Monday, December 16, 2013

The Bitcoin Economy, Looking for Parallelisms to a Real Economy





Image from http://watchdog.wpengine.netdna-cdn.com/wp-content/blogs.dir/1/files/2013/12/bitcoins.png 


Bitcoin headlines and stories have been flashing all over the net as of late and if I were to play the paranoia game, I would think that the push by some finance sites to run stories was meant to ensure that its value (and relevance) is buoyed, perception-wise at the very least.



Although I am in no position to provide any thorough academic data analysis, deducing things from a parallel comparison to a real economy might prove interesting.

I won't play the hypocrite because I admit, I'm trying my hand on bitcoin mining myself: Got a wallet, installed it, joined a pool, and started mining with a program. I don't think I'll be making millions as a miner anytime soon though.




Hindsight is 20/20 as most investors would say, and Bitcoins would've been the Microsoft, Yahoo, or Google stock that made instant millionaires out of gutsy risk-takers after just a few years of sitting on their investments. In fact, what caught my attention to Bitcoins was a recent story about a Norwegian man who put down a $26 investment that shot up to $850,000 (for an asset that is a virtual cryptocurrency) in such a short span of time.




And so, this is where things get hairy in my view. Bitcoins are, in perception, considered by its supporters as an asset. Although we have already moved away from the gold standard when we talk about fiat money, interest rate movements and their relation to the real economy ensure that real currencies put relevance to human activities, transactions, goods, and services. I already elaborated on this matter with my views on my blog entry The Churn last May.



*Image from http://www.churn-rate.com/img/churnSketch.png 


If we, however, consider this virtual cryptocurrency as the ''national'' and sovereign currency of a virtual state and its economy, then it is unavoidable to ask, how is the Bitcoin economy doing? Are the Bitcoin citizens sustaining themselves well earning Bitcoins and paying with Bitcoins? The nature of the Internet itself as a borderless and boundless ''state/country'' for Bitcoin citizens add so many ''frictional'' costs in the forms of logistics, economic regime considerations, real world relevance, taxes (if any), and transmutability to a society/locality, among others. The regulation of an economy like this is staggering, not to mention the headache of dealing with overlapping commercial laws and practices. No one eats virtual burgers, drinks virtual milk, uses virtual shampoo. Do we get a Bitcoin FDA to ensure safety of consumables? The reliance on the labor economy and limited access of technology and understanding by non-IT classes in a society limits full relevance and applicability of a virtual cryptocurrency, especially to the blue collar working class. Someone down the supply chain will eventually want fiat money because it's tangible and integrated to a locality. The virtual nature of e-commerce poses limits to transactions. Interestingly, one of the vaunted benefits of Bitcoins is the elimination of the ''middleman'' to the exchange of goods/services/Bitcoins. There's no more Paypal, ClickandBuy, or credit card company to deal with. You sort the transaction out with the very same person you are dealing with, thus the ''savings'' from middleman fees. In my view, however, middlemen in the wild wild west [the net], we know as the Internet play a crucial role in ensuring fulfillment and security. The very nature of the Internet as a borderless place limits territorial law enforcement and tangibility to real life physical interaction. So the citizens of Bitcoin land will probably eventually need a Bitcoin leader, set up means of Bitcoin taxation, in order to employ Bitcoin law enforcers, assuming a Bitcoin body of lawmakers come up with a Bitcoin Constitution and Bitcoin laws for the sake of the Bitcoin economy's peace and order, maybe shop around for a Bitcoin pet if time allows it. Anyone who has dealt with online transactions/e-commerce knows the headache of having to deal with online order errors, overcharging, among other issues that only bring anger and frustration especially when dealing with unscrupulous Internet merchants.

 *Image from http://www.cartoonstock.com/lowres/business-commerce-middleman-bureaucracy-middlemen-middle_men-cut_out_the_middleman-shr1072l.jpg

As I tried to understand the Bitcoin currency, there are certain points that I have found obscure with its principles. First of all, supporters have likened Bitcoins to gold due to its supply being capped:


A pre-defined schedule limits the total number of bitcoins so that they gradually approach a total of 21 million (ignoring those that have been lost through deleted or misplaced wallet files). The limit of 21 million bitcoins is "hard-wired" in to the protocol, and there will never be more bitcoins than this:


*Posted by Emansipater, Aug 30 '11 at 23:57




So, that's where the term ''mining'' was derived from. The year at which this 21 million Bitcoin cap is reached will depend on how many people decide to use their computers to mine Bitcoins.


*Image from http://www.littlevisuals.com/bitcoin-owners.png


So what we have in the mining community are Bitcoin ''gold prospectors'' who, if you checked the link about Bitcoin basics, are users that use their computer equipment to process, authenticate, and validate the chainblock (the ledger of Bitcoins on Earth/the Internet currently in existence and how they have exchanged hands between and among Bitcoin citizens) repeatedly in order cyclically update the said chainblock and in effect they also mine and earn Bitcoin blocks themselves, which adds new blocks to the chainblock - which is the cryptologic nature of Bitcoins (kind of like adding authenticated pages to the ledger).



*Image from http://f.kulfoto.com/pic/0001/0044/6FsDJ43485.jpg


Second is the vaunted nature of Bitcoins being free from a Central Bank's control. While there are people who have always held the belief that the Gold Standard should be restored by Central Banks and that the fiat money system be dismissed, the acquisition and hoarding of gold is certainly an activity wanting of conflict. Gold is in limited amounts on Earth and proponents seem to be after the sense of security that the tangibility of benchmarks invokes (ironically, Bitcoins will never be tangible in concept because it belongs to the virtual space of the Internet, where relevance is allocated by those who view or come across concepts or ideas on the web and accept them). Gold Standard proponents, in my opinion, miss the whole point of how developing the mechanism of an economy works. Fiat money, in tandem with interest rates regulate economic activity of people, people make up human civilization, and people transact, create goods, and provide services, these are the true basic foundations and resources of a real economy. Activities and the economic energy that echoes through the supply chain or trickles down through economic classes are limitless, as long as people generate ideas and work. Assigning value to a tangible benchmark that is Gold in order to make one believe of security (over a shiny piece of metal, admittedly a very good conductor of electricity) is misplaced and an unfortunate carryover of how backwards civilizations were run in my opinion. Instead of the idea/concept of scarcity being assigned to a shiny piece of yellow metal, scarcity and demand (at a given price point) should be attributed to the level of talent, the quality of the good, service, invention, innovation or practical need by buyers and consumers, that's how benchmarks should be defined. Conquistadors were never exactly civil about wiping out South American civilizations in search of gold, under the guise of Evangelization in the name of the Pope and the Church of course. Should it then be said that conquistadors and warmongers be given higher pay over scientists and academicians or tactful and innovative entrepreneurs?



 *Image from http://diyblogger.net/wp-content/uploads/2011/01/spanish.png



*Image from http://www.ushistory.org/civ/images/00017560.jpg


Furthermore, there is a luck factor to gold mining. I can only speculate how countries would act and possibly invade other sovereign states for gold (as what has already been speculated on when we talk about oil and the Middle East). Hypothetically, what if one day we found out that North Korea had the richest gold mines on Earth? Are we placing that chance (of gold discovery) to fool's luck or should we turn our attention of value-perception assignment to regimes and societies that develop more useful things, more competent people and more innovative ideas? Who deserves to be rich anyway? Is it really the territory with the most shiny yellow metal?


https://en.wikipedia.org/wiki/Gold_standard#Bretton_Woods



*Image from http://www.lovethispic.com/uploaded_images/33247-Is-It-Gold-In-Here-Or-Is-It-Just-Me.jpg 


Third, in Bitcoin mining, similar to real life gold mining, luck is considered a factor. It's even a statistic in this comparison of Bitcoin mining pools



Bitcoins are the currency of the Bitcoin economy, similar to how cash is the currency to a real economy. The concept of Bitcoin mining is likened to building a book, a ledger if you will, of the money supply of the system, known as the chainblock. This chainblock isn't controlled by an ''evil'' central bank, but validated and maintained by anonymous members of the network known as miners, who incidentally are answerable to no one. Central banks ''print'' money or more appropriately increase the money supply through reverse repos, interest rate tweaks, and other monetary tools, which are implemented through the banking system. Although I have no means or evidence to say whether central banks and banks influence interest rates for self serving purposes and profit for their own account, the banking system itself undergoes checks and transparency reviews by the government (who are chosen by the state's citizens), unless of course the government reviewers are in collusion with the banking system itself. The malice in speculating about how nefarious the entire system is, especially in colluding against the common man, I leave to society to ponder on, however.




 *Image from http://www.cartoonstock.com/newscartoons/cartoonists/dhu/lowres/money-banking-federal_reserve-us_federal_reserve-stimulus-stimulus_package-credit_crunch-dhun74l.jpg


Bitcoin miners, however, although they validate the chainblock and add blocks as a form of work to the network and Bitcoin economy, earn blocks as compensation for their own account, too. This means the anonymous proxy of central bankers (i.e., the Bitcoin miners) not only add pages to the ledger but also put their names in the ledger as earnings for this type of ''work''. Assuming, however, that we say that central bankers also get wages for performing their professional responsibilities as central bankers, do they also funnel more money to their personal accounts when they increase the money supply of the real economy? Do they reward themselves for ''adding'' more cash to the economy? Assuming, furthermore, that the central bank runs on the gold standard (as what the Bitcoin framework seems to try to replicate with the cap on Bitcoin supply), do central bankers add more money to their personal accounts for every new delivery of gold to the mint or gold bars to the central bank vault?


  

*Image from http://www.cartoonstock.com/newscartoons/cartoonists/dpi/lowres/business-commerce-bank-bankers-central_bank-the_fed-ben_bernanke-dpin195l.jpg


We again go back to the question I've posited above, ''Are we placing that chance (of gold discovery) to fool's luck or should we turn our attention of value-perception assignment to regimes and societies that develop more useful things and ideas?''


Fourth, is a question regarding the Bitcoin economy. What is churning (The Churn) the Bitcoin economy? Is it truly the profiteer's will that merchants sell to online consumers for Bitcoin as consideration (the invisible Bitcoin hand) or is this an idealistic push that has taken-off too quickly from the pragmatist's ground? I wouldn't be surprised if merchants are Bitcoin miners themselves as well. In the end, after the 21 million Bitcoins have been mined, who's actually doing real work in the Bitcoin economy, selling goods and services? Is everyone just mining away and hoarding the Bitcoins? The end game to me can be likened to a video game, when you reach the end, you've mined every single Bitcoin there is (you've hoarded so many potions, elixirs, and whatnot and you've defeated the final boss), what exactly do you do with these magical items after? Is there a New Game+ mode? Are these items of any use to someone else? Can the members/merchants of the Bitcoin economy survive among themselves in a Bitcoin island state where they sell stuff, get Bitcoins and have to turn around and look at the selection of goods and services they can use their Bitcoins on? Who really thinks they'll be benefiting from what they've saved up, if everyone is a saver in the Bitcoin economy and no one's pushing the hamster wheel to go around? The more expenses, the more income in an economy. I can only speculate that everyone is just waiting to spend their hoarded Bitcoins on something in the future, that is, if someone will be willing to accept Bitcoins in the future, because if no one's selling/offering any service of interest, then everyone's stuck with virtual credits with no one to give it to. I've already mentioned the frictional costs/considerations to a Bitcoin economy.



*Image from http://www.cartoonstock.com/lowres/money-banking-atm-cash_machines-bank_machine-banks-machine-dcr0299l.jpg


*Image from http://duckduckgrayduck.files.wordpress.com/2011/04/funny-comic-desert-island-boat-land.jpg?w=500&h=252



Looking at the chart, even without thinking that it's a chart for Bitcoins to USD value, this asset is probably a bubble. Not unless you know a friend or a neighbor who's lived and sustained his lifestyle on Bitcoins for the past year and has declared that he couldn't live without Bitcoins in his life. All the press releases, as I've mentioned earlier in this entry, are attempts of churning relevance and attention. IF similar to a Ponzi scheme, it's the last who comes in that gets scheistered. Although, if everyone is just mining (like what I'm doing), I don't think there's any true fraudulent loss to incur, except a rise in the electricity bill and an accelerated depreciation of the computer equipment. And yeah a waste of time.



*Image from http://www.stubbornmule.net/blog/wp-content/btc2.png


Finally, I've come across a very good article freshly published by Matthew O'Brien



The author points out the unfortunate curse of Bitcoin and the paradigm it runs on, that it is deflationary. As I've pointed out before, if the Bitcoin economy doesn't run, kind of like a real economy, wherein merchants can't sell their items because no one is buying, these merchants will most likely just go back to the real economy and sell for real USD's, although I'm pretty sure merchants still want to get Bitcoins this early in the game because of the skyrocketing ascent of its value as pointed out by the article's author. Ultimately, though, it is a railed path to the demise of the Bitcoin economy if no one actually goes out and uses their Bitcoins; people have apparently been hoarding them because as an ''asset'', it's value is rising multiple-fold in relation to real life currencies. This is similar to the Great Depression of the 1930's, people had no jobs, entrepreneurs couldn't source capital and produce goods and offer services or engage in risk taking for that matter. No entrepreneurial endeavor could get off the ground, save the industrial/manufacturing boom brought on by World War II after a decade. The movement of money in the economy came to a standstill (and that's why Helicopter Ben had been adamant about flooding the system with cash - he studied the Japanese economic case before after all, and maybe Yellen will be the Darth to Bernanke's Luke or is it the other way around?), mostly because of fear. Interestingly enough, the hoarding of Bitcoins in Bitcoins wallets right now is motivated by greed, with users who have, unfortunately, played dumb about the end game at this point.


All compositions, statements and opinions of the author are copyright © Earl T. Malvar 2009-2013. All rights reserved. There is no honor, respect, admiration, intellectual and academic dignity garnered through plagiarism.