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Another Random Guy’s Thoughts on Cryptocurrencies (mostly Bitcoin)

Happy reading

Someone very smart recently sent me a few interesting links (the first four in the list below) related to crypto in general and Bitcoin in particular, and asked if the ideas and topics seemed interesting. I took a look and tried to put it all together with what I’d read in the past.

I have full confidence that no matter what I say, I can find a so-called “respected mainstream voice” that agrees. Depending on which Nobel prize-winning economist or corporate Caesar you ask, cryptocurrency is either utterly worthless or immensely valuable, either just like money or totally unlike money, either an elaborate Ponzi scheme or the future of money a.k.a “money for the connected age”. Sometimes you’ll even hear both opinions from the same person (I’m looking at you, Dimon)!

Digging just a bit deeper

The known universe of material around cryptocurrencies falls into these three buckets:

  1. Explainers → here’s how the technology works, here’s how smart contracts work, here’s how DeFi works. Not a single engineer or tech nerd I know is uninterested in the technology. There are some cool ideas here going all the way back to Satoshi Nakamoto’s white paper. Yes, many ideas were discussed well before then, but for all practical purposes, asking what happened before the Bitcoin white paper is pretty much akin to asking what happened before the Big Bang.
  2. Crypto maximalism → the entire global monetary system will run on crypto. Bitcoin maximalism is a massive subset of this bucket.
  3. Crypto skepticism → this is a big tent covering everything from “wait and see” to “meh” to “the whole thing is a big fat scam”.

At the risk of massive over-simplification, much of everything rests on the empirically solid but intuition-eluding notion that the reason money (or most anything else) has value is… because enough others believe it does. If we can get comfortable with this notion of “belief-based” value rather than intrinsic value, we can narrow our attention down to three questions:

  1. Why Digitial Currency?
  2. Why Cryptocurrency?
  3. Why Bitcoin?

First, what is money? Selectively sampling from the various links:

Money is a medium of exchange, a unit of account, and a store of value.

With that definition, the answer to #1 borders on tautology. Digital currency because, well, digital everything else. Its portable, its durable, its trivial to store and transfer. Just like ’em mp3s.

Putting the crypto in cryptocurrency lets us add a few more things — importantly: decentralization, verifiability and censorship-resistance. Note that these are properties of how cryptography is used, not somehow intrinsic to all cryptocurrencies. E.g., a Central Bank Digital Currency, or CBDC, could easily be centralized and censorable (?) by design.

Finally, why Bitcoin? Why not some other cryptocurrency or just fiat digital currency? A rough approximation of all the arguments would be that whatever attributes Bitcoin shares with other cryptocurrencies, it will always be the first one to have achieved scale and, therefore, the broad confidence that comes from established history in the limelight. The theory is that it has spent so much time in the sunlight and has been subject to so much poking and prodding over the past several years that its less and less likely there’s some fundamental flaw lurking in it. Moreover, its been forked, its been imitated, and there are no shortage of wannabe replacements that claim some improvement or the other (faster transactions! better privacy! richer smart contracts!). But they’re all still wannabes. The popularity of cryptocurrencies, like so many other things we observe, seems to follow a power law distribution with Bitcoin standing tallest by quite a margin.

So is it time to pull all that cash out from under my mattress and buy as many bitcoins (or more likely fractions, at today’s USD exchange rates) as I can? Well…

Arguments

Vijay Boyapati’s post is a rhetorical gem. Well done, sir! It makes a lucid, measured, well-argued, and of course unabashedly bullish case for Bitcoin.

According to Vijay, Bitcoin meets all the criteria to be a trusted store of value, except for established history. Moreover, it is actually superior to current forms of money in many respects. Bitcoin shines in its portability, verifiability, and censorship resistance.

Much importance is given to scarcity, an attribute baked into the very foundation of Bitcoin with its 21 million coin limit. This is presented as an article of faith. (In a mirror image of the skeptics’ arguments that cryptocurrencies are Ponzi schemes, the lack of scarcity is often presented as a reason fiat currencies are Ponzi schemes.) I’m not sure I understand the foundation of this argument, especially if I look at it through the lens of John Lanchester’s framing of the evolution of money from being represented by “a thing of value” to “an entry in a register somewhere” which, perhaps unsurprisingly, is also a framing used by the Bank of England. As an admittedly vague thought, it seems to me money needs to be scarce relative to the amount of goods and services available on which the money can be spent. Its not clear that fixing supply of some arbitrary unit (bitcoin, say) is inherently good in some way. The Mona Lisa, or even crypto kitties, sure. But some arbitrary unit of some arbitrary representation of economic value? Hmm.

And what to make of the discussion around censorship resistance? Seems ideological, not that there’s anything wrong with that. But there’s little treatment of the difference between “people should use Bitcoin because of its censorship resistance” vs. “people will use Bitcoin because of its censorship resistance”. The former I can get behind. The latter seems unlikely at best, even far-fetched. Andreas Antonopoulos is Bitcoin’s Evangelist #1 (although he concedes that he is only a “minimal maximalist”!), and his overall position is hardly surprising. He takes a strong “people should use Bitcoin” stance. But he says equally that “people will use Bitcoin” with increased mainstreaming of its use as a medium of exchange in crisis economies or other, non-economic, crises where attributes like pseudonymity or censorship-resistance become important.

The little Krugman piece is more polemic than rhetoric. He comes off as an angry codger. It is an uncharacteristically shallow take on the topic, with incomplete comparisons, false equivalences, and to be dramatic, a whiff of the McNamara fallacy as well. He’s written more thoughtful pieces on this topic before and I’m sure I’d find them with a bit of effort. Moreover, he may yet be right — who am I to argue with a Nobel Prize winner? — but not every Nobel winner can be right (see: Milton Friedman, Joseph Stiglitz, James Buchanan, Paul Krugman). While it is not an uncommon line of argument to speak against an innovation based on the problems it has yet to solve, I can only assume someone once must have said “These damn automobiles. They need so much more maintenance than my horse carriages.”

It may seem like a bit of false equivalence of my own, but its hard not to feel that these are just two sides of a debate simply yelling each other down, each seeking out arguments that confirm their views and weaken the opponents. If it takes a hundred years but then Bitcoin has indeed become money, or if Bitcoin comes into wide use rapidly and then completely collapses after fifty years, does it say anything meaningful about which of today’s sides was “right”?

Concisely, Bitcoin bulls’ full chain of reasoning goes something like this: all digital → all crypto → Bitcoin first mover advantage and network effects → Bitcoin as preferred store of value → Bitcoin as preferred medium of exchange → Bitcoin as, simply, money.

This chain of reasoning seems logical by itself. Will it hold up against other possible chains of reasoning?

(My) Takeaways

This is a fast-moving and still unstable foundation on top of which entire edifices are being built. Such is the nature of innovation — creative destruction, bubbles, technological revolutions.

  1. Cryptocurrency is novel, useful, valuable, and here to stay.
  2. No one yet knows which cryptocurrencies will succeed in the long run, but like most other things, there will likely be a few very widely used currencies and a long tail.
  3. Among decentralized cryptocurrencies, Bitcoin has an advantage as the early mover and the first one to gain serious traction through network effects. It could well be the long-term winner, particularly as a medium of exchange.
  4. While attributes like decentralization, anonymity, and scarcity will be philosophically and foundationally important to some cryptocurrency adopters, the bulk of the world’s population is going to do simply do what’s convenient. Yes, hyperinflation can happen and all that. But our collective memory isn’t great (see: the effects of named hurricanes) and our ability to take collective action against such non-immediate threats — even existential threats (see: climate change) — is highly suspect. Moreover, currencies are still a significant aspect of national identity. So don’t bet the farm on Bitcoin (or any decentralized currency) against fiat… at least not just yet. Fiat may itself take the form of CBDCs, but obviously they will not be decentralized, anonymous, or scarce.
  5. All kinds of crypto tokens beyond currency per se are likely to prosper. While we don’t always think of them as “money”, we do have several other “tokenized” representations of money in use — store credit, gift cards, loyalty program points, even things like in-game avatars and power-ups. Representing them as cryptocurrencies may bring several technical (e.g., lower costs or verifiability) and economic (e.g., efficient markets) advantages, but those won’t quite be “future of money” stuff.
  6. So… yeah, Bitcoin seems to be well-positioned today. But what might be its “fair” exchange rate against USD? Is it reasonable to use gold and the gold standard as the bar (heh) against which we assess its potential market value? ¯\_(ツ)_/¯
  7. But back to #1 — cryptocurrencies are here, get used to them. How do you know they’re here? Not when the FBI begins to care. Not when the Fed begins to care. Not when the SEC begins to care. All that happened a while ago, anyway. But lately, the IRS has begun to care, and that’s how we know ;-)

As the seemingly endless supply of blogs, podcasts, newsletters, tweets, and books indicates, much more can be said. Much, much more. But that would require delving deeper into economics, geopolitics, game theory and ZK-SNARKs (don’t ask), all of which are sadly and irretrievably far outside my grasp.

Ultimately, we need to accept the truly Knightian uncertainty here. As Matt Huang calls out with some understatement:

We must acknowledge that a digital monetary asset such as Bitcoin has never existed before. We are in uncharted territory with more uncertainty than is typical.

What better place to leave this?

A “here be dragons” map
“Here be Dragons”

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Ashwin Baskaran

Ashwin Baskaran

Surprised that others (once in a blue moon) read what I write here. Work @VMware. All opinions expressed here are just mine.