Posted on 02/27/2021 8:21:34 AM PST by amorphous
Bitcoin and other cryptocurrencies are all the rage right now.
Of course, the rise of non-government, decentralized, encrypted electronic currencies like bitcoin has been going on for years. But in recent months it has surged to the forefront of the national conversation as major figures like Elon Musk have bought in and bitcoin has hit record valuation levels.
Many Americans may not have followed the trend closely, and are seeking to understand it. So, to help readers better understand the novel technological trend, FEE interviewed Will Luther, an economics professor, director of the American Institute for Economic Research’s Sound Money Project, and an adjunct scholar with the Cato Institute’s Center for Monetary and Financial Alternatives.
What Makes Bitcoin Different From the US Dollar? One easy way to understand bitcoin is to compare it to the US dollar.
“Bitcoin is similar to the dollar in many respects,” Luther explained. “Both are intrinsically worthless, meaning they have no use apart from their role as a medium of exchange. Both are irredeemable, meaning they are not backed by some underlying asset. And both are digital base monies. (Bitcoin is fully digital, while the dollar is only 99.96% digital—close enough.)”
However, the two differ in important ways.
For one, the US government has centralized control over the dollar and its supply. Bitcoin is decentralized, meaning there’s no central authority controlling it.
“Bitcoin’s supply is preprogrammed,” Luther said. “There will never be more than 21 million bitcoin in circulation and the supply will follow a predetermined trajectory until it reaches the maximum. The supply of dollars, in contrast, depends on the discretion of the Federal Reserve.”
One consequence of this difference is that the government can inflate the US dollar if it wishes, by printing money. No one can inflate bitcoin because the supply of the currency is not centrally controlled or subject to manipulation.
One other key difference, Luther says, is that “bitcoin tends to provide more financial privacy in digital transactions.”
While exchanges using the dollar can be very private if done in-person with cash, digital exchanges using the dollar that are not done in person must involve a trusted third-party that records the transaction—like Venmo or your bank. (This opens up an opportunity for privacy violations).
However, “since bitcoin can be transferred without relying on a trusted third party, it tends to offer more financial privacy than traditional digital payment mechanisms,” Luther explains.
Is Bitcoin a ‘Currency’ or an ‘Asset’? Much of the news around bitcoin involves people making (or losing) money by purchasing it and then selling it when its highly-volatile price shifts. At first glance, it seems more similar to an asset like a stock one buys on the stock market than a currency, defined as a medium of exchange.
But it’s both, Luther explains.
“Bitcoin is, first and foremost, a currency (or, potential currency),” the economist says.
However, “all currencies are assets,” Luther offers. “And some assets appreciate. For this reason, some people think of bitcoin as an investment. But that is secondary. Indeed, bitcoin’s price will only rise if (1) it becomes more useful as a currency today or (2) is expected to be more widely used as a currency in the future. Hence, even those interested in bitcoin as an investment should understand its role as a currency.”
Why Is Bitcoin’s Price So Volatile? Bitcoin is infamous for its volatility, meaning that its valuation, or price, often swings drastically up and down over relatively short periods of time. This is what makes it an attractive speculative asset for some, but also is a barrier to its adoption as a widespread currency used for exchange.
Why is it so volatile?
“Since bitcoin’s supply is essentially fixed, its price fluctuates due to changes in demand,” Luther says. “Bitcoin is more volatile than many other assets because it is a medium of exchange. It is more volatile than other media of exchange because it lacks a core, reliable source of demand.”
“Media of exchange are subject to what economists call network effects,” he explained. “No one wants to use a [form of] money that no one else is using. Everyone wants to use the same money that their trading partners are using.”
“Therefore, my decision to accept bitcoin makes it more desirable to you, and vice versa,” Luther continued. “The network effect means that small shocks to demand are amplified, since anything making bitcoin more attractive to me also makes it more attractive to you and everyone else by virtue of the fact that it is more attractive to me. The same process works in the opposite direction for anything making it less attractive to me.”
Again, comparing bitcoin to the dollar can help us understand this phenomenon.
“With other monies, there is some core group of users that everyone can count on with near certainty to accept it,” Luther said. “The U.S. government, for example, stands ready to accept dollars in payment of taxes and fees. It seems very, very unlikely that it will stop doing so. That core group of users provides a lower bound to the demand for dollars… as a result, demand tends to be fairly stable.”
“That’s not the case with bitcoin,” the economist continued. “It’s not unreasonable to think its demand could fall to zero. So we are constantly on guard against that prospect. Relatively small disturbances lead some to reevaluate their positions. And bitcoin’s price fluctuates as a result.”
Will Bitcoin Ever Catch on For Widespread Use in Everyday Exchange? Whether bitcoin is just a fad or could catch on for widespread use in everyday exchanges is a subject of much debate. Luther, for his part, points out that it already can be used in many exchanges.
“You can buy a new couch on Overstock.com,” he says. “You can pay your AT&T wireless bill. Tell me what you are looking for and there is a good chance someone is out there ready to sell it for bitcoin. That it is not more commonly used, despite many retailers willing to accept it, suggests that it is not well suited for many transactions.”
“Bitcoin is very well suited for making cross-border payments,” Luther continued. “It is well suited for making private transactions. But few of the transactions I make in the course of a month involve cross border payments or require more privacy than is afforded by my bank. So I don’t spend bitcoin very often. I suspect other people make a similar calculation. That’s not a knock on bitcoin. It is just to acknowledge that it tends to function as a niche money at present, and seems likely to do so into the foreseeable future.”
How does one "mine" for bitcoin? I keep having this image of a bearded 19th century prospector wading in a stream with a rock hammer, a screened pan and a sluice box.
This isn't something which can be "counterfeited."
You have to know the password and the account number to access the funds.
https://www.youtube.com/watch?v=BODyqM-V71E
My miners mined over a score of BTC.
I have to disagree with Luther’s assessment that Bitcoin has to eventually serve as a currency to have lasting value. I’ve used bitcoin for dozens of transactions over the years (Amazon purchases via purse.io, hotel reservations, consulting fees, online payments and the like). But by 2017 I was arguing that it was going to fill the role of a Store of Value, and that it should focus on being a secure store of value and nothing more.
My conviction is that in the highly competitive cryptocurrency space each crypto should optimize for a specific niche, or face being out-competed if it tries to be a jack-of-all-trades. Cash replacements and stores of value do not mix well, as there are inherent contradictions regarding security/convenience trade-offs, and the impact of the velocity of money on the value of it.
So I want Bitcoin to be the premier store of value, but I want an alternative like Nano or Stellar to play the role of a cash replacement for payments.
To those who after 11 years keep monotonously saying “tulip mania” I would point out that you were wrong 10 years ago, 9 years ago, 8 years ago, and on and on. It’s the dollar that is now the irrationally valued asset that is crashing, both as a result of government overspending and Fed policy, and the fact that we have much better alternatives to switch to. Please don’t keep empowering leftist governments by clinging to the unsound money they rely on for much of their power over you.
No different than the dollar. What it bought 20 years ago is considerably less now, thanks to Mr. Federal printing press. The concept really is no different from the dollar, or the pound, or the Euro or the Franc or the Yen. Its a government saying this is worth money and its ability to back it up its value. with bitcoin the amount is set to 41 million bitcoins. No more no less. So the more people start investing in it and using it and trading in it, the more desirable it is.
What Makes Bitcoin Special? An Economist Fails to Explain: most of it is made in China where power is cheap
Why don’t people that ask critical questions of bitcoin also ask the same questions of their fiat currencies?
Most, if not all of the anti-bitcoin arguments come down to “the government hates it they will ban it.” But what happens when the government admits it can’t?
Their is a limit to their power.
Bitcoin Un-'Tether'-ed
Well said, and I fully agree. Let the "free" market decide, and control development.
If quantum supremacy ever takes off, and it is possible, then bitcoin would be hackable. Only a quantum-based crypto can stay intact at that point.
Wow!
How does that work? And have you patented the concept?
I like it!
Let me take a stab at an explication. Full disclosure, I do mine crypto currencies and I have patents in encryption.
Some basics first-
“Currency” is something that REPRESENTS value but does not of itself, have value. The US dollar is a currency. While it can be exchanged for goods and services, the ink and paper of a dollar bill is of little use. This differs from “money”. Money has value such a gold and silver. Even certificates of gold and silver are considered money. While the terms are often used interchangeably, they are in fact, not. The US left the use of money behind when the dollar was removed from the gold standard at which time it became a currency.
There are more challenges with creating currency that money. Since a gold coin would require ... gold, there is a limit to the money supply via gold coin. With currency, counterfeiting is a significant problem that must be prevented. Since the dollar is paper and ink, significant efforts have been made by the US Treasury to make the dollar unique (I wont go into all the details) and laws have been established to make counterfeiting illegal. Understand that crypto currencies do not have the benefit of those laws so some other means must be used. This is to prevent just anyone from creating all the bitcoins the want. So bitcoin, not having the protection of counterfeiting laws, has to create STRUCTURAL limits. This is done by using a “hash” algorithm.
Side discussion about hashes.
Hashes are one way cryptographic functions. The intent is to make it extremely difficult for the original to be changed without detection. Think of a word document. Without protection, any one can edit the document and represent it as the original work. However, if you generate a hash of the document after it is created, then you can detect that the document has changed by comparing the original hash to the new document hash. If the hashes are different, the documents are not the same. HOWEVER, if the hashes ARE the same, it is the same document. This provides the basis for blockchain. A series of transactions are recorded in a block, the block is then hashed and that hash starts the next block (next link in the chain). Thus if anyone tampers with one of the transactions - by so much as 1 bit - then the hash is no longer valid and the chain is broken. Anyone who checks the hash values can detect the broken chain.
Now as to specific “mining”
So what is needed is a computer algorithm that is large/complex so that it requires extensive sets of computer solving in order to be valid. As an example, think of the old checksums that we used to run on downloaded files. If any checksum would work, then it could be repeated by anyone else and somewhere down the road, a computer would be fast enough to create a hash (checksum) fast enough to defeat the ability for the network to validate a transaction. So the problem has to be “larger” than just executing a single hash algorithm. So now lets introduce some variables
S = source
P = pad
O = outcome
In overly simplified terms, the puzzle that has to be solved is as follows:
The hash(S) + P must equal a specific O
Assume that the specific outcome must start with four bytes of all ones (0xffff....). In order to solve the above equation and since hashes are only one way operations (they can not be mathematically reversed or solved backwards), the only way to solve the above is to try a series of pads and keep checking the iterations of pad until you have found a pad that works. This is a brute force method and is very computer intensive.
This is what a miner is doing. They find the next working pad and that correlates to the next coin.
This is a grossly oversimplified description and more information can be found at: https://www.investopedia.com/terms/b/bitcoin-mining.asp
That is idiotic nonsense. Why don't you tell everyone how the most commonly used currencies on planet Earth, i.e. US Dollar, the Euro, the Yen, the British Pound, the Swiss Franc, etc., "securely record" transactions. They don't.
I’ll leave it up the geniuses to work out the details. I just know it should be possible, but quantum is kind of not progressing as fast as many thought.
You can be pretty sure governments will not tolerate tax evasion.
If the IRS was was offer 100 pounds of gold bars to a person would could crack Bitcoin and enable the IRS to track down delinquent taxpayers, it probably will find a taker.
Anything digital or connected to the Internet is highly untrustworthy.
If you buy something with Bitcoin, the IRS could track every computer involved. Navy Seals could seize the key computer. The NSA could crack the encryption.
Imagine buying a McDonald’s hamburger with a Bitcoin.
What would a restaurant use to give you change for your $54,000 Bitcoin?
There is/was ONE Trillion dollars (depending upon current value) of Bitcoin available NOW, to anyone who can crack Bitcoin...
A lot a lot of rich Germans had accounts at a Swiss bank.
The German tax authorities bought off an inside man of the bank.
The rich Germans had to pay all the taxes normally due plus stiff penalties.
1 Satoshi = 0.00000001 ฿
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