Bitcoins are not digital greenbacks

My understanding is that Bitcoin involves one major innovation (approximate solution to the Byzantine Generals problem) and the rest is existing tech. Granted, one probably should consider the precise balancing of incentives in the more arbitrary characteristics of BTC to be an innovation, but I'm not sure to what degree that required active management and changes (I have not examined the first version of the source code).

Presumably FAI still has many innovations to go, and as they are publicly solved the chances of a basement project solving the remainder increases.

On an unrelated note: Do you have an opinion on the fact that BTC does not include a proof of stake system in figuring out who to trust WRT to forks in the blockchain? It seems like the only major flaw in the protocol. The lead dev Andresen has discussed potentially instituting a proof of stake system for weighting votes in case of another emergency like the fork caused by the client update recently. I was surprised such things were not included in the original protocol given how well thought out the rest was. If someone is smart enough to think about proof-of-work systems it seems unlikely they wouldn't have been aware of proof-of-stake as a means of establishing trust.

Why might it provide much evidence relative to Craiglist or PayPal, or the broader distribution of tech startups?

The cause of Bitcoin volatility is not deflation, it's caused by speculation under conditions of extreme uncertainty. The uncertainty will be resolved eventually, one way or another.

This seems correct to me.

And speculation is popular because it's perhaps the easiest way to make profits from Bitcoin. People don't create money to waste money unless it's inflationary on purpose. People tend to want to earn, save, and invest. Bitcoin allows people to earn, save, and invest, but the reason why people don't like to spend is because it's very hard to earn.

People do like to save, invest and speculate. The point is if I own any Bitcoins I'm not going to spend it on a Pizza which once I eat it those Bitcoins are gone forever and I can never get them back? No I'm instead going to invest my Bitcoins to either help me make more Bitcoins in the future or to protect whatever Bitcoins I already have. I would seek to increase my income in Bitcoins and decrease costs. I would seek to maximize my profits. Once I have enough income and profits that I know I'll always have some Bitcoins to play with that is when I'll start to spend.

The point is not to ever spend them down. It makes no rational sense to spend your life savings down, but it makes all the sense in the world to spend up or spend across. Luxury Bitcoins is not something most people have right now but that will change when the value of Bitcoins go up in relation to USD and the income sources for Bitcoins increase.

Once I can earn Bitcoins fairly easily and I know the value is over $1000 a coin it becomes a different story and at $10,000 a coin even more likely to spend. The point is people are more likely to spend also when the value of a Bitcoin in reality matches the value they have set for it in their mind. People who believe each Bitcoin is worth $100,000 aren't going to spend until they are worth that much and this is okay because our willingness to spend is what decides how much they are worth. So maybe we shouldn't spend them for a while.

It certainly isn't inevitable that deflation causes volatility. The cause of Bitcoin volatility is not deflation, it's caused by speculation under conditions of extreme uncertainty.The uncertainty will be resolved eventually, one way or another.

Right. There seems to be a broad misconception that "The currency will be fixed in [ultimate] supply (physical deflation), therefore it will undergo constant increases in value (value deflation)." But the two are very different: prices change in response to new knowledge, not old knowledge. The implications of future bitcoin supply are already factored into bids.

The belief that "it's a perfect investment that will trend with general economic growth"? Already priced in.

The benefit of guaranteeing to yourself a known fraction of the eventual money supply? Already priced in.

Even if bitcoin goes entirely underground that doesn't mean it will necessarily be insignificant or "niche." Internet piracy is black market but not remotely niche--P2P is 98% illegal copyright infringement but it takes up about a quarter of internet bandwidth.

I could see bitcoin thriving in an entirely illegal capacity, being as widely used among some groups as P2P filesharing. Once upon a time people thought filesharing would become insignificant and restricted to a small community of tech-savvy individuals if they just took down Napster and Limewire. But as far as I can tell, illegal filesharing is as pervasive as ever.

The information to calculate such odds is probably inaccessible. The incentive structures of regulatory action is opaque, otherwise you wouldn't expect to see price swings based on regulatory announcements in normal markets.

It is potentially vulnerable to government intervention. If the government that rules the country where TrusworthyBank is incorporated they could choose to come in obliterate it if they want.

Note: The above weakness is a feature. Moreover it is an optional feature.

Buying USDCoins backed by TrustworthyBank who is established in the real world and subject to government sanctions is a way to establish trust. If they rip people off the usual mechanisms of punishment for that can be counted on. However this relies on having a country that has suitable laws and practices. But what if we don't find this to be the case?

A (hopefully not too plausible) scenario: The US government decides that if encryption is a munition then bitcoin is a Weapon of Mass Destruction. It starts sending nuclear ICBMs at any country that harbors bitcoin banks. That ensures that bitcoin is a black market currency rather than becoming mainstream. Do these alternate real-world-backed currencies still work?

Yes, they do. Consider MorpheusBank. Morpheus is completely anonymous and untracable. He never interacts with anyone directly and instead monitors the bitchain and responds to stimulus. If a transaction sends bitcoin to the 1morpheusETC address Morpheus sends MorpheusCoin to whichever address the bitcoins were sent from. If the bitchain shows him MorpheusCoin being sent to the 1morpheusETC address then sends bitcoins back. The exchange rate is determined by a publicly accessible algorithm referring to established real world exchange rate sources.

Where TrustworthyBank is trusted based in part on trusting laws, and governments to prevent fruad, MorpheusBank is trusted via observation of past transactions (all publicly verifiable) and estimation that the Morpheus reputation and expected value of all future business exceeds the value he gets if he defects immediately. That is, users trust that Morpheus will not kill the golden goose because he doesn't want to lose an indefinite supply of golden eggs. This relies on the service returning a sufficient premium to Morpheus to incentivise him.

It looks like colored coins have the ability to completely replace actual bitcoins as units of value, and in fact this might be preferable. I am surprised I didn't think of this myself because the first (or maybe second or third) thing I thought of when hearing about bitcoins was that a currency based on a issuer-backed market-basket of goods would have been superior, but much more difficult to bootstrap (how do you build trust in a currency that anyone can issue on a network with no enforcement mechanism?). Having an existing infrastructure to pass new coins of arbitrary value sounds like a Win, and bootstrapping the first colored coin value against bitcoin value is smart.

Do you think it's possible that fiat $10,000/USDcoins2 colored coins redeemable for either $10,000 OR 100 bitcoins would be economically feasible? There would be no demand if there was an expected movement from $100/bitcoin since the issuer wins on volatility, but what if a distribution of distinct USDcoins2 were issued, with 1% being redeemable for $15,000 or 150 and the remaining 99% redeemable for $10,000 or 100 bitcoins, but whose actual value would only be revealed after a period of time (months). Pre-committing to this seems fairly straightforward and would generate demand for the currency with a positive expected net value. I believe the effect would be toward stabilizing the exchange rates at ~$100/bitcoin and 100 bitcoins/USDcoins2. I don't know if the exact percentages would work, but I imagine that there is some distribution that would have the intended effect. The issuer would be spending to achieve a stable exchange rate, which may be important for clearinghouses, banks, or individuals with savings.

EDIT: I forgot to clarify that the issuer of USDcoins2 decides whether to pay $10,000 or 100 bitcoins when an owner redeems 1 USDcoins2.

If it hasn't already been implemented/suggested, I would point out a new transaction type is needed: One party announces that they have traded a number of BTC for a number of colored coin of a specified type, and the other party confirms. That would allow a user to buy colored coin from a third-party reseller without needing to trust the reseller.

This is sort of the reason BTC is so interesting. Throughout all of human history everything has ultimately relied on jackbooted thugs or the implication thereof to secure title. A reliable distributed ledger is fundamentally new. Sure, you can be threatened physically, but how do they actually link you to your holdings if you're smart about it? And if your locality is threatening people who use it, you go somewhere where they aren't and retrieve your encrypted wallet from cloud storage. BTC's biggest use case is capital flight IMO.

First of all, I think bitcoins are basically a kind of stuff and not a kind of dollars. My brother commented that the market reminds him of the market for certain rare items in certain MMOs. And that's basically what this is, to my thinking. Stuff that exists online in limited supply, that people want. A more environmentally friendly way of satisfying our consumer impulses than cars and houses. (But also more fungible and so forth, and I think possible to convert into a kind of dollars in the sense of something optimized for price stability.)

However, there is a hole in the model that this particular kind of stuff also depends on the standard set of sanctioned jack-booted thugs who protect it and promise to give it back and so forth. Bitcoins really only exist as information codes (private keys, placed in files known as wallets). You can arrange it so that the only thing that gives someone the ability to transmit your bitcoins is knowledge of a passphrase (or rather, which passphrase out of millions possible was the one you used). Or if you choose, you can move the only copy of the numbers needed to use your bitcoins to a piece of paper, USB drive, etc.

This also isn't the same thing as logging into a website where you basically have to take their word for it that they are storing only a salted hash of your password, where they could potentially shut you down or transfer out your funds due to a power outage or government intervention, etc. Rather, it's something where you yourself do the encryption all client-side and publish your transactions when you want to. The choice to republish and share that transaction to the network is made independently by a bunch of different nodes, who are programmed to block you if you try anything mathematically fishy. You only have to publish anything when you sign a transaction, which itself only happens when you need to prove that money someone else sent to your public address (which otherwise would be just a random number) does in fact belong to you, so you can pass it along to another public address.

There are two aspects to owning stuff: One is knowing who has ownership rights to stuff, and the other is enforcing those ownership rights against people who don't respect them. If you can trust people not to do the second, you still need the first.

The domain experts in making money are hedge funds, investment banks, etc. They haven't put much money into bitcoins, so if you think its a good investment you have to sincerely believe you are substantially better informed or more rational than they are, which seems unlikely.

That seems right to me. In addition it seems that people who harp on Bitcoin's deflationary quality are failing to make a distinction between expected and unexpected inflation/deflation. In particular, I've noticed a number of people making the "deflation hurts borrowers" claim. This is only true if deflation is surprising and unexpected. Otherwise real interest rates adjust to take deflation/inflation into account.

The slow increase in Bitcoin supply is not going to surprise anyone, it's planned and well-known. Demand for Bitcoin should also become more predictable over time as the uncertainty is resolved and the currency matures, becoming less like a highly volatile penny stock and more like a stable blue-chip.

a) Bitcoins are deflationary in the sense that supply does not increase as fast as demand. If you have any bitcoins, your incentive is to hold onto them for dear life -- unless your expenditure is a very safe strategy to net you more bitcoins. You can't easily loan them because as the value increases over time the pressure to default will increase. Maybe this creates creative pressure to minimize risk or some other positive trait, but I'm cautious of labeling it good for the long term economy. The strategy I've outlined minimizes risk of losing your bitcoins by letting you loan them out in a form that will be worth the same later, which means defaulting on a loan has less severe consequences and less extreme incentives.

b) Volatility is a huge concern for contracts. If you can't count on it being worth the same tomorrow, a given contract costing you so much makes it much harder to juggle long term financial gains and losses from holding many contracts with many different businesses and individuals. This imposes extra accounting costs that I would argue make it much harder to do complex business without incurring extreme risk.

c) I do agree that bitcoin does not need to replace the dollar to coexist with it. However, the case for it being a major financial instrument is better if we can define a niche that it fills better than the dollar. Also, if you are planning to hold long-term, it is important to distinguish whether its value is mainly fad/signaling based or not. Right now it seems like something geeks and hipsters use to buy each other coffee -- which is neat, but could easily lose popularity when something else comes along.

It's not anonymous currency, but pseudonymous.

I realize this is one of the current meta-contrarian points about Bitcoin contrarianism, but it's still wrong: the pseudonymity is only partial and doesn't matter:

1. No one has ever been busted on Silk Road due to Bitcoin or Tor
2. Exchanges can be located anywhere and be informal (eg #bitcoin-otc); hawala still exists despite substantial US interest and effort into crackdowns
3. Exchanges can collect all the info they want, because you can always use a laundry/mix to eliminate connections between your bitcoins and contaminated bitcoins
4. No laundry/mix has been successfully attacked so far that I know of.
5. Secure laundry/mixes can and have been done using secure multi-party computation
6. There is no reason that stronger anonymity cannot be built into Bitcoin; the very recent Zerocoin proposal is a reminder of this fact even if it ultimately does not prove to be secure or go live.

Actually, I realized that my mental model of how bitcoins acquired value with respect to the US dollar is wrong. BTC being fungible with US dollars is still important, but it's use in transactions isn't. A drug dealer and drug buyer would both willingly trade $40 worth of drugs for $40 worth of bitcoins, but whether $40 of bitcoins is 1 BTC or 100 doesn't make a bit of difference to them. Drug dealer still immediately cashes out his bitcoins so that they can restock their inventory, and the drug buyer still immediately buys bitcoins so that they can buy drugs. What these transactions do is merely fund the BTC exchanges through transaction fees - there's no long-BTC position held for any appreciable length of time.

There's still a kernel of truth to the analysis, though. BTC speculators - those actually holding the long positions in BTC - aren't going to be willing to stick around for the legal risks of money laundering (at least, that's what it could be in the eyes of the US Government). I'm still retracting, though, since I realized that I did things wrong.

In short, the risk is more of money coming from the bitcoin ecosystem being automatically treated as dirty money. This discourages speculation, which tanks the price.

It's not anonymous currency, but pseudonymous.

My argument does not depend on it being anonymous. Decentralization is valuable for reasons other than anonymity. If being anonymous is bad for bitcoin, then the network has incentive to avoid implementing strategies that make it anonymous.

The idea of "deflation" for a numeraire currency is meaningless.

This assumes that the change in prices with respect to BTC is unimportant, but this is not true in practice for a number of reasons: prices are sticky (so such changes disrupt trade), people hold varying quantities of BCT ( so it has distributional effects), and contracts are often specified in terms of a currency (more distributional effects).

(I will also note it is common for smart people to think they know the major relevant issues about monetary policy, and thus have useful things to say about it, long before they actually do. I think you are one of those people right now. No offense intended.)

This simply doesn't change anything, because you can still trade two barrels of tomatoes for one barrel of oil.

That is true as far as it goes, but for people deciding what portion of their savings need to be in bitcoin versus some other form from one week to the next it is very relevant. A counterexample would be countries with runaway inflation, where people are forced to spend their money extremely quickly. I'm not sure that runaway deflation ruins commerce to the degree that inflation does, but it seems like it would slow it down quite a bit by placing greater incentive pressure towards cash savings rather than investment or expenditure.

For example, say the price of tomatoes is 10 BTC per barrel, and the price of oil is 20 BTC per barrel. What those numbers really mean is that you can exchange two barrels of tomatoes for one barrel of oil. Now say BTC "deflates" by 10x so that you need 100 BTC for a barrel of tomatoes and 200 BTC for a barrel of oil. This simply doesn't change anything, because you can still trade two barrels of tomatoes for one barrel of oil.

If you needed 10x as much money to buy the same thing, that would be inflation, not deflation.

Now say BTC "deflates" by 10x so that you need 100 BTC for a barrel of tomatoes and 200 BTC for a barrel of oil. This simply doesn't change anything, because you can still trade two barrels of tomatoes for one barrel of oil.

Would that be different for any other currency, e.g. dollars?

Bitcoins themselves are limited, but a new Bitcoin protocol can be introduced which includes existing bitcoins and adds new ones, and these would prevent the overall supply from being limited.

Increasing the overall supply of bitcoin will not happen. If a new cryptocurrency with more than 21 million coins becomes the norm it will not be bitcoin. Adding more coins arbitrarily is is also not desirable. The prevention of the 'someone decided to print more money' kind of inflation strengthens the trust in the currency. If this hard prohibition was discarded the credibility of the currency would potentially be outright destroyed.

Fortunately, issuing more coins is also not necessary. The solution is to increase the precision and allow smaller denominations to be represented. This requires an utterly trivial change for the miners to adopt and will occur as soon as it becomes necessary. Particularly because over time the business model for mining is fees on small transactions. The miners NEED small denominations to be tradable so they can take their even smaller denomination fee from them.

The remaining problem with deflation is that trading 0.00000001 bitcoin just sounds ridiculous. It isn't convenient for humans to think about. Fortunately this problem is already solved. The aforementioned figure is already known as a "Satoshi". If the currency ended up valued sufficiently highly then people would just gradually start talking about satoshi, or any of the other plausible units.

That does overcome the in-principle argument that bitcoins are limited, deflationary, and thus too volatile to be used as cash. However, considering that the network (comprised of bitcoin holders, presumably) would have to decide they are okay with diluting the supply and changing the rules, I feel that is somewhat unlikely.

From an incentive perspective, all you get is saving a bit of money on credit card fees.

You vastly underestimate the importance of this. When you run a business with margins of 6%, 3% fees are cutting your profits in half.

Keep in mind that bitcoins have already been around for years and haven't seen really widespread adoption outside of niche stuff like Silk Road.

growth has been ridiculously rapid. https://en.bitcoin.it/wiki/Trade

Let's not quote EY as gospel on this topic. There are a lot of people who say lots of things about the market, and unless something is supported by theorems or solid empirical data rather than handwaving, I'm reluctant to adopt it as a quotable principle.

Err... That isn't EY making stuff up. It is supported by theorems. That is the efficient market hypothesis described in different language. You can deny that a given market is efficient but that is you handwaving away the theorems.

And FWIW, I have a very smart friend who makes a ton of money playing the stock market and part of what he does is look for patterns and exploit them.

This isn't implausible. It can come about from any one of:

• Your friend is smarter than the people he is trading with.
• Your friend has happened to be lucky.
• Your friend is using practices that concentrate risk. (ie. He is one of the countless traders using strategies that give ongoing steady returns with a small chance of being completely wiped out in a day.)

Yes, it would be because she withdrew the 100 times as many dollars and it is the only wallet so far that qualifies as dollars. She does get to set the amount more or less arbitrarily with the first minting transaction. Later when Bob attempts to pull out 10k dollars from his own 99-bitcoin or 101-bitcoin currency wallet, he has to reference the dollar-currency created by Alice (possibly by address or by reference to the initial transaction signature) to connect the two kinds of dollars and render them fungible with each other. When he does that he has to prove that he has enough bitcoins to justify that number of dollars, based on recent history of minting transactions as well as whatever parameters the specific currency goes by, otherwise the network won't approve his transaction.