Bitcoin controversies

At the time of this writing [2014-07-01], Bitcoin is about 5 years old and seems to have overcome the worst (and most ignorant) of public controversies. I believe it is steadily on its way to mainstream adoption, even if I do not expect it to replace national currencies completely.

I could write dozens of essays on the technology and its societal and economic implications, but things are still moving too fast for me to do that; I am too busy discussing on forums, and even writing some code now and then. In the meantime, to keep up the spirit of /rants/, I would like to collect some of the common attacks and misconceptions from over the years. Some of these points are still unfortunately alive, as they reflect more general misunderstandings of the economy.

Bitcoin is a Ponzi/pyramid scheme

There are two separate aspects of this accusation.

First mover advantage

As Bitcoin adoption increases, the fiat price of 1 BTC rises due to the basic laws of supply and demand. When a later adopter buys BTC from an early one, money is transferred in a same way as in a pyramid scheme.

However, this is no different from any growing technology. Consider the stock price of any succesful business, such as Apple or Microsoft. If you bought them early and sold them later, you are exploiting the same idea. Most people miss these opportunities, yet few are complaining that the system is somehow unfair. Being an early adopter incurs a risk of time and/or money.

Interestingly, stock price has no direct connection to the working of a business. When people trade stocks, the money does not go into running or developing the business (unless it is a public offering). Owning shares does have long-term benefits, so they have a price in a free market, which generally reflects the perceived value of the business to some extent. Nevertheless, many people would agree that the stock market has become another scheme of shuffling money around with little real-world meaning. So even though I find this analogy both valid and helpful, it is not exactly flattering.

As for business analogies, some people are confused because Bitcoin is not a well-defined corporation. It is a distributed network, an Open Source / Free Software project at its finest. To elaborate on this further is a whole other topic, but suffice to say, if you use the Internet, you are already using many distributed open-source technologies.

No wealth creation

In a pyramid scheme, all returns come solely and directly from the later investors. In other words, the pyramid itself is not doing anything useful; some investors are simply giving money to others. On the other hand, Bitcoin is a technology with specific uses, whether or not any fiat money is involved — more on that next.

Bitcoins are like tulips

If you can use tulips to send money across the world in 10 minutes, from anyone to anyone with Internet access (i.e. independent of banks, governments etc.), then we can discuss this comparison further.

In other words, Bitcoins are not just fancy collectibles. Bitcoin is a valuable technology that solves problems in the real world. It does not need any fiat-currency price to validate its technical and societal worth. Of course, due to the free market and the interconnectedness of everything in the modern world, 1 BTC has ended up with a fiat price.

As the fiat price is currently on the rise (and true mass adoption is yet to come), the present situation is admittedly a little weird: Bitcoin is both a currency and an investment. I think a lot of the confusion comes from not seeing which side of Bitcoin is being discussed.

It does not have to be both, though. We could easily set up a Bitcoin-like network to transfer fiat currencies, if so desired and approved. (Also, besides the many alternative cryptocurrencies (altcoins), the blockchain technology is not limited to payments.)

On a further note, why should a currency not also be an investment? The dichotomy only applies to our inflationary, debt-based currency, which creates a wealth (pun intended) of auxiliary problems in the real world; a topic for another discussion...

Bitcoins are illegal / only useful for illegal purposes

By feature of being relatively anonymous and independent of third parties, Bitcoin is the closest digital equivalent of cash. Should we ban cash because it is used for things that may or may not be legal in some jurisdictions?

(Bitcoin is not strictly anonymous, but in practice it is immensely more anonymous than credit cards or bank transfers, for example. Bitcoins can be traced roughly in the same way as banknotes with their serial numbers; possible, but rarely done in practice due to the necessary work. For those who desire stronger anonymity, there are altcoins such as Boolberry, Darkcoin and Monero.)

Price crashes

Traditional media likes to portray unconventional technologies in a negative light, or at least in a sensational manner. News on Bitcoin are often implying not to invest in it, because its price keeps crashing. Now, if something keeps crashing repeatedly, surely it must go upwards in between?

Given such data, I am looking forward to the next crash. It should be in the thousands by then :D

One basic error, of course, is not seeing the big picture. Nothing grows monotonically in value, there are always slight nudges up and down. The media (and consequently those who follow it) seems to work in a timeframe of at most weeks, and the overall growth of Bitcoin is rarely reported.

Moreover, the pessimistic nature of media giants is also clear here. The pre-crash highs are rarely mentioned, and if they are, they are invariably termed "bubbles". This is probably correct to some extent — these events are the growing pains of a new paradigm in an old world, and there is always some unsubstantiated hype involved.

However, a more subtle aspect of these three bubbles/crashes becomes apparent when considering exponential growth — which again most people fail to understand, especially given the long timeframes required. But in the shortest term, it is simply about growth with a fixed percentage. With most real-world numbers, relative or percentage changes are much more meaningful than absolute ones.

It turns out that each of the above crashes has been more benign than the previous one, in relative terms. The first one from $32 to $2, a factor of 16; the latest one from $1000 to $500, a factor of 2. While this is still pretty bad for a steady currency, the development shows that the Bitcoin economy is stabilizing. There is overall growth in both the number of users and volume, so each freak effect has less and less chance of rocking the boat.

[2018-02-10] It took a while, but it seems we've finally experienced the next crash, to thousands as I expected. Price has come down from the 5-figure end-of-year highs, and it has stayed around 7k EUR for the year so far.

Proof of Stake == Rich get Richer

[2021-06-20] as commented on LWN and Slashdot

Proof of Stake, as originally implemented in Peercoin in 2012, does not make the rich richer any more than savings accounts at banks do. Everyone gets the same percentage rewards. One might argue that the rich get richer in absolute terms, but the inflation eats up that difference exactly.

Later cryptocurrencies have bastardized this idea by setting arbitratry thresholds for the PoS rewards. For example, with Ethereum you will need a minimum of 32 ETH to get staking rewards.

In general, it is hard to avoid the idea that the rich get richer, because the rich will always have more options for investment. However, the original PoS idea is a level playing field where anyone can start investing and staking.

Original cryptocurrencies were all about decentralization. The newer "masternode" concepts with staking thresholds are a direct attack against this ideal. The staking nodes are what validates transactions for all users; should the network be controlled by select few rich individuals?

Bootstrapping PoS

Another concern with Proof of Stake is initial distribution. Peercoin solved this with a mixed PoW/PoS system, so that Proof of Work could be used for a fair distribution. The PoW rewards declined quite rapidly over time, so that the network would favour the more energy-efficient PoS in the long run. Some other currencies such as Zano have also adopted a similar mixed scheme.

Pure PoS currencies may operate like an IPO, in that all coins to be used must be bought from a parent company. To me, this sounds like a get-rich scheme for the company owners, and goes against the decentralized, fight-the-man ideals of cryptocurrencies. But it is no worse than traditional IPOs and the stock market.

Risto A. Paju