Friday, September 27, 2013

Bitcoin Blurbs

These are collected comments about Bitcoin that I have made to questions that seem to come up often...

Why use Bitcoin?

Bitcoin is not about tax avoidance. Its about buying stuff from China (or other countries) with no fees.  Its about empowering the unbanked. Its about the nervousness you feel when waiting for card "authorization" verses the certainty of a 20 dollar bill. 

Its about "opting out" of the "race to the bottom" that countries seem engaged in with their currencies.

Human technological progress is the story of tools that progress from the use of natural substances with desirable (and undesirable) properties to engineered solutions highly optimized to the problem. The stone axe becomes the chainsaw.  
Gold/silver is "sound money" but a natural substance. The dollar and other currencies are engineered but unsound (no guaranteed scarcity). Bitcoin is the first engineered sound money.

Using a credit card is exactly like making a payment by copying the key to your vault, handing it to a random stranger and having THEM take out your money.  Many times per day.  When you charge something, you give the merchant every piece of information that they need to run a different "card-not-present" (i.e. online) charge.  And then those merchants store that information in a database available forever to anyone who can get into their computer...

Your bank account is like a post office box.  Each box looks secure from the front, but its completely open in the back.  If you sneak over the counter, you could shift people's mail around or take it for yourself.  Similarly bank employees (or criminals with access) can add or remove money from your bank account with just a few clicks.  

Bitcoin is like the blue curbside drop box (only stronger).  Mail (bitcoins) can be placed into the box by anyone, but ONLY the person with the key can remove them.

On Mining and the Security of the Bitcoin Network

There is a distributed network of computers that validate all transactions, including coin creation (inflation).  Coin creation is not variable; it follows a schedule that is an intrinsic part of the currency and cannot be change.  If you change it, your transactions are rejected.  This computer network is currently more powerful than the top 100 most powerful computers COMBINED.  This network creates a "history" that is then essentially "watermarked" using a process that consumes the entire processing power of the network.  To rewrite this history you would need a computer network that can make a stronger watermark -- it must be faster then the sum of this network's speed since the beginning.
But even if you had this amazing network, you could not take MY coins (but you could stop me from spending them).  These are secured in my account using cryptography that is so strong that if you built a computer powered by the entire energy output of the sun, the sun would burn out before you cracked my account.  BTW, this crypto is similar to what secures your online and "wire" banking transactions anyway.  So if someone did crack it, they would likely prefer to steal trillions of USD rather than a few bitcoins.

When people steal bitcoins, they do it via traditional means -- they break into your house/computer and find the piece of paper/file you wrote your password on, for example.
Gold/silver/platinum is good diversification, but is easily detected due to its density and can't easily be used in today's economy.  Your Bitcoin account password can be carried in your head.  A very conservative investment in Bitcoin could increase your financial diversity and security.  This is not financial advice, I am not your financial advisor, etc etc blah blah blah.

Trading Bitcoins

Bitcoin is a financial TRANSFER network, not a financial TRADE network.  You can't TRADE anything on the bitcoin network.  That is, you can't exchange bitcoins for something else.  You can only send bitcoins.  Its like SWIFT or other wire transfer services.  So to TRADE you must use an exchange -- a place where people agree to trade X for Y and have facilities for handling both X and Y.  These places certainly allow extremely fast trades, because they are holding your bitcoins in their account just like Schwab holds your dollars.

There have been lots of issues with these exchanges (hackers, going out of business, etc), but none with Bitcoin itself.

Confirmation Time

No one is correct who says that it takes up to an hour for "confirmations" of transfers on the bitcoin network.  In fact, transfers are NEVER confirmed in an absolute sense, its just that the probability of them being reversed becomes vanishingly small.  The "hour" number you hear quoted is just an arbitrarily chosen consensus value in the same sense as "statistically significant" is arbitrary.   In analogy, you are trying to apply absolute Newtonian physics to a probabilistic quantum mechanical system.

In practice, this means that people can safely sell a $5 coffee instantly, but for a million dollar sale I would for many more then just 1 hour!  Essentially, you want to wait until the cost effort required to overwhelm the probability is greater than the price of the item.


You don't have to wait before spending.  Actually in the bitcoin network you could process thousands or even more transactions using the same money much faster than a day.  So HFT *could* exist on the network (if it allowed trading).

How?  You can actually spend money before it is "confirmed".

There IS NO "confirmed" just vanishingly small probabilities.  But there is no rule saying you can't spend $ when it still has a larger say .000001% probability (in practice some small number like that is as big as it gets, see end).  People could create entire chains of "unconfirmed" transfers, each one predicated on the prior ones being "confirmed".  This is how the betting "service" Satoshi Dice is able to respond instantly with a win or loss result -- it pays you back with $ from your own transfer.  So if your bet transfer is invalidated the return payout transfer is similarly invalidated.

The "in practice" probability of a transfer being invalidated is incredibly low with no waiting at all.   There has been exactly one case in the entire history of Bitcoin, and that case occurred because humans decided to intervene to solve a bug in a new release of the bitcoin software.

3 fundamentals of production, decentralized:

1. Information: What to build, how to build it efficiently, how to market your product  (Web)
2. Exchange: How to efficiently get value for your product (Bitcoin)
3. Fabrication: efficiently constructing the product (3d printing baby steps)

A decentralized system moves faster and is more efficient.  Without the web, I have to submit my product to a catalog or brick&mortar purchasing agent, then evaluation, market testing, haggling, purchasing, warehousing, catalog printing,mailing/retail shelving, and finally sales to end user.  With the web, I can post on forums, run google ads, find my customers and sell directly to them.  When (and only when) volumes increase do I need to do all the pre-web steps.  This model is also more efficient socially/environmentally because it eliminates undesired products early -- before they are mass produced.