Tag Archives: Speculation

When Capitalism Mattered

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A recent conversation had me thinking about what my ideal existence would be. Strangely enough, my thoughts went to a video game named Privateer; the premise of the game is that you live on your own spaceship which you can trick out to perform a number of tasks. It really boiled down to a choice of two occupations in the game: you could be a “privateer” and buy and sell merchandise all over the galaxy and hunt pirates for bounty or you could be a pirate and rob said privateers.

My frequent readers may be thinking “so how did that piracy thing work out?”. My answer:

It didn’t. I loved playing as a privateer.

Yep, I loved buying and selling cargo (and hunting pirates). There was something kind of peaceful about going from planet to planet trading goods. Yeah, I got attacked by pirates and the game became absurdly difficult as I leveled up. But, for awhile, the feeling of being in open space and traveling to different places to sell commodities and equipment for profit was pretty fun.

To my dismay, what I realized is that, in that game, I was a Capitalist. And I enjoyed it.

Needless to say, I had to figure this out. What was so appealing about Capitalism in the game that sucked so hard in real life? Modern Capitalism is about as exciting or appealing to me as getting kicked in the jewels with spiked Louboutins. Why did I like it so much as a “privateer”?

Coming to that answer helped me understand more viscerally why I think civilization has outgrown Capitalism. The key word is “risk.” Let me set the scene for you:

Consider what the world was like throughout most of history. To put it in two words it was “ridiculously dangerous.” Whether traveling over land or sea, the chances of dying were pretty significant. Between hostile natives, highwaymen, disease, starvation, the occupations of exploration and trade were about as risky as it could get. We read about all of the famous tradesmen and explorers who helped us gain a better understanding of our world by traveling and selling stuff but we don’t read about the guys that died from dysentery or having their heads stoved in by angry Aztecs. In other words, exploration and trade were extremely risky.

In my post What is Capitalism?, I made the case that the essence of the concept was the commitment of “capital” to a venture that may either succeed or fail. Now think of the risk that was involved in the accumulation of wealth back in the day. Almost every venture had the potential to end in death. The only way anyone would have been crazy enough to take on that risk is if the payoff was worth it.

Hence, Capitalism.

Now, think of the conditions that exist today. Somali pirates notwithstanding, exactly how “risky” is travel and commerce now? What are the chances of dying or, even for that matter, experiencing serious loss when engaged in global commerce? Let’s not even talk about exploration; any place we haven’t been is someplace we know we aren’t interested in going.

You see, people, modern technology has made risk, at least in its most significant forms, obsolete. Capitalism rose as a means of incentivizing people to risk their lives for wealth. In a world of adventure, it made total sense to build an economic system around incentivizing people to do what no sane person would normally willingly do: wander off into the great unknown (or dangerous known) to find things of value.

But, in our globalized world, where is the risk now? It’s all almost entirely mathematical. Investments now primarily involve making bets against stupidity. The risk is almost entirely in people being stupid. Other than that, there is almost no real risk in our current Capitalist system. Indeed, the term “late Capitalism” is apropos. It’s a solution to a problem that no longer exists.

So, where do we go from here? You know my answer. We find a way to not only provide for people materially, we start to seriously address the matter of human dignity. We find a way to invest everyone in the success of Humanity as a species. We find a way to create “antifragile” systems, laws, and institutions that value the preservation and sustenance of social trust above all else.

Capitalism? It’s obsolete. Maybe in the void of space, where the distances are vast and the pirates have big guns, it still makes sense. But, here on Earth, the pirates are mostly gone and modern technology has made the world much, much smaller and far less dangerous.

The world of the privateer is gone. What is going to take its place?

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The Philosopher King

plato

Like millions of sci-fi fans around the world, I consider Dune by Frank Herbert to be the seminal work in the genre. I’ve only read a handful of books that I’ve enjoyed as much and absolutely none from which I learned more. The breadth and complexity of the topics explored in Dune are amazing; indeed, though its universe is ideally suited for the silver screen, capturing it in a way that is true to Herbert’s work has proven to be a challenge that has only yielded limited success.

The themes in the book regarding politics and economics are the ones that have had the most impact on me. The basic concept of an idea being shaped by its environment was one of the most powerful. Consider the idea of liberal democracy; it seems intuitive and pretty much expected that it is the ideal form of government for our world. But is it? Consider the persistent vigor of totalitarianism, even in the face of its numerous spectacular failures. It is an idea that seems to be shaped largely by its environment. Liberal democracies tend to work better when there is far less societal “noise,” such as when populations are low and largely homogeneous and there is little bureaucratic overhead. However, when populations and bureaucracies increase, it becomes far more difficult for consensus to be reached and common goals to be achieved. From those seeds, totalitarianism often seems to spring. Consider the U.S.’s lurching move in that direction with Donald Trump. Considering the growing ineffectiveness of its government to serve a growingly diverse constituency, it’s only rational that, to maintain some semblance of stability, it would shift to the greater efficiency of simpler, non-nuanced ideas emanating from a charismatic, simple man.

Frank Herbert explored the concept of environment shaping ideas in several profound ways. One was the Imperium itself; it wasn’t an arbitrary choice on Herbert’s part to set his story in a feudal monarchy, it was a logical extrapolation based on the history he invented for the civilization as well as the reality of an economically integrated society. Consider our own globalized world: since the fall of Communism, the United States and its President are the apex of a system of nation-states that, at least for awhile, were becoming far more interdependent. Conspiracy theorists have long posited on the concept of a “New World Order” in the form of a unified global government but such an idea, at least conceptually, isn’t that far-fetched. As oligarchs and plutocrats exert more influence on the politics of countries, particularly in a world in which economies are becoming far more integrated, the idea of the nation-state becomes redundant. However, as long as our current economic and political structure allows for distortions that facilitate the accumulation and increased control of power and wealth, it will continue to exist in its current form.

But consider the political structure of Dune; the Padishah Emperor was engaged in a perpetual stalemate with his feudal lords, the Great Houses of the Landsraad. The Sardaukar, the Emperor’s army, was evenly matched with those of the complete Landsraad, ensuring mutual destruction in the event of civil war. While not completely similar, I see the same stalemate between those with political power versus those with economic power right now. The plutocrats may control wealth but the politicians have the monopoly of force. As time goes on, the struggle between those with “hard” power (force) and “soft” power (wealth) seems to favor those with the soft power. Indeed, governments across the globe seem to have placed the interests of the wealthy above everyone else. As long as the two forms of power have common interests, the system works in a symbiosis. However, inevitably, their combined goals always seem to diverge from those of the greater population.

The way I see it, fascism, the combination of both forms of power into a unified entity, is a natural result simply because it is more efficient. Another natural result is dynastic wealth, the need and practice of passing wealth to one’s progeny; this is consistent with genetic and Darwinian competition. In Dune, both of these phenomena take the form of feudalism, which itself is a product of the vastness of the Imperium. A feudal monarchy is likely the only way an economically integrated society or group of societies could exist over such a vast expanse, particularly one featuring thousands of worlds. Democracy simply would be far too inefficient as the bureaucratic overhead would be phenomenal. The same dynamic plays out in Star Wars as well. It’s easy to witness the same phenomena in our own history; it consistently shows a tendency for force, power, and wealth to consolidate with attempts then to preserve and enforce that consolidation hereditarily. It is likely that, should that consolidation ever truly come to fruition, the end result would be stability at the price of stagnation, which Herbert also astutely examines.

Thankfully, such homogeneity would be very difficult to achieve to a large degree. The dispersal of wealth as well as the forces of chance tend to degrade or destroy hereditary wealth in our world. Frank Herbert addressed this conundrum in his stories with the device of the spice melange, a naturally forming narcotic that severely prolongs the life, enhances the health and vigor, and extends the consciousness of those who consume it. He even cleverly established that it could not be artificially produced and could only be found on one planet in the entire known universe, the control of which was under a corporation wholly owned and operated by the very nobility that exclusively benefited from its consumption. The dynamics of spice are essential to the stability of the Imperium but, rather than delve too deeply into that topic, my recommendation is simply to read Dune and the rest of the Dune series. In my opinion, it won’t be time wasted.

It is another concept explored in Dune, related to what I have presented, that motivated this post:

The Philosopher King.

Introduced by Plato in The Republic, the Philosopher King is the proposed ruler of what Plato envisioned as the ideal nation-state. Plato defines the Philosopher King as a ruler who philosophizes, most often interpreted as one who is guided by the pursuit of optimality through enlightened wisdom. In other words, a Philosopher King rules with good judgment derived from understanding, not just knowing.

On the other hand, for the purposes of this post, I will use my own definition of Philosopher King, which I think will allow for greater context:

Philosopher King – one who is driven to, seeks, and gains the power to lead by his belief in his right to do so, either by capability or necessity, while maintaining the empathy and understanding of his own inherent fallibility.

I think the concept of the Philosopher King is a deceptively significant motivator in human dynamics. There seems to be an inherent, subconscious, almost metaphysical desire for humans to identify and elevate a Philosopher King. I think it is a significant motivator in the development of cults of personality of all stripes, one so powerful that it often defies logic.

First, let’s explore the dynamics of the Philosopher King. By nature, he is one that lives in a state of contradiction. A Philosopher King assumes power largely because he believes that he is most capable or that his capabilities best match necessity. A fundamental belief in his right or purpose to rule is paramount. However, what separates the Philosopher King from a run-of-the-mill tyrant is the complete understanding of the costs of his decisions. A Philosopher King understands that some, even many, of his decisions will have a price. He makes those decisions with no hesitation yet carries the weight of them in perpetuity, which allows him to make decisions of greater benefit for everyone with greater time and experience. The cumulative effect of making decisions of both ruthlessness and empathy is undeniable progress or, in times of desperation, ultimate survival.

The irony of the Philosopher King is that, as much as he is desired, by nature, he cannot ever be fully embraced. He is both loved and hated, accepted and envied. By nature, some will suffer as the result of certain decisions; the staunchest of the Philosopher King’s believers who are impacted by those decisions will interpret them as betrayal. Some will simply envy him because he represents something to which they aspire but can never achieve: greatness. They don’t fundamentally understand that that greatness comes at the price of a wounded soul, the deep understanding of all who may have suffered because there was no other choice. The Philosopher King is a man of destiny who’s greatest strength is the ability to gracefully bear the weight of his sins.

Frank Herbert explores this dynamic primarily with two characters, Paul Atreides, who buckles under the weight of the responsibility, and Leto II, who embraces it and becomes “God Emperor” of the Known Universe. Each is motivated by a terrible purpose. But another characteristic of the Philosopher King is that he possesses one or more gifts that he is aware are completely unique. For Paul Atreides and Leto II, that gift is prescience. I’ve always thought this was a particularly powerful device because it provides both the certainty of action and the burden of knowledge. It also separates them from everyone around them, even those closest to them. Most profoundly, the Philosopher King is alone.

If you look at history, you can identify this theme quite often. Hitler, Muhammad, Jesus, Steve Jobs. The writings of Machiavelli inadvertently describe the basic politics of the Philosopher King. It is my belief that the Philosopher King even plays a major role in religions. Indeed, the so-called “Anti-Christ” is a being who is primarily loved and worshiped even when he commits unspeakable acts, a clue that such a person, should he ever exist, will embody the traits, at least superficially, of a Philosopher King.

In the end, the Philosopher King guides society to greatness even at great personal expense. In my opinion, Frank Herbert’s exploration of this concept is incredibly important because it reveals a psychology that I think exists in all of us. In my opinion, there is a part of all of us that seeks a “father,” one who rewards generously for what we do right and punishes justly for what we do in error. In history, there have been many who have climbed to the heights of power by promising just that. They have largely failed though I can think of at least one who did succeed in his lifetime.

These topics are just a few of those that I discovered in Frank Herbert’s work. Even now, I think my understanding of it is largely superficial. I grapple with the themes in his books every day, in my own thinking and writing.

I will forever appreciate his work. Thanks Frank.

Is Currency Devaluation Causing Deflation?

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As a scholar, I love the “Aha!” moment when something crystallizes in my mind. That moment came to me right after I posted The Gold (and Bitcoin) Fallacy. For some reason, my brain started to fire after writing the following:

Using my methods, Bitcoin’s divisibility could indeed be leveraged to make it a viable currency. However, the exercise also revealed that Bitcoin divisibility is indeed inflationary by nature and that high demand is naturally price inflationary.

These final sentences stuck in my head and I could feel a fire burning. Then, all of a sudden…

It hit me.

I had stumbled upon something in my post Fixing Bitcoin Part II: Pricing with Bitcoin Units; the clue was in the following section:

What I’m proposing allows Bitcoin to be used mostly in whole units irrespective of what it is trading for. This system easily moves from Bitcoin to fiat currency and vice versa. Let’s start with the variables:

  1. Price of item in fiat currency;
  2. Maximum Exchange Rate (= 10 units of correlated fiat currency);
  3. # of expansions of the Fractional Rate. This correlates to demand and is equal to the number of times Bitcoin exceeds the Maximum Exchange Rate. For instance, a Fractional Rate of .000000000000001 means that demand for Bitcoin has caused its exchange rate to “turn over” 15 times. This number is easily determined simply by counting the number of places to the right of the decimal point. In the above example, the # of expansions of the Fractional Rate would be 15.
  4. Price of item in bitcoin units.

The formula for converting fiat pricing to Bitcoin pricing would be as follows:

((price in fiat currency) / (maximum exchange rate = 10)) * (# of unit expansions) = (price in bitcoin units)

Let’s say you want to sell an $899 PC in Bitcoin units. Using today’s current Bitcoin exchange rate in $USD, here’s how it would look:

($899 / 10) * ($221.20/10 = 22) = 1977.80 BTC units

Note: “221.20” is Bitcoin’s exchange rate in $USD as of this very instant; to approximate the Fractional Rate, this number is simply divided by my proposed Maximum Exchange Rate of 10 units of a correlated fiat currency. In this example, this would be equivalent to $10USD.

Conversely, the formula for converting Bitcoin pricing to fiat pricing would be as follows::

((price in bitcoin units) / (# of unit expansions)) * (maximum exchange rate = 10) = (price of in fiat currency)

Using the previous dollar figure of $899, let’s convert Bitcoin units into fiat currency:

(1977.80 / ($221.20/10 = 22)) * 10 = $899

Lets say the fractional rate is 71 instead of 22. Using the same $899 price from the previous example, here are the conversions:

($899 / 10) * 71 = 6382.90 BTC units

or

(6382.90 / 71) * 10 = $899

In this fashion, it is possible to price items in units of Bitcoin relative to fiat currency or the reverse.

What I realized is that an interesting thing occurs in this process: the price of something in bitcoin units has a direct correlation to the increase in demand for Bitcoin. When converting bitcoin into bitcoin units, I use a variable called the “Fractional Rate,” which is the number of times Bitcoin’s exchange rate would “roll over” if it had a a hard cap of $10. When I wrote my post, a single bitcoin was worth $221.20USD; the Fractional Rate would equal “22” based on dividing the exchange rate by the Maximum Exchange Rate of $10 per unit. In the other portion of the example, I speculated on a Fractional Rate of “71”; by multiplying the Fractional Rate by the Maximum Exchange Rate of $10, the proposed exchange rate would be approximately $710 (between $710.01 and $720.01 more exactly).

For more perspective, consider the current exchange rate between BTC and USD, $821.20 per bitcoin as of this moment. To determine the Fractional Rate for my equation, I would do the following:

$821.20/$10 (Maximum Exchange Rate) = 82

Compare the difference in the Fractional Rate from my Fixing Bitcoin, Part II post to this current one, “22” versus “82.” The change in the Fractional Rate represents a significant increase in the “demand” for Bitcoin as represented by the increase in the exchange price (I use the term “demand” loosely as the increase in exchange price also represents the halving of block rewards, which makes bitcoin production more scarce).

If you look at my example, you will see that an $899 computer costs 1977.80 bitcoin units at the Fractional Rate of “22” and 6382.90 bitcoin units at the Fractional Rate of “71.” In other words, the example showed a direct correlation between the increase in demand for Bitcoin and an increase in price as expressed in bitcoin units. No doubt that I could also show the reverse, a decrease in the price of an item in bitcoin units based on a decrease in the demand for Bitcoin. It’s all basic mathematics.

(Note: for more background on bitcoin units, please read The Post Where I Fix Bitcoin and Fixing Bitcoin Part II: Pricing with Bitcoin Units)

Now here is the crazy part, the part that has my brain firing…

What if there is a direct correlation between the demand for any money and prices?

What if currency devaluation is a significant cause of deflation?

The implications of this are pretty significant. Maybe this is common knowledge in the economics profession but, if I’m correct (and it isn’t), this kind of blows me away. Let’s assume I’m correct and neither insane nor way behind the curve… then what does this mean?

If demand for a money directly correlates to pricing then the current deflation and the difficulty addressing it becomes much easier to understand. Most countries are aggressively devaluing their currency to improve their ability to export goods; it’s possible that this process is counteracting inflation. The proper corrective then is for a nation experiencing disinflation or deflation to allow its money to “strengthen.” However, that process relative to other countries devaluing their currency creates a Catch-22 scenario: strengthen your currency to reach inflation targets and have your exports become less competitive or keep your currency “weak” for stronger exports at the expense of disinflation or deflation.

Another interesting aspect of this possible connection is that the ideal state of equilibrium regarding currency exchange between nations becomes determinable. Ideally, the exchange rate between nations is 1:1 based on the total money supply of each country. For instance:

Let’s say Japan’s total money supply is 1000yen and the United States’ is $200USD. The ideal exchange rate between them would be 1:1 or 5yen to $1USD. Now let’s add Great Britain to the mix at 350pounds; at 1:1, it’s exchange rate with Japan would be 1pound to 2.86yen and 1.4pounds to $1USD.

And so on.

Those exchange rates would be ideal as they would promote economic stability. Now what about monetary inflation? My supposition is that the ideal rate of currency inflation is equal to potential demand. A simplified version of this is that each country would inflate (or deflate) its currency at a percentage equal to its populations growth rate to maintain the 1:1 connection with other currencies. Obviously, this is a challenging concept in a globalized world in which demand for a nation’s currency can transcend borders. Also, the temptation for a nation to devalue its currency is pretty strong and maintaining an asymmetry with trading partners is an attractive proposition. I think that many of the issues regarding the world’s currencies stems from the contradictory needs of every country to reach target inflation rates, which may require “strengthening” a country’s money, versus creating an attractive export situation, which benefits from currency devaluation.

So, is demand for a money directly correlated to price levels? Can disinflation/deflation be corrected by “strengthening” a nation’s currency? If so, how will it affect a country’s exports? Will the prospect of this connection allow countries to more accurately identify their target inflation rates? And can strengthening or weakening their currencies provide a new weapon for controlling inflation?

Interesting questions for an interesting time.

The Gold (and Bitcoin) Fallacy

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In theory, it is possible to manage the entire world’s economy with a single brick of gold, probably far less. A brick of gold can theoretically be divided down to the atom and, if money is merely a token representing value, then there are more than enough atoms in it to easily cover the value of everything on Earth.

So why isn’t that the case?

Why do governments collect tons of gold? Why do “gold bugs” buy many coins rather than just a single one?

Guys like Nick Szabo tout the infinite divisibility of Bitcoin to address its fixed limit token issue, which has been my main criticism regarding it. However, I decided to use gold as my primary example for this post in the hopes that those who believe in the infallibility of math will begin to understand the real world challenges of dividing a fixed limit currency versus simply expanding a non-fixed limit one.

There’s a reason why the world doesn’t use a single gold brick as its currency, even though it is theoretically possible to do so. What I don’t think guys like Szabo, Vinny Lingham, Balaji Srinivasan and the like truly understand is that, in order for infinite divisibility to be feasible when managing a fixed limit currency, the proportion that every holder has must shrink in order to meet demand. For example:

Let’s say four people hold equal portions of an entire fixed limit currency. Then each would hold 25% of it. If an additional person above the four was granted an equal share of the currency, then the five holders would own 20% each. If five more people were given an equal share, then the ten holders would each own 10% of the currency.

Now let’s look at the original four holders. By increasing demand for the currency, they went from owning 100% of the currency collectively to owning 40%. Their individual and collective proportions of the currency shrank.

In my previous example, each current holder had to surrender an equal portion of his share to meet the increased demand. Assuming there isn’t a physical limit for how far the currency can be divided, it is theoretically possible that a currency can be divided indefinitely under those circumstances.

However, is that possible in the real world?

Let’s say you have a brick of gold and someone purchases 25% of the brick. Now let’s say that nine others later want to purchase equal shares of the brick. What happens?

What will likely happen is that the nine will get equal shares of what remains of the brick. The proportions would then be as follows: one holder would own 25% of the currency while the other nine hold slightly more than 8% apiece.

The nature of a fixed limit currency is that it is inherently zero sum. In both of my examples, ten people were distributed 100% of a fixed limit currency. However, in my second example, the amount that could be split between nine subsequent demanders of the currency was distorted by the initial large purchase of the first. For a fixed limit currency, accumulation of it that exceeds the mathematical equilibrium of proportion of its supply relative to its demand at the individual level negatively impacts one or more holders of that currency. In other words, for a fixed limit currency, someone’s surplus of currency is someone else’s deficit. If ten people hold 100% of a fixed limit currency, the only way one of the holders could acquire more of the currency would be directly at the expense of one or more of the other holders.

Though I’m not completely certain, I suspect this was ultimately why the gold standard failed. Granted, there is no fixed limit for the supply of gold but its accumulation is slow and generally capital intensive. Its accumulation by governments and the wealthy would not have been an issue in a slow growth world, particularly as long as the pace of gold production kept up with demand. However, as economist Robert Gordon has shown, 1870 was the year the world started to profoundly change. The pace of technological progress began to rapidly accelerate along with population growth. My guess is that, in a world of the gold standard, rapidly increasing demand severely outpaced gold production and was exacerbated by governments and individuals who accumulated large quantities. In the end, my speculation is that the world simply outgrew gold. It was too scarce with which to serve an increasingly global economy.

If I’m correct and the world simply outgrew gold, then what are the prospects of an absolutely fixed limit (wannabe) currency like Bitcoin succeeding where gold failed? The same economic distortions relative to gold would be far worse with Bitcoin. Early adopters have already hopelessly distorted its ability to be used as a mass currency and, unlike gold, it is absolutely zero sum. Accumulation of bitcoin absolutely negatively impacts subsequent holders, particularly in the face of high demand. Bitcoin works until excessive demand smacks face first into the “hodlers,” particularly large accumulators. High demand will cause Bitcoin’s price relative to fiat currency to skyrocket which will slow its velocity to a trickle. Bitcoin is barely used as a currency now and its fixed limit practically guarantees that it likely will never be mainstream.

Bitcoin only works if, when divided down to the next fraction, everyone’s holdings are also automatically divided down to the next fraction. In my articles, The Post Where I Fix Bitcoin and Fixing Bitcoin Part II: Pricing with Bitcoin Units, I introduce the concept of the “bitcoin unit” to simplify the mathematics of Bitcoin and also allow it to be “expanded” and “contracted” usefully for mainstream economic purposes. Using my methods, Bitcoin’s divisibility could indeed be leveraged to make it a viable currency. However, the exercise also revealed that Bitcoin divisibility is indeed inflationary by nature and that high demand is naturally price inflationary.

The Riddle of Scarce Abundance: A Redux

oracle of Delphi

In my post, Currency and the Riddle of Scarce Abundance, I offered what I thought were the ideal traits of a cryptocurrency that had the ability to replace fiat currencies.

Since then, Bitcoin, the current cryptocurrency poster child, has once again embarked on a roller coaster ride of volatility, prompted mainly by the defection of a prominent developer in the Bitcoin community, Mike Hearn. In his post, The resolution of the Bitcoin experiment, Hearn refers to Bitcoin as a “failed experiment.” Many conflated Hearn’s statement to mean that Bitcoin was “dead” and gleefully pointed to the exchange rate and transaction volume to paint him as a bitter opportunist who also had the ignominious condition of being dead wrong.

Here’s the thing though… Hearn never claimed that Bitcoin was “dead” he only claimed that it had failed. In that respect, I think there is a lot of evidence that he may be correct. Despite the claims that Bitcoin transactions are increasing, there is almost no evidence that its use for common financial transactions is increasing. As for its exchange rate, there are many incentives to trade in Bitcoin, few of which are relevant from a currency standpoint. The truth is that Bitcoin, in its best case, only shows utility as a speculative vehicle and, in its worst, shows signs of being heavily manipulated.

The simple reality is that, if a cryptocurrency intends to replace central bank-issued fiat currency, people, first and foremost, have to have an incentive to use it for common financial transactions. As I’ve stated before, no one truly has an incentive to use Bitcoin every day. Why? It’s too volatile and doesn’t really do anything significantly better than the current currency paradigm.

My thinking is that Bitcoin suffers from an abundance, or lack thereof, problem. Its scarcity is used as a means to trap value but it works against the currency being used every day. I’m willing to admit that this may strictly be a matter of psychology. But the truth is, Bitcoin feels scarce. Its deflationary bias exacerbates that feeling. Not only is it not practical as an every day currency, it feels like it’s not practical as an every day currency. People intuitively understand that Bitcoin doesn’t work because there isn’t enough of it to go around (yeah, I know, “divisibility,” blah, blah, blah).

In my opinion, the best use case for a cryptocurrency in today’s world is as a reserve currency. People may choose to buy U.S. dollars for that purpose but I think there would be something uniquely encouraging for many people if there was a popular currency that was not controlled by any nation that could also be used seamlessly across borders. But I think it also has to feel like a currency as well. There has to be both an actuality and an intuitive sense that the currency is stable yet flexible, that it can grow effectively with demand without destroying its ability to store value. Call it “faith.”

What I came to understand is that a currency can expand as long as it remains in lockstep with demand. There has to be effective mechanisms to destroy money as well as create it in an economy. I think many of the problems faced in our current economic system stem from a fundamental disequilibrium in the creation and destruction processes of money. The imbalance is caused by the demand for interest on debt-based money which creates a net-negative sum bias. The result is that, as debt is serviced and profit is protected, an artificial scarcity of money is being produced in the every day economy which is encouraging a deflationary environment.

As an aside, many people believe that technology is a major factor driving deflation. This is an interesting theory. My first response is that this leads to a very strange syllogism:

  • Software allows more to be done with fewer resources;
  • As a result of software “eating the world” and efficiencies of scale, fewer resources are being consumed;
  • The result is deflation as there are more resources available in relation to demand.

Here’s where this gets tricky for me: how does this reconcile with an expanding money supply? At the personal level, if I have a smartphone that can substitute for a myriad of devices, it stands to reason that I should have more money in my pocket. Now scale that out to hundreds of millions of people. If deflation is less money chasing more goods but tech is helping people keep more money in their pockets, then how is technology causing deflation? Indeed, technology should be having an inflationary effect, at least monetarily, relative to the expanding money supply. The expansion of markets globally easily translates into greater use of resources in aggregate. It should not be possible for technology to have a deflationary effect. Quite the opposite actually.

Indeed, there is a massively deflationary element counteracting the naturally inflationary bias of technology. There is mounting evidence that rents, particularly in housing, are contributing to that effect. So, even in an environment in which technology should be putting more money in people’s pockets, the demand for that money in the form of rents is systematically eroding people’s personal wealth. So even with more income and personal wealth, many people are actually poorer as the result of the increased demands on it. This seems to validate Thomas Piketty‘s research on economic inequality. The economist Branko Milanović has coined the term “wealth-poverty” to explain this phenomenon.

The money supply is expanding at an amazing clip, more natural resources are being consumed now than at any time in history, yet disinflation/deflation is a problem in all but the most corrupt countries. This is a strange contradiction, one that has many central bankers puzzled. Disinflation and deflation suggest that the expansion of the money supply can’t keep up with even the tepid amount of growth that we are now experiencing.

So how does all of that relate to cryptocurrency? Well, one of the advantages of a cryptocurrency is that it can provide insulation from the current economic forces. A stable cryptocurrency can provide a completely liquid safe haven and act as an effective counterbalance to central banking monetary mishaps. Think of it as a safety net for the global currency system.

So getting cryptocurrency right is very important, so much so that I think even central banks would be able to get behind a good one. It could be used as an escape hatch should the worst happen.

But, as I’ve shown before, Bitcoin is already rigged in favor of its early adopters. Increased demand would only ensure that each subsequent purchaser of it gets less and less while the fortunes of those who accumulated early and cheaply would go through the roof.

The answer is the creation of a cryptocurrency that allows true supply/demand equilibrium. Everything necessary to create it now exists. As in many things, it is not a lack of capability but a lack of will that is preventing it.

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.

I Don’t Hate Bitcoin, I Just Don’t Like It

0ab2e699805277d8f0f27183d5528e6eI 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”

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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.