First published in The Stanford Daily.
A huge part of the appeal of Bitcoins is its promise of being decentralized yet secured, but what happens when the system requires fundamental adjustments?
In traditional monetary systems, a credible government is necessary to guarantee the value of fiat currency. Across the political spectrum, from the anti-establishment online movements to more traditional libertarians, there are groups of people who believe that the central authority represents a single point of failure in the economy, allowing corrupt or incompetent governments to devalue existing money to the detriment of the people. The dramatic rise in gold value over the past decade can be partly attributed to this desire for a non-inflationary currency. As former Congressman Ron Paul puts it, “Gold is the ultimate money.”
With Bitcoins, we seem to have finally discovered digital gold. Like gold, the supply is finite and not subjected to intentional increases by political entities. The amount of gold is presently limited by the Earth’s composition while the number of Bitcoins is bounded mathematically to 21 million. Therefore Bitcoins and gold are both naturally deflationary – their values tend to increase over time. The inventor of Bitcoin even used the term “mining” to describe the process in which new coins are computed. Unlike gold, Bitcoin is vastly more functional as a currency. The peer-to-peer network handling Bitcoin transactions allows fast, pseudonymous, and cryptographically verified payments all without the involvement of any monetary authorities. Bitcoins do not require trust in traditional institutions, but merely trust in the open source mathematical algorithms.
So is this the freedom that cyberlibertarians have long fantasized about? If we are merely talking about freedom from governmental control, then the answer is yes, eventually. While governments presently exert control over Bitcoins by targeting exchanges and physical infrastructures that power Bitcoins, these leverages diminish over time as the economy becomes more self-contained. If people outgrow the constant need to convert BTC into USD and anonymization of Bitcoin transactions become routine, then it seems inevitable that monitoring financial transactions will become increasingly impractical for governments. Forget fiscal policies and taxation – the government needs to first prove that your wealth exists. That may well be the libertarian idea of paradise.
But is that really freedom? Or are we are simply the subjects of a new, subtler master? Instead of a flawed but democratic government, we place our economy in the trust of an algorithm from an anonymous creator – the same individual whom some believe owns 4.7% of all Bitcoins that will ever exist.
In the peer-to-peer transaction network, the rules of Bitcoin are enforced purely by majority consensus of the nodes. No one has any real idea what the hard limit and the designed deflation would mean for a significantly sized economy, or how the extreme inequality in accumulated Bitcoin wealth would serve to influence and perhaps distort society, especially since these pockets of wealth can never be overcome due to the hard cap. Within the Bitcoin community, the canned response to questions about the hard limit is that each Bitcoin is divisible down to 8 decimal places and therefore there will be more than enough units of currency to go around. The fallacy in this line of thinking is obvious when we look at legacy problems such as the exhaustion of IPv4 addresses.
A separate but related problem is that of lost Bitcoins. Due to encryption, it is not hard for individuals to irreversibly lose access to their coins by accident. There are many precautions one can take in backing up encryption keys, but humans errors will always exist. Since the encryption used to protect the wallet is impervious to cracking (or there would be far greater problems at hand), these coins are lost forever. Therefore, the final number of Bitcoins is not just capped at 21 million but ever decreasing, placing yet another limit on the flexibility of Bitcoin as a global currency.
If Bitcoin truly intends to go mainstream, it must look to address these issues in the long term. However, the decentralized design makes it nigh impossible for anyone to make adjustments to the underlying system. Yet if Bitcoin is to become more than just a temporary asset bubble, there are numerous conceivable systemic changes that may be required as scalability limits of the system are tested by growing demands. For such changes to be successfully implemented, some form of committee or central authority must emerge to fulfil that role.
There have been limited attempts at this in the form of Bitcoin Improvement Proposals (BIP). Suggested changes to the network are put into mining clients as BIPs, allowing individual miners to vote in favour of or against the proposal as part of the mining process. The problem with BIPs is that they are never adopted in practice because any protocol change requires more than 51% of the miners in the network to vote positively as a technical and not merely procedural necessity. Think about how hard it is to get bills passed in Congress and combine that with the low voting turnout of most modern democracies. That is no way to run an economy.
If it proves to be technically infeasible for a credible and potent Bitcoin authority to emerge, then investors and their wealth may ultimately be locked into the unchanging algorithm. Let us hope that Satoshi Nakamoto, unlike the creators of the Internet Protocol, got it right the first time.