Welcome to the CoinDesk Weekly Review 25th October 2013 – a regular look at the hottest, most controversial and thought-provoking events in the world of digital currency through the eyes of skepticism and wonder. Your host … John Law.
The price of fame
There are many possible reasons why bitcoin's value has surged over the past week – China taking it seriously, the robust way it shrugged off the Silk Road shut-down, ever more bullish talking from venture capitalists and fund owners. (John Law covered most of those last week, so the real reason is probably investors hanging on his every word.)
Yet the price hike, whether it's just a spike or part of an unstoppable upward trend, is not particularly good news for bitcoin.
It is for those who have lots of bitcoins sitting around, of course; who doesn't like to see investments appreciate at breakneck speed?
But bitcoin's ultimate success cannot be as an investment vehicle. The world has infinite numbers of those: it doesn't have a serious independent way to move value across the Internet for ordinary people, which is where bitcoin's true potential lies.
There are two big drawbacks to a high price. The first is mostly an annoyance: nearly everyone selling goods or services via bitcoin also sells them in another, far more stable currency, and the bitcoin value of a transaction will be set at the time of the deal by converting the price in that currency to bitcoin.
Once the dosh is in the other chap's wallet, of course, they then have to deal with the volatility – you may only have one or two BTC in your spending wallet, but a vendor who's doing any appreciable business will soon accumulate a pile of the things which still have no particularly big market in goods or services that businesses themselves need.
Not a problem while the price is going up, but most businesses don't like having substantial holdings in a volatile commodity.
A bigger problem is the liquidity of the cryptocurrency. While you can easily spend tiny fractions of a bitcoin – 0.00005430 BTC is the limit, or around 1.1 cents at the moment, many people who want to sell bitcoin as bitcoin expect to deal in integers.
The number of normal people who want to drop $200 on an experiment – for that's what BTC is at the moment – is small. It feels a big number. It is a big number. It's a substantial barrier, perceived or actual, to mass participation.
This sort of problem is frequently encountered in equities, where a company's stock price builds and builds, hindering trades.
It's also the reason that most real-world currencies have a base value that's quite small: a dollar, a pound, a euro are basically just enough to buy a bar of chocolate. And while many currencies' base unit is much smaller than that – a yen is closer to a penny – there's not much that's more expensive than the pound sterling.
What happens when things get out of hand is a revaluation, or in the case of companies, a stock split. You have one $500 share; it gets exchanged for ten $50 shares – although this is less common in markets dominated by institutional investors, as today.
Currency revaluations have a lot more implications, but the principle is the same – if your base unit has become nearly worthless, you chop some zeros off the end or create a new one with a fixed (and very temporary) exchange rate to the old.
Bitcoin will have to do the same at some point if it is to fulfil its potential – a situation made more pressing by the very limited number of total BTC that can be created.
The alternative, and one that John Law suspects will be more likely, is that a new BTC-like cryptocurrency with a great deal more liquidity baked in will catch fire.
The most intriguing manifestation of this idea will be if the new system is publicly backed by a large organisation or group, whether that's trade, government or financial in nature. That could be a trading bloc, an ad-hoc coalition of mobile technology companies, even someone like Amazon – or its Chinese equivalent.
This could happen out of the blue, although it's more likely once BTC itself has got a longer track record, survived a few more fight-backs from the old order, and become more important.
Bitcoin may be a digital currency, but it for one could do with fewer zeros.
Monsters from the scrypt
Of course, there are already many other cryptocurrencies out there in contention for the 'better than bitcoin' crown. They all face substantial challenges: getting noticed, getting traded and getting mined.
The mining aspect is getting some attention. Too easy, and you get dramatic inflation. Too hard, and nobody gets to play: the idea of matching the amount of work to do to the number of miners worked well for bitcoin, ensuring that there was a large supply of cheap coins at the time things got serious, but preventing a sudden surge once the market was established.
You can only do that sort of soft start while nobody's looking, though: now, everyone's looking and the dangers of an immediate arms race are high.
That may already be happening with scrypt, an alternative proof-of-work algorithm used by altcoins such as litecoin, which is experimenting with the idea of having much larger numbers of coins potentially in circulation.
There are already companies in the ASIC/custom miner market, which means that you're not going to get much joy running software on your PC. You'll have to invest in hardware, and that's going to be a gamble if you're mining an un-established currency with little exchange potential and a sliding price.
There are also questions about power efficiency – spending tons of real-world currency on electricity when you could just buy BTC and have done is a hard course to justify – and whether the algorithm scales well with more powerful hardware.
What's needed, and what John law has not yet seen, is a decent way to model all these factors. That in itself is a complex task, as it would have to include population sizes, power pricing, the unneduate economic environment, the technical attributes of algorithms, chip creation and manufacturing costs and long-term market factors.
That is what modelling experts call one hell of an equation to optimise, and probably one that isn't amenable to cleverness. Brute force, and lots of it, will be needed to go through various combinations of all those variables.
The good news is that there are ways to do this. The bad news is that they're expensive.
This may be another pointer to the idea that the next big cryptocurrency will come from somewhere with a lot of resources – something which will also help sort out the other problems of getting known and getting exchanged.
It may be more sensible to skip the initial private mining and create a large pool of the cryptocurrency in secret and then distribute it, thus emulating bitcoin's own semi-stealth years.
After all, not that much of the world's gold comes from whiskery individuals up to their bony knees in mountain streams these days, even if they were first to the scene.
Bitcoin's role for our new robot overlords
Take a look at this short video with Richard Brown on Finextra. He's an executive architect – whatever that may be – for IBM in matters of finance and markets. He's also, John Law is pleased to note, one of the few people thinking ahead about cryptocurrencies, and is quite the fan to boot.
One of the ideas he floated in the interview was seeing bitcoin as a global asset tracking system.
A bitcoin may be worth so many hundred dollars in general, but there's nothing stopping a company saying that a particular bitcoin also represents something entirely different: the example he gave was it might be a hundred shares in a company.
Because any bitcoin can be followed through the system forever and can't be forged, that company could just say that 'whoever has this bitcoin on the day the dividend is paid, gets it', which would change the entire infrastructure of share ownership, and potentially uproot the stock markets altogether.
And it may be something that escapes the current universal fact about assets that they must be owned by someone or a corporation.
Brown brought up the idea that it may be a very good fit to the 'internet of things', the idea that all our stuff will be connected to the Internet and talk to each other.
A classic – and easy to understand – case is smart meters, which can already report back on usage to a central billing agency, as well as find out when cheap rates are available and switch on heating, washing machines or other large loads.
But if the fridge and the washing machine and the central heating have their own stash of bitcoins, they can not only find out when the best source or time for electricity is, they can negotiate between themselves who gets the power when, for maximum efficiency, and swap money between themselves.
A vending machine, John Law supposes, wouldn't have to report back to its owners when its coin box is full or it has run out of Coke; it could directly order and pay for a refill from whichever warehouse is offering the best price, and pass on the profit directly to its owners – who'll end up having to do far less work.
You can't do that efficiently with card-based systems: it's a no-brainer with cryptocurrencies.
It is hard to see where this sort of thinking might end. With more and more of the daily financial underpinning of a technologically advanced industrial society taken out of the hands of people and handed over to the robots, the role of mere humans becomes increasingly unclear –something that may already be happening on the original Internet, with things like Google News replacing a whole raft of what newspapers used to do and Amazon nipping at the heels of retailers.
Dust off those Golden Age science fiction stories, people. Utopian leisure or dystopian wretchedness awaits.
John Law is an 18th century Scottish entrepreneur, financial engineer and gambler. Having reformed the French economy, invented paper currency, state banks, the Mississippi Bubble and other ideas essential to modern economics, he took three hundred years off in a small cottage outside Bude. He has returned to write for CoinDesk on the foibles of digital currency.
The leader in news and information on cryptocurrency, digital assets and the future of money, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.