Sunday, March 29, 2015

Bitcoin Nodes, Central Planning, Coase, and Freedom Firms

Justus Ranvier has a good post in which he tackles some supply and demand arguments being kicked around in relation to block size limits and the costs and incentives of operating full nodes. For those not familiar, Bitcoin nodes store copies of the blockchain and relay transactions and valid blocks throughout the Bitcoin network. Nodes contrast with miners, who, after successfully fulfilling Bitcoin's proof of work requirement, take the transactions they've been relayed and add them to a new block, which is then relayed back throughout the network by the same nodes.

Ranvier sketches out a set of features to be added to the Bitcoin protocol that would effectively allow nodes to operate as toll booths, negotiating a sliver of each transaction fee with (1) spenders and recipients who need to have their transactions relayed and confirmed, and (2) miners who wish to maximize their revenue by including more transaction fees in each block.

His analysis is worthwhile, and I recommend a full read of it for anyone interested in addressing the problem of blockchain bloat while still preserving a decentralized system of nodes. And although I believe his proposal to be a good one and deserving consideration by Protocol decision makers, once again I quickly find Ranvier's and my differences in bias revealing themselves in how he justified his arguments.

Central Planning

Not too far into his post, he heads a section with "Markets are better than central planners." Such a statement sounds nice to those of us with libertarian tendencies, but unfortunately it just ain't true.

It's not that its converse is true...that central planners are better than markets. It's that each has its place.

I was personally introduced to the operative concept here while listening to the old Robert LeFevre tapes, in the context of monopoly and antitrust. LeFevre points out that the term monopoly is meaningless without a defined scope. For example, McDonald's does not have a monopoly in the scope of selling hamburgers, but it does have a monopoly in the scope selling the Big Mac.

Similarly, McDonald's does not have a monopoly on selling goods and services in general (obviously), but it does have a monopoly on selling goods and services inside the stores it controls. Burger King employees may not stroll into a McDonald's and start selling food with the rationale that they are furthering free market competition. I hope that even the most hardened free market advocate would not grant Burger King license to do such a thing.

Extending the same pattern of thought to central planning, again, such a concept has no meaning without scope. Would we argue that a given McDonald's franchise is necessarily misallocating economic resources (as "centrally planned economies" supposedly do) simply because Herr Kommandant McManager centrally plans how his employees go about providing quality service with a smile each day?

No. Unless you believe that a modern McDonald's would somehow be outperformed by a burger joint consisting of a dozen sole proprietors who show up somewhere each day, each with his own factors of production, and trade their prepared burgers, mcmuffins, and freedom fries with one another, all presumably through multiple competing cashiers brokering orders from customers and trading with the kitchen.

The McDonald's corporation no doubt has scads of MBAs fine tuning the amount of competition and cooperation among its human capital, adding and subtracting layers of management and the degree of control each manager has over his downstream employees. If it were obvious that eliminating all management and instructing each employee to "Do as you please. It's a free market!" provided superior, cheaper service to customers, they would have done so by now.


The question then becomes: when is central planning a superior strategy to using markets? This is well worn terrirtory, and described neatly in Nobel laureate Ronald Coase's 1937 paper The Nature of the Firm. In it, Coase attempts to "discover why a firm emerges at all in a specialised exchange economy."

Coase's entire paper is quite brief, and the bit that's relevant to why Bitcoin should or should not add a feature to support node tollbooth functionality is even briefer:
The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism. The most obvious cost of "organising" production through the price mechanism is that of discovering what the relevant prices are.
And shortly afterward:
We may sum up ... by saying that the operation of a market costs something and by forming an organisation and allowing some authority (an "entrepreneur") to direct the resources, certain marketing costs are saved.
I suggest therefore, that as miners, core developers, and other stakeholders consider the proposal to build a set of features to allow nodes to collect fees, they approach it not from Ranvier's apparent ideological perspective of "centralization equals bad", but instead one that fully recognizes the cost of creating and operating a new market for fees and the specialization that will be necessary for it to operate smoothly, and whether the flexibility it creates outweighs those costs.

As I was drafting this post and collecting my thoughts, it occurred to me that I often hear precisely the same arguments from anarcho-capitalist friends and colleagues about the necessity of competition to provide a so-called free society. These friends begin with the correct belief that markets are excellent mechanisms for solving certain complex problems. They then extended the idea as far as it would seem to logically go, to the idea that the only way to foster freedom is for every transaction to be made voluntarily between two individuals or their voluntarily selected agents.

Before I argue why I believe such reasoning to be mistaken, we first need to pin down the meaning of freedom. I personally conceptualize a free society as one which generally (1) maximizes the aggregate opportunities available to its inhabitants and (2) only employs systematic violence or the threat thereof predictably, in ways well understood by the inhabitants before the fact.

For those of you who view freedom as the absence of a formal master or the absence of systematic aggression, I suggest you have succumbed to the same fallacy as Heinlein's worker who quit his make-work job and purchased his own brass cannon to polish. You are seeking the symbol of what you desire rather than the thing itself.

But hey, who am I to stop you from chasing your dreams? If that really is your highest end, above mundane things like physical safety, plentiful food, and vibrant culture, it seems like the best solution to your problem would be to just buy a boat and go live in international waters.

Moldbug, per usual, has a much more trenchant criticism of such an approach to life, so I defer to his and Patri Friedman's brief 2009 back and forth on the matter. But I will leave you with the summary that giving up one's fealty to Bushitlerobama to become a permanent subject of King Neptune probably leaves one more subjugated, not less. And especially if you're willing to anthropomorphize Neptune, it should be completely obvious that you're still the subject of a cruel and fickle master, as much you might try to convince yourself otherwise.

Freedom Firms

We can now ask whether the most effective way to provide freedom is to insist that every transaction everywhere be voluntary, or perhaps instead consider the possibility that there might be some sort of zen approach wherein a "firm" (i.e. government) run by "entrepreneurs" is somehow able to direct resources to provide greater amounts of freedom, even if they possess both the formal and actual ability to withhold any and all of them from us on a whim.

Applying Coase, is it possible that the costs of operating a market for every single life choice is prohibitively high? Might such markets be so complex and insufficiently trained that their price signals are worthless, and far outweighed by their costs? Perhaps, would the imposition of certain cultural or legal constraints reduce the complexity of the markets to the point that their price signals once again become worth more than their social costs?

I leave it to you to answer all those questions for yourself, but when I look around the world, I see "entrepreneurs" bundling and offering up sets of constraints of all different shapes and sizes. I see "firms" like Singapore under the centralized planning of the iron-fisted, tourist-caning, freedom-crushing Lee Kuan Yew achieving far more economic success than and offering far more of the freedoms I personally value than its less-well managed competitors. I also see Singapore's retained earnings account growing accordingly.

Granted, Singapore's product offering might not be to your taste. Your inner pot-smoking graffiti artist might prefer the bundle of freedoms offered by a Netherlands, or a Uruguay, or maybe even a North Korea. Or maybe none of them suit your tastes. It might be the case that nobody is offering exactly what you want at a price you're willing to pay.

That, may I remind you, is the downside of markets.

Personally, I want an online classifieds marketplace with a UX that isn't crap, but the hippies over at Craigslist got there first, have no apparent intention of changing, and the barriers to entry are too high for anyone who values UX to enter and compete. Likewise, existing sovereigns have already scooped up and monopolized all of the decent real estate on our humble planet, and their product offerings are pretty mediocre in most places.

But unless you can afford to launch your own sovereign (or start your own Craigslist) we're both stuck having to choose the least bad product on the market.


As I have argued before, the only important thing I believe Bitcoin might be capable of achieving is serving as the inner core of a fixed supply global monetary standard. Generalized distributed consensus might be interesting, but Bitcoin must first win as a currency before it can perform that function too.

All other political ideals being attached to Bitcoin, such as empowering the unbanked are hot air, except insofar as they're useful in helping Bitcoin evade the same ideological antibodies used by Progressives to stave off a return of the gold or any other "exploitative" hard money standard.

In order to preserve its hard money quality (which is the only thing Bitcoin has going for it), Bitcoin's miners and nodes must remain decentralized. If either is captured by a single party or colluding group, we will be no better off than under a central bank.

So yes, Ranvier correctly sees that sufficient numbers of nodes must have incentive to operate honestly. Whether or not a software mechanism must be designed and deployed to solve that problem is unclear to me, but I hope that the debate will occur soberly, not with special interests making disingenuous arguments on one hand, and market fundamentalists doing the same on the other.

More broadly, I hope that people can discuss general societal governance problems constructively, identifying both the value and limitations of markets in debates such as net neutrality, and even all the way up to the nature and design of those hallowed institutions themselves which we describe as possessing monopolies on the use of violence.

Friday, February 13, 2015

Crypto 2.0--And Other Misconceptions

Discuss this on Hacker News

"It's the Blockchain, not Bitcoin that's the real killer app."

I've been hearing that more and more from prominent tech visionaries. And it's so incredibly wrong.

But before I begin, I want to make sure I'm interpreting it the way people actually mean it. To wit, when I hear the above, I interpret it more precisely as:
A decentralized consensus system using Merkle trees and based on proof of work (or maybe even stake) is the killer app. Furthermore, the specific implementation of a blockchain that we call Bitcoin will die and be replaced by a superior implementation.
But after reviewing a draft of this post, a colleague of mine pointed out to me that another interpretation might be more along the lines of:
Any Bitcoin-like proof of work-based Merkle tree that is meant to be used as a decentralized consensus system is doomed to failure...but (!) there is some sort of undiscovered idea out there that we can't describe and we don't know how it will actually work, but we'll be able to use it as a decentralized consensus system, and it will be awesome, and even though it will only have as much in common with a blockchain as does a platypus with a chicken, we're going to call it a blockchain anyway.
Maybe that is what people mean, and if it is, I can't really argue with that. It's like saying that "low cost energy" is the killer app. No shit. But that tells us absolutely zero about if and how we'll ever get there.

Setting the latter interpretation aside, I will now do my best to debunk the former and give it a proper burial. After all, I didn't earn the nickname "the undertaker" for nothing.

The misconception underlying the idea of "Blockchain good, Bitcoin bad" was most saliently captured for me in an exchange during an Econtalk podcast with none other than Silicon Valley gatekeeper Sam Altman, who is the president of the Y-Combinator startup accelerator.

When the podcast arrived at the topic of Bitcoin, Altman stated, "I think the most interesting piece of Bitcoin is this idea of the Blockchain." And just to make clear that in this instance he did indeed intend to poopoo on Bitcoin while holding up the beautiful idea of the Blockchain, note that he also stated "I own, like, not that many Bitcoins, and I have them as a hedge in case it does win. But I think it still is looking unlikely."

As they began, like, exploring Altman's reasoning for that, Econtalk's host Russ Roberts said "the only that thing I understand about [the Blockchain] is it's the thing that enables Bitcoin to work its magic."

Unfortunately, Russ got it exactly wrong. I don't mean to pick on him--his domain is economics, not cryptography or software--but his mischaracterization of the relationship between Bitcoin and the Blockchain was not corrected by Altman, whose job it is to understand these things, especially when he's going to take a public stance on them.

Let's break down why it's actually Bitcoin that allows the Blockchain to "work its magic" and not the other way around.

First of all, let's agree that the ideas of Bitcoin as a currency or the Blockchain as a consensus mechanism are revolutionary if and only if each's decentralized nature is preserved. The moment one becomes centralized, whether due to a flaw in the protocol or the concentration of mining power, it is no better (and probably worse in fact) than fiat money, e-gold, or any other monetary scheme which is vulnerable to capture by a minority, and therefore vulnerable to abusive seigniorage and capital controls.

Given the crucial requirement to preserve decentralization, the problem Satoshi had to solve while designing Bitcoin was how to incentivize network participants to expend resources transmitting, validating, and storing transactions. The first step in solving that is the simple acknowledgement that it must provide them something of economic value in return.

The next part was figuring what of economic value could be used. Maybe Satoshi considered sending each new block's miner a hand-written thank you note with a picture of a cat. But probably not. Maybe he could have offered them something that's universally marketable, like a fixed amount of gold bullion. And since this scheme was going to live on the internet, he would have naturally made it a digital IOU for gold, perhaps held in trust in a vault.

Oops, there goes the decentralization. We've just reinvented e-gold. Ankle bracelets here we come.

After searching around for some pre-existing object of value to use as an incentive, we eventually realize that Satoshi could not have used anything pre-existing. The incentive had to be created and exist entirely within the network itself!1

Given that the consensus tool's incentive had to live inside the network, its form therefore had be pure information, as that's the only thing that can be transmitted through the internet. Private keys that represent some sort of token are an obvious solution, and when we combine them with two cups of economic scarcity, a Merkle tree root, a spoonful of clever bootstrapping, and a dash of HashCash, we end up with, you guessed it, Bitcoin!

To put the above more plainly, any instance of a blockchain and its underlying tokens are inextricably bound together. The token provides the fuel for the blockchain to operate, and the blockchain provides consensus on who owns which tokens. No amount of engineering can separate them.

So what does that mean for Bitcoin the currency? For blockchain technology in general?

Not only is it the case that the Bitcoin Blockchain cannot win without Bitcoin as a currency winning too, but if the Bitcoin price languishes, the incentive mechanism backstopping the Blockchain will be weak and therefore unreliable, and Bitcoin as we know it will likely live out its days like video games from 80's and 90's, relegated to a corner of the internet where the hipsters of the 2030's will trade them with one another just to be ironic.

If Bitcoin does win, that probably means it displaces the Dollar as the foremost unit of saving (which is what money is in a post-digital age, not the foremost medium of exchange, which was one of its chief functions prior and I suspect what 99% of people mistakenly think is still why money is valuable).

Another source of confusion in this discussion that likely comes from misunderstandings about the nature of money is the idea that there can stably exist multiple blockchains, competing with one another to provide the most reliable and feature-rich consensus tool. But there cannot.

Just like a monetary standard, a blockchain experiences network effects. Any resources being poured into mining one blockchain are resources not being poured into another. Multiple blockchains, like money, will therefore tend to experience the Highlander effect, where weakly-mined (and therefore insecure) blockchains will fizzle out and other blockchains will absorb their mining power, as well as the latent demand for tokens.

But wait. What about merged mining you say. For those who are unfamiliar, merged mining means allowing a miner to essentially use a single nonce for each hash attempt, and if the resultant value is over the required difficulty, multiple blockchains will accept it as a valid hash for a new block.

Namecoin, for example, implements a unidirectional version of this. It allows any miner of a Bitcoin block to simultaneously also produce a new Namecoin block, but not the other way around.

I confess I haven't explored it fully, but my understanding so far is that bi-directional merged mining of the Bitcoin blockchain with another is unfeasible without Bitcoin "consenting" to it before the fact, presumably through a BIP that gets accepted and deployed by a majority of the network.

Unsurprisingly, early steps toward such a modification to Bitcoin are already being put forward by the, as far as I can tell, well-meaning team at Blockstream. They're brilliant and ambitious no doubt, although the one thing their team is missing as of this writing is the presence of John Meriwether. One can only hope they'll read this post and reach out to him.

Blockstream advocates the concept of Sidechains, which they believe will allow for multiple competing yet interoperable stand-alone blockchains, creating sandboxes of sorts to promote experimentation and innovation. If you don't like the way Bitcoin is doing things but you think Sidechain A is really onto something, you can "burn" your Bitcoins in exchange for a certain amount of Sidechain A's tokens and cross your fingers that Sidechain A is in fact the blockchain that Sam Altman has always been dreaming of.

When I read the Sidechains white paper, the first thing that came to my mind was that if blockchains wore funny hats and lived in a royal court, what Blockstream is doing would be what's commonly referred to as a "coup." As established above, any so-called feature that allows Bitcoin to play nice with competing tokens only serves to make it more vulnerable to being usurped.

The argument that Sidechains will promote a vibrant innovative cryptocurrency ecosystem is misguided at best and disingenuous at worst. Thus far, I've yet to see any charges of treason being discussed by Bitcoin's collective mind of core developers and mining pool decision makers. We'll see if it becomes wise before it's too late.

Pondering the implications of Sidechains for a moment, it's interesting to note that, in a vacuum, those who own mining equipment indeed ought to be indifferent to which blockchain they're pointing it at, as the yield to be gotten from their assets is not existing coins, but only those yet to be mined in the future (assuming lock time is not a significant factor). So if Sidechain A's tokens take off in value, and SHA-256 ASICs are somehow still valuable in mining it, miners will gladly point at at the new blockchain instead. Miners have no allegiance to Bitcoin.

Except that miners don't exist in a vacuum. If Cryptocurrency 2.0 ever replaces Bitcoin and all Bitcoins become worthless, confidence in the category of cryptocurrencies in general will be, I believe, irreparably damaged. If Cryptocurrency 2.0 just replaced Bitcoin, there's nothing stopping Cryptocurrency 3.0 from replacing Cryptocurrency 2.0 and sending the value of its tokens to zero. Ad infinitum.

Once the precedent is set that cryptocurrencies are transitory, the end game is known and no critical mass of rational actors will continue to hold the tokens. You've got to remember that, by definition, a cryptocurrency is decentralized and relies on consent. When fiat currencies fail, they can rely on hegemony to get back on their feet. Cryptocurrencies do not have that privilege.

To sum up, Bitcoin was the first mover of proof-of-work-based blockchain cryptocurrencies. It is way out in front of its competition, and it will be a formidable challenge for any other currently-existing cryptocurrencies to overtake it, from the straight-clone Litecoins and theortically elegant Ethereums to the well-marketed but lacking in substance Paycoins and banal Dogecoins.

By design, Bitcoin can be adapted and improved without destroying the value of its tokens. If an undeniably superior method to operate a blockchain is discovered, it's far more likely that Bitcoin Core will implement it and its miners will deploy the patch than it is that they all sit back and watch Bitcoin die while another blockchain passes them.

It remains unclear whether the concept of a proof-of-work blockchain will win at all, but if it does it will be fueled by an underlying token, and I am presently incapable of seeing how any token other than Bitcoin will be the one that wins.

1 This almost certainly wasn't how Satoshi actually created Bitcoin. Given his citation of Wei Dai's B-Money proposal, it's pretty clear that the Bitcoin egg came first and the POW blockchain was spawned afterward. But the argument holds.

Tuesday, August 5, 2014

Joe Coin's Law

We aren't shy about self-promotion here in Farragut North. That's why, with much fanfare, we're proud to finally announce the not-so-modestly-named Joe Coin's Law.

Ever since blockchain technology captured the imaginations of Silicon Valley visionaries, my associates and I have been extremely skeptical of all the questionable promises they've been making about how the manifold forthcoming applications of it are going to Change the world. Ever avengers of truth, we set about to compose a pithy equation that captures when a proof-of-work blockchain is an appropriate solution to a problem, and more importantly, when it is not.

We were hoping to end up with a sort of e^(i*Tau)-1=0 (or e^(i*Pi)+1=0 for the unenlightened)-type equation that ties in all the variables we care about, and indeed they all went into it, but after tinkering with the various factors and then distilling things out, we arrived at the following inequality which must be true in order for a blockchain to be an appropriate solution to a problem:

DoS Attack Value < Mining Revenue / 2

That might not look like much, but after explaining more precisely what those terms mean, breaking it down, and running through an example, we're confident that it will offer some insight.

First, what is DoS attack value? As a reminder, we're Austrians here and subscribe to a subjective theory of value. Accordingly, the value of an attack is in the eye of the beholder, so might be as vague and unquantifiable as the kicks and bragging rights a hacker would get from destroying a blockchain, or it might be as coldly-rational and precise as the Excel calculations of a well run nation state whose seigniorage from its own currency is being eaten into by a competing blockchain-based currency.

For both terms, the unit will simply be dollars (or bitcoins, or whatever unit of value you prefer). Having chosen a unit of value, you must then decide how long a DoS attack you wish to conduct. For instance, running a 51% attack on Bitcoin for five seconds would probably have zero value because nobody would notice. But running it for a day, or a week, or a month might be long enough to send even the most hardened Bitcoin enthusiast running for the hills, thereby destroying Bitcoin once and for all. And how much is such a feat worth to a would-be attacker? Who knows...but whatever it is it's the first term.

The second term, mining revenue, is the sum of all proceeds accrued to miners during a time period the same length as the proposed attack. In Bitcoin's case that breaks down into:

Length of attack (in blocks) * (Average block reward + Average transaction fees per block)

Having explained the meaning of the terms a bit further, let's see how we got there.

First, we consider the Law of Diminishing Marginal Returns and recognize that in equilibrium, marginal revenue from mining will equal the marginal cost of mining. Or in plain English, miners will keep adding mining capacity until there's no more profit to be made. In equation form:

Mining revenue per block = Mining cost per block

Next, we break down mining cost:

Mining cost per block = Amortized hardware cost per block + Electricity consumption per block

The amortized cost of hardware is basically its initial cost divided by its life (we'll assume zero salvage value). Advances are still being made in ASICs, but as I understand it, they're quickly becoming commodities, and I infer will have a useful life approaching infinity, as opposed to CPU and GPU miners, whose lives were cut short by the advent of ASICs due to the formers' vast energy-efficiency disadvantage, not to mention the logistical inefficiency if one attempted to build an array of them just to match the gross hashing power of an ASIC.

So, given that:

Hardware cost per block = Hardware cost / Hardware useful life

and the fact that hardware useful life is headed toward infinity, we can set hardware cost per block to zero and end up with:

Revenue per block = Electricity consumption per block

The cost of running a 51% attack per block is therefore:

Cost of attack = 51% * Electricity consumption per block

Or, to clean up the equation, because technically it's any amount greater than half:

Cost of attack = Electricity consumption per block / 2 + ε

Moving things around, substituting, and getting rid of epsilon we're left with:

Cost of attack ~= Mining revenue per block / 2

We further assume that the value of an attack must be less than its cost. Otherwise it'll definitely happen, right? And so, we arrive back at our original inequality:

Value of attack < Mining revenue per block / 2

Having gone through that exercise, let's examine a couple implications about blockchain design. First, note that block difficulty and expected block frequency are independent of Joe Coin's Law. Increasing or decreasing the block difficulty has zero impact on resilience from a 51% attack.

Energy efficiency, too, does not affect the analysis, as long as we assume that there is no asymmetry in the energy efficiency of attackers and honest miners, which seems reasonable given the commoditization of ASICs.

Next, we'll build on World Bitcoin Network's 51% attack analysis and examine Bitcoin through the lens of Joe Coin's Law.

Bitcoin at Present

In its analysis, World Bitcoin Network calculates the cost of an attack based on the cost of hardware. It looks at retail prices of the latest and greatest ASICs and figures out how many of those would be needed to co-opt the Bitcoin blockchain. It also reasonably discounts the cost of the hardware from the retail, given that a 51% attacker would probably be a nation state buying at a large enough scale that they might as well just procure their own chip fabrication plant. They ultimately arrive at a figure of $20M as being what's needed to attack Bitcoin at today's prices.

Okay, so what does Joe Coin's Law have to say about this analysis? Unfortunately, not much. Remember that all it proposes to address is, in essence, whether the built-in-by-design operating costs of a particular blockchain are sufficiently high to stave off a 51% attacker. Accordingly, the best we can do is plug in some numbers based on where we think Bitcoin is headed and then ask whether "monetary commodity" might be an appropriate long-term application of a blockchain. But just for fun, we'll analyze Bitcoin now as if it were in or near an equilibrium state.

Currently, blocks are paying 25BTC and nominally occur every 10 minutes (ignoring the effect of hashing acceleration). At ~$500/BTC the cost of operating the Bitcoin blockchain is therefore about $1.8M per day or $650M per year. And with a market cap around $6B, that means that Bitcoin hoarders like me are currently paying over 10% in dilution per annum for the privilege of holding Bitcoin. Ouch.

Meanwhile Bitcoin transaction fees seem to be hovering around 15BTC/day, which is a 0.4% drop in the bucket of the 3,600BTC block rewards per day.

Based on those figures, it would imply that a week-long 51% attack on Bitcoin would have to yield the attacker at least $12.6M (7*$1.8M) to be justifiable. Or a month long attack $54M.

In my assessment, it would be absurd to believe that an attacker could pocket that much through double spend attacks and/or rewriting previous transactions. The "honest" Bitcoin community would undoubtedly cease transacting once it became known a 51% attack was on, and at the end of the attack would presumably work out a way to identify the bad blockchain branch(es) and rewind to one that wasn't wreaking havoc on previously assumed-valid transactions.

The only other value I can think of someone would derive from a 51% attack on Bitcoin is destroying it as a competitor. And do you really think that Bitcoin (remember, we're talking about in its present form) is stealing  more than $12M per week in seignorage or other fees from the Dollar? No chance.

Now let's explore the much more interesting question of the Bitcoin end game, and see what Joe Coin's Law has to say about that.

The Future

As discussed last month, we share Moldbug's (and others' no doubt) "Highlander" view of money, that "there can be only one." As such, we expect Bitcoin's future to be binary, either petering out with a trivial market cap perhaps similar to today's, or becoming such a desirable (and easily transferable!) form of savings that it displaces the Dollar, the Euro, gold, and every other other money-ish commodity in existence, resulting in a Bitcoin market cap on the order of $10 trillion. Perhaps even more than that. I confess I find it very difficult to predict whether and to what extent fractional reserve banking might exist in a Bitcoin world where the supply of specie is truly rigid. So for all I know the total value of instruments redeemable for Bitcoin in existence could end up closer to base money, or it could be closer to M2 (and that's before adding gold, etc.)

Looking to the future, block rewards are headed to zero, which means that in this specific case Joe Coin's Law can be rewritten as:

DoS attack value < Transaction fees / 2

And what do we think is a reasonable transaction fee volume to expect? I again struggle to model what exactly what the world would look like, but my intuition is still that the average person will demand one or more layers of financial service atop the blockchain for convenience and consumer protection, and that the bulk of non-criminal transactions (more on that point in a later post) will occur off-blockchain, and only be cleared upstream to the blockchain among such intermediaries.

With that, it's certainly an imperfect set of figures (to my dozen or so readers, please suggest any comparable you think is better), but we'll use Fedwire volume as a loose approximation. Daily Fedwire volume runs around $2 trillion per day. And how much will the giant payments intermediaries willing to pay on their transactions to clear with one another? One percent? No way. Ten basis points? Maybe?

Let's go with 10bps and see where that takes us. On $2 trillion in daily volume, that means they're effectively paying $2 billion per day in transaction fees to miners to operate and protect the network from DoS.  These figures are all back of the envelope of course, but I dunno about you...I think it could work. $2 billion per day seems like a sufficiently high cost to disincentivize non-state attacks on the global financial system's core, and any state action to that effect would clearly be an act of war and responded to as such.

In future posts, we'll explore the incentives created for savers and spenders based on the structure of mining rewards, as well as the phenomenon of new applications being built atop the Bitcoin blockchain. Further, we'll address other applications of (generic) blockchain technology, the most obvious of which being a blockchain qua security transfer agent. Ever the visionary, Overstock's CEO is continuing with his painfully stupid implicit mindset of "all centralizaton is bad" and leading the charge on this front. We'll see how that plays out. My prediction: poor, uneducated people get screwed.

Sunday, April 27, 2014


I recently read the archives of the blog Bitcoinism after a friend pointed me there. I found it to be an original and very worthwhile discussion of topics all up and down the Bitcoin stack, but also found it to be too quixotic for my liking. It kinda reminds me of the time back in 1995 after we bailed out Mexico and Chris Whalen mentioned my name during Congressional testimony while calling for an audit of the ESF. Lol, I mean, do you really think Bitcoin's going to equalize the masses, or that government agencies are going to open up their books to the public just like that!? Keep tilting at those windmills fellas!

Anyway, after reading Bitcoinism's archives, what I realized was that Ranvier's (Bitcoinism's author's) agenda for Bitcoin differs sharply from my own. He seems to view it as a democratizing force that could be a means to tear down concentrated, established powers that are presumably exploiting us typical well-meaning humans.

Following the lead of Russ Roberts on the other side of the Potomac, who provides the most intellectually honest forum I've had the pleasure of observing, I thought it would be a good idea to lay bare my own biases and my agenda for Bitcoin, insofar as that's possible. Hopefully this will bring additional light to the rest of my posts and why I choose to emphasize this or omit that detail.

So, what is my agenda for Bitcoin? I believe that the only thing Bitcoin can achieve, assuming it wants to be something more than an illicit underground payment system, is to be the inner core of a global monetary system that possesses only one significant differentiating feature from our current fiat-Dollar system: that its supply is on a predetermined path to 21 million units and that it relies on a system of "one node one vote" to enforce it, rather than on a byzantine FOMC to control the supply responsibly.

I might have just alienated all of my libertarian readers with that declaration. No doubt, like Ranvier, you want much more form Bitcoin. Privacy. Social justice. Empowering the unbanked. Freedom from state ownership/enslavement. I confess I only partially sympathize with such goals, but regardless of whether I do or not, I suggest that Bitcoin will neither be the central instrument of nor even the platform of such Change.

Let me start with a brief discussion of (1) why I think a "fixed" money supply is a good idea, and (2) why I think Bitcoin could deliver that. Then I'll come back and address why I think ambitions beyond that, if potentially admirable, are misguided.

My model of money is basically Austrian. I also firmly agree with Moldbug's posit that "any quantity of money is adequate"(as long as it's sufficiently divisible), as well as his claim that the foremost quality needed in modern money is to be a desirable form of savings. That is, the need for pricing information between various commodities that has been historically solved by monetary standardization is becoming less and less relevant because the Internet can give us exchange rates between any two commodities in milliseconds.

With Bitcoin, the supply is fixed by its Zeno's race to 21 million and the assumption that its network will not be co-opted by Dilutionists. With gold, the supply is fixed by the limited distribution of atoms with 79 protons on or near Earth and the assumption that it will always be cost-prohibitive to create such atoms out of its more abundant cousins. Holding both of these assumptions true, either commodity has the initial markings of an ideal savings instrument.

In contrast, fiat currencies as well as cryptocurrencies such as Dogecoin that have opted for non-convergent supply paths will always tend to "leak" value to money "creators" that savers would presumably prefer to keep for themselves. As such, it seems unlikely that savers will choose such a monetary commodity. Notwithstanding, I acknowledge it's possible that such leakage might be acceptable if the transaction costs of hermetically-sealed moneys are greater than those of leaky commodities. For example, the savings instrument of choice for many Argentines is the only-somewhat-leaky USD, which is clearly less leaky than the Argie peso, but much leakier than, say, gold.

Given that Bitcoin network transaction costs are quite small, it, like gold, appears to be an ideal form of "hard money", with the added benefit that the centralized clearinghouses gold would require appear highly vulnerable to government attack, whereas Bitcoin's distributed nature seems to make it more robust. That said, I'm quite concerned about the very real possibility of a government-led 51% attack. The only explanation I have for why that hasn't occurred already is that USG is too ignorant and internally dysfunctional for any unit to recognize Bitcoin for the threat that it is, set aside the relative pittance of $50 million-ish, and ask Bitcoin to step out of the car please Sir. But I'll come back and analyze that further in a future post.

As far as all the other various ambitions for Bitcoin, I don't think we'll see much if anything. Bitcoin will not bring about a decentralized utopia, whatever that would look like. I expect that layers of service will be built atop Bitcoin to yield the exact same level of financial privacy (or lack thereof) as with the current banking and credit card systems. Insofar as the unbanked class gains access to the Internet but presumably remains unbanked somehow, they'll still be relegated to a Bitcoin "slum" without verified identities, and I don't see how Bitcoin payments will be significantly more convenient than whatever currency they have on hand in most cases.  Bitcoin micropayments too, are clearly uneconomic, and require an off-blockchain solution, which probably means a centralized solution, which means that Bitcoin offers little to nothing on that front.

In sum, Bitcoin is interesting because it offers a hard money global payment system, and so far appears robust against governments sending troops into specific locales to destroy and seize assets, which is something that cannot be said for gold.

Attempts to steer the Bitcoin protocol, its mining infrastructure, and the businesses atop it in a direction premised on destroying hierarchies and providing social justice are, according to this blogger's bias, misguided at best and will be fatal for Bitcoin at worst.

Saturday, February 22, 2014

Applecoins and Orangecoins

I've just gotten word from some insider contacts in Cupertino that Apple is about to launch a new cryptocurrency of their own. Applecoin™ is expected to drastically improve the user experience surrounding cryptocurrency and will have the key differentiation of being the only one accepted in the App Store.

Applecoin™'s announcement is expected to be followed closely by ING Direct's announcement of Orangecoin™, the only cryptocurrency to be linked to your Orange Savings Account. The benefits of that are so huge and obvious I won't even mention them.

This is exciting news. I'm confident that both will carve out niches for themselves and add a lot of value to the global payment system.

I'm joking of course. Applecoin and Orangecoin would be absurd. Exactly as absurd as Litecoin, Dogecoin, and the countless other copycat coins that are out there. But I'll rant more about all that in a future post.

The actual topic at hand today is not Applecoins or Orangecoins, but rather, the practice of comparing Bitcoin to the current US Dollar regime. As you might have already guessed, we here feel that such comparisons are...apples and oranges. Countless articles I've read get things horribly wrong when they attempt to argue why Bitcoin will or won't succeed and what features it does or doesn't have. Most of the time, their errors lie simply in setting up faulty parallels between Bitcoin and the Dollar.

The particular comparison I'll be exploring today is one made in Alex Daley of Casey Research's latest missive on Bitcoin, which was largely responding to Marc Andreesen's piece in the NYT, that also gets some things wrong. I continue to be disappointed by Casey Research's unabashed negativity toward Bitcoin, but I suppose that being forced to double down on dubious stances is an occupational hazard of the paid investment newsletter industry. Fortunately here at, we're just blogging to hear ourselves talk and don't have to worry about any predictions-gone-wrong adversely affecting our non-existent revenue stream.

The first point of Daley's I wish to take down, which is not so much untrue, but more of a failure of imagination is:
With Bitcoin, if you send your digital money to a disreputable vendor, there is no recourse to get a refund. There is no "chargeback" system. The funds, once gone, are permanently gone. It requires active participation from the receiver to reverse a transaction—and that's not always an option. This service is in high demand by consumers and is one of the reasons that they push vendors to accept credit cards: that customer-of-my-customer demand is what allows credit card companies to demand fees.
His mistake is in comparing the apple of the standalone Bitcoin network to the orange of the vast entirety of the US Dollar regime. Would you not run into exactly the same lack of recourse when paying cash for a bicycle you found on Craigslist? Of course you would. There's no chargeback system for shady cash-based deals with random strangers. Does that mean that the Dollar (or even gold!) is a fatally flawed base commodity for a currency scheme?

A much better comparison of the Bitcoin network would be to one specific component of our current financial system, that is the Federal Reserve's Primary Dealer Network. Both are the core determinants of the "base money" supply and both are controlled by exclusive clubs (we'll expand on my outrageous claim that the Bitcoin network is controlled by an exclusive club in a later post). I contend that determining the base money supply and providing high level clearing services is and should be (in the long run) the only use of the Bitcoin network.

Despite Daley's extensive discussion of ACH payments, debit cards, and credit cards in a Dollar context, he fails to recognize that technically, those are not part of the US Dollar. They are all currency-agnostic layers of financial services built atop the Dollar. And the Euro. And the Peso. I'll have to get back to you on whether Zimbabwe has them.

Obviously, such service layers could just as readily be built on top of Bitcoin too. And Litecoin. And Dogecoin...

Moving on to the topic of using Bitcoin for micropayments, Daley gets it right when he points out what Andreesen gets wrong. Andreesen writes:
Micropayments have never been feasible, despite 20 years of attempts, because it is not cost effective to run small payments (think $1 and below, down to pennies or fractions of a penny) through the existing credit/debit and banking systems. The fee structure of those systems makes that nonviable.
All of a sudden, with Bitcoin, that’s trivially easy.
Trivially easy? I don't buy it. The economics of processing microtransactions directly on the Blockchain is already well beyond being viable. And as miners continue to become more and more organized and adopt practices to prevent "transaction spam,"plus exert their power to filter transactions into the Blockchain based on the size of transaction fees, such micropayments will increasingly be ignored and never make it into blocks.

Again, go back to the notion of Bitcoin as the Primary Dealer Network. Last time I checked, the PDN wasn't handling micropayments. And it never will. I suppose it's possible that another layer could be built, or a non-Bitcoin blockchain could emerge to handle them, but my intuition says that neither is likely to be more economically efficient than in a centralized Dollar system.

As a sidenote,'s Research & Statistics division has been working day and night to come up with what I intend to dub Joe Coin's Law, which will summarize when it's economically viable to use blockchain technology, but they're still working on it. We'll keep you posted.

Back to the topic at hand, you might be objecting to my comparison of Bitcoin to the PDN by pointing out that an individual can go out and buy something, transacting directly on the Blockchain, but not so on the PDN. To that I say, speak for yourself. When you go back as far as I do with the Federal Reserve, they grant you special prvileges.

But you're right, the average person does not make purchases on the PDN. And I contend that the only reason people do with Bitcoin is because it's still so young. If Bitcoin grows into adulthood, grabs a light saber, and fulfills its destiny of striking the Dollar down (thereby taking its father's place at the Emperor's side), layers and layers of financial services will have been built atop it, and only a subset of global monetary transactions will be cleared directly in the Blockchain.

Once a decent platform is built to facilitate Bitcoin payments where chargebacks can be performed reliably, most people will happily pay extra nominal transaction or fixed service fees for such protection. If such a platform chooses to clear transactions internally, it will be exactly what I described, only clearing upstream to the Blockchain when it's dealing with an external party. Alternatively, the platform could still process every transaction directly on the Blockchain and provide a sort of bonding-type service, but I suspect that will be a niche application in the long run.

To sum up, most comparisons of Bitcoin to its alternatives, including the Dollar and gold, are fraught with error. Even my own comparison of Bitcoin to the Fed's Primary Dealer Network is admittedly strained. Just keep in mind that the current Bitcoin network is only one component of a broader Bitcoin-based financial system that may or may not come to fruition. Next time a Bitcoin-hater or blindly optimistic Bitcoin-evangelist pens an article about how Bitcoin will or won't change the world, keep that in mind. And if they're touting Litecoin or Dogecoin, just ignore them.

Thursday, February 13, 2014

The Best Thing You Can Do for Bitcoin

I'll give you a hint. It's the opposite of buying things with them.

I say this hesitantly, as I'm currently paying my rent with funds coming from a company that facilitates Bitcoin payments. But I'm only one post in on this blog, and I can already repeat my caution to the reader, "If I turn out to be particularly clear, you've probably misunderstood what I've said."

This post was prompted by the attitude of most of the commenters on today's Reddit post about a porn site now accepting Bitcoin. Presumably, these Redditors are all Bitcoin enthusiasts genuinely interested in increased adoption of Bitcoin, and perhaps even its displacing the Dollar and other fiat currencies. And yet, here they all are, expressing the intention of doing the opposite of what would actually be good for Bitcoin. Sort of.

Let me be more clear. The best thing you can do for Bitcoin is to buy/mine/acquire as many of them as you can and to hoard them. Bitcoin will "succeed" if and only if it has a high market cap. The higher the better. When Bitcoin had a six digit market cap, CNBC did not do daily segments about it, and Larry Kudlow didn't say awesome things like that he would back Bitcoin if it were somehow linked to gold. The only reason the world is waking up and smelling Bitcoin is because it now has a $10 billion market cap. The higher that number goes, the more adoption there will be and the more resources will be poured into furthering Bitcoin's robustness.

But wait wait wait, you might still be saying. People will only want to use Bitcoins if they can buy things with them. And people can only buy things with them if merchants accept them. We must show our support for these merchants who accept Bitcoin to build the community. Aha! That last part is where you went wrong. Well, only half wrong really. I should give you more credit. After all, you're young and are up on the latest Reddit news, and I'm probably just some stuffy old guy who prattles on endlessly about beige books and interest rates.

The reality is that these merchants probably don't really care about Bitcoin. If they're smart (and they are), they recognize that all they have to do to tap heavily into the market of a fervent group of technophiles (that, as a sidenote, probably already consumes more porn per capita than any other demographic) is to pander to their Bitcoin enthusiasm. How dare they!

In all likelihood, these merchants are taking every Bitcoin that comes in the door and converting it as quickly as possible into dollars or whatever other fiat currency. When they do that, it has the effect of removing wealth from the Bitcoin network...assuming that every Redditor doesn't go out and buy more Bitcoins to replace those he just spent on porn. And even then, it would just be a wash, except for the little bit of "float" it would generate during the brief period between payment acceptance and subsequent liquidation.

In case the economics behind what I just described isn't crystal clear, let's have a very quick lesson on supply and demand. First off, we already know that the Bitcoin protocol puts its supply on a predetermined path to 21 million. So, the supply is fixed in a sense. If we want the unit price of a Bitcoin to rise from $1,000 to $1,000,000, which of course we all do, that only leaves demand. That means that every time you convince one of your friends to give up some of his dollars, or his stock portfolio, or his stash of 100oz gold bars in order to increase his demand for Bitcoins, yay! you're being a good Bitcoin Citizen.

On the other hand, every time you reduce your demand for Bitcoin by spending it on frivolous crap, not to mention transferring those Bitcoins into the hands of someone who has no true love for everything Bitcoin and is going to convert out of it immediately, a fairy dies. And Bitcoin's price drops.

So if you want to do right by Bitcoin, hold onto them. Only spend them if you were going to buy something anyway, and in that case, yes, absolutely, pick a merchant who accepts Bitcoin and pay with them! Just make sure to top of your Bitcoin allocation when you're done.

Having been a debbie downer throughout this post (at least for those who are jumping first and looking down later), I'll turn to being more constructive. One possibility for the Bitcoin community is to demand that merchants you patronize with your Bitcoins signal their love for it. I haven't explored the ecosystem enough to know whether a usable version of this already exists, but ask them to publish messages signed with their Bitcoin wallets to show that they aren't doing exactly what I described above. I know that BitcoinQt has built in sign/verify functionality, which I suppose is a start, but that's too clunky for what I'm envisioning. Merchants will need a mechanism to quickly and easily generate perhaps a QR code to display on their Bitcoin payment page, and you can use a smartphone app to read it then talk to a service on top of the blockchain that confirms the oh-so-sizable holdings of these genuinely, not superficially, Bitcoin-supporting merchants we're all coming to know and love.

If what I just described already exists someone please point me to it in the Comments section. If not, it seems like a feature that someone like could easily provide. Or if any readers have the resources, please go build it. I'll happily cover it here, and you can buy me a beer if you make it big.

Tuesday, February 11, 2014

Hello World

New to blogging and with no particular sense of style or purpose, this will be my first post. Ya know, just to get the ball rolling.

I'll be discussing whatever I feel like here, but the primary focus will be the intersection of monetary theory and technology. Bitcoin and its ecosystem will undoubtedly be the most oft-discussed topic for the time being. I have no fundamental opposition to the existence of any of the so-called altcoins, but I subscribe to a winner-take-all model of money (albeit path-dependent), and thus believe that the most likely outcome is that all the altcoins will die out eventually and should garner attention only as idiosyncratic case studies.

But alas, we'll be tackling the why and the how of such conjectures in more detail in the future. Check back soon!

Finally, I'll end with a quote that will simultaneously be a caveat to my readers and a theme of this blog, even if it's not yet apparent what that is.
I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said.