Introduction

I talk a lot about Bitcoin but a few people I know from outside of the Bitcoin space have asked me why I don’t talk about other uses of “blockchain technology” and other cryptocurrencies.

For the former, I already addressed the blockchain case in a previous article.  I may write something longer or more detailed on that in the future addressing the flaws in some specific examples that are raised over and over like voting and logistics, but for now that article will suffice.

For the latter case of “other cryptocurrencies” however, I haven’t addressed it beyond a few scathing comments on various social media such as LinkedIn and Facebook.  To rectify this, I’ll therefore try to address it in more detail now.

I’d like to start with a definition of “cryptocurrency” so that we’re all on the same page as to what this article addresses.  Unfortunately, there really isn’t a good one.  Even the “experts” at the European Banking Association are completely unable to form a coherent and meaningful description which I addressed here.  The United States Internal Revenue Service (IRS) has a similar issue with their description.

So, the best I can do is to address the following things and hope it covers it to your satisfaction, dear reader:

1. Proof-of-Work security/consensus mechanisms.
2. Other non-Proof-of-Work security/consensus mechanisms.
3. Forks of Bitcoin such as Bitcoin Cash, Bitcoin SV, and Bitcoin Gold.
4. Clones of Bitcoin with minor modifications such as Litecoin and Dash.
5. “Smart contract platforms” such as Ethereum and EOS.
6. Hosted tokens such as the Binance Token (BNB) and VeChain.
7. “Stablecoins” such as USDT and USDC.
8.  “Directed Acyclic Graph” tokens such as IOTA and Byteball.
9.  Novel digital token/coin approaches such as Monero and Grin.

The “TL;DR in advance”

I don’t see long-term fundamental value in anything other than Bitcoin.  There are a few interesting technologies scattered amongst a sea of worthless crap but where these exist, they’re either not significant enough to be valuable on their own, or are able to be co-opted by Bitcoin, rendering it worthless/uninteresting to implement in a different token/coin.

This view is often called “toxic Bitcoin maximalism” by supporters of other coins, but in the sections that follow, I intend to justify the position and show why it’s the only feasible and realistic understanding that can be derived from the facts as they exist.

I don’t rule out the possibility of a “Bitcoin killer” being created one day, but I can be relatively clear on what kind of properties it would need to have and why I view it as unlikely in the extreme that these properties can exist externally and incompatibly to Bitcoin in such a way that Bitcoin couldn’t adopt them.  Also, in case it didn’t go without saying, that I am completely certain that no existing potential competitor to Bitcoin has these properties or is even attempting to do so.

Proof-of-Work Security/Consensus

Blockchains aren’t inherently secure on their own.  That’s a property of their security mechanism, which itself is tied (in the general case, as with Bitcoin) to the way in which the consensus algorithm determines what is a valid transaction or block and what is an invalid transaction or block.

The security and consensus mechanism used in Bitcoin is “Proof of Work”.  The concept behind proof of work is that in order to change the transactions in an arbitrary previous Bitcoin block, approximately the same amount of work needs to be expended as was expended for that block plus every block since then.  As new blocks are generated every ten minutes on average, a successful attack at rewriting a transaction in a block from only one hour ago would require the same amount of energy under the control of one individual as was spent on the entire Bitcoin network for the last hour.

That is to say, the blocks are secured by the ability to prove that a certain amount of work (“work” in the physics sense of energy transfer, reduceable to a measure of entropy) was invested in their creation and the creation of all following blocks that reference it (the “chain” in the word “blockchain”).

Technically, there is some further nuance to this, but as this isn’t a technical article, further examination doesn’t belong here, but definitely will be covered in a future article on understanding Proof of Work.

In a proof of work system, there needs to be an incentive to secure the chain.  Altruistic energy use is an unrealistic expectation and would lead to an extraordinarily weak chain that could be overwritten by anyone with an economic incentive to do so as the energy use required would be very low.

Bitcoin incentivises proof of work through mining rewards.  A mining reward is composed of a fixed number of newly accessible Bitcoin (this amount started at 50 BTC and halves every 210000 blocks; eventually to reach zero satoshi sometime around the year 2140) plus the difference between all transaction inputs and all transaction outputs of transactions that have been included in the block.  This is generally referred to as the “mining fee” or “transaction fee”.  That is, I may create and broadcast a transaction with a total of 10250sat in inputs, but only 10000sat in outputs.  By doing so, I encourage the miner to include my transaction in a block as they can take the 250sat difference for themselves.

As there is limited space in a block, miners will take the transactions with the highest fees in relation to the size they take in the chain.  For convenience and common understanding, this is generally measured in “satoshis per byte”.

Proof of Work is often criticised as being a “waste of energy”.  In reality however, it’s the most efficient use of energy possible for economic value, as it directly ties the energy expended to the value created.  No miner will willingly expend more energy than they receive in rewards, and as an aggregate across all miners, the global energy expenditure on Bitcoin will only ever grow or shrink to meet the rewards that the miners get for their work.  It’s essentially ‘near-perfect’ expenditure and thus can be deemed extremely efficient (I promise more depth on this in the more detailed Proof of Work article.  In the meantime, the best article I’ve read on the topic is here, despite not covering everything I think it could – or perhaps even should – say).

When there is more than one proof of work system in existence, there is competition for energy expenditure.  Energy may be expended on any of the proof of work systems, given any other constraints are fulfilled (e.g. hardware availability/cost, set up costs, etc.).

This means that there are three possible states for a proof of work miner:

1. Performing work towards getting rewards from the most valuable proof of work system.  Not incentivised to change.
2. Performing work towards getting rewards from a proof of work system other than the most valuable.  Incentivised to change to the most valuable.
3. Performing work towards getting rewards from a proof of work system that is “first place” and equally as valuable as one or more others.  Not incentivised to change, yet.

Miners are assumed to be – in aggregate – self-interested and to have no particular preferences for one coin over any other.  They simply follow the greatest reward.

When enough miners leave one proof of work system for another, the system is “doomed” as its value decreases further, increasing the incentive to move away from it.

The first and second cases are hopefully obvious and don’t require any significant additional analysis.  The third case builds on an assumption that there can be proof of work chains that are equally as valuable for a miner to put work towards.  This state can be argued to be unstable at best and impossible at worst, meaning the third case must collapse to either the first or second case within some period of time.

Proof of Work coins that are functionally just clones of Bitcoin have less historical security and are thus definitionally less secure.  All other things being equal, a less secure coin is a less valuable coin, and thus these coins are doomed.

Proof of Work coins that have inferior monetary properties to Bitcoin are expected to be viewed as less valuable and thus are doomed.

Proof of Work coins that have superior monetary properties to Bitcoin are expected to be viewed as more valuable and thus may doom Bitcoin (all other things being equal).  The upcoming sections will address this risk to Bitcoin.

Finally, an exact clone of Bitcoin that includes all of its transaction history is definitionally just Bitcoin.  It’s not possible for this clone to be differentiated from the original and thus is the original.

Non Proof-of-Work Security/Consensus

Because of the perceived high energy use and high barrier to entry inherent in proof of work as a fundamental requirement, several different approaches have been proposed and implemented in cryptocurrencies that try to solve the same problem without energy use.

Bitcoin’s approach to security uses aspects of game theory for things like the aggregate decisions made by miners and expectations around transaction selection, so many attempts are made to extend game theory approaches to more fundamental aspects of the security/consensus mechanism.  This betrays a misunderstanding of the role that game theory can and should play.  Game theory is useful for making assumptions about behaviours and can indeed be generally relied upon when the group of actors in question is large and diverse enough.  However, any attempt to use game theory as the underlying security mechanism ignores the potential for incentives outside of the system itself to override any incentives internal to the system, rendering the security of the system outside of the system’s control.

If this sounds a little abstract, we can use the simple concrete example of “proof of stake”.  Proof of stake is a system where financial actors in a cryptocurrency can “stake” their coins for transaction processing/block creation and earn rewards from doing so.  This is financially similar to the proof of work model where the more significant the financial value is input, the more significant the financial reward is as output.  However, since the stake that is put up is measured in the cryptocurrency itself, an actor who is able to gain access to large amounts of the currency without the financial outlay to purchase it themselves – such as an exchange – can easily gain significant influence over the system without the incentive to stay true to it.  While there is no inherent and direct reason for an exchange to attack a proof of stake system, this is certainly very clearly a risk when it comes to state actors who may view a growing cryptocurrency as a threat to their authority and control.

For comparison, we can quickly reconsider how this may appear in a proof of work system.  The financial requirement that a state must put in to “attack” a proof of work system is a diversion of potentially significant amounts of energy that they could spend elsewhere.  The desire to destroy the system needs to be weighed against the value of that energy.  In proof of stake, this consideration doesn’t exist.  Bitcoin specifically is actually even more difficult as there are difficulties in acquiring or producing the necessary ASIC hardware.  This is non-trivial, even for the largest and most powerful state actors and would also be extremely easy to notice, allowing for coordinated defence against the attack (up to and including a change of the algorithm if absolutely necessary; although this isn’t without its own serious problems).

There are of course more sophisticated attempts to solve the issue beyond simple proof of stake, but they all tend to suffer similarly.  Delegated proof-of-stake simply moves some incentives around and complicates the structure, but doesn’t fundamentally change it.  Proof of capacity relies on algorithms that prove a certain amount of storage space was used, changing from fundamental energy use to “who can afford the most hard drives?”, and so on.

Proof of Authority is a system that simply ignores the broader game theory entirely and instead relies on a small number of “authorities” who (ideally) have different incentives and competing wishes to act together to sign new additions to the chain.  This is obviously extremely weak against an attacker who has the ability to coerce each authority such as a powerful government or even a very powerful private organisation.

Because “work” can be viewed as a fundamental aspect of the universe defined in terms of entropy, an intriguing concept that at first sounds very interesting is proof of elapsed time (PoET).  PoET proposes using another fundamental aspect of the universe that we – at least presently – are pretty sure is outside of our control: time.  The idea is that if you can prove that a certain amount of time has elapsed, you can use this in a system where the actors must also expend a similar amount of time in order to rewrite the chain.  This has the same advantage of compounding security as proof of work and avoids the energy use.  Unfortunately, it remains purely theoretical since we know of no way to prove elapsed time in a trustless manner.  PoET implementations either rely on agreement of elapsed time between multiple actors, which devolves to proof of authority, or rely on “trusted hardware” such as specific hardware from Intel (who coincidentally came up with this variant of the system) which of course devolves in to an even simpler kind of proof of authority with only one authority!

Bitcoin Forks

The majority of “cryptocurrency” projects simply try to solve perceived problems in Bitcoin without understanding the properties that Bitcoin has that provide it value.

A simple but extremely relevant example is that a misunderstanding about Bitcoin’s transaction fees led to the creation of Bitcoin Cash.

Bitcoin Cash is a fork of the Bitcoin blockchain.  That means that they share a common history up to a specific block number, after which a difference in the agreed rules mean that transactions and blocks that are valid according to Bitcoin are not valid according to Bitcoin Cash and vice-versa.  It’s possible to have a chain split where one side considers the other side’s transactions and blocks to be valid, but since this will cause the chain to be continually overwritten by chain reorganisations should the other side have greater proof-of-work behind it, it’s generally avoided on purpose by forked coins (including Bitcoin Cash) by requiring a specific flag or magic number to be present.

Bitcoin Cash (bcash) has introduced several differences to Bitcoin since the fork event but all are relatively minor.  The most significant changes are the blocksize limit (bcash has a larger limit) and the difficulty adjustment algorithm.  The initial desired change was only the blocksize limit, but because the vast majority of mining hashpower stayed with Bitcoin, bcash required a new difficulty adjustment algorithm to avoid simply failing immediately due to a lack of hash power or failing later as miners “game” the difficulty for profit by jumping chains opportunistically.

The case against increasing the block size is covered somewhat in my previous article on that topic which allows us to conclude that Bitcoin Cash has inferior monetary properties compared to Bitcoin and thus – as defined in the previous section – must be doomed to fail.  Bitcoin SV – with its unlimited block size – even more so.

The most obvious problem with Bitcoin forks is that they’re (definitionally) not Bitcoin.  If there were consensus amongst Bitcoin users for the changes that are proposed, the changes would be adopted in Bitcoin and it would simply be Bitcoin.

For many forks – including both Bitcoin Cash and Bitcoin SV – the same mining algorithm is used.  This means that ASIC devices dedicated to Bitcoin are also able to be switched over to mine Bitcoin Cash or Bitcoin SV.  This gives these coins the advantage of a ready-made and powerful mining infrastructure but leaves them extremely vulnerable to attack as their hash power is such a small percentage of the total hash power available globally.  A government actor could very easily exert enough influence over a mining operation within their jurisdiction to effectively attack any fork coins, whereas no such possibility exists for Bitcoin itself.

In the case where the mining algorithm or security/consensus mechanism has been changed – as is the case with Bitcoin Gold – the fork either suffers from inability to economically compete against Bitcoin due to being a weaker proof of work, or is insecure by not being proof of work, as described in the previous sections.

Bitcoin clones

Litecoin and Dash are examples of cryptocurrencies that are essentially “clones” of Bitcoin with minor modifications.

Litecoin is a proof of work system using a different mining algorithm.  Dash is primarily proof of work but has a concept of “master nodes” that act in a kind of delegated proof of stake manner hybridised with proof of authority.

Bitcoin clones by their nature suffer a similar problem to Bitcoin forks of “not being Bitcoin”.  Unlike forks, they’re able to offer a consistent chain but like forks, suffer from either being an inferior proof of work chain or not being a proof of work chain and thus vulnerable to external incentives.

As described earlier, the only way for such a clone to be a risk to Bitcoin is if it were to introduce technology that enabled monetary policies making it a significantly better economic system than Bitcoin.  However, by virtue of being cloned from the same codebase, there are no imaginable properties that such a clone could implement that couldn’t also be implemented in Bitcoin.

Smart contract platforms

The most well-known system to fall under this category is Ethereum and any competitors attempting to do the same thing will suffer the same problems as they’re systemic to the concept, not the specific platform.

The concept of smart contract platforms is to act as decentralised computing platforms for economically valuable computing tasks.  That is, you create a script that performs a set of actions – and unlike Bitcoin, this is generally expected to be Turing complete and thus could truly be any actions – and then encode this as an entity on the blockchain.  The solution can be computed by any node on the network given it has the knowledge of all associated data, and therefore the script cannot be stopped, shut off, faked, or otherwise interfered with.  It gains the strength of Bitcoin’s transactions being distributed and pseudonymous but for computing actions far beyond the simple transfer of value or basic scripting that is possible in Bitcoin.

All of this sounds great.  It’s technically quite beautiful.  It’s unfortunately economically extraordinarily unsound.  Running a script is computationally intensive and the more complex it is, the more it costs to verify it.  Thus, the concept of “gas” is included in Ethereum, whereby a script creator pays for their script to be run.  For any non-trivial script, it’s provably impossible to actually know the computation power required in advance (a variant of the well-known halting problem) and thus the amount of gas to be paid for a script is definitionally undetermined until it’s actually run.

Even if it were possible to determine the correct amount of gas in advance, or if you’re always willing to ‘overpay’ with high estimates to ensure that scripts are executed as desired, the cost rises faster than the value that can be extracted from most scripts, thus severely limiting the use case of these platforms.

Furthermore, while it’s theoretically possible to run any kind of software on a platform such as this, the only scripts that have shown to make any sense are those that have a financial basis themselves.  In fact, the only widespread use of the Ethereum blockchain thus far has been the building of other “token” based cryptocurrencies on top of the network!

Hosted tokens

Tokens built on top of Ethereum or other platforms (such as the Liquid Network by Blockstream, or even in very simple forms like “coloured coins” on top of Bitcoin) are entirely dependent on their underlying systems and thus inherit any disadvantages specific to those systems.  This means for example that tokens built on top of Ethereum are definitionally more expensive than the value that can be extracted from them due to the behaviour of Ethereum’s gas system.  Every such token eventually migrates off the platform or fails, but not before their founders have extracted large amounts of money from gullible speculators.

It is possible to imagine simple tokens on top of Bitcoin being used as things like “reward points” or similar and due to Bitcoin’s properties not conveying any strong disadvantages to the token that they could have some limited use.  They can definitionally never be a currency themselves though as they are strictly less functional than Bitcoin itself and thus can only ever fulfil a secondary role at best.

Stablecoins

Stablecoins are an attempt to create a cryptocurrency that maintains a “stable” value against a fiat currency.  This could be the US Dollar, Euro, or any fiat.

The best known stablecoin is “Tether” (USDT) which has a value floating around that of the US dollar.  It is claimed to be backed by real USD – that is, for every tether within the system, a US dollar is held by a trusted organisation.

Obviously, this kind of system is a measure that only exists in a world where fiat currencies continue to exist.  They’re also entirely based on centralised trust models around the fiat holdings.  The only reason they exist at all is because of regulatory systems that make them “more attractive” in some scenarios than fiat when it comes to ownership, taxation, and reporting.  There is no long-term viability of these systems as currencies in their own right.

As a side note, while a stablecoin could be created that has its own blockchain or similar, all stablecoins that currently exist are hosted tokens and thus also find themselves under the same constraints as mentioned.

Directed Acyclic Graphs

A blockchain can generally be modelled as a continuous “chain” of blocks with occasional short-term forks that are resolved a block or so later.  Directed Acyclic Graphs (DAGs) are fundamentally similar structures but with a large number of constantly forking and remerging chains that have an emergent status at the end.

It’s a complex and fascinating structure mathematically, but so far, no DAG has been built that didn’t require at least some form of centralised coordinator to make sense of the chaos.  It’s possible that such a thing can’t exist.  This is an ongoing area of study.

Novel digital token/coin approaches

Aside from basic blockchains and even DAGs, there are other novel approaches that have been taken in trying to create a cryptocurrency.

Monero is a relatively traditional blockchain, except that the transactions are masked both in terms of the participants and amounts.  The concept uses a system called “ring signatures” to effectively add so much “noise” to the network that meaningful information can not be extracted.  Anyone trying to watch “you” would see so much activity that isn’t actually you, that when you do perform an action it is lost in the noise (this is an oversimplified description, since I promised not to go deeply technical in this article).

The disadvantage of anything that masks actors and amounts is verifiability.  I can be certain of how much Bitcoin exists and what UTXOs (unspent transaction outputs) they currently reside in.  I may be able to know a few things about some UTXOs such as whether they require a script, a simple signature, or are part of a multisignature arrangement, but without external information I can’t link them to real people.  With Monero on the other hand, there is no way I can prove the amount of Monero that exists in the network or whether I am truly transacting with the person that I think am transacting with – even if they want me to know that I am.

Grin is another interesting approach which nearly forgoes the blockchain or graph approach entirely by aggregating transactions to a single transaction within a block and then further allowing historical data to be removed by allowing for spent outputs to cancel against corresponding inputs while still maintaining the verifiability that a transaction historically occurred and thus the proof of ownership for the current coin’s owner is maintained.

Grin’s approach is extremely interesting but suffers – like Monero – from being unable to verify it hasn’t been historically broken.  The status of the Grin “blockchain” would appear the same if it has been compromised or not and there is thus simply no trivial way to know if any planned economic principles have been violated.

There are many more systems aside from these and it’s impossible to evaluate all in an article such as this.  I continually investigate technologies that seem interesting and new, but as yet have not seen any that couldn’t either be implemented in Bitcoin or carry risks that make them unacceptable as a true form of money.

Opportunity Cost

In life, you make choices.  For nearly every choice you make, there are both positives and negatives to each alternative as well as unknowns that are potential positives or negatives.

Consider for example that you are offered a new job in another country.  You may choose to take the job, or you may choose to stay in your current position.  The new job may have a better salary and more interesting responsibilities.  But it also may be difficult for you to adjust to a new culture and you may be leaving a position where you’re well-respected to enter one where you’re a stranger to all of your new colleagues.  Staying at your old job, you may get to use your respect and seniority in the company to move up to a higher position or maintain a high quality of life with a job where you feel valued and comfortable.  Either choice that you make is going to mean that you miss out on the potential advantages of the other choice.  This is what is meant by opportunity cost.

A much simpler example is the decision to purchase an apple.  If you do purchase the apple, your opportunity cost is the loss of the ability to use that money for something else.  If you don’t purchase it, your opportunity cost is not having an apple.

Opportunity costs exist for every possibility whether you’re aware of them or not.  Maybe if you’d gone out to dinner last night instead of eating at home, you would have met a rich eccentric old man at the restaurant who would write you in to his will for taking the time to talk to him.  It’s extraordinarily unlikely, but not impossible.  Since you – definitionally – can’t plan for the unknown, it’s not worth worrying about these opportunity costs, but it is worth keeping them in mind when it comes to the value of knowledge.  The more you know, the less unknowns there are, and therefore the less opportunities you may miss.

Bitcoin vs the Dollar

Bitcoin’s opportunity cost is actually of a relatively simple financial kind, because Bitcoin is a financial tool (specifically: money).  If you exchange dollars (or euro, or pounds, or yen, etc) for Bitcoin, your opportunity cost is the purchasing power of the dollars.  If you exchange Bitcoin for dollars, your opportunity cost is the purchasing power of the Bitcoin.  Equally, if you choose not to exchange dollars for Bitcoin, your opportunity cost is the purchasing power of the Bitcoin and if you choose not to exchange Bitcoin for dollars, your opportunity cost is the purchasing power of the dollars.

As already described, not knowing about an opportunity cost doesn’t somehow mean that it’s not there, you simply didn’t know about it.  Therefore, not knowing about Bitcoin doesn’t remove these opportunity costs.

Another way to phrase these opportunity costs would be as a gamble.  Storing your wealth in or moving your wealth from dollars to Bitcoin is essentially equivalent to betting that Bitcoin’s value will appreciate against the dollar.  Storing your wealth in or moving your wealth from Bitcoin to dollars is essentially equivalent to betting that the dollar’s value will appreciate against Bitcoin.

The timeframe for this bet is undefined.  People who perform any kind of frequent trading between dollars and Bitcoin are making this bet over short terms.  Essentially, gambling on the exchange rate fluctuations in order to increase their overall wealth (whether they store it in Bitcoin or dollars at some “end” point is then a matter of their long-term perspective).

On the other hand, there are people who don’t trade frequently or at all.  These people are making a long-term bet on the relative values of the currencies.

Here’s some salient facts we can give that are likely to be considerations for these bets:

1. Like any asset, supply and demand are the largest contributors to a currency’s value.  If you print more money, it becomes worth less.  This is clear and obvious throughout history, both in terms of hyperinflation as well as normal planned inflation.
2. Fiat currencies like the dollar are generally designed with continuous “controlled inflation” in mind.  A part of this requires that there is continuous money printing, devaluing the currency (the intention is to “encourage spending” which “stimulates the economy”; this is a fallacy, but I won’t address it in this article).
3. Bitcoin has a fixed supply of just under 2.1 quadrillion satoshi (21 million BTC).  This will never change although it is possible for some to be “lost” or otherwise rendered “unspendable”.
4. Bitcoin has significant short-term volatility against the dollar but has a clear long-term strong upwards trend.  This trend is supported by multiple financial models including stock to flow modelling that clearly shows a relationship between the availability of Bitcoin and the dollar value.

The opportunity cost of spending Bitcoin

This leads to the obvious conclusion that Bitcoin is a good long-term bet.  The opportunity cost of holding dollars is simply too high given the long-term outlook.

So why would anyone want to spend it?  If I spend 10000 satoshi on a cup of coffee today, maybe I could have spent those sats on a new computer in the future!  Now that we understand the opportunity cost of spending Bitcoin given its upwards trend, we’d be crazy to spend it.  Surely, I should spend my dollars instead?

Yes, you should… if you have them.  But the question is framed incorrectly.  It assumes that you have both dollars and Bitcoin available to spend.  If this is the case, you’re now in a situation where you can spend 10000sats worth of dollars on a cup of coffee or could exchange those dollars for sats that you save in order to buy the new computer in the future.

That is to say: the opportunity cost of spending dollars on goods and services instead of exchanging them for Bitcoin is identical to the opportunity cost of spending Bitcoin on goods and services.  As long as it’s possible to freely exchange between the two currencies, the opportunity cost exists.

If you choose to hold dollars as well as Bitcoin; spending the dollars first makes sense.  If you choose to only hold Bitcoin and no dollars, spending it is no different than spending the dollars you would’ve spent if you had them.

The opportunity cost of spending dollars (?!)

A naïve conclusion for this analysis would be that I simply shouldn’t buy anything at all anymore.  I should exchange all of my money for Bitcoin and live as frugally as possible so that my savings are worth more in the future.  I say it’s naïve because it assumes the only goal for a human life is the acquisition of wealth rather than the enjoyment of life that one can use that wealth for.  Perhaps drinking a cup of coffee today, chatting with good friends and enjoying their company in the comfort of a cosy café really is worth more than a new computer at some undefined point in the future.  To me at least, it often is.

Therefore, the more nuanced version of the conclusion is that I should be more mindful of my spending.  I don’t spend money that I really don’t see as enriching my life (or by proxy as I enrich the lives of those I care about).  I do spend my money on luxuries, but I don’t waste it.  What I don’t spend, I get to save – in Bitcoin – so that my savings can grow over time and bring more joy to myself and my loved ones in the future.

Preamble

In November of 2019, my employer decided to create an interview with me to be published on the company website. We did this in the form of questions from our Head of Corporate Communications which I then wrote detailed answers for.

My answers were heavily edited, chopped up, and reduced in scope along with the translation to German from my English original and while I don’t feel that they misrepresented my position in any way (or I wouldn’t have approved it), I do feel that the full answers I wrote are a much more accurate representation of my thoughts. Accordingly, I am publishing them here in their original unedited form. Note that I have translated the original questions from German to English.

Interview

Ben, you’ve been a “Bitcoiner” from day one. The development of the Bitcoin price is often compared to the Gartner Hype Cycle. Where do you think Bitcoin’s price currently is on the cycle? Are we past the “trough of disillusionment”?

The exchange rate of Bitcoin (I don’t like the word “price”) is indeed often compared with the Gartner Hype Cycle.  However, I think this is a terrible comparison.  The Hype Cycle is intended to model how much “hype” is around a new technology and show the phases of adoption that technologies go through. During the initial phases, a new technology gathers a lot of attention as people jump on to start using it without clearly thinking about the real potential.  Later, people find that it isn’t living up to their expectations and so usage falls significantly and people speak negatively about it.  Finally, an understanding is reached of the actual productive use cases, and the technology is adopted in a more fitting way.

While adoption of and interest in Bitcoin’s fundamental technologies could be modelled in this fashion, there is no indication that Bitcoin’s exchange rate should follow that pattern along with the technology.

Given how little Bitcoin has been noticed or adopted in the wider technology community as yet, I’d say that if the Hype cycle can be used at all, we’re still in the early part of the “Technology Trigger” phase.  This is largely because due to false understandings being spread about Bitcoin’s technology, the majority were (and many still are) focused on the incorrect idea that a “Blockchain” is the key technology of interest.  “Blockchain” as a technology may indeed be on the first downward slopes of the “Trough of Disillusionment” phase when modelled using this diagram, but that’s a separate topic to Bitcoin.

It’s also probably important to note that I don’t believe that the Gartner Hype Cycle is even very useful for modelling actual technological uptake.  While some technologies can be neatly fit on to this kind of diagram, many others are very poor fits, and so there should be no expectation that any technology is necessarily able to be neatly fit on to this kind of chart.

A major topic parallel to that is the mainstream acceptance of Bitcoin. So far it seems that mainly the “innovators” and “early adopters” are engaged. In your opinion, what needs to happen for the majority of others to jump in? Can this step be forced or will it just happen by itself?

Bitcoin’s value (not exchange rate but fundamental value) comes from its inherent properties as a better form of money.  Because of this, it really is just a matter of time before it naturally becomes the currency that people would rather hold than other currencies.  This could however take a very long time – many generations – to happen if there isn’t active development on the Bitcoin ecosystem.

Right now, other than long term savings, currency speculation (gambling), and some level of transaction anonymity there isn’t a strong incentive towards Bitcoin for the majority of people in modern democratic countries with relatively stable economies.  In more oppressive parts of the world, or places where the economy is much more unstable, there are additional incentives including the ability to transact without censorship, and avoiding hyperinflation.

Some reasons that many people haven’t adopted Bitcoin yet include the difficulty of acquiring Bitcoin to begin with, concerns about how to safely store their Bitcoin once they have it, and a general feeling that once they have it, they can’t really use it anywhere.

I would argue however that the main reason the majority have not yet started using Bitcoin is because they don’t really know anything about it.  They’ve heard some things about people getting rich from “magic internet money” and that criminals use it for conducting transactions online, but aren’t aware of both the advantages that Bitcoin offers as well as the disadvantages and risks around the currency that they currently use.

People don’t adopt technologies without having a reason to do so.  Bitcoin is often presented as either a speculative asset or a payment network.  For many people, currency speculation isn’t something they want to be involved in, viewing it as a form of gambling with a significant potential for loss, and so this is uninteresting for them.  Also, since cash, debit cards, credit cards, PayPal, and many other newer technologies are extremely efficient and effective payment networks, they see no value in using Bitcoin in this area either.

I think therefore there are two complementary approaches that can be actively taken to speed up adoption.

The first is to increase education.  Education around the absolute basics of what Bitcoin is and what it is not should not be ignored.  As long as websites offer payment options where “Bitcoin” is listed side by side with “PayPal” and “Credit Card”, the false assumption that Bitcoin is a payment network will remain prevalent.  Beyond the basics of Bitcoin itself however, education needs to cover general economic principles that most people are unaware of such as the properties of money and how markets describe the value of goods and services.  It’s only then that people can understand not only that Bitcoin really is money rather than a simple traded asset, but why it’s in fact a better form of money than others.

The second is to reduce the friction in the use of Bitcoin for typical daily currency purposes.  At the moment, the majority of places where you spend money on goods and services, the ability to use Bitcoin is not an option.  When it is an option, it may be slower, more expensive, or more difficult than using other currencies.  This is true for both the merchant and the customer and so both are incentivised against it.  There are many places where this friction can be reduced.  In the case of a simple purchase of goods in a shop, we see opportunities for improvement from the wallet application that the customer uses to make the payment, through the payment technologies by which the Bitcoin transaction is performed, to the merchant’s accounting and reporting software.  Even before making the purchase, the customer must have already acquired some Bitcoin from somewhere, whether they were paid for goods and services themselves, or exchanged some fiat money for it.  Frictions exist throughout these and many other processes as well.

For many, it is still too complicated to buy Bitcoin and store them in an own wallet. When will holding Bitcoin become as normal as owning a bicycle?

This will only happen when people have a reason to want to hold Bitcoin.  As already said, people only adopt a technology when they have a reason to do so.  The reason could come in the form of negative pressures pushing people away from their existing currencies – such as a severe economic recession / failing economy or political regimes taking hold that use the ability of sovereign currencies to control and manipulate the people – or in the form of positive pressures pushing people in to Bitcoin such as the simplification of many currently complex or expensive processes caused by the necessity for middle-men in the fiat economy.

The first form – negative pressures – doesn’t require any particular development or improvements to the Bitcoin ecosystem, as the Bitcoin currency already has the necessary properties of sound money to be the fallback in these cases.

The second form – positive pressures – require that new tools are built around the Bitcoin ecosystem that allow for these simplifications and efficiencies to be implemented.  That is currently the most active area of development in the Bitcoin ecosystem, where many tens of thousands of companies and individuals around the globe are building payment systems, currency gateways/exchanges, “sats-back” (cash-back) systems, and more.

It is my personal belief – shared with many others – that if global adoption can be inspired through positive pressures, we can avoid the inevitable collapse of the global economy that would be the natural result of too many negative pressures.  In the end, Bitcoin adoption is ubiquitous in both cases, but if the catastrophic global human suffering of a complete global economic collapse can be avoided, I think it’s obvious that it should be.

What needs to happen, for Bitcoin’s price volatility to decrease?

Volatility in other currencies is carefully controlled and managed by central banks adjusting the supply.  The European Central Bank for example describes their main task as being “to maintain the euro’s purchasing power”.

Bitcoin doesn’t have and – by definition – can’t have deliberate supply adjustments.  As a result, it will naturally follow economic growth and decline.  If Bitcoin were the only global currency, this would simply result in a stable economy with deflationary pressure reducing spending during growth and inflationary pressure increasing spending during decline, ensuring that growth and decline are kept in check by economic pressures.

However, Bitcoin isn’t (yet) the global currency of the world. Instead, it’s a $150-billion US dollar market, which may sound large, but puts it around 4% the size of the total German economy.  Because of this small size, it can be disproportionately affected by trading markets where the currencies of larger economies would barely move a tenth of a percent with similar flows.

This perceived problem however will simply solve itself over time.  Bitcoin’s supply algorithm ensures that supply of new coins decreases over time, which in a classic supply and demand model leads to an increase in value.  Right now, people don’t use Bitcoin as a unit of account and this means that no one needs or wants to have any specific amount of Bitcoin, but instead specific values of Bitcoin as measured in currencies that are units of account.  This means that a supply decrease and corresponding value increase will not generally make anyone concerned about their inability to get as many Bitcoin as before, since they are still just as able to get the same value.

This increase in Bitcoin’s value over time means that the amount of external money required to move the market value also increases.  This naturally begins to limit volatility.  By the end of the 2020s, it is likely that Bitcoin will be less volatile than many national currencies.

Will it eventually become normal to buy a cup of coffee in your lunch break with Bitcoin or will Bitcoin rather be used for large value transfers such as international bank settlements?

This is a matter of the payment technology used and not the currency.  Bitcoin’s “built-in” payment technology is base layer transactions written directly to Bitcoin’s blockchain.  This is relatively inefficient, slow, and expensive because space in a block is an inherently valuable and limited resource.

Therefore, buying a cup of coffee with a base layer transaction is something that – while possible in the past and currently at many fine cafés and bars around the world – isn’t going to continue in to the future.  Thankfully, other payment technologies also exist.  The most promising of which is called the Lightning Network.  Lightning enables transactions to happen between participants without writing each individual transaction to the blockchain through a network of interconnected channels.  Each participant is only connected to a few other Lightning Nodes, but payments can be routed – without trusting intermediaries – through the network to any other participant.

In October, I attended “The Lightning Conference” in Berlin.  At the conference itself, I bought several coffees and quite a lot of very good ice cream by “Chipi Chipi Bombón” exclusively using Bitcoin over the Lightning Network.  In the evening, I enjoyed some beer at Room 77 in Kreuzberg and had my dinner delivered by “Food for Coins”, also both paid for the same way.

As these technologies begin to mature, it is reasonable to expect that this will become much more common and natural and should eventually be an option everywhere instead of only a few specific forward-looking shops.

What do you think: is Bitcoin “digital gold” or rather something like a new currency? And which way will it develop further?

This question is making a distinction that doesn’t exist!  Digital gold is a new currency.  Gold made a great currency until the interconnected and global nature of the world made it impractical due to problems in its divisibility and weight (and later, its inability to be moved digitally).

The unbacked fiat currencies we have today are not the norm throughout history.  They’re an experiment that has been tried a few times throughout the centuries and each time it has failed badly.  Our current system has lasted longer, but only through excessive manipulation that has led to significant financial crises and a lot of hardship for many people.

Returning to Bitcoin – as digital gold that doesn’t suffer the same shortcomings as physical gold – is more like every other kind of currency we’ve had throughout history that hasn’t suffered the problems we see under the current fiat system.

How will Bitcoin mining change once all Bitcoin have been mined?

Because the supply of new Bitcoin halves approximately once every four years (210000 blocks), it will be over a hundred years still before the supply of new coins is finished.  However long before then, the supply of new coins in each block will reach a level where it’s much smaller than the transaction fees included in the block.  From that point onwards, the supply of new coins becomes much less relevant to the miners and instead their income is based on filling the blocks with fees.

Very little is likely to change in the fundamental business of mining itself, however there will be economic incentives for some different behaviour and so we are likely to see that several tricks used by miners – such as mining empty blocks on the back of full ones – will stop being used as they no longer provide useful revenue.  Miners are also likely to become much more involved in the other aspects of the Bitcoin ecosystem than they are currently as they will be more incentivised to promote a strong fee market.

How do you see the roles of Bitcoin, Bitcoin Cash, and Bitcoin SV in the future? In the end, will there be only Bitcoin?

In the end, yes, there will only be one Bitcoin.  Economically, proof of work within Bitcoin is a technology that converts energy in to monetary tokens.  If there is more than one type of monetary token with different values, it stands to reason that the work being expended will migrate towards the most valuable one.

The only reasons that there are opportunities currently for miners to switch chains and potentially make profit off each is the volatility of the markets, economic hedging to influence the market values, and the immature state of the mining industry where technology changes are still able to provide significant advantages.  As the markets grow and mature, these reasons will disappear and the less valuable chains with them.

Bitcoin Cash and Bitcoin SV also both suffer from scalability issues.  By attempting to simply increase the block size to keep up with demand, they are inherently decreasing the cost of the limited resource of space in a block.  As block space is inherently valuable as an immutable data store, there is no size at which it would not be filled to capacity if the cost is low enough.  Once the nominal cost to store data in a block is decreased beyond the cost that a node operator pays for the bandwidth and storage requirements for that block, economically rational node operators will simply switch their nodes off and the irrational ones will follow once they have no money left for upgrading their bandwidth and storage.

Therefore, despite the idea that these forks had of increasing the block size to solve scalability issues, they instead actually created scalability issues that Bitcoin doesn’t suffer from.

Even aside from the economic game theory, it is now clear from current levels of adoption and discussion around Bitcoin that the network effects of Bitcoin would be more than enough to sustain it against competition from alternative cryptocurrencies even if those cryptocurrencies had all of the properties that Bitcoin does.  Since no competing cryptocurrency is able to satisfy all of the properties that Bitcoin does, this essentially guarantees their failure against Bitcoin.

Don’t some cryptocurrencies offer faster transactions and lower fees than Bitcoin without using second layer technologies like the Lightning Network?

Any improvements in speed or fees at the base layer only come at the unacceptable cost of drastically lower security.  It is trivial to create a financial transaction system that is faster and cheaper than Bitcoin, but not without introducing large security risks.

The easiest way for example is to remove the need for a blockchain entirely and just write everything in to a single database that you store on Amazon Web Services.  This is much faster and much cheaper than Bitcoin; however, the moment that a hacker gains access to it, the entire system is compromised.  Even worse, someone with the authority to access it may do so out of greed.  A system like that requires trusting that those with authority aren’t going to commit crimes, and that those who build the security for the system are able to do so perfectly.

This is equally true for traditional financial systems.  Banks charge high fees and interest rates on loans greater than the interest rate on deposits precisely because it is a costly exercise to maintain the many different checks and balances in place to ensure the system is as secure as it can be.  Even with all of that, Banks have been compromised – both physically and electronically – many times in the past and will always continue to be as long as they are such enticing targets for criminals.

Bitcoin is built in such a way that no one has the ability to cheat the system.  There is no centralised authority making decisions and no central database of information.  That means that there is no one who may abuse their authority and no target for hackers that can break the system.  When talking about other cryptocurrencies, some or all of these assumptions may not be the case and just because a blockchain is used, it doesn’t make it truly decentralised.

In July of 2014, the European Banking Association (EBA) published EBA/Op/2014/08, “EBA opinion on ‘virtual currencies’“. This was intended as a general guideline for the management of systems like Bitcoin and other systems that fall under the general concept of cryptocurrency or virtual currency. The guidelines are not universally adopted but the definition of a “Virtual Currency” is referenced by many other organisations including Germany’s BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht / Federal Financial Supervisory Authority) and therefore serves as the basis for determining whether or not any regulations placed on virtual currencies applies to a particular system or not.

Unfortunately, the definition provided within this document is abysmal. Utterly and completely abysmal. It is so vague as to be meaningless. Aware of this, they themselves admit on page 10 that:

Finally, it must be noted that VCs existed long before the more recent emergence of the decentralised VCs that this report focuses on. Early examples of centralised VCs that were not convertible to FCs (such as World of Warcraft Gold or frequent flyer miles), unidirectional convertible VCs (such as the former Facebook Credits or Linden Dollars) and bidirectional convertible centralised VCs (E-gold or Liberty Reserve)

By doing so, they point out that virtual currencies can be either centralised or decentralised and while the report focuses on decentralised varieties, the centralised ones are still considered to be virtual currencies of a kind.

They then begin to list the properties that define a virtual currency:

1. A digital representation of value

Bitcoin and nearly all similar virtual currencies can exist in various forms that are not digital. They are mathematical constructs that are easily implemented in digital form, in the same way that “E-Money” (an official EBA term) is a digital representation of fiat money despite not all fiat money being digitally represented.

This is then immediately followed by the statement:

This does not exclude the possibility that it may also be physically represented, such as through paper printouts or an engraved metal object.

Oh, so it doesn’t need to be “a digital representation of value“. This addition makes it clear that it’s “a digital or physical representation of value“. Obviously this can be contracted quite simply to “a representation of value“.

2. Not issued by a central bank or a public authority, nor necessarily pegged to a fiat currency

The first half of the sentence is clear, but the second is meaningless in narrowing the scope, as the phrase “nor necessarily” tells us that it could or could not be pegged to a fiat currency.

3. Used by natural or legal persons as a means of payment

In other words, “money”. Okay, clear.

4. Can be transferred, stored and traded electronically

Seems to be almost the same as the first… and then the same exception is made:

However, it does not exclude physical transfers, the storage of copies in other forms (e.g. paper, minting and engraving) or that the VC is traded in other ways.

So again, we find ourselves with an overly broad definition that it: “can be transferred, stored and traded electronically or physically, or in other ways” or more simply reduced to “can be transferred, stored and traded“.

Putting these four points together, we find that a “Virtual Currency” is: “A representation of value, not issued by a central bank or a public authority, used by natural or legal persons as a means of payment, that can be transferred, stored and traded“.

This definition covers everything from Pokémon cards to seashells to Bitcoin to Disney Dollars.

The document continues – without clarification of reasoning – by listing several properties that a virtual currency might have but doesn’t have to:

No legal tender status: Currently, no VC has legal tender status in any jurisdiction, but it is theoretically possible that a VC might be declared legal tender in some jurisdictions in the future.

Central versus decentralised scheme: Some VCs are issued and controlled by an individual or a group of individuals, while other VC schemes are issued and operated in a decentralised manner.

Convertibility: Some VCs are convertible (or open) and, therefore, can be exchanged back-and-forth for fiat money at an exchange rate, whereas others are non-convertible (or closed).

Non-redeemable: This refers to the observation that, unlike electronic money, a VC, particularly in its decentralised variant, does not represent a claim on the issuer.

For the final of these, it’s noteworthy that this is a deliberate property of Bitcoin. Bitcoin is a “commodity currency” and therefore is the representation of value itself instead of representing a claim to value such as with a gold certificate or similar.

From these further properties, we could now say that the EBA’s definition of a virtual currency is: “A representation of value, not issued by a central bank or a public authority, used by natural or legal persons as a means of payment, that can be transferred, stored and traded; that has no legal tender status (but might in the future); might be centralised or decentralised; might be convertible to fiat or might not be; and does not represent a claim on the issuer.“

Or simplified by removing the unnecessary might-or-might-not components: “A representation of value, not issued by a central bank or a public authority, used by natural or legal persons as a means of payment, that can be transferred, stored and traded, and does not represent a claim on the issuer.“

This still leaves us with a definition that covers almost anything and is therefore useless in determining what is and is not covered by laws designed to regulate virtual currencies. This may of course be deliberate, since with such a broad definition, it becomes possible to apply laws and regulations anywhere that benefits the lawmakers and regulators.

The remainder of the document contains significant problems, misunderstandings, and meaningless phrases but nothing that adds any further to the definition.

Money is a Communication Tool

It’s often very difficult to explain to people what Bitcoin is.  The main reason for this is that the answer is deceptively simple but highlights a larger problem.  The answer is that Bitcoin is money and the problem that it highlights is that most people have no idea what money is.

Fundamentally, money is a communication tool.  It communicates value between people so that direct barter of goods and services is not necessary.

Talking about money as a communication tool for value, we also need to understand what value means.  Value is “that which we want to have”.  It is inherently individual and one person may value something more than a different individual does.  Our reasons for value are tied to our individual positive feelings either directly, “this thing makes me happy” or indirectly, “this thing saves me time on something I don’t like so much, so I can spend more time on things I do like”.

In order to money to be an effective communication tool, it needs to be represented by something.  In the modern world, we have physical and virtual representations of money.  You can imagine for example a one-euro coin, a twenty-euro note, the value in your bank balance, and the number written on a small pad of paper representing your table’s current bar tab.  The commonality with all of the above is that they’re represented in the same unit – in this example, euro.  This brings us to a second concept: “currency”.

Currency is the metric we use for money.  In other words, the way we measure “how much money”.  There can be many different currencies, but not different metrics within a currency.  One euro in one place or form is always equal to one euro in another place or form.  Whether we have ten euro stored in a bank account, ten one-euro coins, or a ten-euro note, it’s considered the same amount of money.  This brings us to the third concept: the representation of a currency, also called the “currency medium”.

The currency medium – whether physical or virtual – has properties that affect its suitability as a currency as well as how we use it in its role as a communication tool.

Unless a thing is ‘declared’ as a currency by a government or similar (we’ll discuss that later), it will usually go through several phases and hold aspects from these phases as it becomes a currency medium.

The first phase is as a collectible.  Collectibles are things that people want to have and collect more of.  In other words, collectibles are things that some people value.

The second phase is as a store of value.  Once a thing is being collected by those who value it, it inherently becomes valuable to hold on to it whether you personally value it or not.  Because of some specific properties of it that we’ll talk about soon, you expect its value to those other people to either stay the same or increase over time and thus you hold on to it for the future.

The third phase is as a medium of exchange.  Once everyone around you is also holding these things, you can exchange them with each other for other goods and services.  That they might one day be given to collectors is almost forgotten, as the currency now has value in and of itself for the purposes of conducting commerce rather than speculation.

The fourth and final phase is as a unit of account.  The collectors are completely forgotten and now the value of goods and services is directly measured in units of this thing.  Some currencies may at this point also lose their ability to be a store of value, however to understand how that comes to be, we need to cover a lot of other ground first.

Currencies therefore are things that often start off as collectibles and develop in to a medium of exchange for goods and services priced in these things (i.e. a unit of account).  They are also usually – but not always – stores of value.

In order for currency to be a good metric, it needs to have properties regardless of its medium.  The number and degree of these properties that a currency medium has, the better suited it is to representing the currency and the lack of properties may limit something’s ability to be used as a currency medium.

The commonly considered properties with some examples are:

Property	Definition	Examples
Fungible	That one of the things is equivalent to another one of the things in terms of value and also preferably (but not necessarily) indistinguishable.	Houses have low fungibility as they vary in size, quality, and location.  One house is not the equivalent of another. Barrels of oil on the other hand are highly fungible as one barrel of pure oil is equivalent to another.
Non-consumable	That the thing doesn’t get “used up” (whether used as money or another use) and instead remains within the system.	Oil is consumable for many different purposes, which is one of the things that makes it a valuable commodity, but not a good currency. Gemstones are generally non-consumable, as even when made in to jewellery they can be later reclaimed.
Portable	That the thing can be transported easily.	Sand is very easy to transport; often unintentionally if you’ve taken the kids to the beach. Boulders are very hard to transport, despite really just being very large grains of sand.
Durable	That the thing doesn’t get worn out over time and in the course of being used.	Tissue paper is not very durable.  If we tried using it as currency, we’d often find ourselves poorer through common everyday accidents such as spilled water, sweating, or just pulling it out of your pocket too quickly. Diamonds are very durable.  It’s very hard to destroy a diamond unless you really try.
Divisible	That the thing can be broken in to smaller amounts.	Oil is highly divisible.  I can give you a hundred litres or one millilitre without too much difficulty. Paperclips are not highly divisible.  While I can easily give you one or a hundred, it is much more difficult to give you 22.75 of them.
Verifiable	That the thing can be shown to be real and not counterfeit.	Diamonds are very hard to fake.  Making something that is not a diamond but has all of the various testable properties of a diamond will generally cost you more than a diamond would. “Spring Water” is very easy to fake.  You can bottle filtered tap water and people can’t tell the difference.
Transactable	That the thing can be easily used in exchange for goods and services (when accepted).  This is often dependent on other properties such as divisibility but may also be influenced by other properties that aren’t listed.	Diamonds are difficult to transact with because of their size in relation to their value.  Even if you could subdivide a diamond enough, paying for a candy bar with diamond dust is not an easy experience. Facebook Likes are easy to transact with because they are virtual and so can be used to transact almost anywhere in the world to someone else almost anywhere else in the world.
Scarce	That the thing is not abundant nor easily created new.	Uranium is very scarce and very difficult to create. Paper is abundant and also quite easy to create.

Note that none of the examples for these properties is particularly useful as a currency medium, since even where they may be good in one or two properties they are often catastrophically bad in others.  Facebook likes may be highly transactable, but they’re also not divisible, only weakly verifiable, and – most importantly – not scarce.

Hopefully we now have a better understanding of what “money” is, what a “currency” is, and what a “currency medium” is.  To help keep it straight in your mind, we can sum it up with the following series of statements:

• Money is the communication of value using a conceptual tool called a currency.
• Euro, dollars, and Bitcoin are currencies.
• A euro coin is a physical representation of the euro and thus coins are one currency medium employed by the euro.
• A euro value stored in a bank account is a virtual representation of the euro and thus bank balances are another currency medium employed by the euro.

Types of Currencies and a History Lesson

In early money, currency was equivalent to its representation.  The properties of currency were the same as the properties of the currency medium.

According to archaeological evidence, one of the first currencies used was likely seashells.  Far from the ocean in central Africa, seashells are relatively rare to find naturally and at the time – tens of thousands or maybe even hundreds of thousands of years ago – the technology to counterfeit them didn’t exist.  Looking at the other properties that make something a good currency media, we can see quite quickly that shells aren’t a bad choice for a tribe of early humans in central Africa.  They’re quite good in terms of being fungible, non-consumable, portable, verifiable, transactable, and scarce.  They really aren’t so durability or divisible, but six out of eight is a pretty good start.

Seashells of course aren’t something someone actually wants to have under normal circumstances.  They have to be understood as a representation of value – that is, money – before their properties as a currency even come in to play.

There are two main ways that a currency can come in to being: by consensus and by decree.

Consensus currency is usable as money because everyone agrees that it is.  That is, there is no individual or group that demanded it be considered usable as money, it simply became adopted as such because its properties were sufficient for it be a usable currency and the people using it agreed for that to be the case.

Currency by decree comes in to being because an authority claims it to be so and the society that follows that authority accepts it as the case.  Currency by decree is often called fiat, but this is actually slightly incorrect.  The word fiat comes from the Latin verb fiere – to be done – and is best translated as the command “let it be done”, however applied to currency, it doesn’t relate to the initial decree for its existence, but rather the power over the creation of more of it.

No one can simply declare more gold, air, water, corn, or frogs in to existence, no matter how much political power they wield.  These things can be created – some more easily than others – but all require energy to be put in to their creation and thus they have a strict upper limit based on the available supply of energy.  Generally, these things are referred to as commodities.  A commodity is defined as a basic good that is interchangeable with other goods of the same kind.  Or, put in the terms we’ve already used, it’s a good that is fungible.  Currencies based around commodities are commodity currencies.

Fiat currencies on the other hand have potentially unlimited supply at no fixed energy cost per unit.  The creation of a thousand new words in a language doesn’t require a thousand times the energy of one new word.  Equally the creation of a million new dollars in a bank database doesn’t require any more energy than the creation of a single cent.

Inherently, this is the only difference between commodity currency and fiat currency, however as we will soon see, this is significant enough on its own.

Initially, all currencies were commodity currencies.  This is even true for early national coins such as the Roman Denarius.  Being made of nearly pure silver, the Denarius was worth exactly as much as its weight in equivalent purity silver.  The “coin” was simply an easy way to identify how much silver it was without the necessity to weigh it.  Thus, the true currency was the silver and the Denarius coin was the common medium for it.

In the first century, Emperor Nero realised that debasing the Denarius with cheaper metals would allow for the creation of wealth “at no cost” and allow him to pay off his debts more easily while still remaining wealthy.  The Denarius had become so standard as a currency in its own right, no one even paid attention anymore to its relationship to the silver it was made of.

For a while this worked, however more so in Rome where money could be treated more abstractly without too much attention being paid.  As the outlying parts of the empire began to understand the deception, they – still considering the silver to be the true currency – began to charge more for their goods in order to get the silver that they wanted.  The Denarius, without ever being formally redefined, had shifted from a commodity currency to a fiat currency.

Two centuries later, the Denarius was 0.02% percent silver, and considered worthless outside of Rome.  The Roman empire collapsed soon after.

In the thirteenth century, Kublai Khan brought China under Mongolian control.  He bought vast amounts of goods and hired many soldiers for wars.  He even traded significantly with Europe through contact with the Venetian explorer Marco Polo.  How did he finance these many purchases? He simply printed new currency at essentially no cost to himself; or in other words, he used fiat.  Kublai Khan had learned this trick from his grandfather Genghis Khan’s contact with the Jurchen people in the late twelfth century.

The Jurchens had used copper coins, similar to the Roman silver Denarius.  They had however learned to overcome the problem of carrying large amounts of heavy coins around by the invention of proxy currency.  Proxy currency is the first instance where a distinction needed to be made clearly between a currency and the currency medium.  In the case of the Jurchens, it was a printed paper note called a Jiaochao, and can be considered the world’s first banknote.

The Jiaochao was redeemable at the official printer for the coins that it represented and so was much more convenient to carry and use in trade as if it were the coins that it represented.  In modern terms, we refer to this as a currency that is backed by something else.  As long as the currency medium truly is backed by the commodity as promised (and this can be proved, as we’ll discuss later), this is still a commodity currency, as the currency itself hasn’t changed, simply a new medium has been added.

Of course, it didn’t take long for the Jurchens to realise that if people treat the Jiaochao as if it is currency itself rather than just a currency medium, then there’s really no need to actually own all of the coins that it represents.  Very few people claim them anyway, since the paper is “just as good”.  Just as happened with the Denarius in the Roman Empire, the Jiaochao suffered severe inflation as more and more were printed and they became worth less and less.  Eventually, they were not accepted at all and the public only accepted copper and silver for trade.

Kublai Khan knew this history from his grandfather, but didn’t care.  His goal wasn’t financial stability but instead to finance his empire-building at no personal cost.  His notes – declared as backed by silver, where there really was little to none – also suffered severe hyperinflation and by the mid-fourteenth century (after his death) were rejected entirely.

Throughout the centuries that followed, many more attempts were made at creating proxy currencies and the inevitable fate of all was to lose their commodity backing followed by hyperinflation.

In the early eighteenth century, the French enlightenment philosopher Voltaire observed that:

“Paper money eventually returns to its intrinsic value: zero.”

This was shortly after the “livre tournois” – France’s first attempt at a paper money – had suffered hyperinflation and become worthless in less than twenty years from its creation; something Voltaire had witnessed and experienced first-hand through his adolescent and formative years.  As a response, the government had created monetary stability again by precisely fixing an exchange rate between gold and silver and then declaring the exchange rates of coins minted using these metals.

Unfortunately, those who fail to learn from history are condemned to repeat it (Winston Churchill).  Only one generation later, the French government again tried to create a fiat paper currency – the “assignat”.  13000% inflation and a rather well-known revolution later, Napoleon Bonaparte restored France to a gold standard with the introduction of the gold-backed “franc”.  This remained stable – and the basis of a solid monetary union with other nations – until the franc was removed from its gold-backing at the start of the twentieth century, after which it lost 99% of its value in the space of a single decade.

Since then, the world has seen countless fiat currencies be declared and fail.  The Papiermark of the Weimar Republic in the 1920s, the Greek Drachma in the 1940s, the Bolivian Peso in the 1980s, the Zimbabwe Dollar in the 2000s, and the Venezuelan Bolivar in the 2010s, just to name a few.

The US dollar was originally a gold-backed currency, but began to be decoupled from gold in the 1930s, finally being completely decoupled in 1971.  In the 48 years since then, the dollar has lost over 82% of its purchasing power ($2.50 in 1971 went about as far as $20.00 now on equivalent goods and services).

The economic theories of John Maynard Keynes described in his many writings – most notably his 1936 “The General Theory of Employment, Interest & Money” – are often used as a justification for why this is somehow different to all of the failures of unbacked currencies of the past.  To Keynes’s credit, the dollar hasn’t collapsed quite as quickly after having its backing removed as other currencies in the past, but it is worth keeping the size of the US economy in mind as well.  As you will recall, the Roman Denarius took nearly two centuries to fail completely and it was only slowly debased rather than having its silver removed entirely.

The euro was created as an unbacked fiat currency from conception and has decreased in value following a similar pattern to the US dollar in its twenty-year history with the only differences being visible when comparing the two directly instead of against purchasing power.

Another Look at the Properties of Currency

Why honestly (rather than deceptively, like Kublai Khan) move away from commodity currency to begin with?

To answer this question, we need to go back and take another look at the properties of a currency and see how a typical commodity currency – gold – compares to a typical modern fiat currency – US dollars.

Property	Gold	US Dollars
Fungible	Coins may have different things printed on them, but 1g of gold is 1g of gold. Fungibility: 9/10	Printed dollars have serial numbers but no special value is placed on them.  Digital dollars – being virtual – are completely indistinguishable. Fungibility: 9/10
Non-consumable	Gold can be used for non-monetary purposes, but is almost never consumed in the process and is reclaimable. Non-consumability: 9/10	Dollars are virtual (printed dollars are only one medium) and thus are definitionally never consumed. Non-consumability: 10/10
Portable	Gold is a physical commodity and so cannot be transferred electronically.  It is also heavy and so larger amounts are very cumbersome. Portability: 2/10	Dollars can be transferred electronically and come in many denominations easing physical portability also. Portability: 9/10
Durable	Gold is very non-reactive and is difficult (but not impossible) to degrade or destroy. Durability: 9/10	Physical dollar bills and coins can be destroyed relatively easily deliberately but generally last a long time and can be replaced when obviously showing wear if they’re passed through the right hands (i.e. a bank). Digital dollars are hard to destroy due to backups, double-entry accounting, and other similar practices however it can be done. Durability: 7/10
Divisible	Generally speaking, gold is easy to divide, but due to its scarcity, the value is such that divisibility becomes an issue. Attempting to divide, measure, and handle milligram and microgram amounts of gold for small payments is impractical. Divisibility: 4/10	Physical dollars can be divided down to 1/100 – called ‘cents’, which is too large for micropayment scenarios at the current dollar value, but fine for most traditional commerce. Digital dollars can be subdivided further – potentially infinitely – however most systems don’t provide for accuracy levels much better than 10-4. Divisibility: 7/10
Verifiable	With the right equipment, gold can be verified very precisely.  However, such equipment is expensive and so only practical when dealing with larger values. The technology to produce something that looks like gold and weighs the same as gold is relatively simple to procure and employ. Verifiability: 5/10	Both physical and digital dollars are relatively easy to counterfeit when dealing with smaller values as there is little infrastructure in place for fraud detection. Verifiability: 4/10
Transactable	Due to a combination of its divisibility, portability and (positive) scarcity, gold is inherently difficult to transact. Transactability: 2/10	Physical dollars are easy to use for local transactions and digital dollars are generally easy to use for transactions at a distance as there are a plethora of payment service providers.  However, as payment service providers are distinct and separate from the currency itself, they can be coerced (legally or illegally) in to blocking or altering transactions. Transactability: 8/10
Scarce	There is only a limited amount of gold on/in the earth and it takes increasingly more effort to get at it as the easiest supplies are naturally mined first. However, the exact total supply is unknown; the supply rate is variable and unpredictable; and with newer technologies (e.g. asteroid mining, or nuclear synthesis), total supply may be considered potentially unlimited. Scarcity: 8/10	Physical Dollars can be created at very low cost with no relation to the face value. Digital Dollars can be created at essentially no cost with no relation to the amount created. The only thing preventing infinite money creation is the decisions of those with the power to create it. Dollars – by design of the economic system they’re in – have a permanent, ongoing, uncapped supply increase. Scarcity: 1/10

It’s worth noting that these values – especially for gold – are measured as of today with a view to the future.  In the past, properties such as scarcity and verifiability would have achieved much higher scores.

The properties where we see the largest differences between gold and US dollars are: portability, transactability, and scarcity.  US dollars are far more portable and transactable than gold; but gold is much scarcer than dollars.

Gold worked well when the majority of commerce was local and the prices of anything would typically fall in a range of not more than around 10⁴ (the most expensive item typically bought and sold in daily transactions isn’t more than ten thousand times the price of the cheapest item).

In our modern world however, we have significant non-local commerce and our typical price range for daily commerce is closer to 10⁶.  These aspects make gold – and every other traditional commodity currency – highly unsuitable for use as money.

Fiat currencies on the other hand – primarily by virtue of their ability to be represented non-physically – are much more suitable as they can be represented in many forms including digitally and thus don’t suffer the same portability and transactability issues.  They initially seem like a great solution to these problems and in many ways are even a naturally developing solution as we learned from our history lesson.

A Closer Look at Scarcity

We learned in our history lesson that many fiat currencies of the past “hyperinflated” and we also see that ‘moderate inflation’ is generally defined in Keynesian economic systems as being a positive thing.

That leads us to ask: Does unbacked fiat always lead to the problem of hyperinflation? And if so, why? And when will the US Dollar and Euro suffer this fate?

Sometime after the first massive financial crisis of the 20^th century, a story was created that it was caused by “too much scarcity” of commodity backed currency, rephrased in terms of liquidity.  Liquidity is simply how quickly and easily currency can be accessed, moved around, and converted to other forms.  Liquidity can also be local: Pokémon trading cards are highly liquid in many comic shops and schoolyards, but not very liquid at all elsewhere.  It correlates closely with – but is not identical to – the currency property transactability.  While aspects may be tangentially related to scarcity, conflating the two is most certainly a fallacy and sadly one that is taught in many economics classes even today.

A lack of scarcity is the simple – and obvious – reason that fiat currencies generally suffer this fate.  It is possible to imagine a scenario where a benevolent dictator declares a fiat currency and institutes monetary policies of strict scarcity but it’s a hypothetical only and could only last as long as the people in charge continued to decide it to be so.  In reality, no fiat currency has true scarcity and never can because even if it does not get inflated, it can be inflated.

Here, we need to side-track to a small lesson about markets.  A market is the entire economic activity of a specific group, a specific area, a specific set of goods and services, or so on.  When used with the definite article, “the market”, it is simply the aggregate of all markets; that is, the entire economic activity of the world as a whole.

All markets are constantly in flux.  As new people are born, they tend to grow.  As people die, they tend to shrink.  As new technologies create new value for less energy input, markets grow.  As wars disrupt the free flow of money, they shrink.

The monetary value of a currency can be summed up as the size of the market they address divided by the total amount of it that exists (known as the currency’s supply).  That is, if the market consists of a hundred widgets (and no other goods or services) and there are two hundred units of the funbucks currency that can be used for these widgets, the natural value of funbucks is such that one widget costs two funbucks.

No one can truly calculate the total size of any complex market as there are simply too many factors to address.  That doesn’t mean it can’t be modelled more generally though and we can use simplified cases as thought experiments to provide us with a generalised understanding of the more complex reality.

If the supply of funbucks is increased 5% yearly, then over a little over 14 years there’ll be twice as many funbucks as there were before.  If the total market is the same (still one hundred widgets), then the effect is that funbucks aren’t as valuable as they were before.  I used to be able to get two widgets for four funbucks, but now I can only get one.

The apparent increase in supply in relation to the size of the economy is called inflation.  It’s important to note that this not the same as the real increase in supply.  The inflation that occurs with a doubling of the money supply is identical to the inflation that occurs with a fifty percent decrease in the total market.

Keynesian economics fundamentally argues for an increase in the currency supply in order to stimulate economic activity.  If I want widgets and I know that my funbucks will get less of them in the future than they do now, I’m encouraged to spend my funbucks instead of saving them.  This keeps the widget manufacturer in business, who can pay his staff, who also buy widgets.  Everyone is happy.

Except they’re not… this is another myth taught in economics classes around the world.  In reality, this is a masked variant of the well-known broken window fallacy.  A glazier who pays a boy to break windows in the village may certainly be drumming up business for the glazier who then spends his earnings at the baker, the butcher, and the tailor but what’s forgotten is that the money they paid to the glazier to fix their broken windows could have been used directly and without the cut taken by the glazier and the boy.

Inflation by artificially increasing the currency supply is the same thing, only that the “glazier” and the “boy” are more hidden and thus overlooked by many economists.  Inflation certainly does encourage spending, but money doesn’t enter the economy evenly.  When new euro are created by the European Central Bank, you don’t find you suddenly have more in your pocket or your bank account.  But they do.  They create the money and then spend it on goods and services.  These goods and services are available at the price established by the currency supply prior to the new creation act.  Over time and several transactions, this new supply is naturally incorporated in to the market and prices adjust.  You even get an increase in your salary to keep up with inflation and may not think much of it.  Sure, things used to cost less, but you used to earn less, so it’s the same.  Except somehow, it doesn’t balance out.  The price of things has increased more than salaries have.  The extra value has been taken.  Looking back to the broken window fallacy, it’s now clear where the money went: the creators of the currency supply – doing so at no cost to themselves – are taking the role of the “glazier” and their employees, contractors, suppliers and more are the “boy”.  They are taking their ‘cut’ out of the market for free and pointing at the increased market activity as if it’s a good thing.

As new technologies are constantly being developed and populations grow, it’s easy to understand why most markets also appear to be in a constant state of growth.  If a market grows, then to maintain a state of inflation, the currency supply has to grow faster.  Most controlled currencies are targeted at two percent total inflation, which means an increase in the money supply of larger than that during market growth.

However, nothing grows forever.  Even with new technologies, markets must eventually stop growing or shrink.  It should be expected that there will times of growth, times of a level size, and times that it shrinks.  In a perfectly controlled currency supply targeting a specific rate of inflation, this could theoretically be managed through the destruction of currency.  This however is where the system breaks down – very, very painfully.

The creation of money financially benefits those who are empowered to create it.  Likewise, the destruction of money financially detriments those who are empowered to destroy it.  The US Federal Reserve, European Central Bank, and other central banks have costs – the “boy” in the broken window fallacy comparison – and simply can’t afford to destroy money.  They’d be unable to continue operations because their entire business model has become “breaking windows”.

What this means is that Keynesian systems – like the one we currently find ourselves in – is completely incapable of dealing with any market state other than growth.  The only way to even try to stave off economic downturns is through even greater inflation.  Since currency creation is typically implemented in the form of new debts (e.g. the bank loans a million dollars that did not previously exist, thereby creating a million dollars), this is often dressed up in the form of low (or even negative) interest rates to stimulate lending.

It is hopefully obvious to the reader that even when successful on the short term, the only possible long-term result of this is eventual hyperinflation.  As for the final question at the start of this section, no one can reasonably calculate with any accuracy when it will happen to the dollar and the euro, only that it will happen and over the last two to three decades have arguably already seen the first clear signs of the end.

The Properties of Bitcoin

Now we know more about the properties of currencies and how traditional commodity currencies compare to fiat currencies, it’s finally time to look at Bitcoin and see how it stacks up.

Property	Bitcoin
Fungible	Bitcoin are defined virtually within UTXOs (unspent transaction outputs) in a globally shared ledger.  They are generally fungible, but due to having different histories, it is theoretically possible to value one specific UTXO differently to another. This is not practically implementable due to the ease with which the UTXO set can be obfuscated and hidden, despite arguments about “blacklisted” coins and some interest in “fresh” coins. Fungibility: 9/10
Non-consumable	Bitcoin’s blockchain can be used for non-monetary purposes such as immutable data storage, but inherently only when performing financial transactions and therefore at a financial cost.  Non-monetary uses of the blockchain don’t “use up” (or even “lock up”) any bitcoin in the process and therefore bitcoin are never consumed. Non-consumability: 10/10
Portable	Bitcoin can be transacted globally on the Bitcoin network.  They don’t actually “move” but their value is moved by the writing of an entry to the database using a private key that proves ownership of specific UTXOs.  These private keys can also be transported in storage media such as paper, electronic devices and communication channels, and human minds allowing for the effective transport of bitcoin either with or without a person over essentially any distance and with levels of security vs practicality chosen by the person transporting it. Portability: 10/10
Durable	Bitcoin can be sent to a “burn address” where no one has a known private key, or the owner of a private key may lose it such as through the destruction of an electronic device and/or all physical and digital representations of that private key.  This doesn’t actually destroy any Bitcoin, it simply makes them inaccessible, however for the purposes of measuring durability it is reasonable to consider these Bitcoin as “gone”. The only way to truly destroy any bitcoin after creation is to destroy all bitcoin by removing every copy of the Bitcoin ledger globally and concurrently.  This is beyond anyone’s technical capability as the ledger is not required to be stored on computers (there may be a printer somewhere printing the entire ledger… this simply can’t be known). Bitcoin can also be willingly (or accidentally) not brought in to the supply by miners building blocks that do not reward themselves the full amount that they are entitled to and this has happened in the past. However, for all cases where bitcoin can be either destroyed or at least rendered inaccessible, it is usually through a conscious act or a single instance of an error.  During ‘normal use’ Bitcoin are highly durable and have no aspects where they could be considered to ‘wear out’ or ‘become lost’ during an ordinary transaction. While many bitcoin were lost during the early days of the network, the amount of new lost coins has become vanishingly small over time. Durability: 8/10
Divisible	Bitcoin are currently divisible to 108 places in transactions written on its blockchain.  This can be changed with little difficulty if there is consensus for the need to do so. Additionally, Bitcoin are infinitely divisible in transactions taking place off the blockchain, but agreement must be reached for how those transactions are settled on the chain.  The Lightning Network for example allows divisibility to 1011 places if desired, using rounding to the nearest 108 when performing settlement on the blockchain. Divisibility: 9/10
Verifiable	Bitcoin written on the blockchain are publicly verifiable for any user, anywhere, any time. Ownership of bitcoin in second-layer networks such as the Lightning Network are verifiable between the two ends of each channel that makes up the network, but only the sum total of the channel is known publicly.  That the Bitcoin exist and are not “fake” is verifiable by both ends of any transaction as – due to the nature of the technology – the values requiring verification are fully within their channel even when the transaction partner is outside of the channel. Bitcoin stored by 3rd party custodians are usually not easily verifiable if transacted fully within the custodian’s system, but this is not a property of Bitcoin but rather that of the custodian (similar to someone promising that they are holding dollars or gold for you but not really doing so).  Transactions from the custodian to outside of the custodian are fully verifiable. Verifiability: 10/10
Transactable	Bitcoin is extremely transactable at any scale.  It is possible to imagine issues with on-chain confirmation in a future scenario where humans have colonised the solar system and we have greater than ten light-minute communication distances, however that problem may be solved by side-chains and is not a problem that affects our current economy’s requirements. Bitcoin even provides transactability well beyond what any other currency in the past has been able to do.  With Bitcoin it is easy to imagine true microtransactions and streaming-money functionality that are impossible with older currencies. Transactability: 10/10
Scarce	Bitcoin is strictly limited to a number defined by its issuance schedule.  This is exactly 20999999.9769 BTC, but more commonly described as “21 million”.  These are added to the market at a strictly mathematically defined rate, whereby over 85% of the total supply has already been added and of the remaining 15%, 14% will be added over the next twelve years.  The remaining 1% will be added over around a hundred years. Scarcity: 10/10

Bitcoin has perfect or near-perfect scores on every property.  Notably, it avoids the problems of commodity currencies by being perfectly portable and perfectly transactable.  It also avoids the primary problem of fiat currencies by being perfectly scarce.

So far, we’ve been using these properties without considering if there are further properties that make something valuable.  Bitcoin has some significant differences to other currencies that are also worth considering when deciding on its value as a currency.

Property	Definition	Gold, Dollars, Bitcoin
Sovereign	Sovereign currencies are those where their use is mandated by the force of a nation-state. How important this is for a currency depends on the strength of the nation and its ability to influence markets outside of itself.	US Dollars are backed by the force of the US government.  If you want to trade with the US, they can demand that you do so in US dollars. Neither gold nor Bitcoin are currently backed by any nation directly.  Gold often is accepted for trade by many nations. Bitcoin is beginning to be formally recognised by some nation-states and subdivisions of nation states.  It can be used in several US states as well as one canton of Switzerland to pay taxes and has a specific legal framework in New Zealand for the payment of salaries.  It can in no way however be said to be backed by any of these states. Dollars: 10/10 Gold: 3/10 Bitcoin 1/10
Decentralised	Decentralised currencies are those that have no central points of control and therefore no central points of failure. A decentralised currency is – by definition – an incorruptible currency as there is no individual or group of individuals with the power to change aspects of its supply, behaviour, or transactions against the will of the user.  No user has any more ‘might’ within the system than any other (even where they may have might outside of the system; such as governments and economically important participants).	Neither gold nor dollars are decentralised at all.  Gold’s fundamental aspects are governed by physics and the nature of reality.  Dollars’ fundamental aspects are governed by the US Federal Reserve, which may get some pressure from the people and government of the United States to provide certain properties, however it is ultimately up to them. Bitcoin is decentralised by design.  Its fundamental aspects are governed by each economic participant individually, with the broad consensus being used to describe the current ‘canonical’ state of the system.  Individuals may choose to abide by entirely different rules from each other, however if they do, they may find that no one else accepts their transactions. Dollars: 2/10 Gold: 1/10 Bitcoin 10/10
Programmable	Programmable currencies are those that are inherently able to perform logical operations within the framework of the currency itself and not through an external system.	Gold is not programmable as fundamental physics doesn’t allow for conditional statements outside of the reality in which the matter exists. Dollars are not programmable, although can exist within digital systems that allow for programmability, giving them some ability to be acted on as if programmable; however only to a very limited extent. All Bitcoin transactions are built a scripting language that is also capable of building self-contained escrow systems, fundraisers, multi-party transactions where no participants are required to trust each other, and much more. It is not a turing-complete language and thus may be considered less than perfectly programmable, however this is also a design decision for the safety of the network. Dollars: 1/10 Gold: 0/10 Bitcoin 8/10

Sovereignty is currently a clear win for the US dollar over gold or Bitcoin, however it may not be enough to make up for the other shortcomings of the currency and may even cause a reduction in the power of the nation directly if they choose to remain inflexible as while the strength of the currency is backed by the force of the nation, it’s also true that the force of the nation is – at least in part – backed by the strength of the currency.

In terms of Decentralisation and Programmability, Bitcoin is the clear winner as neither dollars nor gold have any significant aspects of these properties at all.

A Bitcoin Economy

A person’s desire for goods and services now is different to their desire for those goods and services later.  This is called Time Preference and plays an important role in the discussion around markets that was introduced earlier when discussing the scarcity issue of fiat currencies.

If I’m out in the city late at night and really need to sleep, then I will have a high time preference for a hotel room or a taxi home.  I don’t need one later, I need it now.

Similarly, people don’t have to buy the latest mobile phone – one from the previous generation will work fine and can still do everything it could do when it was new only a year or so ago – but many people are still more than willing to pay more for the new features and capabilities now instead of waiting until the latest device is cheaper when the following generation comes out.  Other people however might have a lower time preference and consider instead to get the previous generation of device.

Time preference for specific goods and services isn’t another thing that can be calculated precisely but certainly can be clearly illustrated.

In the first example, a taxi home now might be something I’m willing to pay fifty euro for.  If waiting an hour for a taxi at a cheaper price were an option, how much cheaper would it need to be?  Maybe I might feel that twenty euro would be worth that wait.  What about a week from now? Well, that’s worthless to me.  It has no value.

In the second example, how much cheaper would the previous generation have to be for the person with the higher time preference to buy it instead?  How much more expensive would the previous generation have to be for the person with the lower time preference to select the new model instead?  I don’t know, but I can guarantee you that Apple and Samsung have calculated this as an aggregate across their customer bases in their sales planning.

Currencies themselves also have time preference and this is what is being manipulated by the artificial control over currency supply and ultimately the rate of inflation.  As the money devalues, it pushes my time preference for goods and services up.  I want to spend my money sooner and experience the value of goods and services that are paid for later as being higher than it would have been with no inflation.

In an economy with a fixed currency supply like Bitcoin, time preferences for each good and service are allowed to sit at their ‘natural’ levels for each person.

As already described, markets sometimes grow, are sometimes steady, and sometimes shrink.  We’ve also learned that bitcoin can become unavailable through deliberate or accidental loss.  That means that it should be reasonable to expect that in an economy based on Bitcoin, the currency should experience periods of inflation, stability, and deflation.

This is often cited as a concern with Bitcoin since Keynesian economics teaches that deflation is inherently a problem by causing people to ‘hoard’ (better called ‘saving’) their money instead of spending it, which – through lower spending – further shrinks the market, and ends up in a “deflationary spiral” until everything collapses.  Despite this theory being cited as an inevitability, history has never actually seen it happen and many economists argue that it’s an unrealistic myth.

The general expectation with a fixed supply economy is that when the market experiences growth, the currency will appear deflationary and thus discourage unnecessary spending through lowering people’s time preference for luxury items.  Their time preference for basic requirements of course remains unaffected; no one will stop eating for months with the expectation that they can buy more food later.  People with very high time preferences for specific luxury goods – such as in the mobile phone example – may still not have their time preference pushed to the point that they delay spending and the companies that produce these goods will also adjust their prices accordingly in longer periods of deflation.

Of course, the preference for saving over spending will put some pressure on the market against growth.  That may lead it to stop growing if the growth is not sustainable.  At that point, the market is stable, and deflation stops.

At some point, for any number of possible reasons, the market may shrink.  When this happens, the currency will appear inflationary and thus encourage spending through increasing people’s time preference for luxury items.  This is the opposite case from deflation and equally applies an opposite pressure against the shrinkage of the economy.

Unlike in systems where the currency supply is manipulated, a fixed supply economy is self-stabilising and will not experience runaway inflationary or deflationary effects due to the opposite pressures that each of these causes puts on the people interacting with the market.

Further Reading

This primer was primarily written about “money” more generally and not specifically about Bitcoin since the latter can’t be truly understood without understanding the former.  Bitcoin was created because of the failings of the current economic systems and offers the chance of a better one.

The economic principles and ideas described in this primer are largely from the Austrian school of economic thought and so further reading on these concepts and ideas is advised, despite that many thinkers and authors of this school lived and died well before Bitcoin ever existed and thus couldn’t foresee or predict everything that might be possible with the invention of this technology.  Specifically recommended are:

• The Bitcoin Standard by Saifedean Ammous: https://saifedean.com/the-book/
• The Mises Institute: https://mises.org/
• The works of Ludwig von Mises, Friedrich Hayek, Milton Friedman, and Murray Rothbard

Note that although I – the author of this piece – generally agree with these writers on matters of economics, I often disagree with them on other political matters.  In a future piece, I intend to address the differences between right-wing libertarianism (including anarcho-capitalism, to which many Austrian economists ascribe) and left-wing libertarianism (including anarcho-socialism, to which I personally ascribe) and how Bitcoin’s economic model fits differently to these models.

What is the Block Size Debate?

Bitcoin uses a blockchain.  This is a data structure that records blocks of transactions in a special way that – combined with the proof-of-work security mechanism – ensures that it’s essentially impossible to go back and change transactions in the past, enabling scarcity in a digital good without requiring a centralised authority.

The blockchain must be replicated across all nodes of the network – the more the better – in order to ensure that no one is cheating.  After all, if there were only one copy of the blockchain, there would be no way to actually verify it yourself, and you’d have to rely on the person you’re asking about its state not to lie to you.

The “Block Size Debate” is an ongoing argument about what the “right size” for the maximum data allowed in a block in the blockchain is and whether or not it should be changed from the current value.  There are many different opinions which can mostly be summed up as one of the following four, summarised with their main common arguments:

1. “It has to be made smaller”:
   1. It is currently too difficult to many people to run a node effectively.
   2. Miners are discouraged from participating due to low on-chain transaction fees.
   3. Adoption of off-chain scaling technologies is discouraged by having low on-chain transaction fees.
2. “It has to be kept as is”:
   1. Change is dangerous, don’t do it without a good reason (which has not been presented yet by the other arguments).
   2. Adding additional systems without changing the underlying system is safer and so if such solutions can be created, they should be considered first.
3. “It has to be made larger, but not too large”:
   1. It is currently too expensive to make on-chain transactions which discourages adoption.
   2. Off-chain scaling technologies don’t work and/or aren’t secure (yet) and so scaling must happen on-chain (for now).
   3. Non-mining nodes don’t do anything useful for the network, so only miners need to run nodes and they have enough bandwidth/hardware/etc for larger blocks.
4. “It can be unlimited”:
   1. It is currently too expensive to make on-chain transactions which discourages adoption.
   2. Off-chain scaling technologies are unnecessary whether they work or not since everything can be done on-chain which is more secure.
   3. Non-mining nodes don’t do anything useful for the network, so only miners need to run nodes and they have enough bandwidth/hardware/etc for larger blocks.

Note that the arguments for positions 3 and 4 are similar, but not identical.  Position 3 may or may not accept off-chain solution as a future, but do see a need for a limit, agreeing with positions 1 and 2 that unlimited is not possible; whereas position 4 sees no need for a limit and therefore no need for other scaling technologies.

How to Approach the Debate

In a philosophical consideration, the null hypothesis is considered the default position until such time as a claim has sufficient evidence for it to be considered as the most likely description to match reality.

In considering changes to a running system, a similar approach can be employed.  In this, the null hypothesis is the null action, that of no change.  Evidence must be provided to show that the change is the most likely approach to have the most positive effect on the system compared to other approaches offered.  That includes a comparison to the null action, as changes may in some cases be detrimental.  This initial philosophical approach lends support to position 2.

Before we can even start to form a more detailed or nuanced opinion on the Block Size Debate, we need a better understanding of what the maximum block size influences as well as how blocks are filled.

Running a Node

New blocks are added to the blockchain on average once every ten minutes.  Each node on the network will – on average – receive the new block from one other node, and send it to one other node.  Additionally, each node will receive and send on each transaction that makes it in to a block once in addition to the block as they are propagated across the network separately.  Each node also has some ‘chatter’ to communicate information with other nodes about whether or not it has already seen specific blocks or transactions as well as communicating with SPV (Simplified Payment Verification) wallets and other systems.  Ignoring all the chatter, we can say that each node needs to deal with incoming and outgoing traffic of around twice the block size every ten minutes, plus additional storage of the block size added every ten minutes.  There are also CPU requirements for verifying blocks, but to keep this analysis simple for the moment, we’ll ignore that.

It’s not an unreasonable argument that in most of the western world, existing storage capacities and existing home internet connections can handle four to eight times the current block size.  This would seem to be an argument in favour of position 3.

However, Bitcoin is global and there are certainly internet connections that cannot handle this volume of traffic and nodes run on systems where storage space is a significant expense to the owner.  In most of the world, running a Bitcoin node on a mobile phone isn’t practical or even possible.  This would seem to be an argument in favour of position 1.

Regardless of where your position lies with regards to the necessary resources for storing and transmitting the data, it is obvious that an increase in block size is inherently an increase in the cost of managing the data, even if it is within the capability of all those who should/could do so.

This then leads us naturally to next examine the claims that it would be helpful to increase the block size and would be harmful to decrease it or leave it as it is.  If there is an inherent increase in the cost, then there must be an increase in the utility to match or exceed this cost, no matter how trivial it may be.

Filling Blocks

Something that is often misunderstood is that as long as the Bitcoin blockchain is viewed as an immutable and permanent record, blocks will always be filled to capacity according to the cost of doing so.  It is possible to put anything you want in an on-chain “transaction” – it need not actually be a financial transaction.

This means that the natural result of it costing less to store data is that more people will store data until it no longer costs less.

Consider for example, these two Bitcoin Transaction IDs (examined on your own copy of the blockchain or a public blockchain explorer as linked here):

• 014f45b89536549ca8a2b1c2c1fd5975c1e9a53953d942fd79787221f4c11fb5
• 98a30833872324d6b3bda17b02cc25bffc81ed39fd35526d7759985c85ce7eb1

Here you can see that the OP RETURN values of the transactions contain notes.  These were written by myself for my children.  I did it because I could and it cost me essentially nothing.  If it were to cost me the equivalent of $100, I might still have done something like it as a special one-time thing for my children, but it’s much less likely I would do it simply on a whim. If it were to cost the equivalent of $100000, I can’t imagine that I’d want to do it at all.

Some people may see this usage and complain that I’m the problem by using the blockchain inappropriately; that it’s not “made for” writing notes to my kids.  But that complaint is failing to understand that in a decentralised system, people can and will use it however they want, regardless of what you or I think is the “right way”.  If you don’t want people writing messages to the blockchain to be stored for all eternity, you must make it expensive to write data to the blockchain for all eternity.  There will still be messages, but they’ll be appropriately paid for.

This argument supports positions 1, 2, and 3, while completely ruling out position 4 as a viable option.  If transactions are “as cheap as possible” then any data can be stored for the same price as any other set of transactions of equivalent size to that data.  I can say with some certainty that if I could immutably store all my long-term data such as photo albums and similar (with whatever encryption I like to ensure that no one else can ever access it) for less than I would pay Apple, Google, Microsoft, DropBox or any of the other cloud storage providers over my lifetime for the same amount of storage then of course I would do so.  Unlimited block size on an immutable ledger intended for financial transactions is an offer of unlimited data storage at next to no cost to the user.

Further, increasing the block size will solve nothing.  Making it four to eight times larger would only mean we have four to eight times the amount of data being produced that needs to be stored and transferred around without providing any real benefits at all.  Even if all nodes could handle doing so, if it brings no benefits, there is no valid reason do so.

By supporting both position 1 and 3 simultaneously, no clear argument can be made to increase or decrease the size, again supporting position 2 more strongly.

Here it’s important to clarify what the word “transaction” means in the context of the blockchain.  It simply means “an entry written to the blockchain for eternity”.  It doesn’t mean that people who can’t afford to – or simply don’t want to – pay the transaction fee can never transact bitcoin between themselves and someone else.

As long as off-chain transactions are a viable option, it instead simply means that lower-value transactions should be aggregated with others by an abstraction layer so that the fees paid for the underlying blockchain transactions – while large – are spread sufficiently amongst enough real-world activity (that isn’t written permanently to the blockchain) that it is economically viable for each of these real-world transactions to happen.  The fee paid by each individual real-world transaction will always remain at a low enough level as to be acceptable (by definition; since otherwise no one would do it).

Fee Markets

The term “a healthy fee market” is often seen in the Block Size Debate.

A fee market is competition for block space in terms of how much people are willing to pay for that space.  It is important to remember that the transaction fee is entirely chosen by the creator of the transaction and is not demanded by the miner or the network.

In terms of financial transactions, everyone must consider that their transaction’s value in comparison to the other transactions that are waiting to be added to a block. If enough other transactions are valued higher than yours – as determined by the fee you chose to pay compared to the fee that others chose to pay – it won’t be added by a miner in the next block.

A miner’s reward for finding a block comes in two parts.  The block subsidy and the transaction fees.  The block subsidy is the release of new Bitcoin to the supply.  This was initially 50 BTC per block, but halves every 210000 blocks (approximately 4 years).  It has halved twice as of the time this was written and so is 12.5 BTC per block.  The next halving event will occur around the middle of May 2020.  This will continue until around the year 2140, when rounding the final satoshi down leaves a subsidy of exactly zero.

Well before the mining subsidy disappears, it will be inconsequentially small.  Transaction fees currently only make up a small percentage of the total reward but even without any increase in fees, will be significant in only three more halvings and the majority of a miner’s income two halvings later.  If Bitcoin adoption increases, fees can also be expected to increase also, potentially making fees the majority of a miner’s income even sooner.

Economically Active Nodes

It is argued that nodes that do not mine are not necessary.  The counter-argument is that economically active nodes ensure that the rules of Bitcoin are properly decentralised.  What does this counter-argument mean?

When transactions or blocks are broadcast across the network, they are validated by the nodes that receive them before passed on to other nodes.  If they are invalid according to the rules of that node, they will not be passed on.

Because Bitcoin forms a mesh-network however, a node that runs significantly different rules to everyone else around it will simply be routed around.  The fact that it doesn’t validate blocks and transactions isn’t meaningful.  Unless of course, those transactions originate from that node.  When the node is the originator of a transaction, it is economically active.  If no other nodes accept transactions from it, then transactions that it tries to send will not be forwarded.  Therefore, it is in the interest of each node to agree with the rules of at least some of the nodes around it and at least enough for its transactions to be forwarded by those nodes.

This also works in reverse.  If a node is responsible for providing information to the wallet of the intended recipient of a transaction, it is also economically active.  When the transaction is received but considered invalid by that node, it will never be seen by the wallet.  This means that it’s also in the interest of each receiver to ensure that they agree with the rules of those who they are likely to financially interact with.

The ultimate outcome of this is that although rules are determined individually and no participant in the network can force rules on any another, each participant is encouraged to agree with the majority of other economically active participants.  This is why Bitcoin is referred to as having consensus rules.  Politically, it can be seen as a form of social anarchism rather than as a democracy as it is often portrayed.

It is sometimes argued that economically active participants that have disproportionately large shares of the economic activity are more influential.  This is a fallacy.  Although it’s true that a large player such as an exchange can decide on the rules for all of the users that it is holding the funds for, if they are unable to broadcast any transactions, the users will demand that they follow consensus in order for there to be continued business.  The exchange may argue that their rule change is for the benefit of all and “if you want your money, you’ll agree” but as the customers of the exchange and the node operators on the network at most only have a very small overlap, this is not going to work in the exchange’s favour.

As this relates to increasing the block size, it should now be clear that since increasing the block size increases cost, nodes run by those with the least financial ability to do so will be the first to turn off, while those that are more financially capable can keep running them. Put more simply and directly: the larger the block size, the richer you have to be to run a node. This is inherently dangerous, since it means that that minority (people rich enough to run nodes) can then make decisions about network behaviour that may go against the wishes of the majority (who can no longer run nodes to enforce the rules they consider fair).

We can reconsider the example of the exchange as a node operator with a lot of financial resources.  If they are in an environment where only themselves, other exchanges, and a few large businesses are capable of running nodes, they will have a significantly easier time enforcing their will than they do under the current environment.

It can be seen very clearly from this argument that non-mining nodes are not only important actors in the network but in fact play an even stronger role in setting the rules of the network than miners due to the rules’ consensus nature.

This argument therefore strongly supports position 1 or 2.

Off-Chain Scaling

A detailed analysis of whether off-chain scaling is feasible or not is outside the scope of this analysis, since there are many different approaches each with their own advantages and disadvantages.

As it is an active area of development by a large group of talented developers and companies that have invested significant time and money in to making it work, it would be disingenuous to dismiss it out of hand.

Equally however, as no off-chain scaling method is yet wide-spread, it could be argued that these are unproven technologies and scaling approaches should not be built around things that aren’t yet proven to work.

Taking these two arguments at face value, again we can only support the null action position 2 as the data appears inconclusive.

I intend to create a more detailed analysis of off-chain scaling technologies in the future.

Conclusion

After examining the economic and technical arguments, we find that:

• Position 1 may have some merit, but that many arguments in its favour are also in favour of position 3 which is an opposite approach and so has not yet met its burden of proof.
• Position 3 has a few arguments in its favour, but less so and – similarly – shares arguments with the position for the opposite approach.  Position 3 can therefore be considered poor until further arguments can be made in its favour.
• Position 4 is a non-starter and can be discarded entirely.
• Position 2 – as the null action position – is the most defensible position in the absence of further evidence.