Everything I was Afraid to Ask about Bitcoin but Did

Lambert here: Since Bitcoin is in the news lately, and the last post occasioned some lively discussion…

By Rumplestatskin, a professional economist with a background in property development, environmental economics research and economic regulation. Cross posted from MacroBusiness

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The econ-blogosphere has been Bitcoin crazy for a while now. I haven’t quite understood what all the fuss is about, and knowing the personalities involved in much of the hype, I was afraid to ask too many detailed questions.

But I did anyway.

I finally put together my views following Rabee Tourky’s post at Core Economics, and a recent note by CommSec’s Craig James earlier in the week.

So what are the big questions about Bitcoin that need answering? There are two: What is its purpose? And, how will it maintain value and avoid volatility?

To answer the first question it is worth starting with Bitcoin founder Satoshi Nakamoto’s paper about a peer-to-peer electronic cash system. He repeatedly remarks that the benefit of electronic cash is being able to avoid intermediary financial institutions, thus cutting down transaction costs, and that the reversibility of such facilitated transitions is an inherent weakness. I quote from the paper at length.

While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model. Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for non- reversible services. With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable. These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.

What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers. In this paper, we propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions. The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.

Here’s where the circularity of arguments about trust comes in, and where my first question about the purpose of Bitcoin becomes rather confusing. What sort of transaction would buyers be willing to undertake without a trusted intermediary? Twitter was not much help either…

But even in the case of ‘dodgy anonymous transaction’ as one of my mates suggested on Facebook, the whole point of Bitcoin is a record of transactions or ‘money as memory’. A court could order Bitcoin’s administrators to disclose transaction details in any case. Not only that, US officials have shut down digital currency operations in the past.

Authorities have also been looking into the criminal aspects of virtual currencies. Wolf Richter’s exposition of Bitcoin examines some of their discussions.

Officials from the Secret Service, the Treasury’s Financial Crimes Enforcement Network, and the Justice Department bragged to the committee about successful investigations of crimes where bitcoin or other virtual currencies were used, including the busts of Silk Road, eGold, and Liberty Reserve. They were confident that they knew how to tamp down on criminal use of virtual currencies. No one expressed outright alarm about the new world of bit coin.

Since every transaction of every bitcoin is forever recorded and part of the system, Mythili Raman, acting assistant attorney general at the Justice Department’s criminal division, pointed out that “cash is still probably the best medium for laundering money.” And she admitted that “many virtual currency systems offer legitimate financial services and have the potential to promote more efficient global commerce.”

At the word legitimate, bitcoin soared. And I mean, SOARED.

My line of thinking about potential benefits of Bitcoins is to consider what sort of transaction I would like to be unable to reverse. Would I ever purchase items on eBay with irreversible electronic cash, assuming that eBay itself did not provide any other intermediary role apart from advertising? Nakamoto seems to suggest that the cost of financial intermediaries excludes very small transactions, yet facilities like Flatter seems to overcome this problem through batching transactions.

The success of Paypal as an online payment system is partly due to the insurance it buys for both buyer and seller for the transaction. Anyone who refused payment from Paypal would be signalling their untrustworthiness or unwillingness to meet conditions of any mediated dispute. The point being, rather than creating a payment system that doesn’t rely on trust, using Bitcoin over other payment methods will itself signal a lack of trust. All transactions require some trust. There is no escaping that. Online that is even more important. For example, you pay me with Bitcoins, then I don’t post your goods, what recourse do you have?

So far there is no reasonable answer to my first question about the purpose of Bitcoins.

My second question unfortunately reveals similar unsatisfactory answers. If Bitcoins really are limited by constraints on ‘mining’, then that will mean that in a situation where they are in demand as a medium of exchange, they will also be increasing in value and be a means of investment. As more people prefer to hold Bitcoins as investments rather than exchange them, this will push their value higher still. If you can’t see it coming, the end result is a massive bubble followed by a crash when the herd realises that their investment value was purely based on herd mentality, without any fundamental resources backing it, and that the system is no longer being used as a medium of exchange. This view has been put forward previously by Eric Posner.

It’s not like alternative payment methods have not been tried many times before. Bartercard springs to mind as one system that survives in its business-to-business niche.

So let’s summarise. Bitcoins have been severely hyped online yet almost no one can suggest scenarios for both buyers and sellers in which they are actually a more useful medium of exchange than current costly reversible transactions. Furthermore, the ability for Bitcoins to hold there value is severely hampered by the nature of their technically limited supply. To top it off the only people I know of who have owned Bitcoins were speculating and never used them to transact. I can only conclude that this episode will go down in history as a lesson about the nature of money and trust in facilitating trade.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.

40 comments

  1. Dr Duh

    I think you are approaching trust from a overly limited perspective. While a buyer benefits from reversibility, e.g., they can get their money back if the seller tries to defraud them by failing to ship or shipping damaged/counterfeit goods, for the seller reversibility is pure liability. With the increase in identity theft sellers have to deploy complicated schemes to prevent charge-backs secondary to fraud. My understanding is that Paypal and Ebay are almost entirely unsympathetic to the sellers in these cases. With Bitcoin, the buyer could easily duplicate the advantages of Paypal by using a third party escrow service and not release funds until they receive their goods. While it would impossible to defraud the seller.

    But, the real point is that Bitcoin transfers are private. While the record of the transaction is encoded it is linked to a Bitcoin address, which is disposable. These can be tracked by ip addresses, but those can be obscured through TOR.

    In the panopticon era, privacy is in itself a good. Any transaction in which any degree of privacy is desired is suitable for Bitcoin.

    1. Yancey Ward

      This! The transaction is inarguably more private than any other electronic transaction available, and the funds themselves are less open to confiscation by third parties like, for example, a government.

    2. reslez

      Bitcoin transactions are only quasi-anonymous. Setting aside the recent research that demonstrated this, you can identify 99% of individuals if you have 2-3 time/location data points. Maybe this is the part where Ellison chimes in “get over it”.

      1. Yancey Ward

        It isn’t hard to make a totally anonymous transaction using Bitcoin as long as no physical goods and services are transferred. However, Bitcoin purchases have the same anonymity problem a cash transaction has- you need to pick up the goods and services somewhere, or have them delivered to an address.

        1. Yancey Ward

          They weren’t trying hard enough, and the main problem is that a lot them had been buying deliverable goods, just like I warned.

          Stupidity exists.

          1. strider

            Well then WTF are you supposed to use Bitcoins for? I use currency to pay for stuff I need/want. Things that I need to take possession of in order to use/consume.

  2. BitcoinJerk

    Why conclude anything given the experiment is ongoing and no one really knows how it will come out? I’m not clear either what your hostility is to a payment system that works around the criminal banking cartel. I would think you would embrace such a radical idea, even if an imperfect stage in an evolving area of commerce.

    Bitcoin is terribly volatile (at times), has deflation built into it and isn’t as anonymous as it could be, but as a virtual currency it has outperformed every other virtual currency in pretty much every measure. In other words its a major jump forward, and both the proposed alterations to bitcoin (like zerocoin), and the myriad competing VC’s coming online (like litecoin, etc, etc) are very promising. Sure you can’t buy much with it right now (except for all sorts of legal and illegal drugs, computers, guns, VPN service, etc) but that is changing, and the more the media and government ignore bitcoin the stabler its price is.

    Once the legality questions are at least temporarily laid to rest and the newness factor recedes, bitcoin will stabilize, but we may not care because a new currency may be up and coming anyway. This industry is far from mature but its promise is the best we’ve ever had for unshackling the people from the banking cartel. In fact, I’m somewhat shocked that we’re hearing anything positive about it from government given who owns government ;). This is why Yves calls it prosecution futures (I think). But it feels like bitcoin has reached a point where putting the genie back in the bottle is going to get harder and harder going forward. They had their chance to stop it this week with the senate hearings. They know not what they’ve done.

    1. Massinissa

      “has outperformed every other virtual currency”

      Yeah, by becoming not a currency but a volatile security…

      When is Bitcoin ever used for real transactions?

      1. BitcoinJerk

        Your question was answered in my comment.

        I’m not trying to claim some mantle of purity or the salvation of humanity as some silly commenter downthread has insisted anyone who supports bitcoin must. I’m simply pointing out that paypal, which you’ve trumpeted in the OP, and the bankign cartel are an awful system that people are forced to use, and hate. These virtual currencies are trying to offer a new, decentralized currency system that eventually may help to take a huge bite out of the economic rents and currency stranglehold enjoyed by the cartel. Anything that moves us in that direction should be celebrated for its potential alone.

  3. slothrop

    Still waiting for one bloody economist to understand bitcoin.

    “What sort of transaction would buyers be willing to undertake without a trusted intermediary?…For example, you pay me with Bitcoins, then I don’t post your goods, what recourse do you have?”

    It’s called a multi-signature escrow. It’s built into the code.

    “As more people prefer to hold Bitcoins as investments rather than exchange them, this will push their value higher still. If you can’t see it coming, the end result is a massive bubble followed by a crash…”

    Egads! A real market! As the early adopters cash out the bitcoin ecosystem will become more decentralized and therefore stronger. As markets gain depth they become less volatile.

    We’ve heard all this before.

    1. Vedicculture

      Markets never become less volatile. They are by nature built on degenerated segments of society.

      It is why, market statism is one of the final lines before the rule of the peasants and nothingness.

      We have gone from building great pyramids, works of art and accomplishments to now building homes for the mass man and worrying about markets over greatness.

      Bitcoin represents this degeneration to its nth degree. The Nation State was built to replace the decayed Feudal State(which itself was a degeneration). Now wer replace the Nation State with the Market State.

      Enjoy your creation, why it lasts………….

  4. R Foreman

    The bitcoin purpose, and it’s primary attraction is it can’t be manipulated, devalued, by central banks the way fiat can. As for volatility, all I can say is ‘bitcoin cost averaging’ :)

    It always seems to end up higher than it was a few weeks ago. The same can’t be said for fiat. Why would I want to pay some banker fee to get into a security when my currency can go up in value without any fees at all?

    1. El Guapo

      “It always seems to end up higher than it was a few weeks ago.”

      And this will, of course, continue forever and ever and ever.

      1. R Foreman

        You’re in bitcoin country now guapo. You can use it as currency, or you can just sit on it and watch it go up to make you wealthy. That’s money the bankers would like to see going into their own filthy little pocketses. So take your pick, be a rich rock star, or be a wanker bent over the railing anally violated by a pencil neck banker repeatedly throughout your life.

    2. OpenThePodBayDoorsHAL

      Wow this thread has just so much economics blather (yah like that “science” has proven just soooo useful so far), technical ignorance (“…Bitcoin administrators”), and general bloviating. Before people get them further in a wad, just simplify a bit. I can send an email to anyone I wish. Now I can transfer value that way too. No I don’t want or need a third-party in the middle, any more than a Chinese factory manager wants someone between him and the European buyer he found using the internet. The Bitcoin system is an electronic accounting ledger, and a Bitcoin is just an entry on that ledger.

  5. DakotabornKansan

    Bitcoin: Currency of the future? Speculative bubble? Ponzi scheme?

    Not many people understand money. Money often takes on the nature of a belief system.

    Gideon Samid, chief technology officer for BitMint, which is testing digital dollars, writes:

    “My heart goes for the wide-eyed true believers who revel now with the joy of the savior algorithm. It is a beautiful piece of abstract art. As a cryptographer, I am fortunate to have the background to truly appreciate its beauty, much as I appreciate the artistic beauty of ancient statues of various “Gods,” vainly worshipped for centuries.

    What doomed communism, and will likely undermine Bitcoin, is the delusional hope that a protocol, a procedure, a network, an algorithm can neutralize the ugly selfish traits of human beings. Somehow, wrath, greed, sloth, pride, lust, envy and gluttony disrupt the fairy-tale dreams of the true believers. Alas, they camouflage themselves for a long time before the bitter truth becomes clear…

    “The just rising Bitcoin ruling class surely understands what it takes to implement the high minded principle of “decentralized, majority-rule money” immunized against any power-hungry minority by the unassailable weapons of probability, crypto-intractability, and one-way functions. The Bitcoin pacesetters are likely to wash the trusting public with the vision of money that pops up in abstraction owing to the cleverness of the modern priesthood of mathematicians and network wizards. They will paint the alternative, fiat currency, as the root of all evil, as the reason for why so many of us are still poor…

    “Bitcoin traders stand to lose their earthly assets overnight, once the hidden mathematical insight that would melt Bitcoin is one day discovered, and unleashed. Chances are that the National Security Agency and other cyber-war ministries around the world have already cracked the hashing algorithm that keeps the currency afloat, and it is for them to choose when to unleash it. It is sort of an irony that in their flight from central bankers the Bitcoin traders subjugate themselves to cyber-war tsars who serve the same governments.”

    http://www.americanbanker.com/bankthink/the-bitcoin-delusion-1063723-1.html

    The virtual-currency craze is the modern day equivalent of tulip bulbs.

    “A ‘cryptocurrency’ craze has spawned more than 80 entrants, from peercoin and namecoin, to worldcoin and hobonickels. In October and November alone, developers launched gridcoin, fireflycoin and zeuscoin. Bbqcoin has enjoyed a renaissance after a false start in 2012. Litecoin, launched in 2011, has turned into the strongest bitcoin alternative.”

    http://online.wsj.com/news/articles/SB10001424052702304607104579210051252568362

    1. from Mexico

      The Bitcoin pacesetters are likely to wash the trusting public with the vision of money that pops up in abstraction owing to the cleverness of the modern priesthood of mathematicians and network wizards. They will paint the alternative, fiat currency, as the root of all evil, as the reason for why so many of us are still poor…

      That’s my take on the Bitcoin crowd. They’re touting a simplistic and highly reductionist solution to a very difficult and intractable human problem. Since we’re talking theology and ideology with the Bitcoin crowd more than anything else, something the theologian Reinhold Niebuhr said is appropriate:

      Those who are not perplexed have dissolved all the mysteries and perplexities of life by some simple scheme of meaning. The scheme is always too simple to do justice to the depth of man’s problem. When life reveals itself in its full terror, as well as its full beauty, these little schemes break down. Optimism gives way to despair.

      –REINHOLD NIEBUHR, “Mystery and Meaning”

      John Kenneth Galbraith elaborates on “the depth of man’s problem” in Money: Whence It Came, Where It Went:

      Much discussion of money involves a heavy overlay of priestly incantation. Some of this is deliberate. Those who talk of money and teach about it and make their living by it gain prestige, esteem and pecuniary return, as does a doctor or a witch doctor, from cultivating the belief that they are in privileged association with the occult — that they have insights that are nowise available to the ordinary person. Though professionally rewarding and personally profitable, this too is a well-established form of fraud. There is nothing about money that cannot be understood by the person of reasonable curiosity, diligence and intelligence…. The study of money, above all other fields in economics, is the one in which complexity is used to disguise truth or to evade truth, not to reveal it.

      [….]

      [H]istoriography — the tendency to attach vast adverse consequences to monetary behavior of which the observer happens to disapprove — is one which we will find frequently to recur. It should, needless to say, be regarded with the utmost suspicion.

      [….]

      [With the rise of Dutch banking in the 16th century] the problems associated with money ceased to be those of coinage; they became, instead, those of banks and exchequers, not excluding those of the institutions that had been established to safeguard the coinage. A constant in the history of money is that every remedy is reliably a source of new abuse.

      [….]

      Out of the 2500 years of experience and 200 years of ardent study have come monetary systems that are as unsatisfactory as any in the peacetime past. In recent times conservatives have reacted adversely to inflation, though not with great enthusiasm to the measures for preventing it. Liberals have thought unemployment the greater affliction. In fact no economy can be successful which has either. Inflation causes discomfort and frustration for many. Unemployment causes acute suffering for a lesser number. There is no certain way of knowing which causes the most in the aggregate of pain. It was the prime lesson of the ’30s that deflation and depression destroyed international order, caused each nation to try for its own salvation, indifferent to the damage that its efforts caused to neighbors. It has equally been the lesson of the late ‘6os and early ’70s that inflation too destroys international order. Those who expresss or imply a preference between inflation and depression are making a fool’s choice. Policy must always be against whichever one has.

      https://anonfiles.com/file/7401950f3b2717503553dcfb8b51d10a

    2. Robert Dudek

      What doomed communism, and will likely undermine Bitcoin, is the delusional hope that a protocol, a procedure, a network, an algorithm can neutralize the ugly selfish traits of human beings. Somehow, wrath, greed, sloth, pride, lust, envy and gluttony disrupt the fairy-tale dreams of the true believers. Alas, they camouflage themselves for a long time before the bitter truth becomes clear…

      This could just as easily be applied to Central Banking.

  6. Alex SL

    Furthermore, the ability for Bitcoins to hold there value is severely hampered by the nature of their technically limited supply.

    Yup, that’s why the world moved away from gold and silver as currencies and why central banks were created and tasked with maintaining some reasonable inflation targets. May not always work perfectly but we have arrived at the system we have today through trial and error, not merely because of some sinister conspiracy or whatever.

    Supposedly there is a Chinese saying as follows:

    There are three ways of learning how to do things. The noblest, through contemplation. The easiest, through copying others. And the hardest, through experience.

    The Bitcoiners may just turn out to be the kind of people who need to learn the hard way what we should already have learned, collectively.

    1. AbyNormal

      there is an american one too…

      There are three kinds of men. The one that learns by reading. The few who learn by observation. The rest of them/bitcoiners have to pee on the electric fence for themselves.
      Will Rogers

  7. Anonymous

    What kind of transaction would it be useful for, if it has no third party? Really?
    What a ridiculous question; what kind of transaction is cash useful for?
    Will third party systems evolve around bitcoin? Of course. But it will not take away this fundamental cash-like property; it will always be available to bitcoin owners.

  8. Aussie F

    Call me provincial, but I’m sticking to Cash and Cannabis. It’s irreversible, and if anyone attempts to bust me I’ll simply roll a huge spliff in high denomination notes and puff away like Willie Nelson at a Grateful Dead reunion.

    It’s worked for the Clintons, and it’s worked for me. Win/Win.

  9. miles

    “A court could order Bitcoin’s administrators to disclose transaction details in any case.”

    What? Who are “Bitcoin’s administrators”? And why would they need to “disclose transaction details”?

    All transactions are stored on the blockchain forever for all to see. Absolute proof of payment is very easily established.

    “Not only that, US officials have shut down digital currency operations in the past.”

    They can’t simply “shut down” bitcoin. The digital currency operations of the past which were shut down were not decentralised! With bitcoin, there is no single point of attack. The US could ban exchanges that deal in USD but exchanges elsewhere in the world – or on Tor, for example – would thrive.

    1. Anon observer

      The writer of this piece haven’t come out of the big illusion. The court, government, the administrators, to order, to ban, to shut down … (centralisation concepts)

      If he understand 9/11, the bankers, the currency wars, oil wars, and outsourcing of productions and its complication, he wouldn’t wrote as such “A court could order Bitcoin’s administrators to disclose transaction details…”

      The mind we are using is a massive democratic/decentralised structure of billions of neuron. If man and his mind survives, then decentralised electronic cash will.

  10. John

    The reason why the Fed said they will not interfere with the Bitcoin craze is because Wall Street sees another opportunity to swindle the uninitiated. Heaven forbid Washington get in the way of Wall Street ripping off Main Street.

  11. David Golumbia

    this piece, like any other by economists, has already brought out the trolling algo-heads who believe their knowledge of software trumps actual study of economics. Most hilarious are comments like its “primary attraction is it can’t be manipulated, devalued” at the very moment when, and as your charts show, it is being manipulated and devalued.

    I’ve written a brief piece on my uncomputing blog on the political/intellectual or as I’d call it, ideological craziness behind the contradictory claims for Bitcoin that readers may find complementary to this, called “Bitcoin Will Eat Itself: More Contradictions of (Digital) Libertarianism.”

  12. Beppo

    Bitcoin is a wildly successful pyramid scheme first, and a nice way to buy drugs online second, and that’s it. that’s all it will ever be.

  13. indio007

    I stop reading here.
    “A court could order Bitcoin’s administrators to disclose transaction details in any case.”

    He literally has not done sufficient research in how BTC functions and has literally no clue that all transations are already completely PUBLIC.

    The only way to shutdown BTC is to kill the internet worldwide.
    It is immune to network filtering because packets can’t be inspected (looks like any other encrypted traffic) and port usage is randomized.

    This harkens back to my comment yesterday on the same topic. People do not understand how it systemically functions.

  14. Noclue

    Bitcoin may be just a pilot test run for another upcoming new and improved electronic coin, which the 1%’s will love.

  15. Yancey Ward

    My main suspicion of Bitcoin is technological rather than philosophical. Right now, I do believe Bitcoin is unhackable. Claims that the NSA already has broken it are not credible. However, this certainly won’t always be true, and it isn’t clear to me that Bitcoin is upgradeable in a manner that stays ahead of the curve in this regard. For this reason, I think Bitcoin is actually always going to be in danger of being replaced by a virtual currency with higher cryptography standards, and those currencies will face the same issues, but pushed further into the future at each step until one is developed that has cryptography standards that can grow faster than the ability to break it.. In other words, I dont think the store of value function is going to work for Bitcoin over the long haul.

    1. Technosnoop

      Just pure speculation on my part, but some unnamed foreign goverment with big cash could theoretically speculate on bitcoin to gain some money to finance their spies in the US itself, undermine the US payment system based on electronic $ ‘printed’ on the electronic banking system by the now outgoing Ben. $940/BTC means to some not the volatile of BTC, but the value of the USD itself, ie 0.00106 BTC/$.

  16. Yancey Ward

    As for its volatility- this is basically unavoidable. Adoption of this as a means of transactions necessarily starts small, and shallow markets are almost always volatile markets. If adoption continues apace, the volatility should subside as a function of market depth. In other words, the volatility is what draws the speculators, but as more try to speculate in this market, the volatility will decline, not rise.

    1. David Golumbia

      really. care to point to any currency in history that has worked that way? or is that off-the-cuff monetary theory that you are very certain is correct, because you are? Other than e.g. the Zimbabwe dollar or Weimer Germany, I can’t think of successful currencies that have behaved the way Bitcoin does. And calling those “successful” is something. Oh, the tulips would count. They were currency too, and had some inherent value. A big success. And they “settled down” when?

      small commodity and other trading markets are often volatile, but all of that points toward bitcoin being a commodity, not a currency, and a commodity with no inherent value other than as a currency, it is ripe for the manipulation of any with the power and money to do so (e.g., the Winkelvii). the idea that volume will tame volatility is interesting, but there are plenty of widely-traded stocks, options, and other derivatives *more* regulated than Bitcoin that experience wild swings on a regular basis.

      I suspect one reason cryptocurrencies have not been made illegal already is that the big banks see how incredibly naive and ill-informed their supporters are about capital and fiscal policy, and see how incredibly useful unregulated instruments are for them to strip even more capital from the rest of us. And that is freedom.

      1. Yancey Ward

        There are a number of currencies traded in the world whose volatility (up and down) is high, and whose corresponding market is relatively thin and illiquid. This is the problem Bitcoin has- its market is thin and relatively illiquid. The Zimbabwe dollar and the Weimar Mark are not even really good comparisons to Bitcoin either since their volatility was basically one-directional as everybody and his brother attempted to get rid of them.

        This isn’t a monetary theory- the deeper the market, the less able a single transaction is to move the price. This is cold-hard fact, and we see it every single day in the big currency markets where the volumes traded by speculators are simply enormous, but the movements are a fraction of what you see Bitcoin. As for a commodity, you see the exact same thing- the bigger more liquid markets are much less volatile than the smaller less liquid ones, and for the same fundamental reasons- each individual trade is a smaller fraction of the whole.

      2. Yancey Ward

        the idea that volume will tame volatility is interesting, but there are plenty of widely-traded stocks, options, and other derivatives *more* regulated than Bitcoin that experience wild swings on a regular basis.

        It isn’t volume so much as it is the dollar depth of the market. The most volatile stocks are almost always those with low dollar/high volume action- in other words, they really aren’t that many people speculating in them. Think OTC stocks, for example. A penny stock trading 50 million shares/day isn’t a deep and liquid market. However, there are very few highly volatile stocks where the market capitilization is over $20 billion.

        How many people are trading Bitcoin today? I doubt the number is higher than ten thousand people altogether. What is the dollar volume/day? Probably less than ten million dollars over all the exchanges for Bitcoin.

        Your point about options actually supports me. The most volatile options are the ones with the lowest dollar volumes of trades/day.

        1. David Golumbia

          you’re talking *relative* volatility being lower as the number of entrants increases, but that’s really hard for me to understand as supporting the case for bitcoin as currency. Very few stocks reach market capitalization levels that truly damp volatility–S&P Midcap 400 stocks are plenty volatile and the small caps even more so. Gold is awfully volatile, a point that the goldbugs never want to discuss in detail. Do you have a case where a currency starts volatile and then its “market cap” (what is that, what is “dollar depth,” with regard to a currency? it usually has some relation to GDP or some other measure of national economic power, and in this sense Bitcoin is even more of a “fiat” than they are, since there is no underlying economy to which it is tied) grows substantially, making it stop being volatile?

          If you are right–and I suspect you are–that there are very few participants in the bitcoin market today, I’m not sure how or why we’d expect more entrants to *be able to* participate–if I were the Winkelvii & other such folks I’d be doing my best to corner huge parts of the market in order to manipulate to my heart’s content. I just don’t see what the path is from that sort of unregulated, outright manipulation without any connection to any economic reality, to the price stability that a currency reuqires.

          Can you provide examples of the world currencies that you consider to be or to have been like Bitoin and show them progressing from instruments too volatile to serve as stores of value (and yet serving as OK mediums of exchange within their own economies), to relatively stable ones? I can’t think of any, but my knowledge of world money markets is limited to the more major ones.

  17. Ross Thomas

    Bitcoin simply can’t work as it’s being sold right now. The block chain is already over 11 GB (http://blockchain.info/charts/blocks-size) and is growing rapidly. It’s already too big for e.g. mobile devices and will soon be too big for most consumer-grade hardware and network connections, necessitating the use of “thin clients” which compromises both pseudonymity and decentralization–two of the currency’s key selling points. If the majority of users run thin clients, or simply keep their Bitcoins in an online wallet, then I see little difference between it and regular deposit money aside from how the two are created.

    For details see my guest post at Testosterone Pit (http://www.testosteronepit.com/home/2013/4/9/bitcoin-bait-and-switch.html). This really, really needs to be more widely understood!

  18. David Golumbia

    you’re talking *relative* volatility being lower as the number of entrants increases, but that’s really hard for me to understand as supporting the case for bitcoin as currency. Very few stocks reach market capitalization levels that truly damp volatility–S&P Midcap 400 stocks are plenty volatile and the small caps even more so. Gold is awfully volatile, a point that the goldbugs never want to discuss in detail. Do you have a case where a currency starts volatile and then its “market cap” (what is that, what is “dollar depth,” with regard to a currency? it usually has some relation to GDP or some other measure of national economic power, and in this sense Bitcoin is even more of a “fiat” than they are, since there is no underlying economy to which it is tied) grows substantially, making it stop being volatile?

    my point is that there is no guarantee whatsoever of the path from low turnover/high volatility to high turnover/low volatility. many instruments stay in the high volatility range for their whole lives. you say it’s inevitable, but you give examples of instruments that often never make it to the low volatility benchmark.

    If you are right–and I suspect you are–that there are very few participants in the bitcoin market today, I’m not sure how or why we’d expect more entrants to *be able to* participate–if I were the Winkelvii & other such folks I’d be doing my best to corner huge parts of the market in order to manipulate to my heart’s content. I just don’t see what the path is from that sort of unregulated, outright manipulation without any connection to any economic reality, to the price stability that a currency reuqires.

    Can you provide examples of the world currencies that you consider to be or to have been like Bitoin and show them progressing from instruments too volatile to serve as stores of value (and yet serving as OK mediums of exchange within their own economies), to relatively stable ones? I can’t think of any, but my knowledge of world money markets is limited to the more major ones.

    to be as clear as possible, I don’t necessarily believe it’s a Ponzi scheme or dishonest or anything–I believe that Bitcoin is a wacky, very wild, derivative/commodity, and anyone brave enough might make (or lose) money betting with or against it–I would not deny that for a second. I deny that there is anything about it to support the claim that it can serve as the currency it is promoted as.

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