Bitcoin: Hype or Revolution?

A Bitcoin evangelist once said : “Bitcoin will either be worth nothing or it will be worth everything.”

This mindset makes the case for a compelling small bet gamble: in the worst case one loses ‘only’ 100% of a small wager, in the best case a single bitcoin could eventually be worth millions.

Why should we believe that most of the probability mass is concentrated in the two extreme tails of the distribution?  We shouldn’t, but that doesn’t really matter, because almost all of the expected profit comes from the ‘Bitcoin wins’ scenario.  There is clearly a niche for a unified global currency: it would simultaneously solve many of the world’s economic problems.  But really that is just the beginning, because the establishment of a successful distributed cryptocurrency perhaps entails a new socio-economic order.  At the very least it would amount to one of the greatest wealth re-distributions in history.  This threat to the establishment is one of the typical arguments for bitcoin’s eventual failure.

But I wouldn’t bet on it.  Yes, Bitcoin could threaten the powers that be: the bureaucrats and old money of the world will probably not go down without a fight.  But as the music industry has learned, technology usually wins.  The Man is much more powerful than Music, but even the Man can not beat technology.

But if you can’t beat them, join them!  Bitcoin ingeniously solves the distributed trust problem via cyrpto-proof of work on a single global transaction history.  Thus at the core it is a massive unified database of every transaction in the currency going all the way back to the genesis block.  Simple, genius, and completely transparent.  It is this latter aspect which is not usually stressed enough: Bitcoin is radically transparent: every valid transaction is publicly accessible forever.  (Money laundering is still possible through mixing and other techniques, but the point is that radical transparency leaves a permanent global record which authorities can analyse with increasingly sophisticated AI)

Now let us take off our techno-libertarian goggles for a moment and think like a bureaucrat who wants to join the BTC party.  Bitcoin and it’s ilk each function as a global distributed computer, every node running in lockstep and building consensus.  If we liken the Bitcoin network to a nation, the nodes form consensus via something like a voting process.  The developers are then the equivalent of legislators, as the code running on the BTC platform is a legal/economic framework.  Citizens/nodes then vote on which set of rules or ‘nation’ to belong to based on their choice of which bitcoin (or alt-fork) client to use.

The USG/Fed doesn’t need to outlaw BTC, all they need to do is influence and or control it.  The transparent nature of the blockchain could massively simplify tax collection.  For any major transaction in a BTC world (mortgage, rent, car payment, etc) one’s BTC address can easily and obviously be linked to a personal real-life identity (as it already is).  They could go just one small step further and just make the tax accounting completely automatic.

This is the most straightforward course for governments to take: instead of outlawing the currency, they can simply enforce compliance with existing regulations at the code level.

The die hard crypto-libertarians would revolt and use alt-crypto-currencies, but for the mainstream such a ‘sell-out’ solution offers advantages to many parties.  Existing banks could get involved and use their current name brand and capital to offer their existing value-adding services to the BTC world, such as insured/reversible transactions, theft protection, etc.   Yes there are surely startups in the BTC world set on offering these services themselves, but the more enterprising of the existing banksters could adapt.  (not unlike how Barnes and Noble adapted to Amazon).

In this scenario, there is one major player who would be left out of the party: the Fed.  But perhaps that wouldn’t be so bad, considering recent world economic history.  There is something gravely tragicomic about a regime that has seriously considered minting itself trillion dollar coins just to liquidate its own debt.  On the  other hand, it is somewhat encouraging that the Royal Canadian Mint is cashing in on the popularity of BTC via their MintChip initiative (not that it will amount to much, but still).

Our current system for funding government is overly complex: consisting of both direct taxation in many forms and indirect taxation in the form of inflation of the money supply (amounting to an additional tax on savings).  Government could still get the same slice of the GDP pie in a stable currency scenario.  (or perhaps the Keynsian’s will win and force BTC/crypto-currency inflation at the code level.  Let us hope not – wouldn’t it be great if the major economic theories could actually have their decisive battle in the free market rather than in academia?)

Even if BTC begins another long slide/correction against the dollar (following the pattern after the spike/bubble in 2011), this latest spike/bubble effectively will amount to something like an IPO, transferring wealth from naive speculators who bought at the peak to bitcoin early adopters and developers, in addition to attracting significant shark VC funding.  Hopefully some of this cash will create the infrastructure that BTC needs to go mainstream: newbie-friendly security, reversibility/insurance, and instant confirmations for small purchases.  The BTC design is presciently flexible and can support these needs via multi-party sigs, green addresses, thin clients, and so on – it’s just a matter of time/money.  As it stands now acquiring one’s first BTC is not unlike installing linux – it is not for the technophobes, but there is no reason why the platform can not evolve into the mainstream.

Today BTC’s recent exponential price spike collapsed, and perhaps the recent bubble has popped, but hopefully this story has just begun.

chart

At first glance the long-term $/BTC history looks like a typical asset with overall slow steady inflation and a few bounces.  However, notice the logarithmic scale.

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