What’s Holding Bitcoin Back

Money should be a good store of value, medium of exchange, and unit of account. There are a lot of barriers preventing bitcoin’s widespread use by the aforementioned criteria, let’s take a look and see how they might be solved.

Lack of Understanding

Bitcoin is complicated and unfamiliar. This is a huge barrier to entry because people distrust what they don’t understand, and ease-of-use and simplicity is what usually sells a new technology. If you have read this series from the beginning though, you may now see some potential upsides to such a drastically different system than what we are used to. Many resisted smartphones for a time (and a few still do). The benefits have to outweigh the costs of adoption, so we may see niche cases being the early adopters (like citizens of Venezuela or remittances payments). Also, when a new complicated technology rolls around, it sometimes takes a generation before it becomes widespread; young people are particularly adept at adopting new tech.

Volatility

The tendency of bitcoin’s price to change rapidly or unpredictably is what comprises volatility.

When you search for bitcoin you may find that most of the results you get (and the discussions happening on forums) are about it’s price. This is understandable, it has seen some crazy moves both up and down over the years facilitating the potential for huge gains (and huge losses). Still, over time the price certainly is increasing. Unless you bought in a single 2 month period in 2013, holding bitcoin for longer than 2 years at any point in its history would land you in a better position than when you started. And, when viewed on a logarithmic scale (used in long-term stock charts), the trend is quite clear:

LogScaleBitcoinPrice

(Bitcoin Price 2011-2018, Logarithmic Scale)

There is a risk/reward to adopting new tech, and this is no exception. But, my goal is absolutely not to “sell” it to you as an investment by any means.

This is not financial advice. We’re simply looking at the pros and cons of this space, and I encourage everyone to do their own research and come to their own conclusions. Never invest anything you aren’t prepared to lose.

This meteoric rising (and crashing) of the “price” (which, I’ll point out, might just as well be considered an exchange rate) understandably makes it pretty difficult to use bitcoin as a currency. If it moves a few percent in a day, and can move a few hundred percent in a month, purchasing a car or a house could cost you significantly more by the time your finished closing. That’s just not viable, and certainly not a good unit of account.

However, I see the volatility in price simply as growing pains. It is the market that dictates the price of bitcoin, quite literally, it’s traded like a stock. This is referred to as speculation (“the purchase of an asset with the hope that it will become more valuable at a future date”). Speculation happens between national currencies already, but they are generally stable in comparison so it’s not lucrative.

People are unsure of how this whole bitcoin thing is going to play out. It’s not like anything we’ve ever seen, it’s difficult to understand (and use), and it’s not accepted at every corner store or online business. Many in the space are just here for a quick buck, and they sell it when the price rises to get back “real” money we are used to, that is “stable” in price against other currencies, and can predictably buy goods and services.

The way I see it, all of these will concerns diminish in time.

Though Amazon or Target don’t yet accept bitcoin, Microsoft and Overstock.com do. Some cities and towns across the world are embracing it a lot more than others. It’s not surprising to see San Francisco accommodating the new technology. But, other cities like Portsmouth in New Hampshire with numerous cafes and shops accepting bitcoin (and “Dash coin”) might surprise you. There are maps available to see where crypto-currencies are accepted at locations near you, and the amount of them are increasing, albeit slowly. It’s a bit of a chicken-and-egg situation, but that hasn’t stopped revolutions from happening before.

Consider when cars first came about, roads were dirt and mud which cars didn’t do well with. It took building massive infrastructure before cars could ever become mass-adopted, but we spent the time, money, and effort because we saw the potential advantages. It will be trivial for businesses to accept bitcoin compared with pouring hundreds of millions of dollars in asphalt to connect our world. Other parallels include train tracks, phone lines, electricity lines, communication satellites, etc. Each of these replaced or iterated on previous functional technologies, and required massive upfront costs before the benefits were available. It’s clear now that we made some good choices there but there were doubts at the time.

Despite some pretty major setbacks, bitcoin’s trend is up. Interest is growing and more businesses and individuals are actually using it. But due to the trading mentality, the uncertainty with regulations, uncertainty in the technology itself, uncertainty that the price will not drop, and other factors, emotion and greed encourages people to sell in flocks if the price climbs high enough.

Furthermore, right now with a large enough stack of money one can influence this market in drastic ways, and cries of manipulation of the price are not unfounded. So-called “whales” can buy and sell huge amounts of coins and the price can jump a bit each time. Coupled with uncertainty in the space, and so many “investors” trying to time the markets, we end up with a pretty volatile landscape where the price is not stable. My argument is that this is diminishing as it gains in popularity, and it is gaining value because its utility is growing (see “network effect”) and the utility itself is slowly becoming more apparent.

Volatility is actually decreasing.

In the period from 2011 to 2014 bitcoin’s volatility often spikes into the 15% range. But from 2014 to the present, volatility has only just spiked above 7% twice, spending most of it’s time below 5%. Even the large boom and bust in price at the end of 2017 seems tame compared to the early years.

The trends show the price going up over time, and volatility going down. The more actual use the coin has (people saving and buying with bitcoin), the percentage of people entering the space to use it the way it was intended increases, the percentage of “stock traders” declines. And as more capital enters the space, the less influence whales have (because the current against which they swim is getting stronger). And as the price stabilizes, traders will become less interested.

There is a critical point where this becomes a negative feedback loop. I could be wrong, but the idea is at least founded in reality, and it would solve the unit of account issue if the price could stabilize to within a few percent per year.

Similarly, as a store of value, bitcoin becomes more viable in this scenario. This is coupled with the fact that although bitcoin is somewhat inflationary now as the supply is increasing (bitcoins are “discovered” as rewards for mined blocks), the amount of discovered coins are cut in half every few years. This “halving” is logarithmic, meaning eventually the amount of coins discovered is infinitesimally small, and total supply will asymptotically approach 21 million coins (the maximum supply that we will ever see).

This model of supply is actually meant to mimic gold because it’s a well-known store of value and monetary device throughout history (though it is not easily divisible, and not as portable as bitcoin). In both bitcoin and gold, mining is more fruitful in the beginning, and as we extract the low-hanging-fruit, mining requires greater effort and yields less return.

World population is increasing which leads to bitcoin becoming deflationary in the future if demand continues (the supply won’t increase beyond 21 million). And, I argue that it will become more valuable in time due to the network effect as bitcoin use becomes more widespread (the value of being able to exchange with more people anywhere, any time, and without permission from anyone).

This is a positive feedback loop, and shows how bitcoin is deflationary long-term. While deflation is generally considered negative by economists, the main reason is based around debt which isn’t possible in the same way with bitcoin because bitcoins cannot be created out of thin air like fiat currency.

The discussion of deflation vs inflation is an important one, and bitcoin’s monetary policy is an outlier compared with national currencies which are typically inflationary. The US dollar for example averaged 3% inflation since the year 1900. That means that over the last 100 years, a dollar has lost over 95% of its purchasing power. You could buy 95% more stuff with $1,000 last century, or, saving $1,000 from 100 years ago would buy you 95% less stuff at present. Put another way, purchasing power is cut in half after about 25 years, a concern for anyone retiring for over 20 years with a fixed retirement sum.

Some other national currencies have higher inflation rates, and there are numerous cases of inflationary spirals over the years. A few examples include Germany 1923, Hungary 1945, China 1947, Vietnam 1988, Peru 1990, Yugoslavia 1992, Zimbabwe 2008, and right now in Venezuela 2018 (update1: Turkey reaches 100% inflation, update2:Iran inflation approaching 300%).

Entire countries of people have lost essentially all of their money because of uncontrolled government money-printing, and it keeps happening over and over. A wise man would tell you it’s dangerous to say “it could never happen here”.

This is our money with which we hold and exchange value, our earnings, our savings, our livelihoods. Maybe it’s time we had, at least, another option outside of government control. An option that governments can’t destroy through mismanagement. A neutral option that ignores all borders, is open to everyone, and can be accessed anytime from anywhere.

The Fear of “Hacks”

It’s a very real threat to have all your money stolen, if your bank was robbed you are protected by FDIC (in most cases only up to $100,000). The vast majority of coins that have been stolen have come from hackers attacking “exchanges” and getting away with millions. These exchanges are websites where you can trade bitcoin for other crypto-currencies (or “alt-coins”). You can also buy and sell bitcoin on them, and subsequently people end up storing a lot of coins on these exchanges, and the exchanges hold the “private keys” so they can execute trades.

Cryptographic private keys are analogous to a key that opens a door, or, a key that locks a message in a box before it is sent to the recipient. In our case the door opened allows you to sign your message and spend coins, and the message is your transaction on the bitcoin network. Anyone with your private keys can spend your coins. Exchanges are a honey pot of thousands of private keys that represent a lot of money. If a hacker can break into the exchange and steal the keys all at once, their work will pay off.

This is why any crypto guru will advise you not to store large amounts of coins on exchanges, and rather transfer them in your own wallets where you hold the private keys. The mantra is: “your keys, your money; not your keys, NOT YOUR MONEY!”

Of course your own computer can be hacked, but you are not as big a target as an exchange which may hold vast sums of money. There are also some pretty safe ways to store your coins if done right.

Centralized exchanges are a necessary evil for many people because they facilitate acquiring and trading coins easily. But decentralized exchanges are becoming more common because they allow you to trade while keeping your coins in your control at all times. They need some work and more users, but it’s a promising solution to this problem.

Summarizing the above: the big hacks you read about are virtually eliminated if your keys are in your control and you keep them safe.

Fees

Transaction fees are generally negligible in a bitcoin transaction, but in many ways “fees” are holding us back. Interestingly, this is a symptom of being in the very early days.

Firstly, there is a lot of work on “scaling” crypto-currencies (making fees even lower than they already are and increasing transaction speeds). This is just an engineering problem, and many people are working on solving it in many different ways. Other currencies like NANO or IOTA have different underlying tech and have zero fees and instantaneous transactions.

In fact, most fees people encounter aren’t fees from bitcoin transactions; instead, they get hit with fees when exchanging between national currencies and bitcoins. In order to electronically trade USD($), EUR(€), or YEN(¥) with bitcoin, we need to hook into the closed-off for-profit banking network and we need third-parties to do so (and they take their cut).

But even these fees could be avoided in time. For example, you can buy bitcoins with cash directly from a person (localbitoins.com). And, it might seem distant, but in the future you may end up receiving bitcoins as your salary, from a friend, or from accepting them in your place of business. Likewise you can spend your bitcoins directly to other bitcoin users. Getting coins directly eliminates all the exchanging and associated fees because once your money is on the bitcoin network, fees will be negligible (especially as these networks evolve).

Usability

Right now it’s easier than ever to acquire some bitcoin. People can download “Coinbase” or “Square App” on their smartphone and purchase some using a credit card in a few minutes. Depending on which service you use and how much you want to buy, you may need to send a picture of your license for KYC regulations (like you do when you open a bank account). However, as I mentioned above, there are risks to storing all your coins on exchanges, especially with large amounts. I always recommend transferring them to a wallet where you control the private keys.

But using wallets and storing private keys (and “seeds”) securely, is not as straightforward as we would like. This is a major factor holding back adoption, because if it’s not easy to use, people will consider it too much effort.

The next post in this series digs into wallets and storing your coins.

The Implications of Bitcoin – Deciphering the Enigma

Money is one of the oldest technologies. It’s older than written language; we know this because the first writing we find is keeping track of transactions. Money has held many forms (rock, bone, metal, paper, cloth, plastic, etc.), each generation of token ideally being more portable and harder to forge. Portability, (ease of moving around the tokens) increases what you can do with it, while forgeability describes how secure it is against counterfeiters.

Modern online banking is essentially impossible to forge, and is vastly more portable than physical tokens because it exists on controlled central banking networks. For those with access to modern banks, money has never been more free to move around. Enter Bitcoin; it is no less forgeable than its predecessor, but it’s portability is exponentially increased, and being decentralized it introduces a new feature, it’s open to everyone.

What is Bitcoin?

At first glance bitcoin appears very similar to how we already transact in the developed world; it’s “just” digital money. We already have paypal, venmo, online banking, and credit cards that allow us to move our money around. However, to call bitcoin similar is making a huge mistake and vastly misunderstanding its concept, philosophy, and power.

Modern banking services are exclusive to the developed world and only accessed with the permission of for-profit, private institutions, the gatekeepers of local and global money transfer. In the developing world there are billions of people without access to any bank, and many more have limited access to even basic services. Often there’s little competition which stifles innovation and increases monopolistic practices. It’s these citizens of our global society that stand to benefit most from this technology in an immediate sense.

Bitcoin is a decentralized money, a peer-to-peer means of exchanging value. There are several layers to this concept alone; most significantly, that bitcoin is fundamentally different from anything we have ever contemplated. This makes it difficult to understand the implications or benefits of such a revolutionary technology. It’s an epochal shift in how we can transact and store value.

This system can be accessed by everyone, anywhere, anytime. It is neutral, trans-national, it’s freedom of money. Bitcoin itself requires no personal information or account creation through a business, nation, or organization. One simply generates keys and is free to transact with anyone. There isn’t a central authority to dictate who can and can’t use the network, no gatekeepers, no one to freeze payments or hold funds.

How is Bitcoin Secure?

I think people are well-justified to be skeptical of bitcoin’s security, it’s often touted as “unhackable” or “immutable”. I try not to speak in absolutes; so I simply state that it’s not worth trying to hack because its security lies in cryptography and game-theory.

If you guessed my private key you could spend coins associated with that address. Computers can guess many times in a second, but even with every computer on the planet it would take much longer than the universe has existed to guess the private keys to a single bitcoin address. This is still true even with 1,000 earths worth of computing power. This is cryptographic security.

Game theory sounds daunting but it’s easy to understand, it’s “the study of mathematical models of conflict and cooperation between intelligent rational decision-makers.” In bitcoin this manifests through “proof of work” which amounts to “miners” using computers to do lots of math problems, the results of which get embedded in the transaction record (the blockchain), and they receive rewards for their effort of mining a block. Miners are incentivized to contribute to the system.

So what if we try to cheat?

The amount of money and resources required to assemble enough computing power to even attempt to cheat the system (the “51% attack”) would cost more than any benefits of doing so because the attack has no guarantee of working, and it would be obvious to anyone looking at the transaction record. In some cases the cheating transaction could be routed-around, essentially erased, negating all the work put in by the attacker who still had to pony up all the computing hardware and electricity. It’s simply more profitable to take those computing resources and just mine bitcoins instead of attempting an attack. Game theory at its finest.

Many criticize the computing power and electricity “wasted” on bitcoin mining. Another perspective is that all this computational expenditure is quite intentional because it maintains the security of the system. It’s analogous to mining gold; gold ore is just a pile of rocks that require significant extraction and refining to yield highly valuable and useful gold.

Bitcoin’s proof of work is so-called because the blockchain is evidence of massive computation, that computation equals security. The security is what makes bitcoin valuable. The proof of work is the proof that energy and computing power were expended in securing a history that can never be altered.

Furthermore, renewable energy is increasingly providing electricity for bitcoin miners mitigating environmental concerns. We can also compare it with the environmental impact and cost of continuously replacing paper currencies in hundreds of countries, gold mining resources “wasted” on gold just to sit in vaults, or all of the concrete and steel poured into thousands of banks across the globe.

Zimbabwe100Billion

What can it do?

Venezuela:

At the time of this publication citizens of Venezuela are losing purchasing power of their money by 25,000% per year, and the IMF predicts it will reach a million percent by the end of 2018. Their failing government continues printing more money robbing constituents of their savings and there are daily limits to how much Venezuelans can withdraw from the banks and huge lines of people trying to get their evaporating money.

When this happened in Zimbabwe and people needed wheelbarrows full of money to buy a single loaf of bread the residents had little recourse. But some Venezuelan locals are turning to crypto-currencies to flee the currency crisis, escape the inflation, and protect their ability to acquire food and shelter. It’s capital flight away from a national currency without having to even leave their neighborhood because their $20 cell phone can now act like a global bank.

Remittances:

Global remittances account for over 500 billion dollars a year. International money transfer services require physically being near the local office during business hours. A fair amount of coordination is required to find an institution with local access in both countries. Transfers can take days to clear, and fees vary wildly and make it difficult to transfer small amounts. Bitcoin can send a transaction at any time from your phone to anywhere on the globe in seconds with negligible fees without any intermediary. It’s not hard to see why in some places this industry is being heavily disrupted.

Fraud:

Credit cards are a “pull” system, meaning you give out your card number and anyone can pull money from it, this model is the cause of credit and debit card fraud. If your card info is ever compromised you will need a replacement card and sometimes have to fight with institutions for weeks, months, or years to get your money back or have your credit restored. Bitcoin is a “push” system, only you can spend your money. No fees or extra charges can ever be added without you manually sending them. Automatic payments can be set up on your end, but never “their” end.

Freedom:

Bitcoin is programmable and flexible, allowing money to flow around the world as easily as cat videos and memes. It can mimic the way we do business currently when we desire, but, so much more is possible that will never be viable with our current systems. In fact, we haven’t even figured out what yet is possible because innovation has just begun.

Until now the only ones that could innovate in the financial space are those with the connections to permissioned worldwide banking network. Now, a 19 year-old has created a world-computer whereby the programs can never be silenced and money itself can be deterministically programmed.

Ultimately this enables anyone to write the next killer app (an application that can program money) without permission from anyone. This opens the door to escrow services, crowd-lending, crowd-funding, global markets, and more, all without any kind of middleman or business deciding the rules or taking a cut.

It’s a free market of money. And we are just getting started.

Why We Need Bitcoin as a Global Civilization

Humans are now a global civilization

Not just in our occupancy of the planet, but we are connected in a fundamental way that was difficult to even imagine before the advent of the modern global internet. Though tribalism divides us based on locality and culture, we have found communities on the web that unite peoples based on common interests.

Currency is a funny thing, we take it for granted sometimes how little thought we put into the concept. I mean why would we? Give someone a few green pieces of paper and they will give you something in return. And, in order to do that we need a central authority that we can all trust to ensure that no one abuses the system. Centralized authorities concentrate power, and power corrupts.

The 2008 crisis is often pointed at as an example of some of the most blatant negligence, greed, failure of oversight, and arguably criminal and predatory behavior, all perpetrated by those that we trusted to secure our financial system. The general sentiment is that there was not enough punishment for the individuals, organizations, banks, and regulators; and, in fact, they were bailed out to the tune of $700 billion in order to “stop the bleeding” and get us back on track. Too big to fail they said.

Despite massive scandals, criminal activity, and fraud resulting in transference of wealth from the masses to those in power, those that are caught receive a slap on the wrist and a million dollar severance. This is not hyperbole, this is the reality. There’s a new massive scandal at least once a year by the very giant financial institutions that we “trust” to run our global financial system and little-to-no punishment for those involved. People this powerful just don’t go to jail. It’s no surprise they are so reckless, there’s little deterrent to disincentivize it, and the payoff is massive. When the power of the world’s money is in the hands of the few, it’s just a matter of time before the next financial crisis.

We know concentration of power leads to corruption, but we previously had no other choice. There are countless other examples throughout history of rampant corruption and abuse of power. We accept centralized authorities as a necessary evil that organize and secure our money for us because we have no other option. That evil is no longer necessary.

The advent of bitcoin removes the need for central authority in exchange of value

This statement has radical implications that are difficult to fathom because the institution of banking is so baked into our society that it’s hard to see our civilization without them. There are banks still in operation today that date back to the 1600s. They are the oldest cabal, “old money”, incumbent ancient dinosaurs that control the world. But, like so many industries before them, they have become obsolete in almost every way. The power that once lay in their hands is evaporating.

KQR6wxO1Electricity killed oil lamps. Cars killed buggy whips. Digital technology has disrupted video rental, book stores, film cameras, taxis, and more. Disrupting an industry like banking was previously unthinkable. But it’s an unfortunate reality (for banks), because bitcoin turns your smartphone into a bank.

Bitcoin is decentralized and neutral; it removes central middlemen from transactions. This is peer-to-peer digital money.

We are a global civilization and we deserve a global currency

It’s hard to comprehend the advantages of this technology because it is developing so rapidly; we are innovating on money itself as a global civilization. Individuals now posses the power to innovate in the space of finances and money without permission from any government or bank, something never before possible.

The impact of crypto currencies to those in developed “first world” nations will seem small at first, after all we have access to modern financial tools and we can send money to each other with relative ease. Banks in the United States haven’t even ran out of money in over 80 years! Life is good here.

But those in developing countries and those that are under negligent, greedy dictatorial regimes are at the whim of their overlords. Billions of people without access to banking, inflationary spirals, nanny-state blanket financial surveillance, all gone in the blink of the eye thanks to bitcoin and it’s ilk.

“Money, so they say, is the root of all evil today” -Pink Floyd

So why do we need bitcoin?

Money is the system of global commerce, our earnings, spending, our life savings; they say money isn’t everything but it sure is a lot. The power over money must no longer lie in the hands of a corruptible few, and instead, we must take that power back, as a global civilization of billions, we all deserve equal access and freedom of money.