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Bitcoin- A Virtual Mining Disaster Waiting to Happen?

Last week in The Case against Bitcoin I examined some of the flaws with Bitcoin that may prevent it from becoming a mainstream currency. I received some very intelligent comments and had a series of thoughtful conversations with many Bitcoin advocates who promoted Bitcoin’s value and efficacy as a currency. While I believe there is value in peer to peer financial transaction systems, I remain, however, unconvinced that Bitcoin will be a widely used digital currency of the future.

Here’s why:

http://smaulgld.com/bitcoin-a-mining-disaster-waiting-to-hap...

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True. Herp derp.

True.

Herp derp.

"To encourage adoption, prices need to be lower not higher."

The Tesla motors example does not compare to currency.

Prices should not be lower. Bitcoin is divisible down to almost nothing. One can buy a Bitcent today for the price of a Bitcoin during the summer. People can put their value into Bitcoin just as they could before-- the idea that because that value grows people would be scared away is silly.

This argument can be made in favor of silver over Gold-- gold would have to be broken into very small amounts for barter, making it inconvenient, while silver can be traded in whole coins. But it holds no water in the context of a digital e-currency.

I am referring to the bitcoin price

One way of valuing it is vs similar crypto coins
Right now bitcoin is priced far higher than competing coins
I expect the others to rise and bitcoin to drop then perhaps all of them will rise?

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Exactly how is "the price" determined?

I mean, is it the actual price the last one was bought/sold at? Is it the average of the last 2 or the last 200 or 10 minutes or 2 days? Obviously, it can't be variable to the resolution of each transaction. And since each exchange has it's own price, is there even any coordination between exchanges? How about against each of the fiat currencies? How is their inflation (losing value) factored in?

There doesn't seem to be any standard method for determining a globally accepted, time-stamped price or even a standard for valuing that price (dollars? Gold? Basket? SDR?!!!)

These questions need addressed before we can even begin the discussion of what the volatility is or where the market cap will plateau.

If it were left to me, I would suggest the prices of the last blockchain be weight-averaged and valued against all qualifying currencies (including metals) for that same time. This international price could be published by the exchanges that wanted to encourage stability and the merchants could then break their ties to fiats.

Just like the stock market

The big difference being that there are multiple independent markets. As with stocks you can look at the last trade price, the opening and closing prices for the day, the current asks and bids, etc. etc. Basically everything about pricing shares of stock is true about pricing bitcoins.
http://bitcoinity.org/markets/mtgox/USD

There doesn't need to be a standard method for determining a standard price. The bid/ask system is how prices are determined on an exchange. http://www.investopedia.com/articles/trading/121701.asp There's certainly no need to standardize on pricing it in dollars or gold or euros or whatever, especially since bitcoin is designed to facilitate exchange between all those things.

If it were left to me, I would suggest the prices of the last blockchain be weight-averaged

I think you mean the price on the most recent block in the blockchain, but the problem with that is that the block only records the bitcoin part of a transaction. There's no such thing as the "prices" in the block, just the number of bitcoins being moved and the addresses they're moving between. If you pay a million dollars for one bitcoin, the transaction in the block only shows that one bitcoin moved from someone else's wallet to yours, not how much you paid for it.

I think it would help.

Without a standard of price, each merchant needs to display their rules for how they convert BTC to something relevant. Otherwise, there will be a problem of circular exchanging for profit. Besides, the stock analogy doesn't really work because no one is trying to sell homes, cars or pizzas in IBM Common Shares.

I can see a time very soon when online markets compare prices globally and instantly and offer the best deals in bitcoin prices but I think that's waiting for the stability to come. I'm in agreement that today's instability is just because it's still filling its way to the plateau but even when that settles down, markets aren't going to want to see 20,000 vendors with different conversion rates simultaneously. Just think of what the HFT quants would do with that!

(Yes, I meant most recent block.) I also meant that the exchanges for the various currencies would publish their weighted averages so a globally weighted average could be determined. No idea how to qualify exchanges for inclusion in this adventure or not.

I don't see why

I think what you're talking about when you say "circular exchanging for profit" is arbitrage.
http://www.investopedia.com/terms/a/arbitrage.asp

Arbitrage isn't a bad thing, it's how the market smooths out price differences. Right now arbitrage is difficult with bitcoin but eventually there will be exchanges that support bitcoin and other digital currencies in ways that make arbitrage easy, and then price differences between exchanges will be small. That's a good thing and sufficient for what you're talking about. It works well in other contexts, with stocks and currencies, etc., so no reason it wouldn't work well with digital currencies.

The stock market analogy works because bitcoins are traded like stocks, using the same bid/ask mechanism. There's nothing else establishing a price for bitcoin. When you set the price using the same mechanism that the stock market uses, pricing behaves like stock market pricing. I'm not sure how else you'd do it. It's also almost entirely momentum speculation at the moment which makes it behave much more like stock pricing than currency exchange. And that's the real problem, not difficulty pricing.

I've been torn over how to respond to this comment

My apologies in advance for the long rant but in trying to identify the underlying root problems of today, I've always kept an ideal image in my head of how things should work in a perfect world. When faced with identifying a solution to a real world problem, I start with the ideal solution and modify it to accept the non-conformist differences between the two. This has led to some very interesting breakthroughs.

In this case, however, the ideal says that arbitrage is bad. It is one person profiting from some inefficiency in the mechanism of transactions. Those transactions, in the ideal world, should be free so there should not be any profit available. Not to mention that both the transaction and the arbitrage are nonproductive actions in society. For this reason, I must disagree that it's good. I must also say that the inefficiency it corrects (smoothing out price differences) should be eliminated at its source. In short, the system should be designed so that its simply not possible. That would, after all, eliminate the incentive, right?

How to do this, imo, depends on exactly what people want to see at the store when they look at this term we generically call "price". Do they want a regional exchange rate for another currency? Most would say yes until such currency itself becomes unstable from its own fiat-based devaluations.

Do they want a value in terms of goods and services? If so, would that be a local, regional or international number? Since obviously different parts of the world value things differently for many reasons, maybe this could be a factor in bringing economies to equal playing fields.

But maybe those prices should be different. After all, if gi-normous shrimp are only available in Louisiana, why should they cost the same in Latvia? Maybe this calls for some mechanism to factor in the cost of transport. After all, including those prices should set up the demand to compensate appropriately on a local basis. (Latvia SHOULD have less demand but only because of the shipping cost.)

This brings up costs. A while back, I was part of a group of engineers that redesigned the smart grid for proposal. We integrated the cost of power in the exact way that the internet packets are charged for the time (delay) they take different routes on. This could be similar. We could include all externalties in prices, aggregated from each category (shipping, energy, pollution, labor) and then price them back into said product as they apply locally. If this were possible, then people would most likely choose "the (base) price of a basket of goods" as the measure of their currency.

Obviously, this mechanism would not be part of the BTC infrastructure but it could be built up fairly easily among its merchants. Each vendor would have its external costs modeled for each type of customer. To 99% of them, the only difference would be that shipping and taxes would change with destination and they already do this with a clunky mechanism. What this gives us, however, is the base price of goods around the world on equal scales and separated from those externals. And that would allow any currency to be evaluated on something tangible, meaningful and applicable to everyone. It could be the start of something game-changing. After all, do people really want their currency to be influenced by any other one? Beyond exchange rate (say you're dealing exclusively in BTC), you want your money to be rock stable.

This new crypto-currency movement has ushered in some brand new possibilities in monetary dealings that have never been available before in history. One of the only viable criticisms of it is the volatility due to speculation. Sure, much of this is because its just now growing from a seed, but I feel like this is partially due to it's ties to the old system. I think fixing this would be a big step toward smoothing that out.

If you think of the price of a car in dollars, it's set by an annual process (costs at the mfgr) and the value of the dollar (at that annual time). When you purchase it, you separately evaluate the external costs like delivery, dealer setup, taxes, emissions mods. Those prices vary for myriad reasons. The point, however, is that the base price (sticker) doesn't fluctuate 1% when the dollar bounces. Obviously, this is because the dollar isn't seen as volatile, but in reality, it is. Now, with these new cryptos, could be the time to integrate that into our markets. We have the instant, global networks to make it work. We could stabilize the cryptos with a process that exposes the true volatility in the fiats. All we have to do is create an infrastructure that's easy for merchants to use which allows all global markets to use common base prices with 'added' externals. If it catches on, it would encourage those to become more efficient as well. Everything that's seen by the consumer tends to move that way.

What do you think? Viable project, interesting benign debate or ramblings of an old man? LOL

Arbitrage

In this case, however, the ideal says that arbitrage is bad. It is one person profiting from some inefficiency in the mechanism of transactions.

I don't see it that way at all. Markets are never perfectly efficient, for all kinds of reasons. The inefficiencies can be smoothed out by arbitrage, and people doing that work make money for doing that work. Arbitrage is a free market solution to a free market problem! What's not to love?

That's not the level of 'ideal' I was referring to

in the ideal I work around, even the stock market is bad. As with arbitrage, it allows non-productive people to profit for no reason other than simply gaming some system.

Remember, corporations used to be only for large, short term projects. This included building a road, a bridge or something else too large for a single business or group to do. When their task was completed, they were dissolved. This changed a century ago.

After that, public stocks became common place. Under this new system, those running the markets stood to profit tremendously just for handling it. Also, differing kinds of shares are kept out of the public eye. Also, ownership of these new corporations is now diversified to the point where accountability is lost. These are all by design.

With today's capabilities, we can easily create a system where donations can fund quite a bit, loans can fund the majority of the rest and a corporation can be created for much larger purposes. This would cover every need we have for business types. And if we stuck to such a list, the price of products would plummet WHILE the wages offered for the supporting jobs soared multiples of current rates. This windfall would come from the savings of not spending as much as 60% of revenue on this whole system. Think about it. Cut costs by half, triple wages (from 11% to 33%) and still cut prices. This is the theft that has turned into the cumulative inflation of the last century. Isn't it time to take that back?

Different ideas about ideals

I don't have a problem with the stock market as a general idea. There are things about the stock market as it exists that are far from ideal, but having corporations, and shares of ownership in corporations, etc., seems like a good thing to me.

I'd never heard that about corporations formerly only being for large, short-term projects. The South Sea Company from the early 1800s is a famous example of a stock bubble. And railroad companies have been around for a long time. I'm probably just missing your point here.

Certainly though the option of funding businesses from small donations and small investments is a good thing. I strongly endorse local, private small-scale investment in local businesses. The law recently changed to allow companies to raise money from private investors who aren't in the "high net worth individual" category, without having to do an IPO and all that. That will make it easier for companies to get started via crowdfunding. Like kickstarter, except it's not a donation that might get you a product sample later, it's equity in the company.
http://en.wikipedia.org/wiki/Jumpstart_Our_Business_Startups...

That's interesting about the rule change.

It must have been pretty recently because I was in touch with a woman trying to get that changed because it was her exact business model. She was doing one of the startups for equity but I don't remember the name now.

On the rest, the distinctions must be made between corporations and private proprietorships and partnerships. Corporations must have officers for each high level task, must have a board of directors and must put profit above all else. Private businesses can still be funded by stock ownership (and most are to some degree) but it does not come with all those rules that mandate compartmentalization and non-accountability.

This allows for the more detailed explanation of why the stock market is bad (my opinion). This structure encourages risks to be taken by a corporation that a business would never take on. If they did, with the locals all personally knowing the owner, they'd lynch him. I feel this is a critical component that's gone missing in the last century.

And go figure that this was changed around the same time as the Fed and income taxes.

So, looking at the whole picture from high above, we see that the banks have systematically taken over the individual's income, making him give them exponentially more money over time. We see they have taken over the government's money, making it give them exponentially more money over time. We see they have taken over the corporations, making them give them exponentially more money over time. The single exception is the businesses (distinct from corporations). Those are still taxed mostly as personal income. They are, however, going after them with lawsuits of liability which coerces many to incorporate.

That's the how, and here's the what - as in what this all accomplishes. I believe this effectively ties money, income, wealth to social standing. By doing so, they have circumvented the status of a "good and moral person" and replaced it with a "hard worker" or more often a "shrewd businessman". Both of those are horrible traits in a person in the big picture. It means they'll compromise family, friends, fun, fairness in the name of money. Just add a touch of Edward Bernays' consumerism advertising push and here we are.

Gaming the system is also

Gaming the system is also part of free markets and competition. Using brains instead of other methods may be much more efficient, therefore more valuable.

Will have to watch

how pricing is determined as we go

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Price stability in another 3-4 yrs

As bitcoin gets more widespread adoption more people will use it and more people will buy it. As it is scarce, prices WILL get bid up. So ASSUMING increasing widespread adoption, prices will keep going up. Once the adoption rate plateaus, you'll see a plateau in the price and with that price stability.

I'm putting a 3-4 yr timeline for maximum widespread adoption. Until then I believe we'll continue seeing these crazy upward roller coasters (with drops too). But it will continue the trend it's been on... higher highs and higher lows.

Maximum widespread adoption

Most of the money in bitcoin now is pure speculation on continued momentum. People buy it hoping that other people will pay more than they did and drive the price up. And then those people, of course, are hoping that other people will pay even more than that, and drive the price up.

So when you talk about "maximum widespread adoption" are you picturing that speculators just keep bidding it up and up and up until some point, and then it magically stabilizes?

Yes! Exactly!

In the free market things get bid up until markets decide a correction is needed. For bitcoin that "magical" number was $27 and then there was a correction! Then it was $266 and then there was a correction into the $120's. Currently the "magic" # is $1200 and I don't know if we'll see a correction and stability or if we'll continue to see people in the market bid up the prices.

In free markets it's very hard to predict human action and human motivation.

I think the investor participation in bitcoin is actually

The biggest threat to adoption as it causes the volatility

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Also for people investing

you should understand that were only half'ish way thru the bitcoins total monetary supply. so were not gonna see any real stability until the maximum supply has been reached. Also as more and more people attempt to mine them investing hundreds to tens of thousands of dollars this increased cost in generation will be applied in some manner to the price.

If you look at a chart of total network hashrate vs Price they're pretty much in sync

meow

True and perhaps not

The remaining half of bitcoins will hit the market and end up in hands quite different than the first half
The first buyers will probably have long sold a bulk of their holdings and only hold bitcoins for transactional purposes rather than as a store of value.
The newer holders will probably hold them as investments and be less likely to use them for transactions if they rise in value.
So perhaps the early adopters will be the heaviest users and the if the price drops savvy merchants may try to accumulate large amounts of bicoins.
Seems to me there will be massive fluctuations in bit coin. The scenario outlined above May not happen but there are so many different ones that all lead to volatility
That and not the debate over intrinsic value is the greatest threat to bitcoin being adopted as a currency

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yea

that's a good point. really hard to speculate on what might happen especially given the strings of thefts. if people loose confidence in the safety the price could collapse... in any event its going to be an interesting ride.

meow

The string of thefts all

The string of thefts all share a common trend. Ultimately you have to protect your property and those that don't are at risk of theft. It's the same thing with gold, silver, and dollars.

Confidence is key to any unbacked currency

If confidence is lost the currency becomes worthless

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What I love about btc is that TRUST is not part of the equation.

There is nothing about the bitcoin network, the algorithms, the source code that I have to trust. Everything is there in plain view for you to evaluate.

I know the bitcoin is legitimate and can't be hacked.
I know the bitcoin payment system can't be hacked unless someone gets a 51% majority.
I know my bitcoin wallet is secure by measures I've taken to keep it secure.
I know there's no counter-party risk for someone printing to infinity or holding the gold.

The fact that bitcoin is not backed by anything removes trust and with that any counter-party risk from the equation.

Devil's advocate

You're trying too hard to find negatives.

(1) "To encourage adoption, prices need to be lower not higher."

Lower than what? The market cap for bitcoin is the number that matters. The number of bitcoins is an arbitrary divisor. Think of it like the stock market. There are twelve million "shares" (one bitcoin) currently at about $1100 each, for a market cap of about 13 billion. If bitcoin could do a 10:1 "stock split" then there would be 120 million shares at $110. Or 100:1 for 1.2 billion shares at $11 each.

A "bitcoin split" would actually be very positive for bitcoin as a vehicle for speculation, just as it was for the dot coms when they kept going up for no reason and seemed expensive to speculators on a per-share basic even though it was the market cap they should have been looking at. Unfortunately there's no way to do a bitcoin split, even if you could get 51% of the miners to agree to it. It's the sort of thing that needed to have been designed into it from the start, and I'll bet some competitors out there will realize that.

(2) "With competition, prices should drop."

Again you have to look at it like the stock market. The total market cap for social networking companies hasn't dropped over time, it's soared. It was zero before geocities. Now it's hundreds of billions of dollars. The competition didn't make the market caps for companies in that sector cheaper, necessarily, because the market was growing so rapidly.

On the other hand, bitcoin also hasn't faced serious competition yet. Considering that litecoin is little more than a bitcoin clone and yet is getting the attention its getting I think it's a good bet that when real competitors start showing up bitcoins price will drop sharply -- from wherever it is at the time, which could be a thousand or could be a million. (I'd bet against it getting into five digits before it hits real competition, but not with enough confidence to put actual money on that bet.)

(3) "The “invented” characteristic of Bitcoins is what will prevent them from retaining value"

I agree that bitcoin mining was invented, and obviously the "precious numbers" that people are willing to pay so much for today weren't anything special or valuable to anyone before bitcoin was invented -- and if Satoshi had made a different arbitrary decision about what a valid hash looked like it would be a different set of numbers declared to be precious.

But it doesn't follow that this is what prevents them from retaining value. Suppose (counterfactually, although some bitcoin advocates seem to believe it) there was some barrier that prevented any other digital currencies from competing effectively with bitcoin. In that case demand for bitcoin as a digital currency could potentially be as big as the most starry-eyed advocates like to say.

The calculation done by the miners is "proof of work" only. It's a way of slowing down production of bitcoins, and making sure that the bitcoins go to people who are most willing to invest their money into mining them. But how they're created doesn't make any difference to how the price per bitcoin is set.

(4) "A stable Bitcoin price is extremely important in determining its future as a viable currency. "

This one I agree with. In order to function as currency it needs to be stable enough that people would agree to have their salary defined as a fixed number of bitcoins per month, be able to sign a one-year lease on an apartment and pay a fixed number of bitcoins per month, be able to guy gas and food and whatever with prices defined in bitcoins, etc. Right now things that you can buy with bitcoins are almost invariably priced in dollars or euros or yuan or whatever, as a direct consequence of bitcoin volatility.

It's hard to see how it could ever stablize, though, given how easy it is for competing digital currencies to be created, and given the assumption that exchanges will allow for easy transfers between digital currencies. It's bad enough having money in FRNs that lose buying power due to inflation, but imagine that new fiat currencies were being created out of thin air all the time and going in and out of favor, *and* prices aren't set in FRNs they're set in something else. Your FRNs wouldn't just be losing value due to inflation, you might wake up one morning to find that you've lost 80% of your buying power because some other fiat currency got the attention of the fickle market. When there's nothing backing it up but market demand, and competitors with the same functionality can be created easily, competition is deadly.

I know you know better than

I know you know better than to argue for a "bitcoin split", since bitcoins are divisible by eight decimal places. A person will just get used to paying "฿ 0.00000354" for things. :)

Competition will drive the price of bitcoin down but

The assumption is that crypto currencies in their current form will even be around in a few years

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"Stock Split" is interesting, but it hazards bitcoin inflation

A "Stock Split" for bitcoin is an interesting concept, but it hazards bitcoin inflation, does it not? What I mean is, I understand bitcoin can be divided into 100 millionths of a part. That kind of divisibility may keep it fungible in a scenario where each bitcoin is worth a million dollars, making each division worth a cent.

Or, it can be considered monetary expansion, discrediting the claim that there is a limited supply of bitcoins and therefore they are rare. There is nothing rare about 2.1 quadrillion of anything.

"Cowards & idiots can come along for the ride but they gotta sit in the back seat!"