Bitcoin adoption

[badukJr]

Besides those rather philosophical considerations, there are also some practical questions still open:

When mining gets less and less profitable, transaction fees will need to get introduced.
When transactional volume increases, there will be the need for lightweight servers that do not host the complete chain of transactions.

Who is responsible and decides about how those enhancements will be done?

Yeah, that's another thing. Basically a group of at least 50% of the bitcoin holders have to get together and agree on new rules. This is because each peer validates the transactions.

I think though that the chain of transactions can be split up pretty easily, its already built into the protocol.

Really, the whole protocol behind bitcoin is really sleek technically. It is unfortunate that other poor decisions were made.

[daniel_the_smith]

It is interesting to think about what could have been done besides an absolute cap on the number of bitcoins.

Deflation/inflation is a function of demand as well as supply. It's hard to think of a rule that bitcoin clients could follow that would make inflation always be just a few % per year, as the US attempts to do for the dollar. Depending on population size change (I.e. demand), a 0% increase in bitcoin supply could be inflationary and a 10% increase in supply could be deflationary.

You can argue that 0% per year increase in bitcoin supply is not the right number, and I don't necessarily disagree-- but what is the right number? Bitcoin clients only affect the bitcoin supply, not demand...

I mean as we speak bitcoin is probably inflating, not deflating...

[gogameguru]

Besides those rather philosophical considerations, there are also some practical questions still open:

When mining gets less and less profitable, transaction fees will need to get introduced.
When transactional volume increases, there will be the need for lightweight servers that do not host the complete chain of transactions.

Who is responsible and decides about how those enhancements will be done?

Yeah, that's another thing. Basically a group of at least 50% of the bitcoin holders have to get together and agree on new rules. This is because each peer validates the transactions.

I think though that the chain of transactions can be split up pretty easily, its already built into the protocol.

Really, the whole protocol behind bitcoin is really sleek technically. It is unfortunate that other poor decisions were made.

These are interesting points.

To some extent, the "who's responsible?" question has always been something that people ask about anything that's open source. In general it's hard to conceive of it working, but a lot of the internet runs on it. I have a good friend who maintains that Wikipedia shouldn't work as well as it does and his arguments are persuasive...

Presumably most of the people running clients are only involved passively because they're using the distributed network. So even if their computers are validating transactions, they're not making the decisions. I don't think you need to reach a 50% consensus with the users. In theory, you just need consensus amongst contributors and then you gradually roll out software updates for the clients and phase out the old rules. Since there's money involved some people would still take issue with this, particularly if they stood to lose something. So making major changes could be unwise. It's not perfect, but I think that's how it would have to work in practice.

To be honest, my understanding of both economics and cryptography is relatively basic, so even though I did some reading about bitcoin, I won't presume to critique the design. I still view it as a proof of concept and if it fails because of various constraints, it will be an opportunity to learn and make the next attempt better.

One thing I'm wondering about is, when mining becomes less profitable (as SpongeBob says) and the network is big enough, couldn't you just start to take advantage of the idle cycles of all the computers that are running the client? What's not really clear to me is just how intensive the processing for validating a transaction is. Possibly some of the design decisions were predicated on assumptions that processors would become x times more efficient and renewable (but not free) energy would become more prevalent. What do other people think?

Another thing I was wondering about is the deflation issue. On the Wikipedia page someone wrote:

To ensure sufficient granularity of the money supply, clients can divide each BTC unit down to eight decimal places (a total of 2.1 × 10^15 or 2.1 quadrillion units).

So it seems to me you're not going to run out of divisible units any time soon, although that number still does seem a bit small for a truly global currency. But my question is, if there's very slow deflation, to the point where it's still better to invest money elsewhere than hoard it, to what extent does that matter?

Secondly, if a lot of early adopters choose to speculatively hold onto the coins and limit supply, there must be some point where the value of a bitcoin gets so high that the system becomes unworkable, people start to abandon it, demand collapses and the experiment fails. But before that happens, if we assume some people are rational (always dangerous), won't the smart people sell or spend their coins and push the system back to some sort of equilibrium? I imagine that it would then depend on the initial conditions and rules of the system as to where that equilibrium lies, and it may lie at a point where the tendency of the system is to spiral out of control until it collapses. Though it's probably hard to model this and find out without putting it into the 'real world'.

This might not be the right way to think about these things, but my background is in chemistry, so I guess I tend to think in those terms. Does anyone have any thoughts on this?

[daniel_the_smith]

The block difficulty scales with the number of hashes per second the network of miners maintains. Faster computers just mean the difficulty goes up. If the cryptography behind it breaks, we'll have a lot more problems than just bitcoin not working.

Jts will have to respond to the rest of your comment.

[gogameguru]

The block difficulty scales with the number of hashes per second the network of miners maintains. Faster computers just mean the difficulty goes up. If the cryptography behind it breaks, we'll have a lot more problems than just bitcoin not working.

Jts will have to respond to the rest of your comment.

Ahh, I see, thanks for clarifying that Daniel. In that case, I don't really understand how that won't become a problem . I could be wrong though. Whoever designed this thing was pretty hardcore.

[daniel_the_smith]

I guess technically it scales with how long it took to create the last 2000 blocks, but it amounts to the same thing. The difficulty slope is exponential, we'll not run out of difficulty any time soon, and if in the distant future it looks like we might, the hashing algorithm can be changed by 51% of the miners switching over.

[palapiku]

Let's say I have a lot of resources and happen to own more than half of the Bitcoin network nodes in the world (I have lots of computers and perhaps a botnet or two), what then?

[Bill Spight]

Besides those rather philosophical considerations, there are also some practical questions still open:

When mining gets less and less profitable, transaction fees will need to get introduced.
When transactional volume increases, there will be the need for lightweight servers that do not host the complete chain of transactions.

Who is responsible and decides about how those enhancements will be done?

Yeah, that's another thing. Basically a group of at least 50% of the bitcoin holders have to get together and agree on new rules. This is because each peer validates the transactions.

I think though that the chain of transactions can be split up pretty easily, its already built into the protocol.

Really, the whole protocol behind bitcoin is really sleek technically. It is unfortunate that other poor decisions were made.

These are interesting points.

To some extent, the "who's responsible?" question has always been something that people ask about anything that's open source. In general it's hard to conceive of it working, but a lot of the internet runs on it. I have a good friend who maintains that Wikipedia shouldn't work as well as it does and his arguments are persuasive...

Presumably most of the people running clients are only involved passively because they're using the distributed network. So even if their computers are validating transactions, they're not making the decisions. I don't think you need to reach a 50% consensus with the users. In theory, you just need consensus amongst contributors and then you gradually roll out software updates for the clients and phase out the old rules. Since there's money involved some people would still take issue with this, particularly if they stood to lose something. So making major changes could be unwise. It's not perfect, but I think that's how it would have to work in practice.

To be honest, my understanding of both economics and cryptography is relatively basic, so even though I did some reading about bitcoin, I won't presume to critique the design. I still view it as a proof of concept and if it fails because of various constraints, it will be an opportunity to learn and make the next attempt better.

One thing I'm wondering about is, when mining becomes less profitable (as SpongeBob says) and the network is big enough, couldn't you just start to take advantage of the idle cycles of all the computers that are running the client? What's not really clear to me is just how intensive the processing for validating a transaction is. Possibly some of the design decisions were predicated on assumptions that processors would become x times more efficient and renewable (but not free) energy would become more prevalent. What do other people think?

Another thing I was wondering about is the deflation issue. On the Wikipedia page someone wrote:

To ensure sufficient granularity of the money supply, clients can divide each BTC unit down to eight decimal places (a total of 2.1 × 10^15 or 2.1 quadrillion units).

So it seems to me you're not going to run out of divisible units any time soon, although that number still does seem a bit small for a truly global currency. But my question is, if there's very slow deflation, to the point where it's still better to invest money elsewhere than hoard it, to what extent does that matter?

Secondly, if a lot of early adopters choose to speculatively hold onto the coins and limit supply, there must be some point where the value of a bitcoin gets so high that the system becomes unworkable, people start to abandon it, demand collapses and the experiment fails. But before that happens, if we assume some people are rational (always dangerous), won't the smart people sell or spend their coins and push the system back to some sort of equilibrium? I imagine that it would then depend on the initial conditions and rules of the system as to where that equilibrium lies, and it may lie at a point where the tendency of the system is to spiral out of control until it collapses. Though it's probably hard to model this and find out without putting it into the 'real world'.

This might not be the right way to think about these things, but my background is in chemistry, so I guess I tend to think in those terms. Does anyone have any thoughts on this?

Sure.

Money has more than one function. Acting as a store of value is one. People want to put money in the bank or in a hole in the ground and have it retain its value. Inflation works against that. If your money buys less tomorrow, why save it today?

Another function is as a medium of exchange. People want to buy things with money. Deflation works against that. If your money buys more tomorrow, why spend it today?

I would like to say that the medium of exchange function is more basic than the store of value function, but the Yap stones tell against that. However, in modern economies, the value of money is realized when you spend it. The threat to spend it may also have value. (Relation to aji and thickness is interesting, but not relevant to the current discussion. )

In the modern era we have learned a fair amount about money. One thing that we learned is Gresham's Law: "bad" money drives "good" money out of circulation. Good and bad refer to how well money stores value. Multiple forms of money in the same region is not a prominent feature of life today. But from what I hear, before the Federal Reserve Act of 1913, there were some 50,000 different currencies circulating in the U. S. These were not only bank notes, businesses could issue money that they promised to honor for purchases. Of course, bank notes could become worthless if the issuing bank went out of business. If you were unsure about a bank, you might not accept its note at face value, but discount it. You will tend to save money that you trust to retain its value and spend other money. Bad money drives good money out of circulation.

Bitcoin is not backed by a bank or government, but by a community of people who use it. No bank is going to go out of business, no country is going to be conquered. As long as there are people who are willing to accept bitcoin in payment, it will have value. There is no inflation with bitcoin. In that sense, bitcoin is good money, by comparison with every form of government money today. By Gresham's law, other money should drive bitcoin out of circulation. But if it is driven out of circulation, since there is no guarantee that anyone will accept bitcoin, it can lose its value almost overnight. In that sense it is bad money.

I suppose that there may be some value where these countervailing forces are equal, but I do not think that there is a stable equilibrium. If enough people decide to save their bitcoins at the same time, the market could dry up. If so, how does it start up again? Perhaps there will always be enough people who will want to buy bitcoins for money laundering purposes or drug transactions that the market will not dry up. Anyway, it is an interesting social experiment.

[SpongeBob]

Just as transaction fees will ultimately have to be integrated into the protocol (correct me if I am wrong here), it would in principle be possible to do away with the upper limit of bitcoins, wouldn't it?

Also, are there any educated guesses about how high those transaction fees are going to be? Someone has to make profit with validating those transactions, just as other payment systems like PayPal have to be profitable. And if transaction fees would be comparable to those of other payment systems, wouldn't Bitcoin then lose one of its major benefits?

[badukJr]

I have to double check, but when I say 50% I mean 50% of the bitcoin wealth. Not 50% of the participants.

Just as transaction fees will ultimately have to be integrated into the protocol (correct me if I am wrong here), it would in principal be possible to do away the upper limit of bitcoins, wouldn't it?

A small number of people own 50% of the bitcoins. They own a lot. Releasing more bitcoins would devalue their holdings, so they will never decide to do that. It is one of the difficulties that arises when having an unregulated system and nobody is interested in acquiring goods. They are still only interested in the value against the dollar (or insert real currency here) and not acquiring goods or investment with bitcoins.

[Mike Novack]

I think there is a misunderstanding about what "money" is or is not.

An essential feature that distinguishes money from just another commodity is that it is generally accepted and used.

Let's settle this qestion. Have any of you ever used or received a "bitcoin"? I mean in a financial transaction, buying or selling something, not buying or selling bitcoins themselves for (real) money.

If not, then bitcoins are just a commodity.

[Bill Spight]

I think there is a misunderstanding about what "money" is or is not.

An essential feature that distinguishes money from just another commodity is that it is generally accepted and used.

Let's settle this qestion. Have any of you ever used or received a "bitcoin"? I mean in a financial transaction, buying or selling something, not buying or selling bitcoins themselves for (real) money.

If not, then bitcoins are just a commodity.

Commodities have uses. The only use for bitcoins is as a medium of exchange. Bitcoins are just as much money as Monopoly money or airline miles.

[daniel_the_smith]

I have to double check, but when I say 50% I mean 50% of the bitcoin wealth. Not 50% of the participants.

51% of the miners set the rules, not 51% of the wealth.

Let's say I have a lot of resources and happen to own more than half of the Bitcoin network nodes in the world (I have lots of computers and perhaps a botnet or two), what then?

It would be an incredibly expensive proposition to produce more than half of the hashes on the network (would probably cost on the order of 35,000-50,000 video cards, computers to run them, and electricity). It would also be incredibly stupid, because it would probably cause bitcoin to drop in value, and then you wouldn't be able to recoup your investment.

Unless you wanted to kill bitcoin.

[jts]

But my question is, if there's very slow deflation, to the point where it's still better to invest money elsewhere than hoard it, to what extent does that matter?

Secondly, if a lot of early adopters choose to speculatively hold onto the coins and limit supply, there must be some point where the value of a bitcoin gets so high that the system becomes unworkable, people start to abandon it, demand collapses and the experiment fails. But before that happens, if we assume some people are rational (always dangerous), won't the smart people sell or spend their coins and push the system back to some sort of equilibrium?

I'm going to narrowly try to answer these two. These answers aren't necessarily meant to be convincing, just to give you an idea of what mainstream economists think about these questions.

Deflation:

1. The whole idea of using a money system instead of a barter system is to make commercial transactions easier and thus more frequent. Right? If you're a great fisher and I'm a great hunter, we don't want to be trapped in a situation where the only way we can avail ourselves of each other's expertise is if I want some fish and you want some game.

The simplest description of a recession is "the monetary system breaks down". The fisher can't buy game because he has no money, because no one is buying fish; the hunter can't buy fish because he has no money, because no one is buying game. The hunter and the fisher are both happy (desperate!) to work more and produce more goods, and in fact if they can work out some sort of direct trade (fish for game), they will succeed at providing each other with work. But they are unwilling to each pay each other cash for a transaction that they will gladly pay for with reciprocal services. Why? Because cash is too scarce in the economy as a whole. Someone, somewhere, decided they needed to stockpile more money (not valuable assets denominated in money, but money itself, in deposit boxes and bank accounts), and that has driven up the demand for money, which raises the price of money (measured in goods), or lowers the price of goods (measured in money), which is the same thing.

You can also see how this would ripple though the economy. If people stopped buying Go books because they wanted to buy Chess books instead, you would experience that as reduced demand for Go books, and you would have to settle on some combination of lower prices and lower sales. As a result, GoGameGuru would have to cut back as an enterprise (buying less stock, maybe firing a part-time employee), and you, the entrepreneur, would have to cut back on buying things like hamburgers and bicycles. But if this is happening because people are buying Chess books instead of Go books, there is at the same time a Chess book vendor somewhere who is raising prices and selling more books; and who is buying more stock, hiring a new employee, and buying more hamburgers and bicycles. However, when people just want to stockpile money, and are shifting their purchases from Go books to money rather than from one product to another, that will look exactly the same from the point of view of GoGameGuru; but from the point of view of the economy as a whole, you see a uniform cascade of falling prices (deflation) and falling production (recession).

So you want to have a slight amount of inflation in the monetary system, because inflation is relatively harmless, whereas even a small amount of deflation is awful for the economy. A currency with built-in deflation is painfully stupid, if they were trying to build a currency; as a ponzi scheme it's a brilliant idea, of course.

Equilibrium prices:

2. There is both the question of whether a commodity is correctly priced and its volatility. (This is similar to the distinction between bias and precision in scientific measurement.) Think about stocks. If I firmly believe that, on average, the stock market goes up by 5% every year, but that day-to-day its movements are quite volatile, then I'll be quite willing to invest if I'm trying to save money for future consumption and am also sure that I won't need to suddenly tap my investments next week. Right? On the other hand, if I'm worried about losing my job, or I think I might buy a house soon, or for some other reason think I might need to make purchases, this day-to-day volatility of the stock market will be quite worrisome to me, and I might prefer not to invest in stocks.

What do I hold instead of stocks, if I'm worried that I'll need money on short notice? Well, money, or something very similar to money (like a government bond). I want to be sure that I can buy a specific bundle of goods with it. So a commodity that is itself very volatile would be useless as money. (This was one problem with the gold standard - the value of gold changes with booms and busts in gold mining.) If the value of bitcoin skyrockets and then collapses, it will forever be marked as a volatile asset.

[uPWarrior]

A small number of people own 50% of the bitcoins. They own a lot. Releasing more bitcoins would devalue their holdings, so they will never decide to do that. It is one of the difficulties that arises when having an unregulated system and nobody is interested in acquiring goods. They are still only interested in the value against the dollar (or insert real currency here) and not acquiring goods or investment with bitcoins.

I would like to quote this comment as it highlights my biggest concern about bitcoin.

Do you want to create a new online currency? Fine. However, keeping to yourself or distributing to the very early adopters the majority of the "wealth" is a certain way to kill it.
I'm saying this assuming good faith from the creators, even though I highly suspect that this was planed from the beginning as a "feature".