11
Jun
2011
Silas Barta Gives a Bit of an Explanation
Word for word, this is by far the best explanation I’ve read about the nuts and bolts behind BitCoin. Yes, I’m writing on it very soon, it’s just that I have to coordinate with my technical co-author.
(And some of you thought I should have banned Silas from the blog years ago. You see, I am the Dr. Xavier of libertarianism. Don’t make a bald crack.)
I’d just like to point out, and this may be obvious but worth emphasizing, that although the explanation Silas gives is very good, it’s nothing Bitcoin invented. All of those are in fact technologies that we use every day when using HTTPS (Secure) sites (certificates are processed using public key cryptography and hashing). So it is important that Bitcoin is “secure” (to modern standards), but it is more important how Bitcoin uses secure data. Like Silas mentioned, all transactions are public, so that’s one decision that was not necessary (for example, Bitcoin could have used a private database of the same cryptographically signed keys).
Well, Country Farmer, Silas did mention:
–that there were non-BitCoin users of these “crypto” techniques and that the techniques were not unique to BitCoins.
–that his discussion was a prerequisite to understanding BitCoins rather than an explanation of BitCoins.
–that security is an important issue so BitCoins do not have a single point of failure like other databases.
So Silas’ write-up did serve a good purpose for a broader group of readers who didn’t have the foundation of Country Farmer and Silas is more of a “pre-technical advisor” to us. Glad he isn’t banned from the blog!
Are these math problems being solved actual problems that have stumped folks in the past and thus solving them adds to the store of knowledge or are they just randomly generated as a make-work pretense to provide people with Bitcoins?
Thigh I did find out my Star Wars name is Leval Kai so that’s cool. Also Silas wants us to sue Don Imus for some reason.
They are randomly generated make-work problems… constructing a pre-image with partial match to some has function. The only “benefit to humanity” type outcome of these problems is proving that the hash function is cryptographically strong (or at least, proving that someone who does know how to break the hash is not going to waste that knowledge collecting a few bitcoins when it could be put to some far more valuable purpose like rigging internet voting or constructing fake carbon trading certificates).
In theory though, the bitcoin could be awarded for solving any difficult mathematical problem, including those that do add to the store of human knowledge in a more positive manner. I presume that the current bitcoin is a fun proof of concept, to demonstrate the principles and see how people react. Also, any genuine problem (e.g. protein folding for medicine) has a buyer already, and the buyer would be paying in more broadly socially acceptable currency than bitcoin.
I consider BitCoin from three different perspectives. The first is as a digital currency. Is a digital currency a good or even a valid concept? The second is the intended process of the proposed digital currency. Can it work for a market? And the third is technical. Is the proposed digital currency secure and reliable?
I hope someone addresses these issues independently, and for the third issue, this really seems like something for people who know how those stuffs works. I also hope that consideration is given to the possibility that this is truly something new, thus traditional research materials on the topic may be incomplete for arriving at a proper conclusion and some new research or factors may need to be factored in.
More importantly, Bitcoins is just a digital fiat currency, like all current fiat currencies for all practical purposes. As such it is created by deficit spending, in this case rewarding nodes that perform time consuming senseless computations. The main difference is that taxes cannot be paid with Bitcoins, which means it is a foreign currency in every country. That makes it unlikely or even impossible that it will become widely accepted, but as long as it acceptance grows it is the perfect Ponzi scheme.
The computations that are performed help to keep up the distributed database. It’s not random number crunching.
It isn’t fiat. It takes resources to produce it, and people are free to use it whether they want to or not.
The idea is that eventually, the cost of producing a bitcoin will be roughly equal to the price of one. It is quickly approaching this point.
I find it an interesting experiment, and I’ve yet to find any convincing argument to show me why it won’t work.
It is fiat, it has no other intrinsic value than its nominal value. It is created by deficit spending and its value is arbitrarily determined by the issuer, in this case rewarding number crunching. The only difference with state money is you can’t use it to pay taxes which works against its widespread acceptance. It can be an interesting experiment, but it still looks to me a Ponzi scheme from which early adopters will benefit.
If it cannot be used to pay taxes, then it also cannot be used to incur taxes. How will the market perceive this as a disadvantage?
The value is determined by the market. See this article:
http://www.dailytech.com/Digital+Black+Friday+First+Bitcoin+Depression+Hits/article21877.htm
The people who mine gold also make quite a lot of profit. Does that make gold a Ponzi scheme?
Whether it cannot be used to incur taxes is a legal matter. The disadvantage of not being able to pay taxes with Bitcoins is lower demand.
The value is determined by the issuer, in this case when it pays for successful number crunching. Then the market determines its price wrt other currencies at indifference level.
Gold is a commodity and an input to production, not a fiat currency. Gold miners don’t make much profit. Gold extraction companies and speculators do. And yes. gold as an asset is another Ponzi scheme.
Currently, the value of a BitCoin is hardly any more than the cost of creating a BitCoin, so the ‘reward’ is hardly any better than other investments. And given the recent volatility, the cost of creating one may at times be higher than the value of the BitCoins produced.
Given the liquidity, even if BitCoins accepted for payment are taxed, the BitCoins can easily be converted to dollars. In fact, I’d be willing to bet that all of the associated fees with the conversions will still come out to be less than credit card transaction fees, which are very real fees that most vendors hate.
BitCoins cannot be created by decree, so I don’t see how the term ‘fiat’ is properly applied.
The value is constant, 50 Bitcoins per successful number crunching, as opposed to 5 or 5000. The successful number crunching is the decree.
The market determines its relative value wrt to other currencies at indifference levels, like any currency in the fx market.
On some level, everything is a ‘decree’. The amount of gold to be deposited on the Earth is determined by some set of rules that is unknown to us.
In my mind, the ‘decree’ in a currency is one ordered by the sovereign and can be changed at any time. For the case of BitCoin, there is no sovereign, thus the amount added cannot be changed, assuming the system works as intended.
It can and will be changed.
The sovereign issuer is a software in this case.
But the software is not changeable. The code is set to expire some very long time in the future. 2140, I think?
With the software we can see the precise rules that the currency operates under. Fiat currencies have no such rules and the rules governing gold are unknown to us.
@MamMoTh: The sovereign issuer is a software in this case.
Then the term “sovereign issuer” has lost all meaning.
PS: Props to retired engineer for his (her? not many retired femaile engieners alive today) assimilation of my points.
No, it hasn’t lost its meaning for analysis purposes of the currency, which is all that matters athough it might not trigger the standard autro-libertarian tantrum.
Yeah, Autro is a pretty crappy self-produced, derivative, garage band, but I had no idea that they were libertarians. Their music sucks, but at least they’re on the right track philosophically.
😉
That DailyTech article was annoying. Who in the heck uses the term “inflation” to refer to a crash in market values?!
Yeah, the Daily Tech definitely could stand some non-tech editors, but the larger point that the miners don’t set the market price is demonstrated by the events described.
Who sets the market price of any good but the consumer?
Well, I was responding to MamMo Th’s claim that the value is “arbitrarily determined by the issuer”.
That certainly is NOT the law in Australia. Barter transactions count as legal income here (although whether you declare that is a matter for your own conscious and how likely you are to get away with it).
To the extent that bitcoin could be used to facilitate a barter transaction, and leave a paper trail documenting such activity, the Australian Tax Office would expect to get their share. With foreign currencies you can nominate a conversion rate that was valid at the time you made the transaction, or at your choice the time you pay the tax. They only care that the tax gets paid.
Guys, I think Mammoth is right (wow I had a wave of nausea just typing those words…) when he says BitCoin is fiat. We’re going to address this in the article. In terms of the standard Misesian classification, yeah it’s fiat. However, I’m trying to think of a different term, because “fiat” makes it sound like the government is ordering you to do something, which obviously doesn’t hold here. Maybe something like “unbacked” or “non-derivative.” Or we could be marketing guys and call it an “independent currency.”
You could take the angle that it requires fiat currencies to create bitcoins, and/or to purchase the computer equipment necessary to mine bitcoins. I also find it funny that bitcoins require computers and electronics in order to exist, that if some event happened (electro-magnetic storm) to render all of these computers worthless, or wipe everybody’s hard drive, that bitcoins would disappear completely.
I think the fact that fiat currency is used to purchase equipment which produces a digital currency is not relevant to the validity of the digital currency. The fiat currency is used because it is the only type of currency available.
As the the technical issue of some sort of solar storm, you will have this problem regardless of the type of currency used. History shows that most people would choose to deposit their gold in a bank, and since the banks all use computers nowadays, all of the records of your ownership of an account would be wiped away the same as with any currency, so this issue not really currency specific.
Also there could be an earthquake that swallowed all the gold coins.
When the sun turns into a red giant and swallows the earth I guess all exchanges will have to be on the atomic level.
I hadn’t considered just how important the naming is! Isn’t BitCoin something more than just unbacked or non-derivative? It is also self-regulating. Perhaps non-derivative self-regulating? Currency hasn’t previously been offered with its own built-in equations, well, aside from the ones that mother nature uses to ‘regulate’ raw materials.
The word “fiat” implies a decree made by authority. There is no compulsion to use bitcoin, nor is there any authority, so there is no fiat.
What’s more, anyone can start their own bitcoin system using exactly the same algorithm (or a different one if the prefer), and using one, some, all or none of these transaction systems is purely voluntary.
From this perspective, bitcoin is merely a digital means to facilitate trade. The intrinsic “value” that bitcoin brings to the marketplace is the value of having secure non-refutable transactions over the Internet. It is no different to why people pay fees to Amex, or VISA (generally both the card holder and the merchant end up paying fees) in order to have access to a reliable mechanism of exchange.
Whether bitcoin performs this task better than Amex is something I can’t really comment on. At this stage bitcoin is an infant technology while Amex already has an operational worldwide network, so any comparison is fraught with difficulty… but my point it that they compete for the same niche.
It seems that most Austrian economists are coming out in opposition to digital currencies based mostly on the fact that it is unbacked. I don’t own any BitCoins and I don’t have plans to purchase any, but this doesn’t seem like the justification for disqualifying it as a valid currency.
I also find weak the argument that it is disqualified because it is only computer code, thus has no value. There are lots of things made up of computer code that are of value. Microsoft Windows, Microsoft Office, video games, phone apps, etc. People value these greatly and BitCoin is made of the same stuff that makes them.
The digital realm is something that offers things simply impossible in the physical world. WordPress, which you got for free and millions of people use, has no physical counterpart, as with Linux, which runs over 60% of webservers.
My hope is that if someone claims that digital currencies are not valid, they provide some deeper explanation.
To be honest, I am more taking it from a regression theorem stance than anything else.
How would you reply to this post on the bitcoin.org forums? I found it when doing some googling. The forum seems to have a problem with the link, so here is Google’s cached version:
http://webcache.googleusercontent.com/search?q=cache:R9EU_DcDpTAJ:www.bitcoin.org/smf/index.php%3Ftopic%3D583.0+regression+theorem&cd=7&hl=en&ct=clnk&gl=us&client=firefox-a&source=www.google.com
I agree with about 90% of what the first post stated, but I think that he makes a jump in logic when he speaks of a cataclysmic economic event. He states that although fiat currencies will lose their value, the bitcoin will not. The fault that I see here is that while government currencies are primarily debt-based, they are also collateralized; the bitcoin does not share this attribute. Also, I think that he forgets that when such events happen, it is those goods that are tangible whose use value preceded their exchange value, that it is those goods that are first valued for their use (as well as other characteristics) that are the heart of the regression theorem when it comes to the evolution of a medium of exchange.
Also, I wouldn’t refer to a bitcoin as money or currency, because it is not generally accepted as a medium of exchange. In fact, it isn’t even marginally excepted as a medium of exchange as displayed by the minuscule number of vendors that accept it.
Okay, ‘proposed currency’.
I more or less like to think of the bitcoin as a complimentary good, rather than a currency in and of itself. It cannot exist on its own without the other goods that give it utility in exchange, therefore it is entirely useless without these other goods. To use a Mengerian example, you cannot make bread without flower, yeast, salt, labor, fuel, water, and the many other complimentary goods required for such a simple task as making a loaf of bread (oven, mixer, roller, etc). If you take just one of these away, then it renders each of these complimentary goods entirely useless to the task of making bread for consumption or exchange.
This is very important, because it reveals the major flaw in the use of the bitcoin as a medium of exchange. The existence of the bitcoin does not require such a short list of a few readily available ingredients in order to make it useful for exchange, rather it requires thousands of individual complimentary goods in order to even make it existent on this planet, or within the market itself. Sorry, but it seems to me that if one were to simply remove one of these ingredients, or more likely, to remove a portion of these ingredients, then the bitcoin then ceases to have any use as a first order good. And, as per the regression theorem, it does not even exist, let alone have any value for use or for exchange.
Granted, the use of the mixer, roller, etc are more advanced complimentary goods, that each also require a structure of production to produce in their own right, they are not mandatory for the baking of a loaf of bread.
However, the complimentary goods mentioned (flour, salt, yeast, labor, fuel, water) are required to bake the bread. A computer is not this simple, and its stages of production are quite vast in its expanse. Sure, I imagine that there are many substitute goods that could be used to replace the others (that is how the market works), but this is not a thorough refutation of the regression theorem, nor is it a challenge to the idea that such goods are not limited by scarcity.
As I have said before, bitcoins only derive their value from the current fiat currencies available today. Absent these currencies, the bitcoin ceases to have any value because it has no use value, as per the regression theorem. It derives its value in much of the same way that any fiat currency derives its value- by shear belief. While a fiat currency, as much as I dread the thought, has the collateral of me, you, and all of the assets and land under its command to support its currency, the bitcoin has nothing.
How about calling them “credits”? Since that is essentially what you are earning for doing work for the BitCoin people but yet they are not widely accepted and thus not really currency.
Plus, I would think no one would expect credits to be backed by anything.
I like credits. I like ‘cyber-credits’ even more, but definitely ‘space-credits’ would be the coolest, although that wouldn’t really apply in this case.
Bitcoins may or may not succeed at a digital currency, but from what I have read, they have more in common with precious metal currencies than paper currencies.
Except, that you cannot actually see or hold a bitcoin.
You cannot see or hold a video game, but if you owned the rights to Call of Duty, you might feel like you ‘have something’.
Yes, I agree that that bitcoin is just as tangible as the video game ‘Call of Duty’. Does that make ‘Call of Duty’ a general medium of exchange? In fact, I would say that ‘Call of Duty’ is probably more suited to be a medium of exchange, because it offers direct utility, something that the bitcoin lacks. I would feel more confident in basing an economy on the medium of exchange of the ‘Call of Duty’ video game than I would that of the bitcoin, primarily because ‘Call of Duty’ has original use value, and that all complementary goods needed for its use are based upon production.
This seems to be a common perspective of economists and I’m not sure it’s correct. I’m not a software engineer, but I feel they may disagree with your understanding of software.
The bare ‘element’ in BitCoins is software code. It is the thing that is used to make everything from ASCII art to facebook. It can be used to make things of no value and things worth hundreds of billions of dollars. This element is readily protean, but can be rigid in the product created. I don’t see how this is any different than the valued element of gold.
While it is true that in order to make a bitcoin involves capital investment and complimentary goods, the actual bitcoin itself has no use value whatsoever, and its exchange value is contingent upon the value of current government fiat in circulation.
One can call bitcoin an alternative currency or a proposed currency, but I would like to posit that it is merely a complimentary currency, one which derives its value with regard to exchange with the currencies already available (with respect to a mathematical predeterminate).
The bitcoin is not valued for its own utility, rather it is valued based upon the predetermined mathematical equivalent of its exchange with government currencies. It has zero use value in and of itself, and thus would be entirely valueless in a world absent computers or consoles. This tells me that if a cataclysmic event such as I (and, the topic that you posted) became a reality, that not only would the bitcoin be worthless, but it would also be nonexistent. And, as I stated above, even government currencies, whose values have and do fall to zero, have real collateral to back their value; bitcoin has nothing but bits and bytes on a computer. How is it that government currencies can fail to the value and utility of the paper that they are printed on, yet I am to believe that a binary magnetic imprint on a hard drive is immune to this dynamic?
I think that bitcoin proponents are being reactionary, and are also ignorant to the orders of goods. That, if one were to strip the bitcoin of its complimentary goods (or those of the higher orders), that it would render the bitcoin entirely useless. And, it just so happens that the complimentary goods required to give the bitcoin its current value cannot be put back into order without the structure of production that exists today, at this very moment.
One must never neglect to account for the uncertainty of future events, even if no catastrophic event were to ever appear, one must be cognizant of the fact that the very structure that supports current production, and the goods thereof, can change at any moment in time. The bitcoin requires many thousands of complimentary goods to exist, if you strip just one of those away, then it renders the bitcoin entirely useless.
We don’t live in the test-tube world of not having computers or consoles. We live in a world where people are carrying computers around with them.
How would you describe the value of gold? Can I get gold without using a fiat currency (or a gun)?
BitCoin is made up of the thing that people value – software code. I’ll again bring up the example of a product made from ‘worthless’ bits and bytes: Microsoft Windows.
If the cataclysmic event you introduced occurred, then not even gold would have value. The only thing of value would be guns, ammo, food, and possibly gas. We’re talking Mad Max. Do you recall any medium of exchange being used in Mad Max? It’s been quite a few years, but I recall they were on the plunder system.
While the fiat currencies can be used to start a fire, if for nothing else, and BitCoin removes that utility, BitCoin also removes the problem of expansion of the monetary supply, which is the primary cause of reducing currency to tinder.
BTW, that is Mengerian theory. While I am a Rothbardian (with Misesian tendencies), I often find a simpleness in the Mengerian tradition, especially when it come to goods.
I exchange every day with money I don’t hold in my hand.
Let’s assume for the sake of argument that Bitcoins do become a medium of exchange. Their number has an upper limit, unlike dollars, so they should have a slow deflationary effect (which need not be a problem because bitcoins are divisible to multiple decimal places).
Of course, the entire system depends on electronic infrastructure, so they are unlike in that way to gold and silver, and paper money.
Well, they did crash over 30% the other day merely based upon a discussion in a message board. Hmm, kind of sounds like how Jonathan Lebed used to make his money in penny stocks. By the way, how much does it cost in US dollars to get a mining operation underway, and how many bitcoins can you mine in the first month of this operation?
Yeah, I’ll pass. Carbon credits are sounding like a better deal at this point.
So? Bitcoins aren’t really much of a medium of exchange, yet. I don’t know that they ever will be, or that something similar will be, but the basic idea isn’t any more insane than the monetary system you have today. Yes, I too will pass, at least until they are more universally exchangeable.
Bloody government!
Always in the way of our stable free market!
Strawman alert.
Anything can be money, as long as at least two people agree to use it as such. End of story & discussion. If at least two people use bitcoin as money, it is money. Praxeology at its finest. If your deductions from your understanding of praxeology contradict what people actually do, your deductions or understanding are wrong. It’s really that simple.
Most people don’t use Tugrik for payment of anything. Does that mean Tugrik is not money?
x is scarce.
x is fungible.
x is infinitely divisible.
x can be stored.
x cannot be forged (it seems)
x is desired by (some) people
would x be a good base for money?