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.