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Sunday, Jan 13, 2019 - 23:09 SGT
Posted By: Gilbert

Crypto In 2019

Me: ...okay, no point waiting for Mr. Ham to return, I suppose. Let's carry on, Mr. Robo.

The BTC Community Of Practice

Before continuing, we should perhaps establish some background for what is to follow. Amidst all the doom and gloom, the degree to which Bitcoin has captured the imagination of millions about the globe, is perhaps not often appreciated.

There's the grassroots-level engagement popping up in the most unexpected of places, and the acknowledgment - oft grudging - from hallowed international organizations. National leaders are reading up; Savvy countries, Singapore included, are not-so-quietly positioning themselves. South Korea has admitted that it's impossible to ban crypto exchanges, and their chaebol are joining in. Goldman Sachs traders are quitting for blockchain startups, while Russian nuclear scientists are mining alongside local Ah Beng BBFAs. The New York Stock Exchange's owners are integrating Bitcoin, even as it gains the thumbs-up from Muslim clerics. And, let's be frank, crypto's got to be tempting to anyone who has beef with the US Dollar, or whose own fiat currencies are crashing - and there's plenty of both to go around.

There is a sociological concept called the community of practice - defined by the people that share a collective interest. This, then, might be a partial solution to the "what underpins Bitcoin's value?" puzzle. Previous famous fads, other than involving items unsuited to be stores of values - tulips rot, beanie babies can be endlessly produced, etc - have arguably never captured such a diversified and robust community. This community has exploded with each bubble, and shrunk as the bubble deflates, but the main point is: by all indications, it has grown with each bubble cycle, and there are now millions who "get it"; and yet, this remains a tiny fraction of the available global population.

E-mail? What's wrong with pen and paper?
(Source: r/bitcoin)

The resistance to digital cryptocommodities, from my observations, have been strongest amongst the old set. Recall, granddaddy Bitcoin has just celebrated its tenth birthday - there are Silicon Valley startups that have been in stealth mode for longer than that. Today's teenagers have shown themselves to have fewer hang-ups about adopting alternative forms of money, and why not, given how the wiseguy seniors have f**ked their economic future up? If one needs more convincing, the Bitcoin subreddit is nearly twice the size of r/investing, and the CFA exams are including crypto and blockchain topics. Does this look like something that will fade quietly into the night?


"You probably still owe [your car and student loans] because our society is based on a clearly defined and widely accepted yet often unarticulated hierarchy. Violence done by those higher on the hierarchy to those lower is nearly always invisible, that is, unnoticed. When it is noticed, it is fully rationalized. Violence done by those lower on the hierarchy to those higher is unthinkable, and when it does occur is regarded with shock, horror, and the fetishization of the victims."

- MakeTotalDestr0i, r/bitcoin

The emergence of Bitcoin and other cryptocommodities has slowly garnered some respect in academia, with polytechnics and universities, and journals of the stature of Science publishing policy op-eds. However, while originally mainly a technical breakthrough in computer science (Byzantine consensus), Bitcoin's largest significance is arguably in economics: is it possible for a major money to be viably supported by a community of practice, instead of an issuing nation-state?

The more traditionally-trained, doubtless, would insist the negative - to them, Bitcoin has no possible plausible premise, and its very existence refutes the Efficient Markets Hypothesis itself. To this, we might attribute a forgivable deficit in imagination. Their almost-religious vehemence towards crypto's empirically-observed growth however cannot help but remind me of Galileo's whisper after being forced to recant by the Church: "And yet it moves!". Personally, one might next remember Planck's quote about science advancing one funeral at a time.

I for one am willing to state that cryptoeconomics will become a recognized part of economics, as new generations of econs professors struggle to deny crypto's survival - and perhaps as pertinently, get invested in it. As explained in last year's AGM, Bitcoin was never purely a replacement currency, or US Dollar #2. It is partly that, maybe, but more a commodity money.

Consider now the issues with existing fiat currencies, seldom explored with similar passion by mainstream economists. The arguments against commodity-backed (sound) money are pretty well-known: in theory, the money supply should optimally mirror the growth of the real economy. As such, fiat currencies were established to enable this, by delinking from a commodity monetary base. An obvious next question would be whether states can be trusted to manage the supply side of money properly, given their proven incompetence with the supply side of goods - see Soviet and other command economies.

One might, I hope, reasonably assume that states are, in fact, not perfectly knowledgable or disciplined, and that their issuance of fiat currency is, to some certain extent, suboptimal. This isn't an insurmountable failing, of course - people will simply organically hedge in other monies. One might plausibly explain the persistent property, stock and other asset bubbles as a manifestation of this suboptimal management of the currency supply. Now, one might not naturally associate an apartment in, say, a Chinese ghost city as the modern analogue to a Rai stone, but really, they are in practice a similar sort of "money" - citizens have limited trust in governments not to overprint and devalue the currency, and are therefore hedging with investments in a commodity that is less easily created - housing.

Both are a hard shell, with a hole in the middle...
(Source: nairaland.com)

Now, as discussed back in 2016, this "property as money" concept has generally received little pushback from states all around the world, thus the bubbles everywhere. Clearly, at least some policymakers must have realized that they were likely over-issuing currency through quantitative easing - and to the already-wealthy - as the path of least resistance. Then, if this is unavoidable, real estate would be one of the best asset classes to direct the excess currency to; unlike gold and other commodities, at least the rich can't just abscond with them. Gold in particular remains heavily suppressed - to the extent of execution for hoarding - since millenia of experience in currency failures has left little doubt as to where citizens would prefer to store value, in periods of state weakness.

Cryptocommodities, however, have upended this uneasy equilibrium. Property is, ultimately, hardly a perfect "money", after all. Land, especially in desirable areas, may be limited, but as Alex Au memorably mentioned, housing itself is largely a matter of fiat - developers can usually just build a taller high-rise structure, and/or shrink the units. Gold, the self-named standard for eons, is heavy, and adulterated coins are not easily assayed. Many other commodities are perishable, or have a supply that is highly manipulatable. Enter Bitcoin: scarce, durable, portable, fungible, infinitely divisible for all intents and purposes, non-counterfeitable with simple precautions, reliable supply schedule. That it happens to excel in all these classical dimensions of "money" is no coincidence - it was designed this way.

And so, for all the spluttering insistence by certain respected economists that Bitcoin should have zero value because it has no premise, traders and practitioners holding actual power - and facing actual consequences - have been rather less confident of avoiding a crypto-inspired monetary revolution. As explained last year, national policymakers continue to confront the dilemma of legitimizing crypto but losing some state control over money, or banning it and losing out on its economic benefits. As expected, the larger and more authoritarian the state - China probably the biggest example - the less welcoming they have been. On the other end of the spectrum, nimbler navigators like South Korea, Switzerland and Singapore aren't waiting to get in.

With official blockchain versions of national currencies thus gaining relatively little uptake, given that they don't actually fill a new niche in the money landscape, there have only been so many countermeasures to slow the migration, given that stopping crypto itself would be about as difficult as blocking the entire Internet. The entry and exit points where fiat is exchanged for crypto has been a natural bottleneck, oft enforced by regulating exchanges. Other than this, financialization and rehypothecation - where exchanges or other institutions claim to have additional coins on their internal books - is probably the gravest danger. Fortunately, longtime crypto hodlers should recognize that if one doesn't have the keys to their crypto on the de-facto settlement network itself, they don't actually own it.

The real fun, I gather, will begin when crypto becomes officially legitimized - say, when some big central bank declares that they're storing Bitcoin as a reserve asset; I'd pay good money to watch Krugman's - or other similarly-minded big-shot economists' - reaction to that. It would, certainly, be interesting to observe how opinions on crypto might change among normal citizens, if the only real difference were backing by some authority, instead of current barely-disguised disdain. It wasn't that long ago that exposed ankles were immoral, after all...

The Power/Proof of Work Argument

Of all the arguments against Bitcoin's ascendancy that I have come across - many actually anticipated by Satoshi and friends in the original conception - the most convincing was probably that on its energy cost of production. Just to reiterate, the Bitcoin mining proof-of-work algorithm automatically adjusts itself to produce one block - with associated block reward, currently 12.5 Bitcoin - every ten minutes on average. The energy expended at equilibrium is then equal to the expected revenue; assuming a price of US$4000 per coin, about some US$50000 worth of energy should be spent every ten minutes, regardless of miner efficiency. It gets slightly more complicated since the cost of energy differs according to location, but this is the general idea.

We have explained this expenditure of energy as the "price of honesty" for a commodity token previously, but it is easily understood why detractors might consider this mechanism as "insanely wasteful". According to a recent paper in Nature Climate Change, "Bitcoin usage, should it follow the rate of adoption of other broadly adopted technologies, could alone produce enough CO2 emissions to push warming above 2 degrees Celsius within less than three decades". The environmental angle, from personal experience, has become the go-to objection against crypto.

One reaction is, of course, to move towards proof-of-stake and other algorithms that do not rely on work produced, as Ethereum is planning. The thing, though, is that these alternatives are generally not trivial to secure, as might be explained in more depth later. Even considering the current situation of Bitcoin, however, there are several additional mitigations even considering likely faulty math in initial estimates. A first is that, while seemingly large in isolation, even more energy is being spent on less-worthy causes. Another is that the cost of mining, by virtue of reward halvings, naturally halves every four years. In other words, Bitcoin can double in price every four years with no change in energy expenditure. Not only that, by the nature of Bitcoin mining, it tends to migrate to places where energy is cheapest, and would not be stored elsewise anyway. Such sources are often naturally renewable - e.g. Iceland - and crypto can in this sense be seen as a buyer of last resort for electricity, unlike with other commodity monies.

[To be continued again...]

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Next: Crypto In 2019, Continued

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