Platt Perspective on Business and Technology

Considering the nature and qualities of money 4: crowdsourcing valuation and the peer-to-peer model 1

Posted in macroeconomics by Timothy Platt on January 24, 2014

This is my fourth posting to a series on money and on what monetary value functionally means (see Macroeconomics and Business, postings 142 and loosely following for Parts 1-3.)

As I initially noted in Part 1 of this series, my primary impetus for writing it has been the emerging phenomenon of peer-to-peer based currency as exemplified by bitcoin and its immediate competitors. When you strip away the hype and the issues of which personalities back it as it seeks to develop and go mainstream, and when you analyze bitcoin as a potential metric of widely accepted monetary value, the most logical place to start is with its underlying operational protocol. And that serves as at least the starting point for this installment.

Bitcoin and its units of presumptively monetizing information are specified and determined by an open source algorithm. And the execution of that algorithm through a loose network of computers that are separately, privately owned, serves to both generate bitcoins, and validate their legitimacy and uniqueness. That openly public process is where peer-to-peer enters this and it is where bitcoin and putative currencies like it break away from the production and regulatory systems of any national or transnational governmental authority (with the Euro serving as a perhaps best known transnational example of governmentally issued currencies at least as of this writing.)

This algorithm itself formally defines individual units of bitcoin currency: groups of individual bitcoins as blocks of encrypted code. And this algorithm-based system is designed to generate up to a final total of 21 million distinct bitcoins that are arrived at as algorithm solutions and that are developed through a process of hash code programming that is referred to in this context as mining.

There are a number of critically important details in that description, or that are at least implicit to it that merit explicit discussion here, and one of them is that the overall amount of bitcoin or of any of its peer currencies remain tightly controlled and constrained. This means developing and implementing them so as to greatly limit if not preclude forgeries, with apparent inflation of the amount of circulating currency that could arise from that. Just as importantly, this means controlling the numbers of legitimate units of currency so as to avoid the over-production trap implicit in Gresham’s law. But beyond that, this algorithm-based system as carried out in its distributed peer-to-peer computer network would:

• Validate the legitimacy of genuine bitcoin units of currency in circulation and expose frauds as such.
• In the mining process it would identify and discount as a legitimate algorithm solution, “rediscovery” of an already identified and mined legitimate bitcoin identifying solution.
• And in order to prevent currency unit duplication during financial transactions carried out with them, it would have to render nonfunctional, any encoded copy of a bitcoin that is being traded that might still be held by its relinquishing owner, while activating as legitimate the copy now held by an acquiring owner.
• There are a lot of details that have to be managed to ensure that only legitimate bitcoin or similar peer-to-peer, cryptocurrency be recognized and usable as such and that its numbers in circulation remain constrained, and encryption per se can only be seen as one element of that.

What is the value of a bitcoin, when measured against a currently more standard form of money such as a nationally backed United States dollar? When bitcoins first appeared and were largely unknown to the general public, and all but exclusively in the of domain of a small number of more technically oriented computer programmers, their presumed monetary value was loosely pegged at a fraction of a US penny each, and with that value determined by the small computational power and its associated costs needed to successfully mine new bitcoins. Then several things happened. The way that the bitcoin algorithm works, every time a new unit of its currency is successfully mined, the more computationally intensive it becomes and the more expensive it becomes to successfully find and secure a next one.

Bitcoin, as previously noted in this series was initially opened up to the public and the peer-to-peer network behind it was first publically started in 2009. As of this writing, it is estimated that something just over half of all possible bitcoin solutions have been successfully mined, though with increased computational power requirements for successful bitcoin mining, this has become almost entirely the province of specially designed and built computers, set up specifically to more optimally carry out bitcoin calculations. And the only way to make that sustainable is if the presumptive monetary value per bitcoin can continue to rise, when they are matched against standard currencies.

As of this writing, bitcoins claim a value of over $1,200 in US currency each, pegging their unit value at roughly the same price point as an ounce of gold. It is formally and officially predicted that it will take on the order of one hundred years for all 21 million possible bitcoins to be successfully mined and entered into online circulation. Personally, my estimation is that:

• In the next ten years all but perhaps a fraction of 1% of that total count possible will have been found,
• Given the rate at which computational power is increasing, and certainly where specialized data parsing and analysis capabilities at a supercomputer level are brought to bear through cloud computing,
• And where system users do not need to make an up-front infrastructure investment to be able to access that level of computational power.

In this regard I note that the more successful early bitcoin miners programmed their computers to carry out bitcoin calculations on the video cards of their desktop computer hardware, with their particular data processing specializations. Web 3.0 has as one of its core objectives, searchable analysis of essentially any type or format of data. Supercomputer-capable systems that are dedicated to being able to more effectively perform the types of calculations that it turns out are needed for bitcoin mining, are being built already and anyway, and will increasingly become available through cloud computing services, and in support of the developing semantic web if nothing else. These resources will become the leading players in bitcoin and similar cryptocurrency mining.

And this brings me to a question and an observation. The observation is the palpably obvious point that standard currency based valuations of bitcoins and their digital-only peer-to-peer relatives are very largely fad driven. And the increased cost and effort to successfully mine each new bitcoin significantly helps to drive that fad bubble in further inflating its presumed cash value. And the question that I finish this series installment with is:

• What happens when the last bitcoin is successfully mined, and even when all but just that fraction of one percent of them have been mined, and the fad bubble bursts?

And with that question in mind I note the conundrum of seeking to make linear predictions for going forward when you are actually confronting a nonlinearly, disruptively new situation and a correspondingly less readily predictable future as it develops from that. I end this posting by raising the specter of ending up on the wrong side of history, and of even knowing where that is likely going to be.

I do expect something like a peer-to-peer, non-national or extra-national currency to take hold as a widely and even essentially universally accepted currency. The question that I have is one of whether bitcoin or any of its current counterparts have the flexibility to adapt in ways needed to become that generally accepted valid, stable currency while at the same time demonstrating the types and levels of stability and constancy need if they are to serve as reliably rivalrous units of value. Ultimately, and for any long-term sustainable and generally accepted currency, finding that balance is going to require finding ways to increase the overall levels of monetary units available, but without triggering a loss of value for those already in circulation, or hype-driven over-inflation of perceived value either.

I am going to continue this discussion in a next series installment, starting with these last questions, beginning with that last bullet point, above. And in anticipation of that I note here that I will address them at least in part in terms of adaptation curves and the challenge of bringing in middle and late adaptors. And a big part of that is, of necessity, going to require development of a recognized and trusted regulatory oversight mechanism. I will discuss that too. Meanwhile, you can find this and related postings at Macroeconomics and Business.

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