Bitcoin: the perfect bubble

by John Quiggin on April 17, 2013

Over at the National Interest, I have a piece arguing that Bitcoin is a more perfect example of a bubble, and therefore a more perfect refutation of the Efficient Markets Hypothesis, than anything seen previously. Key quote

It beats the classic historical example, produced during the 18th century South Sea Bubble of “a company for carrying out an undertaking of great advantage, but nobody to know what it is.” After all, the promoter of this enterprise might, in principle, have had a genuine secret plan. Bitcoin also outmatches Ponzi schemes, which rely on the claim that the issuer is undertaking some kind of financial arbitrage (the original Ponzi scheme was supposed to involve postal orders). The closest parallel is the fictitious dotcom company imagined in Garry Trudeau’s Doonesbury, whose only product was its own stock.

{ 101 comments }

1

Coulter 04.17.13 at 8:24 pm

Wow that is sloppy:

“If Bitcoins cease to be accepted in payment for goods and services, their value will be precisely zero.
According to the efficient-markets hypothesis (EMH), which still dominates the analysis of financial markets, this should be impossible.”

And how is that different than US dollars? You claim U.S. dollars can be used to meet obligations to the U.S. government. What is that worth? What is the worth of Greek government bonds or Cyprus bank deposits? Sounds like you have an opportunity to make free money … have at it.

2

The Raven 04.17.13 at 8:36 pm

Bitcoin: troll’s gold.

3

Barry Freed 04.17.13 at 8:46 pm

Dunning-Krugerrands

(as originally posted on Fark and all over Twitter)

4

gwern 04.17.13 at 8:48 pm

Quiggin’s piece would be more compelling if he had shown any attempt to understand what makes Bitcoin novel or what benefits it would offer, instead of dismissing that possibility in a sentence and going on to treat it purely as a speculative play.

A post on MR today seems apropos for Quiggin to ponder: http://marginalrevolution.com/marginalrevolution/2013/04/absurd-pitches-pull-out-the-hayek-and-polanyi-lesson.html

5

John Quiggin 04.17.13 at 8:53 pm

” You claim U.S. dollars can be used to meet obligations to the U.S. government. What is that worth?”

Maybe you should ask this guy

6

Kenny Easwaran 04.17.13 at 8:53 pm

Coulter – some people (namely, those engaging in any meaningful economic activity in the United States) are legally required to spend US dollars for some of their transactions (namely, those with the IRS and their state and city tax boards). Therefore, anyone who has any economic dealing with those people (which is a lot of people) has a use for US dollars.

As far as I know, no one is legally obligated to engage in any bitcoin transactions.

7

Brett 04.17.13 at 8:57 pm

I’m not sure how this is supposed to be a refutation of EMH, since the weak EMH hypothesis is that asset prices reflect (and adjust to) publicly available information. If you believe Bitcoins are an asset (and I’m not convinced that’s the case), then that’s what’s happening – the value of them is continuously adjusting in response to changes in the supply and demand for them. It’s just that the overall Bitcoin market is smaller, so particularly large transactions have a disproportionately large impact on the overall market, causing price swings.

8

Matt 04.17.13 at 9:06 pm

The hard core of bitcoin true believers is mostly rabid anarcho-capitalists: crypto-currency will starve the state to death, let’s all go seasteading, the market will decide how machine guns and child prostitutes are distributed, etc. So you might consider that bitcoin has value as sacramental money in a particular faith system.

I mined bitcoins back when the proof-of-work was much easier and used them to buy a bunch of goods during the first big price spike in 2011. Bitcoin is a most unreliable store of value but a remarkably convenient medium of exchange. It’s like being able to email cash, with no risk of theft in transit.

Paypal used to be nearly as simple, but some time in the past decade they required a lot more documentation and links to conventional financial institutions in order to receive more than a trivial amount of money. Receiving online payment from credit or debit cards through a traditional processor is even less convenient and more expensive for a merchant until you have pretty considerable sales — then the higher fixed monthly fees and more complicated software integration are offset by the lower fees per-transaction. Woe unto you if you want to shame the powerful and receive donations as the same time! I hope wikileaks made good use of the few coins I tossed their way after I could no longer donate through paypal.

It would be nice to have an electronic decentralized money transfer system that didn’t try to ape gold and gold-mining, turning its users into steampunk prospectors. I don’t know how that would be possible. But until bitcoin actually existed, I didn’t even know how it would be possible to create trusted transaction records without a central authority.

9

robotslave 04.17.13 at 9:20 pm

There is a market for Bitcoin derivatives that should allow just such shortselling.

This is overstating the case rather severely. Exactly one company presently exists that will let you trade bitcoin futures, and it’s very new– others that came before have folded.

The essential problem is that you can’t borrow bitcoin– or rather, you can’t lend it, and then expect your local monopoly on the legitimate use of force to assist you in collecting your debt, in bitcoin, at the contractually agreed-to end of term.

10

Chas Simmons 04.17.13 at 10:01 pm

John Quiggin states it correctly above, but briefly.

What gives modern fiat money value is taxation. People in Zimbabwe, who don’t trust their own government’s paper, now use US currency as their medium of exchange, despite their not having enough US coins to make change. Why is US money accepted there? Because millions of highly productive people living in the US are compelled, by the police power of the state, to get their hands on enough pictures of dead presidents to pay their taxes. This forces Americans to exchange the products of their labor for those pictures, and such products are valuable, so other people will exchange their labor for those pictures, and so forth, to the ends of the earth, literally.

11

Eric 04.17.13 at 10:07 pm

But John, last week I had x Bitcoin. Today I have x Bitcoin. So value is unchanged. Constant at x Bitcoin. Dollar is volatile though. #ThinkBTC

12

Gareth Rees 04.17.13 at 10:08 pm

The value of bitcoins is that they offer the ability to engage in anonymous (or at least hard to trace) transactions on the Internet. This is difficult to do with other financial instruments.

13

Benquo 04.17.13 at 10:23 pm

Gareth Rees gets it partly right.

My (admittedly simplistic) model for the exchange value of Bitcoins is:

A) Contraband buyers exchange something already agreed to have value (e.g. $ USD) for bitcoins.
B) Contraband sellers exchange contraband for bitcoins.
C) Contraband sellers exchange bitcoins for something already agreed to have value (e.g. $USD)

Steps A and B jointly “back” the value of bitcoins. A provides convertibility into other currencies, but B is the beginning of a true Bitcoin-based market. If more hoods and services become available in Bitcoins, eventually folks will stop thinking of them as merely a special-case means of exchange and start thinking of them as a normal sort of currency.

Perhaps Bitcoin’s new popularity as a store of value will overwhelm the ability of these markets to absorb new bitcoins – but then again, perhaps it will lead to Bitcoin’s use as a medium of exchange.

14

Gareth Rees 04.17.13 at 10:27 pm

“hoods and services” is quite right.

15

Alex K. 04.17.13 at 10:55 pm

Chas Simmons ,

Your argument is rather self-refuting: Zimbabwe’s government also accepts its own currency as payment for taxation, yet people mostly trade in US dollars. Millions of productive people in Zimbabwe are also forced to pay taxes in local currency, yet said local currency is virtually worthless.

Money has value because of the _expectation_ that one will be able to use it in the future. If the expectations about the government change, the value of the money also changes. Having a stable government require that its taxes be paid in a currency does wonders for that expectation, but that is not the only possible form of money.

The historical origins of money is also completely irrelevant except for historians. There are plenty of historical examples of private currencies.

What makes BitCoin special is that it is based on neither debt nor a commodity — it’s purely based on the expectation that there will always be a demand for anonymous transactions and that those anonymous transactions will use BitCoin for payment.

On that basis I don’t see why BitCoins will necessarily tend to zero value, although I see plenty of reasons for why it should be volatile. Only a regulated (hence non-anonymous) BitCoin will necessarily have a value of zero: the only reason to trade in BitCoin as opposed to other currencies is Bitcoin’s anonymity. Without that, there is no reasonable expectation that it will hold value in the future.

16

John Quiggin 04.17.13 at 11:36 pm

Anonymous<>untraceable. It would be wise to assume that any Bitcoin transaction can be traced by the US government. A cautious user would assume (as with phone calls, email etc) that all such transactions are already being recorded.

17

dsquared 04.17.13 at 11:41 pm

Bitcoin does not (per the Bitcoin wiki) claim to be an anonymous system, although a surprising number of people make that claim on its behalf.

18

John Quiggin 04.17.13 at 11:45 pm

As regards private currencies, the whole point is that someone promises to exchange them for an item of value. The value of the currency is determined by the value of the promise.

19

ben 04.18.13 at 12:01 am

bitcoins don’t provide anonymity at the moment. they are pseudoanonymous and unless you have cooperation with a trusted third party to hide your identity (bitcoin washing service) then it can be sometimes quite easy to track your transactions to a real person.

for example lets say you want to buy some drugs from silk road. you make a trade on mtgox to convert USD to bitcoin. mtgox sends bitcoin to your public address. this bitcoin transaction is on the public record. you then transfer bitcoin from your public address to the sellers public address. this bitcoin transaction is on the public record. if the government links the drug sellers identity to their public bitcoin address then they can force mtgox to disclose your identity.

mining provides one option of anonymously converting real currency into bitcoins without leaving a trail to a real identity.

part of the demand presently might be because people incorrectly believe bitcoin is anonymous. but it is worse than cash or electronic transactions because there is a distributed public record of all bitcoin transactions that is effectively immutable. i think part of the demand is for electronic payments that the government does not approve of. this can be for things that are illegal like drugs or legal things like donations to wikileaks. presently, if your business is frowned upon it is hard to receive payments via credit card companies or paypal but at the moment bitcoin doesn’t do any filtering of payments. it also interesting to note that there is nothing stopping miners from colluding to prevent transactions they don’t like but this can be a quite difficult problem because of pseudoanonymity.

20

Keith Edwards 04.18.13 at 12:07 am

you might consider that bitcoin has value as sacramental money in a particular faith system.

Sort of like Chinese Funeral Money. Except that still has more value than bitcoins ever will. They should have just named them Quatloos.

21

Alex K. 04.18.13 at 12:08 am

A quote from a leaked FBI assessment of BitCoin:

“What Users Can Do To Increase Anonymity
• Create and use a new Bitcoin address for each incoming payment.
• Route all Bitcoin traffic through an anonymizer.
• Combine the balance of old Bitcoin addresses into a new address to make new payments.
• Use a specialized money laundering service.
• Use a third-party eWallet service to consolidate addresses. Some third-party services offer the option of creating an eWallet that allows users to consolidate many bitcoin address and store and easily access their bitcoins from any device.
• Individuals can create Bitcoin clients to seamlessly increase anonymity (such as allowing user to choose which Bitcoin addresses to make payments from), making it easier for non-technically savvy users to anonymize their Bitcoin transactions. ”

Naturally there is no full-proof guarantee of anonymity for anything (if nothing else, a police state could monitor every action of every citizen). But those interested in anonymity can make it so costly for an agency to trace them that they will be mostly left alone.

22

Alex K. 04.18.13 at 12:30 am

“As regards private currencies, the whole point is that someone promises to exchange them for an item of value. The value of the currency is determined by the value of the promise.”

I’m afraid I don’t follow. Clearly pure commodity money can exist. Who is the someone that promises to exchange that currency for an item of value? There can be only an expectation that such an exchange can be made.

I guess you could claim that the commodity has value in itself — but even so, in the case of gold there is also only the expectation that the social norms will lead to the shiny yellowish metal being valued. (Possible industrial uses count too, but that is not the main reason for gold’s value.) I don’t see any promises being made in any case — just well grounded or poorly grounded expectations.

23

David 04.18.13 at 12:43 am

The heart and soul of Bitcoin is just another exercise in libertarian wish fulfillment. In this case, the desire to avoid taxes.

24

Barry 04.18.13 at 12:49 am

“Receiving online payment from credit or debit cards through a traditional processor is even less convenient and more expensive for a merchant until you have pretty considerable sales — then the higher fixed monthly fees and more complicated software integration are offset by the lower fees per-transaction. “

True, except that Bitcoins fluctuate on an hourly basis, so you will either pay for the lack of fees with considerable uncertainty, or pay somebody to do so (and every additional partner reduces anonymity).

“Naturally there is no full-proof guarantee of anonymity for anything (if nothing else, a police state could monitor every action of every citizen). But those interested in anonymity can make it so costly for an agency to trace them that they will be mostly left alone.”

I’d just send cash through the mail.

25

Barry 04.18.13 at 12:51 am

What amazes me about this and other such schemes is that I see so many commenters on other sites worried sick about inflation, crying fire during a flood, so to speak.

If there was just some way I could harness that stupidity and profit from it, I’d be rich.

26

stubydoo 04.18.13 at 1:46 am

Eventually folks will realize that anonymity is provided by old fashioned paper US dollars much better than by bitcoin, then the bubble will really burst.

27

John Quiggin 04.18.13 at 2:05 am

“But those interested in anonymity can make it so costly for an agency to trace them that they will be mostly left alone.”

As proved by the experience of Napster and BitTorrent users? Or, for that matter, those with money hidden in Swiss bank accounts?

To spell it out a bit more, let’s translate “BitCoin is valuable because it provides anonymity” to “BitCoin allows you to undertake transactions the authorities want to stop”

There are three possible outcomes of this:
1. The scale remains small enough that the authorities let it slide
2. The authorities develop methods to track individual transactions
3. The authorities shut down the network

Getting back to the point of the OP though, even if methods like those of Bitcoin can be used to facilitate anonymous transactions, Bitcoin doesn’t have a monopoly on those methods, so there’s no particular value to having a Bitcoin.

28

Alex K. 04.18.13 at 2:50 am

John,

I think your (1) and a version of (3) are the most plausible scenarios . I don’t think tracking individual transactions is a viable method for cracking down on BitCoins.

The most effective way of doing it would be by targeting hotspots of BitCoin activity. For instance, most transactions of BitCoins to currency are made on a single site. That would still leave the possibility of the BitCoin system functioning on a small scale (e.g. free software for operating the exchange site, and the exchange site moving from location to location) but it would clearly be quite inconvenient.

(I don’t think some of your other arguments work: illegal downloading is alive and well on BitTorrent, Napster was a centralized system hence less relevant here, and there are network effects that act as barriers to entry for other digital currencies )

The most interesting aspect of BitCoins is how it emphasizes the dependence of money on expectations. As long as those expectations have something to be based on, there will be value to BitCoins — hence without government crackdown there is no reason to expect the digital currency to go to zero.

29

John S 04.18.13 at 3:14 am

“It would be nice to have an electronic decentralized money transfer system that didn’t try to ape gold and gold-mining, turning its users into steampunk prospectors. I don’t know how that would be possible.”

@Matt #8: Consider Ripple. Not yet decentralized, but it will be.

http://jpkoning.blogspot.kr/2013/02/ripple-or-bills-of-exchange-20.html

30

Matt 04.18.13 at 3:30 am

As proved by the experience of Napster and BitTorrent users? Or, for that matter, those with money hidden in Swiss bank accounts?

Getting back to the point of the OP though, even if methods like those of Bitcoin can be used to facilitate anonymous transactions, Bitcoin doesn’t have a monopoly on those methods, so there’s no particular value to having a Bitcoin.

I’m not sure if the Napster and BitTorrent examples are supposed to demonstrate that users will bear high risks or the opposite. The odds of paying damages for illegal use of file sharing programs seem significantly lower than e.g. those of getting a speeding ticket for driving too fast.

There’s no monopoly on the methods used in Bitcoin but network effects may make it hard to switch. Consider email, for example; the basic protocols used could be improved enormously in terms of privacy, authentication, and spam prevention. It’s just too hard to coordinate a change. Instead there’s a multi-billion dollar industry offering workarounds and addons for email to avoid changing the old protocols.

I think there’s too much emphasis on the anonymity (or lack thereof) of Bitcoin. Yes, it came from a mysterious pseudonymous person or collective, and was embraced early on by cypherpunk-libertarian types. But dodging taxes and buying MDMA are just the flashy use cases. The user experience is (IMO) a big leg up on Western Union or Paypal for international electronic money transfer, even if you presume that government agencies can retrace any part of it they like. To receive bitcoins from someone you just need some free software and an internet connection — no bank account required, no credit card or debit card, no mailing address, no social security number, no phone number, no postage, no particular geographic location, and the funds arrive in a few minutes from the initial sending action. Sending bitcoins is likewise simple. I would compare the convenience to the difference between international long distance phone calls and Skype. Now if only bitcoins didn’t have monstrous price volatility — but that’s wishing for a bit too much.

31

robotslave 04.18.13 at 3:37 am

no bank account required, no credit card or debit card, no mailing address, no social security number, no phone number, no postage, no particular geographic location…

…and no recourse at all, should the receiver of bitcoin simply vanish, rather than provide the goods or services promised to the sender.

32

Main Street Muse 04.18.13 at 3:47 am

So I am not an economist. Therefore I struggle with this idea of the bitcoin. And with the idea that anyone thinks markets are efficient.

How can there even be a market in a virtual currency “produced by running difficult (but useless) algorithmic calculations?” How is the value of this virtual bitcoin determined? Seems all smoke and mirrors to me; yes, the antithesis of efficiency and rationality. Then again, the synthetic CDO has me stumped as well, but that instrument makes perfect sense to those on Wall Street.

33

Doctor Memory 04.18.13 at 3:52 am

If there was just some way I could harness that stupidity and profit from it, I’d be rich.

Step One: Advertise custom ASIC-based bitcoin mining machines with a notable but at least sniff-test plausible speed increase over the current generation.

Step Two: Take preorders. In BTC, of course.

Step Three: Vanish, chuckling all the way.

There but for a residual sense of morality and a desire to stay out of jail go I. But perhaps you’re feeling braver.

34

Matt 04.18.13 at 5:02 am

…and no recourse at all, should the receiver of bitcoin simply vanish, rather than provide the goods or services promised to the sender.

Indeed. I acquired bitcoins only through mining (when it was much easier than it is now) and donations, for operating a web community that I had already operated for many years. I expected some transactions to end in fraud when I spent this found pretend-money. None did, surprisingly, out of about two dozen I conducted with total strangers during the first price bubble. I wonder if there are now more sharks in the water. Speaking of email again, it was a long time after its invention that spam became common, and even longer before spam accounted for the majority of email traffic, though abusive behavior was possible from the beginning.

35

Billikin 04.18.13 at 5:48 am

@ Dr. Memory

Are you Dr. Memory of Participate fame?

36

Random Lurker 04.18.13 at 7:17 am

I don’t understand why many say that, if you pay someone with bitcoin and he doesn’t deliver the goods, you have no recourse.
That would be a breach of contract and thus illegal,, regardless of the mean of payment of choice.

37

Harald K 04.18.13 at 8:15 am

I’m distressed at how many smart, educated people buy the claim about bitcoin anonymity.

Bitcoin is fundamentally based on pseudonymous identities, not anonymity. And it’s fully, completely, 100% traceable. Every transaction is logged, this is crucial to how the whole thing works. Every “coin” effectively comes with its entire transaction history (and you can look up the histories of all other coins as well).

Once a government adversary starts attaching names to addresses (accounts), I wouldn’t like to be in the position of having used bitcoin to buy something illegal or hide income. Once they know one identity, it’s going to be easier to find others, and they’ll know every transaction you’ve made. In fact, I’m wondering if the government hasn’t done so already is that they’re in “give them enough rope” mode, hoping to bust big criminal activity.

38

Salem 04.18.13 at 9:01 am

Fiat money doesn’t (just) derive from the taxation power. There are quite a few examples of fiat currencies continuing to be used as money long after the collapse of the government that issued and taxed the money. Somalia is one example.

39

rageahol 04.18.13 at 9:04 am

this is somewhere between a local currency (based on money muling traffic into/out-of eastern europe, where most of the larger cybercrime networks reside that control the major trojans) and a pump-and-dump scam.

40

Edmund in Tokyo 04.18.13 at 9:31 am

Here’s the problem with the piece:

“[A functioning transaction system] would be fine if Bitcoin were simply a unit of account, used to keep track of transactions. But all the interest in Bitcoin is in the idea that it is a store of value, one that may be expected to show steady appreciation rather than depreciation. So Bitcoin needs to be evaluated as a financial asset. Viewed in this way, Bitcoin is perhaps the finest example of a pure bubble.”

It’s obviously wrong to say that ALL the interest in Bitcoin is as a store of value. Some people are only interested in that – just as some people who speculate on houses aren’t interested in living in the houses – but its value as a store of value is parasitical on its usefulness in transactions.

If you’re not convinced of this, imagine what would happen if something were to go wrong with the network which caused it to become irrevocably useless for practical transactions – for example, transaction fees became seriously high, or transaction confirmation ended up taking several weeks – resulting in Silk Road and all BitPay’s customers and the Al Paca Socks guy and everyone selling stuff for Bitcoins giving up, so all you could do with Bitcoins was to trade them for dollars. The value would go close to zero in no time. _Then_ it would be pure bubble, and there would probably a diminishing core of people who continued to hold Bitcoins in the hope that it would retain its value like gold, but Bitcoins would be vastly less desirable than they are now.

41

Tim Worstall 04.18.13 at 9:49 am

Bitcoin’s a bubble, certainly. But then bubbles do accompany the introductions of new technologies. For no one actually knows what the ultimate effects of that new technology are going to be. Thus there’s speculation about what it will be.

Tulipmania was clearly a bubble. Yet Holland still plants 10,000 acres of the things every year and harvests some 3 billion bulbs. A little village by Schipol is still the world HQ of the cut flowers market.

Canal and railway mania, the dotcom boom financed Pets.com but also Amazon.

There have also been bubbles that didn’t lead to anything of lasting value: South Sea as mentioned perhaps, maybe the 70s commercial property boom in England.

I don’t think that the anonymity (which as above isn’t actually there) or ease of use or Silk Road or whatever are a reason why Bitcoin will survive long term. But the bubble, the speculation, is that others disagree.

As I see it there’s two different questions here. A bubble? Sure. Will Bitcoin survive long term? Isn’t that what the bubble is partly about? That people have different views on that second question?

42

John Quiggin 04.18.13 at 10:03 am

@Matt What’s the user experience benefit relative to PayPal (closest competitor, I think)? I’ve never used bitcoin, so I have no idea, but Paypal works pretty well for me.

43

John Quiggin 04.18.13 at 10:07 am

@Salem; Wikipedia suggests that the value of the Somali shilling collapsed along with the central authority, and is now reviving as government power is restored.

44

Katherine 04.18.13 at 11:50 am

The number of bitcoins that can be produced has been set to a predetermined schedule (from 2009 to 2140) by the organizer of the scheme, who uses the pseudonym Satoshi Nakamoto.

So, there is a government involved. A privately owned and run government.

Speaking as another non-economist, this has got to be one of the biggest piles of nonsense I’ve seen recently. This emperor is wearing shiny new clothes that will vanish eventually in a puff of transistors.

45

Matt 04.18.13 at 12:00 pm

@JQ: I agree that PayPal is probably the closest. There is pretty much no advantage for Bitcoin over PayPal if you use PayPal only to send funds, not send and receive, if you don’t use it too much, and if you already have a regular bank account.

I have used PayPal since 2002. I originally set up a PayPal account rather than using a credit card directly everywhere because I wanted an additional layer of protection in case a vendor abused credit card information or had that information stolen. One day in 2010 I discovered that even though I had a few thousand dollars in my PayPal account, the funds were effectively frozen until I had verified my account by linking it to a bank account. I would not be allowed to spend what was already in my account because I had hit a little-advertised $10,000 lifetime spending limit. PayPal says that this limit is to prevent fraud, but I’m not sure what the real explanation is; I had used the account for years without dispute or incident, and surely a real fraud-prevention scheme would contact the cardholder by another channel for verification instead of freezing the funds in PayPal’s hands. I had my funds tied up for about a week while I created another bank account (I wasn’t going to have PayPal linked straight to my primary account when I was using it to firewall against potentially dodgy sellers!) and had it confirmed by PayPal.

I also used PayPal to process credit cards for a small online retailer. The fixed monthly fees are lower than with PayPal than with a “real” payment processor, but the per-transaction fees and percentages are higher. Bitcoin takes a smaller piece than either to process a transaction, and an unreasonable buyer can never reverse a charge (though on the buyer’s side that is a worry rather than a reassurance). Bitcoin also offers simpler APIs for programmers than PayPal and CC processors. There’s no risky persistent data like credit card account details, hence no special security standards for storing the data*.

That said, I still use PayPal today despite my past annoyances with it, and my only foreseeable BitCoin use is making payments to parties that PayPal won’t deal with. BitCoin’s payment mechanism is great but the exchange rate volatility means users need to almost immediately convert BTC to/from local currency as the transaction happens. And if you have to do that you are dealing with exchange fees and terms so transactions are no cheaper or more convenient than using PayPal in the first place.

*Except the wallet file. Do not keep the wallet file on the public machine that runs e-commerce software for a store. Do not keep a wallet file on an internet-connected machine with more than an immediate buffer of funds in it, unless you are very confident in your security measures. I only kept a wallet file on my main computer because it was inside a virtual machine and the client was routing all Bitcoin data through TOR.

46

Trader Joe 04.18.13 at 12:18 pm

There were numerous well documented systems of ersatz and/or commodity based currency systems operating inside of POW and concentration camps during WWII. Some of these systems were quite complex involving variously camp scrip, cigarettes and food items all of which had a semi-floating exchange rate based on the relative scarcity of the items in question (i.e. cigarettes might acquire a higher value, particularly to a smoker, if there were long gaps between Red Cross packages).

In these systems there was a limited amount of store of value, but there was fairly high convertability and relative values were pretty well established to the participants.

There wasn’t a bubble per se, but when camps were liberated camp scrip became worthless and goods such as cigarettes returned to having no more than their intrinsic value, which may not have been worthless – but far below the exchange value that had been ascribed to them.

In the context of Bitcoins – they will have value as long as people give them value but it shouldn’t be assumed they are a store of value.

In the context of using Bitcoins for on-line transactions, it seems like there is some behavioural economy at work – If I was selling something and was willing to charge either $65 or 1 bitcoin, as seller I’m inherenly assuming the bitcoin will continue to hold at least that value or more and as buyer I’m inherently assuming the bitcoin will hold that value or less – otherwise neither party would accept the exchange.

I find it interesting that ‘Matt’ spoke of making a lot of bitcoin transactions “during the last bubble’ suggesting that at least part of the benefit of making those transactions – apart from ease of use – was obtaining value for a medium of exchange he felt was overvalued relative to the goods he could acquire with it.

47

sanbikinoraion 04.18.13 at 12:33 pm

Using bitcoins rather than dollars is sort of irrelevent for guaranteeing security of delivery; Elance.com is dollar-denominated and in order to ensure clients get the work done and that workers get paid, they hold funds in escrow. Absolutely no reason you couldn’t do that with Bitcoins, too.

48

Barry 04.18.13 at 12:43 pm

” I would not be allowed to spend what was already in my account because I had hit a little-advertised $10,000 lifetime spending limit. PayPal says that this limit is to prevent fraud, but I’m not sure what the real explanation is; I had used the account for years without dispute or incident, and surely a real fraud-prevention scheme would contact the cardholder by another channel for verification instead of freezing the funds in PayPal’s hands. “

Basically PayPal acts as a bank, but is not regulated as one, so they’re free to play all sorts of games with people’s money. Probably the only reason that they’re still in business is that Visa is (are?) bigger d*cks.

49

Barry 04.18.13 at 1:35 pm

Harold K: “Bitcoin is fundamentally based on pseudonymous identities, not anonymity. And it’s fully, completely, 100% traceable. Every transaction is logged, this is crucial to how the whole thing works. Every “coin” effectively comes with its entire transaction history (and you can look up the histories of all other coins as well). “

Thanks for summing it up well; I hadn’t thought of that. Bitcoins have to be uniquely identifiable and traceable, or the system would be destroyed by counterfeiting.

50

Edmund in Tokyo 04.18.13 at 1:48 pm

Trader Joe:

“In the context of using Bitcoins for on-line transactions, it seems like there is some behavioural economy at work – If I was selling something and was willing to charge either $65 or 1 bitcoin, as seller I’m inherenly assuming the bitcoin will continue to hold at least that value or more and as buyer I’m inherently assuming the bitcoin will hold that value or less – otherwise neither party would accept the exchange.”

Maybe nit-picking here, but that’s phrased a bit too strongly. In both cases there’s uncertainty, but what a rational person cares about is the average case. If like most people you don’t have any particular expertise to make you think you’d be good at speculating in the currency markets, you’d be best just assume that the market knows what it’s doing as well as you do and $65 represents a reasonable balance between the probability that it’ll go up to $75 and the probability that it’ll drop to $55.

51

The Raven 04.18.13 at 2:04 pm

Bitcoins are deflationary—fewer will be produced over time, and eventually it will not be possible to produce them at all. It is an anti-economic currency; there is a built-in incentive to hoard them. It is difficult to see why I, as a businessperson, would want to do business in a deflationary currency—it is just like having a demand-reducing tax on every transaction. If people continue to demand bitcoins, I suppose currency changers will get very rich, much as brokers in rare and precious items. Bitcoin also depends on the network of computers that create and track them. It is not clear this network will always be available.

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Edmund in Tokyo 04.18.13 at 2:17 pm

The Raven, I’ve heard a lot of people talking about the hoarding issue, but I don’t get it, so maybe you can explain.

As I’ve said in the comment above, at any given time I’d assume that the market has priced in likely future gains. For example, right now they’re at $93. They might go up or they might go down – if I had a strong opinion I’d buy or sell some, but generally I’d just assume that future movement is already in the price.

So if I want to buy a domain name, which has an original price set in dollars and gets converted when I pay, and Bitcoin is more convenient for me than the alternatives, why should I hoard? Why shouldn’t I just do the more convenient thing?

PS. I’m assuming here that Bitcoin is just being used for a subset of online transactions rather than replacing a regular currency completely. If it did that I think get how the hoarding thing would work. I know some Bitcoin proponents think it should / will do that, but we should ignore these people because they’re mad.

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Trader Joe 04.18.13 at 2:29 pm

Edmund @50

Fair enough if you’re talking +/- a couple of percentage points – that’s well within a retailer’s margin. Equally I doubt there are many retailers getting a meaningful portion of their revenues via bit coin so small differences are frictional costs. That said, recent movements of >75% could be disasterous.

Asyou note, most people are unwilling or unable to speculate and the perfectly easy default is simply to only accept payment in dollars (or whatever your local currency is) and bear no uncertainty whatsoever. Accepting bitcoins is a choice a seller makes and the volatility of his payment stream is inherent in that – if he doesn’t believe on balance he’ll profit by that exchange he’s not going to do it because he has an alternative. In my view this makes him at least some flavor of speculator – even if its only small time. A buyer has a different motivation since he knows his cost basis in the bitcoin and is parting with it.

I’d note that merchants accept non-local currency all the time in many parts of the world but they either build a margin of safety into their exchange rate or put the currency risk on the buyer via credit/debit card payments. With a bitcoin both sides essentially bear an FX risk since bitcoins are ‘local currency’ to no one.

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robotslave 04.18.13 at 2:40 pm

That would be a breach of contract and thus illegal

This is of course only true for not-anonymous transactions that are additionally legal according to all of the laws each party is subject to in their respective not-anonymous locations.

There’s little reason to prefer bitcoin to gubmint paper in such transactions, and a substantial reason to use a credit card instead: the buyer can simply reverse the charges with the card, rather than head on down to the local courthouse to file a breach-of-contract suit.

If your transaction processing is free, then it’s worth considering that you might be getting what you’re paying for.

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Edmund in Tokyo 04.18.13 at 2:43 pm

Trader Joe, what people do in practice is to use a company like BitPay, which absorbs the currency risk for them: The price gets converted into Bitcoins when the customer pays, and BitPay give the customer that amount of money in dollars. Presumably BitPay are deferring their own risk by trading in and out where necessary, although in the long run the gains and the losses should mostly come out in the wash.

Doing it that way there’s zero currency risk for the vendor. They have to pay BitPay for this service, but IIUC it’s still a lot cheaper than what credit card companies would charge, especially when you factor in charge-backs and credit card fraud. (Presumably there’s some counter-party risk if BitPay go bust before they get their money out.)

Obviously the customer who holds Bitcoins still has FX risk, which would mean you wouldn’t want a large part of your net worth in Bitcoins, unless you were speculating on them.

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Trader Joe 04.18.13 at 3:05 pm

@55
Thats a helpful addition to my understanding as to why a vendor would choose to accept bitcoin payment – i.e. lower transaction costs. In a way though, the vendor is not really accepting bitcoin, BitPay is and they are making a market – presumably for a spread into which they factor their volatility.

As long as BitPay and others like them are comfortable in this role and can keep the spread/fees minimal, I’d agree it enhances the attractivness of the payment medium.

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robotslave 04.18.13 at 3:15 pm

@55

I would argue that a vendor using a service like BitPay is not in fact accepting payment in bitcoin. They’re instead accepting BitPay, much as they might accept, say, Discover cards.

Not worrying about chargebacks is great for the vendor, but that gain comes entirely at the expense of customers, because they can’t reverse charges when a purchase goes awry.

I can see how shifting risk from the seller to the buyer is an attractive prospect for some, but others might not be so happy about it.

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Alex K. 04.18.13 at 3:16 pm

Here is a link to a good article on Silk Road, the online drug market that uses BitCoins.

The founder of Silk Road has not been caught and there is good reason to assume that the DEA is looking for him, especially after complaints from US Senators.

Other such online black markets were busted — so the system can provide anonymity for those putting in the effort, while criminal slackers get caught.

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Edmund in Tokyo 04.18.13 at 3:54 pm

robotslave @55: You’re right to the extent that a vendor who uses BitPay or similar may not ever actually handle any Bitcoins. But the customer does, and the vendor sees the benefits of lower charges, which they can pass on to the customer, and we get to work around a lot of the brain-damage inherent in dealing with PayPal and credit card companies.

You’re also right that in a lot of cases the ability to make a charge-back is a useful feature for the customer. There are times when I’d use a credit card for just that reason. But charge-backs are a bit of a blunt instrument; In exchange for the customer having the ability to cancel the transaction, consumers have to carry a lot of overhead for people who abuse the ability to make them, and also for the costs of operating a cumbersome and not particularly equitable dispute resolution system. For most of economic history our dispute resolution systems have been separate from our payment systems, and it’s good to have an option to do without it, especially for small transactions.

If Bitcoin or an online cash system like it makes serious inroads into online payment (no small if, I know), I wonder if we might start to see the credit card companies hurt by a kind of adverse selection death spiral, where people who manage to go through life without getting into acrimonious disputes with vendors use online cash, and credit card companies are left supporting an ever-increasing proportion of fraudsters and complainers who value the ability to reverse transactions, and having to charge ever more to cover the costs…

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Main Street Muse 04.18.13 at 4:44 pm

John Q – How are bitcoin and PayPal similar?

It was my understanding that PayPal facilitates (operates as a middle man) between two parties who want to use dollars to buy/sell a product (a kind of modern Western Union digital cash station?)

From what I’ve read, it seems that bitcoin is a currency that people are using cash to buy – now in such a frenzy that irrational exuberance is now bubbling up over this product. Is bitcoin a facilitator for the exchange of cash or a digital currency?

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Wonks Anonymous 04.18.13 at 4:48 pm

“That would be fine if Bitcoin were simply a unit of account, used to keep track of transactions. But all the interest in Bitcoin is in the idea that it is a store of value, one that may be expected to show steady appreciation rather than depreciation.”
No, there is great interest in it as medium exchange (Silk Road being an obvious example, countries blocked from the international financial system being another). If the value of BitCoin was expected to increase indefinitely, that would constitute a violation of the EMH conjoined with any pricing model I can think of. My understanding is that the EMH predicts that the future value of BitCoin is expected to be the current value (with a weighted likelihood of increased value equalling that of decreased value), with some caveats about discounting the future and the cost of borrowing to buy the asset.

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mud man 04.18.13 at 5:48 pm

John #18, It seems as though the real problem is that nobody can/wants to/does demand payments in bitcoins, enforcing a closed economy. Eg company store chits, nothing magical about the public sector. Isn’t it?

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Trader Joe 04.18.13 at 5:52 pm

Wonks
EMH can only work where there is sufficient depth of market, price transparency and information flow that “the market” can properly price an asset. A limited distribution asset trading on a single exchange has none of this – its like the pink sheets of the US stock market. Intra-HOUR trading swings of more than 10% on a near daily basis suggest none of these criteria are present and that the apparent valuation of the asset is highly subject to manipulation.

I tried to get data on this to construct a rudimentary volatility index and at least over the last 30 days its a figure that isn’t comprehensible compared to even the most volatile days of the NASDAQ….maybe there are commodities that move that violently.

Over the 4+ year trading life of the bitcoin it has traded between $0.05 and $20o. I don’t think there is a lot of EMH going on here in any form.

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Trader Joe 04.18.13 at 5:53 pm

To clarify 63
I’m not saying it is being manipulated – I don’t and can’t know that – but that the conditions are very condusive to manipulation.

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robotslave 04.18.13 at 8:18 pm

@63

I don’t think “single exchange” really matters much there, given the other factors. And bitcoin is of course traded on several different exchanges (of varying reliability).

The volatility is a thing to behold, though, isn’t it? And the potential for manipulation is sort of hilarious, given the way bitcoin enthusiasts tend to bridle at the thought of governments “artificially” adjusting fiat currency.

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The Raven 04.18.13 at 10:49 pm

Edmund in Tokyo@50: the number of bitcoins is limited; mining them becomes harder and harder over time and, ultimately, there is a fixed limit. If the world economy is growing, the only way for bitcoins to remain a medium of exchange is for them to rise in value over time. So a holder of bitcoins has an incentive to hoard them.

The problem is aggravated by exchange-rate volatility. If the demand for bitcoins spikes, the value of bitcoins rises dramatically, and there seems to be some sort of price stickiness at work—it doesn’t drop to its original level, afterwards. Andy Greenberg at Forbes offers this observation from a small-time drug dealer:

One Silk Road buyer and small-time drug dealer with the name Joey Terrifying writes that he used the site to buy a gram of Molly, a form of ecstasy, with the intention of quickly selling it to his own customers. By the time he’d sold it three weeks later, Bitcoin had risen in value so much that it dwarfed his profits from the drug sales. “I would have more money now if I had just done nothing at all,” Terrifying laments.

Drug users are not in it for the money, but drug dealers most definitely are.

Extended discussion of something that might be new in economic history—hyper-deflation—at Business Insider.

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Billikin 04.18.13 at 11:00 pm

The Raven: “If the world economy is growing, the only way for bitcoins to remain a medium of exchange is for them to rise in value over time. So a holder of bitcoins has an incentive to hoard them.”

Right. And if everybody hoards them, they become worthless. Therein lies the paradox.

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The Raven 04.18.13 at 11:43 pm

Billikin@67: but it does have value as a currency which enables secret transactions, and a currency that cannot be debased. So maybe its value falls as black market shrinks and world economic conditions stabilize.

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Matt 04.18.13 at 11:43 pm

The volatility is a thing to behold, though, isn’t it? And the potential for manipulation is sort of hilarious, given the way bitcoin enthusiasts tend to bridle at the thought of governments “artificially” adjusting fiat currency.

I have picked up most of my knowledge of economics as an accidental byproducts of reading history, blogs like this, and the stuff printed on the back of cereal boxes, so bear with me. Saving for the future is a funny thing. It’s possible but unwieldy to physically accumulate goods that you might need in your old age (clothing, furniture, housing, fuel, nonperishable foods). People generally try to accumulate something other than the exact goods they hope to consume in the future: maybe real estate, precious metals, financial instruments.

Accumulating savings is an expression of hope that in the future people will labor on your behalf even after you have ceased to provide labor in return. Specifically accumulating gold or other assets that are (hoped to be) stable or deflationary, and immune to politics, is an expression of distrust in other people, and at the same time a fearful anticipation of the inevitable end of self-reliance that comes with age. I earlier noted that you could take physical delivery of goods that you anticipate needing during your old age, rather than holding proxies like stocks, land, gold. But it’s impossible to accumulate services you may need. There’s no way to take physical delivery of surgery in your 30s and save it for your 70s.

People looking for financial certainty in geography (they’re not making any more real estate!), geology (the easiest gold has already been mined!) or cryptography (it’s mathematically impossible to forge bitcoins or inflate the supply!) are seeking magic fetters that will bind people yet to be born in service to needs they have yet to experience. The only fetters that actually work this way — empathy, social convention, law — are frighteningly dependent on humanity if you distrust humanity. So there’s an enormous body of nonsense written by and to people trying to prove that certain conventions (gold is valuable!) are not really social conventions but laws of nature, and contradictory data is just experimental error or interference.

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Pat 04.19.13 at 12:30 am

I’m still a bit confused about why it is impossible to express one’s confidence about the true valuation of BTC in the futures market, rather than on the Op-Ed page. JQ argues that he cannot cash in on the irrational exuberance of others because he does not know when the bubble will pop. But there are futures, and then there are futures: I seem to recall that crude oil futures extend as much as nine years out, so why not a similar time-scale for BTC? If JQ can’t say with confidence: “BTC will trade at 0 USD within ten years”, what does he mean when he says that he believes in the bubble? If the problem is the lack of futures exchanges, why not just take out a mortgage denominated in BTC, &c.?

With 1B USD just sitting on the table, folks who simultaneously maintain that (1) BTC is valueless and (2) there’s nothing they can do about it strike me as suspiciously unimaginative, y’know?

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Doctor Memory 04.19.13 at 1:12 am

Billikin@35: not the the best of my knowledge. The name comes from the Firesign Theatre’s album “I Think We’re All Bozos on this Bus”, and while it’s a somewhat obscure reference I’m aware of at least a few people other than me using it as a handle.

(Also I’m not 100% sure which Participate you’re referring to.)

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Edmund in Tokyo 04.19.13 at 3:01 am

The Raven @50: You’re not addressing my point about this: If we know it’s going to go up in value, the potential for future gains should already be in the price. If it’s rational to hoard, it’s also rational to buy, so the price should rise rapidly until it reaches point – and there must be one somewhere – where the price reflects future gains.

The Forbes piece on Silk Road quotes someone who’s theorizing about it, but note that the discussion of what people are actually doing – as opposed to what this one person thinks they should be doing – isn’t actually providing any evidence for hoarding.

When this person says:

“Hoarding is the rational response to runaway deflation,” adds one user with the name Astor. “If I spend $100 on drugs now and the price of [Bitcoin] doubles in a week, then I’ve effectively spent $200 on those drugs by next week.”

…they’re actually wrong, because at any given moment there’s as much of a chance that the price will drop as that it will rise. If they’d bought their drugs when Bitcoins were at $250, those drugs would have looked very cheap a couple of days later, when they crashed back down to $60.

The rational consumer here is actually the person called AllDayLong, who derives maximum utility from their money:

“But, if I deposit my $100 and spend it on the drugs I want right away then I get my drugs and I am happy.”

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Edmund in Tokyo 04.19.13 at 3:14 am

Just to add on the deflation thing, it would be different if Bitcoin was a normal national currency that people got paid in and had contracts in, because in that situation prices are sticky. For example, people don’t get a pay cut every day until the price of their labour prices in the potential for future appreciation in the value of their currency.

But no sensible person thinks Bitcoin is going to take over as the main currency anywhere. (A lot of not very sensible people think this, admittedly.) We’ll carry on doing what we do now for the forseeable future: Everybody thinks in dollars (or similar) and sets their prices in dollars and converts to Bitcoin based on the exchange rate at the time.

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Zamfir 04.19.13 at 6:25 am

Edmund, that’s a scenario you hear a lot for bitcoin’s long-term use: people buy them just before buying something, and sell them directly after receiving them. So they can be agnostic about the fluctuations in its value, and they function as a payment system more than a full currency.

I don’t see how how this can work. As setup like that requires market-makers who will accept the risk of holding bitcoins for a while, and those market makers will require a spread for their efforts and for that risk. Not that different from a bank or Paypal, except with the added cost to compensate the currency risk.

At that point, what do bit coins add?

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robotslave 04.19.13 at 7:59 am

@70

I’m still a bit confused about why it is impossible to express one’s confidence about the true valuation of BTC in the futures market, rather than on the Op-Ed page.

Because you can’t borrow bitcoin.

why not just take out a mortgage denominated in BTC, &c.?

Because nobody will lend you bitcoin.

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Mao Cheng Ji 04.19.13 at 8:18 am

74 “I don’t see how how this can work.”

If it is as you described, if this is just an intermediate currency, then there should be no need to hold it (it can be created/destroyed on demand), no risk, and the exchange rate is not important. In fact, you don’t really need this currency. Essentially, it’s simply a money transfer service that keeps no records.

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Edmund in Tokyo 04.19.13 at 9:02 am

Mao: What do bitcoins add?

First, a minor point: I’d imagine consumers would typically hold a balance in bitcoins and live with the volatilty, but only for a small part of your net worth. That’s what I do. That means that I only occasionally have to interact with the banking system, which is painful and expensive, and can do everyday trades with online vendors painlessly and cheaply.

It’s true that technically you could get some of the same effects with a company like PayPal that holds a balance for you in their own database, rather that holding the money in the medium of an intermediate cryptocurrency. But the advantages of Bitcoin are:
– International. They are many countries where PayPal is not allowed to operate for regulatory reasons.
– Unbureaucratic. PayPal verification is a PITA.
– Anonymous. PayPal keeps transaction records attached to a real-world identities, again for regulatory reasons.
– Non-judgemental. PayPal have lots of opinions about what you should and shouldn’t use their service for, and will suddenly freeze accounts if they suspect you’re doing something wrong.
– Irreversible. PayPal will sometimes reverse transactions for various reasons. Sometimes this is what you want as a consumer, but sometimes it isn’t. (See earlier comments.)
– Cheap, because Bitcoin doesn’t have to do all the stuff above.

Note that in the offline world regular cash already has most of these properties. If the Bank of Japan or the Fed made an online cash system based on private/public keys, it would be able to do pretty much all that stuff. But they won’t, because somebody would complain in could be used by terrorists or something. Likewise, a private company can’t do it for regulatory reasons, at least not internationally.

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Mao Cheng Ji 04.19.13 at 9:51 am

Edmund, I think what bit-coins do is adding a possibility of electronic money transfer in the underground economy. On a small scale, because if you try to redeem a million dollars worth of bit-coins, the IRS will probably want to ask you some questions anyway.

Which is fine as far as that goes, but if it were to grow and become common, the authorities would’ve killed it in a second.

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Alex 04.19.13 at 10:46 am

Mao: What do bitcoins add?

Fun.

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Zamfir 04.19.13 at 11:58 am

@Edmund, all of those might work for a pure bit coin system, but hardly for the interfaces between bit coins and regular currency. Exchanges, market makers. Those will face the same pressures as banks or PayPal. Verification, reputation, regulation, administration, risks.

Why should they do those much better or cheaper? And if they do, why add bit coins? Use them as payment system directly.

There’s a two-step here. When it is noted that bit coins are risky to hold and people won’t like to keep them, the proposal is a system where you only buy bitcoins to do transactions, and sell them directly when you receive them.

But the advantages are for a system where exchanging is rare.

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SusanC 04.19.13 at 12:48 pm

There are “strong” and “weak” forms of the EMH.

In this context, the weak form would be something like: you can’t reliably predict whether you make the most by selling your bitcoins (e.g. for US$) now, or holding on to them for a while longer and then selling them. This weak form could very well be true. (At least, I don’t see strong evidence against it).

“Being early is the same as being wrong” applies to this form of the EMH.

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Edmund in Tokyo 04.19.13 at 1:24 pm

@Zamfir:

There’s a two-step here. When it is noted that bit coins are risky to hold and people won’t like to keep them, the proposal is a system where you only buy bitcoins to do transactions, and sell them directly when you receive them.

Someone upthread understood me as advocating everybody buying their bitcoins right before they made each transaction, but that’s not what I’m saying. I’m saying that the _vendor_ will most likely want to set prices in dollars and use a company like BitPay which will handle the FX risk for them and pay them dollars (or whatever their local currency is). What I do – and it’s convenient – is to hold a small amount of Bitcoins for online transactions, and live with the exchange rate volatility. This doesn’t bother me, because my Bitcoin balance is a small proportion of my net worth, and it could just as easily go up as down.

This method wouldn’t work well if I was trying to buy a house with Bitcoins, but I’m not, I’m buying things like web hosting and domain names, or making online donations. I guess the volatility may be an issue for some Silk Road users, as presumably some people spend quite large proportions of their income on drugs.

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Katherine 04.19.13 at 1:30 pm

Non-judgemental. PayPal have lots of opinions about what you should and shouldn’t use their service for, and will suddenly freeze accounts if they suspect you’re doing something wrong.

AKA illegal, in many cases presumably. So, bitcoin is extra-good for buying or selling things that are illegal, or doing your buying or selling illegally. Go bitcoin!

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mds 04.19.13 at 1:32 pm

sanbikinoraion @ 47:

Elance.com is dollar-denominated and in order to ensure clients get the work done and that workers get paid, they hold funds in escrow. Absolutely no reason you couldn’t do that with Bitcoins, too.

Kevin Roose at New York magazine describes purchasing approximately one bitcoin:

You tell BitInstant how much you want to deposit in a Bitcoin exchange account, which exchange (Bitstamp, Mt. Gox, etc.) you want it to go to, and your account number. You go to a “cash deposit location” (in my case, a CVS several miles from my house) and use Moneygram to pay a cash-payments service like ZipZap, which then pays BitInstant, which then credits your Bitcoin account.

I presume one could add an escrow service to that chain.

It would be nice to have an electronic decentralized money transfer system that didn’t try to ape gold and gold-mining, turning its users into steampunk prospectors.

Indeed, it would be interesting if the primary tangible benefit of the Bitcoin experiment were the new payment systems and connections spurred by the Bitcoin trade. The Moneygram -> ZipZap partnership used by Roose would seem to further facilitate cash payments for online purchases, for example.

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Edmund in Tokyo 04.19.13 at 1:50 pm

Katharine:

AKA illegal, in many cases presumably.

Bitcoin is certainly very useful for illegal transactions, and also for things that aren’t necessarily illegal in your jurisdiction, but might be illegal somewhere, and they’d rather not deal with it.

But that’s not the only thing that’s hard. For example, I did payment system integration for a school in Japan that sells its courses online. They’re a regular, bricks-and-mortar company with a good reputation. Their model has always been that you sign up for a set of courses, pay at the beginning, then choose when to take each course later. PayPal’s TOS bans you from doing things with delivery dates more than 20 days from payment, and the credit card companies wouldn’t take their business for similar reasons. I ended up building payment system integration for a credit card processor for them, but they can only use it for a tiny proportion of their courses, where you can download videos immediately and there’s no component of the course that gets delivered later.

It’s understandable that the payment processors do that – the problem is that the payment processor could be on the hook for many months of payments if the school went out of business. But the inconvenient upshot is that their customers can’t start using the courses immediately after they apply, because they have to wait until they have a chance to pay cash or clear a domestic bank transfer.

Really, there are lots of problems like this. And it’s very hard to fix on the model where you have to have a balance with the company that handles payment confirmation and dispute resolution etc, especially if it’s got to be done worldwide. It’s much better to unbundle it and enable each bit (interface with the bank, payment confirmation, dispute resolution) to operate independently.

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Patrick S 04.20.13 at 4:14 am

John Q briefly mentions Ponzi schemes in his original article, but I’m surprised that he and/or the commenters here haven’t discussed what seems to me a built in Ponzi-scheme-like and sharp increasing inequality built into Bitcoin from the beginning.

Q: If the cryptographic ‘mining’ algorithm used to produce new bitcoins is initially easy but as time goes on gets exponentially more difficult (to the extent that there is a fixed amount of Bitcoin that will ever be generated) – who benefits most??

A: ‘Satoshi Nakamoto’, the pseodonomous inventor of the currency & systems, and other early adopters – who presumably ‘mined’ great quantities of the things early on, leaving suckers who buy in later to garner much lower number of bitcoins either via mining with increasingly complex computers for diminish returns, or buying them on an exchange for traditional currency.

Everyone who buys in has an interest in the bubble still rising, but it’s Satoshi & co who have by far the most to gain by pumping things up further. With the added bonus that given the fixed amount of Bitcoins to ever be produced, if they ever really do get used as serious medium of exchange people will have to start using smaller & smaller denomitations of BC for real goods.

Doesn’t this all sound very much like an _actual_ Ponzi scheme, or at the very least an unfortunate reworking of rentier and/or robber baron aspects of capitalism to the digital age?

With the difference that BC doesn’t leave society any remotely useful infrastructure afterwards as a result of the speculation like railways, unless like Tim W @ 41 intimates, “experience in managing a distributed digital payment infrastructure” is considered possibly a social good.

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Patrick S 04.20.13 at 4:48 am

BTW – per my last point as Bitcoin at least being a pioneer to economic innovation – as well as anarcho-capitalists interest in new forms of money there are of course a lot of leftist and green decentralist interests in this too, so at least BC as an experiment might do some good there.

E.g. people like Brian Milani in his book “Designing the Green Economy: the Postindustrial Alternative to Economic Globalization” argue that money should be evolved digitally into a pure account system, with no value-store element. Or Lietaer and Hallsmith have a nice article on the Solutions Journal about currencies like the Terra linked to commodities and with a built-in ‘demurrage’ feature.

Finally this upcoming Transforming Finance conference in the UK looks interesting – especially re how currencies could be better modified to explicitly aim to mitigate climate change.

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Edmund in Tokyo 04.20.13 at 11:05 am

Patrick S :87, if you haven’t already seen it you may be interested in Freicoin, which is a fork of Bitcoin that has built-in demurrage:
http://freico.in/

I guess the difficulty here is that it’s very hard to boot-strap a new currency, especially a decentralized one where you need a lot of people to set up infrastructure for it, and start using it even though it isn’t really practically useful yet. Bitcoin got around this partly by rewarding early adopters exceedingly generously, as you describe @86. (*)

(*) A lot of the bitcoins that were created early on have probably been lost, as it started out as an experiment and few people would have expected it to be as successful as it has. IIUC Satoshi Nakamoto doesn’t seem to have spent any of the coins he mined early on, so it’s not unthinkable that he solved this incredibly difficult problem, created a formula which would ultimately allot vast riches to himself, then forgot where he’d put them.

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Watson Ladd 04.20.13 at 2:20 pm

Hey, JQ, the next time you call a bubble, call it before it bursts and I’ll believe your argument. As for the EMH, no one thinks a Ferrari is worth the money you earn from having it.

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js. 04.20.13 at 5:40 pm

This Felix Salmon article, over at Medium, is quite long but very good. Among other things, I found it very helpful re why Bitcoin would be drastically deflationary if widely used.

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Ken 04.21.13 at 12:04 am

Katherine @44: So, there is a government involved. A privately owned and run government [Satoshi Nakamoto].

Or maybe the Satoshi Nakamoto is a pseudonym for some group at the CIA that came up with a scheme to identify international criminal organizations. Not that that’s likely, but it raises a question: If some governmental agency announced it was behind bitcoin, what do you think the price of BITC would be two hours later?

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Edmund in Tokyo 04.21.13 at 5:08 am

If some governmental agency announced it was behind bitcoin, what do you think the price of BITC would be two hours later?

I don’t think it would make much difference – we’ve got the source code, we know what it does, anybody can change it and make their own variation, it doesn’t really matter who made it or what they made it for.

Note that Bitcoin already uses the SHA-256 hash function for cryptography, which was developed by the US National Security Agency. Even anarchist free software developers don’t generally mind using stuff made by government agencies, as long as they can check it, modify it and share it.

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The Raven 04.21.13 at 6:31 pm

I like the Felix Salmon article, too. Perhaps the way to look at electronic currency is to reverse what we are trying to do it: include more history in exchanges, not less. Meantime, caveat emptor, caveat vendor, caveat argentarior.

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John Quiggin 04.21.13 at 9:41 pm

@Watson Thanks for this offer. I called the dotcom bubble here, very close to the peak

http://www.uq.edu.au/economics/johnquiggin/news00/Telstra0003.html

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Watson Ladd 04.21.13 at 10:08 pm

30 March 2000 is 10 days after the Barron’s cover article on cash burn rates. (Source: Wikipedia) So not only were you late calling it, but you were calling it as continuing at a point when it was clear to quite a few market participants it wasn’t going to go well.

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dsquared 04.21.13 at 11:58 pm

that’s pretty pathetic, Watson. You’ve been given a timestamped sell call on the NASDAQ dated March 2000, and your response is to babble about Barron’s magazine. The phrase you are looking for is “Oh, sorry; it appears that you do know what you’re talking about, John. I wish I hadn’t been so rude in the first place because now I look a fool”.

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Wonks Anonymous 04.22.13 at 4:38 pm

Trader Joe, I think extreme volatility is compatible with EMH. It says the price reflects all available information, and new information may continually present itself to disrupt the price. What’s incompatible with the EMH is if there is a predictable path of the future price, instead that expectation should already be “priced in”.

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Watson Ladd 04.22.13 at 11:50 pm

@ dsquared: Strong EMH of the “best-estimate of future cash flow” category is false. What that says about weak EMH of the “no mutual fund ever beat its Lipper average except by chance” form, which is empirically testable with no more tools then a dartboard and copy of yesterday’s paper, I haven’t figured out yet.

@Wonks Anonymous Actually someone tested this with respect to OJ concentrate futures, and observed that trading drove volatility: the Friday-Monday shift was not 3 times as big as the nightly one, despite 3 times as much information about weather reaching the participants.

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Wonks Anonymous 04.23.13 at 8:52 pm

Pretty cool, Watson. Can you give a link.

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Jameson Quinn 04.23.13 at 11:54 pm

@Watson Ladd: If it were a random walk, you’d expect the weekend OJ volatility to be root-3 times as much, not 3 times.

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Barry 04.24.13 at 2:11 am

dsquared 04.21.13 at 11:58 pm

” that’s pretty pathetic, Watson. You’ve been given a timestamped sell call on the NASDAQ dated March 2000, and your response is to babble about Barron’s magazine. The phrase you are looking for is “Oh, sorry; it appears that you do know what you’re talking about, John. I wish I hadn’t been so rude in the first place because now I look a fool”.”

Come on, Daniel – if Watson refrained from looking like a fool, he’d have to shut up completely –

Oh, that would be a feature, not a bug, wouldn’t it? :)

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