Bitcoin

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Voices


We read with interest Paul Krugman’s recent article in the New York Times, humorously titled “Bitcoin Is Evil.” Perhaps the most important part of the article is where Dr. Krugman remarks:

“… when I try to get them to explain to me why BitCoin is a reliable store of value, they always seem to come back with explanations about how it’s a terrific medium of exchange. Even if I buy this (which I don’t, entirely), it doesn’t solve my problem. And I haven’t been able to get my correspondents to recognize that these are different questions.”

Approaching bitcoin as a currency or store of value is focusing on a single and secondary application of the bitcoin network (analogous to analyzing a single feature built on top of the Internet, like email). The first application of the network which has gained broad adoption is payments, where it can be easily demonstrated that real money is being saved by harnessing the efficiency of the network. Since one must acquire bitcoin to use the bitcoin network, this has given bitcoin as a currency value as a secondary effect.

Krugman states that bitcoin does not act as a good store of value because it does not have some kind of inherent floor to its value. Looking at other examples, he implies, gold has decorative and commercial applications and fiat currencies have the backing of their respective sovereign entities. In contrast, bitcoin as a currency has no value unless people use the bitcoin network. If this lack of a clear floor is part of the strict economic definition of a “store of value,” Krugman may very well be correct that bitcoin is not one, but that does not mean the value is not real, nor does it mean that value is ephemeral.

We find the early days of the Internet to be an instructive example in demonstrating this long-term value creation through network efficiency. The Internet had a core innovation that made it valuable: The ability to disseminate data over a distributed network in a way that was significantly cheaper than the prior methods. Similarly, bitcoin has a core technological innovation: The ability to publicly verify ownership, instantly transfer that ownership and do so without the need for a trusted third party. Just as the Internet brought the cost of disseminating information down by an order of magnitude, bitcoin brings the cost of transferring ownership down by an order of magnitude.

Going back to Krugman’s acid test for store of value, there is no “floor” to the value of the bits traveling over the Internet, because people could stop using it at any time. However, the Internet will continue to be valuable so long as it is the most efficient mechanism for transferring data. Bitcoin’s value is the same: It will remain as long as it is the most efficient mechanism for transferring ownership.

In the present, the value of bitcoin as a currency can be viewed as the sum of the cost savings of using the bitcoin network for payments rather than alternative payment networks. If 1.00 bitcoin is currently used for 10 transactions a year with an average value of $100, the bitcoin network is three percent cheaper than the average next best alternative, and this dynamic is maintained for 10 years, multiplying these arbitrary sample inputs values 1.00 bitcoin at $300. This does not require bitcoin to replace existing local currencies.

Again, bitcoin as a payment system is just one of the potential applications of the network. To cap bitcoin’s value here would be like saying that the Internet, in the early days, was only as valuable as its ability to send email in a more efficient way than fax or snail mail. Bitcoin is valuable as a currency because of the economic efficiencies the bitcoin network is already creating as transactions flow over it. As with the Internet, more applications will flourish which will make the bitcoin network, and thus bitcoin as a currency, valuable.

We are content leaving the question of traditional and strict definitional “store of value” to economists better educated in their field than ourselves. That said, we are sufficiently convinced in the value of the bitcoin network. It is delivering tangible economic value first and foremost as a payment system in the present. This will continue to evolve in the future in ways we can foresee now — for example, securities clearing in a distributed, paperless and trustless manner — and in future applications we cannot, in the same way no one foresaw eBay or Airbnb in the early days of the Internet. This is the power and excitement of technological advancement at a low (in this case, protocol) level. It allows things to be built — and thus long-term value to be created — in ways which were not previously possible.

We’d like to thank Dr. Krugman for sparking healthy public discussion. We’re equally encouraged to see him iterate on his thoughts and be open to the thoughts of others shortly after his original article.

Fred Ehrsam is a co-founder and president of Coinbase. Prior to Coinbase, he was a foreign exchange trader at Goldman Sachs in New York; before that, he worked at BlackRock as a portfolio analyst. Ehrsam has been published in the Duke University Journal of Economics. Reach him on Twitter @FEhrsam.



22 comments
jackcurtis
jackcurtis

My confidence in Krugman's analysis was undermined a bit when he concluded that Icelanders were embracing Bitcoins bc the associated computers generated heat!

Stadum
Stadum

The good news is that Paul Krugman is writing about bitcoin.  The bad news is that he has used such a cheap joke as the title of his column.  Nevertheless, I will take it.  Krugman's column is serious and helps take the bitcoin conversation out of the silly level at which it has languished until now.  Your post is another excellent step in that direction -- congratulations.  I would add to the short list of positive commentary the recent report from Bank of AmericaMerrillLynch.  Not all we might wish for, but positive nonetheless, all the more so considering the source and reflecting on what it might have been.


Now young mister Cody Wilson of 3D plastic gun fame down in Austin takes us a step backward with his Dark Wallet project, as reported on the front page of the WSJ yesterday.  And we learn in the article that Peter Thiel, who has taken an interest in bitcoin (see, e.g., https://medium.com/tech-talk/db24476aa865) has also taken an interest in Cody Wilson.  That bears watching.  Thiel is a player to be reckoned with.


Sad but true, we cannot divorce the technology, the excitement and the promise of bitcoin from its politics, and those politics have until now been mainly toxic.  I don't know what kind of circulation your post has, but I would hope that it can be widely circulated and read.

bibilthaysose
bibilthaysose

The thing this article seems to ignore is that there are altcoins that actually solve some of the existing problems with bitcoin architecture (of which there are more that may or may not be solved by bitcoin before another altcoin solves them first).  Scrypt-based coins already solve the most fundamentally antithetical-to-bitcoin flaws in the design of bitcoin, which bitcoin devs will not be able to solve without shattering confidence in bitcoin.  Bitcoin was conceived to be decentralized, but ASIC mining puts the mining power into the hands of those who have access to ASICs.  If people realize that there is no real advantage to using bitcoin over litecoin or even dogecoin, then all those ASIC miners will be holding a lot of useless hardware.  Since Krugman is a bit of a straw-man here's a real economist's take:


https://www.youtube.com/watch?v=7mUn-d8R98k


I find it pretty hard to argue with that actually.

ekkis
ekkis

what makes anything a "store of value" is scarcity, a quality of Bitcoin that doesn't need much elaboration.  as for the question of a value "floor", it's no different from anything else: Bitcoins have a base cost, which is the cost of mining it - just as with gold.  a thing is worth at least what it cost to make it.  so if any investment vehicle out there has a floor, so does Bitcoin.  on the other hand, what is the floor for equities where shares can be issued without limit? or land that nobody wants?

Old_Curmidgeon
Old_Curmidgeon

This is very first time that I have heard the  "e-CONN-o-mist" Paul Krugman mention "store of value" [which I call "store of purchasing power" --- since ALL value is entirely subjective.]

He cites fiat-currencies as having a "floor-value" due to " . . . the backing of their sovereign entities."  

I guess he has never read the trenchant saga of sovereign defaults of their fiat-currencies entitled: "This Time Is Different: Eight Centuries of Financial Folly" by Carmen M. Reinhart and Kenneth S. Rogoff.


Krugman implies that FRNs (Federal Reserve Notes) have a "floor-value." I sure would like for him to tell us what that floor value is.

In 1933. prior to FDRoosevelt's devaluing of the U$Dollar, an ounce of gold or a $20 bill would purchase 400 loaves of bread at 5cents (a nickel) per loaf. Today a $20 bill will purchase 8 loaves at $2.50 per loaf. Whereas an ounce of gold ($1200/ounce will purchase 480 loaves.

  Where's the floor???


The real humor is that Krugman calls himself an economist. I sure don't.


David Michael Myers

cogito01_at_comcast_dot_net

JSF
JSF

Someone please forward to Mr. Krugman "Poe's Law". He can Google it. May help him understand the humor gap. 


Though to be honest I thought he was a humorist for years before I discovered he was actually an economist...

(Kidding, see?)

On a serious note, it is worth considering that these academic debates overlook (or perhaps belie) something important. Hardly anybody really understands money. Money as we know it, is almost a complete mystery to the public.


Ask 100 people on the street to explain fractional lending, POMO, quantitative easing (a creative euphemism indeed), you may find 1 or 2 with a basic understanding. Or not.


Offer the same 100 people a $100 bill and they totally get it though.


Mr. Krugman's opinion on the mechanics/theory will eventually be rendered irrelevant, perhaps, not because everyone suddenly understands Bitcoin and how it works and why, but because.... "oh. Money."


If it weren't so, the current system would never have made it off the ground either.  



Thoughtful response, Mr. Erhsam. Thanks.

pbaril
pbaril

Loyalty, a value without floor once expressed vertically within national, ethnic, or corporate structures, now runs horizontally across sovereign boundaries, increasingly isolating the armed and moneyed minority.

The original Arab Spring and Occupy Movement were the first evidence of this horizontal self-recognition. Now the Bitcoin protocol (not the mere currency), is its surfacing submarine flagship, valuable inducement to hope in a world where out-law-ing abusive surveillance doesn’t work, where attempts to regulate it only entertain and where embedding cryptography in the global horizontal architecture feeds the most audacious hope.

Restoration of the secret ballot to a truthfully informed electorate. 


Donald McIntyre
Donald McIntyre

It seems Krugman is talking about the currency unit of Bitcoin and Ehrsam about the Bitcoin network that, as one of its features, enables the storage and transfer of this unit.

I agree with Ehrsam that if the network is successful then the currency will be so too because it is needed to do the transfers of ownership (a Tesla can be represented by 1 bitcoin and its ownership be moved around through the network like a currency unit).


The currency is a component of the network so if the network is used for transferring not only its units, but anything else that requires registration, then that is a more broad application than only a medium of exchange, a store of value, and unit of account.

I must say I always regarded Bitcoin as the currency, but if new apps are built on top of this protocol then it will become stringer due to increasing returns of the network effect.


The only thing is if the protocol can be replicated, like in the case of Litecoin and many others, is if these new apps with be imnplemented o other networks rather than everything on the Bitcoin network?

acwm
acwm

 "Similarly, bitcoin has a core technological innovation: The ability to publicly verify ownership, instantly transfer that ownership and do so without the need for a trusted third party."


I'm having a little trouble understanding the tangible benefits of this supposed "innovation". If I were to use the bitcoin network to exchange money with someone else, wouldn't I have to trust the security of the network to ensure that my bitcoin reaches the right person (i.e. I'd have to trust that the system can't be hacked)? And then what makes this form of security more trustworthy than my bank or my credit card company (whom I am currently inclined to trust more than the seemingly opaque and volatile bitcoin network)?

znmeb
znmeb

I don't think you can say "Bitcoin *is* good" with a straight face. Bitcoin *could be* good, and since your current public-facing business model depends on making Bitcoin good for *your* defintion of "good", I'll assume you want it to be good.


But here's the thing - there's an old saying: "People do business with people they know, like and trust." Bitcoin simply *oozes* mistrust! Its "creator" is anonymous, its most highly publicized use is for illegal drug trading. The FBI has seized a large chunk of the existing 'supply'. Regulators in China and India have clamped down on it, and it's not exactly regulation-free in the USA. The exchanges are subject to persistent attacks, frequently successful. 

And the time series that tracks Bitcoin exchange rates exhibits bizarre characteristics indicative of at *best* illiquidity and more likely manipulation by malefactors. Cap that with the semi-anonymous nature of Bitcoin "Ownership" and you have what looks to many with a knowledge of financial history something strongly resembling the Tulip Mania.

wmougayar
wmougayar

Thanks Fred for explaining this.


Most pundits (including Krugman) who are writing about Bitcoin don't have a very good understanding of Bitcoin as a whole. In their defense, the Bitcoin industry hasn't done a great job explaining Bitcoin. I think we can do better.

DDpolEcon
DDpolEcon

@ekkis @ekkisMoney emerged historically as a unit of account - what was owed by one person or group to another. Clearly for this to be satisfactory the value (per unit) has to be stored over time. One aspect of that is the medium of exchange - changes in the quantities of the medium (where one is used) influence the value and expectations in relation to the value. An aspect of 'moneyness' is the ability of those holding it (creditors in the system) to delay purchases and 'store their value". The central feature of the social contracts or treaties (although influenced by quantities) is the legitimacy of the monetary system - the authority which stands behind the various features of the contracts - a debtors and creditors issue. In all monetary systems security and stability have proved difficult issues - economic relationships as Weber pointed out are always social competition (a form of war and politics). The notion that a thing is worth what it cost to make is mistaken - a variant of the labour theory of value. A thing is worth its market value - and that is subject to change by a range of forces including deliberate manipulation. Bitcoin users beware...

GuiAmbros
GuiAmbros

@ekkis your comment, together with @bibilthaysose's, are actually better than the entire article.


While I respect what Coinbase is doing, Fred's article didn't address any of the points raised on Paul Krugman's original (flawed) piece. Scarcity, floor price driven by the cost to actually "generate" the currency, the role of altcoins; these are the real discussions that will move Bitcoin forward. We gain nothing by shouting some grandiose but unsubstantiated dreams of "Bitcoin is just like the early days of Internet".


bibilthaysose
bibilthaysose

@NewfinationYou are the only person here that has even acknowledged altcoins.  Krugman also ignores them, thinking that it's enough to say that "they're not backed by anything."  In truth, neither is the USD, except the fact that I would be jailed for duplicating them.  On the contrary, for duplicating bitcoin, I may become famous!

Ganey
Ganey

@acwm  Bitcoin for me doesn't have the intention of replacing money, or credit cards or whatever. It stands alongside them as another payment method, and I joined in the bitcoin mining stage a while back and happen to have some. 


I'm happy to use it more so than my credit card, as transactions are one way, i.e, i get an address to send coins to, unlike with a credit card where i give a 3rd party my card details to take money from. 

So think of the bitcoin transactions like manually making a bank transfer, it's initiated by you, and is as secure as your banking passwords. 

Card information is rather loose in terms of security, from bugged ATM's to poor internet security and theft of details. And i'm not even going to start on where contactless payements is concerned.


JSF
JSF

@acwm From the most practical standpoint, because it is like cash, I was curious about bitcoin when I first heard about it. WIthin a few seconds of using it for the first time the utility is quite obvious and very appealing. It feels like cash. 


Here is my real world scenario. I write a newsletter that is paid via paypal only. My subscribers have all given their information and I have that in my inbox on receipts and paypal accounts. Their names, home addresses, phone numbers even. 


The truth is, none of that is really any of my business or my concern (or my responsibility to safeguard, excepting that it is because I now have it). All I need is their email address. 


Do they mind that have their information? Probably not. If they were given the preference of anonymity would they take it? I suspect most would.


The more meaningful innovation is I don't have to pay the fees via paypal or credit cards. 


My question is how it is even possible for a tiny conglomerate of terminal providers can scalp 2-10% of every transaction in the world (except cash) every single day and merchants and consumers shrug and pay it?


Made sense some ages ago, but... we all have an internet connection now. It's complete madness if you consider the forced redundancies of the current system. It is a huge tax on commerce.


I could go on, I am fairly brand new to bitcoin but my advice is try it and you will know we are not going back.  

Nick Reilly
Nick Reilly

@acwm @acwm  I think to answer that question, you have to understand how peer to peer networks work, and the difference between a decentralized network and a centralized one.  The Bitcoin protocol is the former, so there is no central party that must be trusted.  With the way incentives are aligned with Bitcoin, you don't have to trust anyone.  That's the point.


Sure, you have to trust the protocol, which is to say that you have to trust logic, and mathematics.  There are risks.  The protocol is constantly attacked by 1,000s of hackers everyday.  One way you can think of it, is that there's a $10,000,000,000 bounty on the first hacker to crack the protocol.  If this were so likely to happen, it would have happened already.  As the days roll by, trust will grow (as it does with any technology).


Nick Reilly
Nick Reilly

@znmeb Well, Bitcoin is just a protocol, or a standard.  It is apolitical of course, but it is disruptive, and we're seeing that now.  Bitcoin's have been used in the past for purchasing drugs on the "dark web".  I assume you're referring to Silk Road.  While you appear anxious to point this out, you don't seem to be concerned that the Internet itself enables the accessibility and usability of sites like Silk Road even more than Bitcoin does.  Which is to say that Silk Road, and similar illegal drug trading sites could not exist without the Internet.  Should we shut that down, or is it *possible* that technology can be used for both good and bad, and that we shouldn't make rash decisions by focusing unduly on the dramatic and eye-catching?


Your point on the "creator" is simply an ad hominem.  Anyone is welcome to review the source code.  In fact, 10s of thousands of experts, if not more, already have.


At the end of the day, Bitcoin is just like other disruptive technology.  You can "undo" technology.  The cat is out of the bag, and it's here to stay (regardless of your unusual hostility).

bibilthaysose
bibilthaysose

@Nick Reilly@acwm Bitcoin is bound to become centralized by 2 flaws (and maybe more): 

1) ASIC mining - the proof-of-work algorithm (hash-cash I think?) is too easy to print on an ASIC.  Scrypt coins solve this problem.

2) Blockchain download - the block chain is becoming too large to be practically stored locally, so you have to rely on centralized 3rd parties to store it.

These problems can be solved, but bitcoin would disappoint a lot of miners if the proof-of-work album suddenly changed.

jacopogio
jacopogio

@Nick Reilly @acwm Right. But what happens if a hacker cracks the protocol ? 

WHO is going to "chase and punish him" ? 

WHO is going to change the rules that have failed ?

WHO is going to to do it for free ? 

And who is this WHO that I will have to trust because he will take charge of my savings?

What democratic control can I have on how this WHO works with my savings?

...


Money is more than transfer.

bibilthaysose
bibilthaysose

@jacopogio@Nick Reilly@acwmThere's a community that reviews these things.  For free.  There are people currently stealing your savings (if it's in USD).  They're called the Federal Reserve banks.  They're also getting paid for stealing your savings.  Oh yeah, and also there's no democratic control over the Federal Reserve system, which operates outside of our government's control or even knowledge.

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