The Anatomy of a Money-like Informational Commodity - Amazon S3

318 Pages·2014·6.53 MB·English

The Anatomy of a Money-like Informational Commodity: A Study of Bitcoin
By Tim Swanson

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© Copyright 2014 by Tim Swanson
Cover art credit: Matt Thomas and Invisible Order
This manuscript is released under the Creative Commons - Attribution 4.0 International license: to copy,
transmit, share, adapt, remix, make commercial use of and freely distribute this work.

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Table of Contents
Preface .......................................................................................................................................................... 4
Acknowledgements ...................................................................................................................................... 5
Introduction .................................................................................................................................................. 6
Chapter 1: Bitcoin in theory and practice .................................................................................................... 9
Chapter 2: Public goods.............................................................................................................................. 24
Chapter 3: The Red Queen of Mining ........................................................................................................ 40
Chapter 4: A Bitcoin Gap ............................................................................................................................ 78
Chapter 5: Bitcoins made in China ............................................................................................................. 91
Chapter 6: Living in a trusted, post-51% world ....................................................................................... 105
Chapter 7: Network effects ...................................................................................................................... 117
Chapter 8: TCPIPcoin and User Adoption ................................................................................................ 122
Chapter 9: Deflation in theory and practice ............................................................................................ 137
Chapter 10: Bitcoin’s command economy and knock-on effects ........................................................... 163
Chapter 11: Zero-sum Entrepreneurship ................................................................................................. 176
Chapter 12: Token movements and token safety ................................................................................... 188
Chapter 13: Social engineering and groupthink ...................................................................................... 208
Chapter 14: Separating activity from growth on Bitcoin’s network ....................................................... 224
Chapter 15: What Altplatforms can teach Bitcoin .................................................................................. 236
Chapter 16: Potential alternatives and solutions ................................................................................... 250
Chapter 17: Legal specialization .............................................................................................................. 267
Chapter 18: Conclusions ........................................................................................................................... 281
About the author ...................................................................................................................................... 285
Endnotes ................................................................................................................................................... 286

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Preface

This book is a compilation of research I have written and presented over the past four months,
revised, updated and corrected relative to the original source material.
The purpose of this manuscript is to continue the dialogue on issues that are increasingly
important to the direction of cryptoprotocols, specifically Bitcoin, and decentralized
applications in the near future.
This book is divided into three sections. The first third describes the current state of software
and hardware development. The middle portion reflects on the economic conditions within the
Bitcoin network as well as user adoption. The last third covers alternative platforms and legal
considerations that could impact the on-boarding of users onto the Bitcoin network. While
there is some repetition and overlapping throughout the following chapters the redundancy is
necessary as this field of study is simply put: hard.
Tim Swanson
San Francisco, August 2014

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Acknowledgements

I would like to thank the following people for providing encouragement, feedback, constructive
criticism, contrarian views and anecdotes over the past several months:
Cal Abel, Derek Au, Dave Babbitt, Kevin Barnett, Isaac Bergman, Gwern Branwen, Austin Brister,
Richard Brown, Oliver Bruce, Anton Bolotinsky, Vitalik Buterin, Preston Byrne, Hudson Cashdan,
DC, Joseph Chow, Ben Coleman, Nicolas Courtois, Zavain Dar, Wendell Davis, Robby Dermody,
Mark DeWeaver, Ray Dillinger, Tom Ding, John Dreyzehner, James Duchenne, Dan Forster,
Byron Gibson, Philipp Gühring, Brian Hanley, Martin Harrigan, Marshall Hayner, Alexander
Hirner, Karl Holmqvist, Ron Hose, Petri Kajander, Zennon Kapron, CukeKing, John Komkov,
Andrew Lapp, Sergio Lerner, Jonathan Levin, Adam Levine, Matt Lewis, Taariq Lewis, Adam
Marsh, Andrew Mackenzie, Andrew Miller, Alex Mizrahi, Pamela Morgan, Massimo Morini,
Marco Montes Neri, PN, Pieter Nooren, Dan O’Prey, Ryan Orr, Jackson Palmer, Andrew
Poelstra, Antonis Polemitis, John Ratcliff, Robert Sams, David Shin, Greg Simon, Peter Surda,
Koen Swinkels, Ryan Terribilini, Peter Todd, Eddy Travia, Chris Turlica, Bryan Vu, Jack Wang,
Dominic Williams, Andrew White, Yanli Xiao, Joshua Zeidner and Weiwu Zhang.
Throughout the book I refer to their insights. This is not an explicit endorsement of their
opinions or services but rather serves as an on-the-ground reference point. Nor by providing
me with quotes do they endorse this book or my opinions. Furthermore, in the interest of
financial disclosure, I do not currently have any equity positions in the firms or companies
discussed throughout, nor was I provided any financial compensation for the inclusion of
companies or projects. This book was entirely self-funded; no government, organization,
company, institution or individual provided financial compensation or remuneration for the
creation or direction of its content.

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Introduction

My title comes from a paper, Bitcoin: a Money-like Informational Commodity, by Jan Bergstra
and Peter Weijland who attempted to classify Bitcoin through an ontological analysis, showing
that it is not even “near money” only “money-like.” The paper analyzed existing literature and
clarifies why we cannot technically call Bitcoin the various things it is now popularly labeled –
such as a “cryptocurrency.”
More specifically, Bergstra and Weijland mention the disadvantage of calling Bitcoin a
Candidate cryptocurrency (CCC) is that “there is no known procedure for leaving the candidate
status.”1 However in a recently published paper, Formalising the Bitcoin protocol: Making it a
bit better, W.J.B. Beukema claims that by specifying the protocol in mCRL2 (a formal
specification language used for modelling concurrent protocols) and verifying that it “satisfies a
number of requirements under various scenarios” we have just such a procedure:2

These findings contribute to the position of Bitcoin as a (crypto)currency, as we have to
some extent proven that Bitcoin satisfies properties it should at least have in order to be
safe to be used as currency.

According to Dave Babbitt, a Predictive Analytics graduate student at Northwestern University,
“it sounds like there is sufficient justification to call Bitcoin a crypto-currency, right?3 The
problem with that, according to Bergstra and Weijland, is that confirming its status ‘depends on
a plurality of observers, some of whom may require that a certain acceptance or usage must
have been arrived at’ before it can be classified as such:

Upon its inception Bitcoin did not possess that level of acceptance, and for that reason
Bitcoin has not started its existence as a cryptocurrency. Being a cryptocurrency is a
status that a system may or may not acquire over time. Assuming that Bitcoin is
considered to be a cryptocurrency at some stage then there will most likely be
variations (alternative designs and systems) of Bitcoin around (perhaps hardly used any
more) which have not been that successful. Such alternative systems should be given
the same type, so that Bitcoin might be considered a successful instance of that type.
Clearly CC cannot be that type as it contains only systems that have already become
successful to a significant extent. Because being a cryptocurrency is the primary success
criterion for Bitcoin its classification as a cryptocurrency amounts to a value judgment or
a quality assessment rather than as an initial type.

Thus in line with Babbitt’s reasoning, it is okay to assess the quality of Bitcoin as that of a
cryptocurrency, but initially it was something else. And that something is a Money-Like
Informational Commodity (MLIC) – viewing Bitcoin as a system providing a platform offering the
following features:

1. a system for giving agents access, and
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2. facilitating the exchange of that access, to
3. informationally given amounts measured in BTC (the unit of Bitcoin), through
4. the scarce resource of collections of accessible (to the agents) secret keys, and
5. a bitcoin as a unit of access within this system.

In his view, “we can see that bitcoins were initially ‘a commodity, the substance of which
consists of information that is independent of any accidental carrier of it, while access to it is
scarce’ and only later were valued as cryptocurrency.”

User behavior may change but based on their analysis and existing behavior seen on the
blockchain, bitcoins are probably most appropriately called a money-like informational
commodity.
As the following chapters will detail, competing special interest groups and stakeholders
continually tug at several public goods – such as the underlying core blockchain development
within Bitcoin – to move it into a direction that intersects with their goals and agendas. While
stalemates do occur, at some point a compromise is reached and the same process repeats,
often overlapping with other developmental threads.
Today Bitcoin (the network and the token) is primarily used for goods and services that existing
systems such as credit cards and fiat money have limited accessibility for. Yet it is important to
distinguish between what a bitcoin (the token) is and is not. As explored below in length,
bitcoins do not create value, they merely store it. In contrast, entrepreneurs and companies
create value. They do this by selling securitized equity (stocks) in exchange for capital,
whereupon they reinvest this towards additional utility creation. As it lacks equity, governance
or any formal or informal method of feedback, Bitcoin – a static, fragile institution – is not a
company which in turn creates public goods problems.
Other areas this report covers include the cost of maintaining the network. The transaction
processing equipment (miners) have no cost advantage over existing value transaction
infrastructure, rather Bitcoin’s initial competitive advantage was decentralizing trust and
obscuring identities – both of which are progressively compromised. Acquiring and maintaining
hashing machines, electricity and bandwidth have real costs – and nothing inherent to the
Bitcoin transactional process gives it a significant cost advantage over existing electronic
payment systems. Rather, as noted below, the relatively higher costs of doing business (the
cost structure) of incumbent platforms and other non-decentralized systems is typically related
towards compliance costs which Bitcoin-related enterprises are increasingly having to shoulder.
BitLicenses, for example, add additional financial requirements to companies in this space and
incidentally could in fact insulate Bitcoin from alternative competitive protocols and ledgers
whom lack the capital resources to compete, thereby ceding it monopoly-like status.
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A number of other issues are also covered including the impact these types of decentralized
systems may have on the legal profession and consequently numerous lawyers have been
consulted to provide their insights into how this type of disruption may occur.
These challenges in turn may explain the wide chasm between interest in Bitcoin and meager
adoption rates. In many ways this dearth of adoption is tautological: decentralized networks
will only be used by users who need decentralization. Bitcoin, the network, like any
transportation network will be used by people who need to use it because it satiates certain
needs and not necessarily used by people that early adopters want or wish used it.
Consequently, Bitcoin solves some needs, but it is not a Swiss Army knife pain killer with
innumerable feature-based check-boxes; it has real limitations that are detailed in each chapter
below.
Despite the skepticism and critical analysis of this ecosystem, there are numerous bright spots
that are highlighted along the way including portions of the community who look beyond zero-
sum activities – beyond day trading or gambling – some of whom are genuinely trying to and
likely will create wealth generating businesses.
There is a lot to look forward to but it is also important to be realistic about the ramifications of
Bitcoin. It is not a jack-of-all trades nor a panacea for all the worlds’ ills. It may solve some
issues in niche areas, but it likely cannot do the vast majority of the tasks that its passionate
supporters claim it can. In fact, it is being shoe-horned into areas it is not competitive. And this
is not for a lack of trying. It is largely due to the underlying microeconomic attributes,
incentives and costs within the network itself, many of which were not apparent until the past
year or two.
I assume that the reader is familiar with the economic concepts of marginal value as well as a
general idea of how a blockchain works.

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Chapter 1: Bitcoin in theory and practice

Bitcoin is a nominally decentralized cryptographically controlled ledger released into the public
domain via an MIT license in January 2009. When spelled with an uppercase “B” Bitcoin refers
to a peer-to-peer network, open-source software, decentralized accounting ledger, software
development platform, computing infrastructure, transaction platform and financial services
marketplace.4 When spelled with a lowercase “b” bitcoin it refers to a quantity of
cryptocurrency itself. A cryptocurrency is a virtual token (e.g., a bitcoin, a litecoin) having at
least one moneyness attribute, such as serving as a medium of exchange. It is transported and
tracked on a decentralized ledger called a cryptoledger.5
According to a whitepaper released in November 2008, the original author of the protocol was
trying to resolve the issue of creating a trustless peer-to-peer payment system that could not
be abused by outside 3rd parties such as financial institutions.6 Or in other words, while there
had been many previous attempts at creating a bilateral cryptographic electronic cash system
over the past twenty years, they all were unable to remove a central clearing house and thus
were vulnerable to double-spending attempts by a trusted 3rd party. In contrast, the Bitcoin
system utilized a novel approach by combining existing technologies to create the Bitcoin
network, most of which were at least a decade old.
According to Gwern Branwen, the key components necessary to build this system were:7
2001: SHA-256 finalized
1999-present: Byzantine fault tolerance (PBFT etc.)
1999-present: P2P networks (excluding early networks like Usenet or FidoNet;
MojoNation & BitTorrent, Napster, Gnutella, eDonkey, Freenet, etc.)
1998: Wei Dai, B-money
1998: Nick Szabo, Bit Gold
1997: HashCash
1992-1993: Proof-of-work for spam
1991: cryptographic timestamps
1980: public key cryptography
1979: Hash tree
While there are other pieces, one component that should also be mentioned which will later be
used as an illustration of the nebulous governance surrounding the protocol is the Elliptic Curve
Digital Signature Algorithm (ECDSA) and is the public-private key signature technique used by
the Bitcoin network.
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