Category Archives: Economics

How I learned to stop worrying and love the fork

It’s hot in Israel in August, but not nearly as hot as the global debate surrounding the release of Bitcoin-XT and the contentious hard fork that would ensue if enough people adopt it. It seems that both proponents and opponents of Bitcoin-XT dread the possibility of the network splitting in two, and focus on making sure everyone switches to their side to prevent this from happening. Contrary to this post’s title, I don’t actually like the prospect of a fork; but I do claim that having two networks coexist side-by-side is a real possibility, that it is not the end of the world, and that we should spend more energy on preparing for this contingency.

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What is real? And what is virtual?

The word “virtual” has several meanings. But the most obvious meaning people think of is “not real”. The uninformed often call Bitcoin a “virtual currency”, and contrast it with “real currency” such as the US dollar.

This is of course nonsensical. You could make stronger arguments for Bitcoin being real than for the US dollar. This is why Bitcoin should be more correctly referred to as a “digital currency”, emphasizing the fact that its existence consists in bits of digital information; or as a “cryptographic currency”, emphasizing that its operation is based on cryptography.

Similarly, the defining feature of the US dollar and its kin is that their issuing and usage is mandated by governments (regardless of whether an external body such as the Federal Reserve is charged with doing the actual issuing), and thus should be referred to as “government currency”. Alternatively, the terms “traditional currency” and “legacy currency” are slightly broader and emphasize that this is the kind of currency we have used so far. The term “fiat currency” is sometimes used to mean government currency, but personally I am not fond of that, as the literal meaning of the term is too broad.

A deeper understanding of the phrase “virtual currency” can be achieved only by contrasting it with something which is truly a virtual currency, such as World of Warcraft Gold. In the WoW game, virtual warriors are paying virtual gold to buy virtual swords with which to slay virtual dragons (or something like that. I’ve never actually played WoW).

None of this is real. Dragons of the kind featured in WoW have never existed in our physical universe. The WoW Gold does not correspond to any actual Au atoms. These are things that exist only in the virtual, simulated world.

The virtual dragons are encoded as bits, manifested as electrical and magnetic signals on computing devices somewhere. The bits are very real – they are configurations of actual electrons in our universe. But they are bits, not dragons.

Within the virtual world, the WoW gold is the ubiquitous currency used by the population, it is actual metal the people go out and mine, and it is not controlled by anyone. As such, the WoW gold is a virtual, physical, decentralized currency.

But just as the virtual dragons double as real bits, the WoW gold doubles as a real, digital, centralized currency.

The owners of this currency are the real players with user accounts that possess WoW Gold. And it has real value – real people offer real money (such as USD) to get WoW Gold, because they prefer to spend their real time playing WoW and slaying virtual dragons than farming virtual gold. And there are real sweatshops in China where real people work in real terrible conditions to play the game, earn WoW Gold, and sell it to aforementioned real players.

Of course, as a real digital currency, WoW Gold is centralized and is thus barely usable. It is completely controlled by Blizzard, hence is inefficient, and tricky to use because, AFAIK, its exchange for things of real value is an EULA violation. So WoW Gold is a bad real currency, whose saving grace is the extra semantics placed on it by the controlling company – which is entitlement to in-game virtual currency.

Since WoW Gold and its kin double as both digital currency and virtual currency, it is easy to see why people would get confused. But the contrast with Bitcoin becomes clear: It is digital, but it is not virtual. There is no virtual world in which Bitcoin is the currency. Rather, it is a currency used in our real world to pay for real products and services. It is digital and still fledgling, to be sure – but unlike WoW Gold, which is centralized and thus a bad currency, Bitcoin is decentralized and has all it takes to become a ubiquitous currency.

When in doubt, we should remember – that which vanishes is virtual, that which remains is real.

Naive views of financial markets

When I was a child, I did not really understand stock markets.

Sure enough, I knew that every corporation had stock; I knew that the stock price could go up and down; I knew you could buy stocks and profit or lose accordingly. But I thought these were all just numbers going up and down randomly. I did not know what caused these changes, or indeed, that they were caused by anything at all.

I recall one day when my father referred to the CEO of some company as being successful, seeing that he managed to bring the company’s stock price up. I was confused. Stock prices just behave randomly, right? How is the price going up any indication of that person’s performance?

As I grew up, I have learned that the goal of a corporation is to generate profit; I’ve learned that the company shares these profits with shareholders in the form of dividends; that people are willing to pay for the stock in order to enjoy these dividends, either directly or indirectly. The greater the profit potential of a company, the higher the price people will be willing to pay for its stock. If the stock price goes up, it is because the company is doing something right, and by extension, so do the people in it.

It surprises and saddens me that these days, “professional” economists hold the same naive views about financial markets that I did as a child, at least as far as their criticism of Bitcoin goes. They talk about how the exchange rate of Bitcoin goes up and down wildly without representing anything; how it is stupid to buy bitcoins; how people who want to gamble are better off in the casino or the stock market.

What they fail to mention is that Bitcoin is the world’s first decentralized digital currency. It is like the money we know, only better (in about a dozen ways). In the same way that companies generate profit, currencies facilitate commerce. The better the currency is at its job, the more it will be in demand, and the higher the price people will be willing to pay for it. And Bitcoin has what it takes to be great at its job.

For sure, there is a lot of uncertainty and speculation. If you look at the price of any traded asset, Bitcoin included, in a short enough time scale, it will be indistinguishable from Brownian motion. The short-term fluctuations are noise. But the long-term upward trend from 0 to the $700 range is the signal. It means that Bitcoin is getting better and better at its job, thanks to the brilliance and hard work of its inventor and supporters.

Bitcoin is not about the price going up, that is just a natural side effect of doing well what it is about. People who profited from it are, for the most part, not people who gambled and won – but people who had the foresight to see something big is happening, spent the time to learn what this is, understood what Bitcoin is about, believed that it would be successful, and were right. In so doing, they helped Bitcoin become what it is today, and for that they are fairly rewarded.

So to all the investment advisors that hold the financial worldview of a 10 year old, my message is – please, grow up.