Bitcoin dynamics

Written by: Stephen Hsu

Primary Source: Information Processing

Good discussion of Bitcoin by Mark Andreesen in the Times Dealbook: Why Bitcoin matters. There are also good points made in the comments (see Reader Picks). For example:

… Bitcoin is arguably more like a commodity than a currency as it has no physical assets or central bank behind it. As a commodity should it not therefore be liable to be taxed for any capital gains/losses should the regulators define Bitcoin as a commodity, as in Finland recently? (The example of the guy buying a second-hand Tesla with Bitcoin raises the question, at what price did he originally purchase the Bitcoin? I’m sure the IRS would be ‘investigating’.) To conclude, for the ‘regular’ guy there is very little advantage of getting involved with Bitcoin, apart from speculating on its price.


… Andreessen handwaves away the most important problem: there’s no reason for anyone to want to hold bitcoins, particularly given the bitcoin-dollar rate volatility. He waves this away by saying that people can just conduct transactions in Bitcoin and then immediately convert the bitcoins into dollars, as though actual money is just transmuted into this special form while it’s sent over the wire and then both parties cash out. Well and good; but if that’s the case there has to be a market-maker out there. You need someone with a large dollar reserve who can convert dollars to bitcoins (and vice-versa), and who can even balance international currency flows. That’s a valuable service; it’s foolish to think it’ll remain free forever.

Similarly, the math behind Bitcoin requires a huge amount of electricity and computing power to record current and future transactions. Right now that’s covered by speculators who are basically paid in bitcoin seignorage; but any time you’re consuming real resources and expecting to get them for free you’re being either naive or dishonest.

And honestly, if we just wanted a new payment system, we could do that with far less technical and physical overhead than Bitcoin requires.

In short, I’m sure lots of people would love to have financial transactions be free. That doesn’t mean they actually will be.

Has anyone worked out the equilibrium compensation required for miners to maintain the transaction record (this involves the cost of energy, etc.)? It seems that if there are lots of micro transactions the cost of maintaining the record might exceed the expected benefit to the miners. The volume of trades is in principle independent of the total amount of value in the system, so there seem to be bad regions of parameter space. I read the original Bitcoin paper a long time ago but haven’t followed any of the theoretical developments since then. Don’t forget: bits = carbon!  :-)

My question is partially addressed in the Bitcoin FAQ — they reserve the right to charge transaction fees to help compensate miners. Who, exactly, is “they”?

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Stephen Hsu
Stephen Hsu is vice president for Research and Graduate Studies at Michigan State University. He also serves as scientific adviser to BGI (formerly Beijing Genomics Institute) and as a member of its Cognitive Genomics Lab. Hsu’s primary work has been in applications of quantum field theory, particularly to problems in quantum chromodynamics, dark energy, black holes, entropy bounds, and particle physics beyond the standard model. He has also made contributions to genomics and bioinformatics, the theory of modern finance, and in encryption and information security. Founder of two Silicon Valley companies—SafeWeb, a pioneer in SSL VPN (Secure Sockets Layer Virtual Private Networks) appliances, which was acquired by Symantec in 2003, and Robot Genius Inc., which developed anti-malware technologies—Hsu has given invited research seminars and colloquia at leading research universities and laboratories around the world.
Stephen Hsu

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