On the subject of altcoins

Recently I created a FAQ/Guide for /r/Bitcoin and I was asked to expand it by adding information on altcoins and their merits. Since such a discussion is a big subject onto itself, I decided to devote a whole blog post to this.

If you want the quick and easy version - if you are starting your adventure with Bitcoin and crypto-based currencies, stick with Bitcoin and don't look at other currencies. Most of them exist only to speculate on their value and don't offer anything in return. All the technical innovation is happening in the Bitcoin space, all the merchants are there, this is where you should focus your attention. Come back here once you feel confident in operating in Bitcoin securely if you want to learn more.

Getting dirty

Now, lets quickly talk about a few characteristics of Bitcoin:

  • Bitcoins are very divisible. Currently 1BTC can be divided up to 8 decimal places. This means that Bitcoin can handle very very small transactions (at the current price of about $1000/BTC, we are talking about the precision of 0.001 cent). If the need arises, this precision can be increased further. There will always be enough units of account to handle even the smallest payments in Bitcoin.
  • The way Bitcoin operates is very wasteful, but it is pretty much the only way such a system can operate. Bitcoin solves two very hard problems - decentralized money creation and decentralized money transmission. Both of those problems are easy to address for centralized currencies, but the decentralized nature of the system requires the process of block mining. As discussed previously, this means that bitcoins have an intrinsic value, since they cost money to create.
  • Because of the high cost of mining involved, any attack on the Bitcoin Network is very costly. Anyone trying to steal bitcoins through the means of double-spend or Finney attack will have to overcome the entire Network working against them.
There are many misconceptions being spread around that try to fool people into thinking that altcoins solve those problems. Let me address some of the more popular claims.

You need coin X to allow for small transactions

No, you don't. The Bitcoin Network is capable of handling transactions with 0.00000001BTC precision and the blocks are big enough to handle the traffic. You don't need an altcoin to handle small transactions or more transactions.

You should look into coin X - you can mine it and make a lot of money!

There is no easy money to be made. Mining bitcoins is a specialized industry where one needs to invest a lot of money to be competitive on the market. Mining altcoins is hoping that your small effort is in fact big and will make you rich. Again, mining is wasteful - unless you have the right equipment for the job, it will cost you more in electricity and computer parts than it will earn you. Unless you know what you are doing, there is no money to be made there.

Coin X has blocks generating Y times faster than Bitcoin, this means that your transactions are Y times faster!

No, not really. The amount of computing power behind Bitcoin dwarves any altcoin. At the current time getting 1 confirmation is enough to secure most commercial transactions. The hassle of someone trying to scam you while buying coffee from you is not worth it. In most cases seeing a transaction appear in your client with a proper fee will be enough to transact - altcoins don't offer any advantage here.

Buy coin X and diversify your portfolio!

Bitcoin is not a system set in stone. If there will be an important problem or security vulnerability Bitcoin needs to address, it can change itself to keep up with the world. This means that unless Bitcoin fails abruptly (for example someone suddenly discovers a major vulnerability in ECDSA algorithm and can steal everyone's coins), its failure will mean that other altcoins will fail as well. If government cracks down on Bitcoin, other coins will follow. If the Internet is shut down and Bitcoin Network dies, other coins will follow. Diversifying into altcoins will not save your portfolio.

And remember...

If someone claims their altcoin is really something, take a look at the list of all cryptocoins. There are hundreds of them. Almost all of them without merit.

The exceptions

There are a few altcoins that have a merit of their own. I would not recommend them to anyone starting with Bitcoin, but they deserve a mention as an exception to some of the rules.

TestNet Bitcoins

I think this quote of mine explains TBTCs well:

"TestNet coins are worthless, but useful. They are useful because they are worthless. If you will add value to them, they will be useless, therefore worthless."

TestNet Bitcoins are not used as a normal trading currency, but are created for software developers wanting to test their software in a Bitcoin-like environment without losing their money getting lost or them messing with the Bitcoin Network. If you are a software developer and need some TestNet Bitcoins, you can visit my faucet.


Ripple is an entirely new beast onto itself. It is a combination of decentralized currency, payment network, exchange and peer to peer lending. The system is still in early development, but since it operates completely different from how Bitcoin works, it is worth looking into at some point. Do be warned, the currency that fuels how Ripple functions - ripples, was all created upfront and a vast majority of it is being held by one or two companies. Some people take issue with that, so be warned.


Namecoin is not only a Bitcoin-like currency, but also a distributed Domain Name Service. The project recently experienced some major bug in its system that made it pretty much useless. If the developers address the issue, it will continue to be a very interesting project to follow due to the extra utility of the created coins (although there is also an issue with Namecoin possibly not being future-proof).

Everything else

Coins other than the ones mentioned above don't offer anything beyond what Bitcoin does. Some people may claim that some altcoin has an innovative block generation algorithm that doesn't require much computational power, or contributes to some prime number research, but in the end that doesn't make them better than Bitcoin, only different. Unless you know what the differences mean and wish to support them, don't buy them.

And remember, some people just want your money

A big number of altcoins are promoted only for one reason - to get your money. Some people were too late to the Bitcoin party, so they decided to start their own and get rich with it. They hope that their coin will grow and become a system like Bitcoin, so they paster a lot of people to devote their time/work/money to make that happen. The most prominent offenders I have come across are the Litecoin supporters. I have seen them asking people working on Bitcoin projects to create projects for their coin, to beg exchange owners to allow their coin to be traded on the exchange, and trying to convince a lot of people new to Bitcoin that they can earn a lot more money by investing into Litecoin. Recently their coin's value has risen along with Bitcoin, but the darnest thing is - there has been no major innovation taking place in the Litecoin ecosystem. There are no new big merchants accepting it, no new services have been created to make Litecoin use easier or anything like that.

So far, Litecoin is a big speculation currency.

There are many other ones like it, but this is probably the first you will come across. Unless speculation is your thing, don't give them your money.

To sum all up

If you are new to Bitcoin, don't look further than Bitcoin - there is a lot of people that will confuse you.

If you are confident in using Bitcoin and want to see what else is out there, check out Ripple and Namecoin.

If you are a software developer and want to program something yourself, check out Bitcoin TestNet.

Every other altcoin - keep away unless you know what you are doing and are certain you are doing the right thing.


Bitcoins now has an intrinsic value!

In my previous post I discussed the subject of Bitcoin's intrinsic value vs. the intrinsic value of gold. I found a definition of an intrinsic theory of value as what an item costs to produce. However, I know many gold bugs would argue that I should be taking some other definition, something closer to say, numismatic definition of intrinsic value, where a coin has intrinsic value equal to the amount of precious metal it has. Similarly, there is an argument of money that is backed by something having intrinsic value, like gold certificate having intrinsic value since it is backed by gold.

Lets appeal to such people now.

I don't consider myself rich, but I do have a few silver Casascius coins around. I hereby declare that I will do my best to hold at all times 4 ounces of silver in such coins and I will use them to back all bitcoins created in the past or future, at the exchange rate of 5.25 million bitcoins for 1 silver 1 ounce coin (exchanges will only be carried out in integer amount of coins - they will not be redeemable in parts). Baring forces beyond my control (natural disasters, theft, government mandate), I will hold myself accountable to exchange bitcoins at that exchange rate no matter whether Bitcoins are accepted by any exchange, merchant or other peer.

There, bitcoins now have intrinsic value. It might be a quite shitty intrinsic value, but it's a value - don't let anyone else tell you otherwise! How much is this all worth? At the current exchange rate of 20 USD per ounce, we are talking at about 1 cent being worth 2625BTC.

So there you have it. Since bitcoins now have an intrinsic value, they are on the same level as gold as to whether they are money according to Peter Schiff's video. If someone tells you bitcoins don't have intrinsic value, send them here and prove them wrong. ;)

PS: If someone is willing to increase the "intrinsic value of Bitcoin", contact me and we can try to arrange something. I will accept any precious metal I can safely and conveniently store ;).


Peter Schiff and Bitcoin

Recently, Peter Schiff has been in the Bitcoin news for a series of videos and talks involving him on the topic of Bitcoin. The ones I am familiar with are:

Bitcoin vs. Gold - http://www.youtube.com/watch?v=0L7SOPDOvvI

Ed & Ethan 86 Bountiful Baskets of Bitcoin Banter, Blather, and Bluster. - http://www.youtube.com/watch?v=IaBREg5rzlI

Bitcoin vs. Gold: The Future of Money - Peter Schiff Debates Stefan Molyneux - http://www.youtube.com/watch?v=mFcTJAQ7zc4

I would like to address a few points made through those videos and hopefully nip a few misconceptions in the bud.

Difference between gold and bitcoins

The "Bitcoin vs. Gold" video sums up Peter's view on the difference between gold and bitcoins rather neatly. In his view, gold is better since it has intrinsic value. In the second video, Erik Voorhees counters that argument stating that there is no such thing as an intrinsic value (since value in itself is an abstract concept), but we should be rather talking about the value of how useful an object is. I also heard an argument about having to distinguish "intrinsic value" of gold from its "historical value". Lets debate those points.

Intrinsic value

Intrinsic theory of value article on Wikipedia states talks about a value of an object contained in the item itself. We also get "Most such theories look to the process of producing an item, and the costs involved in that process, as a measure of the item's intrinsic value.". In this view, gold's intrinsic value is the cost to mine it, and with Bitcoin - also the cost to mine it. The value of gold being useful to various people will be debated below, as I wouldn't call it "intrinsic" into gold - it's subjective to a given person and not a property of the material itself like density or conductivity would be.

So the process of mining is similar between both Bitcoin and gold. Early people mining gold had it easier - they could come across big veins of the metal and mine it much easier than people nowadays have to. All the easy gold was mined out early, and the process is getting harder and harder. With Bitcoin, the early coins were easier to create, but with increased interest everyone has taken their digital shovels and started to compete against one another. There are differences between those processes - there isn't much chance gold mining would get easier any time soon (until asteroid mining becomes a thing), while it could get easier to mine bitcoins if the network would lose a lot of miners, but that is unlikely to happen.

So clearly, both Bitcoin and gold have intrinsic value as defined by the cost of creating them. Lets look at the historical value and the usefulness value.

Historical Value

Gold has been viewed as money and a desirable commodity for thousands of years. Bitcoin has been around for almost 5 years now. This obviously gives gold the status of a safer store of value over a long period of time, provided the trend holds. Similarly, Bitcoin has the same historical value advantage over other cryptocurrencies - it has been the first to be created, the most widely adopted and has a story behind it - mysterious crypto wizard driven by the ineptitude of banks creates a new currency to end the banks. All other things being equal, Bitcoin is superior to other cryptocurrencies in this way.

Usefulness value

Food has value since we need it to survive. Land has value since it is used to grow food. Steel has value since it can be used to make durable tools and so forth.

Gold is useful in electronics (good conductor), chemistry (doesn't easily react with a lot of things), jewellery (looks pretty). All of those properties add to its value. At the same time, the high value of gold detracts from its usefulness - as lovely as it would be to make full electronic circuits out of gold, it's not as cost-effective at the current price.

Bitcoin is useful in electronic transactions. It is cheap, fast and can't be taken down without taking down the Internet. Unlike gold, Bitcoin's usefulness does not diminish with it's value, but increases. If Bitcoin is worth less, then the maximum amount of money one can transfer is smaller, but if they are worth more, one can always divide them up even further (8 decimal places of precision). Barring the currently high default fees in the program (0.0001BTC per 1kB of transaction), Bitcoin is getting more useful all the time.

However, Bitcoin's usefulness relies on it having value. It is by definition a way of transferring value, so without it bitcoins would be useless. Bitcoin's value is kept strong by a few factors - it's scarcity, cost to create them (the "intrinsic value"), its wide adoption and so forth, but one can recognize that "if everyone wanted to cash out", bitcoins would become worthless, barring someone giving Bitcoin a "floor".

The story isn't much brighter for gold however. If "everyone decided to cash out", it's value might drop down to something comparable to perhaps copper - $7 per kg. That's not much compared to the current price of gold. One can say, that the usefulness value is what gives gold floor value, not current value. Those are quite different.

Fundamental property of money

In the second video as far as I remember, Peter was discussing the fundamental properties of money in the context of Bitcoin lacking one of them - not being backed by anything, nor having a value onto itself.

Some people claim money has 7 characteristics, others that it has 6. Lets look at them. They both agree that money should be:
  • durable - it can't change properties over time. This is why we don't use food and other perishables
  • divisible - one needs to be able to make smaller fractions of it. This is why we don't use art
  • portable / convenient to use - one needs to be able to carry it around and use it conveniently. This is why we don't use granite as money
  • fungible - different pieces of money should be worth the same, they should be interchangeable - one coin shouldn't be worth different amount than another coin of the same denomination. This is why we don't use real estate
  • limited in supply - money can only retain worth if there is a limited amount of it. If everyone can print money, it's not money
  • acceptability - everyone needs to accept it, otherwise trade is harder
The extra characteristic that is named by some is:
  • intrinsic value - money needs to have value unto itself
With the last one usually being used by people that maintain that only gold and silver is money since it possesses that characteristic.

Gold is durable, divisible, fungible, limited in supply and has intrinsic value. I am not sure how many people accept would accept it - probably some store clerks couldn't take it. Gold is portable in the real world, but fails in the digital world of today. If a company was to issue gold currency online, they would need to hold onto it for people to redeem it, not issue money without backing and hope not to get shut down by a government. Electronic version of gold would have the portability for online transactions, but its durability would suffer should the company be in a threat of being shut down.

Bitcoin is durable, divisible, portable, fungible, limited in supply and is gaining more and more acceptance by the day. Peter has asked for a list of merchants that accept Bitcoin, so here is a modest list of them, and a map of physical places that accept Bitcoin. I would certainly like to see one for gold (where one can spend gold, not buy it or sell it). As discussed before, bitcoins have intrinsic value of cost associated with creating them. They are not backed by a physical commodity like gold certificates would be if one is going by that definition of intrinsic value.

Bitcoin has at least 5 of the 6 characteristics of money, and is gaining the 6th, acceptance, by the day. If one is going by the 7 characteristics, it also depends on the definition of intrinsic value - it might or might not have it.

Gold by some standards can have 5-7 characteristics, depending whether one is dealing with transactions online or offline and the definition of acceptance.

Exchange fees

In the third video, Stefan brought up a few examples of large value transactions being transferred over Bitcoin for next to nothing. Peter countered that statement saying that it's not next to nothing - one would need to pay exchange fees to get bitcoins, and another exchange fee to get fiat back, and the buying and selling itself would move the price due to the big volume.

One can agree to the last part when it comes to transactions of more than a few million dollars worth. Currently looking at the market depth of one of the exchanges, a sale of $3M would drive the price down from the current drive up to 973 USD/BTC to 900 USD/BTC. A similar buy would drive the price up to 1013 USD/BTC. The daily volume of bitcoins traded on MtGox today is about $500M, on BitStamp - $480M, on BTC China it is about one and a half of that worth of CNY. One can say that bitcoin doesn't have the volume to handle such multi-million dollar purchases and sells, but at the same time the daily volume is big enough to handle that.

As for the exchange fees, while they certainly might not be zero (on BitStamp they are between 0.5% and 0.2%), they are still over an order of magnitude smaller than what Peter himself is charging (from the end of his video on CombiBar - 6.95%-7.85% over spot price). PayPal falls somewhere between that - 2-3%+$0.3. Bitcoin is still cheaper than the alternatives.

Bitcoin is a Ponzi Pyramid Scheme

Peter's biggest blunder came up during his talk with Ed and Ethan in the second video. First, he was very adamant about Bitcoin being a Ponzi Scheme. When faced with a clear definition of what it actually is and why Bitcoin is not a Ponzi Scheme, he quickly switched his statement to "Bitcoin is a Pyramid Scheme then".

Clearly, someone hasn't done their research into the subject and is just parroting whatever they heard. Peter, if you are proven wrong, don't jump from one accusation to another, be humble enough to at least say that you are not sure and you might look into that. Being uncertain about something is not a bad thing - we all learn and make mistakes, but claiming something for certain without proof or thought behind it shows that there is no use trying to have a debate with someone.

To put an end to such accusations - European Central Bank has looked into Bitcoin and whether it is a Ponzi or Pyramid Scheme in 2012. Their conclusion is "Moreover, the scheme does not promise high returns to anybody. Although some Bitcoin users may try to profit from exchange rate fluctuations, Bitcoins are not intended to be an investment vehicle, just  a medium of  exchange.". Later it also states that "[...] the current knowledge base does not make it easy to assess whether or not the Bitcoin system actually works like a pyramid or Ponzi scheme [...]". So the facts are that the ECB has looked into it, did not find indications that it is a Pyramid or Ponzi Scheme, but they are not completely certain since it is not easy to know for sure. Unless one has something new facts to bring to the table, there is no proof that Bitcoin is either of the two.

Cashing out

Around the same time Peter made the above accusations, he also brought up a point about the system collapsing when early adopters decide to cash out. A similar notion was stated by ECB - "[...] it can justifiably be stated that Bitcoin is a high-risk system for its users from a financial perspective, and that it could collapse if people try to get out of the system and are not able to do so because of its illiquidity.". Nobody is claiming otherwise. But think about the kind of people that are the early adopters of Bitcoin that can have a big amount of bitcoins.

First people that found out about Bitcoin were tech-savvy programmers that knew a lot abour cryptography. We have people like Hal Finney, Gavin Andresen or Dan Kaminsky. Being a programmer myself, I can try relating to how they are feeling about Bitcoin - an elegant solution using strong cryptography to solve a problem in a novel way. To gold bugs the Bitcoin system would be like a whole country issuing gold-backed currency. Sure, some people would want to cash in their gold stashes and live rich, but a big number of them would want to see it grow. A few early adopters might cash their bitcoins in, get rich quick while the price of Bitcoin would go down and possibly kill people's confidence in the system, but that would be destroying what Bitcoin can become.

I personally have faith in the early adopters of Bitcoin not to do that, but I understand people that have concerns. Then again, Bitcoin has survived two big bubbles and is stronger than ever. It might not be possible at this point to damage it permanently even with the price dropping a lot. But this is getting to the realms of psychology and speculation, so lets move on.

Gold-backed cryptocurrency would be superior

Another one of Peter's arguments is that a gold-backed cryptocurrency would be superior to Bitcoin. Well, there are ways to start issuing a currency like that even today, so if you're interested in running something like that Peter, let me know ;). At any rate, there is one big problem with a cryptocurrency like that.

It has to be centralized by definition.

Again, we have the example of Liberty Dollar. One company holds the precious metals and issues currency backed by it. That company has to have a physical location and is thus an easy target for a government seizure, theft and the like. Gold was made illegal in the US once already, it can happen again, ruining the value of such a currency overnight.

Sure, you can have many locations that would be issuing such currency, but that would essentially be multiple centralized currencies, each prone to default and corruption.

With a system like Bitcoin, nobody can seize your coins. Heck, I can hold millions of dollars in my head. Bitcoin can be made illegal in a country, but that won't make it impossible to spend the bitcoins somewhere else, or use them despite that.

Peter made an argument that a government could stop Bitcoin by spying on people. Not really. It is possible to operate Bitcoin over TOR or use node-to-node encryption, making the Bitcoin traffic unreadable. While people could try breaking into your computer and spying on you that way, that is a problem of privacy onto itself and should be addressed before you address the issue of using Bitcoin.

Other cryptocurrencies

Last argument of Peter's that I want to discuss is him stating that anyone can make another cryptocurrency like Bitcoin, and thus they aren't really scarce. Well, we already have more alt-coins than I care to count, and most of them get no traction. But lets discuss the issue anyway.

Bitcoins are scarce by definition. If your client enforces the protocol, there will never be more than 21M BTC. If someone changes that, you don't have to follow them, and most people will likely stick to the 21M limit present from the inception of Bitcoin. Gold can be mined from asteroids in the future, and currently it is possible to synthesize it if you have huge amounts of energy, so in theory Bitcoins are more strictly scarce than gold.

Bitcoin's protocol is changeable. It can be adjusted to address any issues one would have in the future. If the cryptography behind it gets weakened, it can be switched. If quantum computers become a reality, the algorithms can be switched. Until then, Bitconi's cryptography is secure "until computers are built from something other than matter and occupy something other than space.".

As such any Bitcoin copy does not have much advantage in the long run. There are notable technologies build on top of Bitcoin (Namecoin's distributed domain name service for example), but as for currencies themselves, Bitcoin has similar advantage as gold has to other metals - historical value, as described above. Bitcoin was the first, is more adopted and has been worth a lot more over the time than any other currency. The notion that Bitcoin can be easily replaced by another cryptocurrency like it is similar to gold being replaced by another metal. Sure, people with deep pockets could say that Ruthenium or XenCoin are the new "it", but it is unlikely to happen. Bitcoin is more prone to such change due to smaller market cap than gold, but as time goes on, there will be less doubts as to whether or not Bitcoin is here to stay.


To sum all up, Peter Schiff has all the right to be sceptic about Bitcoin and some of his arguments make sense, but at the same time others are false.
  • Both Bitcoin and gold have intrinsic value as defined by the cost to mine them
  • Gold has bigger historical value (thousands of years), but similarly Bitcoin has the strongest historical value of all cryptocurrencies
  • Both Gold and Bitcoin have usefulness value
    • Usefulness value only gives gold a floor value, not current value
    • Gold's usefulness value diminishes with price, Bitcoin's increases with price
  • Bitcoin with more and more adoption will be closer and closer to having all characteristics of money, gold is losing those characteristics with online transactions
  • Fees are lower in Bitcoin, but the market volatility and depth are not useful for really big transactions
  • Bitcoin is not a Pyramid or Ponzi Scheme
  • People cashing out can ruin the value of Bitcoin
  • Gold-based cryptocurrencies are centralized by nature and vulnerable to government seizure
  • Bitcoin is very likely to remain the top cryptocurrency due to its historical value, just like gold is likely to be the metal of choice for storing wealth


Is it possible to peg the value of a digital good to anything?

Recently I had a big discussion with a person in /r/Bitcoin modmail about whether or not it is possible to peg the value of a digital good to anything. The discussion came about due to them being against Mastercoin links being posted on Bitcoin subreddit. Since I think the topic of the discussion is interesting, I would like to elaborate on some examples and counterexamples.

The person I was arguing with has a strong belief that it is not possible to peg the value of a digital good to traditional currency or other items. I would argue that it is only the case under some circumstances. Lets begin...

For all intends and purposes, pegging a value of digital good to something is pretty much identical to pegging a value of any good to something, so there isn't much point in discerning those two. Similarly, in these examples currencies can be viewed as goods - we're talking only about the value of something

First of all, what does it mean to peg a value of one thing to another? The obvious answer is that one good is exchangeable for another good and vice versa at a constant rate no matter the circumstances. 100 cents are under most circumstances exchangeable for $1 for example (unless you are running Coinstar or the like). For analysis one can also try breaking down the peg of value to the minimal and maximal exchange rate - this will be useful for our analysis down the line. In order for a good to be pegged to another good, it needs to have pegged minimal and maximal exchange rate.

So, under what circumstances can one type of good be pegged to another, and under which circumstances does this fail?

So our first consideration are two finite goods - this includes gold, silver, Bitcoin or the like. There is a fixed supply of a given good and nobody can make more (barring asteroid mining). If I hold a bar of gold and a bar of silver, I can start pegging some of their value. If I know the total amount of gold out there, for example, 1 billion bars of gold, I can put my silver bar up and say that I will pay anyone wishing to trade their bar of gold 1 billionth of my bar of silver. Despite this exchange rate being ridiculous, we have just pegged the minimal exchange rate of gold to silver - as long as I can be trusted to pay up, the value of the billion bars of gold will never be smaller than 1 bar of silver. The same can happen in reverse - I can put up my bar of gold to peg the minimal value of silver. The same could be true for pegging minimal exchange rate of Bitcoin to gold - if someone is willing to pay X amount of gold for any Bitcoin they are given and they have 21 million times X amount of gold, they essentially have created a floor for Bitcoin's value. However, pegging the value in this way might not be very useful in real life, since the spread would be too big. People would only resort to this exchange during extreme situations.

Now, what happens if a person holds all of given good there is? Say, someone created MyCoin, premined themselves 21 million MyCoins and started selling them for 1 BTC a piece, as well as buying them back for 1BTC a piece. This situation is more stable - nobody would buy MyCoins for more than 1BTC, since the creator would be selling them for cheaper, and nobody would sell MyCoins for less than 1BTC, since the creator would be buying them for more. If the ratio is chosen correctly, there would always be enough MyCoins to be sold for BTC. However if there aren't enough MyCoins, the value stops being pegged the moment the creator runs out of MyCoins - since they can't sell any more of them, their price can go up through the roof according to supply and demand, and we end up with our original situation. Clearly, one can only create floors in this situation, although if one makes the floor high enough (enough of finite good and proper exchange rate), the floor will equal or exceed the ceiling and the peg will hold.

Now lets look at an opposite example - goods that are not finite.

Lets say we have two digital currencies - Likes and Upvotes - each one being created by a different companies. Both Likes and Upvotes can be created in any quantity determined by the company that owns them. Since we have a free market, Likes and Upvotes can be traded for one another freely. If someone that is not one of the two companies tries to peg the value of Likes to Upvotes, they will run out of one or the other if one of the companies decides to flood the market. However, it is possible for either one of the companies to peg the value of their currency to the other one. They need to specify an arbitrary exchange rate, be it 1:2, 2:1, 1:1 or anything, and just create enough currency for anyone turning in the opposite currency. Again, this would only peg the value one way - if you can create Likes in any amount but have only a limited amount of Upvotes, you can't be selling Upvotes forever, you will run out of stock at some point. Well, unless you start the system that only created Likes for Upvotes at a given exchange rate, then you will always have enough currency to back up the demand for cashing it in. However if that is not the case, the system can still work. If both companies would have some fixed exchange rate, then they both can have as much Likes and Upvotes as needed - they would just buy them off one another. If the ratio does not match, say 1 Like is being sold for 2 Upvotes, but 1 Upvote for 1 Like, then some crafty traders can start trading the currencies ad infinitum flooding the market with infinite currencies. However, if the ratio is identical, we have a pegged value. Both companies essentially are creating interchangeable currencies.

Obviously however, currencies that can be created at any arbitrary amount are pretty much worthless to begin with ;).

Now, for the final consideration - pegging the value of a finite good to an infinite one. In other words, gold standard, pegging Bitcoin to USD and so forth.

So the initial state of the system is blank. We have our finite good in hands of some people, but our infinite good is not yet in circulation. Only one company can create the infinite good, be it a mint or a private corporation. They decide to say, issue silver notes - one note is exchangeable for 1 gram of silver, and vice versa - 1 gram of silver is exchangeable for one silver note. They get their first buyers, they start issuing their silver notes and keeping the silver they get in exchange. If someone wants to get their metal back, they can do so as well. If the company operates well and owns all of the silver there is, their notes are still worth the same - they wouldn't go up in value in proportion to silver, since the notes can always be exchanged back to silver. The value of both silver and the notes can rise and fall, but they won't be different. If everyone cashes their notes in, they will get their silver and the value will still not change. So we can see in this example, that it is possible to peg a value of finite good to infinite good, as long as the infinite good is fully backed by the finite good.

So what happens when we have infinite good that is not backed by the finite good? In other words, what happens when someone tries to peg value of Bitcoin to USD? Well, Bitcoin is already distributed in the system, and so is USD. There are two ways to approach this situation - if one pegs the value at the current market rate, say, $100=1BTC, then again, they create a floor. If the price of Bitcoin goes above $100/BTC, whoever is selling Bitcoin at that price will sell all of their inventory and have nothing to peg. If the price goes down to $100/BTC, we hit the floor and the exchange rate is stable. Clearly, it's not possible to peg the value of finite good to infinite one this way.

What happens when one tries to "catch up" with their infinite currency and buy up the finite good to back up their infinite good? Well, it would be one heck of an inflation / deflation boom that's for sure. First, the creator of the infinite good (USD) would need to buy up as much finite good as they could for as little as possible. Then, having some amount of the finite good and knowing how much infinite good there is in circulation, they can peg the value. The amount of infinite good in circulation divided by the amount of finite good in the possession of the infinite good issuer would be the exchange rate. So if there was, say 10^12 USD in circulation and the Federal Reserve had 1 million bitcoins in their store, they would have to peg the value of 1 BTC to 1 million dollars. Only then would it be possible for the currency to stay pegged - they could print any amount of USD needed to cover people cashing in their BTC, and if people decided to turn their USD into BTC, they would still have enough to cover that too.

The situation can of course only work if there is a single entity creating the currency, or all of the entities are cooperating to keep the peg. If someone starts to churn up too much of the infinite currency without having the finite currency to back it up, everything breaks down.

All the examples presented here also only work if the entities creating infinite currencies can be trusted - if one starts printing gold certificates without backing, we turn to fractional reserve banking and have to endure inflation, if not runs on the banks.

So, to sum all up, it is possible to create a floor value for any pair of finite or infinite good or currency, but it's not possible under all circumstances to peg the value of the two. This can only happen if one of the currencies can be created as needed (or there is enough of it created with a proper exchange ratio to essentially be an infinite currency) and is fully backed by the other currency - be it finite or infinite.

So what are the examples of one good being pegged to another? Well, we have our gold standard, where gold certificates (infinite currency) are fully backed by the finite amount of gold (finite good). Soon we will have MintChip, which creates a digital Canadian Dollar currency (infinite currency) that is fully backed by the physical currency (infinite currency). Finally, we have systems like Ripple that allows anyone to issue their own IOUs (infinite currency) that can be backed by anything, be it finite or infinite currency.


On Bitcoin redlists

So recently Mike Hearn proposed an idea of "redlisting" Bitcoins. Here is the gist of what is being proposed:

Consider an output that is involved with some kind of crime, like a theft or extortion. A "redlist" is an automatically maintained list of outputs derived from that output, along with some description of why the coins are being tracked. When you receive funds that inherit the redlisting, your wallet client would highlight this in the user interface. Some basic information about why the coins are on the redlist would be presented. You can still spend or use these coins as normal, the highlight is only informational. To clear it, you can contact the operator of the list and say, hello, here I am, I am innocent and if anyone wants to follow up and talk to me, here's how. Then the outputs are unmarked from that point onwards. For instance, this process could be automated and also built into the wallet.

Pondering this issue for awhile, I am reaching a few reactions and points for and against this issue.

First of all, it touches on one of rather important ideas of money - fungibility. In essence, implementing this system as proposed would constantly be reminding people that despite all money being equal, some money would be more equal than other. Money needs to be fungible to make payments fast, cheap and predictable. If it isn't, then we start creating a market for trading bitcoins for bitcoins, euros for euros and so forth. On a more personal level, trying to keep track of money in one's wallet and trading tainted coins for clean coins would be too much of a hassle.

Second problem raised by this concept is how one would track the taint. Bitcoin constantly mixes coins from multiple outputs. There are no singular Bitcoin bills one can track, bitcoins are more like cheques that spend whatever amount one wishes from the money one has. This would create transactions that are 95% tainted, 47% clean, or just contain 1% of "pizza coins". The problem gets more complicated when we take into consideration transaction fees. Does a block that accept a 1BTC tainted along with their 25BTC newly minted money makes that coinbase transaction 1/26 tainted? Would miners want to get reimbursed for receiving those tainted coins?

Third problem I can think of is whether with the redlist one would be entitled to the sweat of one's brow? If someone provided a service in good will and got paid all in tainted coins for a coffee they sold, would they be forced to give that money to whoever it was stolen from? What would happen if a coin got redlisted only after we have received the money? Would everyone have to keep track of everyone they are doing business with them to let the authorities follow the breadcrumb trail back to the original criminal? All of those questions don't have a clear answer if you want to respect the rights of the original owner of the stolen money as well as the rights of a business person earning their living and the rights of every Bitcoin user to the high pseudonymity offered by the Network.

The fourth is the issue of who would be entrusted to keep track of the redlist? If it is controlled by an individual or a single corporation, they are open to manipulation, threat, or government muscling their power. If there is no single redlist, there might not be consensus as to which coins are tainted and which are clean.

Overall, keeping a redlist is a slippery slope. Here is how things could progress:

  1. You start with informing people of coins that were used for crime
  2. People start discriminating against tainted coins
  3. Someone from the US government would have the bright idea of redlisting coins that passed through wallets of "terrorist organizations", so say Wikileaks gets redlisted
  4. People that don't know better can't tell a difference between coins redlisted for crimes and ones redlisted by politicians for "war on terror", so they discriminate against them both.
  5. Term "terrorist" or whatever is the flavour of the month gets extended to more and more organizations that are inconvenient for the US - Anonymous, some foreign journalists that report on war crimes, government of a country that is "at war" with US or "harbouring terrorists", etc.
  6. Soon the redlist becomes a political tool - we start discriminating against the grey area. Say some place does research on human embryos or human cloning in a country where that is legal, but since some western country thinks that their law trumps over regional law, they start redlisting their addresses.
  7. Transactions and addresses are started to be added to it indiscriminately because some government agency says they are tied to this or that crime. Whoever is keeping the redlist can't say no since they have some order from the agency, and they can't tell anyone why they are adding those since they have a gag order.
  8. Soon you start having a currency controlled by the political powers of one country that houses whoever is making the redlist since they can muscle their way into controlling it.

HOWEVER! There is also a flip side of the coin, be it digital or not.

If anyone wanted to track coin taint, nobody can stop them anyway. With Bitcoin, every transaction is on the record forever. You can track your pizza taint until the end of time. This also means that any government agency can use this information against you if they know your addresses.

Going away from the negative things, if the redlist was implemented well, it could be a good tool for stopping bitcoin theft. The proposed idea is an indiscriminate bomb, but consider this approach:

  • Anyone can report a theft of their coins to the proper authority - police and the like. Same as credit card theft.
  • Them reporting a theft officially (not through some forum rant), means that they are accountable in case they are lying. This would deter any wannabe free loaders that want to spent money other people entrusted to them. Again, same as credit card theft.
  • If the proper authorities acknowledge the claim, they can ask for voluntary information to track the thieve, or can obtain a warrant to audit any Bitcoin business operating in their jurisdiction for the record of their transactions. A proper business would be required to keep that information anyway - especially the Exchanges.
  • If the authorities come across evidence that a given person has been paid with tainted coins, they can ask them if they know who they got the money from, or with a warrant request that information. It is in everyone's best interest to help fight the criminals.
  • However, unlike say, buying stolen merchandise, one should not be required to forfeit the tainted coins (unless they are connected to the criminal and so forth). If one provided a service in good will, they are entitled to their money, unless whatever those coins paid for is returned to them - similar to returns in stores or whatever. This ensures that merchants do not discriminate against money from one source or another.
  • If the original criminal is caught, they should be handled like any other criminal.
This approach does not make the redlists binding and indiscriminate, but instead keeps them as a normal tool in fighting crime. Of course anyone would be able to keep a redlist of their own and it is likely that police from various countries might operate together to find trails of crime, but it all happens in a regulated space of the law. Common users should not see the redlists by default - the last thing we need is someone who is oblivious to how Bitcoin works trying to be a vigilante for "justice".

So to sum all up - the current proposal of the redlist is akin to many US attempts to "combat terrorism" through indiscriminate surveillance of everyone. This approach is unacceptable. However, Bitcoin will need a way to combat coin theft, so a regulated and limited approach to redlisting should be developed, but nothing more.

I think I will start blogging again

There are numerous things happening with Bitcoin that I think I should voice my opinion on. So I guess I will start blogging again - it feels like a better alternative to just posting things on Reddit or Forums that will get swamped and forgotten in a day or two.