This is my response to Paul Krugman’s recent article on his doubts about cryptocurrency. I am no expert, and I’m sure he will neither read nor respond to my letter. But I’ll share it here as a statement of what I learned when I spent a bit of time looking into this. I recall reading about the creation of Bitcoin in the New Yorker’s excellent original article about it in 2011, and talking about it with friends, and understanding the attraction of the basic concept and the suspicion that it would take off in some way or another at least as a fad. But I had neither the money nor the time to devote attention to it, and so I lost another fortune (so SAD!). Here is that article, and this is what I know now in a nutshell:
Dear Prof. Krugman,
In response to your recent column:
I am likewise skeptical of pop culture fads. I follow your column pretty regularly, and admire your professorial but common-sense commentary on the major issues of the day, and your avoidance of trends and buzzwords. So I see where your skepticism on cryptocurrency comes from, but you have not done your homework here. I’m certain you have enough mathematical background to understand the basic concepts behind blockchains, distributed ledgers, hashes, and other cryptocurrency garbledygook. These words have technical and conceptual meanings. And I am neither a hacker nor a libertarian, and I understand very little about the technical infrastructure of digital currency. But I’ve read a few (read very few) things and listened to the “Hidden Forces” podcast episodes on this topic. And I am convinced cryptocurrency is here to stay, basically for three reasons:
Ethereum Inventor, Vitalik Buterin: These guys are young and they’re nerds, that’s why I believe them
1) Contrary to your understanding, digital currency need not rely on resource-heavy computation any more than any other currency in the world today. Bitcoin was merely an experiment, explained by its anonymous creator as a white paper and released as a free-floating computer program that had its own rules and security built into it. I’m sure it’s fluctuating valuations and actual use in the world mark an experiment far more successful that its author ever imagined. I don’t think Bitcoin is the future of digital currency however, because of the limitations that are built into it. It may retain significant value based largely on its libertarian charisma as “the first one” and because of the genius of its author’s decision to retain anonymity which confers on him a sort of god-like status and dehumanizes his creation in a way that makes it the possession of all who use it, and therein lies its value. So bitcoin may continue to serve as the “gold standard” of digital currencies for that reason, and that lies almost entirely in its prestige value, not its transaction value. Or it may crash and become merely a sort of creation-story. But regardless of its fate, you should understand that its computational burden is arbitrary and is built into the system to avoid certain types of outcomes (e.g. one person owning all of it, or one set of powerful computers hacking the whole thing etc). It has already been hacked in a certain way in that it was “forked” which is to say the blockchain began to develop in two different directions, undermining its original monolithic integrity. I’m not sure how that ends up, other than that continues to be part of the original experiment. Bitcoin could break into a thousand different currencies, and thereby free itself from some of its own burdens (e.g. that only one bitcoin can be created every 10 minutes or so). Or all the Bitcoin in the world could all become owned by a Chinese firm running a bank of supercomputers powered by the Three Gorges Dam. But, the trend in cryptocurrency is to move away from the resource-heavy “proof-of-work” model that Bitcoin uses to legitimate each transaction, and towards another “proof-of-stake” model that has been proven to rival and surpass the transaction cost and speed of the Visa credit card network. Etheryeum (below) and Hedera Hashgraph and others are all moving towards proof-of-stake to make their currencies lightweight utilities for actual transactions. I don’t understand how it works, but see what they are getting at, and I’m inclined to believe that their math adds up.
2) The real potential of cryptocurrency was recognized by some of its early adopters, not merely in the creation of an anonymous form of digital transaction (even though that remains a major value that it can offer) but because it can become a form of “smart money” that can keep track of a much wider variety of transactions that current currencies (based on a mental model of IOU’s that represent some sort of now-gone-but-not-forgotten “tethered” commodity). “Smart money” could keep track of millions of micro-transactions (e.g. you could get paid a fraction of a penny/bitcoin for every piece of data that Google collects from you). This is the insight of Bitcoin’s main rival, Etheryeum which has always built its brandname on the idea that it is really a platform for digitally monetized apps that can keep track of almost any kind of data in a secure decentralized and self-regulating way. Etheryeum’s “coin” then is not so much about its value as a medium of exchange between strangers as its utility in accounting for interactions among the known users of its network. Hedera Hashgraph is marketing itself in much the same terms, and basically saying that they are going to use a different governance model than the libertarian ideals of Etheryeum. Instead of Etheryeum’s process of holding referenda among its users to decide on major technical fixes to things, Hedera Hashgraph will follow Visa’s model and maintain a rotating board of institutional directors who can make important decisions about technical problems. And they can then protect their currency from “forking” because a linked company called Swirlds owns the patent for their system. These systems will inevitably be hackable, but if they have a decent governance system in place, they should be able to fix the damage in a timely way and prevent future hacks of the same type.
3) Given this approach of building a transactional infrastructure based on blockchain/distributed ledger technology (using the lightweight legitimation process known as proof-of-stake), these companies are not necessarily competing to create the next currency so much as to create the next version of the internet. The possibility here is that the internet as we know it will be replaced by an infrastructure that is fundamentally transactional first-and-foremost (rather than a communication infrastructure as is now in place). And whoever provides the infrastructure will be in a very powerful and lucrative position indeed. Open-source decentralized networks like Bitcoin and Etheryeum probably have the ideological high ground here in their attempts to create an infrastructure that can govern itself through the genius of its own programming creators, and their governance will happen in a collective way without the need for a man-behind-the-curtain to reach in and manipulate the machinery from time to time. I’m a little skeptical that this is possible, given the inevitability of various kinds of hacks to the system in people’s maximization instinct. So, I suspect that we’ll have private companies like Swirlds and its board of directors overseeing its Hashgraph infrastructure as the governing bodies of a system that may take the form of probably several competing behemoths who will dominate the landscape. At some point I would suspect governments will stop trying to block this development and will embrace it, and probably take it over for the “good” of their citizens, and it is difficult to say what that will do to the system. China will almost certainly be an early adapter, Singapore is already inviting all of these young inventors for consultations as they try to figure out how to incorporate cryptocurrency into its economic model.
Where this all leads, I’m not quite certain. But we better do our best to understand it. More than likely it leads to a fundamentally new infrastructure for the internet, and the monetization of everything. Whatever it is, I think there is little doubt that these guys are on to something, and sit on the paper currency mountain and scorn cryptocurrency is to sit behind a typewriter and say: why do I need an electronic screen when I can just type directly on a piece of paper?
PS: In addition to the above, if we take the implications my colleague Katie Moore’s work, we find that the core value of any currency in the modern age is that it is accepted as payment for taxes.
This is the underpinning of untethered US Dollar. Because a currency is accepted as taxes it then becomes clear that the currency’s underlying value is not fundamentally economic but political. To participate in a currency regime and pay taxes to the sponsoring government is to be citizen in a society defined by that currency. The US Dollar’s global utility is the sign of American hegemony at this juncture. But what is really innovative about Katie’s work is that it is not just that we participate in a currency regime as citizens, but that a currency regime is generative of a political community because those who participate in it have an interest in maintaining its value and regulating it. We are coming close to a point in digital currency where there are trillions of dollars worth of the currency and millions of users. As Ethereum’s experience has shown that is by nature a political community and becoming a more powerful one everyday. People will fight to defend their wealth, even if it be digitally guaranteed only by esoteric math. This trend is here to stay and it is a powerful one. Unfortunately I own no cryptocurrency and so stand to make no profit here even as a evangelical post like this one can only contribute in its small way to the value of this market. My interests are strictly academic (or should I say platonic?)