Why is Bitcoin Capped at 21M units?

I was asked this at Quora.com. But the query deserves a companion question, and so I approached the reply by answering two questions.


You might have asked “Why was Bitcoin designed to have a cap?” But, instead, you asked “Why is the cap set at 21 million bitcoins”. Let’s explore both questions starting with the choice of a circulation cap…

Why set the cap at 21 million BTC?

The choice of a cap number is arbitrary and in fact, it could be 1 or one hundred trillion. It makes no difference at all and it has no effect on the economy—even if Bitcoin wereStacks of Bitcoin to be adopted as a currency all over the world. If it were set to 1 BTC, we would simply discuss nano-BTC instead of 1 BTC for amounts of about $650.

In fact, we already do this today. For many purposes, people are concerned with very small payments. And to best discuss these payments, we have the Satoshi. There are 100,000 Satoshi to each bitcoin (BTC).

What is important, is that the total number of bitcoin (regardless of how many units there are) can be divided into very tiny fractions. That way, the total worldwide supply can be divided into smaller and smaller slivers as market adoption gains traction. Everyone needs to earn, save, spend or pay with a piece of the pie. All users need to know is what fraction of the pie do I control? and not how many ounces, pounds, Kg, or tons is the pie. That is just a number.

Incidentally, the same could be said of gold (it can be shaved very thin), but gold is not quite like computer bits. It has industrial and cosmetic value, and this intrinsic demand for gold (beyond it’s role as a pure monetary instrument) has an effect on supply and demand along with the influence of investment, circulation, savings and reserve.

Why is there a cap at all?

At the beginning of this answer, I suggested another question: Why is Bitcoin capped at all? After all, the monetary supply in every country grows. Even gold production is likely to continue for centuries to come. Why not Bitcoin?

Satoshi designed Bitcoin to eventually become a deflationary currency. I believe that he/she recognized inflation is an insipid tax that constitutes an involuntary redistribution of earned wealth. With a firm cap on the total number of units that exist, governments can still tax, spend and even enforce tax collection. They can go about business building bridges, waging war and providing assistance to the needy. But without a printing press in the hands of transient politicians, they can only spend money with the consent of their constituents and residents.

Of course, governments could borrow money by issuing bonds. But with a capped currency, they must convince creditors that the country has the will and the ability of to actually repay its debts from real dollars and not inflated dollars.

In effect, monetary policy is restricted to the business of the governed, but the money itself is not coined by a domestic treasury. It is the province of something that is far more certain than a human institution. It arises from pure math. It is open and transparent. Everyone is an auditor, because the bookkeeping is crowd sourced.

For prescient legislators and national treasurers, Bitcoin presents far more of an opportunity than a threat. It is good for government, business and consumers, because it forces an honest money supply. Ultimately, it builds trust in government, because no one can cook the books, water down wealth, or print their way out of debt.

What about recession. Isn’t it a result of deflation?

Deflation doesn’t lead to recession. Rather, it sometimes accompanies a recession. Recession is caused by an uncertain job market, war, a massive supply chain interruption or political upheaval. In one way or another, it boils down to a lack of confidence sparked by one of the economy’s core foundations: consumers, investors, business or creditors.

Bitcoin as currency removes a major impediment to confidence. By creating a system that cannot be rigged, it fosters trust in government along with an open and transparent treasury.

Ellery Davies co-chairs CRYPSA and was MC at The Bitcoin Event in New York. He writes for Quora, LinkedINWild Duck and Lifeboat Foundation, where he sits on the New Money Systems Board.

Privacy –vs– Anonymity

My friend and business partner, Manny Perez holds elective office. As New York State politicians go, he is an all around decent guy! The first things colleagues and constituents notice about him is that he is ethical, principled, has a backbone, and is compassionate for the causes he believes in.

Manny wears other hats. In one role, he guides an ocean freighter as  founder and co-director of CRYPSA, the Cryptocurrency Standards Association. Manny-guitar-sWith the possible exceptions of Satoshi Nakamoto and Andreas Antonopoulos, Manny knows more about Bitcoin than anyone.

But Manny and I differ on the role of privacy and anonymity in financial dealings. While he is a privacy advocate, Manny sees anonymity —and especially civilian tools of anonymity—as a separate and potentially illegal concept. He is uneasy about even discussing the use of intentionally architected anonymity in any financial or communications network. He fears that our phone conversation may be parsed (I agree) and trigger a human review (I agree) and that it could be construed as evidence of promoting illegal technology. This is where we differ… I agree, but I don’t care how anyone who is not party to a private conversation construes it! Yet, I see anonymity as either synonymous with privacy or at least a constituent component. You can’t have one without the other.

Manny was raised in Venezuela, where he was schooled and held is first jobs. He was involved in the energy industry. He acknowledges that experience with a repressive and graft-prone government, lead to a belief in a more open approach: free markets coupled with a democratic government.

Perhaps this is a key source of our different viewpoints. Manny comes from a repressive land and has come to respect the rules-based structure within his comfort zones of banking, energy and government. He is a certified AML expert (anti-money laundering) and believes strongly in other financial oversight rules, like KYC (Know Your Customer) and RICO (Racketeer Influenced and Corrupt Organizations Act).

Because Manny is appreciative of the opportunity and benefits conveyed by his adoptive country, he may overlook a fact that whispers in the minds of other privacy advocates: That is, we may one day need protection from our own government. After all, who but a conspiracy nut or white supremacist could imagine the US government suppressing its populace. Sure, they engage in a little domestic spying—but if you have nothing to hide, why hide at all?!

This week, Manny posted an open letter to the cryptocurrency community. His organization, CRYPSA is at the intersection of that community with law, technology and politics. His letter addresses privacy, anonymity and transparency, but the title is “How can you report a stolen bitcoin?” For me, the issue is a non-sequitur. You needn’t, you shouldn’t, the reporting superstructure shouldn’t exist, and in a well designed system, you can’t.* More to the point, the imposition of any centralized reporting or recording structure would violate the principles of a decentralized, p2p currency.

To be fair, Manny is not a sheep, blindly falling into line. He is shrewd, independent and very bright. But in response to my exaggerated and one-dimensional Manny, I have assembled some thoughts…

1. Privacy, Anonymity and Crime

Bitcoin pile-sThe debate about Bitcoin serving as a laundering mechanism for cyber-criminals is a red herring. Bitcoin does not significantly advance the art of obfuscation or anonymity. There have long been digital E-golds and stored value debit cards that offer immunity from tracking. They are just as easy to use over the Internet.

Moreover, it’s common for crime or vice to drive the early adoption of new technology, especially technology that ushers in a paradigm shift. The problem with linking Bitcoin to crime is that it drives a related debate on transparency, forensics and government oversight. This is a bad association. Transparency should be exclusively elective, being triggered only after a transaction—if and when one party seeks to prove that a payment was made or has a need to discuss a contractual term.

On the other hand, a good mechanism should render forensic analysis a futile effort if attempted by a 3rd party without consent of the parties to a transaction. We should always resist the temptation to build a “snitch” into our own tools. Such designs ultimately defeat their own purpose. They do not help to control crime—Rather, they encourage an invasive government with its fingers in too many people’s private affairs.

CRYPSA is building tools that allow Bitcoin users to ensure that both parties can uncover a transaction completely, but only a party to the transaction wishes to do so!. For example, a parent making a tuition payment to a college can prove the date, amount and courses associated with that payment; a trucker or salesman with a daily expense account can demonstrate to his employer that a purchase was associated with food and lodging and not with souvenirs. And, of course, a taxpayer under audit can demonstrate whatever he wishes about each receipt or payment.

But in every case, the transaction is opaque (and if properly secured, it is completely anonymous) until the sender or recipient chooses to expose details to scrutiny. I will never accept that anonymity is evil nor evidence of illicit intent. Privacy is a basic tenet of a democracy and a government responsible to its citizens. CRYPSA develops tools of transparency, because commerce, businesses and consumers often need to invoke transparency—and not because any entity demands it of them.

We are not required to place our telephone conversations on a public server for future analysis (even if our government saves the metadata or the complete conversation to its clandestine servers). Likewise, we should not expose our transactions to interlopers, no matter their interest or authority. The data should be private until the data generator decides to make it public.

2. Reporting a Transaction (Why not catalog tainted coins?)

Manny also wants to aid in the serialization and cataloging of tainted funds, much like governments do with mass movement of cash into and out of the banking network. This stems from an earnest desire is to help citizens, and not to spy. For example, it seems reasonable that a mechanism to report the theft of currency should be embedded into Bitcoin technology. Perhaps the stolen funds can be more easily identified if digital coins themselves (or their transaction descendants) are fingered as rogue.

The desire to imbue government with the ability to trace the movement of wealth or corporate assets is a natural one. It is an outgrowth of outdated monetary controls and our comfort with centralized trust-endowed. In fact, it is not even a necessary requirement in levying or enforcing taxes.

Look at it this way…

  1. Bitcoin transactions are irreversible without the identification and cooperation of the original payee (the one who received funds). Of course, identification is not a requisite for making a transaction, any more than identification is required for a cash purchase at a restaurant or a newsstand.
  2. There are all sorts of benefits of both anonymous transactions and secure, irrevocable transactions—or least those that cannot be reversed without the consent of the payee. This is one of the key reasons that Bitcoin is taking off despite the start-up fluctuations in exchange rate.
  3. Regarding the concern that senders occasionally wish to reverse a transaction (it was mistaken, unauthorized, or buyer’s remorse), the effort to report, reverse or rescind a transaction is very definitely barking up the wrong tree!

The solution to improper transactions is actually quite simple.

a) Unauthorized Transactions

Harden the system and educate users. Unauthorized transactions can be prevented BEFORE they happen. Even in the worst case, your money will be safer than paper bills in your back pocket, or even than an account balance at your local bank.

b) Buyer’s Remorse and Mistaken transactions

Buyer beware. Think before you reach for your wallet! Think about what you are buying, from whom, and how you came to know them. And here is something else to think about (issues that are being addressed by CRYPSA)…

i.   Do you trust that the product will be shipped?
ii.  Did you bind your purchase to verifiable terms or conditions?
iii. Is a third party guarantor involved (like Amazon or eBay)?

All of these things are available to Bitcoin buyers, if they only educate themselves. In conclusion, “reporting” transactions that you wish to rescind is a red herring. It goes against a key tenant of cryptocurrency. It is certainly possible that a distributed reverse revocation mechanism can be created and implemented. But if this happens, users will migrate to another platform (call it Bitcoin 2.0).

You cannot dictate oversight, rescission or rules to that which has come about from organic tenacity. Instead, we should focus on implementing tools that help buyers and businesses identify sellers who agree to these extensions up front. This, again, is what CRYPSA is doing. It is championing tools that link a transaction to business standards and to user selective transparency. That is, a transaction is transparent if—and only if— the parties to a transaction agree to play by these rules, and if one of them decides to trigger the transparency. For all other p2p transactions, there is no plan to tame the Wild West. It is what it is.

* When I say that you should not report a stolen coin, I really mean that you should not run to the authorities, because there is nothing that they can do. But this is not completely accurate.

20130529_102314a1. There are mechanisms that can announce your theft back into a web of trust. Such a mechanism is at the heart of the certificate revocation method used by the encryption tool, PGP (Pretty Good Privacy). CRYPSA plans to design a similar user-reporting mechanism to make the cryptocurrency community safer.

2. Authorities should still be alerted to theft or misuse of assets. They can still investigate a crime scene, and follow a money trail in the same way that they do with cash transactions, embezzlement or property theft. They can search for motive and opportunity. They have tools and resources and they are professionals at recovering assets.


 

Disclosure: Just like Manny, I am also a CRYPSA director and acting Co-Chairman. (Cryptocurrency Standards Association). This post reflects my personal opinion on the issue of “reporting” unintended, unauthorized or remorseful transactions. I do not speak for other officers or members.

Governments head toward Bitcoin without realizing it

This weekend, Ecuador joined at least 5 other countries in walking toward a future that replaces paper and coins with cryptocurrency. But, are these national experiments likely to lead to the future that comes to mind when we think of Bitcoin?

AWildDuck offers this 2-sentence analysis:

  • Most governments and national banks that experiment with cryptocurrency have no intention of empowering citizens nor decoupling their monetary supply from political control
  • But in the end, that’s exactly where they are headed

Ecuador 5000 SucreThese national experiments are fascinating. Including Ecuador, there are at least 6 national efforts to embrace cryptocurrency around the world, including two in Africa, two in Latin America, Iceland and Israel.

It’s unfortunate that each potentate has created a disparate, internal and proprietary currency. Most of these territorial adopters have adopted neither a mathematical supply cap nor a permissionless blockchain. They buy into the legacy ‘wisdom’ that controlled inflation is necessary to stimulate spending and grow an economy.

Perhaps they see cryptocurrency as a an evolutionary mechanism to lower the production and distribution cost of coins and bills and thwart counterfeiting—just as  many countries have switched from paper bills to plastic. That’s a limited view of a very positive revolution in the making. The leaders and central banks of many countries seem to miss the point. It’s not just about new technology. It’s about free markets, limited supply, public trust and citizen empowerment. In fact, it’s all about growth, free markets and the expansion of wealth.

Hopefully, these experiments are just a step toward combining monetary policy with an open digital currency while fostering a grass roots revival of public trust… Eventually, governments will recognize that properly implemented cryptocurrency—one that is free to usurp the national mint—leads to increased faith in government. At least, if one’s  government demonstrates a willingness to decouple politics from monetary policy.

Ellery Davies is a founding member of CRYPSA, the Cryptocurrency
Standards Association. He is also chief editor at AWildDuck. Catch
all of his Bitcoin articles here.

Bitcoin Adoption: Series of reactions

What is Bitcoin?

Bitcoin-05Sure—You know the history. As it spread from the geeky crypto community, Bitcoin sparked investor frenzy. Its “value” was driven by the confidence of early adopters that they hitched an early train, rather than commercial adoption. But, just like those zealous investors, you realize that it may ultimately reduce the costs of online commerce, if and when if it becomes widely accepted.

But what is Bitcoin, really? To what class of instruments does it belong?

  • The most ardent detractors see it as a sham: A pyramid scheme with absolutely no durable value. A house of cards waiting to tumble. This is a position of my close friend, JD, a former IRS auditor and the first to comment on this post below.
  • Many people recognize that it can be a useful transaction medium—similar to a prepaid gift card, but with a few added kicks: Decentralized, low cost and private.
  • Or is it an equity asset, traded by a community of speculative investors, and subject to bubble psychology? If so, do the wild swings in its exchange rate diminish its potential to be used as a payment mechanism?
  • Does Bitcoin have the potential to be a full-fledged currency with a “real value” that floats based on supply and demand? Can something that lacks intrinsic value or the backing of a bank or government replace national currency?

Regardless of your opinion about Bitcoin, it does one thing that few pundits dispute: Although the exchange value fluctuates, it reduces transaction costs to nearly zero. This characteristic, alone, is a dramatic breakthrough. It was achieved by virtue of its designer overcoming the “double-spend problem”.

Peering Into the Future?

Removing friction is certainly what it is all about. As a transaction medium, Bitcoin achieves this, but so does any debit instrument, or any account in which a buyer has retained house “credit”.

Bitcoin_pullback-sCurrently there is a high bar to get money exchanged into and out of Bitcoin. It’s a mess: costly, time consuming and a big hassle. Seriously! Have you tried using an exchange? Even the most trusted one (Coinbase of San Francisco) makes it incredibly difficult to get money in and out of BTC. Fortunately, this situation is gradually improving.

Where Bitcoin really shines (or more accurately, when it will shine), occurs at the time when more vendors choose to leave revenues in BTC, pending their own purchases from suppliers, shareholder payouts, or simply as retained savings.

When this happens, all sorts of good things will follow…

  • A growing fraction of sellers leave their bitcoin in their wallets, realizing that they will need to spend it for their own labor and materials.
  • Gradually, wild exchange-rate gyrations diminish—not because fewer people are exchanging money, but because the Bitcoin supply/demand value is driven more by actual commerce than it is by speculation.
  • Sellers begin pricing merchandise in Bitcoin rather than legacy units (i.e. national currencies)—because they are less anxious to exchange out of BTC immediately after each sale.

When sellers begin letting a fraction of bitcoin revenues ride—and as they begin pricing goods and services in BTC—a phenomenal tipping point will follow…

  • If goods and services are priced in BTC, then everyone involved saves money and engages in transactions more efficiently.
  • If goods and services are priced in BTC, then the public will begin to perceive exchange rate volatility as a changing dollar rather than a changing bitcoin.
  • Eventually, vendors will begin spending the BTC that they acquire in commerce (or paying staff in BTC), rather than converting quickly back to national currency. More than anything else, this will transform Bitcoin into a stored value unto itself, and not just an exchange chit. This may seem to be a subtle footnote to adoption, but the ramifications are great. That earthquake is the world gradually moving away from centralized treasury-issued bank notes and toward a unified and currency that we can all trust.

People, everywhere, will one day place their trust in a far more robust and trustworthy mechanism than paper promissory notes printed by regional governments. A brilliantly crafted mechanism that is fully distributed, p2p, transaction verified (yet private), has a capped supply and is secure.

What Then?

O.K. So we believe that Bitcoin is the future of money and not just a replacement for credit cards. But what does this really mean? Can the series of cause-and-effect be extrapolated beyond widespread user adoption? Absolutely! …

Adoption of Bitcoin as a stored value (that means as a currency) leads to the gradual realization among governments that Bitcoin is not a threat to sovereignty nor even to tax policy. Instead it presents unbounded opportunity: The opportunity to stabilize markets, eliminate inflation, reduce costs and restore public trust. In short, Bitcoin will ultimately level the playing field, revive entire economies, transform the role of government, and save consumers and businesses billions of dollars each year.

Did I mention that Bitcoin is the future of commerce and a very possible successor to legacy currencies? Aristotle must be smiling.

Lease rooms in the US Treasury to pay off some of the debt brought about by inflation

Uncle Sam can lease the US Treasury building to pay off debt brought about by inflation

China creates a Bitcoin buy opportunity

When governments seek to inhibit, retard or ban a grassroots movement, it almost always has the opposite effect. Official acts of suppression tend to fuel publicity and growth by shining a light on the activity or venue that some wish to suppress.

The US government apparently knows this. Perhaps that is why a Justice Department official said on November 18 that Bitcoins can be a “legal means of exchange” at a U.S. Senate committee hearing.

  • Mythili Raman, acting assistant attorney general at the department’s criminal division, told the Committee on Homeland Security and Governmental Affairs “We all recognize that virtual currencies, in and of themselves, are not illegal”.
  • Federal Reserve Board Chairman, Ben Bernanke, told the Senate committee that the U.S. central bank has no plans to regulate the currency. He wrote to lawmakers: “Although the Federal Reserve generally monitors developments in virtual currencies and other payments system innovations, it does not necessarily have authority to directly supervise or regulate these innovations or the entities that provide them to the market”.

Of course, as with any monetary authority, the US government needs to preserve public faith in the dollar, and also avoid an exodus to digital currencies, even if used only for online transactions. But rather than attempting to ban individuals from investing in Bitcoin or using it as a currency, the US subtly discredits Bitcoin by placing fear and doubt in the minds of would be traders. For example, in this interview, former fed chairman, Alan Greenspan, explains with remarkable clarity why he believes it is foolish to accept Bitcoin as a currency.

Dr. Greenspan is smarter than me and I am certain that he believes what he says. But I respectfully disagree that trust comes only from the Aristotle doctrine of intrinsic value. Even without the backing of a trusted government or bank, investment value can arise from a combination of provable scarcity and widespread recognition.

Short term investment?  —  or
Long term exchange medium?

I prefer to study Bitcoin as an emerging global currency rather than as an investment vehicle. But even as an investment, its potential is inextricably linked to the likelihood that it will catch on as a currency—at least in some sectors or in some countries. So, let’s look at this possibility…

The long term viability of Bitcoin as a currency depends upon sustained trust by a large number of vendors and consumers. That is, buyers and sellers must feel that there will be broad or growing audience to accept the coins that they accrue, and that the value of their savings—or even of daily receipts—will not be eroded by inflation or a sudden lack of faith. (I am not too concerned with wild swings in exchange value during early adoption. These tend to be overlooked by “bleeding edge” adopters or at least the significant fraction of them that have a strong stomach).

Why is Bitcoin falling?

Bitcoin_pullbackThe short answer: it’s not falling for long. It is adjusting in response to politics, but it almost certainly will return to its historical trend.

The upward path of Bitcoin is already the stuff of legend. The exchange rate with the US dollar rose from nothing to $12 in the first 2 years of trading. This year, it peaked at $1240 on Thanksgiving Day in late November, but then pulled back as low as $650 over the next week. The fall was precipitated by a warning from the Chinese government to its citizens. Their announcement did not ban owning or trading Bitcoins, but it warned citizens that it was a very risky investment and also that it must not be used as currency in any transactions.

After pausing at around $700 for a day, it returned to a range of $850~1050 for most of December. But there was another sudden drop last night, on December 17. It pulled all the way into the high fours before settling between $550 and $600. (This posting was written on Dec 18).

But what happened last night? What caused the second nosedive in this graph?

China_effect_on_Bitcoin

Answer: China is at it again. It is using direct engagement rather than subtle persuasion in an attempt to block gradual adoption of a decentralized, uncontrollable phenomenon. Last night, China’s biggest Bitcoin exchange was barred from accepting new Yuan deposits. But it was not shut down. Citizens can continue to sell and trade Bitcoins that are already in their account and the exchange can still accept cash from outside the country.

Some would say that the downward pressure is a natural response to law and public policy. Wild Ducks augment this argument by pointing out that the fall is a temporary and technical effect. More to the point—we see it as a buying opportunity.

Of course, I acknowledge the short term risk and I continue to downplay the role of Bitcoin as an investment. But I can’t shake the notion that early adoption leads to appreciation over the course of a maturing commodity. I also can’t shake extreme excitement over a property of Bitcoin that places it head-and-shoulders above government and bank-backed currencies: The supply is capped. It simply cannot be printed, inflated, or used as a political tool. It also resists efforts of governments to attack personal wealth as the basis for mandatory redistribution, at least without full and wholehearted consent of the governed.

Given the choice of using it as currency later or owning it earlier, why not do both?

Further reading:

Ellery Davies is acting technology editor for AWildDuck. He dabbles in law, economics, and public policy and has been fascinated with Bitcoin for years.