Saturday, May 3, 2014

A few notes about Bitcoin

I’ve been curious about Bitcoin over the past few months and a couple of these videos have been on my viewing list for a while (Thanks William). I finally got to them. If you have heard of Bitcoin but don’t know how it works, I’d suggest the first video.

The second video is intended to be a crash course in Bitcoin and the notes below are based on what I’ve understood from listening to it. I’m not sure I fully understand this but I do understand Bitcoin and the need for it a lot better than I did before. That’s a start.

I do think Bitcoin can be a great candidate to solve some deep rooted problems. For example, I worked in Argentina for about a month last year on a project and I can speak for the sorts of trouble the common man is in thanks to a disastrous economic system. It’s nice to see Bitcoin being viewed as a potential solution (see below). 

That said, I’ll move on to the notes. I hope it helps whet your interest and give you a background on Bitcoin. Apologies if the notes are sparse/unclear in places.

Why Bitcoin?
Only 1 billion out 7.5 billion people can move money around largely because of politics and government policy.
- Cryptocurrencies have existed since 1980s and all previous versions fell because of one problem - while you can use cryptography to provide ownership, you can't prevent it from being copied. So, you needed a trusted 3rd party that kept track of everything.
- Bitcoin is the first cryptocurrency that is on a distributed system called "blockchain." This has enabled a network of distributed nodes/computers on a network to agree on the current state of the Bitcoin ledger.
- Bitcoin is controlled by everyone participating in the network but not controlled by anyone or any groups of participants.
Financial services that account for 8% of the GDP show that there is something completely screwed up. There is too much inefficiency.
- Payment systems like Visa are a nightmare for merchants. It currently takes a week for a merchant to receive the money. In Bitcoin, transactions are irreversible.
- Bitcoin transactions are location agnostic and have a fixed fee of 0.5 cents irrespective of the amount.
- This is the first time we’ll have a currency driven purely by math and not by politics.

So, how does it work?

- Think of blockchain like Sudoku - it is hard to solve but easy to verify.
- The Bitcoin network achieves consensus every 10 mins on the latest state of the network and reaches a “verified” state. As new blocks are added, it adds security to the existing blocks.
- You'd need to invest 400 million dollars worth of computing power to fool the network for 10 mins.

How did Bitcoin’s creation come about?
- The creation of Bitcoin has been an evolutionary process thanks to governments attacking Peer-2-Peer networks until Bittorrent evolved so much that it became impossible to catch those who torrent.
- So, it is now very easy to create a new cryptocurrency (the cost of conversion from one to the next are very low) to solve a problem that Bitcoin might face. Basically, they are here to stay.

What is all this talk about Bitcoin being deflationary in nature?
- Current rate of Bitcoin inflation is 2%. Demand is increasing much quicker. So, overall, there is a deflationary characteristic and thus, the value of each Bitcoin will grow.
- By 2140, there will be 21 million coins. So, the value has to grow.
We've never had a deflationary currency because of high demand. Normal “fiat” currency (Fiat currency is money derived from government regulation or law) deflates only when demand goes down. It doesn't mean deflation is bad - it is just challenging all our current assumptions.
- It gives rise to the “coffee dynamic” - You don't want to use Bitcoin to buy a cup of coffee because it is a deflationary currency and it'll be worth a lot more in a few years. So, as a merchant, you want to discount the coffee to the point where you hit the sweet spot where I can't not buy. You can infinitely subdivide bitcoin so that’s not a problem. So, we reach a point where you give it for $1 (when you might normally have charged $2) and assume it will grow if you hold on it.

What else should I know about Bitcoin?
- Bitcoin is not the money for the internet. It is the internet of money. It is a platform on which a lot can happen.
- The process of creating Bitcoins or mining is incentivized by a small commission.
- Bitcoin is not anonymous because you can track addresses. However, one person can create multiple addresses. And that's a privacy nightmare and needs to be fixed before it goes mainstream.

What sort of disruption will Bitcoin cause?
Bitcoin will first take out something like western union. Remittances first, international transfer, inter-bank transfers, etc., will follow. Think least efficient to most efficient. Remittances are $115 Billion market with 10-30% percent charged - and it is more expensive the poorer you are.
- Another economy on the cusp is
Argentina. There were recently two 60 year old men who did a big real estate deal via Bitcoin barcodes because all their money is outside the country and this is the simplest way to get the deal done. Argentina is in all sorts of financial nightmares due to capital controls, corrupt government, and a deflationary currency since every Argentinean is trying to swap Peso for USD - if they shut theirs doors next year, Bitcoin will be prime candidate to replace it. It also fits because it is a largely educated market with ubiquitous internet.
- The
Zimbabwean dollar is less valuable than goat shit because it burns longer. So, why not Zimbabwe? That’s because the world is moving up the chain of Electricity -> Internet -> Smartphones while Bitcoin is gradually moving down the chain. For example, Bitcoin transactions can just be done via SMS in places like Kenya.
Expect multiple cryptocurrencies in the future, e.g. Lightcoin, for example, where it is faster.

What sort of risks do we expect?
Regulatory risk is the biggest as the governments are sure to attack it.
- There might be unforeseen bugs.
- It will be h
ugely volatile. So, buckle up.

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