1 - Scam. I regret using the word "scam" in my answer, because I think it overshadows the broader point I was making about Bitcoin's severe structural design flaws. After watching the community react to this debate, I'm pretty confident that the average bitcoin supporter is not intentionally defrauding people. Consider my inflammatory rhetoric redacted and apologized for.

2 - Volatility. Since April 1, the average change (up or down) of the bitcoin/dollar exchange rate has been just under 8%. That's unprecedented. It's a clean order of magnitude more volatile than the stock market, which is considered a "volatile", "risky" class of asset. It's two orders of magnitude more volatile than a legitimate currency pair like the Dollar/Euro. Now, it's all fun and games while the exchange rate is basically trending up, but if that trend reverses look out below.

3 - Liquidity. All of that volatility comes on an average bitcoin volume of something like 20,000 per day. If I put in an order for $15,000 worth of Bitcoin right now, I'm pretty sure I could move the market between 5% and 10% to the upside. It's probably even worse to the downside. Call me a skeptic, but with that kind of easy price manipulation, I'm not quite ready to denominate my paycheck in Bitcoins quite yet.

4 - What It Means. A number of people criticized me for not understanding that Bitcoin is designed to be complementary to traditional currencies, and that analyzing it as an alternative is invalid. A number of different people criticized me for not understanding that Bitcoin is a different kind of currency, which will inevitably replace traditional fiat money, and that analyzing it as a component of the fiat currency system is invalid.

The Bitcoin community is diverse, and no one really knows what this is supposed to be yet. That's totally fine with me. I can assure you I don't have any skin in this game. My money is in LinkedIn stock.* But I've studied world currencies extensively (and trust me, a normal currency debate is not this lively). So, I don't know what Bitcoin will end up as, but I know two things with certainty:

a) that it's unstable as a currency

b) that it's currently behaving as a speculative vehicle in an aggressive bubble

* That was a joke

Even if not a scam, your conclusion that it's currently entirely speculative is inescapable.

Aside from that, I thought this was an excellent rebuttal: http://www.reddit.com/r/NonAustrianEconomics/comments/hputj/...

If the real economy continues to generate investment opportunities, wouldn't the deflation rate just supplement that? Sure, you could put money in your mattress for 5%, but if you can invest for a nominal 10% and thus yield a real 15%, why would you choose the mattress?

But then the mattress rate is also 15%.

Of course some loans are better than average, and some are worse. The "deflationary spiral" takes out the worse ones first. That lowers the average and takes out the next tier, until the average is zero. Actually it goes below zero, to the average rate of real depreciation (e.g. termite damage to houses). Well, that's the bottom equilibrium anyway.

I'm just surprised people aren't considering Bitcoins from a supply-demand standpoint. Why purchase Bitcoins in the long run unless you're laundering money or hiding from the government?

Some people like to play poker online. The same entities have been prohibited by the government from processing transfers to poker sites.

From a startup perspective, the "terms of service" for Paypal, Amazon payments, and others are full of applications you can't use them for, even though many of them are legal. On top of that, Paypal is notorious for locking accounts if they decide they don't like you.

Currency used to be neutral. Now it's not. So people have invented a new one that is.

I live in Europe and you can transfer EUR money from one country to another for free; that's progress. But from the UK (in the EU but doesn't use the EUR currency) my bank only allows me to transfer £5k (US$8k) per day to other European countries, and each time I do it they charge me £25 for the privilege (US$40). I had a tax bill recently in Austria (where I live) due to assets held in the UK, I owed £20k. (I have no problem with having to pay the tax.) That took 4 long phone calls over consecutive (business) days to transfer that money, and cost me £100 in total. Imagine if my assets in the UK, and thus my tax owed in Austria, had been 10x as large, or 100x as large.

I have no interest in dealing drugs or hiding income from the taxman. But using banks make things incredibly difficult, and charge huge fees for their trouble. It's time banks got "disrupted".

That's kind of odd to say-- couldn't you say the same thing about doing cash-only transactions?

There's also the hope that you can "hide" from corporations/bad-people and make transactions that don't require you to provide information that can be used for identity theft, marketing, etc. Just typing in a unique 1-time deposit number has a lot of appeal for stream-lining transactions and making people feel more comfortable performing electronic purchases. I'd love people to get addicted to that kind of high-privacy transaction and push more innovation for traditional currencies/startups to help with that.

In the modern world, every purchase of anything not bought at a yard sale is a privacy and identity concern-- I'm eager to see alternatives that find new ways to avoid that.

Yeah, I added that modifier after thinking some more. People are really interested in bitcoins as a "private" currency, and cash would accomplish the same thing. Large cash transactions raise flags, though.

Still, bitcoins are a bad alternative to popular currency for a number of reasons Adam mentions. An e-currency without a finite supply would be an interesting exercise.

The entire system could thrive on one bitcoin.

The entire system could thrive on one bitcoin.

No, it couldn't. One bitcoin could not sustain a currency market, and a one-bitcoin market would value that bitcoin at highly variable prices.

I bought $30 of Bitcoin just a month or so ago. Obviously they've done very well so far and I'll just leave them indefinitely to see where it goes. Yup, that increases deflation. Nice, for a change!

[1] http://mtgox.com/code/data/getDepth.php

I'd also be afraid of having my assets frozen if I transferred money to and from Mt. Gox or the other exchanges. To use Britcoin, for example, you need to send and receive money from an individual developer -- that is, from his individual account. There's not necessarily protection for his transferees if it turns out that he, willingly or not, was engaging in money laundering.

One additional thing that bothers me about the Bitcoin "community" at present is that they are engaged in an active and deceptive attempt to sanitize their public image. For example, in a Gawker story about drugs, Jeff Garzik, a core developer, inaccurately commented that Bitcoin could not be used to purchase anything anonymously. He surely knows that it wouldn't be difficult to do so; he appears simply to have been underplaying a regulatory risk that the currency faces in order to get part of the public on his side.

Bitcoin == marketing. It has very good marketing on its side, even if the marketing is in some sense "open source" and communal. In that sense, it's very interesting sociologically. But it's, at core, a deception in practice.

Bitcoins are quite likely a mistaken long-term investment, but it doesn't seem like its proponents are trying to trick anyone about the core ideas.

I'm just hopeful that it encourages more creativity in the space of private online transactions, digital currency advances, etc.

One fair non-structural criticism, a weak, temporary criticism and two things billed as criticisms that aren't.

1) Early adopters. I couldn't find a point here. I think he's saying that it's unfair that some people get in early. But in the current system, it's unfair that government (through tax law and control of force) mandates that you use a form of money that doesn't function well as a store of value. Bitcoin wins here - it has a bootstrap disadvantage, and I'd expect that to diffuse.

2) Deflation. There's a creed in mainstream economics that deflation is bad, repeated here. "if your money is getting predictably more valuable, why would you want to spend it?" It's just false. Would you buy a computer today if you can buy a more powerful one by waiting until tomorrow? People do. Mainstreamers like the leaves-on-the-fire effect of inflation and also like to overlook the fact that stimlus impairs cyclic corrections and detracts from the role of money as a store of value.

3) Convertability. It's valid to criticise the use of bitcoins on this basis, but it's not a systemic problem. If we had a period of high inflation, it's reasonable to expect people would trust finite-supply bitcoins over an unending supply of newly-minted, inflating notes.

4) "When Something Goes Wrong, It Will Die." I found the logic here non-sequiter. Bitcoin will be tested but from what we know about it at the moment, it looks solid.

2) Deflation for a primary store of value in an economy is definitely a bad thing; not least, because it does weird things like causing the value of debts to increase over time, potentially to the point of requiring negative interest; and think about what that would mean - the bank pays you to borrow money from it. Bitcoin probably isn't going to become that, though, so I think it is less of a cause for concern.

3) Convertibility is a systemic problem because it's a confidence game. If the value of bitcoin is on a downward spiral rather than an upward spiral, then you would expect fewer buyers, and those buyers would pay less for declining assets. Paying less in turn sets the market value lower; it becomes cyclical.

And that's where (4) comes in. The reason "when something goes wrong, it will die" is a valid point is because of contagion and panic selling, and the reduction in the number of buyers in the market. It makes perfect sense to me, because it's the exact reverse analogue of why bitcoin has a built-in bootstrap advantage.

I'm getting the impression that people who like Bitcoins are the same kind of people who think gold has an intrinsic worth as a currency, rather than a commodity; in other words, they don't understand that the value of money is a product of supply and demand, no matter whether fiat or specie. Don't forget that 80% of gold production is used in jewellery and industry, rather than bullion etc. What fiat money has going for it is a degree of control to get out of systemic problems.

Can't the same be said for people who bought Apple or Google stocks early on?

It is of course possible that there can be a bubble of expectations in a kind of echo chamber that cause a stock to act like a Ponzi scheme, but ultimately over time there must be returns. The return can be as a stock price rise (but that can't go on forever) or dividends; if the cost[1] of the money invested in the stock doesn't match the return over time, then people will sell the stock and it will fall in price. If too much of the stock price is formed from aspirational expectations of the future (i.e. a bubble), then the price fall may be drastic.

[1] Money has a cost; for example, compared with the interest rate on a risk-free government bond. If an investment isn't making at least that much, it's losing money.

> Ownership of a stock is a claim on the net value and future profit of the company.

Ownership of currency is a claim on the net value and future profit of the currency. How does this address OP?

> A share, meanwhile, is a direct claim on things themselves. What if you buy a share of an ETF?

Alternatively: the profits generated by Apple and Google would argue otherwise.

How can having your assets increase in value be harmful? Traders already account for many stock variables, why would deflation be any different?

> and think about what that would mean - the bank pays you to borrow money from it.

Oh no, not that :P

> "when something goes wrong, it will die"

Sort of like hyper inflation?

> they don't understand that the value of money is a product of supply and demand

They also understand when supply is in control by a few bankers, so is the demand. Who do you trust to ensure supply isn't ramped up: your friendly banker, or math? This isn't hypothetical either http://en.wikipedia.org/wiki/Hyperinflation

In an inflationary scenario, money is declining in value. People with a lot of it are actively looking for ways to put it to work, otherwise they'll end up poorer. But if the money is not losing value over time, and is in fact appreciating, what incentive do they have to put their capital to work? They need much larger returns on investment to make up for the loss of their existing risk-free return.

[1] For bank, read anyone who could lend to or finance you.

Why do people invest in stocks when they can play it safe in a bond market? They have a different appetite for risk.

I do see your point, a constantly inflating money supply encourages people to invest. The flip side to that is, are the investments worth it? Inflation is an artificial incentive to invest, which some believe is the cause of bubbles. Remember all those stupid investments in the dot-com bubble? Some believe it's because money was too cheap.

Similarly, an individual will deposit money in a bank rather than keep it under their mattress only if the bank offers returns in excess of what it gets sitting in the mattress.

Since at the moment there is no FBDIC, as an individual you must also balance the risk of depositing in the bank against the return they offer.

Ponder the implications of bread jumping to an effective price of $25 a loaf. That can and has happened in deflationary collapses, as the reserve fraction jumps toward 100% (due to credit panic).

In your story, I would attribute the $25 a loaf bread to the credit panic, not the resultant of a consumers increase in purchasing power -- such as the expected deflation in BitCoins.

The point is that it's a scam. It's designed with enriching the people who made it up in mind. The only difference between this and my "Hey let's all use these pieces of paper that I printed as money" scheme is that these guys actually got it off the ground by allowing the first few adopters to also print their own money in significant quantities.

2) Deflation. There's a creed in mainstream economics that deflation is bad, repeated here. "if your money is getting predictably more valuable, why would you want to spend it?" It's just false. Would you buy a computer today if you can buy a more powerful one by waiting until tomorrow?

Computers, yes. Food, yes. Other stuff I actually need right now, yes. But I sure as hell am not gonna invest in your startup... or in any other business for that matter, so that's just wiped out half the economy. I'm also not gonna buy a house, I'm gonna rent... but who'd be dumb enough to be my landlord?

Really, the faith which some folks seem to have in this particular bubble-in-value-of-intrinsically-valueless-asset is scary.

"Bitcoin will be tested but from what we know about it at the moment, it looks solid."

worry me. Its easy to make things for ideal conditions. If bitcoin becaomes mainstream the stresses will be incredible. Where there is money to be made there are smart people looking for an angle and leverage. Even governments suffer:

http://en.wikipedia.org/wiki/Black_Wednesday

This is an experimental mechanism. It is not based on main stream economics and it has no government or bank protecting it with regulation or defending it. The originators may have hit upon something new that is solid and can stand on its own two feet or they may have initiated the construction of a tower of cards.

Even if you are a full on supporter of bitcoin you would be mad to assume that it doesn't have a fatal flaw at this stage.

You're thinking too small. Think of holders of vast wealth, who in an inflationary system, are forced to invest their money and earn a significant return in order simply to maintain the value of their wealth. In a deflationary system, they are no longer at risk of losing wealth by letting their money sit in a bank, and so the least risky course of action for them is to simply hold on to their money. This means that the markets for things like angel investing and venture capital, among others, dry up as holders of significant wealth are no longer incentivized to invest their money.

An inflationary currency is what gives us our social mobility. Without it, holders of wealth don't make risky investments, meaning socially mobile entrepreneurs don't get funding to allow them to join higher social classes, wealthy investors no longer lose their shirts and move down the social ladder, and the society at large becomes entrenched in its current economic makeup.

I would not like to live in a society with deflationary monetary policy; money is meant to be spent and made to work for you, not hoarded.

s/spend/invest/. I mean, why would anyone spend money on food? There's no storable value! I can dream up silly situations too, y'know.

Meanwhile, there's a bit more to modern economic theory than a single pithy quote. Like, when deflation actually happens, you get this:

http://en.wikipedia.org/wiki/Deflation#Historical_examples

And this is deflation over a short scale. Bitcoin will experience constant, effectively unstoppable deflation every day after 2020.

>Mainstreamers like the leaves-on-the-fire effect of inflation and also like to overlook the fact that stimlus impairs cyclic corrections

Got some numbers on that? I seem to recall basically no problems occurring during periods when inflation rates are 0-10%.

>and detracts from the role of money as a store of value.

Money isn't supposed to be a store of value; the object of money is to facilitate exchange, not to inhibit it. Investments are a store of value. If you want to store value, invest in the S&P 500.

>"When Something Goes Wrong, It Will Die." I found the logic here non-sequiter. Bitcoin will be tested but from what we know about it at the moment, it looks solid.

SHA256 will -never- be broken, that's for sure!

>If we had a period of high inflation, it's reasonable to expect people would trust finite-supply bitcoins over an unending supply of newly-minted, inflating notes.

The medium that is more easily exchanged will be exchanged. Ever wonder why e-gold never took off, even before governments tried to stop it?

Mind you, I really, really want Bitcoin to succeed. I don't like the Federal Reserve and it bothers me that the federal government has control over the money system. However, I'm not going to disregard science to make myself feel better.

There was a deflation during all 19th century, when gold were money, without any ill consequence. And it was a century of growth due to industrial revolution.

Actually, all of Adam's criticisms deal with the supply and demand of currencies, and they are pretty strong and damning as a result. In sum, the supply of Bitcoins is finite (despite a growing population) and the demand for Bitcoins depends on (a) confidence in Bitcoins as a currency and (b) consumers' ability to convert between Bitcoins and fiat money with little friction.

(1) Adam's point is not the unfairness of early adoption, but that early adopters control all the rents. Today's miners will control currency as it appreciates, but after a point (say, the supply of mine-able Bitcoins is exhausted) there is zero reason to demand Bitcoins unless they supplant paper money (very, very unlikely).

(2) I'm weak on my deflation theory, but I don't think the computer-purchasing analogy is 100% right. Instead of buying the computer with paper money, consider buying the computer with gold bullions during the commodity boom. Why buy that Macbook Pro with x bullions today if you can buy it with x-y bullions tomorrow? Adam isn't arguing that "deflation is bad," but rather that the supply of Bitcoins as currency will dry up as their value appreciates.

(4) You can't hand-wave this away. Consumers have confidence in US dollars because the Federal Reserve and U.S. government can step in during a crisis and back people's assets. There is no similar guarantee for Bitcoins once something goes wrong.

(3) Why is convertibility not a systemic problem? Lack of convertibility falls out of all the previous points! Why accept bitcoins for cash if (a) they're not backed by a central authority, (b) almost no one else accepts them as money, or (c) they will be obscenely expensive once the supply dries up?

I can't believe Bitcoins have gotten this far. They're a currency accepted by almost no one as payment, guaranteed by no governing body, and artificially supplied as precious commodities without the benefits of said commodities (Bitcoin engagement ring? 24K Bitcoin watch?). They're a great theoretical exercise, but their real-world value will trend to $0 in the long run.

EDIT: barrkel gets to the point when he/she says "the value of money is a product of supply and demand, no matter whether fiat or specie." The fundamentals of Bitcoins are such that (a) supply will artificially dry up and (b) unlike precious metals/commodities, there will be little demand for Bitcoins aside from use as a currency (or a Ponzi scheme).

Just a point of interest -- the list of sites that accept Bitcoin (http://en.bitcoin.it/wiki/Trade) is actually pretty long. I read it as a pretty good coverage of everyday commodities, actually. You can't pay for food, rent, or doctor bills with it, but you can buy a lot of other stuff.

I guess you could characterize that as almost no one, but you'd have to mean an insignificant fraction of the larger economy. If you mean useless for buying actual stuff with--and you seem to--you're demonstrably wrong.

People have different time preferences. Some value Macbook today high enough to pay y more bullions than they would if they waited till tomorrow. There're many currencies that depreciate faster than the dollar, but it does not stop people stuck with those currencies from buying Macbooks -- even though they could theoretically change their money to dollars (or invest in gold) and wait.

Adam isn't arguing that "deflation is bad," but rather that the supply of Bitcoins as currency will dry up as their value appreciates.

There actually is a possible problem with Bitcoins "drying up" connected with its deflationary nature, but it is not the one mentioned by Adam. AFAIK there's a limitation on the minimal amount of Bitcoin transaction. That means that as Bitcoins appreciate in value at some point it may be impossible to set and pay small enough prices -- and such transactions will require alternative payment methods.

This is a pretty much technical problem with the current Bitcoin implementation. It might be perfectly possible to design a deflationary crypto money system without this flaw.

The governors of the Federal Reserve are appointed by the President and confirmed by Congress, and politicians, for all their numerous faults, understand that if the economy goes in the crapper it hurts their chances of getting re-elected. So there is democratic accountability, albeit democracy on a long fuse, that discourages the Fed from doing something stupid with the dollar.

Bitcoin’s early adopters, by contrast, are only special because they got on the bandwagon first. They don’t have any special talents that they are being rewarded for, and they aren’t accountable to anyone.

That being said, I don't agree with the article's conclusion, either. If/when something goes wrong, it's a completely open question whether or not the reaction will be catastrophic.

No, you just misunderstand the actual statements.

Deflationary currency doesn't mean that people don't buy anything. It means that the supply and demand curves shift, reducing (but not completely eliminating) investment and consumption. The magnitudes of the shifts vary depending on the product being discussed, but the direction of the shifts is the same in every case.

    You can already see evidence of this now. Houses are at
    the lowest point in prices that they have been in
    decades, but people still aren't buying, and they won't
    until there's some indication that they won't ever be
    this cheap.

I think first world property prices are still ridiculous.

It's madness to push people to leverage up in order to get into property just so they can store value. I'm not a hedge fund. I don't want to be compelled to behave like one to look after my savings. Now that the music has stopped, people are wising up that housing is not even reliable as a store of value irrespective of their sacrifices.

Given the rewards that have already accrued to Bitcoin early adopters, I am surprised other competing cryptocurrency networks have not yet already been created. Lots of people who wish they had started mining coins back in the days before GPU mining would be eager to get in on the ground floor of an alternative.

Most problems with the critiques of Bitcoin like those in the linked Quora post is that they are debunking a straw man - the idea that Bitcoin is intended as a universal replacement for all other currency systems. By those standards of course it will fail. Looked at in another way, think of Bitcoin as something more like MMORPG loot. If people are willing to spend vast amounts of "real money" on items for their WoW character, spending that money on Bitcoins instead makes it seem like a sane investment rather than just flushing it away.

I've mentioned before that I think governmental action to criminalize Bitcoin and analogous technology is an even more serious threat to long-term value. If there is one thing that really might make the world's governments team up to completely ban strong encryption, it is a potential threat to governmental control over taxation and currencies.

Broadly speaking, the more desirable properties you try to obtain at once, the more you constrain the design, and it is absolutely possible to constrain the design to the point where there are zero solutions. Arrow's theorem shows an example of that in a voting context. You can not have all of the five desirable properties laid out in the theorem, and it isn't a matter of finding a clever algorithmic solution; they are actually contradictory. You have to loosen the requirements somehow.

There is no guarantee that any given set of desirable properties has a solution. There is no guarantee that BitCoin is even close to having a solution, there's no guarantee that it is merely one requirement over the line, it may well contain multiple contradictions. There's no guarantee that there is anything more optimal than government fiat money.

I'm in favor of experimentation to find out, in general. But it should be pointed out that there is not necessarily going to be a solution at all, and I certainly would say it's not going to be easy to just "take BitCoin and fix the problems" or any variant thereof. There is something stopping people from just "creating an alternative", it's going to be freaking hard, and again, I don't just mean hard in the way that creating an open source operating system from the efforts of thousands of not-centrally managed programmers is, I mean, potentially hard in the way that proving P != NP is, really, actually, hard. Starting from BitCoin isn't necessarily even starting from a useful base.

Bitcoin is supposed to be a currency. That means that it's supposed to be effectively the same thing as USD or the Euro. It's not supposed to replace any other currency, it just needs to be able to do everything that any other currency can(except pay taxes). The problem is that it doesn't do that right now, and I don't see any way of making it actually work. To actually be a useful currency, people need to be able use it on everything, otherwise it's just a proxy for a "real" currency with an added gambling element.

Right now, it's basically the same thing as paypal or Google Checkout-something that people use to buy things online. By that standard, it's not even decentralized anymore, because everyone gets their BTC from MtGox, and they have to keep logs of all their transactions.

What would happen if a new gold-like element was discovered? "Red Gold" that had almost all the attributes of gold but it had a somewhat redish color and was actually a different element and it was proven to be of about the same scarcity worldwide. Would that halve the price of gold and would everyone jump onto red gold immediately or would it be shunned as not the real thing and be mostly worthless?

I'd be interested to know others' insights on this.

In so far as red gold acted in the same way as gold for jewellery and industrial uses, it would probably decrease the value of gold to some proportion, and set a base level on this red gold production. But this is like asking why diamonds are valuable, or designer clothes, or expensive watches. In many cases, it's a combination of marketing, status display effects (ostentatious useless consumption), artificial restriction on supply, and market fixing (e.g. arranging to buy watches on secondary markets at headline prices for PR purposes). They too are confidence games, and if the confidence goes due to a bad association with the brand, the price will fall through the floor. All that is left is productive uses like industry.

Lots of people seem to think gold is 'safer' than paper currencies, while it seems the same. Am I missing something important here?

http://symmetricinfo.org/category/goldprices/ estimates 50% of gold stock is in jewellery, 12% in industry. Of course, some fraction of that jewellery is bought because people believe that the gold will be a store of value, not just because of how it works; though I wouldn't expect selling jewellery for its gold content to give particularly good returns.

Quite possible.

A few large organizations control the vast majority of it, and this is especially true since governments have not needed to hold gold for years

Say what? A few large organizations, who are not governments, hold the vast majority of the world's gold? Are we into conspiracy-theory talk here?

Lots of people seem to think gold is 'safer' than paper currencies, while it seems the same

"Safe" depends on what you mean. For instance, you could say "US dollars have a 99% chance of retaining at least 80% of their value in five years, and a 99.9% chance of retaining at least 10% of their value in five years. Gold has only a 80% chance of retaining at least 80% of its value in five years, but a much higher 99.999% chance of retaining at least 10% of its value in five years".

Gold gives you much more volatility in the short term, but acts as a hedge against the collapse of any particular currency.

I wouldn't buy it though. I'd buy land (with houses on it), which acts as a hedge and pays you income.

I'll add a link to this story if I can dig one up.

It's not valued above industrial value.

What is the intrinsic value of Bitcoins, then? That people are willing to spend money on Bitcoins?

As an investment vehicle these are terrible. Commodities (diamonds, zinc, gold, wheat, oil, etc.) will always be demanded as factors of industrial production or farming. Equities generate real-world wealth for investors in the form of dividends. Both are demanded because they generate real value for investors.

Bitcoins have no intrinsic value. If you're in to make a quick buck, that's fine--this is a big arbitrage opportunity. But for any decently-sized time T, Bitcoins --> $0 as t --> T.

Part of the value is in their utility as an anonymous currency: try taxing the guy that's paid in Bitcoins.

Another part is the integrity of the currency: the currency is backed by math, rather than men, and not subject to hyperinflation resulting from corruption (i.e. the US Fed can create money out of thin air, but there is no authority that can create Bitcoins out of thin air: they must be mined).

Meanwhile, I've already discussed Bitcoin's potential as an alternative currency (or lack thereof) in other comments. If people demand Bitcoins as a "tax haven" from the government, then Bitcoins aren't long for this world.

Whatever the mechanism, fiat currencies are subject to inflation through the pressure of an ever-increasing money supply.

>If people demand Bitcoins as a "tax haven" from the government, then Bitcoins aren't long for this world.

It'll be interesting to see how the state tackles this. It'll be easy to drive it underground, but preventing its use will be another matter. Bitcoin transactions through a VPN seem hard to prevent.

As they should be, given that populations increase.

Anyway, even if Bitcoins go underground, they'd have to be priced such that they'd be cheaper than other money laundering channels. Due to their finite supply, though, money laundering through Bitcoins will get very expensive. So their utility re: taxes will be squashed by either the government or the black market.

Is the U.S. Population increasing like this? [1] That's what the U.S. monetary supply looks like.

More correctly, fiat money supply should ideally match total economic output, not population. But the GDP graph also doesn't look anything like that monetary supply graph.

Given this, the BitCoin phenomenon is understandable: savers are looking for a currency that's not subject to manipulation and is most of all predictable in terms of supply. Whether or not it succeeds, I'm glad there's the pressure of a competing, not-centrally-manipulated currency.

[1] http://research.stlouisfed.org/fred2/graph/?s%5B1%5D%5Bid%5D...

[1] http://books.google.com/books?id=ZNAhXe2pz1cC&lpg=PA196&...

Read the sentence "Prices might even fall gradually as higher incomes led people to want to hold a large fraction of their wealth in the form of money." Inflation is a Money Supply / Money Demand phenomenon. In the long term, Money Demand tracks real output, but in the short term (such as the recession we're currently in) you can see major swings in demand that counteract what would normally be a quite inflationary money printing exercise.

Edits: To make it clear I'm not arguing with the statement that money supply has tracked GDP fairly well until recently. Or that GDP has trended up exponentially.

Yeah, I won't take part except to say (a) you're sampling 4 years of incredibly volatile economic activity, and (b) the other, uh, 96 years exhibit a pretty strong exponential trend.

Imagining a rant, and a classification for the discussion, is not helpful. Your two points (a) and (b) I agree with.

That is only true if T-bills are generated slower than the rise of other money instruments. In the last few years, that has not been the case (and evidence for that is seen in the tanking dollar value compared to any other currency, including gold).

Easy - I collect taxes at the point where physical goods are exchanged for bitcoins or are used to deliver products.

If you can't use bitcoins for food, housing, netaccess, or energy....

Or just collect the taxes at the point where it's converted from BTC to a real, government-backed currency. It's simpler, because there needs to be a paper trail there.

The state does this, but people already get around this by conducting cash transactions. Bitcoin creates another option for this.

Govts tolerate a certain amount of black market because it costs too much to reduce the black market to 0. However, that toleration goes away when govts are seriously hurting for revenue.

...try hiring the guy who is willing to be paid in Bitcoins.

They would tax Bitcoin receipts the same way they tax service-for-service or service-for-property exchanges. The government will calculate the fair market value of the services/property received at $X dollars (based on facts and circumstances such as the amount exchanged in similar cash-based transactions), deem the taxpayer to have received $X in income, and impose a tax of $Y on that deemed income.

Gold has very little - it is used in jewelery, CDR coating, teeth and a few other industries -- but you can't live in it, nor can you eat it. Beans have more intrinsic value than gold of the same weight....

Yet, no one doubts gold as a currency.

The main, strike that, ONLY, relevant feature of a currency is the willingness of others to exchange stuff for it. At this point in time, bitcoin possesses this feature.

Gold is a commodity, not a currency. It is a scarce commodity that is highly demanded as a part of luxury goods. Thus, it commands a high price on the open market.

Beans are also commodities, but they are plentiful. Bean demand is easily met, so they're not priced very highly.

Bitcoins are not production inputs, so their only value is (ostensibly) as an alternative fiat money or value store. Unlike country-backed fiat money, you cannot exchange bitcoins for goods, so the only demand for bitcoins comes from people "investing" in them. If you want to play the bitcoin market, that's fine--in that case, you're generating wealth for yourself. Not value.

At this point in time, you can. Next week, that might not be true. But the same could be said of the currency of Belarus, which was devalued 50% overnight last week (the USD in 1931 suffered the same fate after physical gold was confiscated). Which is all that is required to make it a currency.

> Gold is a commodity, not a currency. It is a scarce commodity that is highly demanded as a part of luxury goods. Thus, it commands a high price on the open market.

:) That's a game of semantics. Gold's current price has little to do with its luxury good status, and everything to do with its scarcity and historical claim to fame as a currency. That was historically gold's role in the last 3000 years or so, and it hasn't been dethroned yet.

> Unlike country-backed fiat money, you cannot exchange bitcoins for goods

But you can. And people around the world are not accepting USD as much as they used to 20 years ago - in the past, in most middle eastern and south american countries, you were able to pay with US dollars everywhere. That is no longer true. Does that make the fiat US dollar less of a currency?

You can play semantics all you want, but gold and to some extent silver are used as currencies.

:) That's a game of semantics. Gold's current price has little to do with its luxury good status, and everything to do with its scarcity and historical claim to fame as a currency.

"Semantics" have nothing to do with it. Commodities [0] != currencies [1], whether you're familiar with the definitions or not. One exists as a medium of exchange, while the other is a good with no differentiation between sources. Currencies are differentiated by the trustworthiness of the governments that issue them (you'd probably accept a US dollar today before accepting a German papiermark [2] in 1924).

Also, gold's price is a function of the market's supply and demand for gold as either (a) an investment vehicle or (b) an input in the production of goods. Investors don't give a damn that the US dollar was pegged to gold 200+ years ago--they're simply investing in it to make money.

The idea that gold is "currency" is ridiculous. Name a first-world country where gold is widely accepted as currency. Some places in some parts of the world might accept gold, but it's not backed by a central body nor does it carry a relatively stable value (unlike fiat money).

[0] http://en.wikipedia.org/wiki/Commodity

[1] http://en.wikipedia.org/wiki/Currency

[2] http://en.wikipedia.org/wiki/German_papiermark

Semantics have everything to do with it, as I will demonstrate below.

> One exists as a medium of exchange, while the other is a good with no differentiation between sources.

Well, as long as the USD is not fake, you don't care what the source is :) Similarly, for non-fake gold.

> Currencies are differentiated by the trustworthiness of the governments that issue them.

Today, that is true. However, the Chumash people had a currency that -- like bitcoin -- was not centrally managed, and reflected work put into something, rather than any fiat or backing store of value. http://en.wikipedia.org/wiki/Chumash_people#Culture - I can't remember where I read a more detailed account. Basically, you could sit on the beach all day and make money -- and it took slightly longer than the equivalent exchange rate would get you in food (so you could hunt/gather food, or make money, with comparable time expenditure, and exchange them). The whole system broke down when European drills (as manufacturing tools) were introduced and made money making simple.

> First: I admit I wasn't aware that retailers accepted bitcoins when I posted that comment. I've discovered otherwise now, so the "hill of beans" comment is wrong. Sorry.

So - let's get back to semantics: do you agree bitcoin is currency? (exists as a medium of exchange), or commodity? (a good with no differentiation between sources) because it has both properties, thus showing that the definitions are not mutually exclusive. A USD is currency but not commodity; Beans are commodity but not currency. Gold, Chumash beads and bitcoin are both.

> Name a first-world country where gold is widely accepted as currency.

In NYC where I live, hundreds of stores will accept your gold in exchange for other merchandise (at a bad exchange rate for you...). You can identify them by the sign "We buy gold". You must have seen them in other places too.

> but it's not backed by a central body

True, but ....

> nor does it carry a relatively stable value (unlike fiat money)

Wrong, and if you truly believe that you might be beyond help. The US devalued the USD by 50% in 1931. Belarus did it to their fiat currency last week. Between 2002 and 2006, the EUR/USD exchange rate went from 0.8 to 1.5 (almost 100%) - "stable"?

In fact, up until 1971, the backing for the USD (and most other currencies) was gold - it only became a true fiat currency in 1971! Before that, it was a claim on some amount of gold in fort knox, and value was derived from that.

People need to start naming the dubious syllogisms bitbugs deploy in discussions like this.

EDIT: The fact that government would have a very difficult time shutting down the Bitcoin economy is yet another example of its utility and value.

What I, and others, are saying is that in the future, no such people will exist. Our prediction is that the current bitcoin economy is transient and will eventually vanish. Hence, we say bitcoins have no value. It's similar to saying that a particular stock has no value if you think that that particular company will collapse.

Not really. They have to be willing to say "I'll give you X thing that you value in exchange for Y bitcoins." The entire point is that the design of bitcoin makes that scenario likely to always be true precisely because it is nearly impossible to stop. As I said above, the very fact that it represents a system that is very difficult for state actors to attack ensures that it will almost certainly be used for exchanging goods and services that governments would rather not exist. Not a terribly noble future, perhaps, but certainly one that ensures bitcoins have value.

For a reason that I am unaware of, you seem to think that just because something can be traded it will be traded. That's not true. People tend to only trade things that are readily exchangeable in the larger economy - things that have value.

Really? When dollars were "silver certificates" the bank's willingness to let you come collect your silver was a real vote of confidence in the currency. But nowadays if they "insure your bank account" they only pay you back in dollars. They're insuring that its value doesn't drop in dollars. How does that constitute a vote of confidence in the currency itself? I'd say it's only a vote of confidence in (a) the bank, (b) the government's ability to print more money, (c) the government's ability to tax.

First, assuming you're talking about the US, your bank accounts are insured by the FDIC, and the FDIC is not part of or formally backed by the US government. There are lots of people who believe that if the FDIC were in danger of bankruptcy, the US government would step in to support it — as it did with Fannie Mae and Freddie Mac — but until the government actually promises to do that, you can't call it a "vote of confidence".

Second, the US government's dollar position is short, not long — its dollar-denominated debts are greater than its dollar-denominated assets. In financial terms, a short position is a way to bet against the value of the underlying commodity. The US government is currently about $7 million million dollars "short".

An illustration may help to clarify. Suppose you are a private in the Zimbabwean military in September 2007. Suppose your monthly pay is about US$180, but you are paid in Zimbabwean dollars, so your pay packet is actually Z$5.4 million for the month. The Zimbabwean dollar has been hyperinflating, and you expect it to continue to lose value. You don't currently need to pay any expenses. Consider the following options:

A. Keep the Z$5.4 million in cash.

B. Immediately buy other commodities with it; for example, buy 300 kilograms of rice and store it in Tupperware in the pantry.

C. Immediately buy other commodities with it, and also borrow an additional Z$10 million some poor sucker is willing to lend you at an extortionate 20% APR, and use that to buy rice too.

Option "A" is maintaining a "long" position in the Zimbabwean dollar. This amounts to a bet that the Z$ will retain its value. If you had taken this option, you would have lost 90% of your salary within a few weeks.

Option "B" is maintaining no position in the Zimbabwean dollar. It doesn't matter what the Zimbabwean dollar does thereafter; you still have the same amount of rice. (Practically speaking, in situations like this, there tend to be price controls on most things you can buy with the collapsing currency.)

Option "C" is maintaining a "short" position in the Zimbabwean dollar. If you had somehow found such a sucker, then within a few weeks, you could have paid them back by selling off a tiny percentage of the rice you bought, as the Zimbabwean dollar continued to inflate.

This is the position the US government has taken relative to the US dollar.

There are, of course, other reasons to take long or short positions on commodities other than speculation on their future value.

Third, even if we accept the premise that the implicit guarantee of the US government to keep the FDIC afloat amounts to "the US government is willing to insure my bank accounts", that is simply a further short position. FDIC insurance is for dollar-denominated accounts up to a fixed dollar limit. Whoever is on the hook to underwrite that insurance in the end, they'll have an easier time paying out their claims if the US dollar loses value. If your bank account has $78000 in it and the currency loses ¾ of its value (which happened here in 2001), the FDIC bailout only has to come up with the current equivalent of $19500 to pay you back.

Fourth, the government is not "more than people". It's just people.

I'll take issue with the government being "just people," but that's just a nit in a great post.

https://en.bitcoin.it/wiki/Protocol_specification

There's also the source code to bitcoinj, which is a very well-commented implementation of the protocol.

I thought there was no centralized point-of-failure?

1) Seeding Initial Wealth

This isn't really a problem. It's not very fair, but I don't think he argues that is actually a problem.

2) Built in Deflation

This is a big, big problem. It seems the creators of Bitcoin have a philosophical disagreement with conventional economic theories that state that increases in money supply (and some limited inflation) are outcomes of a healthy economy. Unconventional thinking is fine, but the outcomes he predicts here are real problems.

3) Lack of Convertibility

Yes, there is a problem here. It could actually be worse than the author suggests, because if state actors move against Bitcoin they could easily introduce high penalties for Bitcoin conversion. Even without that state actors, the dependability and predictability of convertibility is currently unacceptable.

At the same time, it's possible this could be overcome. It is basically a matter of trust, and modern fiat currencies all rely on trust. Usually that is trust in a government (or system of governments in the case of the euro), but it isn't inconceivable that "the internet" could be as trustworthy as a government. People trust billions of dollars or transactions to operating systems and databases that were built by "the internet", so it is possible this could be the same.

4) When Something Goes Wrong, It Will Die

This is the trust issue again.

However, there is one additional point - if someone wanted to deliberately attack the currency it would be fairly easy to buy a large number of Bitcoins, then deliberately destroy them. Once that occurs, they disappear from circulation, which causes instant deflation.

#2) Deflation is bad with real currencies because real currencies are tied to real economies and key things like food bein grown, healthcare, etc - and they are run on debt. In deflation, things get cheaper. Money buys more. But people only need so many cards, so many houses, so many rolls of toilet paper - so produces get net less money for their product over time. You now have to sell twice as many shoes to keep up payroll. BTC could be fine because in this - as it's position of a value store is somewhat different - it's not attached to anyone or anything, and it works digitally in the true sense of a crypto currency. The fact that it has an exchange rate demonstrates that it is working.

Convertibility: This is the same with every other form of electronic-transfer today. State actors telly ou how much, when, where, and what kind you are and are not allowed to do. Some states forbid their citizens from removing currency from the country period. They still "work"

4) This is the same as any other e-commerce provider out there (e-gold, etc) - except in those cases we feel we have someone to sue or whatever. But we're not just talking electronic payment methods - we're talking about an actual crypto currency. If the algorithm turns out to be flawed, yes, it will collapse totally. Thankfully it's open and transparent - and hopefully strongenough. If someoen wanted to damage any currency, tehy could buy up tons of it (with real money! and zap it from circulation. All that buying might drive the price up as well. If they then destroy it - right on, they've driven the price ven higher.

Again, the deflation would only be a problem if people start denominating debts in bitcoins - rather than at market rates set against other currencies they actually get paid in, which seems to be where this will go. If it turns out to be managed and run the way it's planned out - I'd have no problem telling someone "Yup, you can pay me $x USD in BTC calculated at the average closing rate over the last week" or whatever was a mutually agreeable term.

Also - as I haven't read the whole protoocl (but mean to) - if someone deliberately destroyed them - hwo would that affect value - they'd have to let everyone know, right? How do you prove you destroyed them?

If people stop spending (which is what deflation implies - as people keep their money to hold onto its increasing value) then the economy slows, and growth stops or becomes negative.

If we look at the Bitcoin economy, the same thing could happen. There are ways around that (eg, an increasing exchange rate that could occur naturally), but it is a valid problem.

deflation would only be a problem if people start denominating debts in bitcoins - isn't this the idea of any currency?

(Edit: BTW, I didn't downvote you - I think your points are valid, and I hate how people just downvote things rather than discuss them)

But Bitcoins are supposed to be a currency, not an investment. A currency needs to be used to transfer value, not sit around appreciating.

If people sit on their Bitcoins as an investment then it will fail, because no one will ever accept it as a currency.

I don't think deflation in itself is a problem, but the current rate of deflation of BC does worry me. I wonder whether this might be caused by a relative lack of way to spend it.

Right now the value of BTC has been going up (relative to USD) hand over fist due to increased demand. But eventually -- and I think it's going to be pretty quickly -- the buying spree is going to end and the miners are still going to be churning out new Bitcoins.

It's going to feel more like holding Zimbabwe dollars than Krugerrands for a while, I suspect.

Long term, yes, Bitcoins are designed to deflate. If they remain popular past c.2020, prices will gradually decrease and smaller and smaller fractions of Bitcoins will need to be used for transactions. (Actually the number of Bitcoins in existence will probably go down slowly over time, as people lose Bitcoin wallets and thus take the BTC out of circulation forever. There are 9000+ BTC "lost" this way at present.)

"With bitcoin, a single failure of the cryptosystem could result in an utter collapse of the entire financial network. Unlimited inflation. Fake transactions. People not getting paid when they thought they were getting paid. And the perpetrators of the attack would make so much money, so fast, that they could apply their fraud at Internet Scale on Internet Time.)"

IANA cryptography expert. Is this feasible in the way the author predicts? Could SHA256 be cracked quickly, a la MD5? My gut is that it won't be able to, but I can't back up my argument.

Come on, people. This isn't the first asset bubble in history (though it may be the most cleverly-designed). We all know how it ends. People keep paying ever-higher prices for the asset, hoping it will go up. And it does for a while. Then one day, the price of the asset stops going up, people realise they don't want to own this asset now it's stopped going up, the value collapses, ka-pow, it returns to a more natural value.

For a real estate bubble, this may mean a halving in prices, because the natural value of real estate is quite high. For bitcoins, the natural value is zero.

Take the Needham-Schroeder public key protocol from 1979, for example. http://en.wikipedia.org/wiki/Needham-Schroeder_protocol#The_... . It's simple and "obviously" foolproof, but a vulnerability was published in 1995, 16 years later.

Right now, we don't know if the bitcoin protocol has such a flaw. However, if it turns out to have an exploitable flaw, the entire bitcoin network will have to switch to a new protocol, which I haven't heard described as something they have a concrete plan for.

It was found, that due to overflow, someone issued a lot of bitcoins to themselves in the block. During several hours was released a new client, which ignored flawed blockchain. When most people moved to a new client, the new blockchain overcame the exploited one.

Though it was when bitcoin wasn't popular.

This would likely be even easier to accomplish today; as things currently stand, all mining pools and groups have a vested interest in maintaining the integrity of the blockchain.

I don't so why it couldn't be defeated, most of the other crypto systems which were going to last us for centuries got defeated..

IANA cryptography expert either, but my understanding is that the biggest threat to SHA is quantum computing.

http://en.wikipedia.org/wiki/Grover%27s_algorithm

http://en.wikipedia.org/wiki/Quantum_computer

* weaknesses found usually still require some computation time, which may be prohibitively expensive. Reducing 2^128 to something like 2^90 is terrible disaster from crypto perspective (and buyer confidence), but won't open floodgates for fake coins (if faking a coin costs thousands times more than mining/buying, then nobody will bother on large scale).

* attacks typically have certain limitation, e.g. only generate collisions, but not preimage, or apply only to certain types/lenghts of data. Hash could be totally broken for one set of cases (MD5 digital signatures are useless) and at the same time still hold strong for other (MD5-hashed salted passwords are safe, as best known preimage attack is 2^123), so even if some terrible flaw in SHA256 is found, it may not be applicable to the way Bitcoin uses the hash.

And as with any investment scheme the potential for manipulation by rumour is also very real. There is a lot of regulation around more mainstream investment and money mechanisms to stop this (and it still happens) - bitcoin, which has no centralised "defender", will be just as prone to it.

I would imagine that now a wider audience is becoming aware of bitcoin we will start seeing this kind of thing in the next few months (and possibly are already doing)

Judging by how cryptographic methods got defeated in the past, I think it's safe to assume that it's only a matter of time.

Proving cryptographic algorithms are secure involves proving statements over all turing machines. For example, one definition of a 'secure' pseudo random number generator is one such that no turing machine can distinguish its output from 'true' random (with 2/3 certainty) in polynomial time.

However, we do know a really-really-probably secure one way function. If there are any one way functions, then it is secure. It just isn't really practical. http://en.wikipedia.org/wiki/One-way_function#Universal_one-...

  Also, you can't really prove that such an algorithm is secure.

In reality, all OTPs do is shift forward in time a relationship that must still be secured through some other means.

So, from now on, when we talk about the feasibility of breaking crypto, let's implicitly constrain "crypto" to "crypto that people can use in practice".

and no, OTPs do not require that the that any secure relationship be formed forward in time.

in fact, restricting "crypto" to "crypto that people can use in practise" doesn't rule out the OTP - it was used with great success in both world wars, owing to the fact that agents were able to share keys before the fact, use them once, and then discard them.

finally, at no point would i ever suggest using the OTP as a means of encryption in place of a public key system, especially one with a key of 0s. why you suggest such a thing is beyond me.

the key space being the same size as the message space, and cipher text space means that all messages of equal length are possible, with no way of knowing which one is the correct one. i suppose, a theoretical attack would be to be to enumerate all messages in the english language, XOR them with the cipher text, and see which resulting keys come close the properties of the PRNG used..

even non-determinism can't help you here, i'm afraid.

additionally, attempting to exhibit intellectual superiority by making someone look stupid, isn't infuriating, it's just sad.

i wouldn't conduct myself like that in public or on the internet. it's a shame that anyone thinks it's acceptable.

My guess, SHA-256 will fall to a quantum computing algo in a few years.

Actually, you can't even reliably brute force a one time pad. The key is always the same length as the message. All plausible messages of length N are equally valid solutions for a brute forcing algorithm.

Assuming there is no out-of-band information to use to attack the ciphertext then yes I agree is unlikely to find a unique solution.

Aside: I'd never considered that key length was dictated by the term "one-time pad".

And when that happens...

Inflation encourages holders of capital to use it to invest in other things. That is, inflation encourages productivity. The inflation has to be relatively low, of course. Probably low enough to allow someone to retire without worry.

Deflation (or really constant value) means that those who save, build things and invest wisely will benefit.

And no, I am not going to starve today, so that I can get marginally more bread a year from now.

It seems like it would just create aristocracy. If I inherit a large sum of money, I have incentive to ensure that my large sum of money increases (or at least doesn't decrease) in value in the easiest, least risky way possible. If my wealth was in bitcoin, I wouldn't have to do much, except ensure that more people join bitcoin and that the bitcoin didn't disappear. Otherwise, I would just play warcraft all day, procreate, and then die and split my wealth amongst my children to continue the cycle.

If my wealth was in an inflationary currency, I would have much more incentive to take on risk. Perhaps through that risk taking, I end up losing my wealth, and others gain. Or, perhaps I gain more wealth. At least I have incentive to take productive action.

[1] http://news.ycombinator.com/item?id=2611613

I'm unsure about the deflationary aspect of bitcoin - in my opinion the degree to which it is problematic depends on the rate of depreciation compared to other assets. It seems more of a problem if you wanted to use bitcoin to replace a sovereign currency, rather than use it as a currency on a smaller scale intended for grey market/black market transactions. I think the appreciation of the currency over time was probably intended to ensure it originally took off by providing an incentive for early adopters; its dubious legal status probably means it's a poor long term investment choice anyway.

To some extent this discussion is entirely academic anyway - bitcoin is being used as a currency right now (see the Silk Road Market), so in that sense it's already succeeded..

That only works if a majority of your assets or earnings are in bitcoins (e.g. you have to convert them in order to live), or if bitcoins are exchangeable for necessities. If the article's author is correct (and he is imo) and it's more sensible to look at Bitcoin as a commodity, not a currency, then i think your assertion is a red herring.

Wrong. Inflation encourages to invest in commodities or real estates. Watch for increasing price of metals, agriculture products. The primary cause of real estate bubble in US was cheap money.

Let's say you have an amount of money which buys you today 1 house. If within 1 month, with the same amount of money, you'll be able to buy 1.04 houses, nobody will invest in any business which increases real (non-money denominated) assets at anything lower than 4% per month.

Or, to look at it from another angle: the central bank cannot set a negative interest rate, that is, take interest just for keeping the money in the account (people will keep it under the mattress instead). So the deflation rate is the minimum interest rate that the businesses must achieve in order to be economically viable and attract funds (otherwise investors sit on the money). The greater the deflation rate, the more bankruptcies it causes.

I think 60% annualized deflation is significantly more than the deflation we would expect in the eventual steady state of Bitcoin. And if I was experiencing 37.5% annualized inflation (the opposite of 60% deflation), I don't think that would be particularly good either.

If you meant, by bringing up a central bank, to refer primarily to monetary systems based on a central bank, I don't believe that a government (a small subset of the population which is allowed to murder and kidnap and rob everyone else, and which is necessary for a central bank to exist) is a prerequisite for trade denominated in a common currency, so I'm not sure that the way our current monetary policy works is entirely relevant. The Dallas fed wrote an interesting piece on changing policy to allow for negative nominal interest rates (http://dallasfed.org/research/indepth/2003/id0304.pdf), but I think we will have to settle for negative real interest rates for the near future.

Discounting the central bank bit, I'm first unsure that the bulk of business has to be financed through debt, and second unsure that a deflationary environment can continue to exist given a huge loss of productivity. I would expect, if thousands upon thousands of businesses suddenly closed their doors to sit on cash, that the resulting shortage of necessary goods and services would put a quick end to the deflation. This would be extremely painful and inefficient in the case of a large deflation, but any global currency of bounded quantity should eventually only deflate as rapidly as human productivity increases.

The real problem is if someone is more or less likely to buy something in currency denominated terms if it is a deflationary or inflationary environment.

If people don't spend then you tend to end up in a low (or negative) growth environment, which can lead to high unemployment and a falling standard of living.

* Subject X is broached in an exciting blog post.

* The submission receives massive upvotes and hundreds of comments.

* Subject X simmers. Soon various HN link-targets (AVC, that Steve fellow, TechCrunch, the other guy here called Jacques) begin weighing in, netting their initial submitters still hundreds more karma.

* Before long, karma farming means that the front page is overrun with links to posts covering Subject X from every conceivable angle. "Why Subject X is the Future". "Why Subject X is a fad". "Launch a Subject X statup right now!". "Subject X is retarded, here's why".

* Then, one day, somebody posts about Subject Y.

Bitcoins are no different from tulip bulbs.

What is their inherent value, then? Commodities (whether precious or industrial) can be used in production or for luxury goods. Equities generate profits, which are subsequently shared with investors. What do Bitcoins do? Nothing.

That's not true. Bitcoins can be securely transferred between accounts without the need for a centralized broker. That's not "nothing".

Also, mining won't be completed this century, although the rate at which coins are generated decreases over time.

It's kinda sad. I think when it happens I'll make like edw519 and self-publish a book "The Best Of Hugh3" in which I publish all my "told you so" comments. And hey, maybe just to be charitable I'll sell copies for a million bitcoins each!

1) New investors demanding a finite supply of bitcoins are increasing the exchange rate of bitcoins/dollar.

2) Early holders of large volumes of bitcoins can therefore cash in their bitcoins for a great deal of real money from new investors desiring to enter the market.

ergo, money shifts from new investors to the creators. (If the creators are smart enough to cash out. Which it seems they are, as Satoshi has disappeared. http://en.wikipedia.org/wiki/Satoshi_Nakamoto)

In a pyramid scheme the wealth always flows up to the creator of the scheme, but the creators of Bitcoin can only make money by selling their own bitcoins - they don't get a cut when anybody else does.

Please explain how new investors obtain bitcoins, if not from the original members of the system (some of the early users have 1% of the total bitcoins, I recall hearing). Yes, there's mining, but that's not an effective way to transform money into bitcoins - I mean, say that I wanted 1000 bitcoins. Building an expensive new computer to mine and waiting for them to magically appear is not how I would go about it.

However, the people responsible for creating the bitcoin protocol only benefit financially if they sell their own bitcoins, or if an increase in demand raises the price bitcoins are trading at.

The Bitcoin economy is a free market; people can buy and sell bitcoins and will, and any profits they might make are entirely governed by supply and demand.

The Bitcoin marketers do something that's increasingly transparent: they (intentionally?) confuse the hypothetical with the real. A system based on the Bitcoin technology could theoretically be something more than a scam. But the right response to that is "so what?" because in practice, the present system is exactly a scam. It's exactly, as you say, the same as tulip bulbs.

There's a simple reason for this. There are only three kinds of people who buy Bitcoins at present: (1) idealists, ideologues, and experimenters; (2) criminals; and (3) speculators.

The first category is simple; it consists of the libertarian and anarchist extremists who simply like the idea of Bitcoin; they perceive it as threatening governments, fulfilling some fuzzy vision they have in their heads of following in John Galt's footsteps, fostering delusional hopes of a new world order. Read the Bitcoin forums to get a sense of these people; they're crazy enough that you worry about their psychological health, saying things like "I wouldn't pay taxes even if that would be the only way to get a starving welfare baby food" and "I reject all human morality and law." This fringe group is small, however, and marginal, and fortunately they don't have a lot of money. And this group has pretty much been exhausted; how many technologically savvy anarcho-extremists are there who haven't already gotten involved with Bitcoin, and how much money will the remainder contribute? (This category also includes what I call "experimenters" -- people who put in $20 to see how the technology works, etc. That's not objectionable, but it's not a big group either.)

The second group are people who want to buy illegal things, launder money, and avoid taxes. You get people like Jon Matonis suggesting that Bitcoins would be useful to make tax-free payments, even though of course the laws in almost all countries don't agree. You presumably get child pornographers on Tor and so forth. This group will hopefully invite regulation, and also, since they're just trading with Bitcoins, they won't do much to increase their value long-term.

The third group are simply people who want to buy it at $X and sell it at $X+n, hoping to convince someone else to pay the $n.

That's literally all there is. Nobody needs Bitcoin for trade. There's nothing legal (and indeed there's probably even nothing illegal) you can buy with Bitcoins that you can't buy with established currency. Maybe there are a handful of things it'll be useful for in a hypothetical future, like making donations to Wikileaks for those so inclined, but even that can't be done now. Even the EFF doesn't want it.

And the system is promoted without any regard for its weaknesses. Bitcoin transaction fees are expensive when making transfers internal to the system (it recently cost me $3 to transfer $1000 internal to the Bitcoin system as an experiment). In converting currency and making trades, the fees and spreads are typically exorbitant, and you face unreliability, potentially dishonest trading partners, and wildly fluctuating exchange rates. The environmental cost is mounting and needs to be paid for by dwindling subsidies for block generation and, eventually, increased transaction fees. The system is facing talk of increasing regulation, fortunately.

So I have no problem calling people who talk as if the price of a Bitcoin will forever rise -- much less forever rise exponentially -- "scam artists." That's exactly what they are.

If you were to instead use a credit card or a wire transfer, someone (not necessarily you) would almost certainly be charged between 5 and 15 times as much for the transaction.

The thing is, people on the Bitcoin forums talk as if they have no idea how to set up a decent bank account. It's not hard. I do a substantial amount of banking and can't remember the last time I paid a bank fee. (Obviously you're correct that merchants do pay credit-card fees and thus that some of the prices I pay are affected by merchant fees, but I get services for that too.)

That's very similar with a Ponzi scheme, where you need early adopters to pour money in, so you can have a positive cashflow on which to iterate with other customers. But otherwise you don't have an underlying asset to sustain the value.

That's the biggest problem with Bitcoin, I think.

Now, if I could purchase more goods and services with Bitcoins, this might mitigate the risk of using it. But as of now, not many retailers accept it.

As a result, the Bitcoin market is being driven solely by speculation.

No. What it has gained is: speculation.

(What I've heard about bitcoin makes me a bit skeptical, but I want to be skeptical for the right reasons.)

This argument never made any sense to me. You can't eat money, watch it for entertainment ... etc. You might be more inclined to save money that you would otherwise have spent carelessly to avoid its loss of value, but how is this a bad thing? Wouldn't our economy be stronger if the effort we spent was on making things people actually want / need instead of making things people kinda want because their money is burning a hole in their pocket?

"Bitcoin does not have a central bank capable of printing and lending bitcoins"

>>I rather think thats the point. Lending is inflationary.

"Built in Deflation"

>> God knows how the computer industry makes money when if i hold my $$$ just a little longer, i can buy an even better machine.

"For Bitcoin to work as a currency, it would have to act as a predictable store of value"

>>No, currency does not have to store value. The USD is a terrible store of value. Gold is a store of value. Govt paper is not.

" That's called a bank run, and for obvious reasons we want to avoid them."

>> um - I'm not an expert on bitcoin but there are no banks i thought. your money is in your e-wallet. you dont need a bank to keep your money away from theives. there are no banks with fractional reserve lending that are fragile to a run on deposits

This guy is dunning kruger at its best.

Not really. Because if you expect the value of your cash to rise, you would probably hold onto your cash. The liquidity of the system would drop as people hoard their cash (what happened during the Great Depression), depressing an economy.

"bank run"

He's talking about the need to inject cash into the system during economic shocks (the reason for the Fed injecting money into the system). This, again, happened during the Great Depression, as perfectly sound and profitable banks toppled left and right because of the bank runs, taking down the rest of the economy.

Deflation, when things are worth less over time, means producers have to sell MORE to make payroll, pay their bills, pay their debts - which haven't changed in value. It's great for people flush with cash - and horrible for anyone in debt.

The computer industry has planned obsolescence. None of them are buying 10 years worth of parts for today's computers at projected market rates, because that would be a pile of stuff they'd ahve to eventaully sell at a loss.

It's not so simple as simple analogies....

BTC is designed to be, in the true sense of the word, a trustworthy way to move value from point A to point B -and there is avery strong network effect required to make it work (or any similar currency). At a point where I know I can go somewhere, locally, and exchange my bitcoin for local currency (and some posted market rates) - I will probably start accepting using it for a few things.

The concept has merit.

Right, that's why the computer industry doesn't make any money.

> This, again, happened during the Great Depression

Yes. A large part of what made the Great Depression last much longer than the Depression of 1920-1921 was that insolvent businesses were given money instead of being allowed to fail. One might compare this to recent events, and have a look at the present employment rate of the U.S. population: http://market-ticker.org/akcs-www?get_gallerynr=1631

So why don't you? By that logic, you don't own a computer. There has not been a single minute for the past thirty years when it was not an invariant that if you wait a little longer, you can get a better computer, or more lately, mobile phone or *pad-device for the same (or, not rarely, less). Yet, these items sell like hotcakes.

When deflation is temporary, yes, then it's true - but when the deflation is constant, it's not.

People buy a computer when the utility they will derive from it outweighs the monetary cost. They know they may get a better deal in the future, but immediate needs may outweigh potential future savings.

What makes gold a "store of value"?

The best flaw in the bitcoin model (I've not studied it too thoroughly) is acceptance testing. You give me a bitcoin: how do I know to accept it as payment? This may not be a problem if suitable proxies are made (like with credit cards).

1 - as highlighted by the author: bitcoins are equity positive in their creation. we can trade with seashells as the medium (painted red so distinguish them as special currency, of course), but every time somebody goes to the beach with a bucket of paint, they get rich. money creation in its traditional sense (generally, except countries with serious issues) does not create equity, it only increases liquidity. major difference. tomorrow we could all adopt a new currency, but we would generally have to back it with something else of value (sort of authors point #2, weakly explained). bitcoins are the creation of 'free money' out of thin air. we can assign it value (if we dupe others into taking it for goods/services), but its value-less 2 - the computing power devoted to this game is completely wasted. look at this from 30,000 feet -- all of these smart people with smart computers are crunching numbers on a frivolous exercise and not for something productive. total deadweight loss

bitcoins are the equivalent of beanie babies. you could buy a car with those, and they became currency, albeit very briefly. but the inherent value is that of a stuffed doll. bitcoins have a negative inherent value

That's true of gold mining as well, insofar as the price of gold is significantly higher due to speculation and its use as a currency and store of value than it would just for industrial uses (see comparisons to ruthenium). This increase in price drives a whole lot of mining that wouldn't otherwise occur.

But the whole reason for allowing Bitcoin "mining," I think, is because it provides an incentive to early adopters, solving what would otherwise be a chicken-and-egg problem that might be extremely difficult. Other digital currencies (e.g. Flooz) used various marketing gimmicks to spur adoption, but Bitcoin's method is much cheaper.

lol. (I don't usually say "lol" but it seems appropriat here.) So the only people worth listening to on the subject of bitcoin are people who own bitcoin and hence have an incentive to further talk it up?

Is it really a "scam"? Yes and no. It's not an outright scam in that the inventors really hope it will work (and that making themselves short-term rich off other people's money is just a side effect).

Smart psychics are a scam -- they know they're lying to people and they're taking their money by selling 'em something worthless. Bitcoin is more like a dumb psychic, one that doesn't know she's peddling bullshit.

On the other hand, from the point of the view of the person who has given up real money for the insight that they will meet a tall dark stranger, the intentions of the originator don't matter.

Not at all. I personally agree with the author that the whole idea is flawed. With any new system, there needs to exist some sort of vetting process, though. What I'm referring to here is whether or not the author of the post vetted the system. In other words, went through the process of using bitcoins to match their conclusions. A good analogy might be the sample table at the grocery store. If you're skeptical about how something might taste, you try it and give your opinion. Here, it's almost like looking at the food, deciding not to eat it all and then telling people it's complete shit without having ever tasted it. In regard to using the system first, I'm not suggesting that the user put in a large sum of money, but enough to see how it works and what the outcome of that experiment was. I'm not dismissing the points here, but I've always respected the opinion of those who try what their reviewing/opining about first. I don't think that's unreasonable at all.

Bc is not a normal currency, it's not reserve currency. It's much more like a stock that's tradable without exchange. Limited quantity, market set price,

Mining is not free. When something succeeds early adopters always mKe out big. It's their payoff for risk.

Severe Problem Number 1: Seeding Initial Wealth This problem is similar to Gold Miners or anyone initially to an asset class. You already retracted your scam comment, so thanks. Remember, governments are currently seeding banks and itself with wealth through inflation. Its a different set of winners based upon market forces.

Severe Problem Number 2: Built in Deflation

The money supply is actually inflating (slowly). People will make educated, market based choices about how to act with their money once the currency settles down. That will likely be assigning higher value over time to Bitcoin. The Euro or Dollar have the opposite, and many would argue much worse problem: you don't want to hold them because the issuing government slowly saps value through effectively built in inflation.

Severe Problem Number 3: Lack of Convertibility Try trading government currency in a collapse situation, you will encounter problems. Right now, Bitcoins are roughly as easy to convert as any other currency. Bitcoins are inheritly no more or less convertable except for the lack of current market makers (a good point you brought up).

Severe Problem Number 4: When Something Goes Wrong, It Will Die Look at Zimbabwe to see an example of governmental currency collapse. Any currency can die. People used seashells at one point, they died. I'm not sure Lyra or Franks are worth anything today.

Bottom line: Yes, Bitcoin can fail (so can any other currency). It is earlier than other currencies in its lifecycle, so has a different set of risks. Is there speculation going on right now, almost surely. Bitcoins appeal to people because it is not government based, electronic, and low cost. Many of the problems you note are just different problems than existing currency, for better or worse.

It's all about the "reserve currency", which is the currency that sellers around the world prefer to receive. If bitcoins are more attractive to sellers because of built-in deflation then they'll not only accept them but offer their products at a discount to get them. All of this creates an ecosystem and drives adoption, it does not make the currency a scam as he implies.