Posts Tagged ‘currency’

My two cents of Bitcoin

June 19, 2011

Last week a friend recommended Bitcoin, as a novel peer to peer technology and currency. Well, I installed the software, I benchmarked my workstation by mining 0.04 units of currency. But the biggest accomplishment was understanding the mechanism of the currency. Here I see a big issue; if the politicians will not be able to understand how it works, will ban the technology in a defensive movement. If the people won’t understand how it works, they won’t trust the coin. Fiat currency (meaning, currency without intrinsic value, opposite to golden coins) only exist because of people using it are educated: they know they can redeem the paper money in goods or services, and the government (or better said, the national bank) guarantees it. Imagine Cesar trying to pay his brave solders with fiat money.. he would have generated a riot so large, because even with his established authority, the people were not enough educated, or experienced, to accept this. So even today, it may take generations until the large masses will trust the Bitcoin.

The major issue of Bitcoin is the issuer. The coin is dis-centralized, but there is an issuer, meaning there is a way to produce money out of thin air. The mechanism of distributing the coins is relatively rigorous, the block generators receive the credit for their hard computational work. The problem is that somebody has the authority to issue new coins. If this person becomes greedy, the market will be flooded by new coins, in time the trust in the coin will erode, but the issuer will get very rich. And since this is not an official currency, the law will be unable to prosecute the issuer. A way to avoid this would be an accounting of new money issued, by each client. Any discrepancy with the known issuing scheduler should generate a warning in each wallet application, since this inflationist happening will dilute everybody’s value, or even better, the peer to peer clients should act as financial controllers of the issuing authority, and oppose any attempt of issuing more bitcoins than scheduled.

Another issue is the wild value variation. The national bank of every country is preoccupied of keeping its currency stable. This means, the regular Joe should not experience from month to month variations in his income. It is unacceptable that one month one earns a car, but next month is unable to feed his kids. Also, the merchants will not accept the risk of handling volatile currencies, so I assume the currency won’t be widely adopted until it will show some stability. Of course, they can assure themself (by hedging) but how many of you selling t-shirts know how hedging works?

Further, I see the coin unnecessary anonymous and unnecessary non-anonymous. Let’s assume for a minute that the whole galaxy adopted Bitcoin as the only currency. I am buying some goods from a store. By sending them the money, they can learn my whole financial saga, from my birth to now. They know how much I earn, they can eventually identify my employer or competitor sellers I have purchased merchandise from. They may learn where I like to travel, if  I have debts, to whom, how much do I pay rent or mortgage. Even if people believe in total anonymity of the coin, this is not true. As a seller one can easily start compiling a large database of names and Bitcoin, based on shipping addresses, formum adds, etc. And they can exchange data between them, or can even offer this data for sale. Even if somebody is yet unknown to the sellers, knowing other he or she did transact with, can lead to identification of address, preferences, age, etc. The bright side of this is that data mining will flourish trying to understand spending patterns, financial interactions or even the essence of wealth.

If you ask me how do I figure out who send money to whom, imagine the following block:

A  send 1.5

B sends 1.8

C receives 1

D sends 0.5

E sends 0.5

F receives 3.3

Even if not explicit, it is easy for a human, and even easier for a computer, to assert with a good confidence that: A and B send money to F, and, D and E send money to C.

I see an immediate use of BC in cheap goods, such as music, shareware software or tangible goods. This may clear the name of P2P networking when its about software or music piracy.

The Bitcoin software I installed seems to unnecessary use the hard drive (by reading and writing own files). That’s maybe because whole financial history of Bitcoin resides now on my hard drive, too.

For the moment, the users experience free transactions, but in the moment the transaction fee will have to support the generation of blocks, it may be that either a block will have really thousands of transactions, or the users will have to pay a premium fee for an expedite transaction. And if the blocks are large, it will be harder to associate receiver and sender by data mining.