Bitcoin: a solution in search of a problem

Since coins are my business, perhaps I should discuss Bitcoin.

It’s a “cryptocurrency” or digital currency. Or supposed to be. Existing only in cyberspace but worth money of the more conventional sort. It has a whiff of underground rebellion, breaking free from the system of government-run money supply — and all its associated regulation. The idea is to make transactions untraceable by snooping government. Thus, Bitcoin payment has featured in some shady doings, notably the “Silk Road” venue for, mainly, illegal drug trades, and in ransomware attacks (where bad guys hack into your computer and lock you out unless you pay them).

This Satoshi Nakamoto denies it

How does Bitcoin actually work? Such a system’s main challenge is to prevent the equivalent of counterfeiting. People spending Bitcoins they don’t own, spending the same coin twice, etc. Bitcoin’s solution is what’s called a “blockchain,” invented by a mysterious, probably pseudonymous “Satoshi Nakamoto,” who has since vanished. A blockchain, or “distributed ledger” is a kind of database which isn’t centrally controlled, but accessible to everyone, such that when a new transaction is recorded, it cannot thereafter be altered. Thus every Bitcoin transaction ever occurring is indelibly encoded into the blockchain.

Bitcoins are created by “mining.” This entails beating other punters to the solution of a complex mathematical puzzle requiring vast computer power, the winner garnering a reward in fresh Bitcoins. That serves to limit expansion of the “money supply.” In fact, it’s ultimately capped at 21 million coins. Mining Bitcoins consumes so much electricity that this has become a real problem for power supply in areas where miners locate (usually places with low electric rates).

Bitcoin’s value started at nine cents on July 18, 2010. With much fluctuation, it topped $19,000 in December, 2017, then fell by about two-thirds.

That huge run-up in value prompted numerous copycats to jump in with their own “cryptocurrencies,” introduced via “initial coin offerings” (ICOs), mimicking “initial public offerings” for securities. But they aren’t shares in a business or promises to pay (like bonds). They are only worth . . . well, what the market decides they are worth. Not much, it often turns out.

But what makes a Dollar worth a Dollar? A tautological question. Writer Yuval Noah Harari likes to call this a fiction kept aloft because a lot of people believe it. You accept a Dollar as payment because you expect you’ll be able to similarly spend it. But that web of expectation is its only value; you actually can’t take it to the government and exchange it for some commodity of tangible value, like gold. (And what makes gold so valuable, except our mutual understanding to so treat it?)

Anyhow, that ready universal acceptance is what makes a currency a currency; and cyptocurrencies singularly fail that test. A currency must also be a store of value, and the wild fluctuations in cryptocurrency prices fail that too. Nobody wants to accept a currency that could lose half its value in a short time. (Of course, this does happen occasionally with national currencies, like Venezuela’s right now — a huge economic disaster.)

Add to that the lack of what might be called consumer protections. The cryptocurrency world is rife with fraud and sharp practice. Most ICOs are really nothing more than scams.

A lot of people made a lot of money on Bitcoin; a lot of people lost their shirts. The reality is that Bitcoin has become not a currency but, mainly, an object of speculation, which is not at all what “Satoshi Nakamoto” had in mind. And the fact is that Bitcoin, after all, has no objective value that can be ascertained. The mining process is costly, but that expenditure does not somehow confer intrinsic value on the results. Nobody will value a Bitcoin based on its creation having entailed solving an abstruse mathematical puzzle.

Indeed, why it should have any value at all remains a salient question.

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8 Responses to “Bitcoin: a solution in search of a problem”

  1. Lee Says:

    That Bitcoins have some value is a little bit complicated to explain, but here is my attempt. You know those challenges you sometimes get on the web where you have to type in some letters you see in a fuzzy image or have to select all panes of an image that contain a road sign, etc.? Those are there so that web sites can weed out ‘bots and have a higher chance of getting a real person.

    In theory, there is no reason that you have to do the challenge immediately before using the web site. One could imagine a scenario where a third party offered you the opportunity to do a bunch of challenges and receive a certificate of completion for each such challenge. Later, when you visit a web site, you could tender one of your certificates rather than do the challenge then and there.

    A Bitcoin is, in effect, a collection of such certificates: perhaps proof of thousands of completed challenges.

    Heck, if you are believing what I am saying, you could probably imagine that there could be a market for these certificates. Instead of doing a challenge, shell out some moola and buy a certificate from someone who has done the challenge (or who had bought the certificate from someone previously).

    Now, these fuzzy-letter challenges aren’t valuable in their own right, but are worthwhile only because they prove you’ve done some work. Instead of doing pointless fuzzy-letter work, Bitcoin is based upon doing pointless guessing, trying to find strings of letters that satisfy some provably hard-to-reverse-engineer mathematical formula.

    The formula is adjustable and when the number of Bitcoins reaches a new threshold, the formula gets harder by a factor of 2 and one needs about twice as many guesses to get a winner. In effect you then have to do twice as many challenges as before to mint a new Bitcoin.

    All this doesn’t make Bitcoin worth $19,000, but maybe I’ve explained that Bitcoins aren’t worthless.

    One of the competitors for Bitcoin is something called Gridcoin. For the latter, the work isn’t pointless. You volunteer spare CPU cycles on your computer for high-computation scientific analyses — and get Gridcoins to certify that you completed some work for the project.

  2. rationaloptimist Says:

    Thanks, I appreciate what you’ve done, but I don’t think you’ve explained why a THIRD PARTY, who gets no benefit from the “work” should place any value on a Bitcoin.

  3. Axel Kornfuehrer Says:

    The Chinese puzzle seems clearcut — the shoes = 10, the second device [can’t make it out] = 5; the third device = 4. Thus the last total should be 19.
    I am curious to know if in my simpleminded approach I missed a complicating factor.

  4. rationaloptimist Says:

    Actually “third” device in third line is DOUBLED, so answer is 17!

  5. Lee Says:

    There are a number of parties being discussed, so I might be misunderstanding which “third party” you mean. Trying to cover my bases ….

    A web user might not want to do a fuzzy-letter challenge but instead purchase and tender a certificate of completion from someone who has. Saving time is worth money.

    From the perspective of a web site owner …if ‘bot writers could afford to pay humans to do the fuzzy-letter challenges for the ‘bots, the would be happening already and the fuzzy-letter challenges wouldn’t be much of an impediment to ‘bots. When a ‘bot cannot do the challenge nor afford to buy the certificate then the tendering of a certificate is the proof of humanness that the web site owner is looking for. Web site owners find value in that proof of humanness.

    Blockchain is the mechanism by which certificates are known to be genuine.

  6. rationaloptimist Says:

    But this is not how Bitcoin works. You can do nothing with it except “spend” it with someone who will agree to accept it in lieu of money.
    You are making it too complicated.

  7. Lee Says:

    Chinese puzzle ad: 10, 5, and 2. There is a times sign in the last line. But is it (10 + 5) × 2 = 30, computed left to right or 10 + (5 × 2) = 20, computed using “MDAS” order of operations?

  8. Lee Says:

    I would argue that the reason people buy shares of stock that don’t pay dividends is similar to the Bitcoin valuation. With the stock, why buy it if you can’t get your money back in dividends? The reason anyone is willing to buy the stock from you is that, even absent a stream dividends, it is known that the value of the company isn’t vanishing into thin air and that, one way or another, that value will eventually be realized — e.g., dividends or a partial stock buyback in the distant future.

    So, maybe no one is actually using Bitcoin to pay to get access to web sites at present. But that doesn’t mean the value is vanishing into thin air.

    I am not trying to justify the valuation of $19,000! … only that the value is greater than $0.

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