By Daniel Krawisz
Satoshi Nakamoto Institute
Wednesday, July 13, 2016
http://nakamotoinstitute.org/mempool/its-not-about-the-technology-its-about-the-money/
Blockchain Technology
The Bitcoin world is full of people who know nothing about economics or
cryptography; they only know that they could have made millions if they had
not sold at the bottom. These people tell themselves that they are redeemable,
that Bitcoin is just the MySpace of cryptocurrencies, that they will have
another opportunity to get in early on some other revolution. These people can
be dangerous, but most of them are easily preyed upon.
I think this may explain the origin of “blockchain technology”. It lets people
talk as if clones of Bitcoin are important without having to remind themselves
of Bitcoin. If someone says “blockchain technology” to me I give him the
benefit of the doubt and write him off as someone who doesn't know what he's
talking about. If I find out that he's intelligent, then he's most likely a
con
artist.
When people say “blockchain technology” to you, you can often replace it with
“mana”, or “chakras”, or “quantum” and it makes sense the same way.
“Blockchain technology” has evolved into a sound Bitcoiners use to extract
money from venture capitalists and one another, similar to the way that male
birds use a song to attract females. It's a phrase for people who know there
is a lot of money around, but don't exactly know where it's coming from.
I don’t see that there is a lot of use for some kind of general “blockchain
technology” outside of its application in Bitcoin. In Bitcoin, the blockchain
is a way of solving the
double-spending
problem without
privileging any party as to the creation of new units or of establishing a
consistent history. This is an extremely costly and complicated way of
maintaining an accounting ledger. How often do I really need to do my
accountancy in this way? I would say that it is only a good idea when the game
being played is so important that no one can safely be put in the position of
referee. There are not a lot of things that I would really need that for, but
I think there is a good argument to be made that a blockchain is a reasonable
alternative to the monetary system under which the rest of the world is
currently oppressed. Otherwise I'd really rather be able to keep my accounting
records to myself rather than leaving them out in public.
There are no applications of blockchains which do not involve a
double-spending problem. A blockchain that was used for an application with no
double-spending problem is nothing more than a database, so you could just
replace it with a distributed hash table. People have also used the blockchain
for timestamping. This only works because Bitcoin has become well-known as a
point of reference. If you had a need for timestamps, you certainly wouldn’t
invent a blockchain to do it.
Yet people are running around everywhere in the Bitcoin world screaming
“blockchain blockchain blockchain” for all kinds of non-intuitive purposes
until they're buried under piles of money. I can't believe how long it's
taking for people to get wise to this ruse, but I hope it won't last too much
longer. A blockchain does not have a wide range of applications. However,
there is one application
, namely that of being a currency, which is
overwhelmingly important.
Money as a Hallucination
The foundational fallacy about money is to explain in physical terms what is
really a sociological phenomenon.
Gold is not valuable because it
is durable, fungible, portable, and scarce; it is valuable because of a
beneficial and self-sustaining tradition in which it has a special place. The
physical properties of gold make such a tradition possible, but they do not
determine that it will arise; other goods with similar properties may also
become the traditionally established monetary good. Bitcoin is the same way, of course.
It could not run without the technology behind it, but what makes it important
is the fact that it is seen as having value, thus making it exchangable for
goods and services. People who think "blockchain technology" is important are
making the same kind of mistake as the people who think gold has intrinsic
value.
What's weird to me is that I know I have heard many people express correct
ideas about what money is and then look at me like I'm crazy when I seriously
consider the implications of what they said. I have heard people say to me
things like, “money is just a shared hallucination” or “the value of money is
whatever we all agree it is”. Yes! That is correct. That's exactly what I'm
saying. And if money is a shared hallucination, then you can’t replicate
Bitcoin’s value by replicating the technology. You would have to also
replicate the hallucination, which you can’t. You’ll have two blockchains, but
only one of them has a shared hallucination. This makes one of them valuable,
the other worthless.
If that seems like a strange claim, think about the alternative: it means that
it should be possible to create value for essentially no work. Every new
blockchain ever produced was built on the premise that you can create a
valuable investment that offers no income for the fixed cost of copying
Bitcoin with alterations.
There is nothing magic here. Human behaviors have real costs and benefits.
Money may be little other than a bunch of people attributing value to
something without much direct use. It doesn’t matter if this sounds
ridiculous; if there is a behavior that corresponds to this belief which
benefits people, then they will keep behaving that way. Other people had
better understand what they’re doing or else they will become relatively
poorer.
Money as a Behavior
The overwhelmingly most popular thing to do with gold is to store it away and
leave it for long periods of time. Therefore, an explanation for the price of
gold should
mostly depend on the reasons someone would want something that
is good for being stored away, with some minor additions due to gold’s use as
jewelry and in industry. We can study money as behavior by abstracting away
all the uses of money other than that of storing it. No matter how silly that
sounds, we know that it must be good for something because people actually do
it and have been for some time.
When I talk about
money as a
behavior
what that means is that everybody has a socially established number that is
objectively associated with them. They can show other people how much they
have, and everyone will agree as to what the number is. People can do
something which subtracts from this number and adds to another person’s
number. Also, people demand to have higher numbers. This means that they are
willing to give up other things in order to increase their number. If we know
the costs and benefits of increasing the number, then we can understand the
price of these numbers on the market.
There could be many reasons that people are able to behave in this way. The
numbers could correspond to amounts of a physical good, like gold or wampum,
which people physically pass among one another. They could correspond to
numbers which are managed and guaranteed by an institution, like dollars or
World of Warcraft gold; or it could be numbers that are stored in a blockchain
as in Bitcoin; or maybe we all just use the honor system and keep track of our
own balances and don't cheat.
Often, economists define money in a way that makes money a unique good in an
economy. I do not define money this way. There could be more than one good
which acts like money. Instead, I will show that in the long term I would
expect a single money to dominate.
The Risk of Money
Money is often explained in terms of the inconvenience of trading in a barter
system.
While bartering might well be inconvenient, that alone is not
enough to explain the existence of money. It would certainly be nice if we
could all settle on a good to use as money. However, there is no guarantee
that everyone will be nice enough to do that. It is possible to imagine a
tribe of people who are all very good economists and who all understand and
like the
idea of money, without having enough confidence in one another as
to get it working for real. The first person among them would be taking a risk
because he would have to work or sell his property in exchange for something
that's good for not much other than being stored. His risk would only pay off
if everyone else was willing to follow suit, and how could they possibly
guarantee to him that they really would do so?
For almost a year, this was what it was like in Bitcoin. Although Bitcoiners
suspected that Bitcoin could be money some day, its price was zero.
Consequently, it was completely useless as a form of money. For a long time,
Bitcoiners wanted the price to be higher than zero, but they could not make it
so just by wanting it. Bitcoin did not fundamentally change as a piece of
software when it first developed a price; the only thing that changed was
people's’ willingness to trade dollars for it.
In general, there is always an individual cost to accepting money, even when
the use of money is very widespread. If I work in exchange for money, how do I
know that money will still be valuable by the time work is out and I am ready
to do my shopping? If I work for something I can directly consume then at
least I can get some utility out of it no matter what. But if I accept
something whose main use is as a medium of exchange, then I am depending on
there being future people willing to accept that money later.
This is why people can't just
will money into existence and why the
inconvenience of a barter system cannot explain the existence of money.
There's a risk. In order to explain why people would use money, we need an
individual benefit to match with the individual cost; otherwise people would
never prefer to use money no matter how socially beneficial it was.
The Utility of Money
There is an individual benefit to using money, and it’s very simple. The
person who accepts money gets to defer his decisions about what to buy to a
later time. Someone who does not want to use money must have a better idea
about what he is going to do with the goods he receives in payment than the
person who accepts money. When one has money, then one is not committed. If I
am the first person to accept money in payment and my bet on it pays off, then
I have the option to choose what I want later, and I do not have to choose
based on the limited information I have now. This benefit explains why someone
would want something that is good for keeping in storage. If he wants to keep
his options open, then he can open his vault the moment that the right
opportunity comes along.
I have now provided a trade-off which, I contend, explains the value of money.
I have not proved that there are no other costs and benefits to using money,
but I don't know of any others. If someone can show me that there is another
reason to hold money, please do. Now I'll talk about what this tradeoff
implies for the value of money.
The Value of Money
In this article, I mean
value in the investment sense. So the value of money
is the purpose it serves in your portfolio and how much you would want. For
the investor, the value of money is determined by the tradeoff of commitment
versus optionality. If he wants more deferred choices, then he needs more
cash. If he wants more income, then he should get stocks or bonds.
The reason someone might want to defer his choices is because there are
limited periods of time in which investments go on sale. A difficult thing
about business is that it is easy to make mistakes whose consequences are not
evident until long after they are unavoidable. When that happens a business
needs cash in order to survive long enough correct itself. During these times,
good businesses can be bought cheaply for limited periods of time. This is why
an investor wants a cash balance ready to spend. You never know what is
coming, but if you have cash you are prepared for whatever it is. Holding a
stock is a commitment to a particular enterprise, whereas cash keeps your
options open.
The reason that buying an investment is a commitment is that you cannot always
sell an investment easily for cash. It might go on sale, just as in the
previous paragraph, and then the investor cannot get the same amount of cash
back that he put into it. If there is a crash, the investor might not be able
to follow through on his commitment and must sell at a loss. On the other
hand, an investor who can realistically make the commitment won't care so much
if there is a recession because he is prepared to weather safely through any
bad times.
The interesting thing about the tradeoff of optionality versus commitment is
that changes in the overall use of money in an economy can change the nature
of that tradeoff for an individual person. The more demand for money there is,
the less risky it is for an individual person to hold money. If you were the
first person to sell goods or labor for money, then you would probably look
insane or immensely stupid to bet that other people would want this stuff in
the future. On the other hand, if
many people are using money, then you are
merely depending on there not being a hyperinflationary event in the immediate
future. In that case, you might look insane or stupid for worrying about such
a remote possibility at all.
In short, money becomes more useful the more people use it. This may seem like
a very obvious conclusion given how many words I took to arrive at it, but it
has some funny implications that are hard for a lot of people in Bitcoin to
accept because they have money riding on a presumption that the opposite is
true. As more people begin to hold money, the rational response of everyone
else is to try to hold more than they already have. Everyone, therefore, will
try to increase his cash balance at the same time, and they will do this by
bidding larger amounts of other goods in exchange for it. In other words, all
prices tend to go down, and money becomes more valuable. Effectively, everyone
ends up with more money, except that they end up with more valuable units of
money rather than higher sums of it; and furthermore they end up with larger
fractions of their portfolio in money as well.
The Network Effect
This is the opposite of how most investments work. If the price of a stock
goes up, then the value decreases because its dividend yield is smaller in
proportion to its price. If the price goes up too much, an investor would
eventually want to sell for something cheaper. By contrast, $100 worth of
bitcoins today has a better value than $100 worth several years ago, even
though the price of bitcoin is much greater. The value is better because there
are more opportunities to unload the bitcoins at the owner's discretion.
A positive feedback between price and value implies that the growth or
shrinkage of money can be self-sustaining. One might well find this conclusion
hard to accept. Afterall, value in a business is built by hard work and
careful strategy, whereas money can somehow drive its own value according to
me. I would invite anyone to explain Bitcoin’s value any other way. And saying
“bubble” doesn’t count because that’s virtually the same thing. Money is
basically a self-sustaining bubble. We don’t yet know if Bitcoin will arrive
at a self-sustaining state, and even if it doesn’t the “blockchain tech”
people are still wrong because in that case there would be no good blockchains
rather than one.
What would a self-sustaining bubble look like? Naturally, there must be a
limit to the growth of money. As the value of money increases, eventually the
individual benefits of holding more of it will go down. This happens as the
market cap of currency becomes a larger and larger fraction of the whole
economy. There are only so many errors that the economy produces for a
cash-holder to take advantage of. The economy becomes saturated with money
once there are enough investors sitting around with piles of money such that
they are able to catch all the errors that are worthwhile. At that point it is
no longer individually beneficial to hold more money even if the value of
money has gone up. This prevents the value of money from going up further
until more people or businesses are added to the economy.
This limit is independent of the underlying technology of the money. If people
were sufficiently honest, it could run on nothing but the honor system. Thus,
the value of money is a macroeconomic phenomenon, even for a tiny, quirky
cryptocurrency like Bitcoin. This is the reason why Bitcoin can be worthless
one year and valuable the next without a fundamental change to the software or
protocol, and why it can range in price by enormous margins over short periods
of time for reasons that seem inscrutable. It's because the value of money is
a shared hallucination, and the price is caused by the vividness of that
hallucination.
How Bitcoin’s Value Was Created
For a year after Bitcoin was first released, it had no price and was quite
worthless. Therefore, the value was not created when the software was
originally developed. It was caused by step-by-step investments that came
later. Since it first gained a price, Bitcoin has had periods of rapid price
increases. There can be events which are set off for no apparent reason in
which Bitcoin’s price drives itself rapidly up or down. A small price increase
is interpreted as an increase in demand. An increase in demand would mean that
bitcoin is becoming more useful and therefore more valuable. Hence, more
people buy in and cause another price increase. These manias make people
outside wonder if Bitcoin is for real. They make people who previously thought
that Bitcoin was stupid to think that they should maybe buy a little bit just
in case there could actually be something to it. In other words, they are
starting to think that Bitcoin is good for the only thing that money is
actually good for, which is to be kept just in case.
Above I wrote about the hypothetical idea of a tribe of economists who all
wanted to develop a money economy but could not because each felt the
investment to be too risky. Here is how they could solve that problem. They
could go around in a circle and take turns investing tiny amounts. Then none
of them has to take a big risk. Their economy would not be monetized after one
round, but they could see who among them was willing to take a small risk. If
they had all shown themselves willing to invest a little bit, then many of
them would be willing to risk a second round. If the game should proceed well,
the economists would start to think about how wealthy each would be if they
managed to get more than the rest. Soon the game would cease to be orderly as
they all tried to sell as
much as
possible in
order to buy the new money while it was cheap.
Bitcoin did not arise out of a barter system. The dollar and the other
state-managed currencies had long since subsumed nearly all trade. However the
calculation of the initial investors to Bitcoin was very similar to that which
faced the economist tribesmen. It was clear to many that Bitcoin would be cool
if you could actually buy things with it. However you can’t buy anything with
it and its investment prospects depend on the presumption that it somehow one
day will be demanded in exchange for goods. How could one even estimate the
risk of such a possibility? The fact that other currencies already existed
does not change the problem. From the perspective of a Bitcoin investor,
Bitcoin might well have existed in a barter system in which Dollars, Yuan,
Euro, Pound, and Yen were traded rather than tea, silk, salt, and flint. The
only difference is that the national currencies are better competitors than
tea or salt, so the risk is greater than if Bitcoin had arose in a real barter
system.
Competing Currencies
I'm not against competing currencies in the sense of thinking people should be
physically prevented from creating them. I am against competing currencies in
the sense that I think currency competition is inherently monopolistic and
that it is extremely dishonest or stupid to promote a new currency as an
investment without taking this reality into account. So I am against competing
currencies in the sense that someone who creates a new currency had better be
able to present a case that his idea is capable of replacing the current
system, and should be treated as a con artist otherwise.
The fact that money has a positive feedback between demand and value implies
that there cannot normally be a stable equilibrium between two moneys. Any
initial imbalance between them would tend to expand. If one currency was
slightly more preferred than the other, people would react to this by
demanding slightly more. This makes the preferred even more preferable than
before. Any two moneys will interact in this way, thus leaving one to dominate
the rest.
Many people get fooled upon first entering Bitcoin because they think
diversification is important. The problem with diversification is that it is
possible to create an infinite amount of bullshit at no cost, and if you
diversify into that you lose everything. Diversification only makes sense
among investments which are not bullshit. If we were looking at a bunch of
stocks that all already paid dividends, then diversification would make sense.
On the other hand, there are potentially an
infinite number of
scamcoins.
During late 2013 and early 2014, new ones were being produced and hawked every
day. They can be produced at this rate until everyone who thinks
diversification is a good idea goes broke. Now that all the dumbest people
have gone broke, the focus has shifted to using “blockchain tech” to exploit
ignorant venture capitalists.
There is always some risk in accepting money in payment, even something very
well-established like dollars. If everyone settles on the same money, then
they have coordinated so as to reduce that risk as much as possible. If you
expect people to use two currencies, you have to have some reason that both
would offset risk in different ways. I have never seen an altcoiner or
“blockchain tech” enthusiast come anywhere near to addressing this issue.
Clearly, if two currencies are virtually identical, such as Bitcoin and
Litecoin, then whichever currency is bigger has the advantage. Recently,
Litecoin’s price has decoupled from Bitcoin’s somewhat, so maybe people have
finally figured this out. Once Litecoin loses its shared hallucination, no
amount of sloganeering will bring it back.
Litecoin prices, all-time (via CoinMarketCap)
But what about something more elaborate? Let’s pretend for a moment that
Ethereum
actually
worked and was
actually something that competed with Bitcoin on some level. Do its smart
contracts give it a serious advantage over Bitcoin? I don’t see how Ethereum’s
smart contract system would tend to bring in opportunities to unload ethers
which are superior to the opportunities provided by Bitcoin. No matter how
cool smart contracts sound, they make Ethereum just another appcoin, and as
with other appcoins, people will reduce the risk of holding them by not
holding them, or holding them for as short a time as possible. This will
drive the price
down until they
are useless in trade.
By the way, I would prefer to be called a “Bitcoin minimalist” rather than a
“
Bitcoin
maximalist”
because the other blockchains appear useless and are easliy eliminated.
Bitcoin Versus the Dollar
On the other hand, Bitcoin improves over the dollar (and other fiat
currencies) where it actually counts. The dollar is not very good for storing
“just in case”. Over long periods, it loses value due to inflation. You can’t
carry cash around or the police will take it, and if you leave it in a bank,
you can have your account frozen and the money drained if you use it for
purposes deemed unacceptable. You cannot own dollars the way that you can own
bitcoins. It is not that Bitcoin comes at no risk; it is rather that you can
always expect to have the same fraction of the total later on, if you secure
them properly.
The national currencies are affected by forces which are beyond your knowledge
or control. They are managed by committees serving the governments issuing
them. The people on these committees speak in a jargon that is not only
incomprehensible to most people, but unbearably dull even to those who
do
understand it. Everyone is affected by them, but most people will not bother
to learn to understand them. They manage the currency in the national
interest, which is not always the same thing as
your interest. They can
change the rules about how the currency can be spent you can use them or
increase the government’s supply.
It is usually not possible to predict
what they will do, at least over long time spans.
This is not possible under Bitcoin’s
current
rules,
and it would be difficult to change them in ways that might eventually enable
anything similar. Although many new bitcoins will be created in the future,
the release schedule is publicly known, and is therefore already priced into
current Bitcoins. Therefore Bitcoin will not lose value as a result of
inflation. It might lose value as a result of losing popularity, and this risk
is greater than that of the dollar’s (at the moment).
Thus there is a genuine qualitative difference between Bitcoin and the dollar,
from an investment standpoint. It doesn’t mean that Bitcoin will necessarily
defeat the dollar. It just means that Bitcoin has a relevant competitive edge.
There are still significant disadvantages to Bitcoin; it is slow to confirm
and difficult to maintain anonymity. However, Bitcoin has done well against
the dollar so far and there is real-world commerce that has grown to rely on
it. In addition, every time bitcoin grows, its risks decline relative to the
dollar’s.
Final Thoughts
The reason, therefore, that the
monetary
aspects of Bitcoin are particularly interesting is the possibility that
Bitcoin could become the preferred good for being stored away. If it did, then
its value would grow until it was a significant part of the world economy.
That would be a significant change for the world and for Bitcoin’s early
adopters. Call me crazy, but I think that possibility has more portent than
the possibility of applications of blockchains outside of Bitcoin, and is a
lot more likely, too.
Bitcoin the protocol is like a great work of engineering. Its pieces are all
adapted to its function. It is not the technology, but what the technology
enables, that is most interesting. The blockchain as a concept had no reason
to escape the esoteric circles of developers and engineers. Yet when people
looked at Bitcoin, the only terms by which they knew how to understand it was
as a new technology. But Bitcoin is more like a new tradition than a new
technology. It is as if a small section of the crowd in a packed stadium has
started to do the wave, and you can bet on whether the wave will eventually
fill up the entire stadium.
If someone says “blockchain tech” to you, you might as well walk away right
there.
They’re just trying to sell you on their new
decentralized
crowdfunded blockchain tech internet of bitthings appscam. You
know that
they’re lying because everyone who acts like them is a liar and someone who
was not a liar would actually do something to distinguish himself from them.
Someone who knew what he was talking about would know that you can’t just
string a bunch of buzzwords together in order to generate an idea that makes
sense. Unfortunately, if a lack of basic critical thought is widespread, and
if everyone becomes
invested in everyone else’s
stupidity, then
nobody
wants to know either, at least not before they’ve found a favorable
time to exit their position. This will probably never happen because although
they may think they’re preying on other people’s stupidity, they are more
likely being preyed upon instead.
