I think I’ve developed somewhat of a reputation as a troll when it comes to Bitcoin (probably other topics as well but that’s not germane to this post). I’ve pissed off a few directly within the Bitcoin circle, particularly Marc Andreessen, Chris Dixon, and Balaji Srinivasan, all of whom have blocked me on Twitter (to be fair, I think Andreesen did it simply because he thinks I’m a dick). Bottom line, I think a few of Bitcoin’s most visible proponents have not been honest about their intentions with it. The fact is, I think they have drafted on the hype and excitement of Bitcoin to move it in a direction which is completely contrary to the stated intentions of Satoshi Nakamoto, Bitcoin’s creator. At least according to Nakamoto’s famous white paper, Bitcoin was originally conceptualized to challenge the fiat currency paradigm. However, the venture capitalists of Silicon Valley have a very different future for it in mind.
The story coming out of SV now is to think of Bitcoin not as a currency but as a protocol akin to TCP/IP and related Internet technologies. That’s pretty savvy thinking because it gives people something tangible with which to identify. There’s no denying that, if they could be accurately monetized, the value of the Internet’s essential protocols would be astronomical. What Silicon Valley VCs are pitching is an opportunity for people to get in on the ground floor of what essentially is a brand new Internet built with blockchain technology. The real value of this new network is that, unlike the original Internet, it is inherently very secure, an essential element for a system with which you would want to exchange sensitive personal and financial information, particularly currency transactions, on a global scale.
In this respect, I really don’t have a gripe. If Bitcoin had been initially presented in that fashion, I think I would have been far more enthusiastic about it. However, that wasn’t the case. By all accounts, Bitcoin was developed as an experiment in currency. It is that perspective from which I have evaluated its potential. With respect to it being a currency, the reality is that Bitcoin is seriously flawed.
I’ve written a number of articles regarding the fundamental problem of Bitcoin’s fixed limit, which I see as its Achilles Heel. Probably the most salient general explanation of Bitcoin’s structure from the standpoint of agents was recently written by Adam Ludwin titled “Why Bitcoin Apps and Bitcoin Speculators Need Each Other.” I’ll use some of it to illustrate my points. Let’s start with this:
“After all, new bitcoins aren’t the only thing that miners create.
Their competition with one another to mine the next block (and receive the current reward of 25 freshly minted bitcoins for doing so) also produces, by design, a secure financial network: one which is open, decentralized, programmable, and very inexpensive to use. The beekeeper gets honey, and the rest of us get flowers.
So here’s the other half of the story which completes the picture:
- Miners create a secure network
- Because it is open and programmable, apps and services are built on this network, driving demand for bitcoin
- The price of bitcoin is affected
- Miners with a marginal cost lower than the price of bitcoin keep mining”
Honestly, this is brilliantly written. It provides a succinct explanation that pretty much completely expresses the value proposition for speculating in Bitcoin.
Now let’s draw that out to its logical progression, keeping in mind that only 21 million units of Bitcoin will ever be produced. First, for a sense Bitcoin’s scale in units relative to the world’s total population, please read “The Questionable Mathematics of Bitcoin.” It’s essential reading for understanding just how little 21 million units really is if the intention is for Bitcoin to act as a complete replacement for fiat currency. Now let’s take a closer look:
Miners are “by design, (creating) a secure financial network: one which is open, decentralized, programmable, and very inexpensive to use.” If you are a Bitcoin fan, this is a great development. As the network matures, its utility increases. Which increases demand for Bitcoin. Which increases the unit value (via exchange rate) of Bitcoin. Sounds good, right?
Well, that situation creates two problems. The first one relates to the constriction of the amount of bitcoin available for any one person as a result of high demand; to understand more about why high demand for a fixed currency is a problem, please read “Bitcoin and Divisibility.” The second is that this dream scenario is also a nightmare; at some point, the tokens, even in minuscule denominations, are simply going to become too valuable to transfer for any purpose. Think about it… would the value of a network like Bitcoin ever drop? Has the Internet’s? To the contrary, Bitcoin would likely become the most secure and valuable asset class ever. What would be the motivation to trade them even in tiny amounts?
This doesn’t even take into account the fact that a small minority of Bitcoin holders already control a huge quantity relative to the current total available. In this situation, their investment goes through the roof.
But the knock on this scenario is that, after a while, transactional activity will only encompass a tiny amount of Bitcoin. The vast majority of it will be held and any transactions will likely involve dollar figures far beyond the financial capacity of the average person. This flies completely in the face of why Bitcoin was supposedly created in the first place.
“But Bitcoin won’t have to be exchanged with fiat currency forever!” As long as legal tender is in state-sponsored central bank generated fiat currency, yes, it will be. A worst case scenario that would change that dynamic would likely also challenge the viability of Bitcoin as well. For that matter, Bitcoin’s perceived value, ironically, is only measured in fiat currency. As of now, Bitcoin is not a unit of account and there is no realistic way most products could be priced strictly in bitcoin. Its relationship to fiat currency provides an essential point of reference.
Now, for most people, particularly those heavily invested in Bitcoin, that scenario really isn’t too bad. In fact, it might actually be pretty damn good. Between now and Bitcoin’s eventual heat death, there’ll be quite a few opportunities to get rich. Whether buying bitcoin or creating a start-up on a sidechain or various VC investment routes, Bitcoin looks like (pardon the metaphor) a “gold mine.”
That’s just it though. If you build it, they don’t always come. I’ve read about whole cities in mainland China that don’t actually have anyone living in them. Sometimes, the economics of a situation simply prevents an expected outcome. In the case of Bitcoin, there’s a major snafu with the concept of building a completely new, secure network…
Bitcoin’s core technology, the blockchain, can easily be either replicated or substituted.
The intention of the various VC interests in Bitcoin is, for all intents and purposes, to build a new secure Internet suitable for financial transactions. The claim is that Bitcoin isn’t simply a currency but also a protocol and, when approached from that standpoint, it has (according to them) tremendously high intrinsic value.
When discussing intrinsic value, I always make the point that one of the most essential elements of something with high intrinsic value is that, not only must it have very high utility, it must also be unable to be easily substituted. For instance, indoor plumbing… to date, no one has come up with a better system for moving water through a home or building and likely won’t. There are no practical substitutes for it conceptually.
This is where the thinking of Bitcoin fans falls short. We already have a pretty effective substitute for the blockchain… the Internet itself. Almost anything that could be conceived to run on the blockchain can also be done using off-the-shelf Internet technology. Maybe not as precisely or as securely. But, pretty damn effectively. Cases in point: Amazon AWS, Salesforce.com, Google, Wells Fargo, MasterCard, Visa, Apple Pay, etc., etc.
But, more importantly, the biggest issue when considering it from the perspective of Bitcoin being a protocol is that it is open-sourced, which means the blockchain core technology can easily be replicated and/or duplicated. While most people associate the World Wide Web with the Internet, the truth is that there are actually many private “internets”; the most important protocols gain value from their ubiquity. Right now, SV venture capitalists are attempting to build so much value into the Bitcoin ecosystem that alternatives become unattractive. While this may dissuade newcomers, large competitors have both the means and the motivation to create direct competitors to anything produced on the Bitcoin network with their own private blockchain networks.
Unlike with the open Internet, there’s is no real motivation for everyone to centralize on one platform. In other words, there’s absolutely no incentive for incumbents to accept a “World Wide Web” of Bitcoin, it’s more feasible for them simply to build their own blockchain “intranets.” Most of what can be built on top of Bitcoin competes directly with highly capitalized financial services; why would these entities just sit around and let Bitcoin steal their lunch when they can just build out their own blockchain infrastructures? Or just purchase mining operations outright?
This brings me to another topic: governments. While I had intended to write a section regarding Bitcoin’s shaky relationship with government, a recent article written by Henry Farrell titled “Bitcoin’s financial network is doomed” makes a more complete case for the challenges Bitcoin faces regarding government regulation. One point I would like to add is that, unlike market competitors, most 1st world governments and central banks have both the resources and motivation to execute a “51%” attack against any Bitcoin network should it succeed in significantly circumventing or marginalizing their control of their currency.
Technologists often poo-poo the capabilities of governments but fail to consider that many 1st world countries already have sophisticated surveillance and cyber-security apparatuses. The likelihood that countries such as China (which holds the majority of Bitcoin mining operations), Russia (which is awash with hacking talent), or the United States could not sufficiently compromise any relevant Bitcoin network is doubtful.
Over the course of several months, I’ve attempted to articulate why I’m not a Bitcoin supporter. The following is a recap of my main criticisms:
- Divisibility is moot: Dividing bitcoin into smaller fractional units by its very nature is inflationary. The only way this isn’t the case is if there is a direct relationship with a growth component. Currently, the growth component correlated to Bitcoin is fiat currency via exchange rate; when demand increases, the value of bitcoin as measured in fiat currency grows, which makes division into smaller units feasible. However, dividing bitcoin into smaller units when demand decreases would be obviously inflationary. In a pure bitcoin economy, resources themselves would have to expand in order to make dividing bitcoin into smaller fractions feasible. This process has a natural limit because the Earth itself, like Bitcoin, is a fixed resource. In almost every scenario in which demand for Bitcoin is high, the most likely outcome is that the percentage of Bitcoin’s total average purchasing power decreases in a manner similar to hyperinflation.
- There’s no “goldilocks” zone for scaling it: Right now, Bitcoin is a blip on the radar of governments, central banks and major financial institutions. However, it’s impossible for it to “fly under the radar”; once Bitcoin grows to sufficient size, its advantages will either be competed or regulated away. Even assuming that it could get past those entities, Bitcoin’s own strengths guarantee its destruction; a financial network of its nature would become an asset class unlike any other. Token values would quickly escalate to a point that trading them would become practically unfeasible. Bitcoin can only be “too cold” or “too hot,” there is no plausible scenario in which it can build value without facing financial and regulatory interests that are far more powerful or destruction from its own value.
- It can’t overcome governments’ monopoly on authority/force: As long as governments require taxes to be paid in their issued currency, Bitcoin will always have to be exchanged so there is no probable reality in which it can itself become a unit of account. So the prospect of there ever being a pure Bitcoin economy is practically nil. Bitcoin will always be playing someone else’s game, namely the central banks’. Its most powerful entrenched opposition has the advantage of both laws and guns.
- Its competitors are highly capitalized and highly motivated: Bitcoin isn’t just challenging a bunch of stodgy old incumbents ripe for market disruption, it is literally challenging the businesses that make the markets possible. Bitcoin is facing a financial and economic apparatus worth trillions of dollars. The people who run these institutions are so powerful, they can rape the economy and not only not go to jail but actually have governments step in and bail them out when they screw everything up. These guys are not just going to allow their apple cart to be upset. They will protect their institutions by any means necessary, up to and including buying, re-creating or otherwise co-opting blockchain technologies and companies. The one thing these entities won’t have a motivation to do is invest in the Bitcoin ecosystem. They aren’t interested in making anyone else rich. It’d be easier for them just to create their own blockchain infrastructures and rob Bitcoin of its value.
- Bitcoin’s core technology is open for any of its competitors to use: The hope of Silicon Valley is to create such a comprehensive infrastructure that a significant barrier to entry is built. That’s a good strategy when dealing with new entrants but useless when dealing with highly capitalized incumbents. See “Netscape vs Microsoft.” If Bitcoin is indeed simply a protocol, then there is no reason it cannot be adopted by other companies just like any other Information Technology. Companies invest heavily in infrastructure that enables their Internet efforts; why not make similar investments in blockchain technology? The protocol sword cuts both ways. If Bitcoin is simply a new protocol akin to TCP/IP, SMTP and other core Internet technologies, then it’s not much of a logical leap to think that others will also adopt it for any advantages it may offer. Once again, under these circumstances, there is no motivation simply to adopt Bitcoin as those tokens are, more or less, already spoken for.
- A pure Bitcoin economy likely won’t work anyway: Markets are very elastic. Bitcoin is fixed. By its nature, higher transactional increases based on greater demand in some markets will distort the amount of money available to others. A pure Bitcoin economy would be like a balloon squeezed from different angles, certain market values would become distorted simply from activity in others. The very concept of supply and demand would no longer truly apply.
Here’s the thing… I could be dead wrong. Maybe Bitcoin overcomes these factors and gets huge. The one thing of which you can be sure is that it won’t be the Bitcoin of today. It’ll look much more like an asset class and be much more highly stratified. Whatever libertarian sentiments associated to it will be long gone. That’ll be a great outcome for some, particularly VCs and early adopters, but not so much for anyone who thinks of Bitcoin in terms of liberty and anonymity.
My ultimate issue with Bitcoin is that it doesn’t solve what I’ve referred to as “the currency paradox.” If you want to learn more about it, please read the essay. My hope is that the next major economic innovation is one that will improve the lives of everyone, not just a few lucky adopters.
So, does this mean that I think Bitcoin is “doomed”? Hardly. I think the blockchain will eventually grow up and be integrated in a way that is generally beneficial. A more reasonable outcome is that miners will eventually be subsidized or purchased outright by financial services companies. Under the current system, Bitcoin tokens must have significant value for miners to be incentivized. However, in order for mass adoption to occur, those same tokens likely should themselves have no value. My guess is that, sooner or later, the value of Bitcoin tokens will eventually be zero. That is the only realistic way its competitors will become motivated to invest time, effort, and money into the ecosystem.
My advice to Silicon Valley is to find an alternative to the mining incentive. The only way that can be done is to build a value proposition attractive enough for other financial, health and personal service companies to want to invest into one unified platform. With a token value of zero, Bitcoin as a protocol and platform is no longer a threat to entrenched interests but a new frontier. I think VCs will find that there is still an amazing amount of value to be unlocked with Bitcoin, likely billions, even trillions, of dollars worth. But, in order for that to happen, the tokens themselves will have to be worth nothing.
As for fans of Bitcoin as a currency, there is still the “altcoin” community. My guess is that virtual currency innovations and competition will still continue to take place in this particular area, providing many opportunities to build a community money that is convenient, inexpensive to use, and anonymous. I think this area still holds the greatest potential for addressing the problems of the “unbanked.” New blockchain currency innovations still hold a lot of business opportunity potential, particularly in mining and speculation. I fully expect the “altcoin” scene to remain the “Wild West” of virtual currency creation and speculation.
So I don’t hate Bitcoin, I just don’t like it… yet. I think it’s obvious that it will not fulfill Satoshi Nakamoto’s dream of disrupting the fiat currency paradigm, at least not in its current incarnation. But, that doesn’t mean that it isn’t an amazing achievement. The key is in finding a way to properly unlock its potential. And that starts with finding a way to get its token value to zero.