I have seen the Grand Canyon of Arizona, and I am still smarting from its effect on my perception of reality. Its grandeur reminded me of a paradox, the paradox of what I would call “chance and permanence”: nature works mostly by chance, but what it has wrought so far is almost permanent. In the beginning, I am sure the path of the mighty Colorado river that formed the Grand Canyon was determined mostly by chance. As time went by, and the canyon went deeper, what was determined by chance is now almost permanent. Every twist and every turn, every steep cliff that formed, every rock that stayed put and not washed away is there by chance, and yet now permanent. It would take great effort, time, and money to change the path of the Colorado river. So we, as observers of the Grand Canyon, can appreciate how its path was formed mostly by chance, but can also appreciate its permanence. And so it is with the rest of the universe.
We can consider even human institutions in terms of the same paradox. Sure, we’d like to think that all our institutions are there by design, and not by chance, and that is true. But there are certain important aspects of our institutions that become permanent purely by chance. We cannot possibly know beforehand which little twists and turns in our lives become very important later, but there is no doubt in my mind that the sum total of those decisions can make each one of us successful or lose out and simply become a statistic. It certainly makes sense to leave less to chance, and the less we leave to chance, the better.
Just as an example, let’s take the Windows operating system. It has now become an institution. It is very difficult to replace precisely because it has become an institution. We can appreciate the fact that until now, despite the presence of free (and some say even better) alternatives like Linux, Windows remains the most widely adopted operating system, by a wide margin. It is not that the proponents of Linux have not tried enough. A huge effort is being spent, not just by the Linux community, but also by the Apple OS community, to dislodge Windows from its position as number one, but so far to no avail. This is what I mean by becoming an institution, mostly by virtue of Windows’ virtues, but also partly by chance. There were crucial steps that Microsoft took, during its early days, that caused Windows to be an institution. Some of those steps, like partnering with IBM in the early days, did not happen by chance. What was left to chance was which little OS to start with, during the earliest epoch called “DOS”.
(Microsoft started not with an OS of its own making, but bought out some OS from an obscure company. Incidentally, it would be wrong to conclude from this that Windows won by great marketing alone. It had to be a good OS also, limited only by available hardware, and had to continue to compete by being the best. Being a good OS is a minimum requirement, and by now that should be obvious.)
Now I have no doubt that Bitcoin will become an institution, something that maybe very difficult, if not impossible to change in the near future. I would not invest in it myself if I did not believe in it. But there are a couple of things that worry me, and I am writing this to see what other serious thinkers would say.
There have been several attempts to bifurcate the path of transactions. Let us remember that these attempts had a sinister purpose. I believe it is also possible to bifurcate the path of transactions, to have more than one set of transaction files, simply by distributing another branch of the software. The system is designed to protect itself from invalid transactions with a sinister purpose. However, if this is done NOT with a sinister purpose, but in order to come up with a better currency, then politically such new branch would be adopted by a large number of users, which would then cause the path of transactions to bifurcate. We would end up with not one database of transactions, but several incompatible databases. The Bitcoin currency would then bifurcate several times to spawn several other currencies, all competing against each other.
Remember Unix? I believe that Unix should have been the number one OS instead of DOS/Windows. It was certainly better, by any measure, than DOS. It did not win out because it bifurcated several times into different versions, all incomptible with one another. Would Bitcoin suffer a similar fate?
The other thing that worries me about Bitcoins is the rule that puts a hard limit to its quantity. I believe that this is reason enough for it to bifurcate. I still have to hear from a reputable monetarist thinker that a hard limit on quantity is good. Here is why I think it is bad.
What makes gold still THE number one standard currency is the fact that its quantity cannot be increased by a simple human decision. It has to be mined. There have been times when its quantity increased by more than the world economy can sustain, and it inflated just like fiat currency (during the Gold Rush, for example). However, there is no hard limit to the quantity of gold in circulation, and I think that the reason it remains the best currency is because it continues to be mined and so continues to increase in quantity. In the end, I think that it’s not the increase in quantity of a currency per se that’s bad, it’s HOW it increases in quantity. I believe that the best currency is one that increases in quantity in relation to worldwide economic activity. In the future, gold cannot remain the best currency because its increase in quantity is not necessarily a good arithmetic function of worldwide economic activity.
A currency is only as useful as how convenient and beneficial it is to use as a medium of exchange. In this regard, Bitcoins are far more useful than gold. Gold has other values apart from its use value as currency. It has jewelry or ornamental value, it has industrial value (as electronic connector in integrated circuits), and monetary value. Its monetary value has now exceeded its two other values because the U.S. dollar is failing in this function as worldwide currency. Contrast this with the pure monetary value of Bitcoins. Bitcoins have no other value than its use for exchange. We can say it has pure exchange value. One of its attractions is that, by being based on the power of the Internet, it is money that can travel friction-free from one point in the world to another. Very much unlike gold, which weighs so much it takes not just some reliable means to transport, but also a secure one. It takes a lot of money just to transport gold; it takes almost zero to transport Bitcoins.
However, and this is a big caveat, even a Bitcoin itself can see its exchange value reduced. It can reduce in exchange value precisely because its perceived value, or market value, is increasing. As it increases in market value, many holders will start to hoard it. (Like me: I plan to hold on to as much quantity of it as long as I can.) Now when it is hoarded and stashed away, the total count of Bitcoins in circulation necessarily goes down. Hoarding necessarily affects the count of daily transactions that occur per quantity of Bitcoins: its so-called net velocity goes down. When the velocity of a currency goes down, we can say its usefulness as currency goes down also. Therefore, what we may see happen is a long-term trend upwards in market value, but punctuated by violent fits of steep drops in price, as the exchange value compensates for market value, and vice-versa. This is precisely what we want a currency to fix: the occasional steep drops, the violent business cycle.
I propose that the violent cycles of ups and downs can be avoided, simply by increasing the quantity of Bitcoins, not asymptotically as it is now, but as a function of velocity. (It should not be a function of market price because market price by definition is always in relation to another currency, like the U.S. dollar, which can also be volatile.) Velocity is easily measured by the count of transactions per minute or per hour or per day even. Note that “velocity” is different from speed (as in elementary physics). Velocity includes the component of direction, not just speed; so for example, a million transactions that occur only between two accounts contributes less to velocity than transactions that occur between many different accounts.
I am a programmer by trade, and I can go in there and make this modification myself, and come up with a different distribution. If enough people believe that my version is better, then the database of transactions will bifurcate, which is not good. Rather than do that, I have chosen to discuss this matter with the Bitcoin community. Even just two currencies competing at this early stage can be fatal. We have a world to conquer out there, and we don’t want to end up like Unix. Rather, we want to be like the Colorado river, cutting deep into the very foundation of world commerce. However, we want Bitcoin to be successful less by chance like the Colorado, and more by conscious decisions like Microsoft’s Windows OS on the desktop.
Perpetual Cycle of Life 