Two years ago, I was publishing some first thoughts on Bitcoin. Meantime, Bitcoin has grown tremendously, and I remain an enthusiast observer of those developments. I had originally proposed a vision in 5 stages for the development of Bitcoin with
- Mining stage
- Trading stage
- End-user stage
- Merchant stage
- Enterprise stage
Back in 2011, I had written that mining was taken care of. Well, since that time, Bitcoin has witnessed an explosion of the hashing power through the development of ASICs, that is, hardware dedicated to the sole purpose of mining Bitcoins. Mining has definitively emerged as an extremely specialized niche.
Bitcoin is now halfway through its trading stage. Two years ago, MtGox was so dominant that it was the closest thing to be considered as a single point of failure for Bitcoin. Meantime, many other exchanges have emerged: Bitstamp, Kraken, Btcchina … I suspect that MtGox holds no more than 20% of the exchange market share. Are we done with exchanges yet? Well, not yet, Bitcoins remain convoluted to acquire – I will get back to this point.
Fade of interest, a fading danger but still the main danger
Price volatility, malevolent uses and adverse regulations are usually quoted as dangers faced by the emerging currency. I think that those threats have grown into non-issues for Bitcoins. Indeed, the very same criticisms can be made about most currencies and commodities anyway, and Bitcoin is now beyond the point where a roadblock could wipe out the initiative.
No, the one major risk for Bitcoin remains a fade of interest from the community. High-tech is a fast paced environment and few technologies survive a decade. However, considering the steady growth of Bitcoin in the public awareness, I am inclined to think that this risk, the one true danger for Bitcoin, is itself fading away.
Bitcoin, a poster child for antifragility
Over the last two years, Antifragile from Nassim Nicholas Taled, is the most noticeable book I have given the chance to read. In particular, I realized that antifragility is probably one of the greatest and most misunderstood quality of Bitcoin. Bitcoin might seem complex, but it’s nothing but a protocol sitting on top of a shared ledger. Thanks to the present Bitcoin reach, the ledger itself – technically the blockchain – is probably the dataset in existence that benefits from the greatest number of backups world-wide. That part is safe, arguably orders of magnitude safer than the ledger of any bank.
What about the protocol then? Well, the protocol can fail, like any piece of software. It certainly did in the past, and most likely, it will fail again in the future. Let’s bring the case further, and imagine that instead of a simple glitch, someone manages to crack the protocol tomorrow, what would happen? Well, as it’s exactly what happened to Namecoin not too long ago, it’s not too hard to make a good guess. First, a corrupted blockchain would spread wreaking havocs in the Bitcoin ecosystem. Exchange rates would drop of 90% overnight, and then exchanges would simply stop operating. Meantime, within hours after the emergence of the problem, community developers, possibly members of the Bitcoin Foundation, would start working on a fix.
Depending on the nature of the weakness found the Bitcoin, fixing the problem would take from a few hours to a few weeks. Considering the amount of people involved, I fail to see why it would take much more than that. Indeed, Bitcoin is complex, but in the end, it’s not that complex, especially when compared to other popular open source projects such as Linux, Firefox or Open Office.
In the case of Namecoin, the terminal protocol bug was resolved in about 24h, and that’s Namecoin, an alt-coin with about 0.1% of the community traction of Bitcoin.
Then, once a solution is found, a new blockchain would be restarted from one of the many non-corrupted copies of the old blockchain still available. Depending on the depth of the problem, multiple and incompatible solutions might be proposed more or less at the same time by distinct developers. The market might even undergo a few competing solutions for a while, but then a “winner’s take all” effect will quickly push to oblivion all solutions BUT the leading one. Within a few months (maybe less), the exchange rates would have returned to their previous levels.
It’s Bitcoin as a ledger that is truly antifragile. The other part, the Bitcoin as a protocol is fragile and it is likely to be modified dozens of times over the next decade, each new version annihilating the previous version if the community consents to it.
If a massive protocol breach was to happen, many companies part of the Bitcoin ecosystem could go burst overnight: some exchanges might accumulate instant but terminal losses, a revised protocol could possibly make former hardware designs incompatible with the revised protocol, etc. The Bitcoin ledger itself is the only entity to be antifragile within the ecosystem, simply because many developers are personally vested in the preservation of this ledger.
Moreover, shocks do benefit to Bitcoin:
- Blockchain spam forced the community into making the protocol more resilient,
- Major thefts, the rise and fall of Silkroad, helped Bitcoin to make the headlines,
- Cyprus crisis undermined a bit the trust in the euros, again in favor of Bitcoin,
The next country printing its money into oblivion, the next bank failing with or without bail-out, the next country not to honor its debts … any of those events will further boost Bitcoin: not because Bitcoin will have succeeded at doing or succeeded at preventing anything, but merely because Bitcoin will have remained un-impacted.
In a way, betting on Bitcoin is betting on a degree of economic chaos for the years to come. A world of perfectly stable economies offering frictionless currencies does not need Bitcoin.
When an Unstoppable Force meets an Immovable Object
While many trading options have emerged for Bitcoin, exchanging national currencies for Bitcoin remains a convoluted exercise; and, I suspect that it will remain non-trivial for a while, possibly a long while.
Indeed, pretty much everything in the banking system has been built around the notion of reversible transactions: the money on the bank is your’s, but only from a legal viewpoint. If a court decides that one of the transactions that originally funded your account was not legitimate, then the transaction can be reversed, and the money can change of owner based on third party interventions. With Bitcoin, ownership is a matter of knowledge. If you know the private key of a Bitcoin address, and if nobody else knows it, then you are the true owner of whatever Bitcoins this address has accumulated. It’s very physical process deeply uncaring for any legal considerations: no court order can recover a transaction made toward an address if keys have been lost.
This aspect explains why it remains almost impossible to use a credit card to buy Bitcoins, and why considerable delays tend to be introduced by parties even when wire transfers are involved. Exchanging cash for Bitcoins feels a more natural option though. A Bitcoin-to-Cash ATM is now already available in Vancouver. However, I suspect that ATM owners are heading for frictions. For any ATM model that takes off, bad guys will start buying ATMs for the sole purpose of reverse-engineering them with ad-hoc counterfeit money printed for the sole purpose of fooling this specific type of ATM. Indeed, bad guys don’t need to produce quasi-perfect counterfeit bank notes, merely counterfeit notes good enough to fool this one machine – a much easier task.
Again, with regular ATMs, it’s a non-issue. If someone manages to stuff an ATM with counterfeit money, the bank will simply cancel the corresponding transaction later on when the misdeed is uncovered. The bank has full control on its ledger.
A store of value
When I discovered Bitcoin, I was inclined to think it would succeed because it made world-wide payment frictionless. Well, it’s certainly still part of the picture, but the more I observe the community, the more I believe it’s a positive but relatively marginal driving force.
Few people would argue that the growth of Bitcoin has been essentially driven by speculative investments. Then, according to the Bitcoin community wisdom, many would also argue that the ecosystem will gradually transition from pure speculation to more mundane uses, hence justifying high anticipated conversion rates. However,
- what if speculation stayed the dominant force not to be replaced by any other?
- what if Bitcoin did not need any alternative force to maintain its value?
Indeed, a shared yet incorruptible ledger may offer a fantastic intrinsic value on its own, as it gives people the possibility to save value without trusting any designated third party – trusting instead the community as a whole.
Gold arguably offers the same benefice, but in practice, gold is an impractical medium to make any payment; and, as a result, any gold transaction starts by converting the gold back to a local currency.
Then, why trusting a designed third party should be a problem, one might ask? Well, most currencies are simply not managed in the interest of the currency holders. China, Brazil, Russia and Argentina probably come top of the list here because of their respective size, but they are far from being the worst offenders. Then, even dollars, euros and yens are hardly managed in the best interest of currency holders.
Here, Bitcoin benefits from an ancient social pattern called the Gresham's law. According to the Wikipedia:
Gresham's law is an economic principle that states: "When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation." It is commonly stated as: "Bad money drives out good".
This law has been quoted many times about Bitcoin, but its consequences are usually misunderstood. Many detractors argue People are just hoarding Bitcoin, instead of spending them, which will be the downfall of Bitcoin. This observation is partial, and I believe that the conclusion incorrect too. Note that Bitcoin can still fail, but not because of this (see above).
A more accurate observation would be Many, if not most, are hoarding Bitcoins until they have an actual need to spend them. Meanwhile, those people just keep spending whatever non-Bitcoin currency they have. This behavior exactly fits the Gresham’s law, but what does it imply for Bitcoin?
First, merchants should not expect too many people rushing to spend their Bitcoins. Most people will keep spending their non-Bitcoin currency as long as they can. However, as accepting Bitcoins is an inexpensive option, there are little downsides in accepting Bitcoins - especially if Bitcoins are immediately converted to the local currency. Second, the more people keep their coins, the more the exchange rate will rise, due to simple market mechanics; thus, actually preserving the value storage property of Bitcoin.
At this point, detractors would argue that if there is little exchanges through Bitcoin and if it’s only about hoarding something that has no real value, how could this something be worth anything? This brings me back to the ledger (i.e. the blockchain). The one distinctive innovation brought by Satoshi Nakamoto is to make the world realize that a fully decentralized and yet incorruptible ledger was possible. The Bitcoin ledger is unique and it’s is what gives Bitcoin its value.
What people really owns when owning Bitcoins is a quantified amount of favors that could be given back from any member of the community; as long community interest has not faded, and it can be a valuable privilege – hence, not needing further benefits to justify the value.
Alt-coins will drive the evolution of Bitcoin
As an asset, what is the value of the Bitcoin protocol? Well, zero. Anybody can fork the source code, almost 2000 already did. Anybody can restart an alt-coin variant, dozens already did. While Bitcoin can be arguably estimated as invaluable to mankind, the protocol itself has zero market value: nobody makes money by selling the protocol.
The market value is in the ledger and only in the ledger, and this is why alt-coins are unlikely to gain any significant market value: they recycle the bulk of the Bitcoin protocol (the value-less part) while ditching the blockchain (the valuable part).
Namecoin is barely an alt-coin, because it addresses a very different problem; and that’s precisely because it does not compete with Bitcoin that it managed to gain traction.
Nevertheless, alt-coins represent an incredible opportunity for Bitcoin. Through experiments with alternative approaches, alt-coins are producing the knowledge that will make Bitcoin more secure, more usable, leaner, etc. Alt-coins, by being fragile experiments, directly helps Bitcoin in becoming more antifragile.
For example, Zerocoin brings an unprecedented level of anonymity in transactions by introducing rocket-science zero-knowledge cryptography in the protocol. From the Bitcoin perspective, there is absolutely no need to rush to import Zerocoin into the protocol. After all, Bitcoin has been striving without it so far. It’s much more reasonable to remain a passive observer for a (long) while, to let Zerocoin take all the bullets as bugs and flaws are uncovered, to let the Zerocoin community patiently address performance issues; and then, once Zerocoin has fully matured, to upgrade the Bitcoin protocol leveraging all this hard-won knowledge.
Thus, from a currency holder perspective, it means that alt-coins are doomed with high probability, because they won’t be able to preserve any technological advantage over time, bringing the competition back to a competition between ledgers where Bitcoin will only grow stronger over time.
Since Bitcoin is about storing value, foolproof ways to secure Bitcoins is a critical ingredient. Two years ago, I was already indicating this challenge was not specific of Bitcoins: it’s just incredibly convoluted to operate a computing environment that you can fully trust. Long story short: you need air gaps, but it’s harder than it looks.
Furthermore, the overall amount of trust that people should have in their computing devices - notebooks, phones, servers in the cloud – has rather gone downward since the Snowden revelations. Thus, I am inclined to think that many successful ventures of the end-user stage will be Bitcoin appliances, that is, hardware devices designed for the sole purpose of dealing with Bitcoins. The Bitcoin Card and Trezor are both promising appliances, and I suspect there is room for a lot more contenders in this market.
Indeed, as most people invest in Bitcoins, it’s fairly reasonable to assure that most of those people will be inclined in spending a bit to more to secure their investment.
The widespread availability of Bitcoin appliances that have gained the trust of the community will be the sign that the end-user stage of Bitcoin is taken care of.
Annex: More technical considerations
Instant transactions are coming without much effort. It takes half a dozen of blocks to gain an absolute confidence in a Bitcoin transaction, which means about 1h of delay. Many people see this aspect as a design failure, which prevents most live payment scenarios. However, if one is OK from relaxing the constraint from absolute confidence to quasi-absolute, then instant transactions can be made very secure, arguably a lot more secure than credit cards transactions (because of chargebacks). All it takes is an online service that aggressively spreads the transaction over the network while in the same time it aggressively monitors any double-spend attempt. Such a service does not exist yet, but it’s not the most pressing issue for Bitcoin either.
Scalability is a very addressable concern. Scalability is frequently presented as a core design flaw, that is, if Bitcoin starts gaining traction, it will fail because it won’t be scalable enough. (Disclaimer: argument from authority) My own experience in teaching distributed computing and tackling Big Data projects for year indicates is that scalability is never a terminal problem. Scalability problems are straightforward problems merely needing patience and dedication to be solved. Furthermore, many developers just love tackling scalability challenges well beyond market needs. That part of Bitcoin is probably very safe.