‘From the perspective of being good money, Bitcoin fails the unit of account property because we don’t natively price products and services with Bitcoin. Rather we look to a fiat standard like the US dollar and we convert the value of the Bitcoin to actually price goods and services. The argument people tend to use is that, well, it’s still a small economy, if it got really large people would price things with it.
‘The other problem is that I don’t think there’s ever going to be price stability with Bitcoin.
‘First, there are a lot of innovative pressures. There’s tons of competition, there’s over 300 altcoins and there’s always new technology being invented. So that does have a very significant effect on the price of Bitcoin.
‘Second, we have rapid demand changes. Suddenly there are loads of buyers, everyone wants to get into Bitcoin, then just as suddenly they don’t. It’s very volatile.
‘Third, the ownership distribution of Bitcoin – about 50 people seem to control half of all the bitcoins because of early-adopter effect. It behaves much more like a tech stock or a commodity from that perspective than it does like a currency.
‘That said, it is really interesting that someone has basically been able to create a decentralized digital currency – I should say “commodity” – that could be used as a proto-money. That’s a humongous accomplishment.’
Why has he got involved, then?
‘From a cryptographic standpoint, what’s fascinating about Bitcoin is the identity management component and the block chain technology. The cryptographic problem known as authentication is what got me interested in the space. We’ve been studying authentication for about 23 years, 24 years in the cryptographic community. The idea is, how do I know you are who you say you are over something like the internet? If I meet you in person I can authenticate by your face and your voice and your mannerisms and so forth, but if I meet you over email or over chat or you’re logging into a server, how do I actually know you’re really Dominic versus Charles or William or some malfeasant actor?
‘Generally this is accomplished by some sort of authentication scheme like usernames or passwords, but those are imperfect and clunky. I think that the technology of Bitcoin, the block chain itself, can actually become a God-send for a next generation ID system that could inevitably get rid of passwords and get rid of usernames and allow people to better authenticate themselves on the internet.
‘And once you have that foundation built, you’ve actually built secure NSA-proof communications systems. You can build new types of ecommerce systems, you can do a whole bunch of really interesting things that you couldn’t do before. And it’s a global standard, so it doesn’t mean you have to win the geographic lottery and live in England or the United States to get a good credit system or good ID system. This is a system that would work just as well in Africa as it works in North America or Europe, which is a huge step forward for ecommerce and banking the unbanked. And that’s what gets me really excited about the technology and why I came into this space.’
So, what exactly is Ethereum? Everybody’s talking about it, but few seem to understand it.
‘Ethereum is really a continuation of what Satoshi Nakamoto was working on. He wanted to study two things when he released Bitcoin. He’d been working on it for quite some time. The first was this idea of a decentralized database secured by a proof-of-work consensus system, and the second thing was a transaction system – tokens. He wanted to see if the consensus system would be cryptographically secure and if people would actually participate in securing it, and, secondly, if the tokens would achieve any market value without any backing or promises. In both cases it was wildly successful.
‘He had a third option. You could have programmable money and you could have programmable smart contracts that extended Bitcoin into something beyond just a money system – into a kind of a replacement for the current way the internet works. But he felt that there were a lot of concerns from scalability to security, so he purposefully neutered the scripting language of Bitcoin, so as to not enable this. We call it state and Turing completeness.
‘So, it’s been five years, we’ve learned a huge amount of lessons, there’s been a lot of overlay protocols, other attempts to increase the functionality of Bitcoin. What we did with Ethereum is we kind of unified a lot of the 2.0 actors and put them into a big bucket and we’re building a completely new block chain and we’re building a completely new scripting language that basically adds in those missing features.
‘The end result is you can do things now like have Wall Street on a block chain. So any financial contract that you would see in Wall Street can now be put on a block chain just like money can. You can do prediction markets. You can have a Las Vegas gambling system living on a block chain. You can also take traditional server client internet apps like YouTube or Facebook or Netflix and you can actually now make all of these services run in a decentralized way with no central actor controlling them. You can do decentralized Dropbox, so instead of having all your files stored on a server; you can actually store them in a decentralized network and instead provide them with a token system just like Bitcoin. That’s what we’re working on to do with Ethereum.
‘Bitcoin was an exploration of how can we build a decentralized value system. And if you want to call it money, call it money – but a decentralized money system where we dis-intermediate the government from the generation of money, okay. Ethereum is extracting that and saying what else can we dis-intermediate? Can we remove Dropbox from storage? Can we remove Rackspace and Amazon from hosting? Can we remove Las Vegas from gambling? Can we remove Wall Street from finance? And instead can we run these things in a decentralized way?
‘It’s a continuation of that experiment and we’re seeing how many other things in society we can actually decentralize in nature so that they’re not controlled by any one actor. We want to let people choose and program whatever disintermediation they want.’
It’s revolutionary stuff. The implications to existing internet business models are substantial. What kind of progress has been made?
‘We came up with the idea back in November of last year, there was a white paper drafted by a gentleman named Vitalik Buterin, who is the co-founder of Bitcoin Magazine and a pretty big figure in the space. And since then we’ve released five proof of concepts and we’re just about ready to begin a sale to fund the project’s development. We anticipate releasing our block chain in the fourth quarter of this year.
‘It’s very complex. And we haven’t done a great job at trying to sell that to the mainstream, because we’re still trying to figure out the base technology. There’s a lot of work to do to figure out the scripting language and we have to make sure it scales and we have to get developers to build apps. But in the coming months we’re going to really start outreaching to people and our goal is to actually unify the whole space behind something called the ether browser.
‘Our vision at the end of the year is that you’re going to be able to download a piece of software that’s kind of like the android of the crypto-currency space, where everything that you wanted to do is one-click installation. So you download a single app and then you’ll have an app catalogue, and your wallet is one-click installation, any coin you want to use – it’s one click. You can even create your own currency with one click. Your identity management system for NSA-proof communication, that’s one click installation and so forth. And if people want to create their own apps, they can do that. And they can do it in a matter of days, if not weeks.
‘And so that’s our hope, that’s what we want to do. And the app catalogue is totally decentralized just like the network. So even we don’t control it – so we can’t take apps down or anything and the government can’t take apps down or something like that. So, that’s what we’re trying to do: mainstream this dis-intermediation technology’.
The implications of Ethereum – if it takes off – are clearly enormous.
For more information about E
thereum, visit ethereum.org.
10
Should You Buy In?
You can’t stop things like Bitcoin. It’s like trying to stop
gunpowder. It will be everywhere and the world will
have to readjust.
John McAfee, computer scientist, founder of McAfee Inc
In the 1830s and 1840s a mania gripped the UK.
A similar mania would soon grip the US in the 1870s and again in the 1890s.
It was about a new technology, a technology that was changing the world: rail transport.
By the late 1830s all the conditions were in place for a frenzy. The Liverpool and Manchester railway had proved a success, the Bank of England had cut interest rates, the Industrial Revolution had created a new, wealthy middle-class and the new medium of newspapers meant that companies could advertise themselves and news could travel quickly. There was an overriding belief in this revolutionary technology and there was money to invest. Railway mania was born.
Hundreds of railway companies sprung up and investment poured in. Land was bought, tracks were laid and trains were built.
But it soon became clear that railways were not as easy to build as was once thought, nor was it so easy to turn a profit. Many of the companies were unviable. Some of them were get-rich-quick schemes and scams.
Then, in 1845, the Bank of England put up interest rates. Capital flowed out of railways and into the bond market instead. New railway investment dried up. As they were still unprofitable, most of the companies went bust. But a few well-capitalized companies, such as Great Western and Midland, were able to pick up the pieces – buying up the tracks, for example, for a fraction of what it had cost to build them.
Some of those large companies still exist today in one form or another. Trains still pass on the railways that were laid nearly 200 years ago. But almost all of the early investors lost their shirts.
All new technology seems to go through a similar cycle.
Take dotcom stocks at the end of the 20th century. Speculators were right: the internet did change the world. They still lost their money.
Most of those dotcom start-ups never made it. Just a handful survived the mania – the likes of Google, Amazon and eBay – and they grew to dominate the space. It is 2014 and the Nasdaq (where most internet stocks are listed) is still trading below its 2000 high.
In the 1930s there were as many as 600 American car companies. Now there are three.
I have argued that the technology of Bitcoin is not only here to stay, but that it is going to change the world – just as railways, cars and the internet did. Fortunes will be made – that I do not doubt.
But, counter-intuitive though it may seem, that doesn’t mean you should speculate. As with the dotcom boom of the late 1990s and early 2000s, many of the companies now operating in the Bitcoin space, including most of the altcoins that have sprung up, will amount to nothing.
There might be computer geniuses at the helm, but conceiving and implementing a good idea and running a successful company are two very different skills – the latter requires considerable experience that many people do not have. As an investor, successfully identifying the future Googles, Amazons and eBays from the plethora of Boos, Beenz and Flooz is no easy task – even if you know what you’re doing. Often, what seem like bad ideas turn out to be good ones, while good ones don’t make it if their timing is slightly out.
My advice is have a bit of fun and put some speculative capital to work. By all means, research Bitcoin companies or find a fund that will do the homework for you, though at this stage most funds are still private. Buy some coins – but go in with your eyes wide open. The lesson of history is clear: even with technology that changes the way we do things, you will still probably lose money. Only a handful of the companies and altcoins that have sprung up will make it, but those that do could dominate the space for many years to come, just as those few rail, car and dotcom companies that survived did.
Beware of the hype cycle
There is a cycle that a new technology passes through as it goes from conception to widespread adoption. The research company Gartner has dubbed it the ‘hype cycle’. It has five phases: the technology trigger, the peak of inflated expectations, the trough of disappointment, the slope of enlightenment and the plateau of productivity.
In the first phase the new technology is invented. There is research and development and some early investment is found. The first products are brought to market. They are expensive and will need a lot of improvement, but they find some early users. The technology clearly has something special about it and people start getting excited. This is the ‘technology trigger’. The internet in the early 1990s is a good example.
As this excitement grows, we move into the second phase. The media start talking about this amazing new technology. Speculative money piles in. All sorts of new companies spring up to operate in this new sector. Many of them are just chasing hot money and have no real product to offer. They are sometimes fraudulent. This new technology is going to change the world. The possibilities are endless. We’re going to cure diseases. We’re going to solve energy problems. We’re going to build houses on the moon. This is the ‘peak of inflated expectations’. This was the internet in 2000.
But at some point, the needle of reality punctures the bubble of expectation, and we move into the third phase. Actually, this technology might not be quite as good as we thought it was; it’s going to take a lot of work to get it right and to make it succeed on a commercial scale. A great deal of not particularly rewarding hard work, time and investment lies ahead. Forget the ideas men – now we need the water-carriers. Suddenly, the excitement has gone.
Negative press starts to creep in. Now there are more sellers than buyers. Investment is harder to come by. Many companies start going bust. People are losing money. The hype cycle has reversed and we have descended into the ‘trough of disappointment.’ This was the internet between 2000 and 2003.
But now that the hot money has left, we can move into phase four. The incompetent or fraudulent companies have died. The sector has been purged. Most of those that remain are serious players. Investors now demand better practice and the survivors deliver it. They release the second and third generation products, and they work quite well. More and more people start to use the technology and it is finally finding mainstream adoption. This was the internet in 2004. It climbed the ‘Slope of Enlightenment’, the fourth phase of the hype cycle, and entered the ‘Plateau of Productivity’ – phase five – which is where the likes of Google, Amazon and eBay are today.
Of course, cycles like this are arbitrary. Reality is never quite so simple. But it’s easy to make the case that crypto-currencies in late 2013 reached a ‘peak of inflated expectations’.
Perhaps it was not the peak. It wasn’t Bitcoin’s dotcom 2000 moment – just a peak on a larger journey up. Many Bitcoin companies, for example, are not even listed on the stock market. Greater manias could lie ahead.
But it’s also easy to make the case that it was the peak of inflated expectations. In the space of three or four years, Bitcoin went from an understated mention on an obscure mailing list to declarations that it was not only going to become the preferred money system of the world, but also the usurper of the existing world order. At $1,000 a coin, some early adopters had made a million times their original investment. Speculators marvelled at the colossal amount of money they were making. The media were crazy for it. Bitcoin was discussed all over television.
It caught the imagination of the left, the right and the in-between. Computer boffins marvelled at the impossibly resilient code. Economists and libertarians marvelled at the politics of a money without government or border. There were early adopters, from the tech savvy to the black markets (black markets are usually quick to embrace new technology – pornography was the first business sector to actually make money on the internet, for example).
Every Tom, Dick and Harry you met under the age of 3
0 with an interest in IT was involved in some Bitcoin start-up or other. Either that or he was designing some new alt currency – some altcoins were rising at over a thousand per cent per day. ‘Banks, governments, they’re irrelevant now,’ these upstarts declared.
I suggest that in late 2013 we hit the peak of the hype cycle – the peak of inflated expectations. Now Bitcoin is somewhere in the ‘trough of disillusionment,’ just like the internet in 2001. The price has fallen. There have been thefts. Some of the companies involved have gone bankrupt.
The challenge now is for all those start-ups to make their product or service work. They have to take Bitcoin from a great idea and a technology that works to something with much wider ‘real world’ use. They have to find investment and get more and more people to start using the coins. This is a long process.
There are many who will disagree with this interpretation. And, with investment, it is dangerous to have rigid opinions – I reserve the right to change my mind as events unfold.
You could still make a mint
There seems to be a 100-year cycle in money.
1716 saw the first Great Recoinage, in the years after Isaac Newton had taken over at the Bank of England. A hundred years later, after excess spending on the Napoleonic Wars, there was another Great Recoinage in 1816. 1913-4 saw another fundamental change to the monetary system with the founding of the Federal Reserve Bank in the US and in Europe the move away from the gold standard.
And here we are in 2014-15, a hundred years later, with this new threat to the monetary order that is Bitcoin and the other crypto-currencies that have followed. If they really do take off, despite everything I’ve just said, you could still make a great deal of money speculating in Bitcoin and altcoins.
Bitcoin Page 17