Plain Old Money Has Gotten Buggy

“Bitcoin:  It turns nerd forums into libertarian forums.”  Funny, and mostly true.  Nerds sometimes avoid political issues, except to the degree that they break the Internet (thus my involvement in the long and ultimately successful fight against the anti-piracy bills SOPA and PIPA, whose security impacts upon the Internet were simply not considered).  And yet bitcoin, more than perhaps any technology of the last decade, has fired up the imaginations of countless engineers, by simply asking the following question:

What if we really could apply the Internet to money?

To understand this question, and how it’s caused something of a political awakening, one must consider two things.  First, the Internet represents the intersection of a near-complete lack of regulation and astonishing success.  The Internet was by no means the first attempt at creating a global electronic network – old-timers remember well Minitel and Delphi and CompuServe and Prodigy and America Online (with its billion dollar buy of telephone lines).  But this was the one that worked – it was cheap to connect to (no hourly rates), and you didn’t have to ask anyone permission or pay anyone rents to bring services online.

The second thing to realize is that plain old money’s gotten buggy, particularly for those who don’t have much of it.  Just today I passed a sign at a local check cashing shop, proudly proclaiming “Send up to $50 for only $5!”  Only a 10% minimum fee for transmitting funds?  What a bargain.  Not to mention the scams being pulled on workers receiving their payment via debit cards – withdrawal limits, fees for withdrawal, fees for lack of withdrawal, fees for balance inquiry…

Credit cards don’t work person to person, checks don’t work at pretty much any retail establishment, cash doesn’t work if the bill’s too big, PayPal shuts down if you look at it funny, and you can just lie about how much gold you have (a thing you pointedly cannot do with cryptographic currencies).

Bitcoin isn’t perfect.  But it’s certainly not competing with perfection.  What if money worked as reliably as the Internet?

There is, of course, a fundamental aspect of the Net that deserves recognition:  It’s actually not a “guaranteed reliable” system.  Previous forms of networked communication – telephone networks – were “circuit switched”:  A reliable path, with predictable properties, was negotiated for a given communication.  This was difficult to implement and ultimately rather expensive.  The Internet, by contrast, is “packet switched”:  Little chunks are sent out, and hopefully arrive by one of many paths.  There’s no guarantee, but through that fuzziness, remarkable reliability is nonetheless achieved, at ever lowering costs.

Bitcoin leverages this unreliability in two different ways.  First, it actually uses the most unreliable – but redundant – transport of information on the Internet to distribute news of proposed transactions:  A Peer-to-Peer network, just like Napster and its ilk.  Secondly, and perhaps more importantly, bitcoin doesn’t support remediating bad transactions.  The vast majority of regulation is really focused on managing, and reversing if necessary, disputed transfers.  Bitcoin goes so far as to call your store of money your “wallet.”

The U.S. government does not make you whole if you drop a wad of $100s on the street – and if they did, the cost of administering cash would be substantially higher.  Interestingly, while $100s have serial numbers, there’s no realistic way for an individual to track their stolen cash.  Bitcoins by contrast publicly announce their location each time they’re spent, meaning the moment they show up at a non-anonymous location – like a major currency exchange – that party can immediately be sued for possession of stolen property.  In a very real way, stolen bitcoin is like stolen art – tainted, trackable, and honestly, probably too dangerous to steal in the first place.

In a fundamental way, it’s just less expensive to operate bitcoin.  Cost of operation does not define price, of course, as any observer of Coca-Cola or movie theater popcorn can attest.  Other forms of value storage and transfer (two different things) are expensive because they must deal with fraud.  But let’s be honest, they’re also expensive because they can be.  There’s a small enough population of parties to allow for fairly bald-faced rent-seeking behavior.

Is bitcoin immune to small-population rent-seeking behavior?  That is, in fact, a very good question.  Yes, bitcoin is based on math.  The question is, who does the math?

Satoshi Nakamoto, bitcoin’s pseudonymous author and – should bitcoin hit $1,000 – the world’s first cryptographic billionaire, originally designed bitcoin to leverage the hundreds of millions of CPUs deployed all over the globe.  This meant that anyone could go ahead and “join in,” creating far too many participants for any regulatory regime to quell (and indeed, efforts to suppress the population would just end up growing it).

This design could not last.  Once it became apparent that there was, in fact, money to be made “mining” bitcoin, many users switched from using the central processor in their computers to using the graphical processor.  This change dramatically reduced the number of computers able to significantly participate in maintaining the network – if you didn’t have the latest GPU, you were effectively irrelevant.

Still, though, there are a lot of people with fast GPUs.  The “regulatory set” shrank, but not enough.  What’s caused issues is the fact that, no matter how many people are mining bitcoin, there can only be 144 winners a day.  If nothing was done about this, this could mean miners might go months or even years without any revenue.  And so something was done:  Outside of Satoshi’s design, “Mining Pools” formed, aggregating the efforts of many bitcoin participants and “smoothing out” the flow of mined bitcoin.

A system designed to have hundreds of thousands of participants that could never realistically be forced to (or choose to) all abuse their position suddenly found itself limited to a small handful of parties, only two (or even one!) of which held “the keys to the kingdom.”

Notably, the most obvious abuses of bitcoin remain impossible. Nobody can elect themself the bank and declare themselves trillionaires.  But they can revert transactions, block arbitrary parties from using the network, and of course establish high fees.

For a time, one could argue that, should a pool abuse its power, the miners supporting it would rescind their participation.  But dedicated hardware – ASICs, for Application Specific Integrated Circuits – has been built for bitcoin.  The pools simply do not need their armies of miners anymore.  Those who acquire these chips and bring them online essentially have the capacity to immediately dominate all the math done to support bitcoin.

It does not actually need to be this way.  Satoshi’s original design could be restored – there does exist math for which Intel/AMD CPUs are in fact the most efficient chips possible.  (To put it another way, if you could execute this math problem significantly faster, you should not mine bitcoin, you should compete with Intel.)

I’ve publicly predicted – with arguably excessive certainty – that such a change in the “Proof of Work” math of bitcoin will occur.  This prediction is unpopular; the counterargument is that to return the maintenance of the bitcoin network to large numbers of desktop machines is to hand control of bitcoin over to operators of botnets – massive networks of compromised machines, each forced to do the bidding of a criminal taskmaster with neither interest nor investment in the health of the bitcoin network.

I’d like to believe that botnet operators can only maintain their grip on large networks by being non-disruptive.  Forcing millions of machines to spend all available CPU and memory resources maintaining the bitcoin network should be a thing that would attract notice.  But thirteen years working in computer security compels me to admit there’s little to support that assertion.  Bitcoin botnets are already popping up, making the technology something of an “attractive nuisance” (albeit at a limited scale, maybe thanks to these pesky ASICs). 

And so we end up at a rather curious argument by bitcoin’s supporters:  The masses cannot be trusted to maintain the system, as they are easily swayed by a demagogue; instead, only a small group of elites, invested in the continuing and proper functioning of the network, can be trusted.  And it is ultimately these elites who set the fees for transactions in the long run.

Of course, it’s always possible that huge numbers of people will buy bitcoin-specific ASICs, blunting the effectiveness of the big miners.  It’s also possible that the nation-states – who have been making silicon that does cryptographic math for quite some time and actually created the raw math of bitcoin – might themselves just throw their rather large hat in.

On the one hand, bitcoin is in fact a revolution, a dollar bill with a teleporter.  On the other, what if nothing changes?  Say hello to the new boss, same as the old boss.

Also from this issue

Lead Essay

  • Jim Harper reviews the traits that make a given class of items either useful as money or not. These are the traits that, for example, made gold and silver historically such widespread monetary standards. He finds that bitcoin possesses many of them to a very high degree, but that it very importantly fails on some. Bitcoin’s future is unclear in another respect as well: Established government and financial industry interests will do whatever they can to preserve what they view as their own turf. Still, the greatly increased use of digital currency seems inevitable to him in some form or another, and that form could well be private.

Response Essays

  • Dan Kaminsky argues that bitcoin’s success so far stems from the success of the Internet itself, and also from the failures of plain old money. Traditional payment methods all face serious challenges in our digitally connected world, and transaction costs to maintain our financial network make plain old money less and less attractive in contrast to its digital counterpart. But bitcoin isn’t perfect either, and the threat of large conglomerates abusing their power isn’t limited to plain old money. It can happen in the bitcoin network too.

  • Jerry Brito argues that bitcoin is far more than just money. It’s also a distributed-ledger payment system, which means it’s a lot like Visa, MasterCard, or PayPal, but with one key difference: There is no central authority managing the payments. As a result, bitcoin is open to becoming a lot more than “just” money. It can also be used as a token to represent claims on other items. As such, very small fractional bitcoins can function as bonds, stock certificates, property deeds, IOUs, or even decentralized futures markets. The full scope of these possibilities is vast, and we are only beginning to grasp the implications of bitcoin.

  • Chuck Moulton argues that bitcoin is a sound form of money. Its quantity is known, it expands at a known rate, and it will eventually stop expanding. As a result, fluctuations in the value of bitcoin are almost entirely a function of demand. Moulton suggests fractional reserve banking as a way of stabilizing bitcoin’s value. He goes on to suggest that nations might consider dollarizing to bitcoin as a way of preventing inflation, with the very significant caveat that “a second or third generation cryptocurrency may be the one to finally take hold.”

  • We are pleased to publish this contribution from Patrick Murck, Bitcoin Foundation General Counsel, who argues digital currency will disrupt traditional finance. This disruption is both very much intentional and likely to empower consumers who have not been able to take advantage of traditional financial services. Older financial system players are likely to resist, of course: They have a stake in the status quo.