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03 Jun 2011

Bitcoin and tulip bulbs Money

Bitcoin, for anyone who's not up on their techno-trends, is this year's hot trendy digital payment system. Its main claim to fame is that it is peer-to-peer, not depending on a central bank to issue or validate the "coins", actually blobs of cryptographically signed bits. This makes it both fairly anonymous and hard to manipulate (at least in the ways that real money is manipulated), making it a darling of anarcho-libertarians.

A lot of people have opined on its merits, most notably this Quora message.

I took a look at the design of Bitcoin, which is credited to "Satoshi Nakamoto". Nobody seems to know who he is (or who they are), but he definitely knows his crypto. As a piece of cryptographic software design, it's quite clever. As a system you might want to use to pay for stuff, it's hopeless.

To somewhat adapt the arguments in the Quora message, Bitcoins suffer from two problems, one technical and the other economic. The technical problem is that bad guys control vastly more computer power than good guys, but as the bitcoin paper says:

The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.

The way you create a bitcoin (which they call "mining" as in gold mining) is to solve very time-consuming computational problems. So long as the cost of doing the computing is at least as great as the value of the bitcoins created, we'd expect the supply to grow at a modest rate, and the creation rules are designed to ensure that. The cheapest legal source of a lot of computing power is Amazon's EC3 where you can rent a high performance PC with a graphics accelerator for about a dollar an hour, and at this point it looks like it'd take several hundred hours to create a bitcoin which is worth about $10. But the bad guys have botnets, which can easily include hundreds of thousands of PCs. It's not at all clear to me what would happen if a botnet calculated a million new bitcoins and dumped them all at once into the system which currently has about 6 million, total.

The other problem is economic. A year ago, you could buy bitcoins for about 1¢ apiece. In January, they cost about $1. Now they're about $10. We have a name for that -- it's a bubble. (Bitcoin fans tend to assume that bitcoins are money, and describe what's happending as deflation, but you'll have to look pretty hard to find any real-world examples of 1000 to 1 deflation.) Since there's no central bank to manage exchange rates, nor can you pay your taxes with them, which is the practical definition of money, a bitcoin is only worth what the next sucker thinks it's worth. So what we have here is a system that lets you pay for stuff with tulip bulbs, or perhaps shares of stock in theglobe.com.

It's hard to predict exactly when a bubble will pop, and even harder to predict why. Perhaps people will discover that their bitcoins aren't as anonymous as they thought, because they can be tracked via the publicly visible sequence of transactions. (In this regard they are not unlike disposable prepaid phones, where they don't know who bought the phone, but they can see all the calls it makes.) Or maybe there'll be a bot shock like I described above, or maybe people will suddenly realize that you can't actually buy anything other than illegal drugs with them. Whatever it is, the bubble will pop, all the people who paid $20 for their bitcoins will try to unload them and be lucky to get 5¢ for them, and that will be that.

Update: Peter's point about the cost of botnets is a good one. But botnets are usually rented to do obviously antisocial stuff like sending spam or DDoS. Bitcoin crunching would be nearly invisible, and hence lower risk to the bot farmer, so it might be possible to negotiate a lower price.


posted at: 10:11 :: permanent link to this entry :: 9 comments
posted at: 10:11 :: permanent link to this entry :: 9 comments

comments...        (Jump to the end to add your own comment)


To start with, I agree with your thesis that bitcoins are a bubble. Just a couple of points:

If you're going to have to spend several hundred dollars to buy enough Amazon EC3 time to create a bitcoin, it seems like just buying the computer would be cheaper.

Similarly, there's a market for botnets. Reported prices for botnet services aren't all that low. It's hard to find the rates, but it wouldn't surprise me if EC3 was cheaper.

(by Peter da Silva 03 Jun 2011 08:08)



Additional analysis here: http://intelligentdesigns.net/blog/?p=108

(by Huey 03 Jun 2011 18:33)



+1 to the the nearly invisible aspect of the work for cheaper access. A few years ago, all the rumors were that bots had different pricing models based on their IP -- $x for new + non email blacklisted but $x/10 for already email blacklisted.

(by Miles 05 Jun 2011 12:09)



Bitcoins probably *are* in a bubble. But at least one assertion you made is wrong: “you can't actually buy anything other than illegal drugs with them.” In a free market such as the Bitcoin economy, wherever there is sufficient demand, an entrepreneur will step up to create a supply. There is certainly demand for being able to purchase real goods with bitcoins, and lo, entrepreneurs are stepping up to provide such services. For one good example, see http://spendbitcoins.com/ , which allows you to purchase goods on Amazon, Fishpond, and soon Newegg, with no transaction fees.

(by Matt W 08 Jun 2011 22:09)



You say: "It's not at all clear to me what would happen if a botnet calculated a million new bitcoins and dumped them all at once into the system which currently has about 6 million, total."

That's not a concern because that's just not how it works. New bitcoins are created across the whole of the network at a very predictable rate. The node that's lucky enough to find the correct hash precursor required in order to generate the next block gets the (currently 50 BTC) bounty. In practice, lots of folks team up into mining pools to smooth out their rates of return.

Even if some "bad guy" controlled a large network of nodes, they'd be able to *at most* snag all the newly created bitcoins as they trickle in, but they couldn't just reify a million BTC out of thin air all at once no matter how much computing power they have. The other thing to keep in mind is that GPUs are *much* *much* more efficient for mining than CPUs, and bot nets don't generally have sufficient GPU power available to even worry about in this context.

(by Afreet 11 Jun 2011 16:14)



While being unsure about the problems mentioned here, I think the real problem is political. It is really hard to see that the powers that be would ever let this grow into something that would obviously threaten the world order. If not already so, it would be trivial to declare this illegal.

(by Kami Petersen 12 Jun 2011 05:37)



The two issues you cite seem to conflict with one another. If one party mined some quantity of bitcoins in "bad guy" fashion (by what standard? bitcoin as a platform seems not to care about this), they would be analogous to a skilled (or lucky!) gold-miner as compared to his less-productive colleagues. Neither is a threat to gold as a store of value. In fact, gold lacks the guarantee of predictability that bitcoin has, that new units are produced at a predetermined rate. Certainly talk about inflationary "dumping" is invalid.

Economically, what we're seeing now is deflation, but I fail to see the problem with that. Are bitcoins under- or over-valued? You might as well ask about the price of gold. If you have an oracle that can answer either of these questions, you should be researching which tropical island chains to purchase, not blogging.

An asset's price doesn't have to track exactly the prices of other assets in order to be useful for investment or commerce. If and when some adjustment to the price of bitcoins occurs, investors will react as they always have. They won't conclude that an asset that loses value over some period must therefore have zero value.

It seems most people are discounting the possibility that there is a major flaw in the bitcoin protocol and/or a major bitcoin client. In that case the value of bitcoins might very well disappear completely. All assets entail some risk, however, and this risk is certainly priced-in. Those who ignore risk might well get bitten by it, but that's true of all assets.

(by Jess 13 Jun 2011 23:58)


Sigh.
I've used them as an actual currency - to buy and sell actual physical things. Proof of concept has been proved as far as I'm concerned.

Your other objections have been dealt with over and over and over and over and over again in the bitcoin forums. Every time someone new turns up they think they've uniquely discovered the flaw in the system... and they're (not always politely) put right.

What I've learned so far? It's an experiment - and nobody who thinks they know what they're talking about, actually knows what they're talking about. We'll just have to see.

(by Nick Taylor 14 Jun 2011 09:43)


qarl
"what would happen if a botnet calculated a million new bitcoins..."

it's unfortunate that you didn't pose this as a question to the bitcoin community before deciding it's a vulnerability in the system. we're all very nice in the forums, and we would have explained the error in your reasoning.

the fact is - if you own 50% of the bitcoin network, you are LEGITIMATELY given 50% of the coins mined. if you use your majority to cheat, at most you could earn double that.

but that is a (relatively) small number of coins, on the order of a thousand a day. yes that's a nice sum - but not enough to damage the system. and again, you could have gotten half that without cheating.

perhaps you believe that with 50% of the network, you can cheat and mine MORE than a thousand coins a day. you could, i suppose, but the remaining 50% of the network (and every client that is connected to it) would immediately see the activity and know it's illegal.

the system was created by some amazingly smart people - and it has been examined by many more amazingly smart people. to think you can find flaws so easily is hubris.

(by Karl Stiefvater 14 Jun 2011 15:17)


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