Bitcoin 101 with Brett Scott
Bitcoin, an alternative currency protected by cryptography, has been popping up all over the news for a while. First, Bitcoin-driven marketplace Silk Road shut down. Then the Japanese Bitcoin exchange Mt Gox crashed (and is now bankrupt). You can make real-world Bitcoin transactions at a Bitcoin ATM in Texas. And then of course there’s Dogecoin (much coin, very currency).
As skeptics, we wanted to know: should we be skeptical about Bitcoin? How does the currency really work, and what are some of the opportunities and risks we need to be aware of? To find out more, we talked with financial activist Brett Scott to discover the ins and out of Bitcoin. We first learned about Brett through his awesome post on gender inequality in the cryptocurrency world, another issue worth exploring in depth. Before diving into the interview below, you might want to check out Brett’s guide to explaining Bitcoin to your grandma to get oriented.
Do people need to know how to code, or understand cryptography, to use bitcoins? To mine them?
Brett Scott: No. In much the same way as we don’t need to know how to code to engage in normal electronic financial transactions, coding experience is not required to use Bitcoin. It’s actually easier than using online banking. To open a Bitcoin ‘bank account’ you just download a wallet like Multibit, and you’re good to go.
Mining is slightly different. To continue the analogy with bank accounts, being a miner is a bit like being a clerk at the bank in charge of processing other people’s transactions. That requires more expertise. But you don’t have to mine to participate in Bitcoin.
What protections are in place against manipulation of Bitcoin?
Brett: If you have a Bitcoin wallet, it’s up to you to protect it, much like if you were carrying cash around you’d have to protect it. There are many ways of doing that – such as adding a strong password to the wallet and backing it up – but it’s only really an issue if you’re dealing in large amounts of Bitcoin.
In terms of manipulation, the Bitcoin code is very secure, but it is technically possible for the exchange rate of Bitcoin to be impacted by the activities of large buyers and sellers. It’s pretty volatile, so I wouldn’t recommend someone converting their whole savings into it!
Is Bitcoin likely to be volatile indefinitely, or will it become more stable as more people adopt it?
Any new market tends to be volatile, but as more people join the volatility should decrease. Stability tends to emerge when no particular participant in a market has much ability to affect the decisions of any others. Thus, if there are 100 people in a market, it’s easy for them all to get spooked and panic, or for them to get euphoric and create bubbles. If, on the other hand there are 10 million people in a market, it’s harder for quick bubbles and crashes to occur.
Is Bitcoin a currency only a libertarian could love? Is it good to have a financial system based on lack of trust?
Brett: Bitcoin is pretty versatile, so it has the potential to appeal to a wide range of people. It’s true that it has found favour with right wing elements of the libertarian community, who see it as some kind of salvation from government domination, but there are interesting potential uses of Bitcoin that go beyond overt ideological agendas. Also remember that there are a lot of other cryptocurrencies, like Dogecoin, that are emerging and that have different types of communities that they attract.
In some ways, using cryptocurrencies require more trust than normal electronic transactions. If I use a bank card to buy something online, I have to trust a commercial bank to stand between me and a seller, but this actually means I don’t have to trust the seller as much, because I can always ask the bank to reverse the payment if the seller doesn’t send me the goods. Bitcoin is sort of the opposite. In place of the bank intermediary, Bitcoin has a network of anonymous people (‘miners’) who verify transactions between me and a seller, but this means I need to trust the seller more, because it’s impossible to reverse a payment once it goes through.
Is Bitcoin meant for near-term speculators or for long-term investors – or both?
Brett: Well, in theory it’s meant to be for neither – it’s meant to be a currency to be used in day-to-day transactions to purchase or sell real goods and services (just like the US dollar). It’s true, though, that many people have begun to imagine that Bitcoin is an ‘asset’ that you ‘invest’ in. A true investment, though, is something that produces stuff over time – like a factory or a farm. Bitcoin is only an ‘investment’ insofar as it’s ‘price’ (exchange rate with other currencies) is pumped up over time by speculation and by greater usage. I do not recommend viewing it as an investment. View it as an interesting alternative means of engaging in exchange.
How do Bitcoin investment vehicles like Bitcoin Investment Trust work?
Brett: They work like any other investment fund. You put your money (in dollars) in the fund, the fund managers use your money to buy Bitcoin, and then later sell it and then give you back any gains you’ve made (or losses). It’s kind of the same as putting your US dollars in a fund which then buys Russian Rubles. This is an example of viewing Bitcoin as an ‘investment’, rather than as a currency.
Are alternative currencies more likely to alleviate or exacerbate economic inequality?
Brett: It depends on what alternative currencies you look at. Bitcoin is just one type of alternative, and it has no explicit provisions built into it that prevent inequality. If anything, the prime motivation behind Bitcoin is to preserve individual autonomy, rather than say, promoting community cohesion or environmental resilience. This is in contrast to, for example, small local currencies or timebanks that explicitly link exchange into local communities. If you’d like to learn more about these dynamics, I wrote a piece about starting your own alternative currencies.
What are some of the biggest political advantages of Bitcoin? How do the exchanges differ in different countries?
Brett: We can describe the characteristics of Bitcoin – that it is decentralised, anonymous and open source – but the political values attached to those characteristics are really in the eye of the beholder. Libertarians see in it the opportunity to escape the government and taxes. Anarchists see in it the ability to create a mutualistic economy run on community principles. Silicon Valley investors see in it the chance to make loads of money by using it complement the existing banking system. And the governments of each country are reacting differently to it, partly depending on how citizens treat it (which may stem from those citizens’ values). Rich people in China, for example, were using it to get around government-imposed foreign exchange controls (i.e. getting their money out of the country), so the government is now clamping down on it there.
As alternative currencies evolve, will companies like Google get involved in creating currencies? What are the implications of that involvement?
Brett: Possibly. Big companies could create their own currencies in much the same way as they can create vouchers that can only be used to buy their products. Whether people would really want to accept those currencies is debatable though. The psychological power of our normal currency is partly backed by the fact that we know we can use it to pay taxes. Likewise, if there is a huge company that everyone uses – such as a big retailer – they may be able to issue vouchers that people begin to use among themselves as currency, secure in the knowledge that eventually they can be used to get real goods from the retailer.
What’s the best way for people to get involved with Bitcoin?
Brett: The best way is to set up a wallet like Multibit or Electrum and tinker around with small amounts of Bitcoin. If you’re self-employed you can even request payment for goods and services in Bitcoin, which is fun to try out. I personally sell my book for Bitcoin and other cryptocurrencies like Dogecoin, which is how I get hold of it. I then use it to buy stuff – I’ve bought design services with it, paid bills in it, paid interns with it, and I’ve even used it to buy stuff from Crypto-sex toys, which is pretty hilarious. The important thing is to experiment and try have fun, and if nothing else, you’ll learn a lot about how currency systems work or don’t work.
If Bitcoin has sparked your interest, try these further resources on it and other alternative currencies: Brett’s blog, Brett’s book, Bitcoin FAQ, and more.
On cryptocurrencies in different communities, my tribe is starting a cryptocurrency of our own, called the Mazacoin. (Maza means metal. As in mazaska and mazazi, silver and gold.) I don’t know all the economic details of it, though it is designed with a longer-term deflation curve than most cryptocurrencies.
Personally I see cryptocurrency as the logical extension of fiat currency, really. Currency only has value if we all agree it does, after all. But again, I’m not an economist.
I’m not seeing much skepticism here. The crash of Gox is only mentioned in passing as if it doesn’t matter. We already have one confirmed and one unconfirmed BitCoin suicide and a very large amount of real money has disappeared. There is widespread evidence of fraudulent activity in BitCoin, especially in exchanges reporting prices for coins. Gox used to post a very high buying price for BitCoin but you could only cash out $10,000 a month. So the price was never a true market price.
You can tell my position here from the title of my YouTube video: http://www.youtube.com/watch?v=dW8Mn2FaxNY
BitCoin is actually just the largest in a series of digital currencies. My first podcast on BitCoin gives a history of those schemes and how they turned out. BitCoin is only the first to hit the mainstream media but not even the biggest. Actual transactions in BitCoin that can be measured and verified are in the small millions of dollars a week. Most of the ‘transactions’ reported in the blockchain are just speculators endlessly churning their wallets to create the illusion of activity. eGold was much bigger at its peak than BitCoin is today.
Before BitCoin we had eGold and GoldAge and LibertyReserve, to name just three. The principals of the later just got long jail sentences. Like homeopathy these currencies have a solid theoretical basis just one that we have no reason to expect to be true. BitCoiners make a long list of speculative attacks on ‘fiat currencies’ and ‘fractional reserve banking’ but refuse to accept any discussion of the potential shortcomings of their own scheme.
Saying that BitCoin cryptography can’t be broken is similar to the claim in homeopathy that the medicine can’t kill you. The statement is technically correct but completely wrong in every meaningful respect. While homeopathic medicine itself won’t kill you, failing to take real medicine because you are taking sugar pills can. the cryptographic algorithms used in BitCoin are believed to have a very high work factor but the way those algorithms are used has received much less review and the implementation of those protocols is even more suspect.
What is worse is that the requirements that lead to the need for intermediaries and regulation in the financial industry are simply ignored. Which is how MtGox was able to destroy so many lives. Contrary to the ideology, BitCoin did need trusted parties and did not provide the necessary controls to make them trustworthy. If Gox had been regulated they would have been required to reconcile their cash holdings on an ongoing basis. They could not possible have burned through the cash without noticing it had all gone.
Gox was not the first BitCoin exchange to have issues, it became the largest as the survivor from the first generation BitCoin exchanges that went bankrupt after being hacked. There is no reason to consider the remaining exchanges any better than Gox.
And now this happened: http://www.theguardian.com/technology/2014/mar/04/bitcoin-bank-flexcoin-closes-after-hack-attack
“the way those algorithms are used has received much less review”
I’ve seen a lot of crypto people reviewing the protocol in a deep way. It seems to be built on standard primitives used in pretty standard ways. So far, I haven’t heard any criticisms of the protocol from mainstream crypto community. In fact, they mostly seem to be impressed. Have you heard anything negative?
“the implementation of those protocols is even more suspect.”
Absolutely. We’re seeing this problem constantly. Then again, secure implementation of cryptographic protocols has been a problem everywhere. Look at the recent failings implementing SSL in iOS/OSX and WeMo devices. There are holes everywhere.
“I’ve seen a lot of crypto people reviewing the protocol in a deep way. It seems to be built on standard primitives used in pretty standard ways. So far, I haven’t heard any criticisms of the protocol from mainstream crypto community. In fact, they mostly seem to be impressed. Have you heard anything negative?”
Well there is the transaction malleability bug for a start. This was discovered by people looking at BitCoin, not Satoshi or the dev team.
The reaction of the BitCoin community was not exactly stellar. They just respond to bug reports saying ‘we know about that’. Hmmm…
That is not something that the crypto community would do. But it is something an economics prof obsessed with self executing contracts would do.
From my understanding of BitCoin:
* It is wasteful. Every transaction requires significant utilization of real world hardware and electricity. (This hardware and electricity is provided by the miners, in return for newly minted bitcoins.)
* It’s anonymity is limited. Every single BitCoin transaction is broadcast to the world. You can bet that the three letter agencies have archived every one of these transactions. These transactions are between anonymous bitcoin wallets, but if you know enough about a wallet’s transactions, you have a big handle on who owns it.
* It is not scalable, by virtue of the previous point. If everyone used bitcoins for day-to-day spending, every day billions of transactions would need to be broadcast to hundreds of millions of miners, and most of the world’s electricity would be expended on the overhead of the currency system.
Because of these points, I think if bitcoin does have a long term future, it will necessarily acquire an intermediate level of bitcoin banks. You maintain a balance at the bank, transactions are performed within and between banks like electronic fund transfers are done today with standard currencies, and every so often the banks settle differences between them with actual bitcoin transactions. (Like in the old gold-standard days: most of the time you just shuffle bits of paper between banks or nations, but every so often you need to settle up with a shipment of bullion.)
Of course, at this point, almost all of the reason for existence of bitcoin is lost.
I agree with Philip – this was a ‘skeptic’ article? It came across as more like a PR piece for Bitcoin.
What Brett doesn’t say in his comparison to banks is that banks are regulated and have government oversight and guarantees. So no, they do not work like any other investment fund, or work like a bank account. That’s the flip side of the no regulations, no taxes, no banking, no government mantra – when things go pear-shaped, you can’t go running back to the Nanny State and demand it help you get your money back.
Bitcoin: for the people who thought Icesave was too stable…
From my point of view, the biggest problem is that there’s no government or real economy underlying this currency. One of the reasons that USD is such a popular currency is that it’s backed by the US government and there is a huge and (relatively) stable economy in USD that is not going to switch to a different currency. All it takes is a crisis of confidence, and suddenly you won’t be able to buy so much as a stick of gum with your BitCoin account.
It’s all very well and good to say “USD is a fiat currency,” but there’s a huge difference between a “fiat currency” that the economic powers of the Earth have an interest in keeping stable, and a fiat currency that is backed by nothing more than sales talk. And BTW is being promoted by the same people who brought you the financial crises of 2008, Enron, the S&L debacle, the death of Lehman Brothers and Merryl Lynch and the ongoing leverage-and-gut style of management. Not to mention the destruction of the ISK.
It’s too bad you didn’t ask Brett Scott about Bitcoin being inherently deflationary, and the implications of that for its future and/or potential use as currency. It’s the main issue I’ve seen brought up by its critics from an economics point of view. From an admittedly tiny sample (I haven’t particularly researched what everyone says about Bitcoin) the only Bitcoin enthusiasts I’ve seen discuss this were in this Less Wrong thread :
Note the same post asserts that Bitcoin being deflationary means its value is inherently volatile, contrary to Brett Scott’s answer that its volatility is related to the currently small number of people using Bitcoin.
On the same website someone brought up another Bitcoin-like cryptocurrency that claims to avoid the deflation issue by using “demurrage fees”, something I’d never heard of before (it basically amounts to paying a fee the longer you hold money instead of spending it, which like inflation encourages spending over saving).
I’m curious as to whether this would work, or be of any interest if it did.
To be perfectly frank, I don’t really give a shit about bitcoin. It’s useless to me, as a fairy and consistently broke person who has enough time dealing with real money.
It also makes me raise my eyebrows to know that “anyone can come up with their own virtual money system!”
Oh. Okay. Sorry but … lol.
So can I just use World of Warcraft gold, instead?
fairly* heh. I’m not really a fairy :)
I don’t know, most currency has a ‘clap your hands if you believe’ feel to it.
Anyway, I have issues with the way Mazacoin is being handled myself. (Though it is being handled better than most cryptocurrencies, mostly because it’s designed to be mined in perpetuity, and its deflationary curve is plotted out for years.) The creator’s plan is to have it be a pan-indigenous currency. (This type of thing already exists; poor communities in England print their own currency, though the Crown doesn’t recognize it.) I have to wonder, since, of course, a number of indigenous peoples don’t actually have access to the type of tech to mine coins. (Cell phones are common in indigenous communities worldwide, but computers, less so.) The beginning plan (a bit optimistic, IMO) is that in 12 months, half of all vendors on Pine Ridge will accept Mazacoin, and it can go for there.
So, there are flaws with Mazacoin. And it’s one of the better-thought-out cryptocurrencies.
Maybe but not nearly THIS much. This is just silly.
UPDATE: Turns out, Mazacoin never got off the ground. Bryan Brewer even went out of his way to disclaim it.
Now the Mazacoin people are trying to get Canadian Indians to use it.
What differentiates BitCoin and other pure make-believe currencies from government currencies is that you can pay your taxes with dollars or pounds or whatever.
LETS in Manchester (search LETS GO) has been around for many years. But it is designed to be inflationary. It is used by a community that has a deflation issue to create demand.
BitCoin is a rich man’s currency, Distribution of coin is to people with the capital to mine. The mining operations produce zero social value.
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