Bitcoin: Cryptoeconomics and the Future of the Internet

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Cryptoeconomics: The combination of cryptography and economics to create robust decentralized peer to peer networks. Cryptography is used to prove things that happened in the past, and economic incentives are used to encourage desired properties to hold into the future – Jacob Horne

On the 22nd of May 2001, Laszlo Hanyecz famously made the first real-world Bitcoin transaction; buying two pizzas in Jacksonville USA for the sum of 10,000 Bitcoin (BTC). In July of that year the price of BTC rose an incredible 900% within the space of 5 days, going from $0.008 to $0.08. Fast-forward to April 2017, and the price had breached $1,200. Through the course of that year the price would reach almost $20,000 and interest in the first cryptocurrency reached fever pitch, with everyone from hairdressers, co-workers, Uber drivers and relatives waxing lyrical about the future of money and their ticket to riches.

By March 2018 the price had collapsed to around $6,000 from its earlier highs, and interest had cooled to sub-zero temperatures again – except in the fervent “crypto” community which is most vocal on forums like Reddit, messaging services like Telegram and “Crypto Twitter”.

The bubble had popped and the masses returned their money to stock portfolios, housing bonds and perhaps even the casino. Yet listen to any of the prominent voices within the cryptocurrency space and you get a distinct sense of optimism and an almost evangelical conviction that what Bitcoin represents is more than just a speculative curiosity akin to the oft-cited Tulip Mania or Tech Bubble of the early 2000s. That optimism runs from blockchain and the technologies underpinning it being the building blocks of a new and better version of the internet, to Bitcoin itself (or its offspring) fundamentally upending global finance. Why this optimism and what exactly does it mean to talk of the “future internet”?

Pierre Rochard, a software engineer with an accounting background and a vocal proponent of Bitcoin (he calls himself a “Bitcoin maximalist”), is a respected commentator on Twitter and co-founded the Satoshi Nakamoto Institute with his collaborator Michael Goldstein, to educate the public on the technology and economics of Bitcoin. His interest was initially piqued via monetary policy & economics – in particular, the Austrian School of economic thought, which is characterised by a focus on sound money. He suggests there is “no sounder money than Bitcoin because it’s capped at 21 million Bitcoins”. This refers to the fact that only 21 million BTC will ever exist once the last one has been mined.

His suggestion is that Bitcoin is inherently deflationary and thus is a way to combat current monetary policy which engenders inflation that eats away at people’s savings, forcing them to risk their money in the market just to keep pace with inflation. “Inflation tax is when someone is inflating the money in a direction which they desire” he says and the lack of transparency and accountability (as well as honesty about the process) disturbs him, and this is one of the key reasons he feels BTC represents a much sounder monetary policy.

 

 

The current systems based on fractional reserve lending, which is what allows banks to create money, is also “inherently unstable and prone to bank runs” in his view, as we’ve observed repeatedly over the last few decades. Systems built around BTC on the other hand appear also to solve this problem as they are essentially 100% reserve and immune to the bank run phenomenon currently plaguing the banking system. It’s perhaps no coincidence that the whitepaper which formed the basis of BTC was published in the aftermath of the financial crisis of 2008, and a societal mistrust of financial institutions is an important factor driving the growth and adoption of cryptocurrency.

Farzam Eshani is an entrepreneur and both ex-chair of the South African Blockchain Consortium (which he founded) as well as ex-Blockchain Lead at RMB & First Rand Group. He further develops some of the aforementioned ideas by suggesting that up until now, we’ve relied on central trusted institutions and authorities to maintain the ledgers which govern how much money we lay claim to, who has paid us and who we ourselves have paid. He posits that “for the first time in history we can now have a ledger which doesn’t require a central institution” and that we’re able to transact between ourselves – even across borders “without trusted intermediaries at a fraction of the current cost, and in a fraction of the time”. Pierre agrees, noting that the underlying technology “removes the need for central authority”.

The economics and technology are inextricably linked, and more generally the technologies underpinning BTC and its progeny also represent a critical milestone in the digital age – by solving an important problem. Copying digital media is a trivial thing to do – be it a song, movie or document. With the inception of these technologies, we’ve had the introduction of true “digital scarcity” according to Farzam. The idea of true digital money was previously hamstrung because you could literally copy & paste the digital asset you were transferring to one person and transfer it to someone else. Blockchains solve this “double spending problem” as Pierre calls it, which is what drives the ability for digital money without central governing institutions to come to fruition.

The implications of this are also what underpins the excitement around what many hope is the new internet. Not only is money something which can be governed and controlled with these technologies – but any other asset or information which can be represented by these self-same digital “tokens”. What does this mean? It’s possible you’ve already heard of the various projects underway to use these technologies to either augment or replace everything from title deeds offices to birth certificate issuance – again cutting out the need for middleman institutions, without sacrificing security or permanence.

What if however, you were a business start-up and looking to license server space, but didn’t want to deal with Google? Or maybe you wanted cloud computing services but didn’t want to contract with Amazon AWS or Microsoft? How about an individual looking to connect to the internet without using one of the major service providers in their region for whatever reason? Or indeed a photographer or musician looking to globally license their creative work? The technologies in question, of which Bitcoin is a proof of concept, are aiming to underpin services which would potentially allow exactly all of the above in ways which are completely decentralised (i.e. not dependant on trusted single institutions but run by those with resources to dedicate to these networks – at a nominal usage fee).

 

 

This is the fabled future internet which many are hoping will come to pass, although we are still in the infancy of what is possible. Farzam tells a story of a friend of his to illustrate the point. This friend likes to say, “an email in 1992 took him 26 minutes to send after writing it – whereas today it happens almost instantaneously.” It’s fair to say in the mid-nineties “it would have been rational just to stop by the post office while running errands, buy an envelope, seal & stamp it and send the letter” because this would take barely 5 minutes. Today similar sentiments prevail in judgements of the blockchain & cryptocurrency. “We’ve only had this technology for a decade” Farzam notes, while the internet itself “dates back to 1969”. He closes by saying “Evaluating a decade old technology on its performance today is like evaluating the value a child will give to the world based on their 2-month-old cries.”

Trust had been a core tenet of the early internet, having primarily been used then by universities and researchers – with that trust subsequently being transferred to intermediary institutions like social networks and internet companies. Yet recently through centralisation and collection of our data, we’ve seen the potential for manipulation and uncompensated monetisation – for example in the case of Facebook’s recent travails. Similarly, the large financial institutions trusted for generations with people’s economic well-being are experiencing a grave public trust deficit. Cryptocurrencies and their attendant blockchain technologies are looking to redress these through ambitious and far-reaching plans for reworking all from the building blocks of the internet to the very monetary system itself. Whether anything will come from these experiments only time will tell, what is clear though is that the implications of their success are much more far-reaching than the speculative-mania which many have associated with them.

Siya Gule
@Siya_Gule
www.siyagule.com

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