The ups and downs of Bitcoin (by )

The value of bitcoin periodically starts to rise very rapidly, then after a while, crashes and re-stabilises. Whenever a crash happens, I see a spate of anti-Bitcoin blog posts and opinion pieces, such as this by Charles Stross. Now, I think there's plenty of things wrong with Bitcoin, and plenty of worries about what its effects in the uncertain future might be; but these anti-Bitcoin pieces tend to contain a lot of misconceptions and fallacies, so I feel compelled to try and refute some of them I've been seeing.

Bitcoin's price is volatile, so it will never be useful as a currency.

It sure is volatile! There are periodic surges and crashes, superimposed on top of a generally exponential growth in value. Take a look at its price history, on a logarithmic scale, with the MtGox exchange volume in dollars.

But this volatility is all due to rapid adoption, and that won't last forever.

The current rapid deflation is not the inherent deflation of BTC (it's in its inflationary phase, anyway, with lots of new BTC being mined every day), but the rapid adoption of the new currency causing more money to flow into it. The fact that this flow is driven of public awareness of BTC is why it's so closely linked to news, with wild swings following any significant news story about Bitcoin. And the small scale of existing BTC usage compared to the size of the new influxes (and the corresponding panics!) is why the swings are so large. Once BTC has achieved the market penetration it will have in the long run, then we'll see a lot more stability.

At the moment, the growth in interest in Bitcoin is causing the value of bitcoin to rise faster than the production of new bitcoin is pushing the value back down. At some point, Bitcoin will achieve it's "saturation point", with the proportion of the world money supply in Bitcoin settling to its final level. As the rate of money flooding into Bitcoin drops, so will its rise in value drop, until eventually the inflation caused by new Bitcoins being mined will dominate and the value might even start to sink a little; unless a third factor - the rise in value of Bitcoins due to the growth of the economy it represents a stable fraction of - outweighs that (which is hard to predict). Eventually, the generation of new bitcoins will have effectively ceased, at which point the value of bitcoin will grow at about the rate of growth of the economy - a few percent each year.

Easier liquidity with existing currencies will improve the stability, presumably, as part of the volatility comes from the difficulty in exchanging Bitcoin with other currencies, making it easy for a large transaction to deplete or glut the market for Bitcoin on any given exchange. Although volatility is often cited as a reason to firewall BTC from the conventional economy, allowing it to integrate with the conventional economy will be a big step towards removing that volatility...

If Bitcoin is used like a currency (rather than a speculative investment vehicle), it will start to behave like one.

A deflationary currency is terrible as people will never want to invest in anything; it'll be more profitable to just keep savings

Ah, but as I argue above, unless I'm mistaken, in the long run, the price appreciation of Bitcoin will just be a few percent a year; the growth of the underlying economy. So it'll be about the same as an "index-linked" investment, and won't be a "market beating" investment at all. This will mean that poorly-performing investments, which grow at below the market rate, aren't very attractive; but they currently aren't, anyway.

However, will I stop putting my money into banks because it'll grow just fine when stored in my own Bitcoin wallet? So will banks have no money to lend, and be unable to offer loans to students, and startup companies, and mortgages to house buyers?

Well, even assuming that we stick with our current debt-driven economic model (and there's plenty of voices arguing for a new model to be invented, after the banking crises of the past years), a bank offering 0.1% interest will still be an attractive place for me to put my bitcoins, compared to getting 0% interest keeping them in my own wallet; the fact that my bitcoin will also be increasing in value due to deflation, regardless of where I keep it, does not influence that. Banks will have to compete with Bitcoin's ability to be transferred cheaply and easily, versus their annoying and expensive mechanisms to transfer money around, but perhaps they'll just drop SEPA and SWIFT and Faster Payments and Direct Debit and friends in favour of just offering Bitcoin transfers to and from their Bitcoin-demoninated accounts.

Sure, I wouldn't take out a mortgage denominated in bitcoins right now, with the value of a bitcoin soaring exponentially; I might buy a house for a hundred bitcoins, then after a decade, be paying a hundred-bitcoin mortgage for a house that's now worth one tenth of a bitcoin. That would be stupid. But I'd love to take out a mortgage denominated in pounds Sterling that I get to pay in bitcoins at the rate of exchange in effect at each payment; and if Bitcoin adoption levels off before bitcoin mining levels off so it has an actually inflationary phase, I'd very gladly take out a mortgage denominated in it then! But even in the very long run, when the value of a bitcoin is stably and predictably appreciating with the growth of the economy that each bitcoin represents a fraction of at a few percent a year, I'd be happy to take out a mortgage in it; I'd just expect the interest rate I paid to be adjusted to take the rate of appreciation into effect, so that the bank still makes the same effective profit out of me (and I pay the same effective premium for the service of borrowing the money), once deflation is taken into account. Long term loans and investments are calculated in terms of underlying value, and the change in the predicted mapping from that value to a number of currency units is already adjusted to take inflation into account. Basing that calculation on deflation instead won't be the end of the world.

Bitcoin isn't regulated

This is a complex point to refute, because people often don't know what they mean by it in the first place. I hear a lot of "Bitcoin isn't regulated, so you can buy child porn with it". This is confusing two unrelated concepts.

The idea is that existing currencies, such as the dollar, are "regulated". It's sort of implied that this means it's illegal to use it to buy criminal stuff, but that's due to regulations about criminal transactions, and nothing to do with regulations about the currency itself (it's just as illegal to buy drugs with bitcoins as with dollars, and we'll talk about that in the next point).

The regulation conventional currencies actually have is that there's a central bank that can control the supply, which allows them to control the rate of inflation or deflation (and, generally, they choose to inflate it). As they create the currency from scratch, they also get to choose how to introduce it into the economy - traditionally, they use it to buy government bonds, in effect giving it to the government to spend on stuff, but they could just as easily print it onto paper bills and coins and hand it out at random in the streets, although that might cause a riot.

And whether the ability of central banks to control the rate of inflation is a good thing or not is... still hotly debated. There's a grand tradition of economic thought centred around something called the Keynesian model, which is the theory behind the operation of this kind of inflationary economy, but it's not the only model, and there's no solid theoretical argument that it's the best model. Until now, the alternative models have been rather hard to test. If Bitcoin thrives as a deflationary currency, we'll get to test them. But if people tell you that Bitcoin is a disaster for the economy because it's not a good idea in a Keynesian model, that just means they don't believe a non-Keynesian model can be valid. See if you can find out why.

Another interesting point to consider is that, if the people who fear Bitcoin will destroy their Keynesian economies and replace them with anarchy and misery are true, then surely that means that there's something wrong with their Keynesian economies. If the introduction of something like Bitcoin - which will, presumably, inevitably be discovered at some point - destroys their economy, then it's inherently unstable, like a lump of explosive, just waiting for the correct stimulus to cause it to all come falling apart. That, alone, is an argument that this kind of economy is unsafe and we need to find a better one.

Bitcoin will allow money laundering and assasinations, will make tax evasion easier, and will cause the destruction of the welfare state

Well, BTC isn't all that anonymous; is an interesting case in point.

Also, any argument that BTC's pseudonymity will have drastic effects needs to explain why it's different from existing untracked means of transferring value, such as gold, in this perspective. Gold is easily bought and sold, and is less traceable than BTC; it's not even that "heavy and bulky" ($100,000 ~= 3kg of gold, about half a cupful; if your monthly income is "heavy and bulky" in gold, you're lucky). Bitcoin has the edge over gold in being able to be easily transferred online, but at the cost of those online transfers being public knowledge.

Bear in mind that if any legitimate business or person transacts with you in BTC, they're bound (in the UK, at least) by the same legal requirements with regards to declaring it for taxation purposes as if they'd transacted in USD or GBP (in traceable bank transfer, or anonymous cash, form) or gold. If I receive my income from my work in BTC instead of in pounds Sterling, my employer/customer and I are just as liable for correctly accounting for it for taxation purposes. People have tried evading tax by using alternative means of payment before ("payments in kind"), and there's already a framework in place to prevent it. Bitcoin is in no way "designed" for tax evasion; it's designed to allow pseudonymous transfers of Bitcoin amounts securely, while making that transfer entirely public as a side-effect. Whereas handing over gold or cash is anonymous. Is the fact that Bitcoin transfers can be done without moving physical objects really going to outweigh the traceability of Bitcoin in its usefulness for hiding income from tax authorities? So if Bitcoin won't help me avoid paying tax, it can't simply cause the death of the welfare state through fiscal starvation.

So let's look at how Bitcoin might be used to buy drugs, assassinations, child porn, and other illegal products and services. Whether you use a widely-known site like the Silk Road used to be (before it was shut down, having already been quietly infiltrated by the FBI some time ago) or a more discreet arrangement with a "dealer" contacted through word of mouth, you're going to be transferring some of your bitcoin to an address they provide. Perhaps you'll try and launder it through a mixing service first, but unless you're dealing in small amounts, those aren't very safe (even if the laundering service is "honest" and doesn't keep a log). So now you've sent your money to a criminal, and made a public record of it. If they, or another criminal they then send the money on to, are then caught using it as part of the proceeds of crime, it's linked to you. (Even more so if you used it to pay somebody to post drugs to your home address...)

If you'd handed them some cash (or gold), the link back to you is far more tenuous.

And if you're a criminal receiving Bitcoins for murders, child porn, or whatever, it's only a matter of time before one of those Bitcoin transactions is linked to a crime (either yours, or of a criminal customer of yours). So if you ever spend those Bitcoins on anything that gets delivered to your house, or convert it into other currencies at an exchange, that is now linked to your personal identity, and the police will come visiting you, as former Silk Road drug dealers are believed to be finding out at the time of writing.

I hold some bitcoins, which I've bought on exchanges. Not only are all those purchases available for examination by law enforcement - and each linked to my bank account details and, later, scans of my ID documents - but they all go to the same Bitcoin wallet, which means that they're linked to each other (and any illicit secret income from other sources) when I spend money, too. If I keep my illicit and legitimate bitcoins strictly separated (like I keep my public donation vanity addresses separate from my bought bitcoins, in order to preserve my privacy), then I can't spend my illicit earnings on shiny toys delivered to my house, and have to remain living like a pauper despite having vast theoretical wealth in ill-gotten gains. No fun!

Oh, and by the way, if your local intelligence agency decides to log Bitcoin traffic, they'll be able to see whose Internet connection you're emitting transactions on, too. Perhaps you can use Tor to avoid that, if you're careful to avoid timing attacks...

They're causing people to waste electricity on proofs of work

Despite the alarming figures in the article above, Bitcoin mining is a small fraction of the energy used by computers worldwide, and is likely to remain so. The carbon footprint of conventional banking and payments, with its extensive use of bits of paper, is also not to be sneezed at; and Bitcoin could replace that. Also, as the cost of power dominates the cost of a mining operation, a likely future trend is for bitcoin mining to occur in places where power is very cheap (such as near hydroelectric dams) or where heat is a desirable by-product which would have to be obtained via some means anyway (heating industrial processes or homes) - trends which cloud computing datacentres, which still dwarf bitcoin mining in power consumption, have already started to show.

People will steal computer power to generate Bitcoins

Botnets are losing their appeal for bitcoin mining, as it moves over to specialised hardware (the returns on mining with CPUs and GPUs decrease, a tendency that has arisen in the years since the paper linked to was written), and makes it increasingly hard for criminal botnet operators to dominate the Bitcoin supply, or take over the mining network in order to control the rules of the Bitcoin economy. Bitcoin gives botnet operators a new way to make money, which is a shame - but there's already plenty of reasons to run a botnet; eliminating them through better software security architectures and user education needs to remain a goal for us all...

The proportion of the wealth held by the top one percent of Bitcoin holders is significant

This is probably true (although it's hard to tell with the early-mined Bitcoins, which have generally never moved so can't be traced to an owner until they're spent), but this is largely due to the injustice of the larger world in which Bitcoin exists; since that wealth inequality holds for the people interested in buying Bitcoin, it ends up holding within Bitcoin, too. People converting their dollar fortunes into Bitcoin fortunes does nothing (directly) to change the wealth distribution of the world. What is more interesting is the effect of Bitcoin's value changes compared to the value of existing currencies; assuming Bitcoin continues to rise in value and become a fungible and liquid currency, there will be a generation of early-adopting crypto geeks (generally not very rich people) who will get rich off of it from early mining experiments or buying them as a curiosity when they were valued at a dollar or so, and a later generation of already-rich investors who bought them once they showed their tendency for exponentially rising value and got even richer. The latter group will have ridden the growth of Bitcoin to increase the wealth inequality, while the former group will presumably have used it to narrow the wealth gap, by going from not rich to rich.

But both will be a "one-off" event; once the Bitcoin price stabilises, the meteoritic growth will stop, and nobody can get rich from it again. Bitcoin is just following the same pattern as the value of shares in a successful tech company, although perhaps on a larger scale; it is an endemic problem of our economic system that such growth events make a few lucky early adopters rich from nothing, and a middle generation of quick investors even richer than they already were.

"Bitcoiners are techno-libertarian anarcho-syndicalists"

I've often heard it complained that Bitcoin adopters are crackpots with a fringe economic theory they're trying to force upon the world, either blind to its obvious flaws, or greedy to move to a system that will reward people in their situation, with no regard for the costs to humanity as a whole.

I'm sure some of them are. And I'm sure that some of its opponents are also crackpots with fringe economic theories of their own, which Bitcoin is a threat to.

But most Bitcoin enthusiasts are either people looking to make money through investing in it, or people who want a better way to pay for things online. I fall into the latter category; I was attracted to Bitcoin because I want to be able to pay my monthly outgoings from a cronjob, rather than setting up standing orders that get delayed if they happen to fall on a weekend or bank holiday, and because I want to be able to create Web applications that can accept payments without paying huge surchages, risks of chargebacks, and other such obstacles. I bought some bitoins back when they cost £2.20 each, in order to experiment with them and in order to try and promote a Bitcoin economy by spending them; I've managed to spend a few, but the range of available options was disappointingly small until quite recently. The immense growth in the value of my little hoard has been a pleasant surprise, to be honest, but I've never had the spare cash to be a proper investor!


Bitcoin has already changed the world, if subtly; and I think it's showing no signs of stopping. And I can't honestly tell if it's going to be a force for good or a force for bad, in the long run; we know so little about how economies actually work that we can't even predict the behaviour of the one we already have, yet alone theoretical new ones. But what I do know is that ours has lots of flaws, both in terms of the theoretical underpinnings of a debt-based economy, and the practical implementation of banks, markets, and taxation as we have them. The flaws in the current system are hard to address, even if we knew how to fix them, because it has a tremendous inertia; so, although I think Bitcoin has some definite advantages, and some definite disadvantages, and many unknowns, I think it's about time we took a risk and shook things up a little...

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