Category Archives: Cryptocurrency

Information Economy 2.0

Bitcoin is a Trillion $ Economy

We often hear that we live in an Information Economy. We have an information-based economy, but we don’t have a pure form of “money as information”. Instead we have a hybrid of digital money and paper money with encoded information such as denomination and serial numbers and engraving details.

Money (Money 2.0, ‘paper’ fiat money) today is mostly information, but the modern monetary system was designed long before the Information Economy. Even so, money is mostly held in digital form, on the ledgers of banks, and as monetary reserves at central banks. Physical currency in circulation is a small fraction of the money supply. So today it is a hybrid. One can argue it is not fully suited to our rapidly evolving information economy.

Steven Mnuchin, Louise Linton, Leonard Olijar

Steven Mnunchin, Treasury Secretary, and Wife Posing as Bond Villains, while Enjoying Dollar Bills at the Bureau of Engraving, and Daydreaming of Tax Cuts for Multimillionaires

Bitcoin and cryptocurrencies collectively are Money 3.0, a form of money that is entirely digital, entirely information. Even if you have a physical bitcoin wallet or paper wallet, the money does not reside in the wallet, only the keys! The keys release bitcoin money held on the blockchain.

Trying to separate the blockchain from bitcoin or cryptocurrency is like trying to separate the economy from information in the information economy. The blockchain holds the ledger information, the cryptocurrency powers the economy. The term ‘blockchain’ does not appear even once in Satoshi Nakamoto’s seminal paper for bitcoin and cryptocurrency.  See this OrionX.net podcast discussing Nakamoto’s vision and the Nakamoto consensus algorithm: https://youtu.be/ZLS5P7SYcyI

Today, market participants mostly look at the market cap of bitcoin and other cryptocurrencies, as if they were some sort of equity shares. But actually, they are currencies, or perhaps digital gold, and what is somewhat strangely called ‘market cap’ is actually the money supply for that currency. It is simply the price of bitcoin, times the aggregate number of bitcoins in circulation. Here, in circulation means securely committed to the blockchain through a cryptographic hashing algorithm.

The size of the economy for bitcoin is related not only to the money supply, but also how rapidly that turns over. In macroeconomics this is called monetary velocity. In fact GDP = M2*V where the GDP is equal to the M2 money supply and V is the velocity of that money. It reflects how fast money moves through the system per year.

In the US the GDP is about $19.5 Trillion, the M2 money supply is about $13.7 Trillion and the velocity is about V = 1.42. That is, on average, the money supply turns over 1.42 times per year. In fact the Federal Reserve has been worried that the velocity is too low. It has been dropping steadily, which is a symptom of stagnation.

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Velocity of M2 Money: Federal Reserve of St. Louis

For bitcoin the velocity is much higher. It turns over about 9 times a year, V = 9. Today the money supply or market cap for bitcoin is about $121 billion. With a velocity of 9, that translates to a bitcoin economy that is over $1 trillion. It amounts to around 5% of US GDP and more than the GDP of The Netherlands. Bitcoin is not usually described in such terms, but this is a measure of the vibrancy of the economy for the cryptocurrency.

Many cryptocurrencies have even higher velocities. Bitcoin Cash, which has only been in existence a few months, has a velocity of 26 and a total economy of over $500 billion, approaching the GDP of Sweden. The world economy of cryptocurrencies exceeds $2 trillion. This is about the GDP of Italy.

Bitcoin and other cryptocurrencies are enabling the Information Economy 2.0, where whole new forms of efficient exchange of value can be implemented with fewer or even no middlemen and at lower cost.

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Bitcoin: Like Gold or Like a Currency?

Valuing the various bitcoin forks

Breaking News: Segwit2x fork has been postponed indefinitely

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Some say bitcoin acts more as digital gold then as a currency, more as a store of value than as a medium of exchange. It is very interesting to look at the various bitcoin forks with this question in mind.

Everything in life and in finance is a tradeoff. Gold works well as a long term store of value, but not so well as a medium of exchange. The US dollar works very well as a medium of exchange, but not well as a store of value in the long term. Even the Federal Reserve and other central banks hold gold as a reserve asset. It represents the bottom of the inverted money pyramid.

Now bitcoin is from its beginning more like gold in the sense that it is an asset with limited, predetermined supply. Dollars and other fiat currencies are debt-based since they come into existence when new loans are made, and their continual supply growth is rather assured; usually inflation occurs to varying degrees. See the Money 3.0 article for a longer discussion of this point.

Image: Silver ice cream fork, De Young Museum

There are 4 versions of bitcoin, 3 currently, and one possible fork. That was scheduled later this month as Bitcoin 2x (or B2X) a possible fork due to partial adoption of Segwit 2x, but it has now been indefinitely postponed due to lack of support.

As of today, approximate values for the 3 existing forks are:

Bitcoin BTC $7200

Bitcoin Cash BCH $630

Bitcoin Gold BTG $140

And Bitcoin 2x B2X had future values around $1600 before plunging on the announcement that it is now postponed.

All these cryptocurrencies have a supply of around 16.6 million accounting units, and all are limited to 21 million as the ultimate supply. And yet their prices are very different. Bitcoin has a first mover advantage but is that the whole story? How does one value BCH and BTG relative to BTC? In principle the various versions have both asset and currency characteristics.

Each of the alternatives to the original bitcoin is designed to facilitate faster, less expensive transactions. And this makes it more like a currency than a reserve asset.

BTC can be looked at like a large denomination bill, not as easily spent, although it is much easier to break into change than large bills are. Bitcoin Cash differs from BTC because it has a much larger blocksize, 8 MB. Bitcoin Gold differs in adopting a GPU-friendly mining algorithm, Equihash, rather than SHA-256 used by the others, which requires custom ASICs.

Bitcoin 2x adopts Segwit2x with a larger 2 MB block size.

Each of these three alternative coins is designed so that the system can process transactions more quickly and at lower cost, and so, along the spectrum of digital gold to currency, each is closer to a currency than the original BTC.

And that, somewhat counter-intuitively, is why original BTC retains a higher value.

In particular, the Bitcoin Gold is actually least like gold of all of these, since it will have the most accessible and thus fastest mining algorithm, and presumably could end up with the lowest transaction fees.

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Image credit: bitcoingold.org

The respective values of the 3 or 4 types of bitcoin reflect this view. Bitcoin is the “slowest” and has the lowest velocity (slowest turnover) and highest value. Bitcoin Gold appears to be the most rapid and with lowest transaction fees, and thus has the lowest value.

Bitcoin Cash and a possible future Bitcoin 2x are between the two extremes. Since Bitcoin Cash has much larger blocks it has substantial miner support. Bitcoin 2x is favored by the user community that wants to facilitate more efficient transactions.

If you have a gold coin and some fiat currency, which do you spend first? You bought the gold coin in expectation that it would preserve its value and increase in terms of the number of currency units per coin.

So HODL (hold on for dear life) BTC, and spend or convert BTG and BCH seems the way to go for now. As always one should monitor how the different cryptocurrencies are developing in comparison to each other, in this very dynamic and volatile marketplace.

Why Buffett Doesn’t “Get” Bitcoin

Warren Buffett is the most famous name in stock investing, the second richest person in the world, and a leading expert in valuing companies and securities. He also is a big investor in banks, including Wells Fargo, Goldman Sachs, and Bank of America. So he has a lot of vested interest in the current monetary and financial system.

He recently said that bitcoin is in a bubble, which may well be true. He also said “You can’t value bitcoin because it’s not a value-producing asset”. This is not correct. Bitcoin can be valued, but not like a security or a company, which is what Buffet does so well.

As we have written elsewhere, bitcoin is a currency, money, a cryptocurrency. Some will say it is a digital asset, like a digital gold. We say it is Money 3.0 (fiat is Money 2.0, gold and silver coins were Money 1.0).

Do these have value?

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Yes, money is designed as a store of value, a medium of exchange, a unit of account. Cryptocurrencies have the same design goals.

Bitcoin is a unit of account in a secure, distributed ledger. It has been a much better store of value than fiat currency in recent years.

In fact in 2014, Buffet said “It’s a mirage”. And yet, the value of a single bitcoin has increased 16 times since late October, 2014 to about $5800 today.

Money is valued by what you can exchange it for, its utility. It is valued against other currencies. Bitcoin is valued the same way, and by the vitality of the bitcoin economy.

Within the cryptocurrency world, bitcoin is the reference benchmark, just as the US dollar is globally. Bitcoin gets valued every single day, every minute of the day, against all major fiat currencies and against hundreds of cryptocurrencies. Like those currencies it has an economy and a turnover (or velocity) of the currency.

One thing we don’t normally think of with respect to cryptocurrencies is interest, or dividends. It is possible to lend out bitcoin for interest, as one can do with dollars, euros, or even gold. But bitcoin has effectively thrown off two special dividends this year, in the form of forks of the bitcoin blockchain. These are known as Bitcoin Cash (forked in August) and Bitcoin Gold (forked in October). Collectively, those two are worth close to $500, representing over 8% dividend rate to date during 2017, based on the current bitcoin price.

And for someone who bought at the beginning of the year, when bitcoin was under $1000, the dividend is around 50%. Not shabby, and a very reasonable reward for accepting the volatility.

Bitcoin is a technology for internet money, network money that is independent of any government, and can be hard to fathom for the newcomer. Buffett has always said he does not understand technology. He has not examined the technology and potential of bitcoin and other cryptocurrencies sufficiently to have an informed opinion.

Bitcoin’s future value? It all depends on how the economy around bitcoin develops, but it will be quite an adventure. And bitcoin to bagels it will increase in value over the next several years.

Evolutionary Forks and Dividends

What is a fork?

It is early days in evolutionary terms for cryptocurrency. Bitcoin has not been around even a decade. Ethereum has only been here for a few years. The respective economies of these and other cryptocurrencies have been growing at triple digit percentage rates.

A given blockchain can be thought of as a continuing line of a particular species. A new blockchain, e.g. Ethereum with new attributes is a new species of cryptocurrency. A fork in a blockchain, such as the recent Bitcoin Cash, is also a new species, but perhaps one can say that it belongs to the same genus.

Mayr’s concept of species is that of representatives of the same breeding population. They are in some sense on the same continual chain.

A fork is an evolutionary branch in response to environmental pressure. The pressure arises due to the developing needs of the ecosystem for cryptocurrencies overall and for individual cryptocurrencies.

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Pressure

The pressure that gives rise to evolution in the cryptocurrency ecosystem arises from the need to scale cryptocurrency to higher transaction rates and to more diverse use cases. For example, there is the very general use case of smart contracts, that led to the creation of Ethereum.

How new currencies are created or are forked results from the technological requirements and how those are interpreted and implemented by particular members of the development community. This is a political arena since miners, developers, exchanges, merchants, and other groups have different interests.

We have just had the Bitcoin Cash fork and are now facing possible forks for Bitcoin Gold and Segwit2x (Segwit was adopted without a fork in August).

It is difficult to determine which fork or species will be the most successful in the long run; but the original or main branch can have an advantage. Overall forks can be seen as strengthening the ecosystem as a whole since total value seems to rise after forks. After the Bitcoin Cash (BCH) fork the original Bitcoin (BTC) increased in value, and one could also collect the BCH on a one per one BTC held basis as a dividend. 

More generally, this has been borne out by the continually increasing market capitalization of the set of cryptocurrencies, currently having reached around $160 billion (roughly a Buffet plus a Gates).

For investors in cryptocurrency one can view forks as special dividends. Those who held Bitcoin through the Bitcoin Cash fork received a dividend of several hundred dollars per BTC. Sometimes numbered prints or copies are valuable as well.

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Above is not our view, but that of @BitcoinWrld

What you do (hold, sell all, sell half) with your dividends is up to you and your views on individual forks; we make no recommendations here. But the dividends are there to receive, along with possible capital appreciation as the cryptocurrency economy continues to grow rapidly.

Ethereum: Smarter than a Fifth Grader?

Ethereum is described in Wikipedia as an “an open-source, public, blockchain-based distributed computing platform featuring smart contract functionality“.

How does it differ from Bitcoin? Well Bitcoin is open-source, public, distributed, and block-chain based. The difference is principally found in the terms “computing platform” and “smart contract functionality”. And there are other differences as well.

Ethereum is only two years old. It was the brainchild of wunderkind Vitalik Buterin, a Bitcoin developer, and while initial funds for the project were raised in mid-2014, the network went live in mid-2015. A foundation under Swiss law manages Ethereum.

The motivation was to have better scaling than Bitcoin, both horizontally, in terms of transaction speed, and vertically, in terms of use cases supported (implemented via smart contracts). It also has a better specified development plan, with 0, 1, and 2 versions of the software having been implemented, and version 3 (Metropolis) currently in testing.

It has been a great success, and Ether, the coin of Ethereum, now has the number two market cap among all cryptocurrencies at around $29 billion. Its value has risen dramatically during 2017, rising from $8 to $300.

 

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Ethereum logo CC-BY-3.0

Contracts

There are two types of accounts in Etherland. One can have a regular cryptocurrency account, or an account can represent a smart contract. There is a virtual machine (EVM) that is said to be “Turing complete” and that supports multiple scripting languages in which contract rules can be specified.

The idea of smart contracts has been around for over two decades; blockchain with broad programmability on the chain provides a very useful technology for their implementation.

Smart contracts allow value to be exchanged between agents without existing trusted relationships. Sort of like escrow, but much more streamlined. The basic idea is to cut out the expense and complications associated with middlemen.

Use cases being explored for such smart contracts include:

  • Real estate leases or purchases
  • Securities settlement
  • Supply chain management
  • Governance, including voting
  • Intellectual property protection

The number of currently existing use cases is few at present, however, and they tend to be simple and related to the Ether coin itself. Some have argued that smart contracts are much harder to implement in practice than many imagine. A recent interesting one is Prism Exchange, which allows you to hold a variety of altcoins across multiple exchanges from a single application.

Mining

Ether is much quicker to mine than Bitcoin, and can process 25 transactions per second. Transaction fees are also much lower than Bitcoin, around 8 times lower currently. Blocks are generated every 12 seconds, as opposed to the 10 minute target with Bitcoin.

Like Bitcoin, Ether is mined via Proof of Work, but the intent is to move to Proof of Stake (some measure of ownership) over time. A different cryptographic hash problem, Ethash, is solved, and with this hash Ether does not benefit greatly from mining with ASICs and is therefore accessible to CPU and especially to GPU mining. “Ethash PoW is memory hard, making it basically ASIC resistant.”

Basically the algorithm is designed to consume memory bandwidth and to be GPU-friendly. So it is good news for Nvidia and AMD and Intel.

Enterprise Ethereum Alliance

The Enterprise Ethereum Alliance has grown to over 150 organizations as members and includes some of the most important technology companies and largest banks. Its purpose is to address enterprise requirements for smart contracts and blockchains. The founding members are shown in the graphic below. Mastercard and Cisco are two major companies who have also joined recently.

Banks, in particular, have interest in permissioned blockchains, so that they can retain control of their customer relationships. There is a natural tension between open distributed trust of the blockchain and centralized trust that banks provide today.

It is an exciting time. How blockchain will be deployed by the financial industry, and how it will disrupt the industry are open questions. Smart contracts allow blockchain to be even more disruptive because they provide the tools for disintermediation. Jamie Dimon may not want his traders to trade Bitcoin, but he sure wants a seat at the Ethereum “smart contracts” table.

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A Golden Fork

What do Bitcoin and Gold have in common? They are both assets. Both have limited supply that grows only slowly. Both can be seen as a form of money since they are stores of value and can be used as a medium of exchange. Both are liquid and divisible, although Bitcoin is much more easily divided. And both are unlike fiat money, in that they are debt-free. Both are ‘mined’, gold is physically mined, and Bitcoin is ‘mined’ via cryptographic hash algorithms (proof of work).

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But what is Bitcoin Gold? It is neither gold, nor the current Bitcoin. Rather it is a proposed fork of Bitcoin, designed to make mining easier, and accessible to more people. And it could happen very soon, just three weeks from now.

The chief backer is CEO of a Hong Kong-based company, Jack Liao, and he indicates the motivation behind Bitcoin Gold is for it to be complementary to Bitcoin and to grow the community of miners, to allow the Bitcoin ecosystem to move away from its present centralization in a few mining pools.

It is not clear how well the proposal has been developed, and how many miners, current or new, will back it. But the intent is to allow mining by GPUs, rather than the specialized ASICs highly optimized for the SHA-256 hashing used by both Bitcoin and Bitcoin Cash.

Instead it will use the Equihash algorithm, that is GPU-friendly rather than ASIC-friendly, since it demands substantial utilization of memory and memory bandwidth. This could allow for a much broader community of miners since GPUs from Nvidia and AMD are so widely deployed.

The primary cryptocurrency usage of GPUs today is for mining Ethereum. But since Ethereum is scheduled to move away from proof of work and to adopt proof of stake next year, Bitcoin Gold could be the most important new target for GPU-based mining.

The developers of Bitcoin Gold intend to remain aligned with Core and Segwit roadmaps.

Everyone holding Bitcoin, with a suitable private wallet at the beginning of August, received a ‘free’ dividend of Bitcoin Cash. The major exchanges ended up supporting access to users’ Bitcoin Cash, some sooner, others later. Now everyone holding Bitcoin with a suitable private wallet on October 25th stands to receive a free dividend of Bitcoin Gold (BTG) as well.

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Cryptocurrency a Bridge to the Future

Bitcoin, and cryptocurrencies more generally, can be a bridge to a better monetary future for the globe. In almost every nation today, fiat currency managed by a central bank is the norm. This is money that is inherently inflationary by design. Since central banks are controlled by national governments, and governments routinely run substantial deficits, the banks promote inflation in order to benefit their governments.

In our current low growth environment, the Federal Reserve has grown the money supply (M2 money stock) 4.9% during the past year when inflation is running at 2% or less. They are operating on an equation of around 2% inflation plus 2% to 3% GDP real growth for about 5% monetary growth.

Bitcoin has a very controlled and low absolute inflation, much less than 1%. There are currently 16.6 million bitcoins available, and there will never be more than 21 million, and that does not occur until over 100 years from now. In practice, Bitcoin is currently deflationary since the economy around Bitcoin is currently increasing very rapidly, at triple digit rates. It has been gaining value against fiat currencies rapidly, albeit with very high volatility.

Bitcoin meets the attributes of currency, see Money 3.0 article. It is not debt-based, as are all currently circulating fiat moneys, paper and digital money backed by nothing but debt (Money 2.0).


Akashi Kaikyo bridge is the world’s longest suspension bridge. GFDL license.

The entire financial system was at risk of collapse in 2008 due to accumulated debts and risky and fraudulent derivatives built on top of those debts. Trillions of dollars of wealth were destroyed, with Americans losing 40% of their net worth during a 3 year period.

In addition, the system is well-designed for the money center banking elites to pull more and more wealth into their own hands, through financial techniques that create no real wealth. Those who get to create the money lend it out and accrue the highest benefits.

A more stable system is required, and Bitcoin could play an important role, as an asset-based, not debt-based, currency. Dollars and Euros come into creation as new loans are issued by commercial banks. Central banks manage the reserve and equity requirements of those banks, but a large amount of leverage is inherent in the fractional reserve system.

Bitcoin comes into creation as a result of the mining process, that occurs as new transactions are forged into the blockchain. Bitcoin creation is a direct result of the operation of the economy around the cryptocurrency. Bitcoins are ‘minted’, not ‘printed’. Like fiat currency they have value due to scarcity and utility, and dependent on the growth of their economy.

Bitcoin and other cryptocurrencies can be the basis for more honest money, as well as for decreased transaction costs, and higher efficiency. Banking will change forever. Like fiat currency, bitcoin can be borrowed and it can be lent.

Those who are involved in Bitcoin today, a “peer-to-peer cash” are pioneering a future that could be a more stable, more honest monetary system. Today Bitcoin is young, has plenty of growing pains, and volatility, but it is now 8 years old and maturing rapidly.