There’s Bitcoin, and then there is everything else

Posted: December 3, 2022 in Economics
Tags: , , , , ,

by Richard Martin

The current raft of insolvencies of crypto exchanges is causing a panic. But crypto-technology is only relevant to the extent that it allows creative ways to separate fools from their money. Other than that, you don’t need crypto to scam people. There will always be opportunities to do that using low tech and tried and true methods.

We have to separate Bitcoin from all the imitators, such as Doge, FTX, and Ethereum. The latter are only the most well-known of the 20,000 or so “shitcoins.” All of those are centralized and run by a small group of insiders, outright scams, or poorly secured networks with no limits on issuance. Basically, these crypto scams are a way to issue your own currency, with all the risks that implies for outsiders.

There are numerous claims of improvements to BTC, but none have panned out. It turns out that the original BTC is basically immutable, although there are procedures in place to consider and implement small improvements following strict consensus rules.

Bitcoin was designed to be electronic cash that can be transferred from peer to peer without having to go through the banking system. It can also be held “off chain,” in “cold storage,” meaning that it can be held physically in one’s personal custody, basically like precious metals. But without the storage and shipping costs.

Transactional costs are considerably lower than legacy financial system rails. For instance during November 2022, $ 1 trillion was transacted worldwide on the Bitcoin network. There are cases where $ 1 billion+ of value were moved for under a buck! Bitcoin requires proof of work by what are known as miners. Transaction blocks are added to the Blockchain on average every 10 minutes, with a difficulty adjustment every 14 days or so.

The number of BTC that will ever exist is 21,000,000, due to be achieved in about AD 2140, but the current “inflation” rate is under 2% and will halve again some time in 2024. Compare that to the USD and its derived currencies around the world.

The miner who successfully solves the mathematical puzzle gets to publish a new block of transactions and receives the Block Reward (currently 6.25 BTC) plus any transaction fees, and publishes the transaction block to the blockchain. It is generally accepted that the blockchain becomes de facto immutable after about 1 hour (6 blocks). After that, there is a possibility of “forking” the blockchain to try to take over the network, but it’s never been successfully done. While theoretically possible, it is considered astronomically unlikely that this could occur in actuality. And even it if it did, you would still need to achieve consensus among miners, nodes, and holders.

Bitcoin is evolving into what’s known as Layer 1 money, meaning it is in direct competition with the global reserve currency, the USD. The jury is still out on that, but it is already being used as a store of value and medium of exchange. These are two of the three functions of money, the other being universal unit of account. The USD is still the international unit of account, supplemented by accounting in local currencies. We don’t know if that will ever change, and it’s not certain that it is essential to having a base money that is immutable and scarce.

There are a number of Layer 2 applications being developed. The most advanced of these is the Lightning Network, which allows millions of micro-transactions per second without fees and immediate settlement. That means you can use the LN to pay for a coffee or to transfer billions, all at minimal cost and delay.

The current financial system with the US Federal Reserve and US Treasury at the top of the pyramid is a house of cards. The USD is the global Layer 1 money, backed by nothing, other than US Navy aircraft carriers and, now, B21 bombers. It allows the US to export fiat USD around the world while receiving TVs, microchips, and papayas in return.

© Richard Martin

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