Bitcoin Series 16: So you want a bitcoin, eh?

An occupational hazard of our newfound interest in bitcoin is that I am asked weekly "Should I buy a bitcoin?" or "How should I buy a bitcoin?"

On the first question, I take no position - it is between you, your spouse, your accountant and your god.

On the latter question, I made a little infographic below.

Some side notes:

(1) Anyone who has the first clue about capital markets will read this chart and understand immediately why bitcoin is so volatile today.    The whole process of buying and selling bitcoins today is absurd relative to the well-established, very liquid currency markets that bitcoin interacts with.    That will change with time as this process becomes easier and more institutionally friendly.
 

(2) If someone with better graphic design skills wants to clean this up, I would be happy to send you the PPT.   I will have someone make an embeddable version tomorrow in any case;  In the meantime, I think the JPG is downloadable and you can click to enlarge.
 

Very Important Caveats:  (1) We do not care if you buy bitcoins (2) We are not a broker-dealer, broker, financial advisor or licensed in any way to give you financial advice (3) This is most certainly not a recommendation to buy, sell, short, trade bitcoins, litecoins, bbqcoins or StalwartBucks – you could lose all your money in one of many ways including, but not limited to: your incompetence, poor security, poor backups, software bugs, counterparty risk, exchange rate risk, liquidity risk , regulatory risk,  and more! You are 100% buying bitcoins at your own risk and on your own initiative. (4) Bitcoins are not anonymous and exchanges and online wallets even less so.   If you are going to use bitcoins to try to cheat on your taxes / divorce settlement / child support, you are a moron. (5) These are not the only ways to buy bitcoins (just some of the more popular ones) nor are we endorsing these companies – any of them theoretically could be hacked, run away with your money or be shut down by regulators / coopted by the ‘system’. (4) Ledra Capital, our affiliates and our principals might hold any number of old-timey or digital currencies at any time long, short or falling out of our wallet all crumpled up after a long night of drinking.   If we knew how they would trade against each other in the future, we would be having umbrella drinks on our private islands, not tweeting about bitcoin.

For the full bitcoin series: ledracapital.com/bitcoin 
Twitter: @polemitis and @ledracapital
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Bitcoin Series 15 - The discontinuity that is bitcoin

I had known about bitcoin for years.    Along with many other 'sophisticated' people in tech and finance, I dismissed it as a tulip-bulb-libertarian-gold-bug-survivalist-geek fad of no importance.   Like you, my savvy [banker / economist / journalist / person-who-does-not-like-their-cheese-moved], I had seen this movie before.   I knew the generally sordid history of e-gold, Liberty Reserve and other private digital currencies and was certain that bitcoin would not be long for this world.   So I spent some time on Wikipedia and Reddit, snorted at the lunacy of the true believers, and years passed.   

In the summer of 2013, I was quizzed about bitcoin by a colleague at the University of Nicosia who had developed an interest.    I gave him the by-the-books answer of how it works and asked him if he had developed a drug habit that I was unaware of.  He persisted.   So  I spent a couple of afternoons playing with the bitcoin client, buying a bitcoin, reading up on bitcoin and generally finding it technically cool.   But I was still a virgin  - sending bitcoins to yourself does not exactly set the pulse racing.  

One Saturday afternoon here in New York, after making a bowl of cheese fondue with my wife, I called my colleague in Cyprus and we decided to play around a bit with bitcoin.   It was 2pm New York time and 9pm Cyprus time.   I was (impressively) still in my pajamas and I am sure my friend was watching soccer on TV.  

In any case,  I asked for one of his public addresses and sent him 0.1 bitcoins, which at the time was about $20, using the reference bitcoin-qt client .   5 seconds later, he said 'yup, I have it'.    If I am not mistaken, the transaction fee was $0.20 (0.001 bitcoins).

There have been a handful of times in my life when I have felt a discontinuity in the tech universe.    In the 1980s, when my mother, an executive at Bell Atlantic, brought home the 1st car phone (the size of a backpack).  In 1993, when I went to college and discovered gopher and email in the school's computer lab.   In 2007, when I grabbed a friend's new iPhone in a bar and started streaming full-screen video.

That afternoon with bitcoin easily makes my top five - the world moved discontinuously and my brain struggled to re-adjust. 

Imagine what just happened.    I transferred $20 to an individual 7,000 miles away at 9pm on a Saturday night in a matter of seconds,  at a trivial transaction fee, without any intermediary to approve, block or reverse the transaction.   And that transaction would have taken the same amount of time and cost the same amount of money if my friend was in Manhattan, Illinois, Cyprus, Moscow, Tokyo, Nigeria, Bangladesh or Patagonia or if I were sending $2, $20, $200, $2,000 or $2M.     The only thing required was an internet connection.

Now we can argue all day long about if bitcoin is a currency, if its volatility matters, if it is a good store of value, if you should use it as a national currency, if it has network effects and 100 other nuances.  While these are important topics, they are ultimately irrelevant to the big picture.  

Seeing bitcoin in action is like seeing email for the first time.  It has been a long road from my first email in college to Gmail. It has been 34 years since the SMTP protocol was published and there is still no universal email equivalent to certified mail and when Amazon sends me a package, it comes with UPS or USPS, not through email.  Having said that, I knew from my very first email that I would send a lot more emails in my life and write a lot fewer letters and postcards. 

Bitcoin is like that.    It won't replace the financial system, the Fed or the nation-state.    It will supplement the financial system in a big and important way, push it to be more innovative and efficient and, finally, will merge with it, in the same way that IP delivery has crept into telephony and video infrastructure over time.   To start, we will use it internationally, we will use it for micro-payments, we will use it for new types of contracts, we will use it in dangerous parts of the world and our machines will use it, first to help us, and then to coordinate when they rise up against us.

But if you think that this idea can be 'unthought', that somehow I can erase from my memory how I dropped $20 in my friend's pocket in Nicosia in a few seconds, without $30 of fees for each of us, plus 2%-3% of currency spreads in each direction plus 2-3 days waiting for the weekend to end and the bankers to get back to work plus forms and approvals, well, I just don't see how that happens.   Bitcoin might be worth $10, $100, $1,000, $10,000 or $100,000; it might be bitcoin or some other coin that ultimately 'wins'; but this idea is here to stay...
 

For the full bitcoin series: ledracapital.com/bitcoin
Twitter: @polemitis and @ledracapital
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Bitcoin Series 14: Our robot overlords will use bitcoin

tl;dr:  Autonomous software and machines are coming soon.   They will transact with digital currencies.

Imagine the following, all of which is possible today:

1. Someone anonymously writes a software application that accepts payment in bitcoin.  Let’s say, trivially, a joke-of-the-day site that sells you a joke for $0.01 worth of bitcoin.
    
2. Imagine that this app is hosted at a webhost that accepts payment in bitcoin and it is programmed to pay its monthly hosting bill with the bitcoins it earns.   For the purposes of this exercise, let’s assume it is profitable.
    
3. Then, the software developer vanishes or dies.
    
4. At that point, for the first time in human history, a human invention will autonomously engage in economic activity without necessarily having, ultimately, a human owner.

Today no business operations can outlast your death without being transferred to another human owner because the financial system is ultimately tied to natural people.  Dave Winer talks about this all the time in a different context – how can you reliably maintain a memorial website and domain name that outlives you? – and correctly concludes that there are no satisfactory answers today.

If it is an operation held personally, your bank will eventually suspend your accounts once they realize that you are dead.    Even in the event of a corporation or a non-profit, there are still real-life breathing people who elect or appoint the Board of Directors or Board of Trustees that sign on the behalf of the corporation.    Ultimately, there is always a human in the mix to provide interaction with the existing financial system.

Bitcoin does not work this way.   You could embed a bitcoin wallet into an application and set it free into the world, either pre-loaded with bitcoins or with the ability to earn them.   And bitcoin wallet does not know and does not care who its ‘owner’ is.   It will work fine under all scenarios.

There will be an explosion of autonomous or semi-autonomous software and hardware that will come into being over the next twenty years, from smart appliances negotiating electricity rates with utility providers to self-driving taxis to software agents executing complex missions.    As they get more sophisticated, they will need to purchase items autonomously from computing services to, say, gas.   And they will do that with bitcoins or some future similar currency.

For the full bitcoin series: ledracapital.com/bitcoin
Twitter: @polemitis and @ledracapital
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Bitcoin Series 13: Only the Fed can make a DollarCoin

Over the last week, Balaji Srinivasan, Timothy Lee and Joe Weisenthal have mused publicly about a DollarCoin (DLC), aka a cryptocurrency pegged to the dollar that would eliminate the pesky BTC-USD volatility.

Summary:  I don't think it is possible to do in practice unless the Fed backs it.

Detail:

First I will state my bias upfront that the BTC-USD volatility is primarily a factor of market adoption (not something inherent to the currency) and will decrease over time.  But let's say we wanted to make a DLC and let's walk through the four proposals I have seen so far about how it could be done.

Let's assume away the problem of having a benchmark DLC-BTC exchange rate that applies across the world (even though that is a separate and large problem of its own).

Also, let's keep in mind that volatility in DLC  is much more problematic than in BTC.  In BTC, with its mostly fixed money supply, volatility has been generally on the way up.   With most versions of DLC, it is easy to keep it from rising, but harder to keep it from falling and that does not make for an appealing asset to hold -- no upside in any case, but some non-zero downside if the system fails.

Take 1: Adjust the mining difficulty based on supply and demand.  

In other words, when there is a lot of demand for DLC and price in USD goes up, allow bigger block rewards (increase the rate of money supply increase) to bring the price back down.  When there is less demand for DLC decrease the issuance of new DLC to reduce the new supply of DLC.

This will not work because it only affects the rate of increase of DLC.   So if you had a serious demand shock, the price would still fall below $1.

Take 2:  Issue or redeem DLC based on supply and demand

Have a mechanism to decrease money supply when needed by issuing or redeeming/destroying DLC based on market demand.

This would keep the exchange rate more or less stable, but would still destroy the wealth in your DLC wallet so has no real advantages.   In other words, instead of 10 DLCs worth $0.80, your wallet would drop to 8 DLCs worth $1.   Same outcome but more convoluted and introduces some other problems.

Take 3: A private company willing to redeem DLC for USD at a 1:1 rate.

Update:  This is Timothy Lee's idea.  Will add his clarification in italics.

Theoretically this would work, practically it won't.    

First of all, this would require a huge balance sheet to be tied up if all DLCs were backed up 1:1 with USD and I don't see what benefit the DLC-backer would receive in return that is large enough to compensate for that. 

Timothy Lee comment:   Would take deposits in USD, issue DLCs, invest the USD in safe assets and 'bank' could collect the interest as compensation.

Second, it has all the problems of centralization that have destroyed most previous private currencies, including counterparty risk and regulatory risk.  

So, best case scenario your DLCs are worth $1.   Worst case scenario something goes wrong (regulation, fraud, incompetence) and they are not.

Take 4: A network of (banks) using colored coins to represent USD

I think this is what Balaji was hinting at today.   It is the closest idea to being viable, but I think it just obfuscates the counterparty risk.  

Even if a network of banks agreed that they would use colored coins to represent USD for transactions between them, there would still need to be transaction confirmation in their systems (that they actually have the USD available to back up their commitments).    So the costs would be higher, it would have to be centralized and there would be counterparty risk.   In other words, what happens if Citi was on the hook for $1B of colored coins, redeemable in USD, and failed overnight?   

And it remains vulnerable to regulatory pressure in a way the BTC itself is not.    Would a US sanctions regime not be enforced in this DLC network?  It would have to be.   And the same for any other country, which means that fungibility would go out the window too.

Take 5:  FedCoin

Let's say the Federal Reserve set up a DLC and said it would always redeem DLC 1:1 with USD.   It is the most credible party in the world to make the redemption promise as it can always 'print' more USD.    

It would also make a public commitment that if the DLC:USD exchange rate started rising that it would issue more DLCs until the benchmark rate was down to 1:1.     Because their redemption guarantee is credible, the floor would be stable so they could over-issue at first and keep the price from rising as well.

I don't see any technical reason why this couldn't work.  It won't happen any time soon, but if cryptocurrencies become everything people hope they will be, it will happen someday.   The USD won't be the first go to for it, but would it shock me if in 5 years, say, the Swiss do it?  Not at all.

This is approximately my default 'optimistic case' outcome for the cryptocurrency landscape in 10-15 years: Several national cryptocurrencies that have the full backing of their respective central banks and all the transaction benefits of native digital currencies plus 1 or 2 serious transnational currencies 'winners' (aka BTC) that have predictable money supply/issuance. 

For the full bitcoin series: ledracapital.com/bitcoin
Twitter: @polemitis and @ledracapital
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