Guest Post -- Introducing Bitcoins

Reader Grandfubar has contributed the first Guest Post to my blog!  Thank you!  I knew very little about Bitcoins when he emailed me his idea, and I thought it was of great interest.  Secret money, how cool is that?

Here is Grandfubar's profile: "Grandfubar is a software engineer who dabbles in applied liberation theory.  His plan to save your world can be found at grandfubar.com".


And his article:

Introducing Bitcoins (www.bitcoin.org).

Bitcoins (BTC) are a new form of electronic money.  You can readily imagine how this works on the surface.  You have a program on your computer that lets you send and receive BTC  to other Bitcoin "addresses" which are owned by other Bitcoin users.  If you pay careful attention to the instructions, your use of Bitcoins can be remarkably anonymous.  There is a budding economy of businesses which accept BTC as payment.  Anybody can download the BTC program and crank it up.  Alas, the Bitcoin "wallet" starts with 0 BTC.  But fear not, how much money were you born with?  You get BTC by finding other people who have it and persuading them to give you some of their supply.  

Using BTC is a lesson in monetary practice.  There is a lot to say about the nature of money and the pros and cons of the various forms of it.  Most people never even contemplate the issue.  PM aficionados have started the thought process but have not come to the punchline.  So please allow me to describe a few novel features of BTC.

First of all, BTC is not backed by any asset, nor is it even backed by the i/r/o/n/ /f/i/s/t/ full faith and credit of any .gov.  BTC has value merely because other people want it.  And let's face it, if nobody wanted gold, how valuable would that be?  Asset backed currencies have a fatal flaw.  They attract predators.  Either external invaders or internal embezzlers.  One way or another, it's simply not possible to guard a stash of value for any significant length of time.  Beg to differ?  Please let me know the longest time span the biggest pile of gold ever existed before it was looted.

Second of all, BTC is not run by any central organization. The Bitcoin network is a distributed system of thousands (soon to be millions) of computers all over human space that work in a peer-to-peer fashion to make this system work.  Peer-to-peer is good because it becomes essentially unkillable.  As long as there is one surviving node squirreled away at Crystal Peak the system could be restarted.  Compare that to the survivability of a central server. 

One mild difficulty in dealing with Bitcoins is that there is a very complex cryptographic system underpinning the system.  The ordinary user does not have to deal with that in order to merely use Bitcoins.  I mention it because this cryptographic system is the basis of the security of the system and is the mechanism by which a very mild inflation of the money supply takes place.  The gory details of how this works is definitely second semester material.

Did somebody just use the "I" word?  I thought all the refugees from fiat have had their fill of inflation?  And now that you've survived the trip to Planet Bitcoin you hear about more of it?  Well, let's take a closer look at this before we panic:  There are presently about 6 million BTC in existence now, and this will "inflate" to about 21 million over the next several years, thereupon it will stop.  The purpose of this very mild inflation is to pay the people who run the cryptographic plumbing while simultaneously providing the security of the network.  When this inflation ends in the next several years, then some new scheme will kick in to provide the same security.  Please register for Bitcoins 201 for more details.

Now that you have the basic outline, let's see how this works in actual practice.

Most Bitcoiners are pushing hard to get other businesses to accept Bitcoins as payment for their goods and services.  But there's an obvious chicken or egg dilemma in doing this.  Astute readers will recognize this as the medium-of-exchange function of money.  Amazingly enough, the businesses that have embraced Bitcoins with the greatest enthusiasm are illegal in many places and thus have a difficult time in dealing with money in the first place and value the anonymity of Bitcoin.  For example, you can buy drugs of all kind online and pay with BTC (google 'bitcoin silkroad') as well as signup for explicit Ponzi schemes and lottos.  This has already earned the enmity of the Dark Lords, who I guess does not want the competition.

Anybody who contemplates accepting BTC as a form of payment is likely to think "how can I trade BTC for "real" money?"  No sooner did somebody think that then POOF! The free-market fairy poofed some exchange services into existence.  This is where BTC starts to get fun. You can see a list of several exchange sites.  The largest named Mt. Gox, accounting for about 97% of the market, exchanges USD and BTC.  Other sites exchange other currencies for BTC.

In the early part of this year, BTCUSD was trading at under $1.  In early May, it was around $3.  By the time I figured out how to buy in, the price had risen to $6! Over the next four weeks, the price skyrocketed to over $30, going from $10 to $30 in only about one week.  Unfortunately as of this writing it has slithered back to about $12.  Did I hear somebody shout "BTFD Bitchez!" ? Maybe, maybe not.  Who knows what will happen to this.  But consider the supply and demand for BTC.  My guess is that this recent price drop is a correction, but that as more and more people get into this, they will bring more and more money to the table to buy in.

Which leads me to the second function of money as store of value.  

My personal experience with BTC has been primarily in this store-of-value function.  I'm past the stage where buying online shrooms is something I'm interested in.  Nor have I found anything else for sale in BTC that I'm interested in.  Perhaps this will change.  However, a quick lesson in safety comes to mind.  The various "exchanges" that exist are all very new and it will take time for them to develop trust.  When I transfer "real" money to my favorite exchange, its Internet page claims I have a "real" money balance, just like Paypal or ordinary online banking would do.  However, I've quickly purchased BTC and withdrawn them (instantly and electronically) to my Bitcoin wallet.  There it remains safe regardless of the fate of the Exchange.

Earlier I was razzing the gold bugs about their difficulty in securing their stash.  Bitcoin is not an invulnerable shield against menace and evil that we can thereafter taunt with impunity.  If your computer crashes and you don't have your Bitcoin wallet backed up, there goes your money.  If somebody steals the wallet, there goes your money.  If the Dark Lords shut down the Internet, well, give them the finger and start laughing!  It's possible to export the coins to a "paper" format and then re-import the coins back into the system.  While Internet is down, people revert back to paper.  As soon as the hackers re-establish the physical layer, the trading network rises again.

Or perhaps the Dark Lords confiscate all the Bitcoin wallets during their house-to-house confiscation of PM, guns and ammo, radios, bibles, copies of the Declaration of the Independence and the Constitution, etc.  Life is lethal and we do the best we can during our time here.  I won't tell you that Bitcoins will make your life worry free because that's just not the case.  Because of that, diversity is good.  Bitcoin has arrived as yet another one of the myriad of diversification choices you have.  I suggest that it's worthy of further consideration and contemplation.

Grandfubar