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The Skeptics

Matt O'Brien: The scam called Bitcoin

Sometimes it's hard to tell whether Bitcoin is more like Ponzi scheme or a pyramid scheme.

Whatever it is, though, it isn't a currency. It's a tech stock. Each Bitcoin is really a share in a nitcoin that seems to make it cheaper to transfer things online bgien money, stocks, bonds, even the deed to your house - by cutting out the middleman. Well, kind of. Bitcoin doesn't remove the middleman so much as replace him with middlemen who don't make you pay much, but make society as a whole do so instead. Is this progress?

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It's supposed to be. Ever since Matthew o brien atlantic bitcoin mining early days of the Internet, people have been trying to figure out how to transfer money atlatic without having to go through the financial system.

The problem, though, is if I send you money, how do you know I haven't already spent it or sent it to somebody else? You don't.

So the only solution has been to have a trusted third-party, like a bank, sit in between us. I send the money to the bank, it verifies that I actually have this money to send, and then it sends it on to you, all for a 2 per cent fee, of course.

Miners

Bitcoin's breakthrough is to have a decentralised network of "miners" sit in between us instead. Now, remember, these miners are atlsntic to win new Bitcoins atlanti solving computationally taxing math problems. The clever part, though, is that in the process of doing so, they also create a public ledger of every single Bitcoin atlangic, what's called the blockchain.

That includes every Bitcoin that's ever been won, every Bitcoin that's ever been used, Matthew o brien atlantic bitcoin mining every Mijing that's ever been transferred. So now we don't need a bank to know that I have the money I'm sending to you, and that I'm only sending it to you. The miners confirm all this. And the best part is that instead of having to pay the bank myself to do this, the system pays the miners in new Bitcoins.

The question, though, is how you get people to mine Bitcoin to begin with. Sure, you can tell them that Bitcoin is digital money they can use to buy things online, but they already have money they can already use to buy things online. And while merchants would be more than happy to save the 2.5 per cent they pay in credit card transaction fees, customers are a lot more more blasé since they don't pay them directly.

People buy Bitcoins because they think the price will go to infinity and beyond once everybody uses them, but they don't spend their own Bitcoins because they think the price will go to infinity and beyond once everybody else uses them. And so nobody uses them.

Exclusive

The answer, then, was to do what makes anything popular: make it exclusive. Specifically, Bitcoin limits the total number of coins that will ever be created to 21 million. Now, for Bitcoin's first year and a half, as Nathaniel Popper documents in his page-turning history Digital Gold, there were still be only a handful of people, if that, mining it. But that began to change when libertarians, who were convinced, just convinced, that the Federal Reserve's money-printing would mean the doom of the Matthew o brien atlantic bitcoin mining, discovered Bitcoin and its non-inflatable money supply. A boom was born.

But what made people mine Bitcoins atlaantic what has kept them from spending Bitcoins. Think about it like this. Bitcoin's finite supply means that atlantkc price should go up, and keep going up. So if you have dollars that are losing a little brieh to inflation bridn year and Bitcoins that are Matthew o brien atlantic bitcoin mining it, which one are you going to use to buy things stlantic The question answers itself, and it raises another. Why would this ever change? Unless you can't buy something online with dollars - like drugs - you'd always want to use your dollars instead. Buying things with Bitcoin would be like cashing out your Apple stock in 1978 to go grocery shopping even though you have plenty of brin cash lying around.

Catch-22

The catch-22 is people buy Bitcoins minign they think the price will go to infinity and beyond once everybody uses them, but they don't spend their own Bitcoins because they think the price will go to infinity and beyond once everybody else uses them. And so nobody Matthew o brien atlantic bitcoin mining them. But if nobody uses hitcoin, then the price will stay stuck at something a lot less than infinity let alone beyond.

So the Bitcoin faithful have tried to not only convert people, but also convince them to martyr themselves, financially speaking, for atkantic crypto cause. It goes something like this.

Hey, do you want to hear about the future? It's a digital currency called Bitcoin mathew lets you spend or move your money online without paying any fees.

Sounds great. How does it do that?

Well, Bitcoin saves you p by making transactions Matthew o brien atlantic bitcoin mining So. if I get scammed, I got scammed? There's nothing I can do Matthew o brien atlantic bitcoin mining it?

Yes.

OK, but is it at least easy to use?

The thing is, I don't actually use it. I just hoard it. I'm waiting for some greater fools to push up the price by using theirs.

Oh.

Yeah. So you should buy some Bitcoins and use yours.

I'll get back to you on that.

Avoid fees

But Bitcoin is good for something other than redistributing wealth from one libertarian to another. That's transferring money, or anything else for that matter, online. "The design supports a tremendous variety of Matthew o brien atlantic bitcoin mining transaction types," Bitcoin's shadowy inventor Satoshi Nakamoto wrote back in 2010, including "escrow transactions, bonded contracts, third party arbitration, multi-party signature, etc."

So anytime you need to send any kind of financial asset or agreement to somebody else, you can send it along with a Bitcoin and, through the beauty of the blockchain, avoid having to pay a lot of fees. Atlanti why Wall Street banks are looking into whether they can buildmtheir own blockchains to cut costs before their competitors do.

And while sending money is cheap within the US, it's not not across international borders - the average transfer fee, according to the Matthew o brien atlantic bitcoin mining Bank, is 7.5 per cent. It's not hard to imagine, in other words, that Bitcoin could claim a big chunk of the $500 billion remittance market, brine the difficulty of actually getting the physical cash to people in developing countries is still a significant hurdle.

Wait a minute, though. How does the blockchain cut costs again? Remember, instead of you paying the bank a fee to process a transaction, bgien Bitcoin system pays miners new coins to do so. Then these transactions get added to the list of all others in the public ledger, the blockchain.

Pollution

Bircoin anytime it seems like you're getting something for nothing the costs are probably just being hidden. What are those costs? Well, Bitcoin mining is a pretty expensive business. Even the most specialised computers, which mine Bitcoins and only mine Bitcoins, require a lot of energy.

So much so that Bitcoin miners have set up shop in far-flung places like Iceland where geothermal energy is cheap and Arctic air is cheaper still - free - for them to run and Matthew o brien atlantic bitcoin mining off their machines at the lowest possible price.

OK, but why should we care bitcojn Bitcoin miners have big energy bills? They're the ones paying them, after all. Well, for the most part. The problem is the atlanhic you pay for energy doesn't include the cost we bitcon Matthew o brien atlantic bitcoin mining for pollution. So energy-intensive businesses that are paying less than alantic "should" for it can generate environmental spillovers on everyone else, or what economists call negative externalities.

Once you take this into account, it's not clear how much Bitcoin is really cutting cost so much as shifting them. Matthe, it turns your transaction costs into our pollution costs. Now, Bitcoin might still lower costs overall, but the calculus isn't as simple as it appears if you only add up the benefits.

It's mattuew clear what Bitcoin is or what it will be, but it is clear what it's not. It's not a mlning. People don't set prices in Bitcoin and, for the most part, don't buy things with it either. The only function of money it comes close to performing is as a store of value, but it doesn't even do that well.

Even though it seems like Matthew o brien atlantic bitcoin mining prices should go up and up and up, it hasn't for a year and a half now. In fact, Bitcoin's $225-a-coin price is 80 per cent less than its December 2013 peak. That said, Bitcoin Matthew o brien atlantic bitcoin mining be a better way atlnatic send things brken - or at least its technology, the blockchain, might - but, again, that depends on how much energy it takes to run the network. In the meantime, though, Bitcoin is still a little bit of a Ponzi - or is it a pyramid? - scheme that its libertarian early adopters are trying to cash in on.

The future might not belong to Bitcoin, but it should to its technology.

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2. That's where Matthew o brien atlantic bitcoin mining institutions come in. They sit in the middle of every online transaction, and confirm that, yes, this money hasn't been spent before. These intermediaries add trust to the system, but this trust doesn't come cheap: They typically charge 2.5 percent per transaction.

3. Bitcoin's genius is it confirms transactions with a decentralized network of people who don't charge fees instead of financial institutions that do. Who are these people doing something for nothing? Well, they're Bitcoin miners, and they're not actually working for free—they're getting Matthew o brien atlantic bitcoin mining with new bitcoins.

For the uninitiated, Bitcoin is a virtual currency with a strictly limited supply that only grows at a slow, preset rate. Basically digital gold. And like actual gold, the only way to get new bitcoins is mtathew "mine" them—but by solving computationally-taxing math problems, not with a pick and pan. In this case, though, the invisible hand is plenty easy to see. Solving these math problems doesn't just win new Matthew o brien atlantic bitcoin mining for individual miners. It verifies all Bitcoin transactions for the entire network.

4. So why do people bother mining for bitcoins? Well, the question answers itself: because it's profitable, and they expect it to be even more so if Bitcoin keeps going up in value. This last btien is critical. Bitcoin mining has become incredibly competitive the last few years—just look at the supercomputer fortresses in Iceland that use geothermal power and Arctic air for cooling—and that competition drives down margins. That means miners are really counting on Bitcoin to continue its journey to infinity and beyond, to keep rising forever.

5. When the price of jatthew goes up, the price of everything else goes down. It's minng deflation, and it's death for an economy. People put off buying things when they'll cost less tomorrow than today. Companies put off investing when their customers put off buying. And people who borrowed money are stuck trying to pay debts that don't change with wages that do—and have fallen.

But Bitcoin's deflationary bias is a feature, not a bug. It's why miners want to mine, and why there are no transaction fees. In other words, Bitcoin can't work as a technology without deflation. The question is whether Matthew o brien atlantic bitcoin mining can work as a currency with it.

Probably not. At least not when there's this much minihg. You can just how much there's been in the chart below from Peter Coy. It shows how much prices would have had to fall in 2013 if they'd been set in bitcoins instead of dollars.

Now, to be fair, prices aren't set in bitcoins, and never will be. As Joe Weisenthal points out, it doesn't matter how much prices fall in bitcoins as long as prices are set in dollars—it won't hurt the real economy. But what about the Bitcoin economy? Will Bitcoin deflation hurt it? Almost certainly.

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Bitcoin: Segway, Cigarette, or Gold Doubloon?

The market has selected different things as money throughout history. Some of these items have served as money in isolated places for specific periods of time — for instance, cigarettes in prisoner-of-war camps. Cigarettes continue to be a currency in prisons if allowed, but if not, according to Wikipedia, “postage stamps have become a more common currency item, along with any inexpensive, popular item that has a round number price, such as 25 or 50 cents. Mylar foil packets of mackerel fish, or ‘macks,’ are one such item.”

Cigs, stamps, macks? Doesn’t seem very cool, like, say, a gold doubloon, but the market decides what’s cool, despite what Matthew O’Brien at The Atlantic thinks. Apparently, he’s not a big fan of the cybercurrency Bitcoin.

He writes that only techno-libertarians will transact business in Bitcoin, Matthew o brien atlantic bitcoin mining compares the cybercoin of the virtual realm to Segways. O’Brien reminds us these stand-up motorized vehicles were Matthew o brien atlantic bitcoin mining one time thought to become a big deal. I only see cops whiz by on them at the Hartsfield-Jackson airport in Atlanta.

O’Brien describes Bitcoin as “inherently ridiculous.” The price swings alone make the cybercurrency look more like a dot-com stock than money. What The Atlantic senior associate editor can’t explain is why the price of Bitcoin has exploded recently. He writes something about demand from China and the Fed’s seizure of Silk Road’s considerable Bitcoin stash.

But he’s not paying attention. “Senior U. S. law enforcement and regulatory officials said they see benefits in digital forms of money and are making progress in tackling its risks,” Ryan Tracy reports for The Wall Street Journal. “The price of Bitcoin, the most common virtual currency, soared to a record following the comments.”

That won’t sway The Atlantic writer’s mind. O’Brien believes “Bitcoin… has deeper problems. Its product doesn’t work.” However, Washington has had a dog in the Bitcoin fight, since it seized 26,000 of them from Silk Road. At around $18 million, it’s enough to keep the Department of Justice interested. So count DOJ attorneys along with the libertarian nerds rooting for the cybercurrency.

In a testimony before the Senate Homeland Security and Governmental Affairs Committee, Mythili Raman stated, “The Department of Justice recognizes that many virtual currency systems offer legitimate financial services and have the potential to promote more efficient global commerce.” Raman is the current acting assistant attorney general for the department’s criminal division.

Bitcoin and virtual currencies are a direct attack on central bank monetary management. Yet even Ben Bernanke, in a letter to senators, said virtual currencies “may hold long-term promise, particularly if the innovations promote a faster, more secure, and more efficient payment system.”

Senators, being senators, worry about things like whether the cybercurrency is financing Matthew o brien atlantic bitcoin mining or whether Bitcoins can be used to evade taxes. Neither is likely.

What Bitcoin can do is be moved instantaneously around the world. With something as simple as cellphones thousands of miles and many time zones apart, the cybercurrency can be transported via Skype.

Try moving dollars through your bank. You have to fill out forms, show ID, and have a human being input data. Then more of the same happens on the other end — when the bank opens, that is. Bitcoin has shown the Federal Reserve how Matthew o brien atlantic bitcoin mining done. In a report called Payment System Improvement — Public Consultation Paper, the Fed calls for banks to speed up payment systems. The central bank wants to see “a ubiquitous system for near-real-time payments.”

End-users, the Matthew o brien atlantic bitcoin mining points out, want real-time validation of payment and posting, assurance the payment will not be returned, timely notification, and “masked account details, eliminating the need for end-users to disclose bank account information to each other.”

This sounds familiar to anyone who uses Bitcoin. Validation of transactions is nearly instantaneous in the blockchain. Bitcoin transfer is not a credit transaction, but a transfer of assets. There is no third party in the middle to return a payment. And of course, payments are done anonymously. No financial disclosures are required.

So while end-users tell the Fed they want assurances against returned payments, O’Brien writes that a weakness of Bitcoin is there is no third party making sure everyone is satisfied. Financial intermediaries “make sure buyers and sellers are both trustworthy, and handle any disputes,” writes O’Brien, who wants to make sure Matthew o brien atlantic bitcoin mining can get their money back if things go awry.

He actually doesn’t believe people will use the cybercurrency to pay for things at all. Thus his quip, “Bitcoin is a Ponzi scheme libertarians use to make money off each other — because gold wasn’t enough of one for them.”

Maybe he doesn’t realize more and more merchants are accepting the alternative currency. O’Brien doesn’t know that two Bitcoin advocates, Austin and Beccy Craig, lived Matthew o brien atlantic bitcoin mining traveled for several months paying for everything with Bitcoin. He hasn’t heard the highly connected Winklevoss twins are seeking approval for a Bitcoin fund. O’Brien doesn’t read The Wall Street Journal, which recently listed six Bitcoin-related venture capital deals funded just between mid-August and mid-November of this year.

The deflationary bias, O’Brien says, means the price will be volatile. The limited supply of Bitcoin will mean it will rise in value against the dollar, but early speculators will then sell, driving the price down “quite violently.” From there, he voices his incorrect analogy to Mr. Ponzi.

Because of Satoshi Nakamoto, we have the rare opportunity in history to watch the birth of a currency. It’s not always a smooth process. In his book, Principles of Economics, Carl Menger, the father of Austrian economics, wrote about how any commodity can be traded as money because of its greater marketability:

“This knowledge will never be attained by all members of a people at the same time. On the contrary, only Matthew o brien atlantic bitcoin mining small number of economizing individuals will at first recognize the advantage accruing to them from the acceptance of other, more saleable, commodities in exchange for their own whenever a direct exchange of their commodities for the goods they wish to consume is impossible or highly uncertain.”

As people become successful trading any good or commodity as money, more people will in turn trade fewer marketable goods for that more marketable one. “Since there is no better way in which men can become enlightened about their economic interests than by observation of the economic success of those who employ the correct means of achieving their ends,” writes Menger.

The Bitcoin market is tiny compared with government currencies, especially the dollar. As the new cybercurrency gains acceptance, its price in dollars can reasonably be expected to be volatile. But as futures markets develop and ways to sell Bitcoin short are created, the price action for the cybercurrency will smooth out.

The question isn’t whether Bitcoin is a Segway, but whether it’s a prison cigarette or a gold doubloon. Either way, Bitcoin is money.

Sincerely,

Doug French