Don’t cry for them yet; this is merely another way for them to justify their transaction fees. Without bad players, remember, the trusted authorities wouldn’t be necessary. Credit-card companies are earning 3 or 4 percent on every purchase. That’s more than the growth rate of the entire economy. And it doesn’t even account for the primary source of credit-card company revenue, which is all the interest customers are paying (or further accumulating) on their balances. When a whole marketplace is not only paying up to the bank in the form of debt-based money but also paying a trusted authority to verify transactions, marginal costs become unsustainable. Merchants must mark up their prices to account for all the transaction fees, and commerce slows. Only giant retailers, with the ability to borrow money less expensively or even offer their own credit cards, are capable of reducing these fixed costs by filling some of the roles of the trusted central authority themselves.
Besides, as the ever-increasing frequency of major credit-card and consumer-information theft has shown, none of these systems is particularly safe. The trusted central authorities really aren’t so good at what they do. From Target to J.P. Morgan, a single cash register or employee laptop can become the entry point for a systemwide hack, rendering all users vulnerable to credit fraud and identity theft. These companies’ security services are fast becoming loss leaders for their more lucrative lending schemes.
Viewed in this light, this first generation of digital transaction networks are not revolutionary but reactionary. They ensure that the newly decentralized marketplace remains entirely dependent on the same centralized institutions to conduct any business. Meanwhile, the currency they employ—bank-issued reserve notes—is itself the product of a trusted central authority that also charges for its services. This, as we have seen, is an even bigger drag on the potential velocity of money.
What good is a distributed network like the Internet if all the actors on it still depend on central authorities in order to engage in peer-to-peer activity? How is it truly peer-to-peer if it goes through a central clearinghouse? It’s still a bunch of decentralized individuals, each interacting with a monopoly platform—a new front end on the same old system.
These are the problems that the next generation of digital transaction networks are aiming to address. How can a distributed network of participants transfer and verify value collectively, without the need for a central authority? Is that even possible? Could a money system look and act less like iTunes and more like BitTorrent, where, instead of depending on a platform monopoly to negotiate everything, all the participants use protocols to interact with one another directly? Could a digital money system achieve with openness what traditional banks do with secrecy?
The only way to find out is to start as openly as possible. That’s why Bitcoin first appeared as the subject of a 2008 white paper authored by someone (or multiple someones) going under the name Satoshi Nakamoto. The paper outlined a concept for a virtual currency created and traded on a peer-to-peer, open-source platform. It would need no central authority to issue it, nor any central middleman to verify or administer its transactions. The network platform would be called Bitcoin, and its currency would be called bitcoins.27
This idea was not entirely new. Virtual and decentralized currencies had been tried in the past. But what set Bitcoin apart was its proposed method for ensuring the legitimacy of these transactions. As Nakamoto explained, in order for a currency to function as a medium of exchange, it must meet two basic standards: First, users must be reasonably certain that the currency they hold is not counterfeit. Second, the currency can’t be “double-spent”—that is, an unscrupulous buyer can’t spend the same money on two separate transactions. Meeting these standards is fairly simple for centralized currencies. High-tech printing techniques discourage counterfeiting. Credit and banking clearinghouses offer protection against double spending by maintaining secure ledgers of people’s accounts; spend money, and it is immediately subtracted from the single, centralized ledger.28
Nakamoto’s paper proposed that a distributed network could generate even greater security than a centralized money system if users pooled their computing resources to maintain a collective and open ledger of their own. He outlined the proposed technology, thousands of people commented and made suggestions, and in 2009 the Bitcoin network was launched.29
Understanding how Bitcoin works isn’t crucial to being able to use it, any more than understanding the chain of possession of electronic ballots is crucial to being able to cast a vote. But the more we understand Bitcoin’s technology, the more we can trust it without relying solely on the word of those more digitally literate than ourselves. That’s why Bitcoin’s code is published and open source: if you’re afraid there’s some government or criminal in there running things, just look at the code and you’ll see what’s going on. I’ll explain it here briefly, but the main takeaway is that there’s no one in charge—which means the biases of Bitcoin are very different from those of a traditional interest-generating money system. This is a money system that works through protocols—digital handshakes between peers—instead of establishing security through central authorities.
Bitcoin is based on a database known as the “blockchain.” The blockchain is a public ledger of every bitcoin transaction ever. It doesn’t sit on a server at a bank or in the basement of a credit-card company’s headquarters; it lives on the computers of everyone in the Bitcoin network. When bitcoins are transacted, an algorithm corresponding to that transaction is “published” to the blockchain. The algorithm is just a description of the transaction itself, as in “2 bitcoins came from A and went to B.” Instead of a list of users and their bitcoin balances, the ledger simply lists the transactions in chronological order. It doesn’t follow people, it follows the money. It’s not a record of how much you have as much as a record of where the money came from and where it is going to.30, 31
To get a transaction into the ledger, two users must first agree to the exchange. Using a pretty standard form of cryptography (public and private “keys”), both users “sign” the intended transaction, at which point it is broadcast to the network. Immediately, other members of the network who have devoted some of their computers’ power to the Bitcoin process begin verifying the transaction and committing it to the public ledger. This part involves solving a bunch of computational puzzles—a way of guaranteeing that a whole lot of different computers have verified the transaction before it goes in. This prevents one bad actor from posting fake transactions into the ledger. He’d need more computing power himself than the whole network of thousands of users in order to overpower them. When enough people verify the transaction, it becomes part of the permanent ledger—part of a new block of transactions, recorded in the chain. (That takes about ten minutes, compared with a bank, which might take up to a week to confirm new funds.) As the system gets up to speed, people who verify and maintain the blockchain are rewarded with bitcoins. That process is called “mining,” and it is how new bitcoins enter circulation. This dilution of the money supply, as such, is infinitesimal compared with credit-card fees, and its drag on transactions is negligible.32, 33
Nakamoto, it seemed, had at last developed a way to distribute trust in the digital economy: create a public record of transactions and lock it down, not with bank security or virtual firewalls, but with the combined computing power of the community. Your money can’t be stolen, because there’s nowhere to break into. Everyone has a record of everything.
For almost five years, the Bitcoin network and its pool of bitcoins grew, while users exchanged bitcoins for products such as thumb drives, alpaca socks, and, yes, drugs. The fact that people transact through cryptographic keys instead of names or e-mail addresses lets them make purchases anonymously. Since there’s no credit-card statement at the end of the month listing the illicit goods and services someone may have purchased, cryptocurrency became popular on black markets and earned a reputation as money for crimin
als. Then in late 2013, something interesting, if all too predictable, happened. Whether in response to the high-profile bust of an illicit online bitcoin-based marketplace known as the Silk Road or to the growing participation of Chinese users, Wall Street suddenly seized on bitcoins as a new instrument for speculative investing. It became the next big thing.34
What speculators love so much about bitcoins is that only a limited number of them will be mined into circulation. The mining process will be complete within the next couple of decades, and the money supply will remain fixed after that. Moreover, if a user loses his or her private key, then that user’s bitcoins leave circulation. These two factors make the bitcoin currency highly deflationary. If they were actually to catch on, investors reasoned, those who got in early would have cornered the market on an entire currency. That’s why from 2012 to 2013, the price of a single bitcoin skyrocketed, from ten dollars in November 2012 to a thousand dollars a year later.35 There are now bitcoin investment funds—one famously started by the Winklevoss twins, known best for hiring college student Mark Zuckerberg to build their social network platform and subsequently losing it to him.
They may be missing the nature of this opportunity as well.
Bitcoin money is only a utility—not the thing of value in itself. It’s a label. If bitcoins become too precious and scarce, there are always plenty of alternative blockchain currencies to use instead. Unlike the issuers of national fiat currencies, no one—not even the tax authority—is forcing anyone to use bitcoins. So they don’t have the same role as the sort of money that was invented for early Renaissance monarchs to shut down the peer-to-peer marketplace. Amazingly, it’s money people who have the hardest time understanding this part, which is why they are so destined to be burned on their bitcoin investments, however they play this one.
The only way to understand the real purpose and function of Bitcoin is to stop asking ourselves if it’s a good investment. Even now, many of the people reading these words are trying to figure out whether I’m saying bitcoins will or won’t be worth something: should they close the book and buy some right now, or not? If you need an answer in order to move on, then fine: Don’t invest in bitcoins. You could make money if you buy them at the right moment, but that’s not what they’re for.
Although bitcoins need enough investor interest to prove their merit and gain acceptance with transactors, too much investor interest actually limits the currency’s effectiveness. Bitcoin, as a program, is not meant to solve the problem of how people can invest money over time. It is addressing the problem of how people can transact securely without a central mediator and do so anonymously. And Bitcoin is most assuredly secure. For the record, the much-publicized bitcoin robberies and cyberattacks have been on some of the bitcoin exchanges and online wallet systems—one of them adapted from a gaming Web site that was never intended to secure banking records.36 Even so, they have nothing to do with the Bitcoin blockchain itself, which is, for all intents and purposes, impenetrable.
Bitcoin’s failure to overcome our business culture’s bias for hoarding and scarcity may be a temporary setback, or it could prove to be a fundamental flaw in the way the system was designed. The Bitcoin blockchain generates an arbitrarily limited supply of bitcoins. It may have been meant to counteract what sometimes seems like the profligate pumping of money into the economy by central banks. But by setting a cap on how many bitcoins can ever be created, Bitcoin doesn’t transcend the scarcity bias of central currency; it exacerbates it.
The only ones who don’t think about bitcoin that way are the miners—those participants with the fastest computers—whose power to verify transactions and earn new coin puts them at the center of the economy, at least while new coin is being created. All the money originates with them, even though it leaves their hands when they spend it—with no strings or interest attached, unlike central currency. They may be a new kind of elite, but they’re an elite all the same. They are the new bankers, even if they function from the periphery, and even if they exist only in the first ten years or so of Bitcoin’s existence, until the money supply is completed.
Not that mining bitcoins is cheap. In addition to the hardware, miners must invest in a tremendous amount of computer processing and electricity consumption. In 2013, miners expended some 1,000 megawatt-hours per day verifying transactions and mining new bitcoins.37, 38 As Bloomberg writer Mark Gimein noted, that’s half the power needed to run the Large Hadron Collider. Less than one year later, PandoDaily placed the network’s energy usage at 131,019.91 megawatt-hours per day, an increase of over 1,000 percent.39 While specialized computers called “mining rigs” are improving the energy efficiency of bitcoin mining, the shrinking number of unmined bitcoins and increasing length of the blockchain are raising the level of computing power required to perform Bitcoin’s proof-of-work problems.40 So even if Bitcoin did turn out to be economically feasible, it is unlikely to prove environmentally sustainable.
Those with digital literacy, processing power, and the fewest qualms about wasting electricity have the advantage. Meanwhile, those who already have lots of money can simply rent bitcoin-processing computers from companies with names like LeaseRig to do mining on their behalf. Money still buys a seat at the table.
So Bitcoin takes capital creation away from bankers but gives it to programmers or those who pay them. It does fix some of currency’s problem, in that it’s no longer sourced for interest and no longer requires growth. But it’s still scarce and hoarded and never stops taking from the physical environment. If anything, it’s more like the original gold coin that proved too scarce to be practical than it is like the abundant and circulating market money that spawned the peer-to-peer economy of the bazaar. There’s no central bank earning interest on the currency, but its value is still a product of its relative scarcity—the way cigarettes serve as cash in a POW camp. Money for prisoners. This creates a zero-sum mentality in its users and discourages circulation. There’s only so much to go around, so it’s better to hoard it than spend it.
Still, while bitcoins may ultimately prove to have limited value as a currency, the Bitcoin network represents a potentially epochal shift in how we organize finance, computing, corporations, and even our society. On even the most superficial level, thanks to the Bitcoin network, bitcoins are more verifiable than central currency and more collectively negotiated. The amount in circulation is entirely removed from the control of a Fed or a central bank, as well as from the politics and agendas that might inform their decisions. But on a more essential level, the Bitcoin protocol represents a profound leap in how we understand trust and security—two of the original functions of money.
Verification is no longer something we need from an outside authority. There is no official person or entity that can offer (or deny) a stamp of approval. Trust, safety, and ownership are guaranteed not by central command but by the network of participants. In this system, the power of a currency derives not from the enforcement capabilities of the central government but from the grassroots connectivity of the people in the marketplace. Money is not protected with bank vaults, real or virtual, but with the widest possible public oversight.
Wall Street speculators don’t realize that (or perhaps don’t want to realize it), because this change promises a radical shift away from the system by which they extract wealth through finance. Yet their willingness to bet on bitcoins, even in the wrong ways and for the wrong reasons, shows that the market does recognize there’s a shift under way. They just don’t know how to participate in it yet.
Bitcoin is actually bigger than money. The blockchain may not engender unilateral trust, but it compensates for our distrust of one another in a new way. Instead of an authority bearing witness to an agreement, we all do. There is no single “watcher” with a key to the ledger or a hand on the till, so the question of who is watching the watchers becomes moot. There is no authority—absolute or otherwise—to corrupt. Authority is distributed
. If we look past all the cryptography, the algorithms, and the buying and selling, the blockchain is simply an open ledger—a collectively produced, publicly accessible record of agreements made between individuals. Additionally, it is verified by an anonymous peer group, then encrypted so that only those involved in the specific transaction know who participated. This has applications well beyond bitcoins.41
The blockchain can “notarize” and record anything we choose, not just the cash transactions between Bitcoin users. Entire companies can be organized on blockchains, which can authenticate everything from contracts to compensation. Decentralized autonomous corporations, or DACs, for example, are a fast-growing category of businesses that depend on a collectively computed blockchain to determine how shares are distributed. To count as a true DAC, a company must be an open-source endeavor whose operation occurs without the supervision of a single guiding body, such as a board or a CEO.* Instead, a project’s governing rules and mission must emerge from consensus. Project workers are compensated for their labor or capital investment with shares in the blockchain, which increase in number as the project develops.42 We can think of DACs as companies whose stock is issued little by little as the company grows from a mere business plan into a sustainable enterprise. Only individuals who create value for the company are awarded new stock proportionate to their contributions.43
Fittingly, the majority of DACs currently sell blockchain-related services themselves. By committing to the blockchain for their own governance and share distribution, DACs lend credibility to the technologies they are selling. They stand in stark contrast to the bitcoin ETFs being peddled by the Winklevoss twins and others, in which profit is extracted through traditional Wall Street markups and expense ratios, and transactions remain opaque. By using the blockchain, DACs subject themselves to total transparency. Everyone can see everything.
Throwing Rocks at the Google Bus: How Growth Became the Enemy of Prosperity Page 17