There has been so much tumult in bitcoin and crypto currencies over the past few days! Interest and concern extends far beyond arcane online communities. Motives vary.
Decentralized and anonymous
There are two conceptual pillars of trust that uphold bitcoin as being superior to fiat currency. The first is decentralization.
The fiat currency of reference is primarily the US dollar, for the time being. Why? Because the $US is the world’s reserve currency, for now. If Germany weren’t part of the EU, if Japan weren’t still in its lost decade and England weren’t so afflicted with problems, the Deutsche mark, Yen or British Pound Sterling would be attractive alternatives to the $US as a fungible, stable store of value. As ideological (not market) confidence in the $US has diminished, the appeal of an apolitical, modern alternative increases. I won’t go off on a tangent as to why a currency printed by the U.S. Treasury in support of the Federal Reserve’s monetary policy isn’t as highly esteemed as it was in the past. Obviously the $US dollar is a highly centralized currency.
The second conceptual pillar of bitcoin is anonymity. US dollars held as cash will be anonymous until one wants to use them for exchange for commercial transactions of size. Bitcoin has some anonymity short comings, too, but there may be tractable remedies.
Centralization of bitcoin
All markets are game theoretic. Bitcoin is more transparently so. I really wish we could ask Professor John Nash what he thinks of bitcoin! Nash actually wrote a pleasant, accessible article about bitcoin-like currencies a few years ago.
I mention game theory because bitcoin’s most acute concern now is loss of decentralization. It is due to the documented, persistent existence of a 51% majority mining pool controlled by gHash.io. gHash is owned and operated by a private entity, cex.io. gHash’s market dominant behavior was noted in March 2014, but the situation was transient, unlike now. Monopolists, and cartels, can assert control as a function of mining power. See How a mining monopoly can attack bitcoin for a chart of strategies that mining pools can pursue as a function of hash power. It was recommended by Ed Felten in his post, Bitcoin mining now dominated by one pool.
Production and transaction costs
In theory, bitcoin is a perfectly smooth, zero transaction cost medium of exchange. (more…)