The other day someone on Twitter linked to this very interesting essay by Marc Andreesen of Andreesen Horowitz, the prominent venture capital firm, which I highly recommend if, like me, you missed it when it was published in 2014. I think the essay crystalized for me two points in the cryptocurrency/blockchain discussion that are sometimes passed over or muddled.
The fundamental value of Bitcoin is the value of dedicated computing power
If you’re of a certain age, you may remember a program called SETI@home, which took advantage of your computer’s processing power (and your home electricity) when idle to search the vast amount of data cataloged by the SETI project for signals which might be signs of alien civilizations. Many of my friends enabled it as their screensaver, and we got a little philanthropic (xenophilic?) rush whenever we saw our crummy little computers parsing through millions of bytes of data. We never found an alien, though.
The same principle applies to Bitcoin, except instead of feeling good about using (wasting?) the free electricity our college provided, Bitcoin miners get to feel good about earning Bitcoin, which has value in the real world when converted to money, which can be exchanged for goods and services.
As I think the Andreesen essay makes clear, the value of Bitcoin is the value of being able to call upon the electricity and computing power of Bitcoin miners to process, verify, and record Bitcoin transactions.
Bitcoin as a currency is utterly irrelevant to this process — miners’ compensation is denominated in Bitcoin but they are free to instantly exchange their Bitcoin for their home-country currency at the prevailing exchange rate. That exchange rate, meanwhile, is set as all such rates are by the supply and demand for Bitcoin or by the laws of the country in question. It may be illegal to exchange a country’s currency for Bitcoin, for example, or a country may set a fixed Bitcoin exchange rate. A sustained high exchange rate between Bitcoin and a country’s currency is supposed to bring more miners online. But they don’t have to keep the Bitcoin they earn; on the contrary, the reasonable thing to do would be to sell the Bitcoin for their country’s currency, because money can be used to pay for goods and services.
Note that I said this is the logic behind the fundamental value of Bitcoin. That’s to distinguish it from the price of Bitcoin. The price of Bitcoin is established by the amount people are willing to pay for it, and the price people are willing to sell it for. But its fundamental value is established by the amount people are willing to pay for the computing power needed to process transactions on the Bitcoin blockchain in a given amount of time (the more computing power is available to the system the less time a transaction takes to be verified).
The difference matters because the price of Bitcoin should be irrelevant to the users of Bitcoin. If you are using the blockchain to transmit money from the United States to Canada, you should be concerned with the exchange rate between the US and Canadian dollars. Assuming the exchange rate between each currency and Bitcoin corresponds to the exchange rate between the two currencies, and assuming all 3 exchange rates remain stable during the time the transaction takes to process on the Bitcoin network, the price of Bitcoin is irrelevant to the transaction. Whether US$1,000 buys 4 Bitcoin or 0.25 Bitcoin is irrelevant if the Bitcoin are immediately converted to CAD$1,219.60 (as of today).
That’s a lot of assumptions! Maybe the USD:BTC and BTC:CAD exchange rates don’t correspond to the USD:CAD exchange rate. Maybe the value of Bitcoin is so volatile, and there’s so little computing power available to the system, that one participant or the other is unwilling to take the risk of seeing their payment swing wildly in value either up or down: after all, no one wants to pay $1,500 for something they planned to pay just $1,000 for, and no one wants to receive $500 for something they planned to sell for $1,000.
On the other hand, this is the kind of problem late capitalism is extremely adept at solving. A company offering international transfers using the Bitcoin blockchain could buy insurance contracts against short-term swings in the value of Bitcoin relative to the currencies it operates in. A sufficiently large company could even choose to self-insure against those swings. In other words, they could guarantee a given USD payment would be a worth a given amount of CAD to the recipient, even if the BTC-intermediated exchange rate fluctuated in that time.
Bitcoin is not a way of opting out of the real world
The other thing that Andreesen’s essay makes clear is that Bitcoin and its blockchain will only ever be overlaid onto a world of humans, governments, and laws — what some wags used to call “meatspace.”
Consider the Dread Pirate Roberts, who ran the Silk Road marketplace on the dark web in the early days of both the TOR anonymous browsing service and Bitcoin. To be as reductive as possible, Silk Road served as a non-state intermediary between buyers and sellers. A buyer would send Bitcoin to Silk Road, the seller would send the guns, drugs, porn, or whatever to the buyer, and then Silk Road would release the Bitcoin to the seller.
This system only worked for as long as it did because people trusted the Dread Pirate Roberts, whether because of his libertarian screeds online or the simple reputational value of having successfully executed so many transactions.
But the fact is, Western civilization is built upon an extremely similar system, whereby trust between buyers and sellers isn’t necessary because the state is present to mediate complaints between them. If you pay someone for something and they don’t provide it, you don’t need the Dread Pirate Roberts to take out a hit on them; you can sue them. If you sell something and the buyer never pays you, the courts are likewise open to you. It can be a real hassle, but it’s a lot less of a hassle than tracking them down and killing them.
Conclusion: I am optimistic about Bitcoin and remain totally agnostic about Bitcoin’s price
Thinking through Andreesen’s essay I found myself thoroughly convinced that distributed blockchain technology is an important technological advance which will eventually be used to verify and record many kinds of transactions. The financial press has an unfortunate tendency to focus on the price of Bitcoin, since that’s the metric they’re used to covering and Bitcoin devotees have elected to call Bitcoin a “cryptocurrency,” as if there were goods and services denominated in Bitcoin, rather than mechanical conversions between Bitcoin and real money (which Bitcoin’s devotees derogatorily and hilariously call “fiat” money).
But it would be perfectly reasonable to report news about the average time Bitcoin transactions take to complete, the typical volatility of exchange rates between Bitcoin and real currencies, and any resulting distortions introduced in those exchange rates. That would give news consumers a real idea about how ready the Bitcoin blockchain is to handle large numbers of real-world transactions.
But the price which speculators are willing to pay for Bitcoin will never matter, except to the extent it brings additional computing power online or pushes it offline as unprofitable.
“except instead of feeling good about using (wasting?) the free electricity our college provided”
I did this! Mined a bunch of litecoin a couple years ago when I lived on campus, and recently sold all of it for $3660.
Fiby,
I love it! Nice haul.
—Indy
There’s an investment style where 90% of your assets are in very safe assets, and you chase black swans with the other 10%.
If anything in this universe is a black swan sitting up and begging to be noticed, blockchain technology is. But given the proliferation of different xCoins, which one(s) is going to blow up 1000X, if any? I’m thinking that blockchain technology will be in common use at banks, but the denomination will be the plain old US dollar. I’d be surprised if cryptocurrencies ever represent more than 1% of the economy.