The Tone-Deafness of the Bitcoin Community

hands-over-earsI can’t say I was surprised by the recent Bitcoin crash. Indeed, I was expecting it. I’ve written extensively about what I view as its challenges and have even attempted to correct one of its most significant. As it stands, Bitcoin isn’t much of a solution for any problem related to currency.

What has amazed me the most about the reaction to the recent crash has been the tone deafness of the Bitcoin community. The mentality has been what I’d call “defiant denial.” The whole notion is that Bitcoin token value doesn’t really matter, the network will go on. This is pretty much a technicality; yes, the Bitcoin network will continue as long as the marginal costs to produce them is less than their exchange value. The difficulty in producing Bitcoin adjusts based on the number of active miners in the system; difficulty increases when there are more miners and decreases when there are fewer. My assumption is that these fluctuations in difficulty allow the marginal costs of Bitcoin to almost always be low enough for there to be an incentive for them to be produced. However, the trade-off is that, as the total computational power of the network decreases as economic considerations force some miners to stop participating, the network weakens and becomes more susceptible to a “51%” attack.

When Bitcoin crashed, Silicon Valley venture capitalist Marc Andreesen trotted out his New York Times op-ed titled “Why Bitcoin Matters” to rally the troops. I had intended to do a complete deconstruction of it but I thought “Why bother?”. I figured there wasn’t much I could say that a total bottoming out of Bitcoin wouldn’t state more eloquently. Needless to say, Bitcoin sank to under $180 and has since stabilized in the $200 range, down roughly $150 per coin in less than a month. I think that will get much worse over time.

What’s apparent is that the Bitcoin community isn’t looking at it realistically and doesn’t seem to truly understand why no one could really give a rat’s ass about it. There seems to be this arrogant sense of inevitability about it; technologists and Bitcoiners seem to think that it is only a matter of time before the rest of the world opens its eyes to the wonders of Bitcoin. Maybe that is the case, but chances are much better that they are sadly mistaken.

Rather than a complete dissection of Andreesen’s position, I’m only going to address three essential areas. By the end, it should be sufficiently apparent why Bitcoin is not only far from an inevitability, it is currently well on its way to complete failure.

First point: if you’ve read anything about why Bitcoin is supposedly so great, you’ve read about something called the “Byzantine General’s Problem” but more accurately referred to as the “Two General’s Problem.” I won’t go into any more detail about it because:

Neither consumers nor merchants give a damn about it.

The first, and most essential, error Bitcoin fans make is in thinking the Two General’s Problem means anything to anyone other than a software engineer/cryptographer. Third party trust (TPT) is not something to which most people are particularly hostile. To the contrary, TPT is something which generally makes people feel more secure when doing sensitive transactions over the Internet. The notion of an arbiter, even an imperfect one, gives people the sense that, should a problem occur, there is an objective third party capable of solving it.

Since almost no one cares about the Two Generals’ Problem, what actual problem is Bitcoin truly solving for anyone other than computer geeks? Merchants want to make money, consumers want to save it. Bitcoin provides a small way for merchants to keep more of the money they bring in, so a few have adopted it. There is no evidence that Bitcoin saves consumers money (and the volatility of it as a currency practically guarantees it doesn’t), so there is no compelling reason for them to use it… and they don’t. In either case, Bitcoin’s utility is either negligible or non-existent.

This brings me to my second point. In this respect, many Bitcoin supporters think remittances will be Bitcoin’s immediate “killer application.” But here’s the deal… there are only two outcomes possible in the best case scenario. The first is that the value of Bitcoin tokens will increase as transaction demand goes up. For the average person, this will become a problem (I’ll elaborate on this later). The other alternative is that, though low now, transaction fees will increase significantly very quickly. Why? Energy costs, which will increase directly in proportion with transaction demand. The “proof of work” system utilized by Bitcoin is extremely energy intensive as every node keeps a perfect record of every transaction. To cover these additional costs, either the value of the tokens or the transaction fees must increase to compensate. If transaction fees increase, then any price advantage derived from utilizing the Bitcoin network for remittances will dwindle as demand increases.

Which brings me to my last point: let’s say that Bitcoin token values increase and transaction fees remain stable (and low)… what are the economic dynamics of Bitcoin as a currency? For instance, let’s say you purchase .1 of a Bitcoin for $5 and then the value increases such that you can purchase .01 worth of Bitcoin for the same $5. Bitcoin fans marvel at the potentially high deflationary power of Bitcoin but what they won’t tell you is that this is only relative to its relationship with fiat currency. In absolute terms, the purchasing power of every subsequent Bitcoin acquirer decreases as demand increases in a very inflationary way. Pay attention to the fact that your $5 purchases less of Bitcoin’s total purchasing power when demand increased in the example. In other words, as demand increases, the average person’s percentage of Bitcoin in absolute terms will decrease as more people want it. Bitcoin fans will tell you this isn’t a problem because, relative to fiat currency, you can only control whatever amount of Bitcoin you can afford to acquire regardless.

However, what they won’t explain to you is that the increase in demand will cause the values of those who control significant amounts of Bitcoin to explode. Early adopters who have accumulated Bitcoin in large amounts will just be able to sit back and watch their fortunes go through the roof as increased demand shoots Bitcoin values relative to fiat currency into the stratosphere. The result is a form of economic inequality between early adopters (most of whom are already fairly wealthy) and those who acquire Bitcoin later that would make current economic inequality look positively egalitarian. To put this in perspective, as of Feb. 2014, almost 94% of Bitcoin wealth was controlled by about 7% of the addresses. Contrary to what the media would have you believe, this is not a populist movement.

It is on this basic premise that I oppose the concept of Bitcoin as a currency. It fuses the worst aspects of fiat currency and commodity currency into an amalgam which practically guarantees a state of economic inequality that would be orders of magnitude worse than the current fiat currency paradigm. This is not hyperbole, simple mathematics bear this out.

As a technology, Bitcoin is truly amazing. While the average person may care less about the Two Generals’ Problem, solving this issue has long been the Holy Grail for many computer scientists. However, as a currency, problems related to Bitcoin will increase in direct proportion to its utility. It will solve none of the problems of today’s fiat currency paradigm and will increase some in ways that will prove far more destructive.

In the near future, the blockchain may well revolutionize computing. But, in the end, I expect Bitcoin the currency, at least is it operates now, to wind up in the dustbin of history.

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