The seven deadly paradoxes of cryptocurrency

John Lewis of bankunderground.co.uk has given us a great collection of popular misconceptions about public coin with his recent post there.  Sure some might quibble with his use of the word "paradox" but as studying apparent paradoxes can be a great way to discover our own misconceptions and improve our understanding of the world the term has some merit here.  Both of the regular readers of this blog already know most of the stuff here, but as usual: if it's worth saying once it's probably worth repeating.  Lets dive into his seven issue issue and see what else we can learn.

1--  The Congestion Paradox or "Nobody goes there anymore, it's too crowded".

This is hardly something unique to public coins, there are many useful services we use which become more costly to use as the traffic goes up.  In all such cases a balance must be reached.  If a bitcoin network gets overwhelmed with transactions, it becomes more costly to use the network.  This is similar to the response of some city planners to charge much more for licenses to drive in the most congested areas, or only allow certain plates to travel at certain times.  The precise balance of transaction fees and the competition between different cryptocurrencies for your transaction fee is an interesting dance, but it shouldn't seem too paradoxical to us.  If a restaurant gets too crowded, they might raise the prices, and require us to make reservations in advance.  Depending on the difficulty of these costs for us, we might consider taking our business elsewhere.  Similarly, in the world of public coins, if one network is too expensive to use we will consider using another.  A large spike in congestion on the BTC network last year coincided with an influx in transactions in ETH, LTC, and BCH, and the number of transactions on BTC has remained reduced in response.  Yes, congestion can be a problem but we can understand the market forces at work.

2--   The Storage Paradox  

Here John Lewis tells us that "Each user has to maintain their own copy of the entire transactions history".  However we know from experience that far less than 0.1% of public coin users actively maintain such a copy.  The paradox here is that while the advantage of public coin is that that we can if we choose audit the entire monetary system, simply using the currency requires us to do no such thing.  Paper wallets don't take up much storage space, and neither do SPV (simple payment verification) wallets that seem to be the most popular wallets.  Storage is an issue for miners and various coin service providers (blockchain explorers, etc.), one which adds to their bottom line and must be considered in their business plan.  However for the average user there's no issue here at all.

3--   The Mining Paradox

Here it's not clear what the paradox is.  The author refers to a "tension" between miners and users, but this is nothing new in a marketplace as such tensions exist between buyers and sellers of all goods and services.  Sure, new purchases of the coin support the mining operations, this is why the term "mining" is used here.  However it's unclear how there is an additional paradox over e.g. copper mining operations, where new purchases of copper must support the mining operation.  The size and reduction of the miners rewards above the transaction fees, known as the coinbase transaction, is what decides the monetary supply curve of the coin.  Here there is much room for discussion but the author doesn't mention this.  Instead he refers obliquely to something he calls a "private cryptocurrency".  It's unclear what this might mean as usually the word "cryptocurrency" inherently refers to coins of a public nature.  Something like paypal tokens or alipay tokens might fit the bill as a private cryptocurrency (and indeed M1 dollars fit this name as well) but generally if a money supply is privately controlled there is no need for mineability.  The resolution of the paradox here is likely a better understanding of what public coin is and the market forces that miners compete for.

4--   The Concentration Paradox 

The inequality present in a privately issued currency, that of interest rate apartheid, is that some people are members of the issuance class while others are not.  Public coin does away with this inequality by removing completely the private discretionary issuance of currency.  However this doesn't mean that everyone will have the same amount of money.  There is still inequality of holdings, as we see in any market.  Shares of apple for example, or diamonds, show the same thing - a few players hold most of the asset.  Public coins will be no different.  The only difference here is that the "haves" must work more efficiently to increase their holdings, whereas for a fiat system the "haves" can be as inefficient as they like and still maintain their privilege.  There is a reference to the first 3000 blocks in the article which is also mistakenly used to indicate a trend for the next million blocks, but apart from that the only paradox here is in assuming that removing inequality on one front (issuance) will remove it on another (holdings).  It won't.  As fiat issuers continue to buy up public coins, the inequailty of public coin holdings is likely to grow.

5--   The Valuation Paradox 

The paradox here is that money has value despite the fact that it offers no positive future return.  We value stocks and bonds based on future returns, so why not money?  Well, "it just doesn't work" is one possible answer here.  Econometric literature is filled with various theories to put a price on exchange commodities, usually based on monetary velocity and related concerns, with very little practical success.  In the real world market valuations are not made by super-rational participants in frictionless markets but by real people with various different concerns and in much more constrained markets.  The question of why the dollar and the bitcoin are not both worthless assets is a good one, and perhaps somewhat paradoxical.  The solution comes from that fact that such a thing is needed to make trading and valuation easier, and therefore there is a demand, and some scarcity limits the supply to some degree thus allowing a market price to be reached.

6--   The Anonymity Paradox 

Here the paradox is roughly that sometimes we want anonymity and sometimes we don't.  Sure, it's very hard to match the anonymity of M0 paper cash, 90%+ of which is used solely in black markets.  Sure, it's very hard to match the launderability of the US Dollar, enjoying preferred status amongst criminals for about a century now.  That the bitcoin is public and all transactions are viewable any interested party sounds like it would alleviate anonymity, however the strong pseudonymity allowed by the addressing system as well as the immediate portability and teleportability make bitcoin a natural choice for some people who wish to remain hidden and still do business from afar.

While the author doesn't get into it here, there are some real paradoxes worth looking at here.  Especially true is for some coins which do offer anonymous and hidden transactions, such as Zcash and to some extent Cryptonote coins (Monero, Bytecoin, etc.), and also some Confidential Transacion protocols that ride atop coins like etherium.  In particular, can the user really verify that the network is keeping track of assets as described, and there are no leaks of newly issued tokens into the system?  If we cannot, then we are back to what might be a fiat system, and clearly this is not acceptable for society.  Allowing users to remain anonymous if they choose is worth doing, but if we destroy the very nature of public coin we have clearly gone too far.

Anonymity and privacy concerns are important, but usually there is a solution for those who need a higher degree of privacy.  Even on the mainnet BTC network there are tricks that one can use, including stealth addresses, coinjoins, and mixing, which increase the anonymity for a user but which do not compromise on the public nature of the money supply.

7--   The Innovation Paradox 

The idea here is that if we are excited about this new tech, then we are open to even newer tech which will obsolete the current coin and make it worthless.  There are a few ways out of this one.

The first is that this same paradox applies to e.g. a hard drive.  Sure, we know that in 5 years the hard drive we buy today will be worthless.  However we buy it anyway because we need to use it today.

Another way around this is that newer technologies can be added to the current stack.  Without changing the protocol, bitcoin users now enjoy many abilities they didn't have in the first few years of public coin, such as multisignature transactions, time lock transactions, stealth addresses, and more.  In this way newer innovations can add to the value of the coin rather than decrease it.

Finally, it's worth pointing out that the fundamental innovation, that of using a public money supply rather than a private one, is not one that is likely to change greatly.  Many new layers will be added but the fundamental difference of a money supply controlled by private issuers and one which is publicly transparent remains.

 

 

Bitcoin is Socialist, Return of the Son Of

A couple of years ago we swallowed the red pill (nyuck nyuck) and we wound up discovering here with a couple of blog posts that bitcoin is socialist (1) (2).  This discovery started out with allowing for a broadening of the definition of the term "socialism".  Sure, if you put some constraints on the syllables and say they can only be an indicator of central control by a national government, then this whole discussion is off the table.  However that's not what people mean who take the term seriously.  Therefore if we want to have a meaningful discussion, we need to use words that the other people listening will understand and agree to what they mean - and we need to broaden our definition a little bit.  The other is sacred after all, dear reader.

So for today's venture back into this territory we will consider one set of definitive factors of socialism, a set of 12 core qualities that have something to do with social behavior and a successful socialist society.  We'll tackle each one individually and see how public currency like bitcoin fits the bill, compared with a privately issued currency aka fiat.  Then we'll tally it up and report the score.

So without further ado, Public Coin vs. Fiat Coin - let the battle begin!

富强 - Prosperity.

Yes, public currency means that money issuers are not able to take wealth from the whole society.  If not being robbed is good for prosperity, then a public currency is a big advantage over privately issued currency in this regard.  Even if you are considering as your measure of prosperity only the prosperity of those who are now currency issuers, public coin still looks good!  Even though it won't give them the power of private issuance in the future, they still have the power to issue now and can use this power to accumulate public coin.  Public coin wins this round 1-0.

民主 - Democracy.

Democracy refers to government by the people, which means all the people.  In a well run monetary system, the monetary tokens provide a means for people to voice their support for one institution over another, selecting products and services from one group over those offered by another.  The integrity of this democracy is then the integrity of the monetary system.  If money can be issued privately, then this democracy is completely undermined and the people don't really have any say unless they are issuers.  Public coin would be a huge advantage to this core value of socialism.  Another win for public coin, even before we consider the potential use of blockchains in other kinds of voting.

文明 - Civility

Well sure, if one looks at the loudest folks one sees anything but civility amongst the so-called bitcoin community.  However, this is just the froth on the surface.  In fact the use of an open and transparent digital currency system could be seen as extremely civil.  A triple entry accounting system allows for backup records to be retrieved and payments to be publicly verified.  It allows for millions of currencies providing redundancy and providing cushions against the boom-bust cycles of issuance and the civil disobedience that often results.  I think Charles Barkley would agree: anything else would be less civilized.  1-0 public coin.

和谐 - Harmony

OK so Pythagorean resonant harmony might not be so relevant to bitcoin.  However, financial harmony - stability and avoiding dissonance - is certainly enabled by a public coin.  The turbulent booms and busts present as waves of inflation crest and recede in an economy are simply not present in a public coin economy, at least not in one with a rational money issuance curve.  Music to our ears.  1-0 public coin.

自由 - Freedom

Yeah, well here we have a huge advantage to the public coin.  Anybody can use it any time, right?  Well mostly but not exactly, as there is still the issue of a digital divide facing us where not everybody has access to the technology.  Fortunately that story is improving, as decent bitcoin wallets are available for very little cost in the form of $10 android phones.  It is rather the divide in education that is a bigger problem here towards bringing more individual freedom to all.  Public coins put the money in your hands, if you want it, but many people still opt for custodial accounts if they want them.  There is some interesting irony here, as some people today prefer to use slavery tokens and they are free to do so.  Anyway there's no need for me to expound on the "bitcoin is freedom" meme here, it's already both true and overplayed.  1-0 public coin.

友善 - Friendship

OK lets be honest, bitcoin has little to do with friendship.  Sure this is an important core value and without it we are lost.  However no monetary system addresses this, money is much more of a base quantity nowhere near as interesting or important as friendship so I won't bother to bullshit my way through this one.  Lets call it a draw between the different forms of currency here.  Public coin 1/2 -- Fiat coin 1/2.

平等 - Equality

We've talked about equality here before.  Public coin is absolutely equal with regards to the people that use and issue it, all people must follow exactly the same rules.  Fiat currency is the opposite, forcing a class structure of issuers and non-issuers upon the populace.  Bitcoin is clearly the winner here.  Sure, there are perhaps 1000 people who own 40% of all the bitcoins.  There will always be some inequality in this regard.  However, they can't issue themselves new ones and so they are at least in that regard equal to the rest of us.  Thus public currencies present a clear improvement in equality.  1-0 public coin takes it.

公正 - Justice

Like Richard Pryor said when he went to tour the criminal detention facilities of the justice department, he did find justice - "just us".  If your idea of justice involves currency issuers being allowed to do anything they feel like with no responsibility, then you will like fiat coin as the winner here.  Otherwise, public coin takes it clearly and obviously.  A sound money system is more just.  1-0 public coin.

法治 - Rule of Law

This is a rather indirect issue because it's not clear which laws are being claimed should rule.  While we may like the rule of law, we don't like it if the law is unjust.  One might argue that fiat systems could give more power to the enforcers of laws, if those enforcers are supported by the currency issuers, and so the rule of law might be stronger under a fiat coin.  However if the enforcers are not supported by the currency issuers, then public coin system looks much preferable in a rule-of-law sense to what would result.  Being lazy here it might be best to leave this one as a draw  1/2  1/2.

爱国 - Patriotism

At first glance, one might think that fiat money is better for patriotism, as it appears to bear the name of our nations and fatherlands while public coin doesn't usually bear such name.  However, one must differentiate between 很笨爱国 and 聪明爱国, patriotism that actually supports the country and patriotism that in fact weakens the country.  We could all agree that while spending the entire budget of a country on flags might appear to be a patriotic gesture, it really isn't - instead it is weakening the country and not showing 爱国.  In this case, accepting fiat coin is a very similar case - a treasonous act.  Allowing private currency issuers to drain the wealth of your nation is hardly patriotic is it.  A true patriot would refuse to allow such blatant corruption to take over his or her nation.  1-0  public coin.

敬业 - Dedication

It is tempting to bring up proof of work, the open source ethic, and the dedication of public coin educators and speakers here.  However these are anecdotes and not systemic lines of reasoning.  In fact dedication is higher topic here and like friendship we will leave it as a draw for today.  More important than money, so much so that the sloshing of moneys shouldn't affect it.  1/2  1/2  public to fiat coin.

诚信 - Integrity

Well this is perhaps the most obvious of the lot.  A sound money system is integral to integrity, you might say.  The secretive injection of newly issued tokens into an economy is anything demonstrates anything but integrity.  It encourages further fraud and further corrodes any integrity present in a society.  Clear win here for public coin -  1 - 0  public coin.

RESULTS

Final score:

Public coin 10.5
Fiat coin   1.5

Public coin like bitcoin is absolutely clearly more suited than fiat coin to a society in which the 12 core values of socialism are respected.

 

The complete story of price inflation in the last century

Abstract:  The total amount of wealth that has been taken by currency issuers over the last century is usually estimated at about 95%.  This estimate is based on data of price inflation, which given enough time will reflect the monetary supply inflation (issuance) created by issuers.  We show here that this estimate is off by at least a factor of ten, and due to time delay the estimate is off by another factor of 10.  The real loss due to our idiocy and treason inherent in accepting privately issued currency is greater than 99.5%, and more likely as high as 99.95%.

A typical plot showing the loss of purchasing power of the dollar, used to infer the amount disbursed to issuers.

1-  Money supply inflation and price inflation

In a monetary system of privately issued currency, inflation is the lifeblood of the system.  Participants jostle for position near the spigots, or in positions in which this blood will trickle down into their coffers.  The arrival of newly issued and laundered tokens is referred to as "growth".  Some people are able to get their hands on newly issued fiat tokens (dollars, euros, yuan, yen, etc.) easily, while others have to pay dearly for them.  This is referred to as interest rate apartheid, because the inequality is well described by the interest rate that people have to pay.  For the most privileged, in a fiat system, that rate is negative infinity percent.  For those much worse off, not only is the interest rate positive but quite high.  An observer is left with a lot of unknowns watching this system in action, in particular:  how much did they issue?  There is no way to tell how much of a privately issued currency (fiat) has been issued, for obvious reasons.

However, all is not lost for the econometricist of the fiat era.  With enough time, issued currency will trickle down through the layers of interest rate apartheid, finding its way into the hands of the general public, and eventually the larger markets will notice its influence.  The inevitable result?  We will see price inflation.

Understanding all of this, we can in some way quantify how much real wealth the currency issuers have taken from currency users by looking at the eventual price inflation which arrives.  Sure, it takes a generation or more for this trickle-down to occur and really affect the prices, but this might be our only metric to see how much the issuers have been issuing.  How much have they been issuing?

The idea is simple, that if we take the price of a commodity like a sandwich, we see that 100 years ago the sandwich cost 95% fewer fiat tokens to trade for then it does today.  A local eatery might have charged 5 cents for a beer a century ago, today they charge 1 dollar.  So, this means that the currency issuers have absconded with 95% of the currency users' wealth, right?

Historical Context

The problem with the above argument is that it ignores historical context.  In particular, a lot has changed about the world in the last century apart from just the number of fiat tokens floating around.  The technology and infrastructure available today is far greater.  How much did it cost for the brewer to make a bottle of beer 100 years ago?  One had to find a skilled knowledgeable braumeister then, as recipes were not available on the internet.  Making bottles was much harder, as was shipping them.  It took more materials and more energy then, and the designs were not as efficient nor were the machines that produced them.  Even growing the wheat was more expensive, as huge increases in automation, engines, fertilizers, and even irrigation have made it easier to grow wheat today.  Distribution and accounting and business were also much harder then, without computers and the internet.  Finding employees was harder, and finding customers, and procuring all the necessary materials.  You get the idea.  Everything was much harder and more costlier then.  A factor of ten here is a reasonable estimate.

What if there had been no monetary supply inflation over the last century, how much would that 5 cent beer cost today?  The answer is about a half a penny.  It's just way easier today to produce, bottle, and transport the beer.  We have massive trucks and interstate highways, we have bottling machines and pumps and computer aided design now.  The point here is that it's not just the loss versus the 1918 dollar that we need to consider in our estimate of how much the issuers have taken from the users, it is the loss versus what we would have been able to purchase had the issuers not been issuing.  And if the issuers had not been issuing, that 5 cent beer would not cost 5 cents today, it would cost half a penny.  That means we are down by not 95% but by 99.5%!

This is what many analysts miss here: the huge wealth that has been generated due to our technological progress and infrastructure.  To look at the current economic situation and say "It's OK, we still get by at least as well if not better than we did a few generations ago" is missing completely the potential gains that you have missed out on due to currency issuers taking them from you.

Imagine that unbeknownst to you there were a package of 1000$ in cash shipped to your residence every week.  Imagine further that a neighbor has been taking it from your mailbox, so that you didn't even know it was arriving.  This is the situation in regards to monetary supply inflation over the last century, as the potential gains of the information age and ubiquitous electric power have been grabbed by currency issuers while fiat currency users are left saying "everything's fine".  Well, really the issuance grab has gone well beyond that and well into taking the direct paychecks too.

Delayed Price Inflation

Once we have considered the changes in productivity due to technological infrastructure, we have an additional factor of 10 or more in our calculation of just how bad our idiocy of accepting privately issued currency has affected our bottom line.  However there is another factor we will need to consider, namely the delay present between the issuance and the price inflation.  This delay is due to the fact that large holdings of a tiny portion of the population don't immediately affect the prices at walmart.  Prices have a certain inertia to them and the issued currency won't affect the price until it has trickled down into the economy to the point where a substantial fraction of customers have a piece of this money.  One guy in the town with a trillion in cash stored in his garage isn't going to mean the local shops jack up the prices - until the guy hires a small army of extremely well paid servants who also shop there.

If we assume that this process takes roughly a generation (this depends highly on spending habits and population size), then we are left with the conclusion that issuers had taken 99.5% of the nation's wealth as of 35 years ago.  This means another factor of 10 in our estimates of how much the issuers have taken as of today.  After all, the money supply gains since we all started talking about quantitative easing still haven't affected food and energy costs.  OK they may have affected some real estate markets and the most expensive art auctions, but not what we typically refer to when we look at price inflation.

The final estimate?  99.95% of all capital has been collected by money issuers and those whom they have bestowed financial favor upon in the last century.  No wonder we are desperate to pull out all the natural resources we can, it's really hard to stay ahead in this game (hint - you never will unless you are an issuer).  The whole thing is just inexcusable really, the enabling of wholesale corruption and squandering of resources by people who should know better.  Sure, it's an episode you might expect of primitive man, an interesting story from marco polo and a lesson to learn from.  But in the 21st century?  People are engaging in the crime of accepting privately issued currency for real goods and services?  Really?