Bitcoins are not digital greenbacks

Should you probably donate a bitcoin to your future self?

Bitcoin has been in the news a bit lately. In case anyone hasn't been following recent events, its price hit $266 per coin, toppled to $50, and then climbed back to a rate which has been between $80 and $140.

This goes to show its high volatility at the present time, which means that any individual trade you make will be something of a gamble with a noisy, hard-to-predict outcome. You could be buying in right before a boom or a bust. Buying and then selling at random intervals will probably cost you more money than you make, due to transaction fees. Trying to outsmart the market in the short term with nothing but your own human instincts and powers of induction will probably cost you even more money because Markets are anti-inductive. The most realistic way of making much money with bitcoin -- sans owning your own exchange, having skill and resources for serious technical analysis, a faster-than-usual trading bot, or fantastic luck -- is if you can determine that the current price is very poorly calibrated relative to its future value, and if you buy and hold very long-term.

Market swings constitute a psychological attack, assuming you know and care about them, so employing the buy-and-hold strategy can be more difficult than it looks. However, as it happens, you can render bitcoins almost purely unspendable (i.e. impossible to transfer via the network) for a finite period of time as a technical matter. You could for example create a brainwallet based on a lengthy memorized passphrase with a random value appended to it. The larger that appended value, the (exponentially) greater the amount of processing time needs to be spent to find out what it contains. Having access to the memorized passphrase gives you the overwhelming advantage over a brute force attacker, whereas the appended random value immunizes it against dictionary attacks. (Todo: Find or write a program for this. Prove it works, and move some of my bitcoin holdings to a wallet requiring a day or more to unlock.)

Early adopters with moderate crypto skills could thus have a distinct advantage compared to the average investor and realistically hope to beat the market on that basis if mere human psychology and resistance against short term panic-selling is the fundamental constraint. So that's one consideration that could play to our advantage. Assuming, that is, that bitcoin is worth taking seriously to begin with, and not just a matter of geeky fun.

The question that matters for that consideration (the one that differentiates long term speculation on bitcoin from various speculative bubbles in gold, real estate, tulips, etc.) is this: Of all the possible worlds, where is the probability mass concentrated with respect to the future of bitcoin, in terms of how it will actually be used? Is there an overwhelming tendency for bitcoin to fail and be replaced by other things (e.g. other cryptocurrencies, or fiat dollars) -- or is it actually likely (in at least the minimal sense of "not overwhelmingly unlikely") to turn into a major store of wealth in coming decades?

I rather think it is the latter. But first, let's consider what I believe to be the strongest argument against it, which unpacks to three parts:

  1. Deflation. Bitcoin will never be more than 21 million coins strong due to the production rate going down by half every 4 years. That implies that it will always deflate, i.e. there will be less available to buy as time goes on.
  2. Volatility. This is the natural result of deflation. As scarcity increases, people buy out of the speculative belief that value will rise forever. They fear to spend because really, who wants to have bought a million dollar pizza? Eventually, when enough of the value is due solely to this belief in future growth, people abruptly begin to sell, and the bubble bursts.
  3. Distrust. Currency requires trust. Volatility decreases trust. If bitcoins continue to be volatile, because of deflation, which is built into the system, it cannot be trusted well enough to compete with more stable currencies -- and will therefore eventually die out.

Taken together, this seems like a pretty good knock-down argument. It apparently implies, as a matter of basic economic law, that some other cryptocurrency must win over it in the long term, and/or that fiat money will retain its dominance. But the thing to notice is that it's not so effective against bitcoin as a massive store of wealth per se, so much as a currency that will be directly used, in a manner directly analogous to how government-backed monetary units are used. Non-currency forms of wealth which serve some other purpose can safely handle quite a bit more volatility, because their value is not dependent on being trusted as a currency, but rather as a value storage mechanism.

Here is the general scenario that I think holds more probability mass than bitcoin-as-a-traditional-currency, and yet works as a fairly realistic alternative to bitcoin-as-a-flop:

  • Bitcoin will fall out of circulation as a currency because of its relative volatility.
  • Nonetheless, alternate currencies will be built into the blockchain.
  • These alternate currencies will be designed for stability, instead of deflation.
  • Mechanisms for trading alternate currencies for bitcoins will be part of the protocol.
  • Rather than a currency, bitcoin plays a role as a scarce, fungible, stabilizing commodity.
  • The ease of turning it into these successful alternate currencies gives it the ability to outcompete traditional options like gold.

Can this be done? Consider the following more specific scenario as an example:

  1. Alice puts 100 bitcoins in a currency wallet denoted "dollars".
  2. Alice withdraws 10,000 of a currency called "dollars" from an associated address.
  3. The network knows that there are 100 times as many dollars as bitcoin, and makes a note of this.
  4. The network will not allow Alice to withdraw bitcoins from the currency wallet until she replaces the dollars.
  5. Bob puts 99 bitcoins in a currency wallet also denoted "dollars"
  6. Bob withdraws 10000 dollars from it.
  7. In the event that Alice replaced her dollars and withdrew her bitcoins quickly, the network recognizes this as valid. But in the event that she did not, the dollar is recognized as having more value and the network will not permit Bob to withdraw that amount unless he has 101 bitcoins in the wallet.

This is just one example I've come up with, and may not be the best. Various other schemes are possible. (For example, it could be possible for any dollar-owner to convert them back to bitcoin, as opposed to the person who originally minted them.) What the various possible models for doing this have in common is that they allow you to set up currencies which dynamically increase and decrease in supply, depending on how much bitcoin people are willing to invest into them, and how badly people want bitcoins back later on.

A competing scenario to the above would be one in which a better-optimized cryptocurrency protocol implements this, or some other stability-prone algorithm and thus outcompetes the volatile, easily manipulated, "primitive" bitcoin protocol in use today. I used to think I could just jump on the bandwagon when this comes around, maybe strategically sell someone a pizza and end up a millionaire.

However, I've somewhat lost faith in that possibility of late because I realized that bitcoin is much more powerful than it seems, and is capable of substantial self-modification if needed for compatibility with a newer and better system. The only thing locking us to the current protocol is the degree to which bitcoin-owning miners find it in their best interests to continue to use it as it is. A competing algorithm that makes bitcoins more valuable without violating existing expectations would probably not be hard to get people to update to.

Another thing that makes me think bitcoin will tend to self-improve to the point of winning against competitors is that at least some people with substantial assets in bitcoin form are likely to be very proactive in defense thereof. Assuming they remain committed to the long game, and are able to acquire sufficient short-term wealth to pursue their goals, they can do a number of things to defend it against the various plausible attacks: Hiring programmers to improve the client software and render it less hackable, hiring lobbyists to protect it against regulatory interference, employing botnets to attack competitor currencies, slowing down or preventing transactions that appear to be going through anonymizing laundries that could be associated with tax-dodging and illegal drugs, and so forth.

So it seems to me like owning at least one bitcoin and holding onto it for long-term purposes is probably a good idea.

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I've been wondering how much evidential value the rise of Bitcoin offers for the success of a basement-style FAI project. Unfortunately I don't have a lot of time to participate on LW recently but has anyone else thought in this direction? (Sorry, this isn't directly related to the OP but I figure more interested people will see it here than in open thread.)

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.

My understanding is that Bitcoin involves one major innovation (approximate solution to the Byzantine Generals problem) and the rest is existing tech.

I guess I was counting the idea of "decentralized pseudonymous money implemented as a distributed ledger" as well as all of the major elements involved in how Satoshi realized this idea to be part of Bitcoin's innovations, since my understanding is that Satoshi was not aware of either b-money or Bit Gold (both of which BTW were also developed outside of academia/government/industry) before he wrote his paper, and had reinvented the idea on his own.

since my understanding is that Satoshi was not aware of either b-money or Bit Gold (both of which BTW were also developed outside of academia/government/industry) before he wrote his paper, and had reinvented the idea on his own.

You've previously said that Satoshi was not aware of b-money (incidentally, Adam Back recently took credit for telling Satoshi about b-money), but this is the first I've heard anyone suggest that Satoshi was unaware of Szabo's Bit Gold. What makes you say that?

this is the first I've heard anyone suggest that Satoshi was unaware of Szabo's Bit Gold. What makes you say that?

I think if he had been aware, he would have cited Szabo in his paper, like he did with b-money. And yes, Satoshi learned about b-money from Adam Back. Here's part of Satoshi's email to me:

I was very interested to read your b-money page. I'm getting ready to release a paper that expands on your ideas into a complete working system. Adam Back (hashcash.org) noticed the similarities and pointed me to your site.

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

Presumably Wei is referring to how the Bitcoin codebase appeared to emerge fully-formed, from out of nowhere, with no obvious precipitating discoveries or breakthroughs; and even now in 2013, perhaps 5 years after the first mentions of Bitcoin, Nakamoto's pseudonymity remains intact: we do not know who Nakamoto is, where he worked or lived, what his training might be, what affiliations he has, what he is doing now, and having spent a bit of time over the last week investigating all of Nakamoto's traces and looking at previous investigations like The New Yorker's, this condition seems likely to persist*. (Unless of course Wei is Nakamoto, for which there's not terrible evidence, in which case he knows all that but the evidential value is still there for us.)

Its subsequent uptake may have vaguely startup-like characteristics, but that is because the Bitcoin codebase is not sapient or intelligent and cannot act on its own...

* I think Nakamoto is probably not Japanese (Austrian libertarianism having zero exponents in Japan, basically, as makes sense given their own deflationary currency and deflationary spiral, and the complete absence of any Japaneseness in his writings) but beyond that he did a great job concealing any real-world aspects of himself, and so the only viable approach is to compile a large corpus from possible suspects such as every poster to the Cryptography ML, do the best stylometrics possible, weight the rankings by known aspects of Nakamoto such as C++ fluency, and then maybe do some active attacks. Even then this might fail since it relies on Nakamoto being present on the ML to a sufficient extent previously under another name.

Bitcoin seems more relevant than Craigslist, PayPal, or other tech startups because it involved major technical and conceptual/philosophical advances on the existing state of the art, and these advances didn't originate from nor was likely funded/supported by academia, government or industry. Also, its social impact seems larger - if Craigslist or PayPal didn't exist, something essentially identical would have been created very soon anyway, but if Bitcoin didn't exist, another Bitcoin may not have been created for another decade, and/or may have been created with very different characteristics, for example it might have been coded with a monetary policy that emphasized price stability instead of a fixed supply of money.

I would consider Bitcoin to have failed with regard to its monetary policy (because the policy causes high price volatility which imposes a heavy cost on its users, who have to either take undesirable risks or engage in costly hedging in order to use the currency). (This may have been partially my fault because when Satoshi wrote to me asking for comments on his draft paper, I never got back to him. Otherwise perhaps I could have dissuaded him (or them) from the "fixed supply of money" idea.) I don't know if it's too late at this point to change the monetary policy that is built into the Bitcoin protocol or for an alternative cryptocurrency to overtake Bitcoin, but if it is, then Bitcoin is similar to self-improving AI in that it may be critical to get the first one right and it offers evidence on how hard it is for an individual or small group working outside the mainstream to do that.

Since I have a personal connection with Bitcoin I'm probably tempted to read more into it than I should relative to other evidence such as other tech startups. I'm curious what your impression is after reading the above, and whether there is other specific evidence that I should be paying more attention to.

I'm curious what your impression is after reading the above, and whether there is other specific evidence that I should be paying more attention to

Sure.

because it involved major technical and conceptual/philosophical advances on the existing state of the art,

I agree Bitcoin is relatively audacious, novel, and technically sophisticated .

and these advances didn't originate from nor was likely funded/supported by academia, government or industry

Couldn't you describe many early-stage self-funded startups that way? Or do you mean you guess that Satoshi was not working in academia, government, or industry before developing Bitcoin?

Also, its social impact seems larger - if Craigslist or PayPal didn't exist, something essentially identical would have been created very soon anyway, but if Bitcoin didn't exist, another Bitcoin may not have been created for another decade, and/or may have been created with very different characteristics

What kind of impact? So far the volume of Bitcoin transactions is still relatively small, and presumably a large portion of the transactions conducted using Bitcoin would otherwise be undertaken using other payment systems. So getting a version of PayPal or Craigslist working somewhat earlier or better could easily affect more transactions and generate more consumer surplus if Bitcoin does not grow to larger scales.

ETA:

PayPal’s net Total Payment Volume for 2012, the total value of transactions, was $145 billion, up 22% year over year.

Cf Bitcoin transaction volumes.

Couldn't you describe many early-stage self-funded startups that way?

Self-funded startups that also involve major technical and conceptual advances that weren't first developed in academia, government, or industry (and then spun off) seem rare. Can you give some examples that are similar to Bitcoin in this regard?

Or do you mean you guess that Satoshi was not working in academia, government, or industry before developing Bitcoin?

If Satoshi was working in academia, government, or industry, it seems very likely that he didn't develop the ideas behind Bitcoin as part of his day job, otherwise he probably wouldn't have been allowed to publish the ideas and software under a pseudonym.

So getting a version of PayPal or Craigslist working somewhat earlier or better could easily affect more transactions and generate more consumer surplus if Bitcoin does not grow to larger scales.

It's hard to even say whether Bitcoin ultimately has a positive or negative impact at this point. For example one possible impact of Bitcoin might be that due to its deficient monetary policy and associated price volatility it can't grow to very large scales, and by taking over the cryptocurrency niche, it has precluded a future where a cryptocurrency does grow to very large scales. If we take the expectation of the absolute value of its impact, it seems higher to me than the impact of a somewhat earlier or better PayPal or Craigslist.

due to its deficient monetary policy and associated price volatility it can't grow to very large scales, and by taking over the cryptocurrency niche

I'm also quite worried about this, but on the other hand Bitcoin creates an obvious entry gateway into more advanced cryptographic currencies (i.e. once Bitcoin infrastructure is set up, other currencies can use Bitcoin infrastructure if there's a way to exchange them with Bitcoins, lowering the bar to entry).

I've had all sorts of ideas along these lines, in fact. The main reason I haven't published them is that I'm not sure that more advanced cryptocurrency advances FAI over AGI. In fact, you'd think it would be the reverse - the Great Stagnation may be all that's keeping us alive right now.

In fact, you'd think it would be the reverse - the Great Stagnation may be all that's keeping us alive right now.

I don't see why we should obviously expect funding for AGI to benefit from economic growth in a way that funding for FAI doesn't. If Silicon Valley is booming, I'd expect MIRI to receive more donations and Google to put more money in to self-driving cars. If Silicon Valley is contracting, I'd expect MIRI to receive fewer donations and Google to put less money in to self-driving cars. Am I missing something here?

I'm surprised that you are so interested in this area (i.e., monetary policy for cryptocurrency), given that the subject matter and required backgrounds to study it are not closely related to FAI. I don't even have any strong opinions on what is the right policy, except that the one currently built into Bitcoin is pretty suboptimal (ETA: at least in the long run, in the short run it seems close to optimal for getting Bitcoin some initial scale).

The main reason I haven't published them is that I'm not sure that more advanced cryptocurrency advances FAI over AGI.

Yeah, me either, or more generally whether cypherpunk-related technologies help or hinder a positive Singularity, which is part of the reason why I stopped pushing very hard on my cypherpunk ideas.

Econ relates to intelligence explosion dynamics, Scott Sumner appears to be a Correct Contrarian.

I don't have any good ideas for how to do NGDP level targeting inside a cryptocurrency in a way that would automatically distinguish more widespread adoption from increased RGDP from somebody gaming the system.

Econ relates to intelligence explosion dynamics, Scott Sumner appears to be a Correct Contrarian.

No, he doesn't. Edit: and I've found that his general reasoning to be poor in general. Some examples (which I can source later if anyone plans to update on this):

"Sumner, if what you're saying is true, shouldn't the Fed let anyone, including the average Joe, borrow from the Fed at 0%?" -- > "Yes."


Sumner: "Income" is a meaningless concept.
Critic: No, it's obviously vital to know how much you can spend before becoming unable to buy anything. And how would you value an enterprise but by discounting its income streams?
Sumner: If you want to know what a venture is worth, look at its stock price, not income.

I don't have any good ideas for how to do NGDP level targeting inside a cryptocurrency in a way that would automatically distinguish more widespread adoption from increased RGDP from somebody gaming the system.

Non-crypto, "real world" currencies have exactly the same problem of gaming the numbers to make NGDP artificially high. They're only worthwhile to pursue when NGDP specifically is targeted, rather than some "close enough" policy.

Right now, the best velocity measure seems to be coin days destroyed. But it is gameable. It is not being gamed in bitcoin because nothing is dependent on it.

The closest GDP measure in a cryptocurrency of the structure of bitcoin seems to be sum of transaction fees. It can be gamed by early adopters, but that is true of almost every measure

(i.e. once Bitcoin infrastructure is set up, other currencies can use Bitcoin infrastructure if there's a way to exchange them with Bitcoins, lowering the bar to entry)

Yes; it's been pointed out that you can, and people have, set up competing currencies using the codebase but without the builtin caps. More interestingly, you apparently can build currencies directly on the existing Bitcoin codebase & main blockchain using colored coins (which wedrifid seems very interested in).

No, what I mean is that if anyone else sets up a cryptocurrency right now, they don't have to worry about making it exchangeable with dollars, they just need a good way to make it exchangeable with Bitcoins, and that could easily be done using pure programming. Bitcoins is a horrible store of value and an even worse medium of account, but some of the underlying ideas have great potential as a medium of exchange, and Bitcoin can sneeze any previous development of real-world interfaces directly into a new, competing cryptocurrency.

I'm having trouble reconciling the "horrible store of value" part with the rest of your argument. A competing crypto-currency eventually comes into existence, better than dollars, everyone wants to use it instead, and you can't get it without bitcoins... And we're supposed to think bitcoins are not particularly likely to go up in value as a result?

Edit: I guess if you only mean "currently horrible" this makes plenty of sense. Also it could maybe lose value once it has played its part in getting everyone used to the new currency.

A competing crypto-currency eventually comes into existence, better than dollars, everyone wants to use it instead, and you can't get it without bitcoins... And we're supposed to think bitcoins are not particularly likely to go up in value as a result?

If such a crypto-currency comes out, everyone holding Bitcoin will want this Newcoin, everyone who would have held Bitcoin will instead be demanding Newcoin, and the only reason anyone will be holding Bitcoin will be as part of the float generated by people trading dollars for Newcoins via Bitcoin non-instantaneously. The exchange rate supported by the float could be far less, the same, or far higher than the current exchange rate.

(An example: suppose Bitcoin somehow lost popularity so that the sole use of the current n bitcoins was for Silk Road, and no buyer or seller let more than a day elapse between exchanging their $$$ for Bitcoin (buyers) and exchanging their Bitcoin for $$$ (sellers); if there's $1m of total turnover on Silk Road per day, then buyers need to turn $1m into Bitcoins and seller need to turn X Bitcoins into dollars, and this need will be spread out over n bitcoins. IIRC, there's like 5m bitcoins so in this scenario we would each day see 5m bitcoins traded from the sellers to the buyers in exchange for the buyers' $1m, or an 'exchange rate' of $5/btc, which is approximately 1/28th the current exchange rate, and then the buyers move the bitcoins to SR and hand them over to the sellers, who move them back to the exchange to sell to the buyers...)

Are we talking about converting Bitcoins into Newcoin (say by sending them to a fake address as a precondition for minting X many Newcoins) or are we talking about trading them ("you send me X many Bitcoins, I send you Y many Newcoins" transactions)? The former strategy would drive scarcity of Bitcoin up as a direct result of demand for Newcoin.

I thought we were talking about the latter - people would convert dollars into Newcoin via an intermediary Bitcoin stage (perhaps because Newcoins are banned or something).

If we were talking about 'converting', such as by some of the suggested verifiable-destruction strategies... I'm not sure. Presumably each Bitcoin would always sell for at least as many dollars as its equivalent in Newcoin would fetch modulo the transaction fees and effort (since otherwise people who want Newcoins would buy up Bitcoins and convert them immediately), but if Newcoins were so much better why would any Bitcoin holder at all not immediately convert all their Bitcoins to Newcoin? Reminds me of the flows between coin and bullion in metallic regimes.

I now see that when I wrote the original post, I probably should not have used the term "trade" as a synonym for "convert". Someone who did not read my post closely might have thought I was enthusing about incremental improvements that let you reassign ownership like a traditional marketplace, only more efficiently, with automatic bid processing or something. That might be nifty, but it is not the earth-shattering point that makes me want to buy lots of bitcoins. What makes me want to buy more bitcoins is that reassignment of ownership is not the easiest way to do it. Instead it's easier to make a system that destroys so many bitcoins and creates so many newcoins. It is also something that the current owners of bitcoin have significant financial incentive to make sure happens. Since it's easier and massively incentivised, I think it carries the bulk of the probability mass.

Is Bitcoin's monetary policy really expected to be a problem? If it were to reach a steady state adoption and usage level, I imagine Bitcoin's price would stabilize around some constant fraction of (the present value of) the market's expectation of future world GDP. Is that not what you would predict?

Or is the problem that you don't think Bitcoin can reach widespread adoption without users reasonably being able to price goods in BTC?

That's a problem because then BTC is a perfect investment which always grows at exactly the same rate as the global economy. So it gives you the exactly average return on investment with zero volatility. So it seems like a near-perfect store of value and people will want to hold it rather than spend it. This decreases velocity which causes deflation and value that increases apparently even faster than the total global economy. This makes Bitcoin apparently an even better investment, until the volatility or expected volatility from the huge stores of unused Bitcoins outweighs its apparent returns on investment, and note that financial markets are apparently unusually bad at expecting future volatility to be greater than present volatility; people try to time bubbles instead. This is bad for Bitcoin because of the inevitable crash followed by hyperinflation. And it's bad for the global economy because your currency is deflating and any given bank would rather hold Bitcoins, on average, than make loans; and then the inevitable crash is also bad. That's a nutshell version of a longer story.

That's a problem because then BTC is a perfect investment which always grows at exactly the same rate as the global economy. So it gives you the exactly average return on investment with zero volatility. So it seems like a near-perfect store of value and people will want to hold it rather than spend it.

Assuming BTC gives exactly the average return on investment with zero volatility we shouldn't expect all people to hold it rather than spend it. Neither an economy of actual humans nor an economy of ideal agents would act that way.

With respect to consumption: Use as a transactional currency for spending would track convenience factors. People buying stuff with one fungible asset is much the same as buying stuff with another asset then transferring between their two accounts. For spherical cow in a vacuum purposes we can ignore this. Investment spending is the issue here.

In the counterfactual BTC currency which perfectly tracks the global economy the incentive is for anyone who believes they know of any investment that they expect to have higher returns than the average of the global economy to spend their bitcoins and invest in that opportunity. Those who don't believe they have any knowledge of anything that will produce better than average returns or who are risk averse will instead purchase bitcoins either directly or indirectly from those that do have that knowledge.

In that idealised scenario the BTC currency is essentially operating as a vehicle to efficiently transfer real-world capital to places those who people with value expect will provide better return in investment than the average growth of the economy. Note that I am emphatically not claiming that this is an ideal system, it would be bizarre if something so arbitrary happened to be optimal. Just that it doesn't seem to quite have the degree of problem that is described. People would certainly want to spend it.

There are plausible reasons why predictable inflation of the above currency could be more desirable than precisely zero inflation. Let's say Satoshi had arbitrarily decided that BTC mining should go on indefinitely, with the bitcoins produced per year exactly equalling 2% of the number of bitcoins already mined. Then the incentives to the the participants change slightly. Rather than people who expect an investment to grow at more than the average for the global economy to be the only ones to so invest, it is any (risk neutral) person who expects an investment to grow at not less than 98% of the rate of the global economy. That has (well known) advantages.

The unfortunate problem with the above monetary policy is that we just effectively dedicated 2% of the of the value stored in the bitcoin currency each year to the computation of irrelevant hashes (in addition to irrelevant computation that is proportional to transaction fees). This problem applies to any cryptocurrency based on cryptographic mining. There may not be a good solution to that problem that potentially prohibitive degree of waste that does not rely on something external to the cryptocurrency as basis. (And the latter is not necessarily a problem. The currency having value in itself isn't the most potentially useful feature of bitcoin.)

Let me rephrase: The problem is that Bitcoins will have an advantage over the average productive investment, e.g. stocks (sort of), as a store of value, since Bitcoin has all their average expected growth with none of their added (local) volatility. This is what presents the starting problem in an economy that starts out with a steady velocity of Bitcoins, and then increased holding makes the velocity go down (and the value go up, and the bubble effect hit even harder). This is why we don't get an equilibrium with steady Bitcoin velocities. Even if we did have that equilibrium, people would have a much greater incentive to just "invest" in Bitcoins instead of being forced to try to invest in something productive. You don't want an economy to have a perfect non-inflating store of value which is intrinsically unproductive!

Let me rephrase: The problem is that Bitcoins will have an advantage over the average productive investment, e.g. stocks (sort of), as a store of value, since Bitcoin has all their average expected growth with none of their added volatility.

I like the rephrasing. To expand on what seems to be a generalisation of this problem: Any cryptocurrency sibling of bitcoin that relies on cryptographic mining as a basis will either have this problem or will result in (value of currency * inflation rate) additional resources wasted on computation each year.

I believe (tentatively) that the above is an unavoidable result of the cryptographic and micro-economic principles that such currencies rely on.

I like the rephrasing.

Note, I wrote this in reply to the original version of the grandparent, which is as quoted in the parent. This is confusing since it is a bug/feature of the lesswrong system that Eliezer's edits to his own comments do not get marked with an asterisk like others.

I do not endorse the current version of the grandparent, in as much as it overstates the position and seems to verge on encouraging magical thinking about how a currency can extract value from a system.

To expand on what seems to be a generalisation of this problem: Any cryptocurrency sibling of bitcoin that relies on cryptographic mining as a basis will either have this problem or will result in (value of currency * inflation rate) additional resources wasted on computation each year.

I believe (tentatively) that the above is an unavoidable result of the cryptographic and micro-economic principles that such currencies rely on.

This is not limited to cryptocurrencies, e.g., gold-based currencies cause people to "waste resources" mining.

This is not limited to cryptocurrencies, e.g., gold-based currencies cause people to "waste resources" mining.

Yes, the 'mining' metaphor was well chosen.

In terms of that gold analogy, what we are talking about in the context would be if gold spontaneously generated itself in proportion to the amount of existing gold and automatically buried itself at whatever depth makes it barely worthwhile to dig up. That waste is the unavoidable cost of making bitcoin-style cryptocurrency have ongoing inflation.

That's a problem because then BTC is a perfect investment which always grows at exactly the same rate as the global economy.

That seems to be saying that all of the BTC would always be able to buy exactly all of the things. I can't imagine how that could be the case.

Okay, I think I understand the argument that Bitcoin will likely be permanently volatile, because growth at exactly the rate of the global economy is not a stable equilibrium for the reasons you describe (esp. 'people like to time bubbles').

Thinking about this a bit more though, it seems like the same argument would apply to any asset we might otherwise expect to grow in sync with global wealth. In particular, the apparently-perfect-store-of-wealth-attracting-investment-and-appearing-to-be-an-even-better-store-of-wealth phenomenon seems like a straightforward explanation of what's been happening with the price of gold in the last decade.

But also, it seems like this argument could even apply to the stock market as a whole -- would we expect a global ETF (like Vanguard's VT) to grow at the rate of the world economy? Is that stable?

So I'm curious, do you agree that the no-stable-equilibrium argument applies to the price of these other assets as well, and if so, does the existence of Bitcoin still seem like it would be a problem for the global economy?

It partially explains the price of gold, yes. Gold's situation isn't really the same for three reasons: First, gold can be mined if the price goes too high, and higher prices would imply larger amounts of recoverable gold. Second, a lot of the gold on the market is paper gold, theoretical gold that two parties are trading rather than sending large gold bars around, which also adds to the supply. But most of all, unlike the supposed use-case of Bitcoin, gold is not being used as a medium of account or medium of exchange any more, just one store of value among many, so its real competition is not paper gold or mined gold but other stores of value such as platinum, silver, real estate, and many other things being added to the competition for 'stores of value' as the economy grows. If the same fraction of the population tried to store the same fraction of their net assets in gold today as in the 1600s then the price of gold would be vastly higher - or so I would think, I haven't run the numbers. But this in turn means that the share of the economy represented by gold can easily drop further, making it less than a perfect store of value etcetera, although gold has still tended to be a better store of value than fiat currency.

Of course fiat currency is really supposed to be a medium of exchange and account, not a long-term store of value, though dumb people like me tend to use it as a store of value too because it's convenient and we haven't gotten around to setting up anything different and we don't have that much value to store. And then using your medium of exchange and account as a store of value causes recessions and depressions due to the paradox of thrift; when people want to consume in the future instead of the present they try to hold paper money instead of demanding equity in projects with long-term payoffs. On the plus side, central banks can, in principle, easily rectify some part of this problem by printing more money to meet demand for currency when fear rises, and thus make up for velocity slowdowns, keeping NGDP on a level growth path. On the minus side, central banks are stuck in 30-year-old economic thinking and don't keep NGDP on a level growth path. Bitcoin has the potential to make things much, much worse though.

New stocks on the other hand are constantly being created as the economy grows - no particular stock, or set of stocks starting at a fixed time, are guaranteed to grow at the same rate as the global economy.

To paraphrase, you're pointing out that stocks and precious metals come with built-in demand shock absorbers, whereas Bitcoin has none. I'm not totally sure that I accept this point, because I could see alternative cryptocurrencies playing the role of marginal new stocks or newly mined gold. However, even if Bitcoin were unique in having no demand shock absorbers, I'm not sure this matters, because it seems empirically to be the case that these shock absorbers are not always up to the task, and that both stocks and precious metals do experience a great deal of price volatility, even over the medium to long term.

In other words, even if Bitcoin is especially sensitive to changes in demand, it is neither novel nor unique in being susceptible to bubbles.

This would seem to me to imply that Bitcoin's existence and use as a store of value is no threat to the economy. (And its use as medium of exchange seems harmless as well.)

It would seem that problems would only arise for those who try to use Bitcoin as a unit of account. This is in line with Wei's comment where he suggests that with a currency in fixed supply, fluctuating velocity of money implies that either prices or GDP must be unstable.

So my conclusion is that using Bitcoin as a medium of exchange or store of value is not detrimental to the economy, but one should continue to price goods or services in some other fiat, ideally NGDP-targeted, currency. Does that sound about right?

Using it as a store of value is detrimental. Anyone bidding on a Bitcoin is not bidding on a productive project.

Anyone bidding on a Bitcoin is not bidding on a productive project.

It seems that the same goes for gold, real estate, and so forth when they are used as a store of value. The difference is that unlike bitcoin, these things have other productive uses that they could be put to, less expensively, if they weren't being used as a wealth-counting mechanism.

"No one wants bitcoins anymore, they're too valuable."

If it were to reach a steady state adoption and usage level, I imagine Bitcoin's price would stabilize around some constant fraction of (the present value of) the market's expectation of future world GDP.

According to Wikipedia, "velocity of money" is not a constant but tends to fluctuate. The article lacks citations, but I think this is the current mainstream view among monetary theorists. My understanding of the implication of this is that if you have a fixed supply of money then either prices or GDP would have to be unstable. In other words either you end up with an economy with very flexible prices that change constantly, or you end up with an economy that goes through constant boom and bust cycles (or some combination of each), and both of these outcomes are costly.

I feel like this isn't nearly the issue it is made out to be when you separate real growth from nominal growth. Say you have real growth but prices fluctuate a lot, why should you care? Frictional costs should decrease over time as people figure out how to hedge properly in this environment.

So is the solution just to use Bitcoin as a medium of exchange and a store of value, but not as a unit of account? Then prices are free to fluctuate in BTC terms, while they can remain relatively stable in fiat terms, and GDP will be unaffected.

That would make it a terrible at being a medium of exchange or a store of value, though, wouldn't it? No one knows how much it's worth, and you have to acquire some, pass it off, and then (on their side) turn it into currency every time you use it.

That depends on how volatile it is. On the timescale of a single transaction, a certain level of volatility might not matter very much even if the same level of volatility would prevent you from wanting to set prices in BTC.

I wonder to what degree FAI/CEV engineering considerations overlap with cryptocurrency/efficient-market engineering considerations. If they are a close match, encouraging the development of the latter would have benefits for the former, and could even be essential to overcoming scaling problems (since FAI is harder to sell investors on than cryptocurrency).

This isn't just a random idea; markets are how humans in the absence of superintelligence actually do try (with some, not-unlimited success) to implement their values. Prediction markets are a possible extension of this concept, but even your run-of-the-mill securities markets are reliant on various kinds of predictive logic that responds somewhat to human desires and needs.

Not trying to trivialize the AGI field since it is outside my specialization, but is there some not-terribly-unlikely way in which a really good cryptocurrency could basically be/evolve into the same thing as an FAI? If so, are there any particular properties that would be likely to nudge it in that direction / away from uFAI?

I'm kind of concerned because I see bitcoin (and/or anything sufficiently similar) funding competition to purchase obscenely large amounts of hardware -- which could possibly even extend to the point of satellite arrays that harvest solar energy, and space based fabrication of new ones. If it gets to that point, we might end up with a Dyson sphere that basically does nothing but compute bitcoin hashes. Extraordinarily wasteful, but not necessarily catastrophic for existing humans if the network continues to recognize them as owners/controllers of the resources in question.

If it gets to that point, we might end up with a Dyson sphere that basically does nothing but compute bitcoin hashes.

This seems unlikely. If you're going to invest that much capital, why waste it on bitcoin hashes when you could instead provide a product and sell it? This would be analogous to worrying that everyone will go into the financial sector because it pays so well, and we'll have no one left producing actual goods.

Hmm. I think you're probably right, now that I think about it. The maximum size of the bitcoin reward falls towards transaction fees, which are themselves a small fraction of any given transaction. So there should tend to be significant money out there to reward manufacture of other kinds of space based goods more highly than bithashes.

I wonder to what degree FAI/CEV engineering considerations overlap with cryptocurrency/efficient-market engineering considerations

Basically zero on a technical level. Philosophy of caution overlaps with cryptography. Some econ knowledge overlaps with hard takeoff theory.

If Satoshi was working in academia, government, or industry, it seems very likely that he didn't develop the ideas behind Bitcoin as part of his day job, otherwise he probably wouldn't have been allowed to publish the ideas and software under a pseudonym.

Well if Satoshi is in academia and has tenure.

See this (somewhat unreasonable) speculation from Paul Graham that bitcoin was created by a government. https://news.ycombinator.com/item?id=5547423

It could have been created by the UN or by multiple governments. Does it even matter just so long as the code is released, it works, and it solves problems? It wouldn't surprise me at all if Intel agencies utilize Bitcoin nor would it surprise me if operatives helped to develop it. It does not change the utility of Bitcoin for me just because of it's origins.

Does it even matter just so long as the code is released, it works, and it solves problems?

Yes. It tells us information about currently unknown or uncertain variables. Having the source code and seeing that it works by no means screens off any inferences from its origin, any more than reading carefully a paper on smoking should make you not care that it was sponsored by the tobacco industry.

In the spirit of 'name three examples', here are 4 off the top of my head:

  1. future (ab)uses of the <1m bitcoins Satoshi is believed to have mined based on the minimal initial uptake by other miners and leaked nonce information; the orderbook on MtG implies that if all 1m were dumped, that could take Bitcoin down well into the <$1 range and could destroy Bitcoin as a currency and possibly destroy the prospects of any future currencies
  2. backdoors

    • in the source code itself (the Underhanded C Contest, and the history of cryptography, demonstrating that backdoors or weaknesses can persist for a long time, despite review by very talented people - in Bitcoin's case, Kaminsky and others - and note that the coding style of Bitcoin has been described as very weird and Bitcoin is also an implementation-defined standard, 'whatever the Satoshi client does or accepts')
    • in the primitives it uses (canonical example: NSA & DES)
  3. likelihood of future government crackdown or crackdowns based on blockchain movements
  4. future government uses of Bitcoin (mandatory public transactions, eg. using the colored coins mechanism, leading to a complete loss of all financial privacy?)

a) Future abuses via Satoshi having too many Bitcoin or from a Bitcoin elite can be countered right here and right now by supporting alt-cryptocurrencies. If one government backed Bitcoin then back the alts so that that one government competes with all those other government backed alt currencies. My attitude and behavior remains unchanged regardless of who backed Bitcoin initially or who Satoshi is.

b) Backdoors should be assumed to be in Bitcoin already. If you run it on Windows and you didn't compile it yourself then assume the NSA and FBi backdoor is already there in the code you either didn't compile yourself or you ran on a closed source operation system which once again you didn't compile yourself. If your behavior would be the same whether the backdoor exists or not then you're okay, and in my case my behavior would be exactly the same whether a backdoor exists or not so I don't fear the possibility.

c) The government crackdown possibility is real but the best way to defend against it is to actually support many cryptocurrencies knowing that some governments are possibly going to benefit from them. When enough governments stand to benefit from the technology in general, then sort of like the Internet it's here to stay and for the same reasons.

d) Even if the government designed Bitcoin it does not control it, and it's highly unlikely that any single government could maintain control of cryptocurrencies as a technology let alone control Bitcoin. So in a way Bitcoin is decentralized enough that no single government can dominate it but I'm sure many governments are involved at the clandestine level.

No. You're not getting it. This is about information, not your vague issues of 'I feel this is a large enough danger to worry about or I can come up with some vague ways to limit the fallout'. The question was: does learning the government did Bitcoin change our beliefs about anything else at all? The answer remains, for all you've said: yes, it does.

a) Future abuses via Satoshi having too many Bitcoin or from a Bitcoin elite can be countered right here and right now by supporting alt-cryptocurrencies.

These tactics are not guaranteed to work, therefore on learning the government did Bitcoin you will be more worried about abuse then before; Satoshi as technoidealist is far less likely to abuse or use the mined coins than Satoshi as calculated government project and public manipulation.

b) Backdoors should be assumed to be in Bitcoin already.

No, they shouldn't. Only some software is ever backdoored, which means you should make no 'assumptions'. If we learn Bitcoin was done by the government, do any of our beliefs change at all? Yes, the odds of backdooring go up since the US government has, as a matter of historical record, advocated backdoors and sought to build in backdoors (eg. the Clipper chip), and the possibility of NSA involvement that much higher.

c) The government crackdown possibility is real but the best way to defend...

Is completely irrelevant, because you're not getting the point, and actually getting it backwards: if we learned the government did Bitcoin, would this affect our predictions about future crackdowns at all? Yes, it would: we would worry less about a crackdown, because that would render developing & releasing Bitcoin a complete waste of effort and accomplish no apparent goal which was not already accomplished by actions like crushing e-gold. The obvious continuing example of this is Tor, developed by the US government and still supported and not cracked down upon, because cracking down would defeat the point of making it, which was to enable its servants to browse anonymously and also help out its enemies' critics & foes.

d) Even if the government designed Bitcoin it does not control it,

Something which you cannot know, and which flies in the face of points #1 and #2.

but I'm sure many governments are involved at the clandestine level.

No doubt you are as sure of this as anyone can be sure of something in the complete absence of any evidence.

The obvious continuing example of this is Tor, developed by the US government and still supported and not cracked down upon, because cracking down would defeat the point of making it, which was to enable its servants to browse anonymously and also help out its enemies' critics & foes.

The US government made Tor? Awesome. I wonder which part of the government did it. The intelligence agencies could be expect to oppose it because they effectively lose power.

Volatility. This is the natural result of deflation. As scarcity increases, people buy out of the speculative belief that value will rise forever. They fear to spend because really, who wants to have bought a million dollar pizza? Eventually, when enough of the value is due solely to this belief in future growth, people abruptly begin to sell, and the bubble bursts.

Consider the Great Deflation. US prices sagged from 1870-1890 due to a slow increase in the supply of money (gold) and a rapid increase in total economic production due to the 2nd Industrial Revolution. Prices weren't volatile, they just steadily dropped... by about 2% per year.

This may well parallel the situation Bitcoin will face as it matures, as the supply of new bitcoins slowly increases and the Bitcoin economy grows. Before that can happen, the markets will have to go through a process of discovering things like how widely it will be used for transactions, how governments will respond, etc.

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.

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.

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.

Is that how you spend dollars already?

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.

Certainly true for now, BTC currently is experiencing ~13% inflation YoY. Pricing in future deflation is inherently speculative as it assumes BTC will be around long enough for it to matter.

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.

I can at least imagine that your position is correct. But I still think that attaching a complex set of beliefs regarding the future value of a currency's individual units generates noise that makes them less useful as units of price value, and really less valuable as a medium of exchange. Added complexity to a given calculation makes it harder to perform, resulting in a relatively slower, clunkier economy, with high probability of buyer's remorse and so forth arising from miscalculation.

Don't get me wrong; I am overwhelmingly pro-bitcoin, and see it gaining massive value for reasons I've stated (destroying/locking a sum of bitcoins is an extremely efficient way to add recognizable value to another currency), but I have reservations about the specific scenario of it directly filling the niche occupied by cash such as dollars, i.e as a method of. fulfilling long term contractual obligations, pricing goods, and so forth.

I can at least imagine that your position is correct. But I still think that attaching a complex set of beliefs regarding the future value of a currency's individual units generates noise that makes them less useful as units of price value, and really less valuable as a medium of exchange. Added complexity to a given calculation makes it harder to perform, resulting in a relatively slower, clunkier economy, with high probability of buyer's remorse and so forth arising from miscalculation.

Are you talking about bitcoin or conventional sovereign currencies? The future supply of bitcoins is much more certain than the typical currency out there because it's laid down in advance.

Are you talking about bitcoin or conventional sovereign currencies?

Bitcoin. Traditional currencies have the same problem though, in that they tend to have variable, policy-based inflation rates that confuse the markets. I am arguing in favor of a something designed for price stability, enforced by algorithmic means in accordance to demand.

The future supply of bitcoins is much more certain than the typical currency out there because it's laid down in advance.

Sure, the physical supply is laid out in advance, but the amount available to do transactions with at any given time, or even in the long term, is not. There's no reliable way to predict who will choose to sit on their coins (possibly even cryptographically putting them in an unspendable stasis for an unknown amount of time) versus spending them on useful trades or engaging in short-term speculation. The market is rendered more stochastic, with more of a butterfly effect, more black swans, and so forth. Each and every transaction is impacted to some degree by this hidden complexity, which negatively impacts the use currency's use value.

I don't see how you've explained a problem more predominant with or unique to bitcoins. All currencies have the problem that their usage as a currency can shift. There's no reliable way to predict who will sit on their money rather than spend it. You're comparing bitcoin to perfection, not to real currencies.

versus spending them on useful trades

The whole point of money is that it has the option value to spend it now or later, so the fact that its option value isn't being exercise doesn't mean it's failing at its purpose; just the opposite, in fact. If all you care about is how often a currency is used, then the optimal currency would be spent the moment it is earned -- but that's scarcely better than barter.

Here is the general scenario that I think holds more probability mass than bitcoin-as-a-traditional-currency, and yet works as a fairly realistic alternative to bitcoin-as-a-flop:

  • Bitcoin will fall out of circulation as a currency because of its relative volatility.
  • Nonetheless, alternate currencies will be built into the blockchain.
  • These alternate currencies will be designed for stability, instead of deflation.
  • Mechanisms for trading alternate currencies for bitcoins will be part of the protocol.
  • Rather than a currency, bitcoin plays a role as a scarce, fungible, stabilizing commodity. *The ease of turning it into these successful alternate currencies gives it the ability to outcompete traditional options like gold.

Can this be done?

The good news: Yes, it can be done.

The better news: It can be done right now without any changing to the bitchain or mining protocols.

The even better news: It's being worked on right now. Not least of which by myself.

The caveat: It cannot work quite like your specific proposal. This is due to limitations in the other currencies, not due to limitations in bitcoin. Due to the very nature of the alternate currencies there must be trust in a third party. Someone must have the alternate currencies stored and they must be trusted to deliver it on request (even if in practice this is seldom required).

Consider whether the below modification of your example would satisfy the stable alternate currency need:

Can this be done? Consider the following more specific scenario as an example:

  • Alice sends 100 bitcoins to TrustworthyBank, with a request for USDCoins.
  • TrustworthyBank calculates the value of the bitcoins received in USD at current exchange rates and finds that it is worth USD$10,000.
  • TrustworthyBank sells or stores 99 bitcoins and signs the remaining coin as a colored coin which it then sends to Alice. These coins are identifiable to everyone as USDCoins and are redeemable by TrustworthyBank for USD$10,000 each according to the publicly accessible contract cryptographically signed by the same key used to 'color' the coin.
  • Alice gives 0.8 USDCoins to Bob in exchange for $8k worth of cocain.
  • Bob places bets summing to the entire 0.8 USDCoins on the (still hypothetical) BitKnow.com Prediction Market, all on the proposition "Arnold Schwarzenegger Elected President of Australia in 2013".
  • Craig, one of the people having bet against Bob, receives 0.2 USDCoins on January 1st 2014.
  • Craig sends 0.2 USDcoins to TrustworthyBank.
  • TrustworthyBank sends $2,000 to Craig (or equivalent value in bitcoin). It does not know or care what has been done with the coins since they were created. It simply looks at the bitchain, confirms that the coins can be followed back to a signing transaction.

The above example demonstrates the use of bitcoin as a way to make exchanges any other currency. It has the features:

  • Only a small amount of trust required.
  • Pseudonymity (with the same mechanisms for increasing that to anonymity if necessary).
  • Transparency. All the (bitcoin based) transactions made by TrustworthyBank are public. If TrustworthyBank breaches the contract it isn't possible to hide it. Then people start using ActuallyTrustworthyBank instead. TrustworthyBankOwner goes to jail. (Because naturally the bank that people actually use should be one in whichever country has the most suitable laws.)
  • Distribution. It requires no interaction with the banking institution except when adding or removing currency from the overall micro-economy. Transactions of the currency are between peers and do not involve TrustworthyBank at all.
  • All services that already use bitcoin either just work with USDcoins or can be adapted to with little effort. For example an escrow service or Prediction Market that works on bitcoin using 2-of-3 multisignature transactions can be used with USDcoins without the escrow service even needing to have heard of USDCoins.
  • 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.

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.

Why not have the state where MorpheusBank need not be trusted? Allow a user to propose an exchange, and MorpheusBank to sign off on it, and make the two transfers simultaneous and contingent on both being legal transfers.

Why not have the state where MorpheusBank need not be trusted? Allow a user to propose an exchange, and MorpheusBank to sign off on it, and make the two transfers simultaneous and contingent on both being legal transfers.

I don't think I have properly communicated just which kind of trust in MorpheusBank is required. Perhaps I shouldn't have used the term 'Bank'. Morpheus is only required at the point in which external-to-bitcoin value is exchanged with internal-to-bitcoin stuff. ie. It is something that ties an electronic asset to the value of gold, or the value of an index fund, or a particular government backed currency.

Allow a user to propose an exchange, and MorpheusBank to sign off on it, and make the two transfers simultaneous and contingent on both being legal transfers.

Absolutely, that kind of arrangement is possible (using the same kind of transaction mechanism we discussed elsewhere). Where the reputation of Morpheus is concerned the trust is in Morpheus's contracted promise to make such exchanges in future at a specified rate. The basic decision theoretic reasoning is then:

  • Morpheus has publicly committed to exchanging MorpheusGold for bitcoins at any time at a rate determined by and .
  • The fully transparent and publicly accessible bitchain confirms that Morpheus has indeed honoured that commitment.
  • Morpheus can be seen to be making a known, significant, amount of profit from his business under that identity.
  • Defecting on his contracts will give Morpheus an immediate payoff while destroying his ability to do business under that name.
  • The expected future profits of business under the Morpheus name (either by the person using it or whoever it is sold to) exceed the amount that an immediate defection could grant him.
  • It is likely that Morpheus will indeed trade back the specified value in exchange for MorpheusGold (or MorpheusUSD, whatever) in the future. It is (fairly) safe to buy or exchange MorpheusGold now.

Note that there is actually some advantage to just unilaterally transferring MorpheusGold to Morpheus's address. That makes the exchange part of the public record and obliges Morpheus to send bitcoin back promptly or be obviously shown to be unreliable. Whereas when proposing simultaneous exchanges with Morpheus, if he delays or refuses trades then the ripped off party must use some other mechanism by which to actively damage Morpheus's reputation and Morpheus deny it. It also requires communicating with Morpheus directly somehow, either by encrypting data into the bitchain or by Morpheus being directly contactable somehow.

Note that in this case the only additional counterparty risk taken on by making unilateral transfers rather than arranging simultaneous exchanges is whatever the value of the bitcoins were upon which the MorpheusGold has been 'printed'. He is already being trusted for the component (Gold-representing component of the coins - bitcoin value of the coins).

I figured that the proposed trade would enter the public record; doesn't it have to in order for MorpheusBank to see and sign it?

I also didn't notice where MorpheusGold was ever convertible to gold. Clearly MorpheusBank cannot be guaranteed to have enough bitcoin to redeem all of the MorpheusGold to bitcoin if e.g. bitcoin tanks. MorpheusBank is being trusted with the total value of the gold represented by his coins (minus their bitcoin value) and can walk away at any time with that difference. MB has an incentive to sell as much MG as possible and then defect, and any transaction that appears to build trust is not evidence that MB does not intend to defect. (Since if MB was intending to defect, it would perform transactions to build trust)

All in all, I can't tell the difference between MB and Currin Trading.

MB should be engaging in continuous rebalancing to keep their ability to purchase gold constant.

Whoa-what? If the demand for gold drives a price increase in gold, there is no 'rebalancing' possible to keep one's ability to purchase gold constant without putting additional reserves into the bank. Likewise,