The fundamental question about Bitcoin is not whether it is sound from the cryptography standpoint. The question is: what is it?
Money is Debt Ink
To define Bitcoin we need to look back at the history of money. The earliest money was in the form of things that were scarce and impossible to falsify, something like specific kinds of sea shells. Everyone knew that stuff could be traded for these tokens.
Once such monetary tokens were invented, we no longer needed to decide what to barter right there and then, we could postpone the decision. One could sell milk for tokens, then use those tokens to buy a spear later, this way the milk didn’t spoil while waiting for the spear to be made.
What is not very obvious is that the tokens represented debt. A sale is really a loan in disguise. Before the sale, the seller had milk. After the sale, the seller had tokens, which are proof that value of tokens is owed to the seller. In other words, the tokens received for the milk sold were a record of debt. Tokens are the ink in which this record is written.
It is noteworthy that there is no money if there is no debt, or that money implies debt. It’s a simple principle that so few understand.
World-Wide Debt Ledger
The best way of thinking about money is that it is the medium in which we maintain a world-wide record of debt. The entries in this book or ledger are written as physical tokens. Only the people in possession of the tokens actually know how much they have and there is no history, only the final state. The history exists only in the minds (or records) of the traders. It is very private.
Later people started using rare metals such as gold or silver as money. Metals were better than sea shells because they were divisible. We could now make arbitrary size tokes we called (coined?) coins.
Although we intuitively think that gold has a lot of value, in reality it has very little. Gold does not feed us or keep us warm. It does have some unique properties, but back when we started using gold as money we couldn’t possibly appreciate those, other than perhaps gold being pretty and extremely durable.
Gold is also rare. But rarity does not imply value. The sea shells were worthless before they were used as money, and they are worthless now, yet they too are rare.
Banks, Paper and Records of Records (of Records)
But it turned out that keeping valuable tokens was difficult, they could be lost or stolen, and worse, people were willing to kill for them. And so we decided to keep them all safe in one place. This was the original bank.
The bank issued paper notes that corresponded to the gold in the vault. Now these paper notes could be traded for anything. This was because people knew that even though the paper is worthless, it represents gold that is in the bank. At any time one could go to the bank, give the bank the paper note and receive gold (at which point the bank would destroy the paper note because the debt is settled).
A paper note is a record of the record of debt. The true record was in gold, paper was a copy. It’s a bit of a mind-twister, but humans have become really good at rewriting the original debt ledger in other mediums.
Ironically the concept of the bank as a safe vault never really worked: people were willing to steal and kill for paper money just the same. These days bank vaults keep paper notes as if its gold. And the bank’s computer keeps a record of the record of the record of debt.
Real Estate Ink
At some point bankers realized that they can manipulate the monetary supply because only the bankers actually knew how much gold they had. It was done “for the good of the public” who could get easier loans, but it was also an easy way for the banks to make money out of nothing.
Eventually it was decreed that not just gold, but anyhting could be similarly held by the bank so that vastly more paper notes could be issued. Most notably real estate, the arrangement of issuing paper notes for a house being known as a mortgage. And since a house cannot be placed into the vault, it too had to be recorded, creating yet another layer of abstraction. It all ended with collateralized debt obligations, credit default swaps and ultimately the 2008 subprime mortgage crisis. Next year Bitcoin was born…
Monetary System is Just a Ledger
The bottom line remains: we kept a legder. The recording medium was precious metals, then evolved to paper and metals, and finally when we went off the gold standard it became just paper reflecting value of arbitrary things held under lien as collateral.
The Bitcoin blockchian is also a medium for this legder, only instead of relying on scarcity of precious metals, the scarcity is in the mathematical complexity of a problem.
And this is where our minds begin to play tricks on us, because this is a concept previously unknown to humans. A Bitcoin, which takes an enormous amount of computational power to generate, is actually, really scarce. Yes, it is not physical, it is just “knowlegde” or “information”, but by all laws of nature it is scarce, in fact more scarce than gold, the total amount of which in the universe isn’t fully known.
But Bitcoin is just an Agreement?
Interestingly, Bitcoin is merely an agreement and one might argue that some day we can collectively decide to increase the 21 million limit thereby diluting Bitcoin value. But can we actually do that, or will it not be Bitcoin at that point? I think only time will tell.
We do already have a lot of things that we agree on and we don’t really question how it happened. The aforementioned shells were collectively agreed upon. We agree on what the current date is, does it matter how it happened? In fact, much of what the world is, just is, including the fiat money (where “fiat” literally means “let it be done”). And so now Bitcoin just is.
The sea shells ceased to exist as money in favor or precious metals, and it is likely that same will at some point happen with Bitcoin.
History does show that when it comes to money, people show their worst traits. This is why countries with solid currencies have big armies and police, and very strict laws regarding manipulation of money. This is how “fiat” actually works.
Amazingly, the mathematic principles on which Bitcoin is based do not need to be defended. No army in the world could ever change a single prime number.
The name Bitcoin refers to a specific blockchain. There can be many like it. The name could have been different, the parameters of the algorithm could have been different, just like the dollar bills could have been blue. There are other cryptographic currencies, and they are different, they too now exist. (Caveat: some of them are mathematically bogus).
One could argue that gold exists in nature, while Bitcoin was created by man, and thus gold is somehow more real. But Bitcoin rests on the mathematical principles that too are just part of this universe, they were not created by man, they were discovered and applied, and again in this sense Bitcoin isn’t much different than gold.
The Mystery of Value
The mystery to me is how we collectively set a value of things like gold or Bitcoins. Now that we’ve demonstrated that as money, they are equivalent. Why is an ounce of gold worth $1300? Who decided that? The market? Is the real value of it in how good of an ink it is in the world-wide debt ledger?
To be continued…