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I am Joannes Vermorel, founder at Lokad. I am also an engineer from the Corps des Mines who initially graduated from the ENS.

I have been passionate about computer science, software matters and data mining for almost two decades. (RSS - ATOM)

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Entries in bitcoin (6)

Wednesday
Aug032011

Bitcoin, thoughts on a nascent currency system

Bitcoin is a fascinating concept, in short, it's a crypto-currency backed by nothing other than raw processing power and geeky enthusiasm. For those who've never heard of it, you can have a look at the introduction provided by the Bitcoin community itself or by The Economist.

This currency seems to trigger a much positive reactions than skeptical ones. My personal stance is very inclined in favor of Bitcoin, and I have invested a conservative amount of Euros in exchange of Bitcoins. Granted, nothing that would too troublesome even considering a 100% loss of value for those Bitcoins.

A lot have been said already about Bitcoin, so I will not go through the routine discussion of pros and cons, but merely make some observations.

Bitcoin vs Credit Cards and Classical Banking, the long term value

A good deal of interest in Bitcoin is strictly speculative: people go for Bitcoin thinking they have a good chance of cashing out. Yet, when it comes to evaluate the value of venture of any kind, I am a strong believer of the Guy Kawasaki credo: does it make sense? Is the world a better place with Bitcoin than without? Indeed, making a speculative profit is not enough, Bitcoin has to improve the world in some tangible ways.

Here I believe that Bitcoin addresses a very deep problem: how to pay or receive money without involving either an expensive physical process (meeting and exchanging gold, goods, ...) or an expensive middleman (your bank, your credit card operator, PayPal, ...).

To a web entrepreneur, the current banking system looks like a 19th century legacy setup:

  • About 4% (1) of my money gets consumed through system friction.
  • It takes days (2) to complete anything that does not go through credit cards. 

(1) Indeed, there are many costs that pills up (rough estimates):

  • 0.5%, fees of the consumer bank account (explicit or not), 
  • 1%, fees of the credit card owned by the consumer, 
  • 2%, merchant fees for any online payment, 
  • 0.5%, fees of the merchant for its own bank account.

(2) International wire transfers with a bank routing in the middle where a 7 to 10 days delay is pretty much the standard.

And yet, in my experience there is not so much to be done about this friction, at least not if you're just Joe the Plumber or a small business. Marginally lowering those costs through negotiations with the bank is possible if you have leverage (that is to say money) and a lot of patience; but there is so much one side can do because both sides (payer and receiver) are paying fees anyway.

The long-term promise of Bitcoin is to bring down this 4% friction to 0.1% or less, and to reduce payment latency from days to minutes, possibly seconds with a healthy competitive ecosystem of trusted 3rd parties. Indeed, Bitcoin is not natively designed for low latency transactions, but Bitcoin can be complemented by low latency services (backed by Bitcoin) if the need arises.

Anecdotal evidence: When I purchased Bitcoins on MtGox a few days ago, the sole wire transfer from France to UK cost me about 4% (EUR to GPB conversion included), plus the transfer took 8 days, because the receiving bank in the UK had a multi-day downtime of one of their system.

Weaknesses of Bitcoin

When it comes to assessing the weaknesses of Bitcoin, most people discuss the possibility of breaking the underlying cryptography, or swarming the network with some overwhelming computing power. Yet, Bitcoin has been designed to be natively resilient against this sort of attacks, and very capable people are working hard to make Bitcoin even more resilient. Hence, I am not too worried here: the Bitcoin community is now big enough to make those sort of attacks really complicated.

Anecdotal evidence: I have tried to mine about 0.01 BTC through Deepbit.net and on my GPU enabled laptop it was taking about 30h. Naturally, I gave up before the end of the experiment, as it was pointless to waste further electricity. Bitcoin mining has reached the state of being vastly unprofitable for everyone but the experts, which is good. It means Bitcoin had reached the point of diminishing returns where printing money (aka mining) is only very marginally profitable.

The most critical threat for Bitcoin is something simpler and stronger: a potential fade of interest, which may vastly hinder the tooling ecosystem to mature. Fade of interest would not annihilate Bitcoin, but it would make it stagnant. Then, in the innovation trade, being stagnant is the closest thing to being dead.

For the short term (next few months), my No1 concern is that a tiny few individuals such as the enigmatic Satoshi Nakamoto may possess +100k BTC (or this guy with 370k BTC). And no, the problem is not that the system is unfair - being unfair does not hinder economical success, quite the opposite actually. The problem is that each one of those individuals has the power to disrupt the emerging usage of Bitcoin. As a matter of fact, the first Bitcoin market crash was not the result of a weakness within the protocol, but the result of a not-fully-secured wallet within a trading system. A lot of early adopters are moving around with thousands of BTC, and each one of those, willingly or not, may disrupt the Bitcoin trading by simply getting their wallet stolen. A similar analysis goes for all the emerging companies supporting the Bitcoin economy that are really lacking the expertise needed to operate properly (ex: the now infamous MyBitcoin.com downtime fiasco). Those bumps are not for the faint hearted, and are likely to slow down the Bitcoin adoption. As time goes, this sort of problem will fade through survival of the fittest, but a couple of Bitcoin crashes should be expected.

For the mid-term (6 months ahead to 2 years), the most difficult operation will be to transition the Bitcoin community from mining stage to trading stage, then repeat the process again from trading stage to end-user stage (see below, for the detail of the phases) - and do those transitions without loosing commitment and enthusiasm of the people who contribute the most to the Bitcoin community. Basically, as long there are smart people enthusiastic about Bitcoin, Bitcoin will keep growing; but the attention sharing economy is a harsh mistress, and the community interest might jump to the next revolutionary idea just as well. See the law of conservation of hype as a practical illustration. Bitcoin has successfully attracted a horde of miners. Now this horde needs to involve into the next stage, as mining earnings are marginalized.

For the long term (2 years), assuming Bitcoin interest has not faded already, direct Government interventions - for whatever reasons (*) - may kill the community. Outlawing Bitcoin would be hard to enforce to its fullest extent, at least if Internet still exists, but flagship companies supporting Bitcoin are easy targets. It would also be easy to spot any company publicly accepting Bitcoin as payment method. Again, the problem is not Bitcoin annihilation - which seems a remote possibility - but rather Bitcoin undergoing a fade of interest if its community has to go underground.

(*) Until 1996, all encryption methods were banned in France, classified a warfare materials. As a result, encryption usage was close to inexistent despite obvious benefits.

Assessing a global value for Bitcoin

Many people looking at Bitcoin make the naïve assumption that BTC mined X USD per BTC gives any reasonable assumption of the overall market value of Bitcoin. This approach is misleading. First, we don't know for sure how many BTC have been lost already. Super early users were not really treating BTC as a real currency, and it took more than 2 years for Bitcoin to take off. I suspect that many early casual miners have not properly preserved their wallet. This could account for 1M or 2M BTC being lost already (warning: this number is vastly unverifiable).

Second, those who've read Making Money  - which I strongly recommend - know that the real long-term backing of any currency is the people behind it, possibly as unwilling taxpayers (but I am digressing). Granted, Bitcoin has no magical Golems backing the protocol, but they have about the next best thing: a enthusiastic, dispersed and growing community of geeks working hard to make of Bitcoin a success.

It's not uncommon to see startups with technically sound technologies valued at roughly $1M / employee (just an order of magnitude, YMMV) for no other reason than tapping into a pool of recognized talents, even if the IP asset itself isn't that valuable. A quick tour on the Bitcoin forums indicates that there are more than 700 people with more than 100 posts on the forum. Granted, all of those are not working full time on making of Bitcoin a success, and all of those people are not talents either, but considering that this forum does not reflect the entire community either, it gives a rough order of magnitude of the number of people significantly involved.

Then, with companies such as Ruxum entering the Bitcoin arena, that's very strong expertise, not mentioning fundraising potential, that is converging to Bitcoin. I expect those sort of companies to bring the Bitcoin ecosystem to its next stage of maturity.

Maturity stages of Bitcoin

Bitcoin is fundamentally a protocol. Its usefulness, and ultimately its economical value, is extremely dependant from the tooling ecosystem made available to the community to operate a Bitcoin powered economy. Telling the future of Bitcoin can only be wild guesses at best, but I will try to describe some development stages that represent significant milestones for the Bitcoin ecosystem.

Bitcoin v0.0 - Mining tools (done)

By design, the first milestone for Bitcoin was to develop a strong mining community. Indeed, the larger the mining community, the stronger the P2P protocol against external aggressions. I believe that Bitcoin has reached a point where brute-force attacks are unlikely to succeed, even if botnets are put to the task. As Bitcoin mining operations have now become extremely greedy in term of computing power (which is a good thing), the mining phase is basically over: no need to worry about mining Bitcoin anymore, mining is taken care of.

Bitcoin v1.0 - Trading tools (in progress)

For the years to come, Bitcoin will have to closely operate alongside fiat currencies. Hence, the need for trading platforms that let people convert BTC into fiat currencies (and vice-versa) will be an ongoing need. The current Bitcoin community is still relying too much on MtGox; the later still being a relatively early stage bunch of scripts. Serious contenders, such a Ruxum, are entering the market, but it will take more companies to consolidate the Bitcoin trading market. Also, classical credit card operators (Visa, MasterCard) are very reluctant in letting anyone operate a bridge from Bitcoin to their system (which is a very reasonable oligopol behavior). Making the purchase of Bitcoins as easy as purchasing a book on Amazon will be the major milestone for the Bitcoin community v1.0.

Bitcoin v2.0 - End-user tools

Securing Bitcoins is still complicated and geeky. In short, if your computer is hacked, then Bitcoins sitting on your computer are at risk. For the time being, make sure to setup an offline wallet. This aspect is a big hindrance for a widespread adoption of Bitcoin. Services such as Bitbills.com, that let people print their Bitcoins, is the first generation of user friendly setups, at least as far long-term Bitcoin preservation is concerned. Yet, Bitcoin needs a lot more than that. On the software side, it needs bare-naked OS distributions designed for the sole purpose of securely running the Bitcoin client (with PCs under $250, having a dedicated machine is not that much a problem). Then, on the hardware side, the IT ecosystem is still lacking an extremely durable storage. As low tech as it sounds, printing Bitcoins (aka the Bitbills approach) is still only serious multi-decade persistence method available. Letting the masses operate Bitcoins as easily as they operate their mobile phones is the v2.0 milestone.

Bitcoin v3.0 - Merchant tools

If Bitcoin gets adopted by a sufficiently large amount of people, then it will start getting the interest of retail folks. There are already a few eCommerce out there supporting Bitcoin, but it's still very niche. The design of Bitcoin offers unprecedented opportunities to support micropayments that were simply not tractable with classical systems. Indeed, anything below $20 is considered as a micropayment by Visa, and there is no widespread electronic solution out there for payments below $1. In comparison, Bitcoin would easily scale down to $0.01 payments (or rather the equivalent amount in BTC) with only a marginal friction. Yet, in order to grab those opportunities, it will take some serious Bitcoin-powered merchant systems, as complete automation is required. Offering to any (non-geek) merchant all the tools he/she needs to receive and process Bitcoin payments is the v3.0 milestone.

Bitcoin v4.0 - Enterprise tools

No matter the success of Bitcoin, large companies will probably be among the latest entrants in the Bitcoin economy. In order to make Bitcoin useable in corporate environments, it will require a lot of support from the software industry. For example, there is nothing yet in the Bitcoin software ecosystem that would enable an enterprise to grant rights to people to operate within spending quota, possibly requesting multiple approvals if a spending goes over a certain threshold. Naturally, the same Bitcoin system would also need to be seamlessly integrated into the primary accounting system in order not to drive nut both accountants and auditors. Getting Bitcoin corporate-proof is the v4.0 milestone.

So what next?

Bitcoin is still in the middle of trading stage but, for those who are inclined in giving Bitcoin a chance to establish a very low-friction currency system, the most simple contribution is not to purchase Bitcoins, but simply to start accepting Bitcoin, which is exactly what my company, Lokad.com, started doing.

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