Some people believe that the design of Bitcoin is flawed, and that it cannot work. David Kramer is one of them and has made an interesting post over at Lew Rockwell, about Bitcoin. Lets take a look.

I’m sure by now many of you have heard about Bitcoin. The fact that it’s called “virtual currency” gives you an idea about its actual value as a real medium of exchange.

This isn’t true; the only thing that gives you an idea about its value as a medium of exchange is what you can exchange it for. Right now you can trade a bitcoin for 26.141 Federal Reserve Notes. This is the truth about what the value of a Bitcoin is right now.

While many people who are touting it on Facebook are enamored with the fact that it was voluntarily created by the marketplace (i.e., is not forced down our throats by a private central bank), I’m afraid that those people are losing sight of how a real medium of exchange arises in a free market.

Bitcoin was developed as a way to exchange between people in a cash like fashion at a distance, without a central clearing authority. It was created because there is a need for this service, which has been recognised since the days of Dr. David Chaum’s E-Cash.

The people who work on this project were not directed to by anyone, and no one told the man who made the breakthrough that this is what he should be doing. This is yet another example of free people solving problems for themselves, and that is a good thing.

We should point out that Satoshi Nakamoto could have patented this idea but choose not to; instead, he released his idea and the software he wrote to implement it as Open Source, so that everyone everywhere can benefit from his concept. This is a noble act, and it is proper that we recognise this.

A medium of exchange arises from something that had a material use/value in the market prior to becoming a medium of exchange, i.e., it was also a good being bartered for other goods and services. Over the centuries, gold and silver won out as the two most preferred mediums of exchange—with gold holding the number one position due to it being more scarce than silver.

You could argue that the electricity and the CPU cycles that are used to generate bitcoins had a use in the market prior to their use to create a Bitcoin, but we will leave that for today.

Over the centuries, gold and silver have been settled upon as the best medium of exchange by the market, and this is still true today.

Now fast forward to the twentieth century, which is happening right now. How can I transmit gold (or any thing that I and another person want to trade) without double spending, anonymously, to a person that is half way around the world, without a central clearing authority? Before Bitcoin, this was not possible, and now it is.

Bitcoin, whilst not conforming strictly to the definition of what money is, is a very useful tool to exchange value. It takes some understanding and knowledge of mathematics to grasp exactly how it works and why it is so brilliant, but even without that knowledge, it can still be used by everyone eventually.

Mr. Kramer can use email to send and receive messages without understanding SMTP or POP syntax. He can write blog posts without understanding HTTP requests or MYSQL, and most certainly he will be able to use credit cards and buy books from Amazon whilst his transaction is protected by SSL. None of these things, these very complicated things, need to be understood fully before you can grasp their importance. SSL, upon which the entire commerce infrastructure is built, is nothing like putting a paper document in an envelope to be mailed by the government monopoly postal system and yet, it is used every day to secure documents in transit. PGP and Public Key Cryptography is used every day to sign documents in a way that means they cannot be forged; signing a document with Public Key Cryptography is not the same as putting your ‘John Hancock’ on a piece of paper, but it is a quantum leap in a different direction that has uses way beyond what signing a piece of paper can do for you.

This is what Bitcoin is all about; it is a breakthrough in sending and receiving acknowledgement of ownership.

Anyone who scoffs at this is simply not seeing the big picture.

What was Bitcoin’s prior material use/value? Zero. It is just bits in a computer.

This is a straw man argument. David Kramer’s post, and the two links in his update to Murray Rothbard’s books (one of which I have read; ‘What has Government done to our money?‘) are just ‘bits in a computer’ and yet, these bits can be used to transform the thinking of men. Bitcoins when they are stored on a device, are represented by bits, but it is what those bits represent and their relationship to other bits on other people’s computers that is important. This line of Kramer’s shows that he really does not understand what computers are, how they work and why Bitcoin is a breakthrough.

And what’s with the “fixed” amount of Bitcoins? Who determined the “proper” amount? A computer programmer?

And why not a computer programmer? This is exactly the same as Lacy Clay saying Thomas DiLorenzo cannot talk about economics ‘because he is an historian’. For what reason are computer programmers excluded from inventing something that has a potential use in economics? Or should this be left only to the high priests? This is not a serious argument against the design of Bitcoin. Clearly there needed to be an upper limit to the number of Bitcoins in circulation, otherwise it would not be useful as a way of transmitting ‘money’. The person who designed Bitcoin, a computer programmer, set the upper limit. If the market will not accept this limit, then the system will not be used. But I digress.

Data is infinitely copyable. There is no limit to the number of times data can be copied. This means that any token in a system of exchange can be copied at will by anyone with access to the system at any level. This is where the problem of double spending comes from, and part of the breakthrough in Bitcoin is the solution to this problem, which computer programmers have been searching for for decades.

When you have even a slight grasp of how data and computers work, and you understand that the double spending problem has been solved, your first reaction would be to gasp, as the enormity of what Bitcoin is dawns on you.

Only the free market can voluntarily determine how much of a real medium of exchange is needed in the marketplace over time.

This is true, but once again, this has nothing to do with Bitcoin. By releasing Bitcoins slowly over time, by the efforts of the people who use it, there can never be a flood of Bitcoins. Satoshi Nakamoto must have grasped on some level, if not entirely, that money is a commodity, which is why he designed Bitcoin to be mined in this way, instead of starting off with 21,000,000 coins in circulation all at once. All we know about his thinking is what we see in his software and in his original proposal. We have between now and 2142 to see what the market voluntarily determines how much of a real medium of exchange Bitcoin is, and if the number of bitcoins is too small or too big. Whatever the outcome, there is nothing stopping someone else with another system from supplanting or improving on Bitcoin, by whatever means they can come up with.

While the idea of attempting to get rid of the Bankster monopoly on creating money out of thin air is commendable, Bitcoin is also money created out of thin air. Bitcoin is just substituting one bogus medium of exchange for another.

http://www.lewrockwell.com/blog/lewrw/archives/89471.html

Declaring Bitcoin to be ‘Just Another Bogus Medium of Exchange’ is not an argument and is clearly false. It is also not true that Bitcoins are created ‘out of thin air’. Bitcoin is new and unique, and that is a fact; even if you believe it to be bogus, you have to demonstrate why it is bogus.

If you want to refute Bitcoin (or anything for that matter) you have to address the facts about it. Here is an example of someone who has done precisely that.

Tav addresses how Bitcoin works, acknowledges its breakthrough, demonstrates an understanding of economics, identifies what he believes the specific flaws in Bitcoin are, and explains why he concludes it cannot work, clearly and with precision. Here is another critique and another by the same author.

If you want to contribute something meaningful and useful that is the way to do it. There are arguments swirling around the ‘hoarding problem’; it would be nice to read a good analysis of hoarding and how it applies to real money like gold and silver, and how those dynamics apply to Bitcoin. In any case, I don’t care much for people who refuse to think hard about subjects like Bitcoin; something that is voluntary, harmless, an exiting breakthrough and which has massive potential even if in this iteration, it fails.

We have seen the failure of other systems, like Chaumian E-Cash before. Each of these iterations causes analysis, innovation and new products to emerge. This is something to celebrate, to think hard about, to address with logic and facts and indeed, to even try out on your own computer so that you actually have a grasp of what is involved in it.

Finally, whatever happens with Bitcoin, the individual wins.

If Bitcoin becomes the de-facto way of spending money on the internet, displacing all other systems like Credit Cards and PayPal, the public wins, and the State loses. That is win.

If Bitcoin fails because the State outlaws it, hatred for the State increases. That is win.

If Bitcoin fails for economic reasons, it will not be tried again in this form and the lessons learned will be folded into the next iteration. That is win.

If Bitcoin fails for technical reasons, same again, the lessons learned will be used in the next iteration, which is win.

Whatever way you choose to look at it, Bitcoin is a good thing.

+++++++ UPDATE! +++++++

In a well considered article, which I linked to above, “BitCoins: All Buzz, No Substance” by Grant Babcock, the problems with Bitcoin as perceived by the author are addressed. In listing his objections to Bitcoin, he actually argues for it. Lets take a look.

A given good’s exchange value has a tendency to snowball.

This is happening with Bitcoin right now.

If I believe that a larger number of people are willing to trade for a good, I am more willing to trade for that good myself.

This is happening right now with Bitcoin.

Eventually, we expect a single good or a handful of goods to emerge as the predominant media of exchange; they are then called monies.

This may happen with Bitcoin on the internet. If enough people download the client and accept it, and websites use the simple tools needed to accept it, we can expect it to emerge as a form of money. Bitcoins, by Grant’s own reasoning, are no different to coconuts, feathers, tally sticks or cowrie shells.

Historically, goods such as cigarettes, precious metals, shells, and many others have emerged as monies.

And so why not digital certificates that cannot be forged or ‘printed’ (mined or generated) beyond a certain number (21,000,000)?

People’s willingness to treat an item as money is based on experience. They forecast that a good will be accepted in trade tomorrow because it was accepted in trade the day before and the day before that.

And so, if enough people accept Bitcoins, they will treat it as money de-facto by this definition.

If we follow this chain back in time, eventually we arrive at a point where the commodity is has not yet been used as a medium of exchange and is only wanted for its use value.

This is true of Bitcoins; digital certificates and signatures have been around for many years; they were never before thought of as money in and of themselves (though you can buy certificates for money; ask Mark Shuttleworth about how he became a billionaire by selling ‘just bits on a computer’).

The principle that the value of a currency can be traced back to a time when it was not yet a currency but just a commodity like any other is called the regression theorem, and interested parties can read more about it in Human Action Ch 17 § 4.

If you do not like tracing Bitcoins back to digital certificates, you could trace them back to the electricity used to make them. Or is electricity not a commodity because it is not physical? It is intangible, but is transmissible… hmmmm!

Typically once a commodity becomes a money, a variety of certification agencies will emerge.

Bitcoin has this, of course, in the form of its decentralized P2P clients. That is the breakthrough; no centralised certification agency.

Suppose for example that our money is gold — examples of certification might be an imprint on a gold coin stating its weight and where it was minted, or a piece of paper entitling the bearer to a certain amount of gold at a trusted repository.

A stamp on a bar of gold is meaningless, as we have seen with the tungsten centered fake gold bars. Bitcoin, in this respect, is superior to gold because each Bitcoin is absolutely certified.

This certification makes the commodity an even better money than it would have been without the certification. The certification is bundled with the commodity and traded, but is in principle distinct; the coin and the stamp in the coin are different “things.”

Indeed. As you can see, all the arguments presented here for gold as money, apply to Bitcoins as money.

Just as the computers and the internet changed the way letters and books are made and distributed and read, money is being changed in the same way.

This means that if you want to read a physical book, you still have to go out an buy one, or have it posted to you. If you want money in the real world, you should use gold and silver coins only.

If you want to read a book on your iPad, you get a PDF copy from somewhere on the internet, and then read it on your device. This does not mean that ‘PDFs are not books’ and no one with any sense says this. PDFs are for e-readers. That is their nature, its what they are for and the medium where they make sense is the computer.

If you want to send money to your cousin in Jodhpur, you take your gold coins to a shop in Manchester, turn them into Bitcoins and then send them. Your cousin can then turn them back into gold, or he can buy goods and services with them on the internet. Bitcoins are to money as PDFs are to books. Its not hard to understand, and the wow factor comes in when you understand that whilst PDFs can be copied ‘double spent’ ad infinitum, Bitcoins cannot, even though they are both digital.

That is simply incredible and its why everyone is so exited about them. Add to the mix the anonymity, the lack of central authority, the transparency in both the client software and the network, and you begin to see just what a revolution this is any why the word ‘revolution’ is appropriate.

Finally read this excellent analysis of gold vs Bitcoin by Anthony Freeman.

Chinese translation of this article.

This entry was posted on Friday, June 10th, 2011 at 11:45 am and is filed under Economics, Libertarianism, Music, Someone Clever Said, The Facts.