Waiting for the Shoes to Drop

The phrase “waiting for the other shoe to drop” comes from a story about an old apartment house. One of the dwellers on an upper floor comes home late and, in preparing for bed, drops his shoe. Realizing this would wake his downstairs neighbors, he carefully and quietly places his other shoe on the floor. After a long interval, a neighbor who has been lying awake yells up, “For God’s sake, drop the other shoe!”

Widespread agreement about the merits of bitcoin among our panel inclines me to lay awake wondering which of two shoes will drop. Will it be a flaw in the technical structure that results in calamitously skewed incentives? Or will it be the opposition of governments, who see the threats in unfettered value transfer and seek to censor it?

The bitcoin protocol anticipates much in the world of money and payments, but it doesn’t appear to anticipate a quirk of its own creation, the possibility that one miner will do more than 51% of the “mining.” As Dan Kaminsky points out, if one person or entity is positioned to do most of the processing that maintains the public ledger that Jerry Brito extols so well, he, she, or it can affect what makes it into the ledger. That power is subject to exploitation.

Likewise, as Chuck Moulton points out, the bitcoin protocol may not be well tuned to the monetary needs that actually result from the use of digital currency. The amount of bitcoin is not responsive to the demand for money — it even insulates against attempts to create bitcoin ahead of schedule — so it could serve less well than a currency whose supply is responsive.

I believe problems like these and others are headed off in the near term by the prospect that bitcoin will increase in value. Given potentially huge growth in value, anyone with the ability to undermine the bitcoin ecosystem should realize that doing so will make him- or herself worse off. Witness the reticence of the BTC Guild to mine more than 50%. The bitcoin protocol can probably be amended to fix problems, even dealing some parties short-term losses, because all stand to see longer-term gains.

There’s some hand-waving in that, and there may be dynamics that are not susceptible to these self-correcting incentives. Perhaps when bitcoin nears an equilbrium price based on perceptions that it has reached its largest scale, exploiters of technically based incentive errors will emerge. But that will be a while.

The other shoe — the first most likely to drop — is government interference with bitcoin adoption and use. The governments who now supply money, enjoying the benefits of seigniorage and surveillance for doing so, have the opposite incentives. The greater the value of bitcoin (especially as driven by common use), the greater the incentive of governments to take steps against it.

In my main essay, I noted the ham-handed issuance of “cease and desist” letters by the California Department of Financial Institutions. Since then, the Bitcoin Foundation has gently chided the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) for insinuating that anonymous transactions and irreversible transactions are inherently questionable. If they are, then cash money is inherently questionable.

These are bellwethers of future antagonism to bitcoin from the actors who stand to lose the most, governments and traditional financial services providers. And you shouldn’t need to be told that they’re a team.

Simplifying quite dramatically, the outcome for bitcoin is dictated by a sort of perceptual-political-economic calculus: Are the apparent benefits of bitcoin (B) available to enough people (P) who are capable of defending (D) it? Or are the apparent costs (C) of bitcoin to governments (G) and financial services providers (F) greater?

Is (B)(P)(D) greater than (C)(G+F)?

Over the long-term, the benefits of bitcoin to people who can defend it in the public square will win out, but between now and then, the combined efforts of politically adept government regulators and the financial services industry will be significant.

Also from this issue

Lead Essay

  • It’s Just Money by Jim Harper

    Jim Harper reviews the traits that make a given class of items either useful as money or not. These are the traits that, for example, made gold and silver historically such widespread monetary standards. He finds that bitcoin possesses many of them to a very high degree, but that it very importantly fails on some. Bitcoin’s future is unclear in another respect as well: Established government and financial industry interests will do whatever they can to preserve what they view as their own turf. Still, the greatly increased use of digital currency seems inevitable to him in some form or another, and that form could well be private.

Response Essays

  • Plain Old Money Has Gotten Buggy by Dan Kaminsky

    Dan Kaminsky argues that bitcoin’s success so far stems from the success of the Internet itself, and also from the failures of plain old money. Traditional payment methods all face serious challenges in our digitally connected world, and transaction costs to maintain our financial network make plain old money less and less attractive in contrast to its digital counterpart. But bitcoin isn’t perfect either, and the threat of large conglomerates abusing their power isn’t limited to plain old money. It can happen in the bitcoin network too.

  • It’s More Than Just Money by Jerry Brito

    Jerry Brito argues that bitcoin is far more than just money. It’s also a distributed-ledger payment system, which means it’s a lot like Visa, MasterCard, or PayPal, but with one key difference: There is no central authority managing the payments. As a result, bitcoin is open to becoming a lot more than “just” money. It can also be used as a token to represent claims on other items. As such, very small fractional bitcoins can function as bonds, stock certificates, property deeds, IOUs, or even decentralized futures markets. The full scope of these possibilities is vast, and we are only beginning to grasp the implications of bitcoin.

  • It’s a Sound-Money Alternative to the Dollar by Chuck Moulton

    Chuck Moulton argues that bitcoin is a sound form of money. Its quantity is known, it expands at a known rate, and it will eventually stop expanding. As a result, fluctuations in the value of bitcoin are almost entirely a function of demand. Moulton suggests fractional reserve banking as a way of stabilizing bitcoin’s value. He goes on to suggest that nations might consider dollarizing to bitcoin as a way of preventing inflation, with the very significant caveat that “a second or third generation cryptocurrency may be the one to finally take hold.”

  • The True Value of Bitcoin by Patrick Murck

    We are pleased to publish this contribution from Patrick Murck, Bitcoin Foundation General Counsel, who argues digital currency will disrupt traditional finance. This disruption is both very much intentional and likely to empower consumers who have not been able to take advantage of traditional financial services. Older financial system players are likely to resist, of course: They have a stake in the status quo.

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