Blockchain Chronicles or food for thought about Bitcoin*

1. Economic fundamentals

A question that I often hear is “Where does the VALUE of bitcoin come from? The obvious answer “Whatever someone is willing to pay for it” refers to the quote on an exchange and relates to its price but how we can determine its value ** In Proof of Work algorithms you may suggest that the value of Bitcoin is determined by the energy consumed but than it would be worth asking:

Is it determined by the electricity needed to mine one block? Should we calculate the cost to mine 12.5 bitcoins and use this as mark to market to determine the total market cap. But with the increase of the difficulty we will have to re-evaluate since we will receive the same 12.5 bitcoins but at a higher cost. Should we assume that the value will double on next halving? Tough questions to answer but at least it will be a linear function of the network difficulty.

or

Is it determined by the electricity needed to mine all the blocks in existence (reconstruct the whole chain***)? The latter will result in an ever-increasing value, but it will be an exponential function of difficulty since we will need to solve the complete Merkel Treeª. More electricity (greater by a factor) will be used compared to the actual consumed at the time of the historical block creation. Remember that the difficulty has nothing to do with the actual number of transactions — It is just a linear function calculated from the total hash power available (ASIC machines deployed) intended to average block time^ creation in about 10 min.

But unlike gold or any other commodity that can be transferred and put back in the economy as a resource the energy consumed during block validation is gone for good. The fundamental difference between Money and Currency is that the first is considered a store of value. And something that has no value can’t be a store of value. Of course, the above is true for fiat currencies as well.

The commodity that functions as a measure of value, and, either in its own person or by a representative, as the medium of circulation, is money. Gold (or silver) is therefore money. [1] Currency can be used where we need a measure of value or medium of exchange. You can use bitcoin as a ledger and therefore as a medium of exchange but not as a store of value. Everyone will agree that the main purpose of Bitcoin is to solve the problem with constant supply expansion and diminishing purchasing power of fiat currencies.

Solving this problem is only the first step towards re-inventing money.

2. Technical aspects

When you hear technical mumbo jumbo such as Byzantine Fault Tolerance, Proof of Work or 51% attack you should keep in mind that these are technical solutions to one particular problem:

How to prevent transaction that either spends a coin that you don’t have (create a fake coin) or spends a coin twice at the same time before the unsuspecting parties can check the ledger (blockchain) for confirmation. This problem is inherited from the digital nature of the transactions (messages) in a distributed computing system.

On the other hand, we have one simple “analog” solution: Use old fashioned gold coins. The physical properties of gold don’t allow us to create fake coins — The Proof of Work was done billion years ago in a supernova explosion and all we have to do is an easy validation. By measuring two properties of a given coin: volume and weight we can determine if it is golden. The area and the images on the heads and tails can easily prove the volume of a coin and you can check the weight by using scales. The physical nature of the gold coin doesn’t allow us to spend it with two parties at the same time.

3. Decentralization and privacy

Since we need the nodes (mining farms) to reach consensus on the state of the Ledger and to distribute and validate genuine transactions they become a trusted party. The majority of nodes in the network become an authority and the ledger (blockchain) itself is a central point to validate my transaction against. On the other hand, gold coin transactions are decentralized because every party can check the validity without the ledger and make a real peer-2-peer transaction without broadcasting any information outside of the parties involved.

3. Social behavior

Today we have systems governed through voting and they are the best we have designed but are still far from being flawless. Consensus on 21 M bitcoins is internal to our society and therefore it is a matter of time to have someone advocating that deflation is bad and we need to increase the Bitcoin supply. On the other hand, scarcity of gold is a physical phenomenon external to us and can’t be affected by human decision. There will be always inequality in distribution of money and someone that will campaign with the promises of free coins for everyone.

Either blockchain will become a network of the top 1% (owning mining farms) or it will mimic the populist political system that we have today.

4. Protect our economic freedom

If for any reason my transactions are NOT included in the longest chain (a consensus defined by the majority) I might end all alone in a forkᵇ with a few useless coins. The first and most famous fork was this of the Ethereum blockchain because of The DAO (Decentralized Autonomous Organization) that split into ETH(Ethereum) and ETC(Ethereum Classic).ETC as of the time of writing is priced at about 3.67% of ETH

But If I transact in gold and it is NOT accepted by a vendor claiming my gold coin is fake this doesn’t have negative impact on me. I can always buy from another vendor that will accept it. Even if there is a conspiracy against me until there is at least one node (vendor) to accept my gold I am fine. And it is in their best interest to accept it since unlike bitcoin the gold coin does not hold the history where it came from.

As a summary I want to make clear that I am still a believer in blockchain. Can we use Bitcoin instead of fiat — Yes, it is far better since we have limited currency supply and we have full control of our coins instead of virtual currency that is some bank’s liability. But at the end don’t forget that Bitcoin is NOT money — It does not have a value and can’t be a store of such value. In fact there have been no money in circulation but only currency since Nixon ended convertibility of USD to gold in 1971.

What are the use cases for blockchain if not money — Check out the project Namecoin that is a ledger to replace the traditional DNS system. A brilliant idea that will improve censorship resistance, privacy and security when registering a domain for your website. Another brilliant idea is a cloud storage similar to Google Drive or Dropbox but mixed with Napster(torrent) and secured by the SIA blockchain — With this solution you achieve both redundancy and encryption that only you can unlock.

[1] Karl Marx, Das Kapital, 1867

* Please note that most of the time Bitcoin is used arbitrary for any crypto currency

** Value defined as the human labor necessary to produce goods or services

*** The chain of blocks is considered to be the whole Merkle Tree where the current block is only the top

^ You can think of each block in any blockchain as the daily settlement of the banks.

Kaleidoscope images resemble the hash signature of the block. Image courtesy of Pixabay.com; Artist: Speedy McVroom

ª Merkle Tree (the math fundamentals behind blockchain) is best described with the kaleidoscope from your childhood — Every twist rearranges the colorful pieces inside it in an unique way. The image that you see can be achieved only from the previous state — Change one piece and you will have completely different image. In blockchain terms the colorful pieces inside the tube represent transactions and if you shuffle it every 10 mins you will have a block where the fascinating image is called the hash signature (or fingerprint) of the block.

the best explanation on the term fork of a blockchain I find to be the schism in Christianity to Orthodox and Roman Catholic in 1054 or the Sunni-Shia division in Islam. It is important to understand that we can have two concurrent realities that are logically complete and valid for their followers

Disclaimer: Author’s ideas and opinions expressed only for research purposes and can’t be considered as financial advice or recommendation. The author may own the assets mentioned in the article and you should do your own independent research.

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