• Tag Archives cryptocurrency
  • Why Bitcoin Is Technically an Inflationary Currency—Even Though Its Purchasing Power Is Increasing

    Inflation is commonly defined as “a general increase in prices and fall in the purchasing value of money.” For example, if a six-pack of beers cost $8 last year, but this year the same six-pack costs $16 then the annual inflation rate was 100 percent. This is because the price doubled for the same quality and quantity of beer.

    To put it in perspective, the most famous hyperinflations occurred in Zimbabwe and in Germany. In 2003, Zimbabwe’s monthly inflation rate hit 7.96 x 1010 percent, and in 1923 the German government’s hyperinflation caused the exchange rate to rocket to 4.2 trillion German Marks to one U.S. dollar.

    Using the common definition, Bitcoin is deflationary because Bitcoin’s purchasing power increases over time.

    However, the traditional definition of inflation, according to the British Currency School, was an increase in the supply of money that was unbacked by gold. According to Reinhart and Rogoff’s This Time is Different, governments have been inflating currency over the past 800 years.

    Originally, governments would inflate the currency by debasing gold coins. During the 20th century, government inflation technology advanced to printing presses, and currently, governments are able to inflate the monetary base by digitally creating money by updating internal databases that track fiat money, which is predominately digital.

    Using the traditional definition, Bitcoin is inflationary because the supply of Bitcoin increases over time.

    Gold is considered the ultimate store of value because of one specific characteristic: scarcity. No person or group can will gold into existence. Instead, the supply is controlled by nature. Figure 1 (above) shows the supply of gold has had a stable inflation rate. The creators of Bitcoin designed its inflation rate to mimic gold’s stable inflation rate.

    Figure 2 (below) shows the circulating Bitcoin since its creation in 2009. As the inflation rate decreases, the price for each Bitcoin should increase, ceteris paribus. Bitcoin’s inflation rate was hardcoded into the software that operates Bitcoin. Hardcoding Bitcoin’s inflation is similar to Milton Friedman’s K percent rule that called for an algorithmic and regulated inflation rate that would eliminate human-error and the temptation to manipulate the monetary base for political reasons. However, Bitcoin’s inflation algorithm was designed to make Bitcoin even scarcer than gold.

    There is a fixed amount of 21 million Bitcoin that can be minted, which means that no coins can be minted once this amount is reached. Approximately 80 percent of the total amount of Bitcoin has already been minted. Bitcoin’s algorithmic inflation rate since 2010 is displayed in Figure 3 (below) and is explained in the original white paper written by Satoshi Nakamoto.

    “To compensate for increasing hardware speed and varying interest in running nodes over time, the proof-of-work difficulty is determined by a moving average targeting an average number of blocks per hour,” Nakamoto explained. “If they are generated too fast, the difficulty increases”.

    As of July, the inflation rate of Bitcoin was 4.25 percent. The difficulty re-adjustment makes it impossible to simply mine more Bitcoin by allocating more computer resources to the network. As more people try to mine Bitcoin, the software automatically increases the difficulty of successfully mining a Bitcoin and vice-a-versa.

    Once the inflation rate reaches zero, miners will no longer be able to earn money from minting newly created bitcoins. Instead, transaction fees will have to increase or the number of transactions will have to increase. The last edition of the Crypto Research Report contains an in-depth explanation of how transactions are confirmed on the network and how miners earn income by confirming transactions and minting new coins.

    Although Bitcoin and gold are currently inflationary monies, according to the traditional definition of inflation, their inflation rates are predictable and constantly decreasing. Similar to gold, Bitcoin’s annual inflation rate will eventually reach zero percent.

    According to the mainstream economic definition of inflation, Bitcoin is deflationary because the purchasing power of Bitcoin increases over time. Currently, Bitcoin’s purchasing power is extremely volatile, although, this is expected to stabilize in the long-run. Since Bitcoin’s total supply is fixed, Bitcoin’s purchasing power will continue to grow slowly over time if demand continues to increase.

    Source: Why Bitcoin Is Technically an Inflationary Currency—Even Though Its Purchasing Power Is Increasing – Foundation for Economic Education



  • Bitcoin, Despite All its Problems, Could Revolutionize Property Rights

    Weak or nonexistent property rights lead to low economic productivity. Citizens of countries that do not protect property rights must necessarily spend much energy, thought, and time in an anxious effort to secure what little production they can manage. Many innovations and business models are unfeasible without property rights because they will be destroyed (or, more often, deterred) by one or another form of theft. Even a marginal improvement in access to property rights should drive the economic equilibria of many countries in the direction of wealth creation.

    Because it is decentralized, significantly easier to transport, store, or hide, and—this is crucial to augmenting property rights—significantly more difficult to seize than any traditional asset, Bitcoin delivers a real improvement in property rights at a comparatively modest cost (risk due to price volatility + transaction fees).

    However, Bitcoin is not a better currency (at least not in its current technical implementation). In fact, it probably will never quite be able to compete with centralized solutions in terms of speed and efficiency. Bitcoin is a bank account that is hard to track and hard to seize. The hard-to-track and hard-to-seize features are where the bulk of the real current value (speculation aside) originates.

    Beyond black market applications, Bitcoin has utility and value because most of the world’s population lives in countries that do not uphold property rights.

    The average human on planet Earth lives in serious uncertainty about whether his property will be his tomorrow. (This interactive map is from Index of Economic Freedom published by the Heritage Foundation, click here to play with it)

    What Bitcoin Provides

    1. Provides a last resort store of value—and means of escaping with some assets—for people living in politically unstable or oppressive countries.
    2. Makes people more confident and more likely to be productive by providing a hedge against expropriation, hyper-inflation, theft, divorce (comical but true), and so on—meaning that people can work hard to accumulate wealth, with the confidence that they will be able to keep some portion of it, despite being the victim of some political turmoil or the target of some (in)justice.*
    3. Provides a means to streamline the pervasive and often necessary evasion of taxes, bureaucracy, and regulation in poorly governed countries.**

    *It is important not to underestimate this. Uncertainty discourages people from working hard and taking risks. First world countries owe a significant part of their productivity and wealth to the rule of law and property rights. Any shift in that direction should also increase the amount of economic activity in a country that is normally a dangerous place to be successful.

    **Having done business in China and India, I speak from personal experience when I say that nearly every businessperson and any typical middle-class citizen in these countries is guilty of regularly, or at least occasionally, breaking tax laws, bribery, and so forth, to get by.

    This is not just a third world phenomenon. At one point in my food cart manufacturing days, we worked with two Egyptian food cart partners in New York (they jointly ran several dozen food carts in Manhattan) who—in a bid to report as little income as possible to the IRS, a universal practice among small cash businesses in the city—stored tens of thousands of dollars inside a wall, only to find part of the money eaten by rats several months later (they, of course, only realized what had happened after hotly accusing each other of theft).

    Giving People a Way Out

    It is difficult for those of us living in peaceful Western democracies, and occasionally grumbling about taxes, to understand how front-and-center property rights issues can be.

    Bitcoin provides a last resort for individuals and communities contending with hyper-inflation, capital controls, corrupt courts, extortion, and expropriation of all kinds.

     

    Try selling your small business and leaving Zimbabwe.

    Or take a stroll to the ATM to try and withdraw your hard-earned savings in an attempt to spend them before the currency loses 80 percent of its value.

    It’s no surprise that by October of 2017 (note that articles above are both from 2016) Quartz reported that Bitcoin is breaking all kinds of price records in cash-strapped Zimbabwe.”

    The Bitcoin network, despite its many imperfections, is proving itself as, at least, a moderate improvement in access to property rights and financial freedom for much of humanity.

    Property rights issues cast a shadow that spans the entire income spectrum—whether you are a middle-class entrepreneur in Zimbabwe, who is not legally allowed to leave the country with more than $1000 in cash as the political and economic situation descends into uncertainty, or the world-famous investor Prince Alwaleed.

    Ironically, shortly before being detained indefinitely and very likely expropriated by the despotic Saudi “government,” Prince Alwaleed called Bitcoin an “Enron in the making.”

    Although it’s very possible that Bitcoin’s price has run far ahead of its underlying value (and certainly many of the people bidding it up—including myself on occasion—are speculators, not users), the Prince’s bubble ended up bursting first.

    While people like Prince Alwaleed obviously have access to more traditional methods of evading capital controls and expropriation (offshore banking valued at well over $15 trillion, shell companies, and so on), it is clear that Bitcoin—and perhaps the even-less traceable cryptocurrencies like Monero, Dash, and Zcash—is at minimum a useful new gadget in the offshore banking arsenal.

    Bitcoin is even more useful for criminals (who in all likelihood made up the first critical mass of its users). But they are a rather small market compared to the enormous potential market of law-abiding and semi-law abiding citizens hedging against expropriation, unreasonably high taxes, unfair lawsuits in corrupt courts, capital controls, and so on.

    Obviously, Bitcoin is not a silver bullet—the classic $5 wrench XKCD meme says it all:

    Governments, fair or corrupt, still have plenty of very effective ways of detecting income, collecting taxes, expropriating property, and carrying on all manner of other financial/economic despotism. One cannot live on Bitcoin alone. The government can still take your house, your car, your land, and so on. However, decentralized cryptocurrencies do have the potential to shift the equilibrium noticeably in favor of the individual.

    My own parents were forced to give up all of their possessions when they left the USSR. In fact, they had to pay a fee in order to leave. Had cryptocurrency existed in the 1980s, they would have surely sold their Moscow apartment and other assets for whatever they could get in Bitcoin. In the event, I think they managed to smuggle several thousand dollars worth of gold sewed into the lining of a fur coat.

    [Side note: It was popular among people emigrating from the USSR to have gold dental work installed in a bid to carry out at least something of value… imagine what the USSR would have been like if this was possible.]

    Communist countries are a perfect storm for cryptocurrency—subsidized electricity and zero property rights. Venezuela is the best example.

    However, even China, which is hardly Communist, only allows private citizens to take $50,000/year out of the country. Unsurprisingly there is a general, and well-founded, anxiety among wealthy Chinese that the government will take away what they have earned. Chinese money has been a huge driver of Bitcoin’s price.

    Even banning Bitcoin-RMB exchanges cannot stop the outflow completely.

    Valuation

    IWhen reckoning the long term (years, not months) market cap potential of Bitcoin and other competing cryptos, it is important to consider not just its black market use cases or its competition with gold (gold has ~$7T market cap) and offshore banking ($15–30T market cap), but also the new value it may create if it proves, in the long term, to be a better mousetrap for individuals in their struggles with corrupt and ineffective governments/social structures everywhere.

    Not only does Bitcoin create value by providing a new, albeit imperfect, way to secure existing wealth, it will likely encourage the creation of new wealth by individuals living under otherwise discouraging political regimes. Even governments may trend toward better behavior as they find themselves forced to contend with Bitcoin. I can’t make any price predictions—there is still no certainty that cryptocurrencies will stand the test of time and scale—but the next decade of the cryptocurrency industry’s growth should be interesting to watch.

    Disclosure: I have been holding BTC and some other cryptos on and off since some time after India withdrew large cash notes from circulation—which got me thinking along the lines above.

    Reprinted from Medium.


    Michael Dubrovsky

    Michael Dubrovsky is a libertarian-leaning systems engineer interested in science, entrepreneurship, history, and economics. He was the co-founder of several startups—most notably MOVE Systems—and has experience establishing manufacturing operations both in China and the American Midwest. Michael is currently working on a cryptocurrency mining protocol project and planning to begin graduate studies in Materials Science. You can find more of his blog posts on Medium, where he applies meandering first principles analysis to a range of topics from woodworking to Net Neutrality.

    This article was originally published on FEE.org. Read the original article.



  • The Internet Revolutionized Communications, But That’s Just the Beginning

    Because of the Internet, our lives are significantly different. Writings on any topic, no matter how obscure, can be found with a quick Google search. Citizens can challenge powerful authority figures such as the police by publishing videos of their misdeeds. Remote workers can participate fully in company life, and relatives can video chat each other cheaply from nearly anywhere in the world.

    Yet, these innovations are only a fraction of what the adopters of the early Internet hoped to accomplish. Google searches and blog posts are innovations of a particular type: innovations in communication. That is, the rise of the Internet has revolutionized publishing. Anyone can be a creator and distributor of content, and anyone can access and read it. However, a subset of early Internet adopters (who go by many names: cypherpunks, crypto anarchists, and Internet Exceptionalists, to name a few) thought the Internet would go further. They thought we would have an Internet revolution in economics and in law.

    Instead of relying on government-issued money, we would have digital cash, the ability to pay any person on the Internet instantly and anonymously. Instead of being regulated by our brick-and-mortar governments, we, the new settlers of the Electronic Frontier, would make our own rules.

    These were the expectations of the Internet as of 1994 or so. What happened? Life has changed, certainly, but in the United States, we still use US dollars and US law. Perhaps these ideas were only fantasies.

    But maybe these ideas were merely ahead of their time. By building on advances in cryptography and distributed systems, blockchain technology promises a future with globally available digital cash, tamper-proof property records, auto-enforced commitments, and even private law. In this piece, I’ll explore these hopes for the Internet, the attempts that failed, and the future possibilities of blockchain technology.

    Crypto Anarchists Declare the Independence of Cyberspace

    In 1996, John Perry Barlow, co-founder of the Electronic Frontier Foundation and lyricist for the Grateful Dead, wrote a grandiose declaration of independence. “Governments of the Industrial World,” he wrote, “you weary giants of flesh and steel, I come from Cyberspace, the new home of Mind.”

    He argued that cyberspace represents a new frontier, a place separate from where our bodies live. Moreover, on the Internet, geographic borders (the usual markers of where government power begins and ends) don’t exist. In Barlow’s view, the citizens of cyberspace are subject to “increasingly hostile and colonial measures [that] place us in the same position as those previous lovers of freedom and self-determination who had to reject the authorities of distant, uninformed powers.” His solution? “We will create a civilization of the Mind in Cyberspace,” he proclaimed. “May it be more humane and fair than the world your governments have made before.”

    Barlow’s declaration had its detractors. As David Bennahum put it, “I’m wondering what it means to form a social contract in cyberspace, one with the kind of authenticity and authority of a constitution. It sounds great in theory, but I don’t actually live in cyberspace: I live in New York City, in the state of New York, in the United States of America. I guess I’m taking things too literally. Apparently my mind lives in cyberspace, and that’s what counts. It’s my vestigial meat package, also known as my body, that lives in New York. Government, geography, my body: all are obsolete now thanks to ‘cyberspace, that new home of mind’” (Bennahum 2001).

    Less snarkily, Harvard law professor Jack Goldsmith argued that cyberspace is “no different than real space” because many other communication technologies also involve people making transactions across borders. “To this extent,” he explained, “activity in cyberspace is functionally identical to transnational activity mediated by other means, such as mail or telephone or smoke signal” (Goldsmith 1998). In other words, the Internet is nothing more than a smoke signal with a better tech team. No legal changes are necessary.

    The Internet is Fundamentally Different

    Yet, there is a real truth to the arguments of the crypto anarchists: the Internet is fundamentally different. Unlike a telephone call, the Internet persists even after a person signs off. And unlike a letter sent in the mail, an Internet posting can affect thousands of people in other countries without giving any indication that borders will be crossed. With the telephone or the mail, recipients must be selected and the communication must be paid for, the cost increasing with each new recipient. However, a post on the Internet can be freely available to all. No prior form of communication creates this kind of virtual space.

    Renowned cyberlaw1 legal theorists such as Jack Goldsmith, Timothy Wu, David Johnson, David Post, and Lawrence Lessig spent much of the 90s arguing this point. Goldsmith and Wu occupied the pro-regulation, “Internet is merely communications technology” camp, whereas Johnson and Post represented the Internet Exceptionalists, arguing that cyberspace should govern itself. (Lessig is harder to pin down.) In 1996, Johnson and Post presciently claimed that the Internet would throw “law into disarray by creating entirely new phenomena that need to become the subject of clear legal rules but that cannot be governed, satisfactorily, by any current territorial sovereign.”

    Over twenty years later, the Internet Exceptionalists were finally proven right. One of the major dreams of the 90s, digital cash, has been implemented. Cryptocurrencies definitively show that the Internet is more than the sum of its parts, more than a leap in communications technology. Instead of making transfers from one centralized ledger to another (which Goldsmith correctly observes could be done over a telephone) cryptocurrency ledgers are stored and updated simultaneously on thousands of computers at once. This radical decentralization gives digital currencies an emergent property—the feeling that they are native to the Internet, more than transfers of data from one physical place to another.

    The Empire Strikes Back

    Historically, territorial governments have been very successful in their attempts to force multinational Internet companies to comply with their demands. In an early cyberlaw case, France effectively banned Nazi paraphernalia on Yahoo’s auction sites, even though Yahoo’s servers were in the US. It was enough that the sites were accessible in France, and that Yahoo had French assets that could be seized and French interests that could be thwarted (Goldsmith and Wu 2008, 8). More sinisterly, China has forced search engines to censor their results, removing anti-government and pro-democracy sentiments (Waddell 2016).

    Despite Barlow’s declaration of independence, governments have been reluctant to loosen their grip, leaving website owners effectively subject to all legal jurisdictions in which their assets could be seized.

    As Goldsmith and Wu explain,

    There’s an old European joke that captures the problem. In heaven, the joke goes, you find French cooks, English government, Swiss trains, and Italian lovers. In Hell, by contrast, you find French government, Italian trains, English chefs, and Swiss lovers. Territorial control of the Internet seemed to promise a parallel version of legal hell: a world of Singaporean free speech, American tort law, Russian commercial regulation, and Chinese civil rights.”

    These territorial governments, Barlow’s “distant, uninformed powers”, cling to the belief that they are providing a needed service. After all, how else will order be created, if not with government? This argument sounds an awful lot like Hobbesian legal centralism, the belief that government is the “wellspring of social order” (Ellickson 1991, 10). However, whether the government can provide social order and whether only the government can provide social order are two different claims, and the arguments for regulation usually depend on the latter.

    Goldsmith and Wu illustrate this line of thinking when they explain how eBay dealt with fraud. At first, eBay was a small community and social norms against fraud sufficed—people could be presumed to be well-intentioned. But it became apparent that extra measures were necessary.

    …eBay quickly learned that to prevent fraud, enforce its contracts, and ensure stability in its auction services, it would depend critically on government coercion and the rule of law provided by a stable country like the United States,” Goldsmith and Wu argue. “These are a few of the many complex benefits that only territorial sovereigns can bring, and without which most aspects of the Internet that we love and cherish would not exist” (2008, 129).

    Blockchains as a Tool for Private Ordering

    At the time, eBay may have required government coercion, but the idea that “only territorial sovereigns” can prevent fraud is false. Law and economics scholars such as Robert Ellickson have shown that people can often find ways to trust each other without the state. Furthermore, blockchain technology and smart contracts offer a different solution.

    For instance, OpenBazaar, an online marketplace that uses cryptocurrencies as payment, allows users to use very simple smart contracts (actually, 2-of-3 multisig addresses) to prevent fraud. As OpenBazaar describes it, “When a buyer wants to purchase a listing, instead of sending the funds directly to the seller, he will send the funds to the multisig account. The three people who control this account are the buyer, the seller, and a trusted third party selected beforehand.”

    In the simplest case, the transaction goes smoothly, but if there is a dispute, the trusted third party decides whether to release the funds to the buyer or seller. Importantly, no one has control over the transaction apart from the buyer and seller (and only in the case of a dispute, their arbitrator), preventing fraud and making government seizure not only unwelcome but impossible.

    This approach may seem bizarre, but this sort of private arbitration is used widely to resolve disputes in commercial agreements. It also has historical precedent: in medieval times, merchants who engaged in international trade, frustrated with the inadequacy of local courts to enforce contracts, created their own rules and their own courts. Rather than having to travel to the court of a distant noble who likely knew very little about trade practices, these new rules, known as the “law merchant,” allowed merchants to resolve disputes quickly before knowledgeable courts (Hadfield 2017).

    Legal scholars such as Johnson and Post recognized that the law merchant provided an example for Internet dispute resolution. In 1996, as part of the Cyberspace Law Institute, they launched the Virtual Magistrate Project, an experiment in which a pool of “neutral arbitrators with experience in the law and in the use of computer networks” would resolve disputes in a timely manner. Unfortunately, the project hit a snag—there was no way to enforce decisions, and therefore the experiment ended after only a few cases. However, with smart contracts and cryptocurrencies, enforcement is relatively easy and well-defined. An arbitrator only has the power consensually granted to them in code, but once a dispute occurs, they can use that power to direct the money sent to a smart contract as they see fit.

    “The scope of all these efforts is certainly narrow,” Peter Ludlow admitted, talking about the Virtual Magistrate Project, “but it would be a mistake to conclude from this that they will not evolve into full-blown legal systems with profound impact on future legal theory worldwide. It is important to remember that our current systems of law have humble and in some cases whimsical beginnings… Rather than be dismissive,” he continued, “perhaps we should consider the possibility that we are witnessing the birth of the juridical systems and practices of the new millennium” (2001).

    Ludlow’s statement was made before blockchain technology existed, but the same spirit applies today. It is a mistake to assume that only government can provide certain services. As Johns Hopkins cryptography professor Matthew Green made clear, “If you think something is impossible but you don’t have an impossibility proof, then what you have is an open problem.” Blockchain alternatives to government services are still an open problem, but the solutions thus far indicate that order can be achieved without government coercion.


    Works Cited

    Bennahum, David S. “United Nodes of Internet.” In Crypto Anarchy, Cyberstates, and Pirate Utopias, 39-45. Cambridge, MA: The MIT Press, 2001.

    Barlow, John Perry. “A Declaration of the Independence of Cyberspace.” Electronic Frontier Foundation. February 08, 1996. Accessed February 28, 2018. https://www.eff.org/cyberspace-independence.

    Ellickson, Robert C. Order Without Law: How Neighbors Settle Disputes. Cambridge, MA: Harvard University Press, 1991.

    Goldsmith, Jack L. “Against Cyberanarchy.” The University of Chicago Law Review 65, no. 4 (1998): 1199.

    Goldsmith, Jack L., and Tim Wu. Who Controls the Internet?: Illusions of a Borderless World. Oxford: Oxford University Press, 2008.

    Johnson, David R., and David G. Post. “Law and Borders: The Rise of Law in Cyberspace.” Stanford Law Review 48, no. 5 (1996): 1367. doi:10.2307/1229390.

    Waddell, Kaveh. “Why Google Quit China-and Why It’s Heading Back.” The Atlantic. January 19, 2016. Accessed February 28, 2018. https://www.theatlantic.com/technology/archive/2016/01/why-google-quit-china-and-why-its-heading-back/424482/.


    1. The “cyber” prefix has apparently been hard to shake.

    Reprinted from Libertarianism.

    Kate Sills


    Kate Sills

    Kate Sills holds degrees in Computer Science and Cognitive Science from UC Berkeley.

    This article was originally published on FEE.org. Read the original article.