Wednesday, January 28, 2015

Crypto-currencies, Bitcoin and Blockchain

Photos from two meetings I attended last week.

Some general comments on crypto-currencies:

1. Bitcoin doesn't really solve any payment problems, unless of course you are a paranoid libertarian who hates "fiat" currencies. But why should you trust the Bitcoin Foundation any more than you trust a central bank? (See Bitcoin dynamics.)

2. Most potential users just want something that works and don't care at all about crypto magic.

3. The high volatility of Bitcoin makes it unattractive as a store of value, except for speculators looking for price appreciation. It's possible that confidence in and the liquidity of Bitcoin (or another crypto coin) will rise to the point that this problem is eliminated. At that point things will get much more interesting. However, it's not clear what the timescale is for this (but see point 7 below).

4. Blockchain processing is extremely inefficient and has a high cost overhead.

5. Ethereum, with its Turing-complete blockchain operations, does make possible low-cost derivative contracts, insurance, etc. But I have yet to hear a convincing case for a killer application. Gambling is an obvious use, but the US government has shown a strong inclination to pursue those involved with illegal online gambling.

6. Innovation in payment technologies is long overdue, but because of positive network effects it will probably be a big player like Apple or Google that finally changes the landscape.

7. One interesting scenario is for a country (Singapore? Denmark?) or large financial entity (Goldman, JPM, Visa) to issue its own crypto currency, managing the blockchain itself but leaving it in the public domain so that third parties (including regulators) can verify transactions. Confidence in this kind of "Institutional Coin" (IC) would be high from the beginning. An IC with Ethereum-like capabilities could revolutionize the financial industry. In place of an opaque web of counterparty relationships leading to systemic risk, the IC blockchain would be easily audited by machine. Regulators would require that the IC authority know its customers, so pseudonymity would only be partial.

Here's a good podcast on crypto-currencies for non-experts.
Wall Street journalists Paul Vigna and Michael J. Casey talk about cybermoney in The Age of Cryptocurrency: How Bitcoin and Digital Money are Challenging the Global Economic Order. Vigna and Casey argue that digital currency is poised to launch a revolution that could reinvent traditional financial and social structures, and bring the world's billions of "unbanked" individuals into a new global economy.


BobSykes said...

Someone on one of the survival blogs noted that in the case of a financial collapse that destroyed fiat currency, the preferred barter item would be a 0.22 cal LR cartridge. They are physically small and easily transported, have a small intrinsic value (gold is too valuable for small exchanges), and they have actual uses.

Of course, if you have guns and ammo you don't really need to barter.

dxie48 said...

#7 It is unlikely that any country/central bank would want to give up the ability to print money from thin air. Currently the creation of each unit of crypto currency like bitcoin will consume approximately equal value of electricity, i.e. the central bank will bankrupt itself in gold/currency reserves to have exclusively crypto currency, and cannot leverage it to have fractional reserve system.

steve hsu said...

The central bank doesn't have to peg the coin price to the cost of blockchain verification.

dxie48 said...

Still, there is a significant cost in creating crypto currency. With currently the race to the bottom currency wars thru quantitative easing going on, creating fiat currency is just a bookkeeping entry at the central bank while the break even point for creating crypto currency will soon be reached. Just like historically the value of the silver content of coin could be higher than the face value.

steve hsu said...

With lending and derivative contracts the effective money supply isn't the same as the number of coins in circulation.

Elliot said...

Regarding point 1: The Bitcoin Foundation has far less power over Bitcoin than the Fed/US government has over the dollar. The Bitcoin Foundation can release a new version of the Bitcoin software that changes the rules, but users are free to ignore it and continue using the Bitcoin that exists now if they prefer.

Also, I think you underestimate the long run significance of a currency that is free from government control. As more and more commerce moves to the Internet, there will be an enormous incentive for people to use cryptocurrencies to avoid taxes (especially when technologies like zerocash allow complete anonymity). They don't need to "hate" the government or fiat currency, they just need to like money.

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