Archive for April, 2018

People are Dumb: Part 2 – Bitcoin

Thursday, April 5th, 2018

Crosspost

This is a very technical subject and those in the know will be enraged by missing figures – from the dawn of modern cryptography and the Diffie-Hellman to elliptic curve cryptography and the small block big block schism. If you’d like to discuss those things, it would be my pleasure. My daily consultancy rate is more than you think, and I don’t take crypto.

This is part two of my Dumb Series. Check out the first part here.

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What is Bitcoin?

Now, if you’re still here and you want to understand how Bitcoin works, or, if you just want to be able to explain it at parties, here’s my best effort:

Bitcoin and basically any blockchain-based currency work like this: When the very first users started buying and selling the currency, they wrote their transaction down. Who sold what to whom? Nearby miners then competed to write that transaction down to a block, or list of transactions. That block was limited to 1MB and on average that transaction takes about 495 bytes, so that block was full after about 2019 more transactions. Once that block was full, the miner who built the cleanest block – using a great deal of computer horsepower – won and could take a little of the top. So finally, there was the one block. When someone made a new transaction, the process started over and another block was created. Currently, there are over 150 gigs of these blocks.

Here’s an analogy: Imagine a train station where people come in to get on a train. But the train isn’t built yet. Nearby, builders are sitting around, waiting to build train cars. They all simultaneously build cars every time around 2000 folks enter the train station, and the cleanest car gets put on the track. The builder who built it gets to keep a set amount for their trouble. Then, when more people come in, another car is built. In order to build a car, though, builders need to keep an exact replica of the whole train in their workshop, and every time a new car is added, they add that to their replica as well. Currently, the train – and the trains in their shops – has over 153,000 train cars on it.

The reason that this is called decentralized is that at any time, if you wanted to find a passenger – or a transaction – you could look anywhere. Every builder or miner has a copy of every single item, from the first train car to today. In contrast, the way my bank knows I have $5 is that they have paper and electronic references to a unit of currency that is maintained by the US government. It’s centralized.

In fact, Bitcoin is favored by economic libertarians like its founder under the assumed name Satoshi Nakamoto who argued that governments – like those in Venezuela or North Korea – shouldn’t be trusted with managing currency. In a sense, Bitcoin has no middlemen – and no politics. It’s just pure transaction. Further, they argue, with low transaction costs and nearly infinite redundancy, it’s an un-hackable yet purely egalitarian endeavor.

Some Problems with Bitcoin

There’s a somewhat existential problem with Bitcoin that I’m not going to put on my formal list, but just explain here. As I explained above, every single transaction from the very first one is stored on every single Bitcoin computer. If you were to crack the code – and I assure you someone will eventually do this – you could see every single transaction. Bitcoin – which in its early days was used to fund less than savory endeavors – is the exact opposite of anonymous.

Think about this: If someone hacked American Express, they could theoretically tie you to that 2AM My Little Pony Box Set purchase. If they hacked Chase, they could find out about your cash withdrawals. But if you use bitcoin, they would have uncovered literally every purchase you’ve made, ever all in one go. It’s not like hacking one bank, it’s like hacking the concept of the dollar itself. And it’s not just that you bought the Pony Criterion Collection, but also that you received the money to buy it when you sold your home-made doll house bidet to Joseph in San Antonio. Now imagine that the hacker wasn’t some random criminal, but Russia – and the hacked… wasn’t you.

There’s another hack that’s actually even more feasible – the 51 attack. This is an interesting attack because it requires a lot of local computing power and relies somewhat on odds, but it is a well-known and completely accepted facet of Bitcoin logic. It works like this: Remember that the cleanest car gets put on the track, and then everyone copies that in their workshops. In this case, a large hacker group creates their own car and puts that on the track simultaneously. Now, there are two basically identical cars on the track – so it would be impossible to tell if the owners of the bad one just happened to steal everyone and everything riding in their car. Think about who, on the world stage, has that kind of hacker firepower.

But these are not even making the list, because just like every cryptography ever, Bitcoin basically claims it’s impossible to crack. So taking them at their word, here are three crucial problems with Bitcoin:

  1. It doesn’t scale. Remember how every engineer had to keep a copy of the train in their workshop? Right now, it requires 153GB of storage to keep that train. In fact, every month we add about 4GB – or 4000 cars. But think about how many times you’ve made a Bitcoin transaction. Never you say? Well, most people haven’t. In order for it to be as valuable as it claims, Bitcoin has to be used by more people. And that means more train cars per month. And that means that replica train, which again every miner needs to have, gets so large that fewer and fewer people can afford to process it. And then suddenly, as it grows, it becomes less and less egalitarian. And at some point, it becomes so expensive, that we develop large, heavily funded organizations to manage it. You know – like… banks.
  2. It’s basically unregulated. Above, I mentioned the idea of fiscal libertarians. These are folks that worry about economies collapsing and the need for a safe, real currency. Bitcoin was founded right during the crash of 2008, and it solves a problem that wasn’t really the problem. We didn’t lose our shirts because the banks controlled the cotton, we lost them because no one regulated the banks, and they gambled all our cotton away. But Bitcoin is even more wild west than the markets were ten years ago. You can legally fix prices. You can legally inside trade. Just think – if Martha Stewart had been trading in Bitcoin, she would never have gone to jail. And above all, Bitcoin can’t easily beregulated – since by definition it exists outside of the government. Of course, there are people reading this going, That’s the way it should be! And to them I say, Oh yeah? How did that work ten years ago?
  3. It’s desperately inefficient. Remember that no one has really found this train station, and so the numbers below are just before rush hour. But even as of ’17, bitcoin consumed as much energy as Denmark. This actually might be one of those figures that’s so big you can’t be scared by it since it’s so out there. So here’s another way to describe it: Every single transaction – every time you pay in Bitcoin – that singletransaction is enough to power a home for nine days. This isn’t per train – this is per passenger. Bitcoin is so mind-bogglingly expensive on resources that you might question how true that is. But remember – every single builder has to keep the entiretrain in their workshop. But think on this – for every ONE builder who gets to put their car on the track, there are likely over 150,000 others who are just maintaining workshops. This might make sense if every builder were contributing to the economy, but in fact, almost all of them are just trying to build cars and failing, scrapping them, and then just syncing up their copy of the train for the next go. So, people are using real electricity and real money to pay for it – to create and inflate the concept of another currency. I will be unapologetically dramatic when I point out that those same computers could be processing the human genome, searching for intelligent life, or hosting Minecraft servers. Anything would be less ridiculous.

These problems can and may be solved. Right now, there are whole camps within Bitcoin with different ideas as to how to make it more scalable and maybe even more efficient. In fact, the proliferation of sub-currencies and other nifty solutions proves that there is a whole legion of people looking to do just this. This, however, isn’t the point.

So, What is the Point?

The point is that there is nothing inherently valuable about Bitcoin.

There’s a lot above to digest. The whole concept of decentralized currency, the gorgeous use of Blockchain, the horrifying scale and security implications. But go back to the idea of spending a Denmark of electricity – and then ask yourself, Okay, why? It’s one thing to do something because you like the idea – but adults invest their money in something because it will… give them more money. Why put so much in if there’s no actual product being returned?

Is it worth it because of Blockchain?

Blockchain is elegant and kind of an excellent way to solve problems. For example, if you want to store secure data and yet have it be redundant and publicly accountable. Many financial transactions will be made better by using blockchain. Bitcoin is the most visible user of this logic and it’s not an inherently bad idea. Except that it’s not a good idea either. It’s chaotic neutral. It’s funny money. And you can like blockchain and still wonder at Bitcoin. They’re not the same. Blockchain is the nicest Lego package you’ve ever seen, Bitcoin is what happened when a tinfoil hat with a math degree built the first building out of these great Legos.

So Why?

Bitcoin and many of those who invested in it lost a ton of money in recent months for a very good reason. A very Pets.com reason. It didn’t make any damn sense. All those kilowatts. All that security. All those exchanged and blogs and that just plain awful friend on Facebook who won’t shut up about it. All of these things solve a problem that would only seem real about ten years ago, when complex financial packages in a newly unregulated banking industry created an inevitably mortal instability in the core of our economy.

But if you’re the sort of person who doesn’t believe in market regulation – or the fact that after Glass Steagall the United States enjoyed the greatest economic expansion in the history of history – and that almost immediately after its repeal we got… the worst recession since… the big one – if you’re the sort of person who by constitution or red hat refuses to believe that, then you’re going to do one of two things: buy gold or make up your own currency.

This is what makes people dumb. It’s not that you could power your home for days for every transaction you make. It’s not that hackers could destroy the economy with a few clicks. It’s not that replacing a currency doesn’t have inherent value, since by definition the value of a currency is just what people make it. It’s that Bitcoin is just a techie version of buying gold because you think there’s going to be a zombie apocalypse and you figure that in one hand you’ll have your shotgun and in the other, your duffel bag filled with gold bullion bars.

And what happened with the ecstatic news coverage and the huge speculative buys was just that… no one remembered what it was actually built to do. If you go back to the source – to Satori – even back to Diffie – you get the same argument. Here’s Whitfield Diffie:

And given government proposals, I thought I had a clear view that they were antagonistic to human freedom.

This is fine – and Diffie is a great guy – but he and Nakamoto held a very deep conviction that the government couldn’t be trusted and that things like Bitcoin were the solution. That was the value it brought to the table. That was it. But this is a view and a valuation that is not likely shared by the average investor who, like some of my older but still hip relatives who ask me about it over Thanksgiving dinner or just put in a little around November when it was looking hot.

Bitcoin might regain its value. And it has a place as a kind of shadow economy that will allow terrorist and drug dealers and freedom fighters alike to do their business with relative impunity. But that’s no place for my aunt to put a few grand – at least not any time soon.

Most people, most of the time, don’t invest in an idea whose founders were hedging against the US dollar. But a kind of mass delusion takes place every so often and rational people make really dumb decisions. Why? I’ll be exploring that in upcoming pieces.