Diminishing Bitcoin Mining Rewards

By now, most Bitcoin and Blockchain enthusiasts are aware of four looming issues that threaten the conversion of Bitcoin from an instrument of academics, criminal activity, and closed circle communities into a broader instrument that is fungible, private, stable, ubiquitous and recognized as a currency—and not just an investment unit or a transaction instrument.

These are the elephants in the room:

  • Unleashing high-volume and speedy transactions
  • Governance and the concentration of mining influence among pools, geography or special interests
  • Privacy & Anonymity
  • Dwindling mining incentives (and the eventual end of mining). Bitcoin’s design eventually drops financial incentives for transaction validation. What then?

As an Op-Ed pundit, I value original content. But the article, below, on Bitcoin fungibility, and this one on the post-incentive era, are a well-deserved nod to inspired thinking by other writers on issues that loom over the cryptocurrency community.

This article at Coinidol comes from an unlikely source: Jacob Okonya is a graduate student in Uganda. He is highly articulate, has a  keen sense of market economics and the evolution of technology adoption. He is also a quick study and a budding columnist.

What Happens When Bitcoin Mining Rewards Diminish To Zero?

Jacob addresses this last issue with clarity and focus. I urge Wild Ducks to read it. My response, below touches on both issues 3 and 4 in the impromptu list, above.

Sunset mining incentives—and also the absence of supporting fully anonymous transactions—are two serious deficiencies in Bitcoin today.
I am confident that both shortcomings will be successfully addressed and resolved.

Thoughts about Issues #3 and #4: [Disclosure] I sit on the board at CRYPSA and draft whitepapers and position statements.*

Blockchain Building: Dwindling Incentives

mining-incentive-02Financial incentives for miners can be replaced by non-financial awards, such as recognition, governance, gaming, stakeholder lotteries, and exchange reputation points. I am barely scratching the surface. Others will come up with more creative ideas.

Last year, at the 2015 MIT Bitcoin Expo, Keynote speaker Andreas Antonopoulos expressed confidence that Bitcoin will survive the sunset of miner incentives. He proposed some novel methods of ongoing validation incentives—most notably, a game theory replacement. Of course, another possibility is the use of very small transaction fees to continue financial incentives.

Personally, I doubt that direct financial incentives—in the form of microcash payments— will be needed. Ultimately, I envision an ecosystem in which everyone who uses Bitcoin to buy, sell, gift, trade, or invest will avoid fees while creating fluidity—by sharing the CPU burden. All users will validate at least one Blockchain transaction for every 5 transactions of their own.

Today, that burden is complex by design, because it reflects increasing competition to find a diminishing cache of unmined coins. But without that competition, the CPU overhead will be trivial. In fact, it seems likely that a validation mechanism could be built into every personal wallet and every mobile device app. The potential for massive crowd-sourced scrutiny has the added benefit of making the blockchain more robust: Trusted, speedy, and resistant to attack.

Transaction Privacy & Anonymity

Bitcoin’s lack of rock-solid, forensic-thwarting anonymity is a weak point that must ultimately be addressed. It’s not about helping criminals, it’s about liberty and freedoms. Detectives & forensic labs have classic methods of pursuing criminals. It is not our job to offer interlopers an identity, serial number and traceable event for every transaction.

Anonymity can come in one of three ways. Method #3 is least desirable:

  1. Add complex, multi-stage, multi-party mixing to every transaction—including random time delays, and parsing out fragments for real purchases and payments. To be successful, mixing must be ubiquitous. That is, it must be active with every wallet and every transaction by default. Ideally, it should even be applied to idle funds. This thwarts both forensic analysis mining-incentive-03and earnest but misguided attempts to create a registry of ‘tainted’ coins.
  2. Fork by consensus: Add anonymizing technology by copying a vetted, open source alt-coin
  3. Migrate to a new coin with robust, anonymizing tech at its core. To be effective, it must respect all BTC stakeholders with no other ownership, pre-mined or withheld distribution. Of course, it must be open, transparent and permissionless—with an opportunity and incentive for all users to be miners, or more specifically, to be bookkeepers.

That’s my opinion on the sunset of mining incentives and on transaction anonymity.
—What’s yours?

* Ellery Davies is co-chair of the Cryptocurrency Standards Asso-
  ciation. He was host and MC for the Bitcoin Event in New York.

Bitcoin continues to gain trust & respect

In 2011, we discussed Bitcoin, a pure and decentralized digital currency. Introduced in 2009 as a mathematical treatise from a still-mysterious source, Bitcoins already had their own exchange and some retailers were beginning to accept it as payment. Bitcoins are decentralized. That is, they are not issued or backed by any government or bank, and they can be exchanged between buyers and sellers without either party having an account at a financial institution. Yet the supply of Bitcoins are provably limited, the growth in supply is mathematically constrained, spending is untraceable, and the validity of ownership is instantly provable. For these reasons, AWildDuck predicted that Bitcoin would gain steady traction and eventually be trusted as a mainstream form of payment and investment.

A “flash crash” is nothing more than a buying opportunity.

A “flash crash” is nothing more than a buying opportunity.

Of course, as with a new security or exchange medium, the road to maturity is bumpy. Bitcoins have endured wild swings in value, even very recently. These so called “flash crashes” are caused by pre-programmed trading or simply rumors on a day of thin trading. Despite swings in the exchange value, Bitcoin is gradually gaining legitimacy as a vehicle for payment, investment and even as a hedge against regional conflict. Here some things that cause a sudden change to Bitcoin’s exchange value:

  • Programmed trades: These affect any immature or thinly traded security. In fact, they present opportunity for long term investors or anyone less prone to panic.
  • Banking Crisis: Contemporary examples include Cyprus and Greece
  • IRS decision: Recognizing Bitcoin accumulation as a tax reporting obligation
  • Hacker attacks: Bitcoin is safe. These are temporary DDOS attacks
  • Reports or investigations: Anything concerning illegal trade (e.g. Silk Road)

Regional events also drive the Bitcoin exchange value higher, but only because of problems with another currency:

  • Excessive Government Borrowing & Printing: (Japan and USA come to mind)
  • Hyperinflation: South Sudan is currently at 79% while Belarus is at 70%
  • Trade embargo or regional instability: (Iran and North Korea). Citizens seek a safe haven that requires no physical transport and no cash exchange agent.

Are governments along for the ride? Of course not! They try hard to suppress pure, decentralized currency that is impossible to counterfeit, trace or tax. But Bitcoin is gradually becoming legitimized through wider retail acceptance, international currency exchanges, and a broader public understanding of the very positive privacy & security implications. Bitcoin is here to stay.

While it may seem bold to add another radical prediction to our 1-for-1 record, we believe that governments will eventually embrace Bitcoin—or some other pure and decentralized digital currency. In fact, they will halt the minting of their own regional paper and coin currencies—perhaps in our lifetimes. Even governments will one day see advantages of a currency that cannot be forged or directly manipulated.

Bitcoin-2Here is an interesting development: An entrepreneur in Sandy UT has begun minting brass and silver tokens that offer a physical representation of a Bitcoin. They sure look like currency and they come in various denominations. Each coin includes a hidden code covered by a tamper-evident hologram. The code is a hash that helps an owner to verify that the value represented by the minted token has not been used by others.

Of course, this seems to thrash the whole concept of Bitcoins. It raises a litany of contradictions. For example, if it is in your pocket, then it is not truly anonymous. And although you can test the hash to ensure that the coin is valid for the moment, you must trust Mike Caldwell in Utah every day that you carry it. If he were unethical, he could circulate a copy. In fact, he is no different than a central bank, which of course is what Bitcoins render irrelevant. So what’s the point, Mike? …

It would occur to few who understand the decentralized and mathematical nature of Bitcoins to bother with a physical token. It goes against everything that they stand for. Yet, Mike’s mint, casascius.com, offers non-Geeks a reasonable off-line, portable and still somewhat anonymous exchange medium. Most importantly, as long as he can avoid attracting high-tech counterfeiters, his coins offer a medium for those who don’t fully understand how to trust, test or move digital Bitcoins, a “pure” digital currency.

Read more about Mike Caldwell and physical Bitcoins:

Did Ted Nelson deduce Satoshi’s identity?

Readers who follow Bitcoin or have read about it’s 2008 roots know that it was the embodiment of a paper dropped onto the internet by a mysterious mathematician using the pseudonym Satoshi Nakamoto.

Shinichi Mochizuki

          Shinichi Mochizuki

In May, Ted Nelson, the man who coined the term “Hypertext” (way back in 1963) donned a Sherlock Holmes hat, grabbed a pipe and magnifying glass and did some very clever deducing. Of course, Nelson also reads technical papers by like minded thinkers around the world and this gives him a lot of raw data from which to deduce! He thinks that he has discovered the true identity of Bitcoin’s creator and has made a very convincing video. It ends with a plea for the genius’ next big invention.

I have an alternate theory based on a 1999 visit with cryptographer and DigiCash founder, David Chaum, over a period of 10 days in Palo Alto, CA. But Nelson’s video is compelling. Now I am not so sure which way to lean.

Bitcoin: Can cash have value if it isn’t real?

The Bitcoin discussion, below, offers a solid introduction to
digital currency. After reading it, check out
our 2013 update

It’s likely that early man had no widely accepted currency. They dealt in the food they hunted or gathered, and the clothes they fashioned from whatever materials were available. Perhaps some individuals offered services, such as labor, transportation or healing. But without currency, they weren’t buying and selling these things. Instead, each transaction was a gift or a trade.

Trading is good, but it is difficult for a trade to involve more than 2 parties. Also, It’s difficult to save for a rainy day. Food spoils quickly when there is no refrigeration.

Economies built on private trades

  • Limited to private transactions.
  • No exchange/settlement: An Inefficient market
  • Difficult to accumulate wealth
  • Doesn’t facilitate governments or public works projects

Eventually various forms of cash began to emerge. According to the comic strip, B.C., caveman traded clams for goods and services. That’s not far from what historians tell us. Beginning at around 1200 BCE, the Chinese exchanged the shiny shells from a Pacific sea snail for goods and services. For centuries Cowry shells were accepted as a portable “coin” because they were both rare and impossible to counterfeit. Historians think that it may have been the first medium of exchange.

“Medium”is a good word for money, because it is an intermediate layer between things of value — the thing that you sold today and the thing that you will buy tomorrow.

Was the Cowry shell really the first form of currency? It’s difficult to look further into the past, especially into events that occurred before written language. But we can be certain that with the rise of central governments, currencies were coined by banks and by nations. But this gives rise to two classes of currency. Things like gold and Cowry shells which have inherent value because of their limited supply—and things that are valuable because of someone says that they are valuable (dollars or other national currencies).

Cowry shells are like gold. They are portable and honored everywhere, just like a coin. And yet they are not minted by a central authority. Instead, they have value, as long as the new supply is limited by natural law, and as long as individual traders believe that their suppliers will continue to desire them. With all monies – clams, gold or government-issued cash – when a majority of productive individuals agree that coins have value, it becomes possible to save and to time shift assets. For example, if you produce clothes – but you aren’t immediately hungry – you can sell your clothes and accumulate wealth. Unlike asparagus or shoes, currency is fungible and it doesn’t spoil. Of course, it is also easier to tax.

Let’s jump forward several millennia. Today, people buy and sell with dollars, euros, pounds, shekels, Zlotys and Yuan. Each currency is minted by a government and backed by either a precious asset (typically Gold) or by the promise of a central bank or government. But wait! Few currencies in circulation today are backed by the recent behavior of a transient government. And most governments are saddled in debt. They have no ability to make good on their promise. The only reason that money in your pocket or bank has value today, is because you feel reasonably certain that vendors will treat it with value tomorrow. But for how long? Given the dearth of underlying assets, the value of money is about as far from “real” as one can imagine.

Putting your faith in money is terribly risky especially in the 21st century. It is rapidly eroded by inflation and debt. It is easily taxed. It is manipulated by day traders and emerging nations, and it’s value is dramatically influenced by energy, and political/social policy.

Before we move on to virtual currency, let me point out that the “virtual” part is nothing new. We already trust computers to keep track of our savings and we prefer bank statements over folded paper in our wallet or mattress. Very little of the money you spend is traded in the form of paper or coins handed from one individual to another. Credit cards, checks and automatic debits bypass the cash stage. Few people use cash to pay taxes, purchase a home or car, or even to buy groceries. Instead, credit cards and mobile payments are accepted everywhere, even at McDonald’s and at the post office.

And investing has become even more virtual than buying. When you purchase stocks or bonds, the entire transaction is virtual. You digital cash (computer bits) is converted into a new row on a spreadsheet. This row of characters and numbers reassures you that you own a tiny sliver of a mutual fund in Omaha. This fund, in turn, owns a fraction of 1400 companies or is the beneficiary of municipal debt (more computer bits). It can’t get more virtual than that. Can it? Well, yes. In fact, it can!

Even though money you spend today is virtual, it is still minted by a government (or in the case of Hong Kong, by a bank). You have no idea how much of the stuff they print and how it is distributed from the printer. The value you perceive in your pockets and all of your accounts is based on trust. So who are you trusting? Is it your own banker or business partner. Not on your life. You are placing your trust in the same entity that taxes you and the entity that can’t balance its own checkbook.

Bitcoin is different. First, it is totally decentralized. No bank or government is required to validate the coin, record a transfer, or to determine if a virtual coin was spent twice by the same party. And get this: New coins can be “minted” by any user, but the process is inherently limited and trustworthy. Moreover the more that is minted, the more difficult it becomes to mint additional currency. Eventually, the total amount in circulation will level off to a known and verifiable number of coins.

Confused? Of course, you are confused. But, believe it or not, there are already currency exchanges for Bitcoins. They are even bought and sold on eBay. Why? Because Bitcoin circumvents government manipulation. It also deters taxation, tracking, inflation and… Well, you get it. Bitcoin comes pretty close to a perfect currency.

Bitcoin: A virtual, decentralized, trustworthy currency

In my dreams, I fancy myself as a futurist. I like to think that I could hold my own with Ray Kurzweil, Esther Dyson, Bill Joy or Alvin Toffler. Putting myself into that mold right now, I would speculate that Bitcoin or something built much the same way will quickly subsume the world’s economies—perhaps even in the next 15 years. The fallout will be seismic, because governments will need to base taxes on real estate and transaction fees rather than income, property or savings. After all, it’s difficult to hide land or a home, and it’s pretty easy to issue a speeding ticket or charge for a marriage license.

See our April 2013 Update