Wednesday, May 18, 2011

Simple critique of Bitcoin

For all its technotarian groovyness, Bitcoin suffers from classic private currency flaws that make it a scam.

Bitcoin MIGHT work if only it was able to be unique. But there is nothing to stop a proliferation of identical networked coinage systems. Even if it were patented, the patent would expire. With no intellectual property protection, we would see an unlimited set of identical citcoin, ditcoin, etceteracoin.

With no limit on the amount of identically created coinages, what could stop the precipitous decline in value? Trust in the original? What reason would anyone have to trust one more than another? The basic problem is that bitcoins are ENTIRELY speculative in value: there is no intrinsic value (such as a real-world use) to them at all except perhaps the value as a medium for exchange: but there is no scarcity of mediums for exchange, so no intrinsic value.

We've seen this in the past when private currencies were attempted. Without trust in the currency because of a backing in something with intrinsic value, it rapidly can become worthless. Bitcoin has no backing. Even if it had backing, insiders may remove the backing and leave the currency worthless.

Bitcoin relies on some computational artificial scarcity to claim that it won't explode in volume and thus inflate away to valueless. I'd have to see a clear explanation before I believed it, but even so the prospect of innumerable competing identical currencies would create the same problem.

Bitcoin looks like fool's gold to me. A classic scam of selling something that will eventually leave somebody holding a worthless currency.

[Added 6/3/11] Here is Adam Cohen's criticism of Bitcoin. The punchline:

"But Bitcoin is not designed to be a functioning currency, it's designed to enrich early adopters. Again, that is why it is a scam. Period."

[Added 6/19/11] There’s a Virus that Will Steal all Your Bitcoins The first of many, no doubt. The features of bitcoins that make them private will also make them difficult to recover when stolen. Who will be the first to cash in by offering bitcoin insurance against theft? One reason why public assets are valued is because their theft is obvious.

[Added 6/20/11] Bitcoin Prices Plummet on Hacked Exchange At the very least, there's a whole new world of flaws to shake out of the system. Note also that they have "rewound" the transactions to solve the problem: do you want your transactions subject to somebody else's "rewinding"? Note also that the user database was stolen and circulated publicly. So much for privacy.

[Added 12/6/13] So this is how fiat currency dies, with thunderous CPUs?
As predicted, Litecoin has arisen.  And it can make 4 times as many coins!  It is open source, and thus can be reimplemented over and over by anybody who wants to open yet another bubble.  But worse, "In fact, Cryptocoincharts shows something in the region of 164 different virtual currency-based cross rates in the market..."  which means a minimum of 13 competing currencies.

[Added 12/31/13] How and why Bitcoin will plummet in price
Tyler Cowen uses my "citcoin, ditcoin, etceteracoin" argument (though with much more economics sophistication) to make a strong marginalist argument for why values of crypto currencies will plummet. Prices of currencies will be limited by marketing costs of potential competitors. "In short, we are still in a situation where supply-side arbitrage has not worked its way through the value of Bitcoin. And that is one reason -- among others -- why I expect the value of Bitcoin to fall -- a lot."  

[Added 1/6/14] Coingen
"Think you can market an altcoin better than Dogecoin, Catcoin, or even Litecoin? Want to create your own coin and get in on this gravy train? Follow this simple form to get started with your very own alt coin!"  Can you say proliferation?

24 comments:

Joanna Liberation said...

Wow that is awesome. That changes the game completely. If that really works, collectivists will simply be cryptomonied out of existence. And I won't even need to waste time here any more (happy, Mike?)

Mike you fail to even understand why dollar is valuable. According to your reasoning, dollar is valuable because it is unique, because there is no other currency out there... OMG. And here is Mike accusing bitcoin as having no intrinsic real world use, as if dollar has it. OMG. And yes, we've seen this in the past when private currencies were attempted. Delegalized by US government. Hence the cryptographic anonymity this time. Read the wikipedia at least for God's sake. OMG. Yes bitcoin relies on artificial scarcity, same as dollar. Except government can inflate the dollar. No one can inflate bitcoing. OMG OMG OMG, it's really happening. I can't believe that either.

foobar said...

What is interesting is that bitcoin fans are mostly goldbugs and foes of fiat money. Now they are all excited about - virtual gold. What an irony!

Bitcoin will not work because it does not make any sense whatsoever. Spent(!) computing cycles as payment is really very outlandish, to say the least. The confusing cryptobabble around it is just there to distract from the absurdness of this all.

Mike Huben said...

Looks like the bitcoin people have another sucker: Joanna.

Dollars are not valuable because they are unique: they are valuable because they are backed by the power to tax.

If you think dollars are worthless, sure, give me yours.

Private currencies were prohibited because they were used to defraud. Even libertarians claim to dislike fraud.

You say nobody can inflate bitcoin: the problem is that innumerable coin-alikes can be made. Competition will drive their values down to nothing. Scares about their values will destroy their value.

And "OMG" just makes you look even stupider.

Chris said...

Thanks for posting this, Mike -- I'd never heard of Bitcoin before. What a strange concept.

AlchemX said...

Mike, is it possible for YOU to do a full review/critique of David Boaz's "Libertarianism: A Primer"? If a person were to attack Libertarianism, this would be a good book to take down first. Especially by using specific quotes and statistics from the book on the various topics Boaz covers.

You would be the right person (given the long time your site has been running) for the job, especially to expose Boaz as the deceiver he is commonly made out to be.

It could be a quote a day type of thing if Libertarianism were so ridiculously, hilariously stupid as many sites suggest.

Despite the massive amount of hate leveled at Libertarians, after reading the book I've come away with the feeling that it is all undeserved. Boaz lays out his arguments solidly, backs them up with statistics and sound reasoning. He shows that Libertarianism can be arrived at both empirically and deductively.

I feel like human dignity, freedom, tolerance and prosperity are all things that could be obtained by this simple philosophy.

b-psycho said...

Mike:

"Dollars are not valuable because they are unique: they are valuable because they are backed by the power to tax."

Would you extend that to mean that the value of a currency relative to another one communicates a meaning about the tax base of the regime issuing it? If so, what do you think the current situation with the U.S. government in default (that is, having overshot its revenue stream by so much it may be politically impossible to approve continued borrowing and keep credit available) suggests about future worth of the dollar?

If not, then...why not?

b-psycho said...

BTW: this is not to say I'm on board with Bitcoin. I'm not.

Mike Huben said...

"may be politically impossible" has been heard since the treasury was set up 200+ years ago. And it has never yet defaulted, a better record than almost any nation.

And it is an unconstitutional doubt:

"Amendment 14, Section 4. The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned."

Congressmen who do not make that happen will be held accountable.

Joanna Liberation said...

foobar, not irony but your ignorance. Gold and bitcoin money are both hard or impossible to inflate by government, so it is only logical for goldbugs to love bitcoins and hate fiat money.

Joanna Liberation said...

Mike, yes dollars would be worthless if government was not able to force people out of their valuables at gunpoint, but tax aggression is not the original source of value in any meaningful sense. Most of the stuff on this world is valuable not because its owner has a license to steal.

I have nowhere said dollars are worthless, read again.

Why don't you want to ban kitchen knifes, they are used to kill.

Currency competition has no impact whatsoever on currency valuation. We already have hundreds of currencies out there.

OMG, I'm not pretending to be wise, I'm just thinking common sense.

Kevin Wayne said...

I'm not pretending to be wise, I'm just thinking common sense.

Meanwhile, your precious Bitcoin is an utter failure, acc to the updates being posted.

As wells as this:

http://en.wikipedia.org/wiki/Bitcoin#Criticism

Bitcoin is the currency used by the Silk Road online marketplace.[31][64] In a 2011 letter to Attorney General Eric Holder and the Drug Enforcement Administration, Senators Charles Schumer of New York and Joe Manchin of West Virginia called for an investigation into Bitcoin and Silk Road.[64] Schumer described the use of Bitcoins at Silk Road as a form of money laundering.[7] Consequently Britcoin, the UK exchange, put out a statement calling for regulation of Bitcoin exchanges by law enforcement.[15][16] The hacking organization 'LulzSec' accepted donations in Bitcoin, having said that the group "needs bitcoin donations to continue their hacking efforts".[14][65]

______________

Once again, the Robber Barons are using their unwitting duped in the Libertarian world to centralize power among the aristocracy and fleece the public.

Joanna Liberation said...

Kevin, if something was a failure just because there were criticisms, nothing would ever be a success. Utter failure in your logical thinking, yes.

The fact that bitcoins are being stolen and used for money laundering is a very happy news, it simply means bitcoins are valuable, as any money should be to be called money in the first place. Again utter failure in logical thinking.

I'm sure all governments will prosecute bitcoin usage heavily, which is actually required to make sure bitcoins are as robust as their creators claim.

eonn43 said...

Huben apparently doesn't know the first thing about currencies. There is nothing here worth commenting on.

Kevin Wayne said...

The fact that bitcoins are being stolen and used for money laundering is a very happy news,

Wow you really are retarded, aren't you?

I bet you think that it's a good thing when terrorist make nukes? Well, it's obvious they have great value, right? Until it blows up in your face.

Your Bitcoin will accomplish nothing, just like your Libertarianism. It will be swept away and forgotten before most are even aware of it.

Kevin Wayne said...

I just showed the Wiki article about Bitcoin to a friend of mine who's a Gold-standard or Partial Gold standard advocate, since he's also critical of the US money system. Here's what he said:

"I read the full article, and it didn’t make much sense to me except for the fact it’s 'untraceable money' – that shows it’s intentionally criminal 'by design'."

Thomas Costello said...

I am not a supporter or critic of bitcoin but simply an open-minded skeptic. With that said, I must disagree with the logic of the original post.

The main critique seems to be that bitcoin cannot work because it is unable to be unique. Other currencies like bitcoin could be created, increasing the supply of digital currencies. This point is well understood, but it does not follow that the ability to have multiple digital currencies invalidates bitcoin. There are many different currencies in the world today. There is no limit to the amount of identically created paper money. In fact, much of the euros and dollars and world currencies used today are in fact circulated primarily through digital means. You could live without using a single physical dollar if you wanted to. Modern currencies are no better if “uniqueness” is necessary.

A good currency should be scarce, for fluctuations in supply can cause disruptive price changes. Bitcoin is far more scarce than the US dollar, capped at 21 million bitcoins. Of course other digital currencies could be created that vastly increase in supply, but few would willingly use these currencies as their value would be constantly decreasing with supply increases. You assume all digital currencies would be valued equally, but this makes little sense. They would not be for the same reason that all paper fiat currencies are not.

Yes, bitcoin is in a speculative stage right now. As it should be. The value of bitcoin will change depending on how many people adopt it. As for viruses, you forget how much we already use digital money. BankOfAmerica.com is no more secure than bitcoin. A man who can steal bitcoin could just as well steal digital dollars or hack Paypal.

Is the dollar worthless because Zimbabwe creates currency in excess? No. Is the bitcoin worthless because some other digital currency may act in a Zimbabwe manner? Of course not. You worry bitcoin will lose value? Look at the dollar. Since 1913, the dollar has lost 96% of its value. A dime used to be worth something. Now most would rather leave a dime in the gutter than bend down and pick it up.

Mike Huben said...

Thomas:

Other nations cannot create US dollars. Whatever currencies they create must have separate backings, protections from counterfeiting, and limits of issuance. There are actually very few countries which can create good currencies, which is why usually only a few currencies are preferred.

Bitcoins, on the other hand, have no such physical limitations. We could doctor the bitcoin software to create citcoin, which would have every property of bitcoins, and act identically. Presto! The supply is effectively doubled. And then ditcoin and etccoin. With no limit to the number of coinages all with the exact same properties, we'd expect their values to go way down because there just wouldn't be any scarcity.

Matt said...
This comment has been removed by a blog administrator.
Matt said...

"Crytobabble"? Just because you don't understand it doesn't mean it's bunk. I'm a software engineer with extensive experience in cryptography, and I will say that the cryptographic fundamentals of Bitcoin are rock solid. There's a better chance of someone successfully stealing your credit card number en route from your computer to Amazon than there is of someone stealing and spending your bitcoins.

Regarding the claim that Bitcoin won't work because it can be endlessly copied: I had this same concern early on but came to realize that it is not actually a problem. If someone "cloned" Bitcoin, the clone would have all the properties of Bitcoin *except* that it would have no user base. That alone makes it inferior to Bitcoin, and the market will price the two currencies accordingly. (Likely the clone will never get off the ground.) In order to beat Bitcoin, a new cryptocurrency would need to be *significantly* better from a technical perspective. Bitcoin has so much momentum now that overcoming its momentum would require a generational leap in technology.

Mike Huben said...

Cryptographic fools gold is still fools gold, no matter how strong the cryptography. Whether or not your bitcoins can be stolen (and that has happened.)

Expertise in cryptography hardly qualifies as expertise in currencies. Neither of us should pretend to that, most likely.

And no, another currency would not have to be "better" than bitcoin. Bitcoin is just as susceptible to copying as any other product. As a matter of fact, considering that bitcoin was designed to enrich the early adopters (who didn't have to compute as much to mint bitcoins) and given the fact that there is essentially a limited supply of bitcoins, we should expect to see citcoins and ditcoins eventually crop up.

Jouko L. said...

Mike, I think you're wrong when you say "Bitcoin is just as susceptible to copying as any other product".

If Bitcoin will gain stong market position and will have tens of thousands of shops that accepts it, it will be overwhelming competitor to "Citcoin" (which would start from zero).

As Matt said, the difference in user base will make the difference between technically equivalent Bitcoin and "Citcoin".

"Citcoin" could copy the technical features of Bitcoin, but not the user base! In order to succeed, any electrical currence will need these both...


[In general level, my opinion on Bitcoin - weather it makes sense or is useful or not - is still in development phase...]

Mike Huben said...

If Citcoin is identical to Bitcoin, then it will be easy to adopt to those multiple currencies. Look at ALL the major sales sites: they already accept many national currencies. All the credit cards let you make purchases in most currencies.

If anything, we'd expect a currency standard to arise that would make it easy to use any currency.

So, no, I don't expect Bitcoin to exclude competitors that way. If anything, I expect some fairly different competitor (perhaps a national electronic currency) to arise and keep Bitcoin a curiosity operating in black and gray markets.

Mike K said...

Mike-
I am Bitcoin skeptic myself, but I wonder why you haven't addressed the issue of Bitcoin's user base compared to the copycats you suppose would crop up. Could you address that?

Mike Huben said...

I'm not quite sure what issue you're talking about, but I would expect the Bitcoin user base to know all about the opportunities to "mine" at a profit for copycats.