Saturday, November 2, 2019

Bitcoin, 11-years in

Satoshi's first email [source]

Eleven years ago, Satoshi Nakamoto announced the bitcoin whitepaper to the world. Coinbase, a large cryptocurrency exchange, recently celebrated this milestone with a retrospective.

I'm going to remix Coinbase's narrative to tell a different account of bitcoin's last 11-years.

The thing that fooled us all for a while, myself included, is that we all thought bitcoin was solving a monetary or payments problem. It was labelled a coin, after all, and coins fall within the realm of monetary economics. To further complicate matters, Satoshi told his story using phrases like "electronic cash system" and "non-reversible transactions". Perhaps we deserve to be forgiven for not seeing bitcoin's underlying nature. After all, tearing down the existing monetary system and building a new one was a fresh and exciting narrative.

Anyways, Coinbase still believes this old tale. "As with other technologies, money has gone through many upgrades over the years," its marketing team writes. "Bitcoin is the latest breakthrough in a technology that’s millennia old."

What is now apparent is that bitcoin was never a monetary phenomenon. No, bitcoin is a new sort of financial betting game. It is a digital, global, highly-secure, and fairer version of the old-fashioned chain letter.

The premise behind bitcoin-the-game is that the current wave of buyers must guess when (or if) a subsequent wave of buyers will emerge, this second next wave's participation being contingent on when (or if) they believe a third wave of buyers to emerge. If they guess right, the early birds win at the expense of the late ones. And they can win a lot of money, as Coinbase points out in its post:

Source: Coinbase

Think of bitcoin as a pure mind game, a Keynesian beauty contest in which we "devote our intelligences to anticipating what average opinion expects the average opinion to be." Those old fashioned chain letters that you (or your parents) used to get in the mail were an early type of beauty contest. The price that Alice was willing to place on a chain letter was a function of whether she expected the next recipient, Bill, to play by the rules and send it on, Bill's expectation in turn depending on the odds that Jack would join the game.

But chain letters had a major flaw. The chain order could be easily compromised by a fraudster who miscopied the list and put their name at the front. Bitcoin fixes this by introducing robustness to chain letter-type games. Bitcoin's blockchain is an unbreakable public record of where in line game players stand. Altering this chain order would require tremendous amounts of computer power, as Coinbase illustrates in this chart:

Coinbase: Source

Bitcoin-the-game has been spectacularly successful. As Coinbase points out, it "went from an idea in 2008, and a first transaction in 2009, to over 27 million users in the US alone in 2019, or 9% of Americans." Below, Coinbase has charted the number of active bitcoin addresses that have been created over the years:

Source: Coinbase

Why did bitcoin-the-game succeed?

First, it's a fun and cutting-edge game. Many people dream of thrusting themselves out of financial obscurity into millionaire land. Bitcoin is a technologically-sophisticated way to get there. No one wants to play grandpa's lottery.

Secondly, the way that bitcoin is designed helps it spread. Most of the legacy financial games that bitcoin competes with (poker, lotteries, sports betting) are regulated by the government. Strict rules prevent game providers from reaching a wide audience. For instance, online casinos may be prevented from serving out-of-state players, problem gamblers may be banned, and those who are under 18 must be excluded. These financial games are usually centralized. This means they are hosted on a single website, or at a physical location like a casino, or by a government-run lottery corporation. Which makes it easy for regulators to shut down game providers who break the rules.

But bitcoin is different. Because it is a decentralized and digital financial game, it can't be regulated or shut down. And so it can serve the entire globe with impunity. Which it has done by spreading into every crack and cranny on earth. As is illustrated by another of Coinbase's charts:

Source: Coinbase

Based entirely on whisps and storms of psychology, the price of bitcoin is inherently volatile. Its core volatility has stayed pretty much constant over the last 11-years. Users should expect the same for the next 11 years. Even if more people join a Keynesian beauty contest, the average opinion of the average opinion will always be a fickle, inconsistent thing, and so price will always be jittery.

So what about bitcoin-as-money? Yes, people do use bitcoin for payments. But this gets dwarfed by its popularity as a financial game. The problem is this. Bitcoin payment functionality is implemented on top of a highly volatile chassis, a fun but fickle beauty contest. Which hobbles the effectiveness of the payments platform. Regular folks won't use the stuff to pay. They don't want the value of their spending stash to fall by 20% overnight. And game players don't want to waste their tokens on buying goods & services. That could mean potentially missing out on a life changing jackpot. That's why the promise of mainstream bitcoin payments has died a thousand deaths over the last 11 years.

That being said, the demand for bitcoin in economically volatile regions such as Venezuela has hit record highs. Coinbase suggests that thanks to inflation and capital controls, bitcoin is finally being used as the electronic cash for which it was originally designed.

Source: Coinbase

Coinbase could be right. In places like the U.S. with functioning monetary systems, bitcoin is just too awkward to serve as a payments alternative. But in places where monetary breakdowns have occurred, regular folks may be more willing to put up with the inherent pitfalls of transacting with bitcoin. And so we finally get to see bitcoin-as-money emerging.That's a good thing.

But bitcoin's popularity in Venezuela is also consistent with the bitcoin-as-game narrative. When people are desperate to improve their lives, they may have little other option but to roll the dice. In Run Lola Run, Lola needs to quickly make 100,000 Deutschmarks to save her boyfriend's life. She races to a casino and plays roulette. Likewise, in the face of societal collapse,  Venezuelans may simply be gambling on whatever potentially life-changing bet they can find. Bitcoin is one such a bet. Unwinding what portion of Venezuelan usage is due to bitcoin-as-game versus bitcoin-as-money is tricky.

Coinbase goes on to spout the typical cryptocurrency industry nonsense about legacy payments. It claims that "sending an international wire transfer by major US banks costs around $45, can take days to process, and can be done only during banking hours." And here is the chart it uses:

Source: Coinbase

That may be a good critique from ten years ago. But with SWIFT gpi having rolled out a few years back, multinationals can make near real-time cross border payments using the traditional correspondent banking system. For individuals and small businesses, fintech Transferwise offers instant remittances over fiat rails. These can settle on weekends in nations like the UK, which have real-time retail payments systems. I've touched on this before.

Continuing along with hyperbole, Coinbase makes the claim that bitcoin remittance fees are minimal compared to fiat. But this ignores the sizable foreign exchange fees that one must pay when converting fiat into bitcoin and back into fiat. I've gone into this calculus before.

What's next for Bitcoin? asks Coinbase in closing. Let me give it a shot. It's possible that bitcoin-as-game will stay popular for a very long time. And if it does, that could be a good thing. As I've suggested before, there is a demand as-such for financial games and bets, specifically early-bird bets. Compared to many of the fly-by-night games out there, bitcoin provides a fair and trustworthy option.

What about the original vision that got us all so excited, bitcoin-as-money? Crippled by bitcoin's game-based engine, bitcoin payments are probably never going to move beyond the niche role that they currently occupy. That's better than nothing. When those on the fringes are temporarily cut off from the conventional payments system, they'll always have an option for making transactions. It might not be a user-friendly option, but at least it's there.


  1. I see what you're saying.

    Would it be correct to summarize this post as you seeing Bitcoin as a finite digital resource, which can be transacted with anyone around the world and nobody can stop those transactions?

    And the "game" is therefore people trying to figure out how much this resource is worth? Like some sort of market?

    1. You would be incorrect to summarize this post as "Bitcoin is good."

      My takeaway is that game is that each individual know the resource is not worth much but they are incentivized to pretend / predict that the resource is worth a lot.

      A historical example would be:

    2. The author makes a strong case for it's value.

      " can't be regulated or shut down. And so it can serve the entire globe with impunity."

      This may be worth more than "not much".

    3. Jeff, the game involves trying to get into other players' heads to determine if (or when) they will buy. Bitcoin's openness and censorship resistance means that more people can play than would otherwise be the case.

      The ability to use bitcoin for payments is something that emerges from the fact that game players have given bitcoins a positive value in the first place. But game play will always stop the payments function from getting much use.

    4. I don't believe anyone who has read Satoshi's writing would see any intention for Bitcoin to function as a game, but as a solution to the centralization of payment transfer.

      Would you say that the "game" is a side-effect of the limited supply, or more that Bitcoin was designed to be a game from the start?

    5. I see what you did there :)

    6. Greg, the fixed money supply has nothing to do with it. The only reason that bitcoin is worth $9000 is because the current generation of players is gambling that another generation will pay more, which is gambling that another generation will pay more, which is... Bitcoin is a recursive, self-referential guessing game that stops when no one wants to play anymore.

    7. JP Koning,

      I think your theory of bitcoin as a game would be reasonable if the asset had no utility.

    8. I think he meant as a trading asset. I bought 25 eth, I never bought Bitcoin because I saw it only as a means to get more [quantity] of money.
      Bitcoin was intended to solve a problem that no longer exists, however the culture, infrastructure, and investment into Bitcoin is still the root of the cryptoworld.
      We, as human beings, simply can't sit back and rest on the laurels of a digital currency made to fix a problem that no longer exists.

      The cryptocurrency Chia by brian cohen, if he pulls the rabbit out of the hat, will alter the game so completely this discussion will become moot.

      Chia is designed to get rid of the infrastructure part of Bitcoin. No more chinese electric computer farms, still digital money. That's the dream at least, and that is P U R E utility.

      Anyone can play World of Warcraft and mail another player money in-game. No one cares - it's completely boring, super easy to use, functions instantly. It's only a matter of time that the same ease with which we can transfer numbers in a game like World of Warcraft becomes closer to what we can do with the financial system.

      It's the software that isn't there, not the hardware. Most out of the cryptospace don't have the desire to create software that actually works for people for utility.

      The current monetary system was and is going to be outdated for the rest of the financial systems existence. I don't think we're ever going to catch up to the level of utility that we can already bring to bear in a game.

      People simply take money too seriously. As more and more people realize this, the technology will continue to emerge that supports simple, effective systems that allow people to use money instead of money using them.

  2. Bitcoin is worth nothing, because it's backed up by nothing. But same goes for fiat currency, it's not backed by gold or any other resources. It's just monopoly money, out of funds? Print more.

    So the author is delusional, you can't compare fictional money with fictional money.

    1. For (many) fiat currencies, there is the backing of an entire country with no interest in seeing their currency become worthless. That's often quite some serious backing and they have a lot of power they can bring to bear on it.

    2. Yep, anon @7:55 is right. Banknotes are issued by a central bank. Central banks have huge amounts of assets that they can use to enforce the value of their banknotes. There is no bitcoin central bank. The only thing anchoring bitcoin's price is what others are willing to pay.

    3. Good assessment overall. Except that -
      Poker, lotteries and especially sports betting are regulated, but only a small portion of them. Most sports betting online has been around for decades, long before it was made legal in the USA by the Supreme Court this past year. And, you can bet with crypto.
      All kinds of money is played by all kinds of people in all kinds of ways since the beginning of time.
      And,just because a tool (currency) is not used for its' "preferred" purpose doesn't mean it won't be at some point.
      Nothing, even monetary policy stays the same.

  3. The mistake the author of this blog makes is thinking that capitalism is long-term sustainable in its current form and that what happened in Venezuela can never happen in the first world. When the US dollar begins to lose its value and it is a matter of when and not if, you can bet your ass that the type of gambling you are referring to above will happen there and everywhere else there is a monetary crisis. The genius behind "bitcoin as money" is that over time it proves to be much less of a gamble than trusting in the printing press economics of the Federal Reserve.

    TL;DR - The two aren't mutually exclusive. Bitcoin as money solves the problem is claims to solve precisely because the current banking system is doomed to fail everywhere, every single time.

    1. If the liberal order collapses, then yes, bitcoin would be quite useful. Even though it is crazy volatile, it would be the best of all options given that the traditional financial system would have collapsed.

      But if the liberal order collapses, we may also no longer have the sorts of infrastructure necessary for bitcoin to work. Bitcoin needs computers, smart phones, processors, cellular networks, etc.

    2. What about a depression instead of a collapse (assuming a collapse is something worse than a depression)? Phones can last plenty long past the standard two-year upgrade cycle. Desktops and laptops can usually last about five years. Cellular networks might be a bit precarious, but one would think the government, at the very least, would seize control to keep that critical infrastructure from collapsing.

    3. Like the Great Depression? I mean, the economy suffered through the Depression but the international banking and payments systems continued to work fine.

      You need a much bigger breakdown than that. Not only do we need a massive contraction in GDP growth. But also regional and global war, armed civil conflicts in developed countries, liberal democracy replaced by illiberal dictatorships with a tight surveillance apparatus, widespread ethnic cleansing, etc.

  4. The thing that fooled us all for a while, myself included, is that we all thought bitcoin was solving a monetary or payments problem. It was labelled a coin, after all, and coins fall within the realm of monetary economics. To further complicate matters, Satoshi told his story using phrases like "electronic cash system" and "non-reversible transactions". Perhaps we deserve to be forgiven for not seeing bitcoin's underlying nature.

    The above is your conclusion and your opinion - it is not fact. You have just 'made up' this underlying nature! How many people agree with this? I would hazard a guess as not many...

    A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.

    The above is taken from the 1st line of the Bitcoin whitepaper - if I may beg your forgiveness for continuing to interpret this 1st line as it reads and not your own rather random thesis on chain letters.

    Rob Dyer

  5. I found this article provided an insightful and interesting perspective. I am happy to have discovered your blog from a link on the Monevator site.

  6. Your content is smart and useful JP. Any chance you could make it shareable by adding social share buttons to your posts? Maybe an email sign-up box would be great too.

  7. I dismissed the attempt to describe bitcoin as a currency from the outset -- it seemed to me that it behaved more like a commodity.

    Your description of it as a game token is much better, thanks.

  8. I think the mistake you make is trying to analyse bitcoin as a "currency" (most saleable medium of exchange). Bitcoin cannot be that today and may never be in most countries.

    Bitcoin value proposition is being the medium of exchange with the lowest cost of storage available. It improves on gold being digital and it improves on debt because it has no third-party risk.

    If you need to keep a balance to fund production you have 3 options:
    - Fiat currency. It's eroded relative to total wealth at a pace equal to CPI + Growth.
    - Investment. You may be able to earn a return equal to CPI + Growth + risk_premium, but you need to be willing to assume that risk.
    - Fixed supply asset (BTC). The only risk comes from changes in its demand to keep cash balances for the future.

    As demand for a fixed supply asset to keep cash balances grows, its volatility gets lower and fits the preferences of more people to keep cash balances. This is a virtuous cicle increasing demand, as demand for a low risk non volatile asset is greater than for a risky one.

    Bitcoin will only have a chance of becoming a currency (generally accepted) when most people demand it for cash balances, and this will only happen when its volatility gets much lower. Judging its adoption by this metric is not correct. Adoption and utility as a medium of exchange (with a time component) can only be judged by its demand (market cap). Acceptance as means of payment may never happen as fiat currencies are pretty good covering that use case in most circumstances.

    There is not much value to be created in reducing white market payments friction, but there is a lot of value to be created in reducing cost of storage to maximize future purchasing power of our specialised production.

    1. "As demand for a fixed supply asset to keep cash balances grows, its volatility gets lower and fits the preferences of more people to keep cash balances. This is a virtuous cicle increasing demand, as demand for a low risk non volatile asset is greater than for a risky one."

      It is unlikely that this virtuous circle will ever be entered into. A different virtuous circle has predominated up till now, and will probably continue to dominate. Volatility stays high, so no one holds it as cash, so game players dominate, so volatility stays high. That this process is the dominant one is consistent with the observations that the volatility of crypto remains high even as it becomes more popular, and the repeated failure of bitcoin, bcash, xrp etc to break through as a mainstream payments option.

    2. We are still orders of magnitude away from target valuation for a trust-minimized fixed-supply asset. There is still more capital invested even in investment gold (mostly-trust-based and with 2% monetary inflation).

      Don't expect volatility to get get much lower when price is in its way to grow another 2 or 3 orders of magnitude in the next few years. We are not there yet, and this is not as gradual as you may imagine.

      Don't expect it to become a mainstream payments option until demand for cash balances in bitcoin are mainstream. Mainstream payments adoption may never happen even then, for most people apple pay is almost frictionless and very difficult to beat to buy a coffee. Mainstream payments is the wrong metric to look at.

  9. Hi JB, this comment doesn't relate to this particular article but instead another one you wrote 2 years ago regarding T+0 cash settlement. My question: Is T+0 really gonna be that much of a pain in the ass to brokers? Is it because those securities have to be delivered physically? I am far from an expert but if the shares don't have to be physically delivered than why can't they just send the shares electronically to a brokerage firm instantly as soon as a transaction is made? Thanks in advance.

  10. I think even in dysfunctional economies like Venezuela its utility is not clear. Local Bitcoins has not shown a significant increase in Venezuelan transaction volume over the past year. People claiming usage by other channels don't have good volume data.

    Furthermore, the sustained utility of Bitcoin in these situations is unproven. While governments can't ban it outright, it is not impossible that they could create hurdles sufficient to make its usage rather small.

    Furthermore its utility in those situations depends on alternatives also being suppressed by banking regulations.

  11. A good article but you've left out the primary real world use cases for bitcoin and cryptocurrencies in general: crime.
    Whether ransomware payments or evasion of currency controls - this is what drives actual usage.