Saturday, January 18, 2014

Bitcoin's bootstraps

by Paul Conrad

When we talk about bitcoin, one thing we need to ask ourselves is this: can worthless things circulate and be accepted in trade? If so, how? And can this state of affairs continue indefinitely?

An intrinsically useless, unbacked, and costless fiat object might be accepted in trade, but only if it already has a positive price. A history of positive prices will generate sufficient expectations among potential acceptors that they will be able to trade that object on tomorrow. But how might our fiat object earn a positive price to begin with? If we reply that early adopters expected it to be widely accepted by others in trade, how did these early adopters ever form these expectations if that object didn't already have a positive price? We're dealing with a problem of circularity. There is no way to "break into" a dynamic that might generate a positive value for a fiat object. So logically, worthless things cannot trade in the market at a positive value.

However, fiat objects like dollars and yen do seem to have a positive value. Two types of economists, Austrians and MMTers, recognize the circularity dilemma that emerges when trying to explain the positive price of a useless fiat object. Both solve the circularity problem in different ways.

Austrians say that when early adopters first acquired the fiat object, it was not yet intrinsically useless, unbacked, or costless. Thanks to its original commodity nature, or perhaps its status as a backed financial asset, it already traded at a positive price. Even if that character is lost, the object suddenly becoming a fiat one, it may still be widely accepted in trade on the basis of people's memory of its pre-fiat price. Thus the circle can be broken into, and worthless bits of paper can legitimately have a positive value in trade. This is Ludwig von Mises's famous regression theorem.

MMTers solve the circularity problem by bringing in the tax authority. As long as some agency like the government imposes an obligation on people to pay taxes with these fiat objects, that will be enough to drive their positive value.

I should point out that I don't think we actually face a circularity problem with modern central banknotes since they aren't worthless bits of paper but rather exist as a liability of their issuer. But we do run into the problem with bitcoin. Here we have an unbacked, intrinsically useless, stateless fiat object trading at $950 or so, not to mention a legion of copycat coins trading at various positive prices. [1]

Austrians are all over the board on bitcoin. Because their solution to the circularity problem is to invoke the legacy commodity value of a fiat object, bitcoin poses some theoretical hurdles for them since it is by no means clear whether bitcoin ever had an original commodity value. Bob Murphy for one argues here that bitcoin may have earned its first foothold thanks to non-pecuniary ideological reasons. However, there seems to be no consensus among Austrians on that point. MMTers seem to genuinely dislike bitcoin since their preferred tax obligation story can't bear the load of explaining bitcoin's price. Here is L. Randall Wray who says that bitcoin is a test of the "infinite regress view of money", then gleefully points to its falling price as evidence that the taxed backed theory is the dominant theory (it later rebounded).

Let's move on from MMTers and Austrians. George Selgin recently came up with an interesting way to explain how bitcoin might have earned its all important original positive price:
Records show that a just a few persons took part in most early Bitcoin transfers, and especially in the larger-volume ones. My guess is that they all knew each other, and that those trades were more-or-less fictitious, with large values being traded and then traded back again, with the intent of enhancing the prominence of the positive-value equilibrium by drawing attention away from the much larger set of inactive Bitcoin markets. Bitcoin’s inventors, I’m now almost certain, were making conspicuous leaps onto their own bandwagon, so as to encourage others to do so, whether to express themselves or to profit by doing so. In short, a clever marketing strategy, including a little strategic sleight-of-hand, can substitute for history in putting a positive sign on the expected value of an otherwise useless potential exchange medium.
Here we have neat way to break into the circle. Have a group of insiders trade the fiat object amongst each other in order to generate an artificial history of positive prices, at which point outsiders will be willing to accept it in trade based on the expectation that others will repurchase it from them later.

Making "conspicuous leaps onto one's own bandwagon," as Selgin calls it, is a well worn tactic. In stock markets, the term wash trading refers to the illegal practice whereby an individual or group of schemers trade an illiquid, often worthless, stock back and forth among different accounts. The goal is to give the illusion of activity, thereby attracting innocent traders who would otherwise pass up the stock. A more colourful term for this is "painting the tape", which refers to the old ticker tape of yore.

Another way to paint the tape is to high close a stock. Using this technique, a trader or group of traders will buy a stock in the closing seconds of the day, pushing its price up. Since media outlets tend to focus on a stock's daily closing price, and stock charts depend on the daily close, high closing may be a cost effective strategy for traders to create and benefit from the positive price momentum that news of a high closing price engenders.

Auction markets, say in livestock or art, are sometimes populated with confederates—those who work in conjunction with a seller to provide fictitious bids so as to drive some object's price, say a dubious piece of abstract art, or a lame horse, far higher than it would otherwise be worth. Should the confederate's bid be the only bid, the worst that happens is that the schemers get their own painting or horse back, upon which they can try the same trick over again in the next auction. If their bidding excites someone else to add a bid, then they've succeeded in earning something for nothing.

In any case, all of these techniques can push a worthless object's price above zero, at which point that object may have generated enough of a history of positive prices that it will be valued by enough outsiders that it will join the mass of non-fiat objects in circulation. From nothing, our worthless item it has pulled itself up by its own bootstraps.

Which explains bitcoin's incredible volatility. A bootstrapped object can just as easily let go of its own straps and fall back to zero. Without some real use or backing, there's nothing to catch it on the way to $0. And at $0, there's no guarantee of re-bootstrapping bitcoin back to some positive price. As such, Bitcoin users justifiably expect incredible returns from bitcoin holdings in order to bear the risk of a zero-value equilibrium. Expected hyperdeflation is the carrot that must be proffered up for risky cryptocoins to be held. When those expectations of price appreciation aren't met, a large crash in the current price (relative to its future expected price) is necessary in order to tempt the next crop of speculators to hold it again. Thus bitcoin's pattern of incredible rises, or hyperdeflation, followed by 50% flash crashes, followed by the next round of hyperdeflation.

So if unbacked, useless, and costless objects can be imbued with a positive price via Selgin's painting-the-tape story, why isn't everyone doing it? But they are! Attracted by the potential for large gains, plenty of people are creating alt-coins, as I wrote here and here. In theory, their combined greediness should have the effect of swamping the market with fiat objects, driving their price towards the cost of production. The idea here is similar to the Somali shilling story, in which continual counterfeiting of old fiat shilling notes drove their price down to the cost of production, namely the costs of paper, printing, and shipment.

This hasn't happened yet with bitcoin, which is hovering at around $950. In my old post Milton Friedman and the mania in "copy-paste" cryptocoins, I hypothesized that the seeming inability of competitors to drive bitcoin prices down had something to do with the unassailable benefits that bitcoin enjoys as being the first mover, including superior security and liquidity. Tyler Cowen has some interesting thoughts on this. Bitcoin has a market cap of about $20 billion. As long as Bitcoin's entrenched advantages are so supreme that it would cost $20 billion to create a competitor, then there's no profit in tackling its niche. Cowen, however, thinks that the cost of mimicking bitcoin is far less than this. Rather than being in equilibrium, the cryptocurrency market is currently working itself via a process of "supply-side arbitrage" to a new equilibrium at which bitcoin will be worth far less.

On this same topic, Nick Rowe suggests that a BackedCoin might be one of the competitors capable of carrying of this feat. I agree with Cowen and Rowe —that's why I mostly sold out of bitcoin last year, and why I plan to eventually sell my litecoin. Of course, I'm the dummy who sold BTC back at $100, so my opinions should be taken with a grain of salt.

Where will the competition come from? Robert Sams makes a good argument for why bitcoin knock offs like litecoin, sexcoin, etc., though costless to produce, can't easily compete with bitcoin itself. The mining power that goes into maintaining the integrity of the various blockchains is in scarce supply. Merchants will always congregate to the blockchain with the most security, since that will be the coin that guarantees that the threat of double-spending is the smallest. While clones can be created with a few key strokes, good security can't be bought. Thus bitcoin's price can't be competed down to $0ish by alt-coins.

I think I buy Sams's point. However, he couches his argument within the existing universe of bitcoin and its clones. I'd make the argument that the crypto phenomena through which "supply-side arbitrage" will be carried out could be something entirely different than bitcoin, say Ripple or something we haven't yet seen. Ripple for one isn't constrained by the supply of existing mining power, or hashing, since the Ripple blockchain is maintained via consensus, not by hashing miners. Is this type of security cheaper? I'm no techie, so I won't speculate. But it is something different. And though it may take a while, at some point new and different will also be cheaper.

Another bonus of the Ripple system is that the crypto currency it creates are not bootstrapped assets, they are redeemable IOUs (let's not confuse Ripple IOUs and XRP!). In Rowe's UnbackedCoin vs BackedCoin world, Ripple IOUs are the equivalent of BackedCoin. It is their backing that should protect the exchange value of Ripple IOU from the threat of competition. This very same backing frees them from the hyperdeflation-crash-hyperdeflation patten that bootstrapped coins tend to display, stability being a desirable feature among  those who want to hold an inventory of media of exchange. As long as Ripple IOUs are just as transferable & secure as bitcoin and other alt-coins, this stability will be the edge that pushes them above the crypto competition.

So in sum, worthless assets can be kickstarted into circulation, say by a group of confederates who paint the tape in a way to attract outsiders. The riskiness of these bootstrapped assets requires that they yield incredibly high returns, or constant price appreciation. However, this state of affairs can't last forever since others will be eager to issue their own competing fiat objects, including superior non-volatile competitors. If I'm right, in the future bitcoin will be a smaller part of the cryptocoin world than it it now, whereas stable-value non-bootsrapped crypto assets, like Ripple IOUs, will be a larger part of that world.

[1] Bitcoin may not be entirely intrinsically worthless. I have floated the idea before that bitcoin has commodity value as a symbol of geek cred.


  1. Very good post.

    I think Bitcoin has already disproved chartalist theory, Which is good, because it was a bad theory to begin with. Selgin's rescue of the regression theory is not implausible.

    1. Probably worth mentioning von Mises Regression theory by name.

    2. "I think I buy Sams's point. However, he couches his argument within the exiting universe of bitcoin and its clones." exiting = exciting?

    1. Thanks Nick.

      "exiting = exciting?"

      Whoops, that should be existing.

      I think bitcoin has disproved chartalism as the only theory of money, but there could theoretically be a few chartal objects in circulation... I just have troubles finding them.

  2. There are other distinguishing factors besides hashing power. There is a crapload of auxiliary infrastructure that needs to be developed and maintained, for example, and this costs money. Some coins failed because the developers either didn't have time to maintain the official client, or they were not sufficiently experienced to patch the bugs.

    The existence of infrastructure creates switching costs as well. If there were no switching costs, then Bitcoin would already have displaced fiat money. While the switching costs from a fiat money to a cryptocurrency might be higher than switching from cryptocurrency A to cryptocurrency B.

    As a counterexample to the "low marginal switching costs theory of Cowen". I present IPv4 vs. IPv6 (i.e. what we call "the internet"). While I do expect IPv4 to be displaced sometime in the future (possibly by IPv6), I don't think it's going to happen soon and the transition would stretch over a long period of time. IPv6 has existed for about 18 years, and is actually supported by most common network components and operating systems. Yet its market share is only around 2%.

    1. "If there were no switching costs, then Bitcoin would already have displaced fiat money."

      I'm not sure it's all about switching costs. One of the major costs preventing mass bitcoin adoption is its incredible volatility. With an inventory of dollars, at least you know what your purchasing power will be for the next year. An inventory of Bitcoin doesn't provide one with more than a few hours of stable purchasing power.

      "There is a crapload of auxiliary infrastructure that needs to be developed and maintained, for example, and this costs money."

      Yes, that's a good point. But what sort of infrastructure are we talking about? Would it cost more than a few hundred million? A billion? Do you think the price of bitcoin already reflects the combined total of all these costs, about $20 billion, and is therefore semi stable, as Cowen puts it?

  3. JP, you were right that bitcoin had commodity value as a symbol of geek cred, and that is sufficient counter to those who still argue that the regression theorem somehow damages bitcoin.

    But even if you hadn't been, to now argue that bitcoins are useless sadly betrays a persisting lack of understanding of why the Bitcoin protocol is valued by its users. Perhaps if you'd used your bitcoins for something, rather than selling them, you'd have a better idea.

    1. "Perhaps if you'd used your bitcoins for something, rather than selling them, you'd have a better idea."

      I thought that selling bitcoin (and buying) was supposed to be their prime use ;)

      There could be some geek cred in there. But I'm not sure how well it serves as a lower bound to bitcon's price, since you can fill your geek cred quota just as easily with 0.001 BTC worth $1000 as you can 1 BTC worth $1. Geek cred would be help to regulate bitcoin's price if you were expected to buy it for a fixed 1BTC -- that way if BTC got cheaper, more people would want to buy geek cred, and if it got more expensive, they'd want to sell.

    2. "I thought that selling bitcoin (and buying) was supposed to be their prime use ;)"

      Is buying and selling GBP, Euros and Yen the "prime use" of dollars?

      "Geek cred would be help to regulate bitcoin's price if you were expected to buy it for a fixed 1BTC"

      Exactly. There's a finite supply of BTC.

  4. "I should point out that I don't think we actually face a circularity problem with modern central banknotes since they aren't worthless bits of paper but rather exist as a liability of their issuer."

    Do you have any other posts expounding on this?

    Is there any fundamental reason why fiat money couldn't be 'printed' as an asset with no liability on the central bank's balance sheet, and when the CB wants to transfer it into the private sector, it loses an asset and the private sector gains one? Just something I've been wondering.

    1. "Do you have any other posts expounding on this?"

      Here's one:

      "Is there any fundamental reason why fiat money couldn't be 'printed' as an asset with no liability on the central bank's balance sheet, and when the CB wants to transfer it into the private sector, it loses an asset and the private sector gains one? "

      Debuting it is tricky. You've got the circularity problem, so you've got to bootstrap the asset somehow. But that's difficult -- why would anyone accept a fiat asset that has no history of a positive prices?

      George Selgin says it best here:

    2. Thanks, I'll check those posts out.

      I guess my question/point was 'why would adopting the accounting convention of booking fiat money as a liability of the central bank, when it seems it could be booked just as easily as an asset of the central bank, solve the circularity problem?'

    3. I think my point is less about accounting conventions and more about the economic form that central bank money takes. If a central bank issues a piece of paper that takes the form of an IOU, promise, obligation, liability or claim, then this can generate a positive price for that item from its debut.

      If it issues bits of coloured paper that are just bits of paper, then there is no way to break into the circle --- after all, the bits of paper have neither a pre-existing history of positive prices, nor commodity value, nor do they serve as a claim on some other pre-existing item with a positive price.

    4. Right. But what I'm asking is -

      a) What is the IOU attached to that piece of paper?
      b) Is it economically valuable?

      If not, then while fiat money may still be booked as a liability on the CB's balance sheet, that doesn't seem to do much for the circularity problem. I threw in the 'asset' comment because if there is no meaningful contractual IOU attached to fiat money for the central bank, then it seems perhaps it could be booked as an asset instead, which would just make it clearer that there is no IOU.

    5. If we think about it historically and from the US's perspective, the Fed banknotes started out as IOUs for x grains of gold on demand. Dollar IOUs no longer promises x grains of gold. Rather, the Fed promises to ensure their value doesn't fall more than 1-3% against a CPI basket, with a guarantee to buy back IOUs in a sufficient quantity if the 3% limit is exceeded, perhaps even buying back and canceling every single IOU should the need arise.

    6. So your view is sort of hybrid with the Austrians. I just think your use of "IOU" is a little odd, because in the gold standard case, there was a formal and contractual IOU attached to the paper. Today, there is none. Instead, you're talking about stated goals of the central bank, which may change over time. Nonetheless, this type of "IOU" may contribute to peoples' willingness to continue to use dollars.

      What if CB's abandoned inflation targeting? What if instead they adopted full employment targeting? Would you still consider there to be an IOU attached to the dollar, such that people will continue to use it because it has fundamental value?

      What if a new country started with a new currency, and the CB promised to keep inflation at 1-3% if people used it. Would that be enough to get out of the circularity issue, if there is no historic tie to gold?

    7. Actually, maybe I take that back. I don't know exactly what the piece of paper said back then, but perhaps it didn't say ''the fed owes you x grains of gold.' I'm not sure it'd be enforceable in court anyways. So maybe the nature of the IOU really is similar.

      Ultimately, I'm more interested in the questions regarding changing the goal of the central bank away from the value of the dollar, or keeping the goal but having no historic tie to gold.

    8. Even in the gold standard days the contract was not set in stone -- currencies would be revalued relative to gold, and sometimes were made inconvertible for periods of time (the pound was delinked from gold from 1796-1821). Sometimes they'd be switched over to silver convertibility or vice versa.

      A central bank abandoning inflation targeting would be very much like the experience of the pound going off of gold. There would be a lot of uncertainty about the nature of the IOU. One focal point would be the possibility of the central bank readopting an inflation target or gold redemption at some point in the future, assuming that it retained sufficient assets to enforce that possibility. But without clarity, the value of the IOU would probably fall.

      Could a new currency debut if it promised inflation of 1-3%? Good question. I think so, but don't hold me to that answer until I can find a good example.

  5. I believe your summary nailed it. Informative blog.

  6. I think Bitcoin does in fact have intrinsic value. Its principal innovation is an impartial and immutable timestamped ledger of entries containing small but otherwise arbitrary pieces of binary data. On top of this you can build services like or These aren't just some sites accepting BTC in payment, it's much more interesting than that. The timestamping functionality is built right into the Bitcoin protocol itself, and the only way to use it is to pay for it with tiny amounts of Bitcoin. It may be hard to put a dollar figure on this, but surely it has some finite non-zero value. And the more people use it, the more valuable it will get. In principle, banks could use this as a ledger to record ordinary fiat transactions. If they did, Bitcoin would become enormously valuable as a side effect.

    This in effect is part of the Ripple strategy. In addition, Ripple has built-in currency conversion. You can make fiat payments in one currency even if you hold only IOUs in another currency, or IOUs in the same currency but from another issuer. Whenever you do this, you will most likely be using XRP in the background, even without being aware of it. Demand for conversion between various IOUs will drive demand for XRP.

    It's hard to see how XRP could not both appreciate enormously and become progressively more stable in price if Ripple catches on as a superior payment system for ordinary fiat payments. And if it does, XRP will automatically become more convenient to use than all other currencies that are traded with it since it is the only currency within the Ripple system that doesn't involve counterparty risk and that can totally escape government supervision.

    I think it is inevitable this sort of distributed technology will eventually be used for most electronic payments. It's too early to tell if Bitcoin, Ripple or some other system will win the race, but regardless of which system does win, its designers will be stupid if they don't introduce a new internal currency along with it. At the very least they will need one to combat DDoS attacks, and they'd be stupid to pass up on the possibility of creating a bridge currency.

    1. I should probably explain the "use of XRP in the background" a bit better. This doesn't just refer to transaction costs, which have to be paid for in XRP, or even the minimum reserves in order to be able to use various Ripple functionalities, though those are important too. Most importantly, it refers to the special role XRP has in the Ripple system as a bridge currency.

      The foreign exchange component of Ripple is a distributed exchange between all sorts of pairs of IOUs as well as between IOUs and XRP. Because of the special status of XRP in the Ripple system (no government oversight, no counterparty risk), it is the preferred currency against which all others are traded. All other pairs are riskier, because they involve regulatory and counterparty risks on both sides of the transaction instead of just on one side.

      As a result, the order books of, say, EUR:Bitstamp vs XRP and USD:SnapSwap vs XRP have much greater depth than EUR:Bitstamp vs USD:SnapSwap. Therefore, currency conversion will most likely go through XRP as an intermediary: EUR:Bitstamp --> XRP --> USD:SnapSwap.

      The role of XRP in this is somewhat similar to what BitPay does with BTC, immediately converting to and from BTC, thus limiting the exposure to BTC price swings while generating BTC liquidity at the same time. As long as the price doesn't systematically fluctuate too wildly on a second to second basis, the price level and even volatility on a minutes to hours timescale don't affect the utility of BTC as a medium of exchange, and the same would be true for XRP within the Ripple system.

    2. XRP is certainly different from other cryptocoins. I called it a chartal currency in this post, for instance.

      As for XRP's potential for price appreciation, I'm not so sure. See my conversation with John here, but I do agree with you on stability.

      "The timestamping functionality is built right into the Bitcoin protocol itself, and the only way to use it is to pay for it with tiny amounts of Bitcoin. "

      Interesting. Yes, you're right. That provides some intrinsic value to bitcoin. I wasn't aware of this feature. Do you have to pay a fixed amount of bitcoin or does it vary?

    3. I have to agree with John that the transaction fees aren't a problem, because they are so tiny and can be changed by a vote as XRP appreciates. I think that right now a single XRP will last you a long time.

      You say the IOUs will be used to settle most transactions, with XRP being a side show. That may be true initially, but I think international payments will change that.

      Suppose I hold EUR:Bitstamp and want to buy something at, either with dollars or BTC. Ripple will consult the trust graph and various order books and choose the cheapest route to convert my USD IOUs to whatever Overstock wants to accept. That cheapest route will likely involve XRP, and Ripple will automatically buy and sell XRP on my behalf to make the transaction work. I'd have to make an effort, maybe even develop custom software, to stop it from doing so.

      The combined transaction is processed atomically, so either all of it goes through, or none of it, so there is no exchange rate risk and I cannot end up owning XRP I never wanted, but behind the scenes I will be using it, whether I'm aware of it or not.

      "Do you have to pay a fixed amount of bitcoin or does it vary?"

      Generalised ledger transactions are just ordinary Bitcoin transactions in disguise, and they are subject to the same fee policies that miners impose. Different miners can charge different fees, so if you add a fee that's too low, you may have to wait a long time before a miner that's willing to charge a lower fee next wins the race to solve a block. Large pools can try to charge more in the hope that people will pay more in order to see their transactions confirmed more quickly.

      The extra data necessary for use as a general ledger can be stored in a small memo field to the transaction. Such transactions are currently valid, but most nodes do not relay them yet and most miners do not include them in blocks. Existing sites use tiny payments to encode the necessary hashes, which is possible at today's relatively low price of Bitcoin.

      Bitcoin-qt 0.9, the next release, will change that and relay transactions with memo fields of up to 80 bytes, which is more than enough. The recently proposed stealth addresses would also make use of this functionality.

      It's possible miners would charge more for transactions with memo fields, but I doubt they will, especially given the enthusiasm for stealth addresses.

    4. Interesting. However my point still stand that bitcoin very probably began as a bootstrapped asset. The first instance of Bitcoin carrying a positive price would not have emerged because people wanted a token to pay for valuable time-stamping services. Secondly, now that bitcoin has been bootstrapped and its time-stamping qualities are emerging, is it the case that the cost of replicating these services comes out to $20b? Can't all the other coins now in existence replicate these same services? If these services are indeed that valuable, then we've got Cowen's "semi-stability". I'm not convinced.

  7. Might also be a portfolio index value. If bcoin accounted for 0.0001% of global transactions the market may adjust their portfolio of currencies. In some way, like your stock promote/manipulation example, small companies have been doing this for years, taking small companies and "rolling them up" to make their market cap large enough to get onto some index like Wiltshire 5000 or Russell 3000. Index buyers then jump on.

    BTW aside from cool tech, can someone tell me what wide-spread problem Bcoin solves? PayPal solved the (somewhat) secure small payments problem. Is it just competing on fees (vs. PayPal)? Sorry, anonymity is not a wide-spread problem.

    1. The problem that the cypherpunks wanted to solve was that governments have too much power over the existing payment systems, which could lead to things like the extra-legal financial blockade of Wikileaks. Monetary policy was a secondary consideration at best. Anonymity was a means to defend against violence and coercion, not a goal in and of itself. Bitcoin is subversive, just as Napster and eDonkey were, and it was deliberately designed in such a way that it couldn't be shut down the way Napster and eDonkey were.

    2. Thanks Martijn. That adds another dimension to bootstrapping. The rationale for bcoin is that it can't be shutdown for extra-legal activity, but that requires it have no interfaces to regulated currencies, which requires it to be a self-contained economy. But why would a (legal) milk producer accept bcoin over USD? Also, drug dealers have been using USDs for a long time with success, so there needs to be something new that drives them out of USDs into bcoin (e-cash?)?

    3. "what wide-spread problem Bcoin solves?"

      My quick answer, costs. I currently run my chart business using Paypal and have to fork over $2.00 a chart to them in transactions fees. With bitcoin I'd be paying a fraction of this.

    4. Another aspect is the possibility of lots of value-added services based on m-of-n signatures. That doesn't so much solve a problem as add new possibilities. Escrow and arbitration are interesting new possibilities, see You'd need a trusted third party, but the third party can't run off with the BTC without colluding with one of the parties. You don't even always need a trusted third party, see, where both parties have each other by the balls so to speak, and need to cooperate to recover the deposits they both made. A third exciting possibility is algorithmic decision making based on the output of a trusted "oracle". Reality Keys will launch a prediction market site for that tomorrow.

    5. You both raise an issue re;trust.

      JP. Most of the 3% that PayPal charges (directly and indirectly via the credit card co's interchange fee) is perceived value of anti-fraud (or reputational) insurance for the seller and buyer. Just look at the growth of third-party sellers on Amazon Marketplace or eBay (and the buyer/seller guarantee)..

      MM. offers human escrow services. Reality Keys looks like just a (futures) clearing house for prediction markets. Also, how is this different then any gambling site or off-track betting? Again there may be the advantage of fees but this is not bcoin specific.

    6. Could be. I lean towards the theory that credit card fees are so high because credit card companies are entrenched oligopolies extracting rents out of merchants.

  8. Your bootstapping point does indeed still stand. I mentioned the intrinsic value more because I think it suggests the combined market cap of all cryptocurrencies won't go all the way to zero eventually.

    So what was it that got Bitcoin bootstrapped? I think people started mining Bitcoin because in their judgment it was technically capable of serving as a global payment mechanism and because of the 21M cap it would have to appreciate spectacularly to get to that point.

    The uncertainty was more one of mass psychology, could the majority be convinced it was technically sound, and could they be persuaded everybody else would start using it too? That's still an open question, but even if Bitcoin ultimately fails it's been a remarkable achievement so far.

    And initially mining was almost free, so it was only a small bet with a very high upside potential. In essence that is still the value proposition. On the one hand the price has increased dramatically, so the potential upside has been reduced considerably, but is still large. On the other hand, adoption and ownership have also increased, thus increasing the plausibility it could see widespread global adoption.

    So while the general timestamping functionality is technically at the core of the Bitcoin protocol, you're right it's not what people had in mind when they got into Bitcoin. It has some finite value and companies like GlobalSign and DigiStamp provide similar services. It's possible Bitcoin and similar systems could disrupt that market.

    Is that market worth the $11B market cap of Bitcoin? I don't think so, at least not yet, that market cap is still mostly speculative. The interesting thing is if you start using such technology for timestamping ordinary fiat transactions (or stock, bonds, gold etc) . You can do that with Bitcoin, but Ripple is specialised for it.

    I think your comparison with a subway token is appropriate. You need a small amount of XRP to start using Ripple (currently 31 XRP ~ $0.67) and the functionality of Ripple is very useful for fiat payments, especially across borders, regardless of the price of XRP. But the price itself is of course among other things a function of its utility, so that could make XRP more stable in value than Bitcoin.

    On top of that Ripple Labs has the ability to practice a monetary policy of sorts given that it still controls most XRP in existence. It could use that to further stabilise XRP and could be doing so already.

    But I think the decisive factor is the automatic currency conversion that will lead to extensive use of XRP without users even needing to be aware of it. If you start selling your wares abroad through Ripple by holding an account at SnapSwap in order to receive USD IOU payments, you will be generating additional use of XRP whether you like it or not.

    I don't know if there is enough liquidity to make the conversion rates interesting at the moment, but since international wire transfers are very expensive for small amounts they might be.

  9. Maybe the art market has some insights on bootstrapping, marketing, liquidity, store of value ... currency for rich people ...

  10. What's unique about Reality Keys is that they merely "certify" that an event happened. This can be used as an input to Bitcoin scripts, causing money to be transferred to one address or another based on the certification. RK need not know the content of the transactions and cannot run off with the funds. RK is trusted only to be a reliable certifier of information, the Bitcoin network itself is the trusted third party that keeps the funds until either the true or false key is released.

  11. You ought to consider Bitcoin as a community response to economic depression. Many alternative currencies popped up in the 1930s. In a way it is a natural response of non-credit-worthy people to low money velocity. An independent currency can increase their liquidity and thus their ability to participate in markets, which they had been shut out from prior due to loss of income from the established currency.

    I think bitcoin will be successful (as in: significant use in exchange) for as long as the economy fails to recover and unemployment is elevated. And considering the future prospects of oil production, the horizon of economic recovery is receding faster than we are moving toward it.

    1. Interesting point.

      But it still doesn't address my points. Things like stamp scrip, LETS, and other community currencies are not bootstrapped assets. They are essentially promises or IOUs, and this feature ensures they achieve a positive value. Bitcoin isn't an IOU. It's a purely fiat object, which (I think) is why it rises and falls so markedly. Stamp scrip and the rest are/were stable currencies because they aren't/weren't bootstrapped assets, so they are neither volatile, nor can their value be competed down to $0 as is the case with bitcoin.

    2. Technically, there are some complemetary currencies that are not IOUs. The Ithaca Hours, for example, is not an IOU and neither is WIR (even though the latter is created through loans). But, they are "kind of" pegged to the dollar/franc.

    3. In terms of the 1930's currencies, I was thinking more along the lines of notgeld currencies (

      Most were simply paper notes, denominated in the legal tender units, but issued by non-legal creditors and usually non-redeemable. They were simply locally/communally agreed to be valuable and exchangeable.

      Bitcoin is like notgeld or "emergency money" for the unemployed 25-34 demographic who are being hit hardest by systemic unemployment. The notgeld of this demographic just happens to be taking the form of something unique and innovative like bitcoin because we like computers and digital stuff :)

    4. My memory of notgeld is that they were IOUs of states and cities, often denominated in odd units like rye, gold, or US dollars. So I don't think they were just coloured bits of paper. One thing that surely gave them currency was that the Reichsbank agreed to clear & settle approved notgeld at par with official reichsmarks.

      Let me double check my memory.... aha, here is a quote from Adam Ferguson:

      "Because the Reichsbank's printing presses and note-distribution arrangements were insufficient for the situation, a law was passed permitting, under licence and against the deposit of appropriate assets, the issue of emergency money tokens, or Notgeld, by state and local authorities and by industrial concerns when and where the Reichsbank could not satisfy employers' needs for wage-payment. The law's purpose was principally to regularise and regulate a practice which had gone on extensively for some years already, with the difference that authorised Notgeld would now have the Reichsbank's guarantee behind it."

      So bitcoin is something qualitatively different from notgeld since the latter weren't bootstrapped (although I'll grant that unemployment and a shortage of liquidity could explain why each have grown so fast)

  12. Interesting editorial from MARC ANDREESSEN (I have a huge respect for this guy) ...

    After thinking it over (and with the good comments from Martijn & JP), I think the killer app for bcoin is: an open-source (programmable|) payment system allowing the disaggregation of payment from services (unbundling). Now the question is who will be the next Google or I don't think bcoin itself will be where the value will be created. The first group of winners will be those providing new services with no analog today. The second group will be enabling infrastructure (a global FX exchange, probably based in an off-shore tax haven) and the ones that eat the value add of credit card companies, payment processors, and bundled "reputational/3rdparty" services. The third group will be the companies that specialize in anonymizer services (and defeating the same!), money laundering (using e.g. real trade) etc.. Any thoughts?

    1. BTW he discusses the bootstrapping problem.

  13. JP, Was thinking about this while running. Do you think the tactics of monetary policy (targeting) is really a bootstrapping problem as well? Using forward guidance, asset purchases/disposals signals, etc., like a stock/art promoter to manipulate the target value? I wonder if the Fed should use more of their dirty market manipulation tactics: phantom trades between market desks (to push key indicators with narrow markets like 30 yr TIPS), unconstrained/unpredictable QE rather than uniform monthly purchases, manipulating securities lending, selected futures manipulation (commodities, fed funds)?

  14. A Ripple gateway in Singapore is now issuing IOUs backed by gold. It combines the stability of gold with the low transaction costs of cryptocurrencies. It will be very interesting to see how well it will do as a bridge currency compared to Ripple's native XRP.

  15. "Both solve the circularity problem in different ways."

    Each versus both: They *each* solve the problem in a different way. (They *both* solve it in the same way.)

  16. I understand that by fiat object you are referring to the fiat definition of “creating something without effort”, which would mean that all raw unprocessed natural resources including gold would be fiat, but I suspect that if you qualify Bitcoin as a fiat object is precisely because you thinks gold is not fiat. So the only explanation I can think of is to justify gold is not fiat is the worst I can imagine, which is that as raw gold is barely available for use, the **effort** (costs) involved in mining and refining is what makes it useful. This is labour theory of value, which I fully reject.

    The reality is that both Gold and Bitcoin are useful because of its natural or artificial intrinsic properties (portable, divisible, difficult to fake, etc), no matter the costs or effort involved in their production.

    Here I explain with more detail and I also address the other definitions of fiat.

    1. "I understand that by fiat object you are referring to the fiat definition of “creating something without effort”, which would mean that all raw unprocessed natural resources including gold would be fiat"

      No, that's not the definition I am using. In the context of this post, fiat means that the thing in question has no use-value, only exchange value. Uselesstainium if fiat. You can touch it, it costs lots of resource to mine it out of the ground, but it has no intrinsic use. If it trades at a positive price, this is pure exchange value.

    2. Ok. That´s a bit confusing for me becuase it is not within any of the generally accepted definitions of fiat. But for the sake of the debate I´ll take the definition instead of the term.

      The definition is "the thing in question has no use value".

      In that respect I refer to the text in my comment below:

      The need for exchange is one of our most important needs. Without exchange our access to economic goods produced by others would be extremely limited, we would have very little division or labor, we wouldn’t have prices, without prices the economic calculus and coordination would be impossible (Which Mises accurately demonstrated, shame that he was not so good at monetary theory with his very unfortunate and unnecessary Regression Theorem).

    3. So if exchange is an important need, anything that might fulfill that need is useful on itself, no need to look for other different uses.

    4. "So if exchange is an important need, anything that might fulfill that need is useful on itself, no need to look for other different uses. "

      Yep. If something has exchange value, than of course it is useful. Think of the distinction this way. If something has only exchange value, than the only reason it is useful is because its owner can eventually trade it away. A house has both use value and exchange value, but if the state declared that its owner could never sell the house, and neither could the owner's children, then that would extinguish the house's exchange value, and it would be a bit less useful, and so its price would decline.

      It's a helpful distinction to make because we can ask how items that only have exchange value (like bitcoin) might emerge, how their price is determined, and what might happen with them in the future.

    5. But there is no reason for exchanging something that is useless. How can a useless thing have exchange value? At least some utility or future utility has to be foreseen based on the good´s properties. Utility always preceeds value.

      Being useful as medium of exchange is completely different concept from having exchange value. The former is a characteristic feature of money, the latter is a common characteristic of all economic goods.

  17. More on the same issue:

    The need for exchange is one of our most important needs. Without exchange our access to economic goods produced by others would be extremely limited, we would have very little division or labor, we wouldn’t have prices, without prices the economic calculus and coordination would be impossible as demonstrated by Ludwig Von Mises. So qualifying as worthless or useless something that its only use is being medium of exchange is an extremely reckless claim. Here I explain a bit further (2 min read):

    Money Bitcoin and social consensus