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.