24 May 2019

Let's Talk about Bitcoin

What is Bitcoin? Well, if you're a coder you've probably read the 2008 eight-page 'Whitepaper' by someone calling themselves Satoshi Nakamoto here. There it is called a "Peer-to-Peer Electronic Cash System," and that is a clear and precise description. If you haven't read the paper, you should. It is an elegant schema laying out a proposal for an internet of money that avoids the controls of both the private and public banking and monetary systems. If, for example, I am somewhere in the Amazon basin and you are in Outer Mongolia and I know your bitcoin address, I should be able to transfer bitcoin to you (or, at least, transfer to you the permission to use a certain segment of bitcoin I happen to control at the moment) almost instantaneously—without having to go through multiple steps involving various banking systems and clearinghouses, each of which takes an inordinate amount of time and energy and, importantly, an intermediary cut.

The basis of bitcoin lies not in any underlying value or commodity like gold or silver reserves or sow belly futures or even the "full faith and credit" of some government but in mathematical logic. Transactions are bundled together, permanently encrypted or "hashed", and memorialized into a publicly available 256-bit block. Each subsequent block includes within it the hash of the previous block, thus bootstrapping a functionally unalterable chain, i.e., a blockchain. Ultimately, the blockchain is a database or ledger of every electronic transaction. [NB. Clever greedy folks have been trying to hack the math and the code and chip away at the blockchain for over a decade now, and it seems to be holding. So far.]

There are tons of issues with bitcoin that we've all read about. Ethically, all bitcoin transactions are anonymous thus inviting criminality and international laundering beyond the controls of governmental authorities. Politically, of course, this is probably the major issue for the powers that be. Financially, volatility due to bitcoin's lack of underlying "real world" or tangible value—linked to some commodity or so-called fiat currency—makes it a potentially risky investment. Functionally, the irreversibility of transactions can create problems where one party is preying fraudulently on another unsuspecting party. Further, the proliferation of other types of cryptocurrency creates confusion for those not actively involved in the space. Likewise, practically, the necessity of understanding and implementing appropriate digital security measures is a significant barrier to entry for many. And physically, the amount of energy required to digitize the monetary system is daunting. [NB. Cleverer folks than me are working on systematic ways to deal with these and other issues.]

Notwithstanding, there is something profoundly interesting about bitcoin. (And here, I talk only about bitcoin and its blockchain.) First, it stands the current monetary system on its head: trust resides in the certainty of each and every individual transaction instead of in the financial system—Fort Knox, Wall Street, Federal Reserve, government central banks, the IMF, the World Bank, etc. (I only need mention 2008, the year Nakamoto's Whitepaper appeared, to emphasize the importance of this.) Each bitcoin transaction, no matter how large or small, is considered a contract. And the only criterion for the transaction to be memorialized to the blockchain is the validity of that contract as determined by a fixed, public set of protocols. A transaction either satisfies the protocols and is valid, or it doesn't and isn't. Bitcoin democratizes trust. Or, if you prefer, de-colonizes or de-imperializes the international monetary system. Each individual is his or her own bank. Bitcoin empowers individual smart phones to do everything a Citibank or a financial clearing house does. Instantaneously and without intermediation.

Second, and this is what I find most interesting (and promising), ultimately bitcoin seeks to monetize information. It's right there in the name: BIT + COIN. According to Wikipedia, "[a] bit (short for binary digit) is the smallest unit of data in a computer. A bit has a single binary value, either 0 or 1." The world is witnessing an explosion of digitized data as we move from the Googlized web of text searches and cat videos to the internet of things and 5G where, e.g., dumb appliances communicate with each other and with the energy systems that power them without human intervention. It is almost impossible to describe how vast these systems of information transfer are becoming, from driverless automobiles to smart refrigerators, from always-broadcasting, always-interfacing social media to interoperable energy grids, from online voting systems to Mars colonization. And the list goes on. Yet, each bit of data transfer requires a measurable amount of energy to execute. Theoretically, if you can put a price on the energy required for the transfer of a single bit of information—no matter how minuscule the monetary increment—you are creating a potential system of wealth that is, at least for me, incalculable. And this, it seems to me, is bitcoin's great promise.

What's interesting about this is that though the systems of digitial data transfer will proliferate exponentially over time in ways we cannot begin to imagine, there is only ever going to be a fixed amount of bitcoin. For complicated mathematical reasons, there can only exist 21,000,000 bitcoins. That's it. And the last of these will not be mined until sometime around 2140. (Practically, a number of these have been or will be lost due to poor digital hygiene, but that's beside the point.) Twenty-one million is woefully inadequate—by orders of magnitude—to account for each bit of information involved in all these digital transactions, thus Bitcoin has been subdivided into units called Satoshis. Each Satoshi is equal to one hundred millionth of a single bitcoin (0.00000001 BTC). And as a corollary, there will only ever exist 21 quadrillion Satoshis.

The idea here is that instead of an inflationary currency, one which like our own continually prints more money (which devalues and discourages saving: think about the interest you are currently getting on your savings account), bitcoin is deflationary: it's value will only increase as its applications expand because there can never be more bitcoins. This encourages saving and speculation but may disincentivize spending and transactions. Again, bitcoin has no inherent value; its value is entirely transactional, that is to say, its agreed upon value at the time of transaction. Recall that the first "real world" bitcoin transaction was 10,000 bitcoins for two pizzas. Nowadays, such a transaction would be measured in thousandths of one bitcoin. Due to its essentially transactional nature, bitcoin will continue to have, for good or ill, a relativistic and unstable valuation.

The amount of energy required not only to hash and mine each and every transaction (a problem the Lightning network seeks to address by ledgering many transactions off-chain) but to link a monetary value to each and every bit of information transferred would seem to be astronomical, and some amount of abstraction is inevitable. Beyond buying pizzas or clothing or cars or even houses, one can imagine that a user might choose to pay a Satoshi or two to like a Tweet or put a smiley emoji on a Facebook or Instagram post (with the cash going directly to the original poster) rather than having their online personal data surreptitiously mined and sold by social media advertising corporations. Similarly, one can imagine YouTube paying users a few Satoshis for each second they watch an ad or users paying Satoshis per second of streaming music or video. These are literally the simplest sorts of internet transactions imaginable. Or think about putting a precise cost on the amount of energy (down, say, to the milliwatt) a smart refrigerator or HVAC system uses or the exact number of bits of data required to manage a city full of self-driving Übers. The possibility of increasingly precise and timely measurements, i.e., costing, of energy usage and data processing is not negligible. And it's easy to imagine that much of the accounting for these sorts of things could be automated and bottom-lined both to reduce fees and expedite transactions. But the question remains whether the cost of that energy provides sufficient value to make its ultimate, universal application worthwhile. The answer to that question will impact the ultimate viability of bitcoin.

Bitcoin seems to put the lie to the idealism of the early internet attributed to Stewart Brand, to wit: "Information wants to be free." That statement seems as hopelessly naive today as the 'Peace, Love, and Rock 'n' Roll' hippie movement of the Sixties. Information transmittal is rapidly being automated. If it can be automated, it can be commoditized. And if it can be commoditized, it will be monetized. Down to the very bit. This feels like an economic inevitability—certainly in a capitalistic economy, something I don't foresee changing any time soon. And it's not difficult to envision bitcoin as a globalizing force in the current, increasingly fractious, nationalistic mood of the world.

I'll leave off this discussion with a question for mathematicians, physicists, coders, and engineers smarter than me to resolve. Bitcoin is specifically tied to electronics, that is to say binary computing based on base two 0's and 1's. Bits. New and more powerful computing that goes a level below electrons and bits is emerging rapidly though: quantum computing and DNA computing, to name two such. A hundred or so years from now, when the last bitcoin is scheduled to be mined, one wonders whether an economy based on bits and electrons will still be viable. Whether bitcoin might be replaced by, I don't know, a self-ledgering Qubitcoin (NB. Something by that name apparently already exists; I have no idea what it is or does.) or self-replicating RNAcoin is an open question. [Comments welcome.]

Notwithstanding, I believe there's a lot of potential in this whole blockchain paradigm, and bitcoin seems poised best to capitalize on it at the present moment and for the foreseeable future.

[Disclaimer: This is one man's opinion. I'm just a blogger. Nothing herein should be construed either as legal advice or financial investing advice. Bitcoin and cryptocurrency investing is extremely risky in the current climate, and should be undertaken cautiously and with the advice of a trusted professional investment advisor, i.e., not me!]

4 comments:

Mongo, At The Moment said...

One of the most complete descriptions of BC and the underlying technology. Thanks.

Not a criticism, but it's still troubling that, as with so much else, it ultimately becomes a discussion about valuation and commerce and exchange.

Jim H. said...

Mongo like Sheriff Jim! Thanks. There seems to be a real tension between the libertarian aspects of Bitcoin and its promise of a technocratic globalist currency. I tried to stay away from both the technical and political here. One thing that troubles me is that folks like the Winkelvi twins and early adopters and technological elite who loaded up on Bitcoin in the early days when it was CHEAP CHEAP CHEAP will, if its promise pays out, wind up being the new Medici or Rothschild oligarchs while the poor (the rest of us) continue to be without access to capital, scrapping for mere Satoshis.

Mongo, At The Moment said...

One of (for me) the most attractive aspects of Blockchain is in cryptocurrency's *not* being tied to benchmarks for traditional currency valuation -- the current financial industry has had generations to rig the rentier capitalism game in its favor. There will be more (already are) ways to rig the Bitcoin system, too -- like Office Space, build the app that bleeds off 1 Satoshi per transaction in X systems, and pretty soon you've got some real Quatloos.

XRP: You might want to look into the underlying assumptions of how its developers originally created it, relative to Bitcoin.

'Scuse me; gotta go prove I'm not a Robot.

Jim H. said...

Also, Richard Pryor in Superman 2!

I was initially attracted to the idea of BAT—Basic Attention Token: interweb users get paid for watching ads, e.g. And ETH still makes some sense to me as the programming platform for smart contracts. The question is whether Bitcoin will absorb all the other coins' functions within it.

Funny you should mention that sapping off; the protagonist of my third novel attempts to do just that: creates a coin tied to a specific function but first alots himself a ton of same as well as a piece of each subsequent transaction, watches the immediate bubble with glee, then despairs (sort of) as it bursts and it's all worthless. It makes for a good subplot, I think. That being said, know anyone who would like to publish it?