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Hi, I’m Brad Feld, a managing director at the Foundry Group who lives in Boulder, Colorado. I invest in software and Internet companies around the US, run marathons and read a lot.

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Bitcoins Bitcoins Everywhere

Comments (45)

Bitcoins Bitcoins EverywhereI woke up this morning to several articles about Bitcoins. From Dave Taylor’s explanation in the Boulder Daily Camera to a paywall article that you can’t buy with bitcoins (ironic) in the NY Times (A Bitcoin Puzzle) to Fred Wilson’s blog (A Note about Bitcoin), I was surrounded by words about them.

We have an awesome CEO list that covers plenty of topics. Early in the week I posted a link to Fred Wilson’s post Buying Your Holiday Gifts With Bitcoin. That generated a fun discussion including lots of “what are bitcoins and why do I care”; “here’s what they are” kind of things. And then Kwin Kramer of Oblong weighed in with a phenomenal essay. It follows.

I’m with Seth; I think bitcoin is interesting on several levels, including as a real-life experiment with a semi-decentralized currency.

Bitcoin is a software engineer’s implementation of money (as distinct from, for example, a politician’s, banker’s, or economist’s).

There’s a lot of overlap between bitcoin fans and folks with strongly libertarian views. Many of bitcoin’s most vocal proponents see bitcoin as a currency, a replacement for currencies that are created and managed by governments. These folks tend to view bitcoin as a sort of electronic version of gold, a new currency that’s not a “fiat” currency.

I’m deeply skeptical of this set of ideas. First, and very generally, I don’t tend to think that dis-intermediating government institutions is a useful goal in and of itself. I would describe a well-run central bank like the United States Federal Reserve the way Churchill described democracy: the worst solution to the problem of managing a monetary system, except for all those other forms that have been tried from time to time.

In addition, core design decisions in the bitcoin spec make bitcoin a pretty terrible store of value and unit of account, which are two things we expect from a currency.

As has been noted in this thread, the total number of bitcoins is capped at 21,000,000. Currently there are about half that number of bitcoins in circulation. The rate at which new bitcoins are mined is designed to decrease over time. This means the bitcoin market behaves more like a commodity market than like a currency market, prone to volatility and some specific kinds of market pathologies. In my view the fact that the money supply can’t be “managed” by a central bank that is able to turn various “knobs” (interest rates of several kinds, the amount of money in circulation) is a bug, not feature!

The cap also means that a bitcoin-denominated monetary system will be a system built around deflation — the opposite of how the monetary system we use today is constructed. Over time, prices will fall, rather than rise. Economists generally view deflation as a problem. If prices get cheaper over time, all the time, people have strong incentives to delay purchases and to save money. If everyone saves, rather than spends, economic growth is impossible.

Economists have lots of tools for talking about this stuff. And, while economists often disagree violently with each other, the collective knowledge in the field is important and valuable. To draw an analogy, non-programmers can and often do have very insightful things to say about digital technology. But it’s definitely worth talking to experienced programmers when trying to understand a particular platform, protocol, or application.

I’m not an economist, but I find convincing the economists’ consensus that deflation is “bad.” At the very least, I’d argue that we don’t know how to build a stable monetary system on top of a currency that is fundamentally deflationary.

On the other hand, even if bitcoin makes for a poor currency, it may well be a very useful payment mechanism. The original bitcoin paper focuses heavily on this aspect of the system design.

To explain this a little more, we can think about how we use US dollars in normal, every-day life. I usually keep some printed dollar banknotes in my pockets. These banknotes — these “dollars” — are a store of value. (They’re worth something in an economic sense.) The banknotes are also a unit of account. (Lots and lots of things I encounter every day have prices denominated in dollars.) Finally, each banknote is a payment mechanism — a transaction mechanism. I can hand over a banknote to most people I might want to buy something from. They’ll accept it. We’ll both know what that means.

But physically handing over a “dollar” isn’t the only payment mechanism I regularly use. I have credit cards, and checks (sort of — that’s kind of changing), and now some other electronic payment mechanisms like PayPal and Amazon points.

It’s possible to separate the functions of value store, unit of account, and transaction mechanism. They fit together neatly and are systemically related, but they’re three different things.

The bitcoin peer-to-peer transaction protocol is pretty cool. It’s basically strong cyptography, good timestamps, and a consensus protocol for blessing transaction reporting.

Which boils down to a way to “hand someone cash” electronically. With no trusted third party having to broker the handover. And, theoretically, anonymity for both the payer and the payee.

As a software person, I think of this as a platform. A new electronic payment platform that may have significant advantages over most of the existing ones. To get broad adoption, platforms need killer apps. So far, there aren’t killer apps for bitcoin. But there are some possible raw materials for killer apps. Cheaper international payments. Completely anonymous electronic payments. But the great thing about platforms is that it’s often quite hard to predict early on what the killer apps might be. Particularly for the really disruptive ones.

A couple of final caveats. It’s not clear (at least to me) whether it’s possible to separate the currency aspects of bitcoin from the transaction platform aspects. If bitcoin does turn out to be a flawed currency, that could be a problem even if the transaction platform stuff is really useful.

Also, the bitcoin platform is pretty new and there may be some fatal flaws in the design of its anonymity features and its transaction log. For example, the transaction log is a global, permanent thing. To verify any bitcoin transaction you have to have a full record of every bitcoin transaction ever. That’s okay now; the system is small. Our computers and networks will keep getting faster as bitcoin use increases. But a broadly used currency will have to be able to support a lot of transactions. Maybe the design can be patched, either in a technical sense or in a social/institutional sense. But we don’t really know.

Some links:

  • http://www.cornfedsystems.com/ Frank W. Miller

    I’ve got a Ph.D. in Computer Science and I marvel at the concept and technology behind Bitcoins. But that Ph.D. also screams at me to stay the hell away from them. There’s no way I’m putting any of my hard earned cash into anything as ephemeral…

    • http://www.feld.com bfeld

      I own 10 of them as an experiment.

      • http://www.startupmanagement.org/ William Mougayar

        Have you been buying goods or services with them as a consumer?

        • http://www.feld.com bfeld

          Nope. Just enjoying watching the speculative rise in value.

          • http://www.cornfedsystems.com/ Frank W. Miller

            Like watching the beautiful tulips in Holland eh? ;)

          • GoodNPlenty333

            Except that bitcoin has already crashed 4 times now, and each time it does, it levels off higher than it was at before it spiked. “Money” by definition is a bubble that never pops, and in this regard, bitcoin seems more like money every day.

          • http://www.cornfedsystems.com/ Frank W. Miller

            Bitcoin has crashed 4 times? What does that mean? Sounds like all the more reason to stay away from them…

          • http://www.startupmanagement.org/ William Mougayar

            That’s the key question: is that rise in value speculative or permanent? And is it a good or bad thing? I’m getting push back on AVC because I’m saying that speculation should be curbed, whereas others are saying it’s a good thing for the BTC system to vet itself, and that speculators will get flushed or neutralized over the long term.

          • http://www.feld.com bfeld

            “Speculation should be curbed”? Huh, what?

          • http://www.pointsandfigures.com/ pointsnfigures

            As a reformed speculator I don’t think that we should worry about speculation at all. The more speculators, the more liquidity will increase. Over time that will help dampen volatility and help people that don’t want to speculate enter and exit the market.

          • http://www.startupmanagement.org/ William Mougayar

            bit of regulation so that speculation doesn’t hurt the system.

          • http://www.feld.com bfeld

            You sound like a Canadian (big smile).

          • http://www.startupmanagement.org/ William Mougayar

            That’s why I said “bit” of.
            Maybe a clearinghouse, like Jeff Carter advocates.
            The only thing I don’t like about BTC is the speculative prices it is reaching. My question is: Does it need to continue going up for its value to become distributed?

          • Trond Johannessen

            It is like selling tokens to a ladies’ toilet on Saturday night, with demand outstripping supply. The ones who have to go set the price. When demand and supply is in balance, you get a token for a dollar and you get your dollar back on exit. In the early going, the tokens immediately circulate as the girls use the toilet as a makeshift powder room, just tuning looks and exchanging gossip. When the crowd gets in, and the bar gets up to operating capacity, the token market becomes an auction at the toilet, and then you would still only get your dollar back from the attendant – unless the market turns peer to peer. The powder-room and gossip exchange customers are crowded out. Likewise, the ones who have no urgency right now.

            All you have to do to understand BTC pricing is to know what bladder pressure means, and then abstract to what these limited supply tokens might be used for that would feel like “having to go NOW”, being chased by millions of people in a 7bn global population perspective with internet connected devices at 8.7bn end of 2012 (Cisco est.)

            Entrepreneurs expand toilet capacity and get to sell their tokens, but everyone knows exactly how many new toilets can be built, and it is way too few to accommodate demand, and it will take time to get to max capacity. Building in a tighter and tighter space costs more and takes longer. These entrepreneurs sell their tokens in the peer-to-peer market out of the gates, as they do not make money from the bar turnover.

            In the morning, nobody has to go, but 55 – 78% of tokens are not returned. The ladies just reserved access to stalls. The rest of the tokens are exchanged based on forward planning and some buy Sunday morning because they need the tokens next weekend. Prices temporarily come down, but not a lot.

            One day, the Police or Fire Department visits and finds that the bar is in breach of City regulations and closes the bar. Token prices just fall back to issuing price of $1 as bar owner redeems them with the intent of re-opening, or they get thrown away. If they also work at other toilets around town, and can later be used in the shops as currency, the value quickly comes down to nominal pricing.

            Tokens provide access to scarce resources, and have no intrinsic value beyond that. When launched in a peer-to-peer market, the tokens will trade according to supply and demand for the scarce resources, crowding out the secondary uses of tokens at peak demand. If people can mint or mine tokens, these will increase in value, potentially giving rise to profits not available in good markets or other financial markets. If the demand for tokens fall away from the users who cannot access resources in a safe, anonymous or immediate fashion without the tokens in the short run, the market collapses. If the market participants consist in part of token producers and these put over half in their wallet in order to have the token market clear at ever higher prices, and so see a token appreciation as their reason for being, you set up a game of chicken or a collusion game among these speculators. If any one individual or group of producer/holders gains a dominant position because perhaps he understood the opportunity early on, and he got the faster computers, he can rig it all in his favor, serving ladies in need, while cashing in for liquidity and profit taking and partner distributions periodically.

            Faster computers than the rest allow a participant to “win” the mining contest on a larger number of coins as the supply constraint is imposed by the algorithm in ever harder problems for the computers to solve.

            Faster computers allow faster trading and with Big Data a conveniently timed new phenomenon, the possibility of mapping the entire system of Bitcoin, gaining valuable insights for trading strategies, is ever closer.

            Faster computers than the other participants allows fraud:

            “Nakamoto already anticipated that an attacker with more than 50% of the computational power in the network would be able to find proof-of-work solutions faster than the rest of the network. The attacker would therefore be able to eventually replace the transaction history from an arbitrary point in time. While certainly sufficient, the condition is not strict, as our result shows. In reality the efficiency of the network as a whole, including a propagation delay, is not optimal. This inefficiency may give a prospective attacker that can reduce the delay a considerable advantage.

            The effective computational power in the current network is 1

          • http://www.startupmanagement.org/ William Mougayar

            Interesting conclusion “Bitcoin is such a system that is inherently defective, by intent or incompetence, and it does not matter which it is.”

            Personally I’m neutral on the current BTC. I know there’s something there, but it may not develop the exact same way as we see it now.

            Thanks for that long comment.

          • Trond Johannessen

            “Something there” is not enough when they threw away the key on the architecture and it’s an all or nothing deal. Sometimes we just have to Stop the Borgs!

      • Leith Stevens

        An investment experiment, a commercial experiment or just general curiosity?

        • http://www.feld.com bfeld

          Curiosity at this point. I buy the notion of “bitcoin = protocol” and have some potential interest at an investment level, but I haven’t gone deep yet.

      • http://avc.com fredwilson

        i own 7.39 of them as an experiment. but i have purchased a total of 175 bitcoin over the years and have given most of them away to friends, family, and a foundation.

        • http://www.cornfedsystems.com/ Frank W. Miller

          I think I’ll live vicariously through you guys. If you turn into bazillionaires, how about you buy me a drink with it. If they go to zero I’ll buy y’all a drink to drown your sorrows in. ;)

          • Guesty McGuesterson

            You’re joking, right? If so, good joke :)

  • Dain Carver

    I saw a discussion with Richard Branson where he stopped short of saying that Bitcoins are the new gold standard and have produced great returns over the last few months…http://www.cnbc.com/id/101220710

  • http://www.startupmanagement.org/ William Mougayar

    “The rate at which new bitcoins are mined is designed to decrease over time. This means the bitcoin market behaves more like a commodity market than like a currency market, prone to volatility and some specific kinds of market pathologies. In my view the fact that the money supply can’t be “managed” by a central bank that is able to turn various “knobs” (interest rates of several kinds, the amount of money in circulation) is a bug, not feature!”

    Bang on. You took these thoughts out of my mind. That is one of Bitcoin’s Achille’s heels.

    If there was a way to decouple BTC the currency from BTC the platform, we might see some clarity.

    Some BTC proponents are confusing freedom and openness with anarchy.

    • Dain Carver

      Well, I think that is the best feature of Bitcoin. Just because a currency is directly tied to the actions of a central bank does not necessarily mean its in the best interest of the people who use it as their base currency. By not having an entity tied to it, you take out political risk, purchasing power parity, interest rate parity, and just make it concurrent across all markets. Needless to say, it makes an interesting case as a solid hedge against positions that are effected by aforementioned.

    • Trond Johannessen

      If you decoupled, there would be no Pyramid Game opportunity. It is a fraud by design or a currency made by the coders, with no customer in the room. It already attracted all the fringe actors for the first reason, and the coders still do not get it on the second point.

      • http://www.startupmanagement.org/ William Mougayar

        It certainly has its flaws and virtues. Let’s see how it develops.

  • Trond Johannessen

    You are pointing out some of the important flaws, and some of the things that are “cool” about Bitcoin. You are not recognizing the three killer apps of Bitcoin available today:

    1. anonymous trading in illicit substances (anything, not just drugs – sarin? c4? hired guns? etc.).

    2. money laundering

    3. exploiting the supply limitation feature in an asymmetric game, trading Bitcoin contracts on the four major exchanges.

    Each of these apps are based on the recognition by groups of the salient features of Bitcoin that allows its use to serve a pre-existing purpose. This is how porn was to internet in the early days (not that it is not still there today). To the extent that you intend that a “killer app” is one that is a must have for “everyone”, it is next to impossible to see that Bitcoin will ever get there, for reasons that you point out.

    Like other analysts, you fail to recognize that the exchange trading is not part of the protocol, and that is where the opportunity for substantial manipulation is evident. Ever considered how the price fixing of Bitcoin occurs and who has the opportunity and capacity to influence this process in their favor?

    One of the mandatory references for thinking about what might be going on under the hood is provided by Dorin and Shamir: http://eprint.iacr.org/2012/584.pdf
    I also encourage critical thought on your observations about the supply constraints that reference the view of economists, and whether that reflects intent or incompetence. Please take into account that the creator appears to have operated under a pseudonym. Why would he, if he thought it important to maintain system integrity?
    The answer to the issue of anonymity that most obviously comes to mind is for the system to avoid the suffering the fate of Napster, another peer-to-peer system. Infringement suits were successful and Napster went bankrupt. Nipping Bitcoin in the butt will take other methods, as there are no co-conspiring instigators to bring to court, if deemed necessary, at least on the founder side. You will of course be able to attack at the exchange level, and eventually trace individuals and firms who might be deemed to be in technical breech of a series of regulations and laws across the world. Any successful action against the Bitcoin value chain will discourage users, especially if the effective anonymity proves to be less than perfect. All the users have hackable terminals, and Bitcoin provides perfect transparency of its internal workings in an age where Big Data is the hottest concept in computing.
    If you read the comments of Bitcoin’s anonymous defenders, you can see the contours of the schemes in operation for taking advantage of its user base. It takes a bit of money to be a manipulator, while a lot of smaller operators are finding earnings opportunities in trading under the larger player price manipulations. I think of its design as perfect for a Pyramid Game, while each of the smaller players do not really see themselves as doing other than what they do on Wall Street as day traders, operators of “pump and dump” schemes. You do not have to agree with my assignments of sinister intents with respect to Bitcoin creators in order to see how the system is favoring the talented rip-off artists to gain at the cost of a user coming in to experiment, or to engage in the killer apps that I identified above.
    It is what we do not know about Bitcoin that is competing with what the congregation members evangelize as an Open System and “totally secure” (had it not been for the vulnerable points of interface.) that is the ponderable. You and others are kindly leaving it open to Bitcoin surviving, because it is somehow “cool” or “innovative” or similar. Napster was innovative, but not desirable. If you design a peer-to-peer system where there is ONE secret that allows for someone to compromise wallets, transactions or exchange trading, even through simple and evident price fixing through dominance or collusion, then you want to let the system grow in scope and acceptance. The Hunt Brothers of Texas tried to corner the Silver market a generation ago without being convicted criminals or even thought to be engaging in illegal activity at the time. Setting up a similar manipulation against Bitcoin is relatively easier, if there is money in the system to make it pay to bid up prices by restricting supply. I find it is inherent in any market being created that operators will test its resilience and opportunities for manipulation at whatever scale that operators can participate. Bitcoin operators openly admit to being in the market to do what they also do in individual commodities or stocks on Wall Street – their techniques do not include making money for clients. Once you take the deficiencies of Bitcoin and marry those with derivative contracts where supply constraints no longer apply, but the supply constraint in the underlying contracts are very firm and controllable with limited funds, the possible consequences of unregulated trading can be important. We just went through a financial crisis where some of the issues related to the lack of transparency in the derivative contracts, and in computer algorithms that determined the hedges for risky securities. Calling Bitcoin by its real name is therefore a first step towards clarity and position-taking. It is for sure not a currency, as we know what the criteria are for that term in the financial industry. Given its features, Bitcoin is a hybrid token with important characteristics that deviate from other exchange traded securities. Insofar as derivatives with classical definitions are written against Bitcoin, these particular features may lead to market events that will create unjust enrichment of some entities at the expense of others.

    • Dain Carver

      Valid points, but I believe this is an opportunity to become a Bitcoin market maker within the regulations of the SEC. If an entity were to agree to succumb to self regulation until markets are regulated they could really make a name for themselves. Otherwise, as an investment it is very susceptible to market manipulation. It’s definitely an interesting enigma though.

    • FreeJack

      Too much has been made of the “criminal” uses for Bitcoin. I can assure you that substantially more criminal business has been conducted using the US Dollar than Bitcoin…and it was not anonymous enough to keep Silk Road from being busted. Detractors like the sensationalism of the ties to Silk Road (it’s mentioned in virtually every article downplaying its significance) but it’s a non-issue and as was said in the Senate meetings last week, it is NOT totally anonymous. In fact, every single transaction is a matter of public record.

      • Trond Johannessen

        Assurances about crime statistics from the anonymous are really helpful, credible additions to civilization.

        • FreeJack

          Bitcoin has been in existence for about four years. The US dollar has been in circulation and used for criminal activities for how long? Do you even bat an eyelash about using your dollars to purchase anything, knowing that one of them may have – at some point – been rolled up and used to snort cocaine? Or stuffed into a stripper’s g-string? Didn’t think so.

          • Trond Johannessen

            We are very fortunate to live in this country, but at the same time, the reason the forces are so much more destructive here is because they are faceless.
            Brandon Boyd

  • simone_brunozzi

    Brad, it is not Fred Wilson’s blog, but Albert Wenger’s (partner at USV).

    • http://www.feld.com bfeld

      Oops – thx – I linked to the wrong post. Fixed.

  • FreeJack

    People seem to keep focusing on the 21m limit on bitcoins that can be mined and ignore the fact that the protocol can be modified to make them almost infinitely divisible. You can carry that 21m bitcoin out to as many decimal points as is required to support the widespread use of the currency.

    The price is fluctuating so much right now because the users are determining the value of it and this could go on for quite a while, as more and more people adopt it. What we’re seeing right now is only the beginning, just as it browsing the text-based world wide web with the Lynx web browser in Unix, back in the early 1990s, was just the beginning.

  • http://avc.com fredwilson

    wow, what a great essay. i agree with everything Kwin says. he nailed it.

    • Kwindla Hultman Kramer

      Thanks, Fred! When I wrote the above, I hadn’t seen your partner Albert’s post on “Bitcoin as Protocol” that you linked to yesterday. That’s very much a must-read, in my book. Wish I’d included it in the list of links.

      http://www.usv.com/posts/bitcoin-as-protocol

  • mcjazz

    The writer said: “If prices get cheaper over time, all the time, people have strong incentives to delay purchases and to save money. If everyone saves, rather than spends, economic growth is impossible.”

    Fact is, this is the strength of Bitcoin. The entire basis of free enterprise capitalism (a opposed to fascist crony capitalism) is that people save money and form capital! Savings are the foundation of a growing economy. So Bitcoin, as a deflationary currency would indeed encourage savings – and that’s a good thing.

  • http://correll.cs.colorado.edu/ Nikolaus Correll

    Thanks for launching such an interesting discussion here. I had similar feelings about Bitcoin’s killer app being the trade of illicit goods, which would – together with a hard cap on Bitcoins – align the value of this currency with the overall trade volume. Eventually, even companies might use Bitcoins to hedge their funds. I don’t think illiquidity arguments apply as goods are always evaluated using their dollar amount. However, the article pointed out by Trond Johanessen (http://eprint.iacr.org/2012/584.pdf) is discouraging: a large part of the daily transactions are apparently elaborate self-loops, suggesting much higher turn-over (and therefore interest) than is actually happening, and a large part of the coins (55-73%, depending on how you measure) have never been spent. Having a price being driven by a very small percentage of valid transactions is very indicative of a bubble that can burst anytime a bitcoin millionaire decides to give up even a fraction of their hoardings.

    While all of the above still make it attractive to engage in mining, in particular with the second generation of ASIC hash generators pending and attractive $10/GHash leasing models, the very thorough analysis of Felix Salmon (https://medium.com/money-banking/2b5ef79482cb) does not forget to mention that this activity is most likely illegal in the US.

  • http://ifjoshrantheworld.com/ joshOiknine

    I initially had the same thoughts about the wallet being more interesting than Bitcoin itself. I think the biggest disruption that can sustain would be a wallet system that allows for fast transactions (no middle man) and anonymity.

  • Scott Banister

    Bitcoin is a deflationary medium of exchange and store of value that requires no third-party intermediary. No one is suggesting that there is not also a market for an inflationary currency that moves via physical notes and banks. Think of Bitcoin as a “Macintosh” to the Federal Reserve’s “Windows”.

  • Alexander Peschkoff

    Funny, 41 comments again…

    One of the best articles on Bitcoin I’ve seen! Brad nailed several aspects of it really well.

    As for anonymity, consider you get a kidnap ransom demand asking for bitcoins. How would you feel about anonymity then?..

  • http://technbiz.blogspot.com paramendra

    I am much less skeptical.

  • Dain

    FYI….Here is the Bitcoin dissertation by Satoshi Nakamoto (creator of bitcoin). http://bitcoin.org/bitcoin.pdf

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