Results for “bitcoin”

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Such “permissionless innovation”, in the jargon, should in time result in a cornucopia of applications. Bitcoin’s technology could be used to transfer ownership both in other currencies and of any kind of financial asset. This, in turn, would allow the creation of decentralised exchanges which let asset holders trade directly. And money could be “programmed” to come with conditions: for instance, it might be released only if a third person agrees.

Some want ownership of devices—a car, say—to be represented by a Bitcoin, or a tiny fraction of it. The car would work only when turned on with a key that includes the Bitcoin token. This would make managing ownership of and access to physical assets much easier: the token could be sold or rented out temporarily, enabling flexible peer-to-peer car-rental schemes. Such “smart property” would turn the blockchain into a global registry of ownership in physical assets.

All that may sound like science fiction, but a growing number of startups are working on bringing such applications to market. Coloured Coins and Mastercoin will soon release software that enables trade in other financial assets, including stocks and bonds. The most ambitious project is Ethereum: it will launch a new blockchain, similar but unrelated to Bitcoin, with a programming language to encode financial instruments and other contracts.

From The Economist there is more here.

…a raft of bitcoin thefts at exchanges like Mt. Gox is raising the question of whether the sophisticated currency still needs the same sort of physical security infrastructure—impenetrable steel vaults, armed security guards, and even paper ledgers—as cash and gold.

A Silicon Valley startup called Xapo is among a handful of young companies trying to become the Fort Knox of bitcoin, building secret bank vaults deep in the earth that would safely store millions of dollars worth of bitcoin code on computer drives. And if modern bank robbers still manage to pry open the vault? Xapo promises to fully insure all deposits.

On Wednesday, Xapo said it raised $20 million in funding led by venture-capital firm Benchmark, to support a network of underground vaults that the company says are in mountainous regions on multiple continents.

There is more here.  I think of this as a lesson in how bid-ask spreads tend to reemerge, one way or another, no matter how hard we try to abolish them.  One key question about Bitcoin is whether it has found a better place to “put” the bid-ask spread.

From William Coates, here are a few points of note:

Transaction fees are fairly horrible with traditional payment providers, especially when it comes to smaller transactions, as there is often a minimum fee.

Let us, for example, consider the purchase of a music track costing 1.49 euro from our store. Paypal charges us 3.4%, plus a 35-cent fee for each transaction. So, in this case, Paypal would get 40 cents from this transaction: a 27% fee.

Now charges that high aren’t going to be sustainable for any low-margin business (they are probably fine if you are selling Bolivian marching powder, though!). To get round the problem, we at digital-tunes.net charge our customers a 35-cent surcharge on Paypal payments, to help us offset the exorbitant fees.

With bitcoin, transaction fees are entirely optional. The currency’s protocol allows you to set the transaction fee to zero if you so wish, however this might mean it takes a bit longer to process.

The idea behind bitcoin transaction fees is that the computers running the network (in an entirely distributed manner) get to keep the transaction fees associated with the transactions they have successfully processed.

It’s quite likely that, in the future, we will see the fees be determined by the market, and if you want your transaction processed as fast as possible, you will have to pay a premium. Currently, transaction fees are not the primary motivation for people to run the network, but that’s an entirely other topic. A useful graph showing the fees charged by the entire network over time can be viewed here.

The article offers other points of interest.

Robert Sams writes:

This is also why it doesn’t make sense to speak of new cryptocurrencies expanding the aggregate crypto money supply without limit (or limited only by the fixed costs of creating one). What matters is how the aggregate hashing power, which is scarce, gets distributed over the set of extant cryptocurrencies. The above reasoning predicts that hashing power will not spread itself arbitrarily thinly, keeping MC well-above 0. (The distribution currently looks more like a power law.)

Much (something?) hinges on this point.  If I understand the argument correctly, the claim is that the market will not consist of a large number of thinly hashed cryptocoins, because those coins will not be secure.  There is an aggregate amount of hashing power, and it gets distributed in a quite concentrated fashion and that helps prop up the value of Bitcoin and limit the number of truly viable alternatives.  Sams emailed me:

Ignoring any desired technical differences among the various coins, it’s optimal for users to coordinate on one, not b/c of some network effect but b/c spreading hashing costs over lots of coins eventually results in no coin having much security. At the margin, a user will choose the higher hashing coin between two otherwise identical ones.

In the (implicit) model of my earlier post, there is always a bribe to be paid to new cryptocurrency adopters — out of the seigniorage created by the founders of new cryptocoins — that will encourage a larger number of active cryptocoins.  (And total hashing power is somewhat elastic in supply, contrary to how I am interpreting Sams.)  How actively will those coins be hashed?  I am not sure it matters.  There will be two margins: the cost of doing more hashing of existing coins, and the cost of creating additional cryptocurrency through “bribing out of seigniorage.”  In equilibrium those two marginal costs should be equal, adjusting of course for the possible heterogeneity of outputs, as you are not getting exactly the same services.  To the extent “security” is an issue, the initial bribe for using a new cryptocurrency needs to be that much larger.  If no bribe is big enough to induce some defection, I wonder how Bitcoin got started in the first place (which didn’t even have the benefit of the same kind of explicit upfront bribery).

My view is that if bootstrapping can happen once — as it did with Bitcoin — it can and will happen again.  In which case we are back to contestability limiting the value of Bitcoin.  I am not sure how much Sams and I are disagreeing.  At the end he coins (sorry) a new theorem:

So maybe here is a new theorem: the value of a cryptocurrency will converge to its optimal level of hashing costs?

In any case, do read Sams’s entire post, it covers many cryptocurrency issues of interest.

Usually the house wins!  (With the exceptions of counting cards at blackjack or beating the table at poker.)  So why not try a game where the odds are — if not outright “better” — at least a lot less clear?  Enter Bitcoin.  No matter what your theory of its future value, there is no simple story which flat out amounts to “the house wins,” if only because of the opaqueness of the matter.  It is also a fun gamble and bundled with various symbolic commitments to future tech, libertarianism, and so on.  For many people that is better than affiliating with Vegas, the local football team, or perhaps Macau.  You can follow the price on as frequent a basis as you wish, rather than having to wait for a sporting event to take place.  And unlike in equities, futures, and options markets, you can feel — rightfully or not — that the pros also don’t know what they are doing.

I can’t find a reliable source on how much is spent on gambling each year, legal and illegal, but a variety of unreliable sources are suggesting a few hundred billion a year for the U.S. alone.  It’s likely to be well over a trillion dollars worth for the world as a whole.

Let’s say one percent of that gambling demand spills over into the cryptocurrency arena.  That’s a flow of $10 billion a year to fund new cryptocurrencies or bid up the value of old ones, maybe more.  Bitcoin also may interest people in gambling who otherwise do not gamble or think of themselves as gambling types.

I don’t gamble and I don’t enjoy gambling, but if I were going to gamble, I would prefer to gamble with Bitcoin than to bet on a dog race.  And it has to be better than buying a lottery ticket.

To the extent we are uncertain about the future gambling demand for Bitcoin, the price of Bitcoin will be correspondingly volatile.  And we have no solid sources for trying to estimate such future demands.  At the very least it seems likely that such demand has not yet peaked or close to it.  In any case, the trading of Bitcoin itself will reveal information about the shape of the demand curve and thus the trading of the asset can inject further volatility into the market, a standard result when not everything is a flat, horizontal demand curve.

Here are various tweets related to Bitcoin and gambling.

My post from yesterday was perhaps not specific enough, so let me outline one possible scenario in which the value of Bitcoin (and other cryptocurrencies) would fall apart.  For purposes of argument, let’s say that a year from now Bitcoin is priced at $500.  Then you want some Bitcoin, let’s say to buy some drugs.  And you find someone willing to sell you Bitcoin for about $500.

But then the QuitCoin company comes along, with its algorithm, offering to sell you QuitCoin for $400.  Will you ever accept such an offer?  Well, QuitCoin is “cheaper,” but of course it may buy you less on the other side of the transaction as well.  The QuitCoin merchants realize this, and so they have built deflationary pressures into the algorithm, so you expect QuitCoin to rise in value over time, enough to make you want to hold it.  So you buy some newly minted QuitCoin for $400, and its price springs up pretty quickly,  at which point you buy the drugs with it.  (Note that the cryptocurrency creators will, for reasons of profit maximization, exempt themselves from upfront mining costs and thus reap initial seigniorage, which will be some fraction of the total new value they create, and make a market by sharing some of that seigniorage with early adopters.)

Let’s say it costs the QuitCoin company $50 in per unit marketing costs for each arbitrage of this nature.  (Alternatively you can think of that sum as representing the natural monopoly reserve currency advantage of Bitcoin.)  In that case both the company and the buyers of QuitCoin are better off at the initial transfer price of $400 and people will prefer that new medium.  Over time the price of Bitcoin will have to fall to about $450 in response to competition.

But of course the story doesn’t end there.  Along comes SpitCoin, offering to sell you some payment media for $300.  Rat-FacedGitCoin offers you a deal for $200.  ZitCoin is cheaper yet.  And so on.

Once the market becomes contestable, it seems the price of the dominant cryptocurrency is set at about $50, or the marketing costs faced by its potential competitors.  And so are the available rents on the supply-side exhausted.

There is thus a new theorem: the value of WitCoin should, in equilibrium, be equal to the marketing costs of its potential competitors.

This theorem will hold even if you are very optimistic about market demand and think that grannies will get in on it.  In fact the larger the network of demanders, the lower the marginal marketing cost may be — a bit like cellphones — and that means even lower valuations for the dominant cryptocurrency.

(It is an interesting question what fixed, marginal, and average cost look like here.  Arguably market participants will not accept any cryptocurrency which is not ultimately and credibly fixed in supply, so for a given cryptocurrency the marginal cost of marketing more at some point becomes infinite.  Marginal cost of supply for the market as a whole is perhaps the (mostly) fixed cost of setting up a new cryptocurrency-generating firm, which issues blocks of cryptocurrency, and that we can think of as roughly constant as the total supply of cryptocurrency expands through further entry.  In any case this issue deserves further consideration.)

Note that the more “optimistic” you are about Bitcoin, presumably you should also be more optimistic about its future competitors too.  Which means the theorem will kick in and you should be a bear on Bitcoin price.  Arguably it’s the bears on the general workability of cryptocurrencies who should be bullish on Bitcoin price because a) we know Bitcoin already exists, and b) we would have to consider that existence an unexpected and unreplicable outlier of some sort.  Yet the usual demon of mood affiliation denies us such a consistency of reasoning, and the cryptocurrency bulls are often also bulls on Bitcoin price, as too many of us prefer a consistency of mood!

In theory

Now, theoretically, you might believe that the current price of Bitcoin already reflects exactly those marketing costs of potential competitors and thus the current equilibrium is stable or semi-stable.  Maybe so, but I doubt that.  The current value of outstanding Bitcoin is about $20 billion or so, and it doesn’t seem it cost nearly that much to launch the idea.  And now that we know cryptocurrencies can in some way “work,” it seems marketing a competitor might be easier yet.  (You will note that by its nature, there are some Bitcoin imperfections permanently built into the system, imperfections which a competitor could improve upon.  Furthermore the longer Bitcoin stays in the public eye, the more likely that an established institution will label its new and improved product LegitCoin and give it a big boost.)

You can think of that $20 billion — or perhaps just some chunk of that? — as a very rough measure of the prize to be won if you can come up with a successful Bitcoin competitor.  Even a fraction of that sum will spur some real effort.

In short, we are still in a situation where supply-side arbitrage has not worked its way through the value of Bitcoin.  And that is one reason — among others — why I expect the value of Bitcoin to fall — a lot.

I thank Brad DeLong for an email query and analysis which sparked this blog post.

Addendum: Maybe I’ll write another post on the possible expected deflationary bias in any cryptocurrency, given that expected price changes usually get compressed into the present and that an overall expected rate of return equality must hold.  And the question of how much an initial issuer can exempt itself from mining costs as a form of reaping upfront seigniorage. and the profit-maximizing way of sharing these gains with early adopters.  Those are two hanging issues with respect to the analysis here, in addition to the matter of cost structure discussed in the parentheses above.  And now go reread Kareken and Wallace (1981).  “=/∞” I think one has to say here.

An email query from Brad DeLong reminds me of this old Bart Taub paper, “Private Fiat Money with Many Suppliers” (jstor):

A dynamic rational expectations model of money is used to investigate whether a Nash equilibrium of many firms, each supplying its own brand-name currency, will optimally deflate their currencies in Friedman’s (1969) sense. The optimal deflation does arise under an open loop dynamic structure, but the equilibrium breaks down under a more realistic feedback control structure.

There is also Marimon, Nicolini, and Teles (pdf) and the work of Berentsen., all building on Ben Klein’s piece from 1974.  This literature has been read a few different ways, but I take the upshot to be that a) a monopolized private fiat money might be stable in supply, to protect the stream of future quasi-rents, and b) private competing fiat monies will not be stable in overall supply, for reasons of time consistency and also the competitive erosion of available rents.  In other words, when it comes to the proliferation of cryptocurrencies, the more the merrier but not for those holding them.

I don’t agree with the modeling strategy of this 1981 Kareken and Wallace paper on the indeterminacy of equilibrium exchange rates, but still it is another useful starting point.

Addendum: Krugman adds a bit more on Bitcoin, from a friend of his, John R. Levine.  Here is the final bit from Levine:

My current guess is that the Bitcoin bubble will collapse when there is some bad news, e.g., a regulator demands registration of Bitcoin wallets, people try and cash out, and find that that while it’s easy to buy bitcoins, it’s much harder to find people willing to buy back nontrivial amounts, very hard to collect the sales proceeds, and completely impossible without revealing exactly who you are.