Thursday, April 25, 2013

Bitcoin critical mass, greed, and new digital currency

Bitcoin is the most popular cryptocurrency.  While extremely volatile these past weeks, I believe it is on the verge of reaching critical mass.  It is not perfect, and I will discuss those issues, but the success of bitcoin brings interesting insight into the emotion of greed.

Bitcoin is worth more than 0 because:

  • There is a fixed supply currently of 11M, and it cannot grow past 21M coins.  
  • It has provable scarcity.  Cannot be counterfeit.
  • There is a verifiable public ledger of all transactions and coin creation in history.
  • It costs electricity and equipment in order to create new coins, and so that effort is only made if there is belief that the value is greater than the cost.
Bitcoin is worth $100-$10k each (critical mass) because:
  • Its relatively difficult to make new ones today.
  • It is the most convenient form of value transmission, since it can be sent instantly from home or phone to anywhere, at low or no fee.
  • At over $1B in market capitalization, and $40M+ daily exchange volume, and $70M+ in daily transactions, there is sufficient value to let any one person "buy" most things (that cost under $1M or $2M).
  • If there is enough total value to support one person's transactions, then the value needs to go up as more people use it for transactions.  This is the critical mass point, and arguably occurs well below $1B in market capitalizaion.
  • As more people find bitcoin useful for transactions, more people find it useful as a store of value, anticipating that more other people will find it useful either for transactions or as a store of value.
  • Even if other crypto currencies exist, valuing them in bitcoin, as the leading cryptocurrency, makes the most sense, and this is another source of transaction and store of value for bitcoin.
Disadvantages of bitcoin:
A bitcoin wallet is like a wallet or briefcase full of cash or gold.  It can be convenient to pay for some things with a briefcase full of cash, and bitcoin is quicker and doesn't risk authorities confiscating it when travelling accross borders, and it is divisible to 8 decimal places.  But like a cash wallet, there is no recourse if it is destroyed (without backup), and it is extremely difficult to obtain restitution if it is stolen, and even difficult to have a clue who stole it.  Because a bitcoin wallet is typically stored on a computer, it is susceptible to hacking, viruses, and other electronic theft that would not threaten your briefcase(s).

The banking system does a good job in protecting from and tracing fraud and theft.  While holders of state currencies are not protected from losing value as a result of currency printing, on balance, it would seem more valuable to more people to be protected from theft and fraud, through some tracing of transactions and an "undo" feature/process than they risk losing from political action.  The banking system's imperfection came to light with the April Cyprus events.  Previously most people assumed that when the banking system loses your (depositor) money for whatever reason, your money doesn't disappear.  That confidence, whether factual or not, is critical to the validitity and usefulness of the banking system.

This is the only real disadvantage of bitcoin as a trade currency.  If you are not trading face to face with your cash briefcase, then you have to trust some intermediary, or even your briefcase manufacturer/provider, to temporarily hold your wallet/coins.  

Greed's effect on bitcoin:
Although I am not criticizing, people looking to acquire and hoard bitcoin make it more scarce for people that would like to use it as currency.  But the hoarders are likely eventual spenders, and if the value of the currency goes high enough, the hoarders will sell it back to spenders or other speculators.  Speculation is healthy because higher market capitalization is healthy.  Higher market capitalization is what sustains higher transaction (spending) volume in the long run.  If the value of the US Dollar dropped in value by a factor of 1000 to other currencies, then spending levels of Americans would tend to drop by a factor of 1000 as well.

Greed allowed the decentralized development of bitcoin.  By not requiring central control, early adopters were able to get a head start in accumulating (mining) bitcoin, and invest in software and hardware that allowed them to grab more bitcoin for themselves, and through sharing of software breakthroughs, shared with other early adopters.  Decentralized greed democratized (enabled a wide number of people to participate in) to evangelize, and form a social connection around, bitcoin.

The noteworthy insight on individual greed is that it can be maximized through shared social belief in ideas.  Shared faith in Santa Claus, bitcoin, the dollar, and the banking system leads to a healthier and happier society than if that faith is broken.  Similarly, if people understand that taxing their income benefits them individually by allowing them to work and earn more income, and so is in their interest.  Similarly, we can understand that a fairer, less corrupt, society is in our interest, even if we are not personally at risk of being abused, because a fairer society motivates other social members into contributing to society, and thus assisting you in some way (you might consume their work, and benefit from their share of tax burdens).

New crypto currency design
I have a design for a new crypto currency which I will share with anyone that gives me $20k.  The $20k would be a deposit for future value and promises high returns (the $20k is similar to a loan and has some similarity to this concept).  The design does reward greed through early adoption and investing.  It keeps a predictable limited money supply, but does away with mining lotteries.  Most importantly it provides personal account security, while retaining the option of anonymity.

It incorporates almost all innovations I have previously developed on this site.  For hints (consider it a scavenger hunt) on the implementation, look at this and get through to the grocery store example on this article

As another hint, think crypto society instead of crypto currency.


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