Thoughts on Bitcoin - and why I cashed out of BTC at $18k

From one point of view, cashing out is foolish. The price has gone up, and will go further. From another perspective, holding so much in BTC was already insane.

In 2013, I swallowed my pride for not having invented Bitcoin, and invested a total of $60,000 in it. About $30,000 was into Butterfly Labs mining hardware. This turned out to be mostly a scam. Time after time, the company delayed delivery, while actually, they were using hardware prepaid by their customers to mine Bitcoin themselves. A year later, I was able to receive my order refunded. I'm not sure that would have happened if it wasn't for a friend.

With the other $30,000, I bought around 250 coins on MtGox, at around $120. For months after, I had a disturbing gut feeling about leaving them there. I rationalized that it's safer to trust the world's largest exchange than to store them myself. When MtGox came crashing, I salvaged around 30. For a year, I beat myself up for ignoring my sixth sense.

I have now sold those coins for about $570,000. I did this fully expecting that in the short run, they are still going to go up. In fact, they're up now. But I did not sell BCH.

What's wrong with BTC?

The block size limit

Contrary to some opinions, I don't think cryptocurrency is inherently a bubble. It's a novel form of currency that previously did not exist, and its value is not based on nothing. It is based on mathematics.

Cryptocurrency derives its value from whether it's useful as a currency. This is to say, if it's useful to make transactions. The real value of the currency is directly derived from (a) how much of the currency there is, and (b) how many people need how much of it to perform transactions.

In a similar way as there are multiple cryptocurrencies, there are also multiple versions of Bitcoin. The most well-known version right now, "Bitcoin Core" – the one known as BTC – has been co-opted by a company, Blockstream, which has hired most of the "Core" developers. People affiliated with this company control prominent places where Bitcoin is discussed: the Bitcoin Forum (bitcointalk.org) as well as /r/bitcoin on Reddit. This company has an angle: they want to limit the growth of the Bitcoin blockchain, and move the vast majority of Bitcoin transactions off it. To this end, they have resisted increasing the maximum size of Bitcoin blocks. BTC transactions remain limited to 1 MB per 10 minutes.

As transactions compete for this small space, this drives up BTC transaction fees to unsustainable levels. It presently costs $15 to make the simplest BTC transaction. When I transferred my BTC to sell them, my transaction had 16 inputs, and cost $200 to make. I've made cheaper international transfers of similar amounts using SWIFT!

In addition to price volatility, transaction fees are clearly a problem. It's why merchants like Steam are dropping BTC, instead of adopting it. BTC, as it currently exists, is not useful as a currency.

The lightning pie in the sky

Why does Blockstream persist with this insanity? Why don't they increase the block size? 1 MB is trivial, surely 2 MB, or 4 MB, or 8 MB per 10 minutes would work fine today?

They do not because they have a solution! It's called the Lightning Network, and it purports to move most transactions off-chain, where they will be almost free, and execute at lightning speed!

The only problem is that this proposed solution (1) is vaporware - it does not yet work in a scalable way; and (2) it cannot meet its promises in a decentralized way. The whole point of cryptocurrencies is that they are peer-to-peer. We can invent a second layer on top of the blockchain, yes; but all solutions we can actually implement devolve into a peer-to-peer mesh of central authorities.

But there already exists a peer-to-peer mesh of central authorities that can facilitate worldwide payments which are processed nearly instantly. It's called Visa!

What's the benefit of another Visa on top of a high-volatility currency with huge transaction fees, when it already exists on top of USD or EUR, backed by entire economies?

And if you really want to make such a network using Bitcoin – why Bitcoin Core? Why not BCH?

Competition and censorship

People saw the block size issue coming. When the Blockstream-sponsored "Bitcoin Core" refused to allow larger blocks, others foresaw the looming abyss, and created what's now Bitcoin Cash (BCH, sometimes also known as BCC). The main change is that BCH removes the 1 MB block size limit. At a time when transactions on BTC cost $15 to $200, you can make transactions on BCH practically free. And there are merchants that support it.

So why don't you hear as much about BCH? Ah, because Blockstream-affiliated people censor any mention of it! On Reddit, moderators of /r/bitcoin remove any discussion of BCH, and permit only vilification of /r/btc – a home of freer conversations – as a group of heathens and heretics.

Hype

If you follow /r/bitcoin – the Blockstream-censored, "official" BTC subreddit – a disturbing pattern emerges. By far the most popular posts are those that encourage holding BTC, never selling, and cheering as the price goes up. There is no discussion of negative news, such as high fees making transactions unviable; or large merchants like Steam dropping the currency. The only "negative" posts are tongue-in-cheek: the title says "This is a worrying trend...", and the content explains that the poster only has room for one Lamborghini in the garage, and will have to park the second one in the street.

At the same time, I'm being asked about Bitcoin, Litecoin, Ripple, and cryptocurrencies by people who have only marginal experience with IT. They're trying to board a train which departed years ago. Coinbase reports they now have over 13 million accounts! What's driving the BTC price now is no longer smart money. It is widespread, poorly informed speculation.

There's a commonly told parable about how the 1929 stock crash could be predicted by widespread involvement in stocks by people who shouldn't be speculating:
"Taxi drivers told you what to buy. The shoeshine boy could give you a summary of the day's financial news as he worked with rag and polish. An old beggar who regularly patrolled the street in front of my office now gave me tips and, I suppose, spent the money I and others gave him in the market. My cook had a brokerage account and followed the ticker closely. Her paper profits were quickly blown away in the gale of 1929."
In order to beat the market, you see, you have to invest in something that everyone else doesn't think is a good idea; but you have very good reasons to believe that it is. I had such reasons for Bitcoin in 2013. I still have them for BCH, but they seem scarce for BTC at its current price today, and the vapor state of the Lightning Network.

General futility of cryptocurrency

Irrecoverability

The inability to recover misspent coins is a bug that some proponents espouse as a feature. Computers are inherently insecure, and the story of cryptocurrencies so far is a story of small scams and large heists that were so far never recovered.

I have no desire to use a currency where no one has my back if I make a mistake, or if I am outright cheated. Making a cryptocurrency payment is a high-adrenaline activity in a way a credit card payment or a wire transfer isn't. This is not solvable without centralization.

Inefficiency

The invention of Bitcoin is a stroke of genius: it allows for a public ledger without a central authority. This does not mean this public ledger is efficient.

The mining of Bitcoin wastes more energy than is consumed by 150 individual countries. What we are getting in exchange is about 3 transactions per second. For comparison, the Visa network, with comparatively negligible power consumption, processes up to 20,000 transactions per second during peak days.

This efficiency is the strength of a network built on cooperation, over a network built on distrust.

Faulty assumption of distrust

A fundamental issue of cryptocurrency is that it does not solve a problem we have. It is novel and interesting, but so is a Rubik's cube. That makes it a toy, not an economic foundation.

The economies of the developed world are fundamentally based on trust, not distrust. Trust facilitates trade, and trade builds the economy. The poverty of the developing world is fundamentally caused by distrust: ubiquitous backstabbing and deception. This discourages trade, the economy does not get built, and the country remains poor. In this sense, a rich economy is fundamentally a state of mind on the scale of countries.

To build a currency on an assumption of mistrust is futile. If you don't have trust, you don't have a functioning economy. If you don't have a functioning economy, there's little worthwhile you can buy.

A trustless currency! To use, requires blind trust

I am one of a small proportion of people on Earth who are capable of understanding the technical details of Bitcoin, including the systems and the cryptography. I understand them, and they're sound.

But in order to use a cryptocurrency, you need software. And understanding the technical underpinnings is nothing compared to verifying that the software you use won't betray you, and is correct. Even when experts perform code reviews, they miss bugs.

In a currency that is ostensibly based on distrust, it is ridiculous that the very act of using that currency requires the vast majority of people – everyone who does not write their own wallet and Bitcoin client – to blindly trust whoever provides the software or service to use the currency in the first place.

As of right now, the software still comes from questionable sources. For an example, the Bitcoin Armory download is not signed. The website is "secure", but the certificate only shows domain control, no information about ownership. The developer is someone known only as "goatpig".

???

The software is open source. I could technically verify it does what it says. But who even has the ability? If this software steals my cryptocurrency, whom do I sue? Whom do I blame? Only myself, for not having verified what no one can verify in the first place.

In the end, what is a trustworthy, user-friendly platform to buy Bitcoin? It is Coinbase. Do you know how you link your bank account to Coinbase?

To link your bank account, you enter your online banking username and password. Then you enter answers to all of your security questions. Then Coinbase logs into your online banking and pulls information about your account.

This is the way business is done in the US. Other services do so. Accounting services for businesses do this. You let Coinbase have your username and password, and all your security questions, because there is someone to sue.

In the end, we rely on our economy based on trust to even access this supposedly trustless currency. Because in reality, very few people can participate in a true trustless way. So what's the point of having a trustless currency?

Deflation encourages saving. This is bad

Saving is individually smart, but creating a need for it is socially stupid. In a society that lacks social safety nets, of course it is necessary to save, and irresponsible not to. But for a society to put in place rules that stimulate this, and design an economy around it, is anti-social, inefficient, and ineffective.

To the extent that saving is intended to help with individual crises, it is both more effective and more efficient if society just helps people who are in an individual crisis, than expect them to have saved up for the event. If they don't save enough, we have to foot the bill anyway, or let them die or go hungry. But if everyone saves, there's much more saving going on than there are crises, and time and resources are being collectively tied up in saving. This has contributed to ghost cities in China, which is known for a population that tries to save too much and consume too little.

But to the extent that saving is intended to help with social crises, it cannot work at all, because saving does not build up economic infrastructure that would actually deliver resources to where they need to be in a time of crisis. Only consumption can build the infrastructure, by creating demand for infrastructure to exist and be maintained.

Lack of control over money supply

Lots of people don't understand this because they maintain macroeconomic confusions:
  • People think money is a store of value. It's actually harmful for an economy to store value as money. As per above, the only way for a society to store value is by maintaining a vibrant and functioning economy. Storing value as money is an illusion that can only work if a small proportion of people do it.

  • People think central banks controlling the money supply is evil. It's actually harmful for the economy to have too much money or too little money, and the amount needed changes with economic events. If money decreases in value slightly, people adjust. Prices go up by a small amount, and so do incomes. Loans are easier to repay. But if money increases in value, people react poorly. Employees are reluctant to accept "lower" incomes. Loans have to be repaid in currency that's harder to come by, so fewer loans get repaid. This snowballs into economic standstill; a crisis. It is safer to have a currency that slightly inflates over time, than a currency deflating.

Those who dislike central banks are right about one thing: it favors the rich class by injecting money into the economy top-down, instead of bottom-up. But cryptocurrency does not solve this. A fixed supply of gold, or any other medium of exchange, does not solve this. A fixed supply of anything still concentrates in the hands of a few.

What's a good currency?

The proper approach is central banking, but with money injected bottom-up, instead of top down. Rather than central banks loaning money to commercial banks, who loan it to corporations, and then it maybe trickles down to individuals – but probably not – money simply needs to be granted to people as a universal basic income. Part of it also needs to be created to pay for services the government provides. An amount slightly less than the amount that was created then needs to be collected in taxes, and destroyed. This would provide social well-being with a steady, slight inflation.

That's how the macroeconomy needs to function with increasing automation. It's the only way that does not cause a deep haves and have-nots divide, in an economy in which ever more of us are becoming unemployable. We're not getting there with cryptocurrency. A fixed supply is not a step forward; inequality was not lesser when gold was king. We need central banking, but a different kind of central banking than we have now. We need trust, not a solution for a perpetual state of distrust about creation of money.

What is crypto's real value?

Cryptocurrency can serve as a backstop if government really screws up. It can serve as motivation for governments to do better. The fact that alternatives exists can motivate countries to be better custodians of their own money.

The extremely high cost of irrecoverable theft of cryptocurrency can motivate development of computer security. This is a good thing overall, and makes all of our systems stronger.

However, I do not see cryptocurrency as being able to replace the world's major currencies, in any form that exists now, unless its decentralized nature is significantly compromised.

Maybe that is the future of BTC: a working, and quite possibly valuable, CorporateCoin – backed by a locked-down ledger. "Peer-to-peer", if you have $100k to actually store your Bitcoin on-chain.

Comments

Ian said…
Thanks for your thoughts! I appreciate the perspective.
Boris Kolar said…
Most of the problems described are technically solvable (either by improving Bitcoin or, more likely, switching to some altcoin):
- Block size limit: 1 line change (or switch to altcoin)
- Lightning network: the fundamentals are sound (implementation will follow)
- Competition and censorship: the consensus mechanism can be used for protocol improvement (example: Decred, delegated voting protocols)
- Hype: wears off with time
- Irrecoverability: fixable to some extent with smart contracts
- Inefficiency: mining is only needed to bootstrap (the next big currency can bootstrap from an existing one)
- Assumption of distrust: optional (anonymity implies distrust)
- Requires blind trust: fixable with smart contracts backed by huge collaterals
- Deflation: small inflation can be programmed into the blockchain (some altcoins have it)
- Control over money supply: I believe it's fixable without fiat collaterals

Comparison with Visa and central banking:
Getting the numbers from a Visa card is enough to spend money. I still remember our bank performed transaction based on faxed payment order. For almost every service I need to scan my passport and utility bills (AML/KYC requirements). Lack of innovation.

Universal basic income is a good idea (in modern society nobody dies from hunger anyway, so we might just as well distribute some money to everyone to simplify things). I think voluntary taxes could work too, by limiting some rights (customer rights, copyright, saving accounts, trademarks, patents, etc) to taxpayers.

I think a good ICO to solve the problems would be more constructive than abandoning cryptocurrencies (some coins already solve a subset of problems). Just a suggestion ;)
denis bider said…
Block size limit is a one line change, yes. That single change would make BTC viable as-is. But Core has to agree to do it. :)

Lightning Network can work, except for no decentralized path finding. The absence of decentralized path finding is what's going to reduce it to a mesh of smaller central authorities.

Then, according to current US law, such smaller central authorities have to be licensed as money transmitters.

The blockchain is already a consensus mechanism. It does not fix an information monopoly.

Hype wears off, yes. One way or another. :)

See Ethereum for fortunes lost in buggy smart contracts.

Mining is needed forever, that's what provides stability. The more valuable the currency, the more mining is needed to keep it safe.

It's true it's possible to replace mining with a different wasteful activity, but here's an economic argument on why it's ultimately impossible to avoid an equivalent amount of waste:

http://www.truthcoin.info/blog/pow-cheapest/

Assumption of distrust in design is not optional, if you remove that, you just have plain old fiat.

Smart contracts that purport to solve blind trust need to be implemented by something, and users need to blind trust that.

Small inflation of M0 can be programmed, yes. Can't target GDP though, or react to economic circumstances. Central banks don't just target inflation of M0, they target velocity of money in the economy. This is greatly dependent on behaviors like lending and saving. These behaviors are variable over time, and may require much greater changes in M0 and/or interest rates to compensate. A coin without a central authority cannot. Fixed small inflation of M0 is insufficient.

I don't see how a distrust-based currency that operates by consensus can maintain an effective monetary policy. Current evidence is that it can't even maintain a block size that would allow for it to be useful as a currency.

You don't get out of AML/KYC requirements by getting into crypto. Instead, AML/KYC requirements become part of crypto.

Visa adopts innovations slowly, but it does slowly adopt them. Chip cards are now the norm, for example. But if cryptocurrency grows to the size of Visa, it will innovate even more slowly, because it doesn't have a "this shall happen" mechanism. Consensus based mechanisms are notoriously behind the times compared to mechanisms with a prominent core that can decide to do something. It's why the US is not combating climate change right now even though the rate of climate change is already appalling. It's why BTC is not useful as a currency right now. Cannot adapt to accommodate growing interest, because based on consensus!

I don't think cryptocurrencies need to be abandoned. I think they will exist, I just don't think they're a good fit to be the main currency for an economy, either local or global.
Boris Kolar said…
The argument that PoW is the cheapest is really interesting. I've had a hunch that something about PoS and PoB (proof-of-burn) doesn't add up. I also have a feeling that the number of miners will gravitate towards 2. The idea of wasting huge amounts of energy for mining is troubling; I'd be happy to see an alternative. There is hope, because sometimes we get a practical solution for a provably unsolvable problem (like Bitcoin solves the "unsolvable" Byzantine Generals problem).

Could the "consensus stifles innovation" problem be solved with a system where lack of consensus would trigger an election of a smaller group (possibly recursively) that would resolve the proposal?
denis bider said…
I didn't understand it in the way that PoW is cheapest. More that, if a crypto currency offers a reward in exchange for "proof of X", then the economic cost of the induced waste is always going to equal the value of the reward, no matter what X is.

Wasting energy is not so much a problem as heating the Earth is. Right now, our Sun releases about 3.846 × 10^26 Watts of energy, and we waste 99.999...999% of it, simply because it radiates into space.

The energy used to mine Bitcoin doesn't have to heat the Earth. For example, international law can require that 100% of all energy has to be generated in a 100% renewable, temperature-neutral way.

The true economic cost is not measured in energy, but in human time – the work that must be redirected to generate and "waste" energy. It is opportunity cost. But there is such built-in waste in capitalism itself. Why have industries with anywhere from 2 to thousands of companies competing to do the same thing, when a single company could do it more efficiently? Because a single company can fall in a rut, and without competition, there's no force to dislodge it. The benefits of innovation are greater in the long run than the waste from competing.

In a similar way, maybe it turns out that the benefits of cryptocurrency are greater in the long run than the economic cost of proof.

My only proposal to solve the consensus problem remains graph-based democracy. :-)

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