Friday, March 07, 2014

Why Libertarians shouldn't use "The Currency of The Greater Fool" (BitCoin)

Guest Post by Neal Reynolds

[Note from KN@PPSTER: Yes, I am a Bitcoin supporter -- maybe even a bit of a Bitcoin evangelist. I disagree with Neal, in conclusion and in certain details, as I'll make clear in comments or a rebuttal piece. In the meantime, enjoy and feel free to debate as well!]

Despite how much the BitCoin system has been in the news lately, the two vital reasons for libertarians to avoid using it have gotten very little (if any) mention.

First, unless libertarians divest immediately, when the almost inevitable BitCoin system collapse happens libertarians will be the main group to be blamed, doing significant damage to our cause. Second, even if the BitCoin system doesn't collapse, it almost certainly wouldn't exist in the first place if we had a more libertarian society.

The first step to understanding all this is to realize that, despite what some advocates say, BitCoins do NOT have any value just because the math required to "mine" them took a lot of computer time and some electricity.

Consider this analogy: Say a currency system was proposed whereby people earn "HoleCoins" by digging a big hole in their back yard, taking a digital picture of it (a picture that incorporates the precise GPS location of the hole), then filling it back in.

Do you really think others would be willing to pay the digger for that unique "HoleCoin" (GPS coordinate number), just because it took a lot of effort to dig that hole and fill it back in? Of course not! Just because something took a lot of effort doesn't mean it has value.

Alas when such "make work" is shrouded in computers and math people are much more easily fooled. For virtually all the work done in finding a BitCoin is not real work (such as processing and validating transactions, which for today's computers is fairly trivial), but "make work" made artificially difficult for no other reason than to make BitCoins take a long time to calculate ("mine").

Specifically, the protocol requires doing the validation of the most recent block of transactions over and over again until the result ("the hash") conforms to an arbitrary (and rare) pattern. The hash value is different each time because the block contains an arbitrary extra data value (the "nonce"), which is changed to a different random value before each block validation iteration.

For instance, to give a very simplified example, say you had to keep multiplying eleven large numbers together (ten unchanging real data values and one arbitrary one changed at random) until the digits of the answer met a certain pattern. Such as, say, the third digit was a seven, the eighth digit was a 3, and the tenth digit was a five.

Clearly this would take a lot of computing time, but in the end (perhaps after a thousand iterations) you don't have anything more of value than you did after the first iteration. The rest of the computation is simply to waste computer time (and therefore, green folk, electricity), because computers are so fast these days and the first computer in the BitCoin network to find the "nonce" value that results in a hash conforming to the designated arbitrary pattern is awarded twenty-five credits ("BitCoins").

(By the way the real BitCoin algorithm is far more complicated than the above example, enough to make it impossible to "reverse engineer" the "nonce" value or speed up the process by storing temporary values from one iteration to the next.)

Now, if you're lucky enough to be talking to one of the few BitCoin advocates who understands all this (and heaven help you if you're talking to one of those people who insists that BitCoins have value because "they're backed by math, man!"), he or she will likely insist the fact that BitCoins lack any intrinsic value doesn't matter as people can place value on anything they want to and, further, anything that two or more people place value on can be used as currency.

Which, as far as it goes, is true. However, never before in history have humans voluntarily and widely used for currency something which has absolutely no intrinsic value to anybody. But that is what Bitcoin users are doing, for if the system goes away then those BitCoins have absolutely no value. It's not like you can say, "well, I had five hundred dollars worth of BitCoin in my wallet yesterday and now that the system is going out of business I want my five hundred dollars back." To use an old saying, there is no "there" there!

Contrast this with metals, grains, lumber, and so forth which have intrinsic value beyond their use as currency. In fact, contrast BitCoin with Paypal! If it had to go out of business for some reason, users would likely be able to get back all or most of the money in their accounts. Why? Because dollars have value outside of the paypal system! This fundamental difference between Paypal and Bitcoin is something that can't be emphasized enough, and yet my impression is that most BitCoin users haven't thought much about it.

Furthermore, until we went off the gold standard even dollar bills could have been exchanged for a certain weight of gold if everyone decided to stop using dollars.

(And even now, to figure out the approximate intrinsic value of a dollar bill all you have to do is figure out how much the supply of money has been inflated since we went off the gold standard (I'm guessing there's at least ten times as much) and divide the value of a dollar (in gold) the day before it went off the gold standard by that factor.)

But BitCoins have no such intrinsic value. So why are so many people using them? I submit it's a variation on the familiar "Greater Fool" theory. That is, some people will buy stocks (or real estate) for far more than their intrinsic value because they think someone else (the "Greater Fool") will buy it from him or her later for even more. Of course bubbles never last forever, and when they collapse not only are fools hurt, often (sometimes due to government intervention) others are as well.

In the case of BitCoin probably the most likely way for the bubble to burst would be for some enterprising hacker to discover a way to breach the privacy protections and publicly post the transaction histories of random users on the internet where everyone can see them... no matter how personal, embarrassing, or legally problematic the purchases (and/or sales) may have been. And once people start leaving the BitCoin system in droves the value of the BitCoins will plummet from fifty dollars (or whatever it is currently) to near their intrinsic value: zero. Meaning a lot of people will lose a lot of money.

Why do I care so much, even though I've never used BitCoin? Because society at large, especially "progressive" democrats and independents, heavily associate libertarians with BitCoin. (And alas, from what I've observed, rightfully so.) So when the BitCoin bubble bursts it won't be the Establishment Party that is blamed, but libertarians... costing us significant harm in the eyes of independents who were leaning libertarian.

I think there is still time for libertarians to distance themselves from BitCoin. (I am not optimistic they will, however, based on all of the BitCoin ads I see on libertarian and semi-libertarian web sites.)

Now I know many BitCoin advocates will point to all of the great features (including the latest proposed enhancements) that protect a person's privacy. Especially the fact that the network doesn't store a person's name or address, just the address of their "wallet" (of which any given user may have several for extra protection if they want to go to the trouble).

But having been a computer programmer for over twenty years I just don't believe that any system can be secure when every single transaction ever done exists on the database forever, and that database exists on every computer in the network, and (worst of all) that database can be accessed by any new computer that claims it wants to be in the network (in order to "mine" for the remaining BitCoins).

Especially since there is tremendous incentive for a group of hackers to breach the system! Why? Because (if I understand correctly) derivative markets in BitCoins are springing up more and more, whereby one can buy options (like with stocks) to buy and sell BitCoins in the future at a set price. Meaning that if you know the perceived value of BitCoins are going go way down you can make a lot of money.

As far as I know, there is nothing to prevent someone from coming up with software that will trace the entire transaction history of a BitCoin user's address ("wallet") and then (using other publicly available sources and statistical methods) figure out from this "meta data" who that address belongs to.

(One way someone might find out a wallet owner's true name and address would be by simply sending them a free [or discount] coupon for something which, if used, reveals the owner's name and address. Another way is of course malware on their PCs or Smartphones (perhaps embedded in the latest cool game).

Or simply, as in old fashioned detective movies, "tailing" a person when they make a purchase in a physical store. If you know the date and time [to within a few seconds] and location of the transaction and who made it, I think you are a long way to figuring out that person’s wallet number. If that’s not enough, get behind him in line and purchase the same item. (And if that isn't enough, return the item the next day when a different cashier is on duty and ask for a refund, giving the other person's name and see if they will credit your [his] wallet with the refund even though you "forgot" it.)

Has any BitCoin advocate out there actually used this example (you know everything about the transaction except the wallet address because you bought the same item(s) right behind a person of known identity) and proven that, even with advanced mathematics and computers, it isn't possible for a group of brilliant hackers to figure out the wallet address? (And therefore all previous purchases using by that person using that used that same wallet?)

Don't get me wrong: I am a proponent of alternative currencies. But each piece of paper should have some intrinsic value, whether in terms of gold (or something else tangible and valuable to virtually everyone) or a unit (such as an hour) of a person's time.

After all, that's all money ultimately is: A means to exchange our time with each other. (Or possessions, but for the most part we acquired the possessions in the first place with our labor/time.)

I think alternative currencies are best used locally, and as far as the larger picture goes the best thing to do is spend one's energy trying to get rid of The Fed (and making it illegal for the government to increase the money supply any further). I think if that was done the rest will pretty much take care of itself.

(At least, it will if we have a libertarian society in general; after all, dollars [in either cash or electronic form] can be an acceptable means of exchange in most circumstances so long as the government can't artificially inflate [or deflate] the supply.)

I still maintain that the real purpose of BitCoin was (or has become) to enable large-scale speculators to make money off of it at the expense of all of the "little people" who are basically using it for fun. Which brings me to why, even if I knew that BitCoin was completely private and secure, I still wouldn't use it: it relies on the fact that we don't have a free-market!

Virtually nobody would put up with the wildly fluctuating, zero-intrinsic value BitCoin system if crypto-currencies backed by gold (or even dollars) were available, but our oppressive government has made it clear (as the people behind e-gold and Liberty Dollars and others have learned the hard way) won't permit that.

(Heck, most people probably wouldn't use BitCoin even if all that was different was the Fed was abolished, preventing the government from constantly manipulating the effective number of dollars in circulation.)

So, ironically enough, the very fact that the BitCoin system is based on "The Greater Fool", rather than something of intrinsic value, is probably what is keeping everyone who owns a computer in the BitCoin network (or at least a sampling of them) out of jail.

Now I realize that for some users the benefits of BitCoin outweigh the risks. But I think for most users it doesn't; it’s just that they've been so bamboozled by borderline fraudulent statements by some advocates ("BitCoins have value because they took computer power and electricity to mine them"; "it's backed by math!") that they think it is a far better deal (less risky) than it really is.

But even if we rule out outright fraud on the part of BitCoin advocates (since the system is admittedly pretty technical and prone to misunderstanding by non-programmers), I decided long ago that I (unlike many libertarians) was not going to take advantage of government oppression to make money. (In fact, I've written and posted essays explaining in detail how I won't even go to casinos because most of their profit is derived from the fact that gambling is illegal in 99% of the country.)

And, just like libertarians who make a lot of money defending drug dealers don't have much incentive to get drugs legalized, those who make money from BitCoin (or hold millions of dollars of it) actually have a large disincentive against doing things in their daily life that will bring about a more libertarian society (that has better alternatives to BitCoin).

(But they do not deserve all the blame. I've long felt that one of the reasons we haven't made more progress towards a libertarian society is because so many libertarians actually make their living off of government oppression. Obvious examples are most lawyers (especially tax, drug, and patent, no matter which side of the aisle you are on), electronic and software engineers whose high pay is partially a result of their companies use of abusive patent law, and science geeks whose funding comes from NSF grants. But there are even less obvious examples, such as Certified Public Accountants [to the extent that a significant portion of the demand for CPAs is due to the demands of the government, not intrinsic business needs].)

Finally, if you’re still not convinced that you shouldn't be using BitCoin I highly recommend reading the following links (most are are fairly short and easy to understand). Even though the organization that wrote most of them (Coindesk) loves BitCoin, I maintain that the information they provide actually supports most of my points.

(And I especially like how they admit that at this point the probability of anyone with just a PC ever mining a BitCoin again is almost nil since most miners are now using high-speed hardware add-ons to make the calculations faster. And if you buy advanced hardware to put in your PC you still probably won't mine more than what you need to cover the cost of the hardware. So forget your fantasies about making money mining BitCoins; that time has apparently passed.)


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