.  Funny money distorts interest rates, which alters not only who controls resources within an economy but also what an economy produces.  Here is an entire lecture by Prof. Roger Garrison that explains exactly how printing money causes detrimental distortions in the structure of production.

When interest rates are artificially low, long term interest rate sensitive projects that normally would NOT be undertaken due to interest rate costs suddenly look like viable projects.  This is how bubbles get formed.  When rates are low, housing looks like a great deal.  Everyone can suddenly afford half million dollar homes because they figure they can make the payments on 4% mortgage.  If rates were at their market set levels, those same people would not be looking to purchase a new home because they know they would never be able to make the payments at a 15% rate.

So the economy moves to produce many new homes when rates are artificially low, but since the productive capacity of the economy is finite, some other area of the economy must suffer in order to meet the demand for new home construction.  The economy can not make the same level of consumer goods if housing production expands.  People and resources must be diverted from consumer goods production into housing production in order to meet the demands of new home construction that is inspired by the artificially low interest rates.

This bubble will last until the market realizes that there are so many new homes on the market that the people who speculatively bought in the hopes of making money on asset appreciation can’t unload their homes at prices higher than they bought them for.  At this point home prices plunge as the speculators move out of the market and dump all the houses they have been holding.  Eventually a point will be reached where people are so in debt that they can’t afford to take out more debt even if the banks have an unlimited funny money reserve pool to lend from.

Additionally, we must consider where the consumer goods end up coming from if the economy decides to focus on housing production to the detriment of consumer goods production.  Here’s a very brief article that covers what happens to the flow of investment dollars as low interest rates divert resources within the economy.  Economist Robert Murphy writes:

So if the Fed fuels an artificial boom, such that assets prices in the US are rising, then foreigners want to get a piece of the action. On net they want to buy more US assets, than Americans want to buy of foreign assets. The only way that is possible is if the US runs a current account deficit. Intuitively, as US stocks, real estate, etc. are booming in market value, Americans are willing to sell off more of them (in absolute dollars) and use the proceeds to import more TVs, cars, and other goodies from foreigners as payment.

But setting that aside, let me get back to the problem of finite productive capacity.  Printing new money never creates more goods and services within an economy.  PRINTING MONEY ONLY CHANGES WHO CONTROLS RESOURCES AND WHAT AN ECONOMY DECIDES TO PRODUCE WITH THOSE RESOURCES.  If the government prints up a trillion dollars to buy 10 new aircraft carriers, it is the same as if the government robbed the private sector of all the steel and manpower that those carriers require.  If those productive resources are diverted into carrier production because the government printed money, that means they are not available for the private sector to utilize in car or computer production (or any other productive enterprise that meets consumer demand.)

A quick demonstration of why printing money does not create more wealth.

Say we have an economy that normally produces goods and services in the following ratios:

Will printing money change the size of the pie or will it simply change the ratios?  What the Keynesian nut jobs argue is that printing money actually causes the pie to expand because the new money will somehow put more resources to work.

What actually happens is quite different.  It should be obvious to anyone with a brain that printing money will not make a country richer (more abundant goods and services.)  It can only change who controls already existing goods and services.

I already covered why printing money distorts interest rates, which in turn, effects the structure of production.  So what you end up with is something that looks like this:

In the process of altering the structure of production through the lowering of interest rates, unemployment will INCREASE from this.  As we can see, as housing expands, consumer goods manufacturing decreases.  The people who previously worked in consumer goods are diverted into housing production, and in the interim, will be unemployed.  Also, since a bubble in housing has been created, when it finally bursts it will create massive unemployment.  This is because while the diversion into housing production was a slow process, the unwinding of the bubble is a fast process, which creates a tidal wave of unemployment once it finally bursts.

This is why in a comparison of unemployment rates, it appears as if unemployment is lower during the run up to a bubble bursting.  The truth is unemployment is exacerbated at both ends, marginally while going up and tremendously when coming down.

In order to actually grow the pie, the economy has to undergo an increase in productive capacity.  These increases in productive capacity can’t come about through wealth redistribution (inflation), they can only occur either by an increase in production efficiency or by more workers and resources becoming available to the entire economy.

If we add more workers and discover more physical resources, like mines, oil wells, fusion power, etc.. we can have an expansion of the pie that looks like this:

The increase of real wealth within a society can only occur by an expansion of the pie.  Printing money does not expand the pie, it can only shift around what is produced within the pie.

I could go on and on with examples of why printing money never produces more economic prosperity.  It necessarily can not do that because money isn’t something that can magically create resources where none existed before.  It is simply a resource allocation mechanism.

Related articles:

The Economics Of Bitcoin – Doug Casey Gets It Wrong

How To Use Bitcoin – The Most Important Creation In The History Of Man

Libertarian Goldbugs Hating On Bitcoin – Free Market Money

The Economics Of Bitcoin – Why Mainstream Economists Lie About Deflation

The Economics Of Bitcoin – How Bitcoins Act As Money

Against The Gold Standard

The Ridiculousness Of Demanding Government Return To A Gold Standard

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The Economics Of Bitcoin – Challenging Mises’ Regression Theorem

By Michael Suede 

Posted July 7, 2011

There has been a lot of outcry from the libertarian gold bug community over the Bitcoin monetary system, with some commentators even going so far as to produce feature length videos decrying the monetary system.  David Kramer writes on Lew Rockwell.com:

What was Bitcoin’s prior material use/value? Zero. It is just bits in a computer. And what’s with the “fixed” amount of Bitcoins? Who/what determined the “proper” amount of 21 million for Bitcoins to top out at? A computer program? (Next we’ll find out what the proper minimum wage should be.) Only the free market can voluntarily determine how much of a real medium of exchange is needed in the marketplace over time. While the idea of  attempting to get rid of the Bankster monopoly on creating money out of thin air is commendable, Bitcoin is also money created out of thin air. Bitcoin is just substituting one bogus medium of exchange for another.

UPDATE: I’ve been getting a lot of reader response trying to “explain” to me the economic virtues of Bitcoin. Some responders have even mistakenly used Austrian economics to rationalize their views. I would suggest that before you write to me about the Austrian economics view of a medium of exchange, you should read the two books by one of the two giants of Austrian economics, Murray Rothbard, on what a medium of exchange is.

Doug Casey also chimed in with the following commentary:

L: Do they have value in themselves?

Doug: There’s the rub; I don’t see that they do. Bitcoins are just an electronic abstraction. They can’t be used for anything else, nor are they made of something that can be used for anything else. They are like one of those knots in a string that disappear if you pull hard enough on the ends of the string. They are not backed by anything at all. Like government fiat currencies, they are a con game, functioning only as long as people have confidence in them, regardless of whether that confidence is well placed or not.

The arguments made by Casey, Kramer, and Nielsio are typical of the gold bug community, and I present them to you so that you may judge for yourself which set of logical arguments is superior.  Judging by the ratings of the Nielsio videos, I think the public agrees with my position that not only are Bitcoins a legitimate money, but they are in fact superior to gold as a medium of exchange.

There is a lot of disdain for Bitcoins by the Austrian gold bugs for a few reasons.  The primary reason is that, well,  they are all holding gold!  It stands to reason that they don’t like potential threats to their investment holdings.  Another primary reason, which all of the above authors allude to, is that Bitcoins challenge the Misesian Regression Theorem of Money, which states:

…because of Menger’s explanation of the origin of money. We can trace the purchasing power of money back through time, until we reach the point at which people first emerged from a state of barter. And at that point, the purchasing power of the money commodity can be explained in just the same way that the exchange value of any commodity is explained. People valued gold for its own sake before it became a money, and thus a satisfactory theory of the current market value of gold must trace back its development until the point when gold was not a medium of exchange.

I’m going to come right out and say it – Mises was wrong.

the crowd wails Boo!  Hiss!  Heretic!  

I’ll explain why I think the whole basis for this approach to the origin of money is wrong in a moment, but first I will present you with an argument that attempts to demonstrate why Bitcoins do not violate Mises’ Regression Theorem.  Therefore, even if you don’t agree with my theory, you can clearly see that powerful arguments exist within the Misesian framework which demonstrates why the gold bugs are wrong in their interpretation of the Regression Theorem.  In this absolutely brilliant analysis on the Bitcoin forums, XC writes:

The Money Regression and Emergence of Money from the Barter Economy The entire purpose of the regression theorem was to help explain an apparent paradox of money: how does money have value as a medium of exchange if it is valued because it serves as a medium of exchange?  Menger and Mises helped break this apparent circularity by explaining the essential time component missing from the phrasing of the paradox.

As Rothbard explains in Man, Economy, and State (p 270),

“…a money price at the end of day X is determined by the marginal utilities of money and the good as they existed at the beginning of day X. But the marginal utility of money is based, as we have seen above, on a previously existing array of money prices. Money is demanded and considered useful because of its already existing money prices. Therefore, the price of a good on day X is determined by the marginal utility of the good on day X and the marginal utility of money on day X, which last in turn depends on the prices of goods on day X – 1. The economic analysis of money prices is therefore not circular. If prices today depend on the marginal utility of money today, the latter is dependent on money prices yesterday.” [all emphasis added]

Rothbard then goes on to explain that in order for money to emerge from a barter economy, it must have a preexisting commodity value.  This commodity value arises from barter demand for the potential money in direct consumption (i.e. ornamentation).  This value seeds future estimations of the value of the money as a medium of exchange.  The natural market emergence of money is thus fully explained.

The Monetary Economy However, once an economy has been monetized and a memory of price ratios for goods and services has been established, a money may lose its direct commodity value and still be used as a money (medium of indirect exchange).  Rothbard explains (p 275):

“On the other hand, it does not follow from this analysis that if an extant money were to lose its direct uses, it could no longer be used as money. Thus, if gold, after being established as money, were suddenly to lose its value in ornaments or industrial uses, it would not necessarily lose its character as a money. Once a medium of exchange has been established as a money, money prices continue to be set. If on day X gold loses its direct uses, there will still be previously existing money prices that had been established on day X – 1, and these prices form the basis for the marginal utility of gold on day X. Similarly, the money prices thereby determined on day X form the basis for the marginal utility of money on day X + 1. From X on, gold could be demanded for its exchange value alone, and not at all for its direct use. Therefore, while it is absolutely necessary that a money originate as a commodity with direct uses, it is not absolutely necessary that the direct uses continue after the money has been established.”

This explains the history of fiat currencies.  They originally started off as simple names for weights of commodity money (silver) that developed out of the pre-monetary barter economy.  Despite later losing their ties to direct commodity value through state interference, paper currency retained status as money because of memory of previous money prices.  This factor is so strong that the relationship between gold and the USD, for example, is somewhat inverted.  Gold no longer circulates as a common medium of exchange.   Prices are set in USD, not in gold.  Most individuals wishing to trade in gold do so based on their knowledge of USD/gold price ratios.  (“Hey, let me buy that $100 couch from you in gold?”  “Ok, USD/gold is $1000/oz. Give me 1/10oz of gold.”)  Legal tender laws, state taxation, and the entire financial regulatory environment maintain this inertia of USD prices and make it challenging to return to gold money directly, despite the destructive inflationary nature of fiat currencies.

The Emergence of the Bitcoin Economy The very first businesses in the Bitcoin economy were exchangers (NewLibertyStandard, BitcoinMarket, BitcoinExchange,….).  This is not an accident, but flows from the analysis above.  In order for Bitcoins to serve as a medium of exchange without commodity value for uses besides indirect exchange, there must be a translated knowledge of money prices.  Market exchangers fill this gap and give Bitcoin users access to this knowledge.  Bitcoins may therefore currently serve as a money intermediary for paypal dollars\pecunix\euros.  But why is there demand for Bitcoin over USD??  This is a subjective valuation arising from properties such as anonymity, decentralized system of clearance, cryptographic trust, predetermined and defined rate of growth, built in deflation, divisibility, low transaction fees, etc…. inherent to the Bitcoin system.

The essential point is that once exchange can occur between a money (USD) and Bitcoins, providers of goods have a means by which to value Bitcoins as a potential medium of exchange.  The money regression is satisfied, because taken back far enough we reach traditional commodity money: BITCOINS -> USD -> MONETIZED GOLD & SILVER [start monetary economy] -> [end barter economy] COMMODITY GOLD & SILVER.

Of course, if a major meltdown occurred and knowledge of all price ratios was wiped out, Bitcoin probably would NOT directly emerge as a money (assuming Bitcoins have limited value outside of exchange).  Fiat currencies with zero direct barter value certainly would not.  Commodities such as gold and silver that have widely recognized direct value in barter would likely emerge first.  The economy would then be monetized with price ratios in gold and silver.  Bitcoins then, being valued for intrinsic properties amenable to exchange, might then become prevalent in trade.  Initially, creators of value would continue to make their price value ratios in terms of the true money (gold oz/BTC ratio), but with time Bitcoin prices (BTC) can emerge (see vekja.net as example).  We are in this initial phase now.

Therefore, so long as exchange of BTC and USD/Euros/etc… occurs, knowledge of existing price ratios can be utilized in the Bitcoin economy.  In time as Bitcoins become increasingly marketable, these fiat<->BTC price ratios will seed direct BTC price ratios.  The Bitcoin Economy thus emerges.  The Misean regression theorem is satisfied.

Now, to challenge the assertions of Mises, Rothbard, and XC, I will start by presenting a question:

If there were no money or money prices in existence today, could Bitcoins arise as a currency without a pre-existing dollar price framework?  

According to XC’s interpretation, this should not be possible.  Nor should it be possible under Rothbard or Mises’ interpretation.  However, I don’t see a conflict with Menger’s theorem about money arising from the saleability of a good.  If you carefully consider Menger’s proposal, you’ll find that a good does not have to have a pre-existing use in order to arise as a money.  The good simply has to be saleable.  Consider that a good could have absolutely no use except to act as a money.

Menger attempts to demonstrate that money arises from the market selecting the most saleable good as the preferred medium to facilitate indirect exchange.

…astute traders will begin to engage in indirect exchange. For example, the owner of a telescope who desires fish does not need to wait until he finds a fisherman who wants to look at the stars. Instead, the owner of the telescope can sell it to any person who wants to stargaze, so long as the goods offered for it would be more likely to tempt fishermen than the telescope.

Over time, Menger argued, the most saleable goods were desired by more and more traders because of this advantage. But as more people accepted these goods in exchange, the more saleable they became. Eventually, certain goods outstripped all others in this respect, and became universally accepted in exchange by the sellers of all other goods. At this point, money had emerged on the market.

A direct quotation of Menger on this subject:

Under such circumstances it became the leading idea in the minds of the more intelligent bargainers,and then, as the situation came to be more generally understood, in the mind of every one, that the stock of goods destined to be exchanged for other goods must in the first instance be laid out in precious metals, or must be converted into them, or had already supplied his wants in that direction. But in and by this function, the precious metals are already constituted generally current media of exchange. In other words, they hereby function as commodities for which every one seeks to exchange his market-goods, not, as a rule, in order to consumption but entirely because of their special saleableness, in the intention of exchanging them subsequently for other goods directly profitable to him. No accident, nor the consequence of state compulsion, nor voluntary convention of traders effected this. It was the just apprehending of their individual self-interest which brought it to pass, that all the more economically advanced nations accepted the precious metals as money as soon as a sufficient supply of them had been collected and introduced into commerce. The advance from less to more costly money-stuffs depends upon analogous causes.

This development was materially helped forward by the ratio of exchange between the precious metals and other commodities undergoing smaller fluctuations, more or less, than that existing between most other goods, — a stability which is due to the peculiar circumstances attending the production, consumption, and exchange of the precious metals, and is thus connected with the so-called intrinsic grounds determining their exchange value. It constitutes yet another reason why each man, in the first instance (i.e. till he invests in goods directly useful to him), should lay in his available exchange-stock in precious metals, or convert metals, and the consequent facility with which they can serve as res fungibiles in relations of obligation, have led to forms of contract by which traffic has been rendered more easy; this too has materially promoted the saleableness of the precious metals, and thereby their adoption as money. Finally the precious metals, in consequence of the peculiarity of their colour, their ring, and partly also their specific gravity, are with some practice not difficult to recognise, and through their taking a durable stamp can be easily controlled as to quality and weight; this too has materially contributed to raise their saleableness and to forward the adoption and diffusion of them as money.

Menger doesn’t delve to deeply into why the metals should be so saleable, but he does touch on it by making various points about their fungibility, divisibility, scarcity, and recognizability.  And here in lies the heart of my argument.

As Menger points out, people can perceive the benefits that arise from having a money product to facilitate trade and to act as a store of wealth.  In Murphy’s article he makes the argument that “there’s the unlikelihood that someone could have invented the idea of money without ever experiencing it”  – and I say this the same as saying “there’s the unlikelihood that someone could have invented phones without ever experiencing phone service”.

The market has a need for a trade intermediary and a store of wealth.  This need can easily be preceived by anyone who has ever tried to barter a product.   Of course the people will recognize that a form of money is important from the time the very first trading community of humans arose.

Saying that people couldn’t figure out money was necessary without ever experiencing it is ridiculous in my book.  Archaeology suggests that people were using trade intermediaries as far back into human history as we can possibly see.  Money arose across continents between people who had no interactions with each other independently across all of human civilization.

So, once we have a perceived need in a free market for a trade facilitator and a store of wealth, what should we expect the market to do?  We can expect it to try and find a solution to this problem!  Mises attempts to argue that the market solved this problem because people valued gold for its own sake before it became a money, and it was this value they had for gold in ornamental use that allowed it to become a money.

This is patently wrong.  Consider that as soon as the market perceives a need for money, it wouldn’t matter if gold had a pre-existing value in ornamental use or not, because it would suddenly have value as a trade intermediary as soon as the need for a trade intermediary entered the public consciousness.

The very act of humanity perceiving a need for a trade intermediary would imbue gold with value as a trade intermediary because of the specific money properties that gold has.  Even if gold was brutally ugly to look at and made for poor jewelry, the money properties of gold would give it market value as a trade facilitator.

Consider this example using silicon microchips.  If I was to go back in time to ancient Egypt and carried with me a pocket full of extremely expensive microchips, do you think I could trade them for some wheat?  Of course the answer would be no, because absolutely no one could perceive any possible use for those chips.  They would be worthless baubles to the Egyptians.  It is only after the perceived use for them becomes apparent that they would suddenly have value.

When people first perceived that a form of money was a valuable thing to have, the next thought that would have gone through their heads is – what makes a good money? 

Should the money be cocoa beans?  wheat?  gold? – what properties should a good have that make it a quality money?  People used all of those things as a “money” at some point in history.  Consider that the process of selecting and determining the best money does not require that an item have a pre-existing use!  Because the need for a money exists, any item that can meet that need will be valued for its own sake as a money product.  It doesn’t matter if gold is ugly or entirely useless for any other purpose because those other purposes have nothing to do with fulfilling the need for a money.

The properties that make for a quality money are easily recognizable by markets.  The qualities that make for a good money are fungibility, scarcity, divisibility, and recognizability.  Because gold is one of the most fungible, divisible, scarce, and recognizable metals that exists within our physical universe, it came to be selected as the best money.

So now we must get back to how prices arise based on the market selected money product.

Consider my original question; if there were no money or money prices in existence today, could Bitcoins arise as a currency without a pre-existing dollar price framework?  I would argue that prices in Bitcoins could be readily established by the markets simply by introducing Bitcoins to this state of barter.

Given our technology today, people could easily establish a few facts that are entirely independent of prices:

1.  The number of Bitcoins in existence

2.  The amount of work necessary to produce a Bitcoin

3.  The rate Bitcoins come into existence

4.  The number of Bitcoins that will ever come into existence

5.  The money properties of Bitcoin (ie. its fungibility, divisibility, scarcity, and recognizability)

From which people can automatically make generalized assumptions about the value each specific coin would have.

Merchants would see the value of Bitcoins as a money and agree to accept them in exchange for goods and services because of the inherent properties they have.  The merchants would be speculating on the value of the coins at first until prices were established, but eventually if enough people recognize the inherent value of the coins, prices will be established for all products and services in terms of those coins.

Consider if I walk into a cafe and I inform the owner as to the existence of Bitcoins and their properties.  So he agrees to sell me a cup of coffee for a Bitcoin.  As soon as he makes that agreement, we now have pricing in terms of coffee established.  Why would the owner agree to such a trade?  Because he sees the inherent value of the coins as trade intermediaries.  He can evaluate the fungibility, scarcity, divisibility, and recognizability of the coins instantly and establish a value of each coin for himself without having to reference any pre-existing prices for any other products.  To the cafe owner, he sees the value of the Bitcoin as being more than the cup of coffee, so he is willing to trade the coffee for the coin.  It might be that he wants two coins or ten coins for a cup of coffee, but the number of coins the owner agrees to doesn’t matter in terms of negotiating a price.  All that matters is that the cafe owner sees potential value in the coins as a money.

In the same way a painting may have tremendous value to an art aficionado, while having almost no value to anyone else, the aficionado makes the determination about how much value the painting has based on his own internal value scale.  He sees value in the painting for its own inherent properties.  He doesn’t have to reference the prices of any pre-existing paintings to make a valuation of a particular painting for himself.

If enough people agree to accept Bitcoins for various goods and services simply because they see the inherent value of the coins as trade intermediaries, a pricing system in terms of the coins will rapidly establish itself.

To some, like the Bitcoin detractors I noted at the top of the page, the coins would have no value at all.  While to many others, the coins would have a tremendous value.  It doesn’t matter if some people reject them as having value in order for a pricing system to establish itself.  It only matters that some people see the value in them in order for a pricing system to establish itself.

From this point the market will weed out which goods act as the best trade intermediaries.  Those goods which are the most  fungible, divisible, appropriately scarce, and recognizable, will become the most broadly accepted forms of money.  Like all market competition, there may exist pricing across a market in several goods at once.  I don’t see any reason why people would not or could not price their items in terms of gold and Bitcoins simultaneously.

So to sum up my arguments:

Pre-existing use is not necessary for a good to become a money.  It is not necessary because the markets are able to recognize the value of a good in terms of its use as a money based on the good’s properties of  fungibility, divisibility, scarcity, and recognizability.  Once the market recognizes the value of a potential money product for its own sake, people will be willing to trade goods and services for it.

Prices in terms of the new money product can be established without having to reference pre-existing use values, in the same way prices for fine works of art can be established without anyone having to reference pre-existing values for other works of art.  The value calculations are internal to each individual who is willing to accept the currency based on the properties of the currency being offered for trade.

I can demonstrate that a free market money exists which has absolutely no other use other than to act as a money.

The market has deemed this good to have value in-and-of-itself.

The market has determined prices for this good without the good having to be valued in some other capacity, other than to be a money.

There will come a time in the future when textbooks reference the “Suede Monetary Utility Theorem” .

Probably after I’m dead, since that seems to be the way of things.

Read Prof. George Selgin’s response to this article here.

Related articles:

The Economics Of Bitcoin – Doug Casey Gets It Wrong

How To Use Bitcoin – The Most Important Creation In The History Of Man

Libertarian Goldbugs Hating On Bitcoin – Free Market Money

The Economics Of Bitcoin – Why Mainstream Economists Lie About Deflation

The Economics Of Bitcoin – How Bitcoins Act As Money

Against The Gold Standard

The Ridiculousness Of Demanding Government Return To A Gold Standard

The Economics Of Bitcoin – Resource Allocation And Interest Rate Distortion

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How Private Are Bitcoin Transactions?

By Timothy Lee

Posted July 14, 2011

Tech

Former Contributor.

Forbes contributors publish independent expert analyses and insights.

I write about how technology shapes society

Jul 14, 2011, 09:31am EDT

Aug 09, 2011, 03:40pm EDT

This article is more than 10 years old.

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Are Bitcoin transactions really private? In an age of ubiquitous government surveillance and corporate information collection, the peer-to-peer currency’s boosters tout privacy as a major benefit. I’m not convinced.

Bitcoin’s peer-to-peer method for clearing payments means that the currency’s “books” are inherently open. Every transaction ever made using the currency is available for inspection using a tool like Bitcoin’s Block Explorer.

The privacy benefits come from the fact that you can create an unlimited number of anonymous Bitcoin identities. Block explorer tells me that someone sent 36953.2525 Bitcoins to the address 148X4kTYZhjeKQcd1AVhcytXvh5gL6FNSe. I don’t know who owns that address and there’s no central database where I can look it up. Nor is there a Bitcoin Inc. that could be compelled to create such a database. And this, Bitcoin enthusiasts say, give their currency a privacy edge over the US dollar.

But the fact that the database doesn’t exist doesn’t mean it couldn’t be created. Remember, people want money so they can buy stuff. There are a few goods and services, like pornography or consulting work, that can be delivered entirely over the Internet. But people mostly buy products that need to be physically delivered. An American who wants to deal primarily in Bitcoins will, at some point, need to either buy food and shelter in Bitcoins or convert some of their Bitcoins to dollars. And that means making Bitcoin payments to people in the US.

But the US government could easily require any business accepting Bitcoin payments (or converting Bitcoins to dollars) to collect identification information from their customers in the same way that “know your customer” regulations require financial institutions to collect information about their customers. And once the government has de-anonymized a significant fraction of the addresses on the network, they’ll be able to infer many of the others using basic detective work. Remember, the full pattern of transactions is a matter of public record. Officials trying to identify a particular address will have a complete record of every address that’s ever sent money to, or received money from, that address. If any of them are within the United States, they can be compelled to disclose details (IP addresses, shipping addresses, contact email address, etc) that could help identify the address’s owner.

Now this isn’t to say that a determined individual couldn’t use Bitcoin in a way that preserves his privacy. But it would either require a high level of technical savvy or significant lifestyle changes. He could avoid working for traditional US employers and buying things from mainstream US businesses. But most users just don’t care about privacy enough to make those kinds of major lifestyle changes to get it.

Another approach would be to use technical means to obfuscate the flow of funds to and from his accounts. He could route all Bitcoin traffic through an anonymization service like Tor. He could create a large number of decoy accounts and have different people pay different accounts. There could even be Bitcoin “money laundering” services that accept money from you and pay you back in another account. But few people have the patience or technical know-how to do this effectively.

Moreover, people willing to go to that much trouble can obtain roughly the same degree of financial privacy using dollars. Most obviously, you can conduct transactions in cash, which is inherently resistant to government surveillance. For remote transactions, there are any number of offshore intermediaries in Switzerland, the Cayman Islands, and elsewhere that have been helping privacy-conscious Americans stay beyond the long arm of the law for decades. And all of these transactions have an important advantage over Bitcoin: they don’t produce public entries in a global distributed database.

In other words, Bitcoin’s alleged privacy benefits mostly reflect the fact that the government isn’t really trying to spy on Bitcoin users. It hasn’t built the kind of surveillance infrastructure the government has for tracking dollar-denominated transactions. And to be clear, I would rather that infrastructure not exist. But if Bitcoin becomes popular, the government will build precisely the same infrastructure for spying on the Bitcoin network. And when they do, it will become clear that for ordinary users, Bitcoin is, if anything, less surveillance-resistent than traditional cash.

Update: For an opposing view, see Tom Lowenthal and my follow-up post.

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Why Do People Want A Gold Standard When History Shows Us It Does Not Last?

By Michael Suede

Posted December 1, 2011

It is curious to me that so many libertarians are dead set against any form of currency other than gold when history has made it abundantly clear that a gold standard can not be maintained.

Consider that as soon as gold is represented by paper (or digital account balances), all the checks against inflation of the money supply that gold provides are lost. In order to argue that gold can not be inflated, one must also argue that all transactions in the economy must take place using physical specie.

Clearly this presents a problem in our digital age. Imagine trying to buy something from Amazon.com. You would have to place an order, and then mail your gold bullion to the seller. There could literally be no digital accounts of gold at all if one wanted to ensure that the money supply could never be co-opted and inflated. Obviously this would require the imposition of State rules to prevent people from digitally representing gold for its use as a money.

Clearly in order for gold to function as a currency in our modern age, it must be represented either by paper or digital account. Which means it is ultimately of no more use in preventing inflation than if the government simply created rules today outlawing the inflation of dollars.

Inflation of the money supply under a gold standard is replete throughout history. The US banks did it, European banks did it, every one did it! In fact, fractional reserve banking itself is a direct by-product of the gold standard. The first instances of fractional reserve banking came into existence when banks began issuing more receipts for bullion than they actually had in reserve. Nothing physically prevented them from doing this. They might have to face market consequences for this fraud, but obviously it would be better if the monetary system simply prevented them from committing this fraud in the first place!

Really think about this for a minute. If the government made a law today that eliminated fractional reserve banking and froze the number of dollars in circulation at a fixed level, how would that be functionally any different than a gold standard? Would it even matter if those dollars were backed by gold or not if the money supply could not legally be inflated?

The arguments in favor of a gold standard all revolve around the idea that physical gold can not be “printed up”, which limits the ability of governments to inflate the money supply. But since all gold must ultimately be represented by paper in order to be useful as a money, obviously this undermines the check against inflation that gold brings to the table.

Another problem with paper representing gold is that paper is easily destroyed while gold is not. This represents an accounting problem for banks issuing the paper. If paper is destroyed, the gold that is represented by that paper still exists, but now that gold is in a state of limbo. There is simply no way for the bank to know with any certainty that the paper was really destroyed. Every bill that is lost puts the gold behind that bill permanently out of circulation (assuming the bank abides by standard accounting rules). In a large banking system, this dilemma represents a real problem.

I argue that what “backs money” is unimportant. What matters is that the units of account that people use can not be inflated. What matters is that I can not simply alter an account balance by plugging some numbers into a computer.

Fortunately for us today, such a currency exists. It is called Bitcoin. It is a decentralized peer-to-peer encrypted currency system that totally prevents arbitrary inflation of the units of account. With bitcoins, one can not simply increase an account balance of Bitcoins by arbitrarily entering some numbers into a computer. The actual currency itself is unreproducible.

In order to increase a Bitcoin account balance, the transaction must be validated against the entire peer-to-peer network. The entire network knows the account balance of every wallet in existence and it will refuse any changes that attempt to alter number of Bitcoins in existence. Bitcoin account balances simply can not be inflated.

This cryptographic method of approving transactions prevents arbitrary inflation of the money supply in a way a gold standard never could. It stops fractional reserve banking before it ever gets started. People don’t have to worry about banks defrauding them through fractional reserve banking under a Bitcoin standard because it literally can’t happen.

Further, the destruction of Bitcoins is of no consequence other than to the person whose coins were lost. This is because Bitcoins are basically infinitely divisible. So as coins are lost for various reasons, it will simply drive up the price of the remaining coins. No accounting issues are created by the destruction of the coins.

So to my libertarian brothers who think a gold standard will solve all our problems, I say you are leaving out the biggest problem of all! The fact that gold must be represented by paper for it to function as a currency in our modern economy! Do not forget about this issue or brush it aside. And do not dismiss crypto-currencies simply because they lack a gold backing.

Remember, the market should tell us what money is and what it is not. And the market has spoken. Bitcoins have value because the market says they have value. They are not imposed by government decree. They are not mandated by law. They have value purely because people can see the inherent value in a token exchange system that is decentralized and impossible to inflate.

Bitcoins are real market money for the digital age. They are the solution to the inflation of gold receipts by banks and governments. They solve the fraud problems that pervade all commodity representation systems.

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1. Satoshi claims that before he write the whitepaper, he wrote a prototype. ↩

2. I had a hard time figuring out when bit gold was first thought of; Szabo kindly blogged that he had written about it in 1998 on a private mailing list

   Here are some more specific reasons why the ideas behind Bitcoin were very far from obvious: (1) only a few people had read of the bit gold ideas, which although I came up with them in 1998 (at the same time and on the same private mailing list [libtech) where Dai was coming up with b-money—it’s a long story) were mostly not described in public until 2005, although various pieces of it I described earlier, for example the crucial Byzantine-replicated chain-of-signed-transactions part of it which I generalized into what I call secure property titles.

   ↩

3. Another person or group to ask this same question is Barber et al 2012 (although this essay was posted in early 2011, so Barber et al 2012 may not be entirely independent):

   Despite some pessimists’ critiques and disbelief, Bitcoin has admittedly witnessed enormous success since its invention. To the security and cryptographic community, the idea of digital currency or electronic cash is by no means new. As early as 1982, Chaum has outlined his blueprint of an anonymous e-cash scheme in his pioneering paper [10]. Ever since then, hundreds of academic papers have been published to improve the efficiency and security of e-cash constructions—to name a few, see [15, 8, 9]. Naturally, an interesting question arises: Despite three decades’ research on e-cash, why have e-cash schemes not taken off, while Bitcoin—a system designed and initially implemented possibly single-handedly by someone previously unknown, a system that uses no fancy cryptography, and is by no means perfect—has enjoyed a swift rise to success?

   …Bitcoin has a completely distributed architecture, without any single trusted entity. Bitcoin assumes that the majority of nodes in its network are honest, and resorts to a majority vote mechanism for double spending avoidance, and dispute resolution. In contrast, most e-cash schemes require a centralized bank who is trusted for purposes of e-cash issuance, and double-spending detection. This greatly appeals to individuals who wish for a freely-traded currency not in control by any governments, banks, or authorities—from libertarians to drug-dealers and other underground economy proponents

   …Incentives and economic system. Bitcoin’s eco-system is ingeniously designed, and ensures that users have economic incentives to participate. First, the generation of new bitcoins happens in a distributed fashion at a predictable rate: “bitcoin miners” solve computational puzzles to generate new bitcoins, and this process is closely coupled with the verification of previous transactions. At the same time, miners also get to collect optional transaction fees for their effort of vetting said transactions. This gives users clear economic incentives to invest spare computing cycles in the verification of Bitcoin transactions and the generation of new Bitcoins. At the time of writing the investment of a GPU to accelerate Bitcoin puzzle solution can pay for itself in ~6 months…the earlier in the game, the cheaper the coins minted.

   ↩

4. Although ironically, proof-of-work never seemed to go into widespread use because of general inertia and because to deter large amounts of spam, proof-of-work would also deter legitimate users under some models.

   Spam seems to have been kept in check by better filtering techniques (eg. Paul Graham’s “A Plan for Spam” using Bayesian spam filtering) and legal action against botnets & spammers. [^China]: For more on that history, see Wikipedia on Industrial Revolution#Causes in Europe, Chinese_industrialization#Reasons_for_the_delay_in_industrialization, the Great Divergence; I recommend Gregory Clark’s A Farewell to Alms. [^Laurie]: I am only a layman with an interest in cryptography, but I am not alone in seeing this lack of really novel primitives or ideas in the Bitcoin scheme; Ben Laurie expresses exactly this idea in an aside in a blog post attacking Bitcoin:

   A friend alerted to me to a sudden wave of excitement about Bitcoin. I have to ask: why? What has changed in the last 10 years to make this work when it didn’t in, say, 1999, when many other related systems (including one of my own) were causing similar excitement? Or in the 20 years since the wave before that, in 1990? As far as I can see, nothing. [^Palmer-Luckey]: “Voices From A Virtual Past: An oral history of a technology whose time has come again” (2014):

   Palmer Luckey: I spent a huge amount of time reading through basically every single published piece of literature on VR. I think that there were a lot of people that were giving VR too much credit, because they were working as VR researchers. You don’t want to publish a paper that says, “After the study, we came to the conclusion that VR is useless right now and that we should just not have a job for 20 years.” There were a few people that basically came to that conclusion. They said, “Current VR gear is low field of view, high lag, too expensive, too heavy, can’t be driven properly from consumer-grade computers, or even professional-grade computers.” It turned out that I wasn’t the first person to realize these problems. They’d been known for decades.

   Here’s a secret: the thing stopping people from making good VR and solving these problems was not technical. Someone could have built the Rift in mid-to-late 2007 for a few thousand dollars, and they could have built it in mid-2008 for about $500. It’s just nobody was paying attention to that.

   ↩

5. Recent criticism, too, sometimes focuses on the quality of the C++ codebase and ad hoc nature of many of the choices; from an anonymous Facebook comment:

   The protocol is not well-defined and clearly designed by an amateur (that is, not someone who has done much protocol implementation work). It’s a binary protocol with a smattering of length-prefixing, null terminated strings, etc. The messages look reasonable, just a horrible encoding. The rules of the protocol are poorly defined and tightly coupled to implementation; the implementation is done by someone who feels it’s good and well to have only 5 major source files for 17 KLOC. Due to lack of a well-specified protocol, there is also a bit of client monoculture going on.

   It’s worth noting that the whole system assumes SHA-256—the bitcoin community says that rolling over to something else is just a matter of introducing a new algo, but in actuality it’s not nearly that simple. The protocol has no concept of upgrading to different algos, so it would necessitate a complete overhaul of the protocol (since there’s a lot of 32-byte fields in there) AND a re-computation/rollover of the entire transaction history. …The protocol also has had no thought put into it re: network architecture—there are peers and that’s it. Due to the cryptographic nature of transactions, it’s simply not possible to have realtime transactions with bitcoin as the network scales (it already take 5–10 mins on average for the network to see a single transaction). Thus, there will need to be some concept of a node in the network that can facilitate interactions between two peers in a faster fashion, with the assumption of a measure of trust. You shouldn’t require it, of course, but it should be defined, I think.

   Security expert Dan Kaminsky is similarly appalled at the bandwidth requirements to scale (“:0” was his emoticon) and predicts that the Bitcoin network will eventually turn into a quasi-bank-like oligarchy of supernodes (which changes the system and “offers a host of ugly semantics” since the supernodes “don’t need 50%—just need to inconvenience 50% to accept your opinion”). He comments that while “Normal Code” seems good but “Scratch the surface, it’s actually really bad”, the Bitcoin codebase “Looks really bad up front” but “Scratch the surface, it’s actually surprisingly good”. The New Yorker article’s “The Crypto-currency: Bitcoin and its mysterious inventor”:

   “When I first looked at the code, I was sure I was going to be able to break it”, Kaminsky said, noting that the programming style was dense and inscrutable. “The way the whole thing was formatted was insane. Only the most paranoid, painstaking coder in the world could avoid making mistakes.”…He quickly identified nine ways to compromise the system…when he found the right spot, there was a message waiting for him. “Attack Removed”, it said. The same thing happened over and over, infuriating Kaminsky. “I came up with beautiful bugs”, he said. “But every time I went after the code there was a line that addressed the problem.”…“I’ve never seen anything like it”, Kaminsky said, still in awe…“Either there’s a team of people who worked on this”, Kaminsky said, “or this guy is a genius.”

   On a technical basis, he dislikes the use of SHA-256 as opposed to slower time-lock crypto functions like bcrypt, because SHA-256 “can be accelerated massively with GPUs” leading to GPU shortages and massive hashing disparities between peers, and his slides conclude “BitCoin is actually well designed, if you accept that anonymity and scaling forces the entire present model to be shifted into something that effectively looks like banking”. He reiterated his positive impression of Bitcoin in 2013—“But the core technology actually works, and has continued to work, to a degree not everyone predicted.”—and has begun to reconsider some of his earlier criticisms about the resource demands & gradual centralization of nodes. Another testimony to the protocol’s security comes from TechCrunch:

   While researching Bitcoin, Lemon’s Casares hired two separate teams of hackers to examine the Bitcoin source code for vulnerabilities for about a half-year. “They are arguably the best in the world. I spent a lot of time and money on the best hackers I could find and came back from that convinced that Bitcoin’s security is robust,” he said. “What they found was very, very compelling for me.”

   Bruce Schneier mentions offhandedly that “I haven’t analyzed the security, but what I have seen looks good.” [^Szabo]: Nick Szabo, discussing Chaumian ecash (“the greatest simple equation since $e=mc^2$”), comments with almost palpable distaste of a hypothetical system akin to Bitcoin in this respect:

   A use-once-address communications mix plus forswearing any reputation gain from keeping accounts, in theory also buys us unlinkability, but a communications mix [BTC: “mixing service”; not necessarily easy] is weak and very expensive.

   The most widely known, popular, and secure communications mix is probably Tor; a number of flaws have been found in it over time, and Tor will never be very secure—it’s fundamentally difficult to impossible to have a anonymizing communications mix which is also near real-time. Some flaws can’t be removed by the Tor network, like the ability of exit nodes to snoop on traffic (as has been done many times, most memorably during the startup of Wikileaks). Communications mixes are usually expensive in resources, so typically only make up a part of an overall network—and the rest of the network leaks considerable information, including in Bitcoin.

   These are not necessarily fatal objections from a practical point of view. A simple mix or laundry may well buy one all the anonymity one needs; they can be chained to substantially reduce risks; more elaborate and secure off-blockchain laundries can be constructed using secure multi-party computation; and finally, there is always the hope that someone will figure out how to build upon the existing pseudonymous Bitcoin system to enable genuinely anonymous and untraceable transactions (which may have been accomplished in 2013 with the proposed Zerocoin extension to the Bitcoin protocol). ↩

6. Perry Metzger summarizes Laurie’s approach:

   I think people have missed the more subtle point that Ben Laurie made here. Bitcoin requires the use of an unusual sort of secure consensus protocol to work reliably, and such protocols are not known to exist in this context. In the presence of such a protocol, however, there is no longer any need for mining—the system can simply elect a member to acquire a new coin every N seconds via a secure election protocol (and those are known given the rest). Thus, Ben’s point that if you’re going to have a system like bitcoin, one could at least have an efficient system of this sort rather than a stupid one based on an electrical potlatch.

   ↩

7. Zooko Wilcox O’Hearn, 5 April 2013 (in hidden comments):

   …I recall upon first hearing about Bitcoin, losing interest in it for precisely one of those “ugliness” issues that you cite: it depended on (what was described as) globally synchronized clocks, which I had a negative emotional reaction to. [^beauty]: Not everyone agrees with me or those initial posters, though; “Bitcoins create truly democratic policy, followers say”, Canada.com:

   “It’s like the Mona Lisa.” said Bruce Wagner, an IT consultant who discovered bitcoin in October and now hosts an online TV show about it. “It’s a masterpiece of technology.”

   From the New Yorker article:

   Haber is a director of the International Association for Cryptologic research and knew all about bitcoin. “Whoever did this had a deep understanding of cryptography”, Haber said when I called. “They’ve read the academic papers, they have a keen intelligence, and they’re combining the concepts in a genuinely new way.”

   “The Rise and Fall of Bitcoin”, Wired:

   But slowly, word of bitcoin spread beyond the insular world of cryptography. It has won accolades from some of digital currency’s greatest minds. Wei Dai, inventor of b-money, calls it “very significant”; Nick Szabo, who created bit gold, hails bitcoin as “a great contribution to the world”; and Hal Finney, the eminent cryptographer behind RPOW, says it’s “potentially world-changing.”…Stefan Brands, a former ecash consultant and digital currency pioneer, calls bitcoin “clever”…

   More recently, Wei Dai has said:

   …it involved major technical and conceptual/philosophical advances on the existing state of the art, and these advances didn’t originate from nor was likely funded/supported by academia, government or industry. Also, its social impact seems larger—if Craigslist or PayPal didn’t exist, something essentially identical would have been created very soon anyway, but if Bitcoin didn’t exist, another Bitcoin may not have been created for another decade, and/or may have been created with very different characteristics, for example it might have been coded with a monetary policy that emphasized price stability instead of a fixed supply of money. [^Szabo-power]: Computing power is useful because it’s impossible to fake: you either can regularly bruteforce a hash or you cannot, assuming the hash is still secure. But strictly speaking there are other possible unfakeable properties which future digital cryptographic currencies may use; Szabo lists 3 others:

   Canonically Byzantine agreement assumed each node had a secure true-name identity, but because privacy is a desiderata, and because it would be very difficult to implement such a secure identity system on the Internet, we have to use some characteristic of users provable within the Bitcoin or bit gold system to weigh Byzantine “votes”. I’ve now come up with a list of provable attributes in Bitcoin (or bit gold) by which message correctness “votes” might be weighed:

   • proof-of-work/mining effort (what Bitcoin currently does)
   • value or number of coins or solution bits owned by key
   • number or value of transactions as payor, payee, or both by a key
   • number or value of transactions weighted by how recent they are
   • various combinations of the above

   This is an incomplete list, especially if we add new attributes. One of the general ideas here is to weigh Byzantine “voting” towards those with more experience in the system, making a novel invasion more difficult. However in a currency there should also be a balance between various stakeholders (holders, creditors, and debtors). Since Bitcoin- or bit gold- denominated contracts generally exist outside the system, one would have to, at the very least, publicly register those contracts signed by the parties’ keys for creditor or debtor status to be provable.

   One proposed scheme for Bitcoin is Proof of Stake:

   With Proof of Work, the probability of mining a block depends on the work done by the miner (e.g. CPU/GPU cycles spent checking hashes). With Proof of Stake, the resource that’s compared is the amount of Bitcoin a miner holds—someone holding 1% of the Bitcoin can mine 1% of the “Proof of Stake blocks”….Each block must be signed by its miner using a single bitcoin account. The account used to sign a block must also be the recipient of txn fees and generation from this block. Blocks are mined by proof-of-work hashing as before, but with modified difficulty criteria. The difficulty criterion for block validity is modified as follows: Hash generates valid block if and only if

   Hash Difficulty >= Difficulty Target / ( max(Coin-confirmations used to sign block, 100 satoshi-confirmations) )^( p / (1-p))

   where 0 <= p < 1. Stake becomes more and more important as p approaches 1. p=0.8 is suggested as an appropriate choice. p=0 is identical to the current proof-of-work system. If the block is signed by a bitcoin account holding less than 100 satoshi-confirmations, this is treated as if the account held 100 satoshi-confirmations. Thus non-stakeholders are allowed to verify blocks, but relative to stakeholders they must meet extremely stringent difficulty criteria. Permitting non-stakeholders to verify blocks solves the initial distribution problem. As before the Difficulty Target is a periodically adjusted constant which is set to maintain a target generation rate of 1 block every 10 minutes. [^May]: Chaum pays a price for his systems’ ability to work offline / without directly processing transactions. Don’t take my word for it; see Tim May in section 12.6.6 of his early ’90s Cyphernomicon (not to be confused with Stephenson’s novel):

   …Chaum went to great lengths to develop system which preserve anonymity for single-spending instances, but which break anonymity and thus reveal identity for double-spending instances. I’m not sure what market forces caused him to think about this as being so important, but it creates many headaches. Besides being clumsy, it require physical ID, it invokes a legal system to try to collect from “double spenders”, and it admits the extremely serious breach of privacy by enabling stings. For example, Alice pays Bob a unit of money, then quickly Alice spends that money before Bob can…Bob is then revealed as a “double spender,” and his identity revealed to whomever wanted it…Alice, IRS, Gestapo, etc. A very broken idea. Acceptable mainly for small transactions.

   • Multi-spending vs. on-line clearing

     • I favor on-line clearing. Simply put: the first spending is the only spending. The guy who gets to the train locker where the cash is stored is the guy who gets it. This ensure that the burden of maintaining the secret is on the secret holder.
     • When Alice and Bob transfer money, Alice makes the transfer, Bob confirms it as valid (or verifies that his bank has received the deposit), and the transaction is complete.
     • With network speeds increasing dramatically, on-line clearing should be feasible for most transactions. Off-line systems may of course be useful, especially for small transactions, the ones now handled with coins and small bills.

   Further contemporary description can be found in a declassified June 1996 NSA review, “How to make a mint: the cryptography of anonymous electronic cash”. [^Laurie-2]: “Decentralised Currencies Are Probably Impossible: But Let’s At Least Make Them Efficient”, Ben Laurie:

   Now that we understand the core problem, namely that of agreement, we can quite easily understand Bitcoin’s solution to the problem. Bitcoin defines the consensus group as “all the computing power in existence”, and requires participants to prove their possession of whatever fraction of this power they care to spend on Bitcoin by using it to produce proof-of-work tokens. And once we state the problem like this, we can quite clearly see the flaw. Until at least half of the computing power in existence is actually used to produce Bitcoins, we cannot know that we have consensus! If, for example, 1% of the total power available^Strictly,\ I\ mean\ energy\ rather\ than\ power,\ since\ Bitcoin\ actually,\ in\ effect,\ sums\ power\ over\ time.^ is used to produce Bitcoins at present (in fact, the amount is far less than that), then at any point someone could come along with a further 1.1% of the total power and use this to define their own consensus^By\ forking\ history\ right\ back\ to\ the\ first\ block,\ and\ producing\ a\ hash\ chain\ that\ is\ longer\ than\ the\ current\ consensus.^, thus invalidating all the work, and all the money, of the initial group, and instead take possession of the entire currency for themselves.

   …Even worse, it is clear that arriving at the equilibrium state for Bitcoin is incredibly expensive: half of all the computing power in existence must be burnt, in perpetuity, maintaining agreement about the current state of the currency. It also unknowable: we can never be sure that we actually are burning half of all the power in existence, because we do not know how much power exists.

   Laurie points out that in practice, the Bitcoin community does depend on a centralized authority which periodically passes down ‘blessed’ block-chains—the Bitcoin developers periodically hardwire known-good states of the block-chain into the clients (which of course is a theoretical weakness). ↩

8. “Oral History of Butler Lampson”, 2006:

   Alan Kay: “But I wish that you had been at CERN on a sabbatical when that…”

   Butler Lampson: “I probably would have been a disaster.”

   Kay: “I don’t know. But I think you would have made a slightly better…”

   Lampson: “No. No. No. No. No. No. What Tim [Berners-Lee] did was perfect. My view about the web is that it’s the great failure of computer systems research. Why did computer systems researchers not invent the web? And I can tell you the answer. It’s because it’s too simple.”

   Kay: “It is too simple.”

   Lampson: “If I had been there I would have mucked it up. I swear to God. The idea that you’re going to make a new TCP connection for every mouse click on a link? Madness! The idea that you’re going to have this crusty universal data type called HTML with all those stupid angle brackets? We never would have done that! But those were the things that allowed it to succeed.” [^preface]: The UNIX-HATERS Handbook, which contains many entertaining and often still-applicable descriptions of the fecklessness and sharp edges of Unixes, also contains an extremely funny ‘Anti-Foreword’ by Dennis Ritchie:

   To the contributors to this book: I have succumbed to the temptation you offered in your preface: I do write you off as envious malcontents and romantic keepers of memories. The systems you remember so fondly (TOPS-20, ITS, Multics, Lisp Machine, Cedar/Mesa, the Dorado) are not just out to pasture, they are fertilizing it from below…You claim to seek progress, but you succeed mainly in whining. Here is my metaphor: your book is a pudding stuffed with apposite observations, many well-conceived. Like excrement, it contains enough undigested nuggets of nutrition to sustain life for some. But it is not a tasty pie: it reeks too much of contempt and of envy. Bon appetit!

   ↩

9. Decentralized systems are usually convertible into centralized systems easily, while the converse is not true. (Much like parallel versus serial programming—to make a parallel program serial, just insert a lot of blocking.) For a simple example, consider cases where n=2: imagine a BitTorrent swarm (a decentralized system) with one seed and one leech. Or take Distributed Revision Control Systems like Darcs or Git; it’s a commonplace to point out that if a group really wants a ‘centralized’ workflow, they can just designate one particular repository the ‘master’ canonical repository and continue onwards with the DVCS as a more capable replacement for Apache Subversion or CVS. ↩

10. betterunix offers an interesting defense of DigiCash:

    …It is worth pointing out that Digicash survived longer than Bitcoin has even been around—twice as long, in fact. The reasons for its failure are not as simple as “people just did not care.” There were forces in the US government actively working against all civilian use of cryptography, especially those systems that might thwart law enforcement investigations. Patents on cryptography (ironically, this includes patents held by Chaum himself) did what they typically do: prevent systems from being deployed on a large scale. There were bad management decisions, like Chaum’s refusal to accept a huge monetary offer from Microsoft to integrate his system with Windows 95 and another large offer from Visa…In another four years, if the news about Bitcoin is something other than, “Bitcoin trading at all-time lows”, or “Analyzing the failure of cryptocurrencies”, you can at least claim that Bitcoin fared better than Chaum’s systems. [^Ponzi]: Many anonymous commenters point this out because it makes Bitcoin smell like some sort of Ponzi scheme or multilevel marketing scheme:

    Bitcoin, like the recent commercial phenomenon Groupon, tends to turn people into marketers because they feel they have something to gain, however small it might be in the end; I think that partly accounts for its temporary success.

    Or “The Rise and Fall of Bitcoin”, Wired:

    Stefan Brands, a former ecash consultant and digital currency pioneer, calls bitcoin “clever” and is loath to bash it but believes it’s fundamentally structured like “a pyramid scheme” that rewards early adopters.

    John Robb, “More Thoughts on Bitcoin”:

    Lots of people are saying: “The deflation built into bitcoin was a terrible idea. People are getting rich.” In fact, it was a brilliant idea. It brought in speculators (people that are buying/selling it as if in a game). It created a bubble. The bubble put it on the map. The bubble has attracted thousands of developers/participants. Think of how the Netscape IPO fueled the Web/Internet.

    Szabo is a little more generous in his explanation of why people were uninterested in Bitcoin-like strategies:

    (2) Hardly anybody actually understands money. Money just doesn’t work like that, I was told fervently and often. Gold couldn’t work as money until it was already shiny or useful for electronics or something else besides money, they told me. (Do insurance services also have to start out useful for something else, maybe as power plants?) This common argument coming ironically from libertarians who misinterpreted Menger’s account of the origin of money [see “On the Origins of Money” as being the only way it could arise (rather than an account of how it could arise) and, in the same way misapplying Mises’ regression theorem [see The Theory of Money and Credit]. Even though I had rebutted these arguments in my study of the origins of money, which I humbly suggest should be should be required reading for anybody debating the economics of Bitcoin.

    There’s nothing like Nakamoto’s incentive-to-market scheme to change minds about these issues. :-) Thanks to RAMs full of coin with “scheduled deflation”, there are now no shortage of people willing to argue in its favor.

    ↩

11. Wei Dai, 25 February 2011:

    …If you read the Wikipedia article, you should know that I didn’t create Bitcoin but only described a similar idea more than a decade ago. And my understanding is that the creator of Bitcoin, who goes by the name Satoshi Nakamoto, didn’t even read my article before reinventing the idea himself. He learned about it afterward and credited me in his paper. So my connection with the project is quite limited.

    Dai has also criticized the monetary policy built into Bitcoin:

    I would consider Bitcoin to have failed with regard to its monetary policy (because the policy causes high price volatility which imposes a heavy cost on its users, who have to either take undesirable risks or engage in costly hedging in order to use the currency). (This may have been partially my fault because when Satoshi wrote to me asking for comments on his draft paper, I never got back to him. Otherwise perhaps I could have dissuaded him (or them) from the “fixed supply of money” idea.) I don’t know if it’s too late at this point to change the monetary policy that is built into the Bitcoin protocol or for an alternative cryptocurrency to overtake Bitcoin..

    Adam Back, 18 April 2013 (confirmed by Wei Dai):

    …So anyway I know a few things about ecash, privacy tech, crypto, distributed systems (my comp sci PhD is in distributed systems) and I guess I was one of the moderately early people to read about and try to comprehend the p2p crypto cleverness that is bitcoin. In fact I believe it was me who got Wei Dai’s b-money reference added to Satoshi’s bitcoin paper when he emailed me about hashcash back in 2008. If like Hal Finney I’d actually tried to run the miner back then, I may too be sitting on some genesis/bootstrap era coins. Alas I own not a single bitcoin which is kind of ironic as the actual bitcoin mining is basically my hashcash invention.

    ↩