We all know about Bitcoin: It’s that electronic currency that exists somewhere in the ether and can be used to buy illicit products on the Internet. And it isn’t backed by hard assets (such as gold specie) or a sovereign nation. And to create new Bitcoins you must “mine” them, which means solving complex mathematical problems to demonstrate you put x number of computer hours into the process.
Or something like that. Actually—let’s come clean here. Very few of us know anything about Bitcoin, or any of the other “cryptocurrencies” such as Ripple and Ethereum that are now traded in the digital realm.
But Kieren James-Lubin is one of the few people deeply versed in this most arcane of financial arcana. The UC Berkeley mathematics graduate student has established himself as an authority in the field: He’s the director of the Cryptocurrency Research Group and a designated editor for a pending journal on cryptocurrencies, with the working title Ledger.
So how did a mathematician whose lectures have focused on such rarefied subjects as Automorphisms of Von Neumann Algebras and their Fixed Point Subalgebras get involved in the hurly-burly of digital finance?
“My father was focused on Bitcoin before I even heard of it,” says James-Lubin. “He’s an electrical engineer by training, and he ran a hedge fund. He was interested in it as an investment and when he made me aware of it, I read nearly all the papers that were available. I really admired the work that was behind it.”
Among the early publications on Bitcoin that James-Lubin perused was the seminal 2008 proposal for a software-based “currency” by the mysterious Satoshi Nakamoto (a pseudonym; s/he has yet to be positively identified). Bitcoin: A Peer-to-Peer Electronic Cash System described a medium for reliably conducting transactions electronically. This was followed by the release of open-source Bitcoin software in 2009, with the subsequent mining of the first Bitcoins by Nakamoto.
Bitcoins, observes James-Lubin, provide (somewhat paradoxically) both anonymity and public oversight. You can exchange your Bitcoins for dollars with a total stranger. That’s the anonymity part. But all transactions are recorded in a public ledger that is always available for scrutiny by the Bitcoin community. So even when Bitcoins are used on “black” web sites for illicit goods or services, the transactions can be followed—and in all likelihood, the perps ultimately identified. The same basic dynamic applies to theft. Bitcoins can be stolen from accounts by skilled hackers, but are hard to launder due to the public transaction record.
“Bitcoins can facilitate illegal activities in that they move faster than cash,” says James-Lubin, “but they’re also easier to trace. I’m quite confident that there’s a sizable law-enforcement contingent monitoring the Bitcoin network.”
Bitcoins can also be lost. Every Bitcoin user uses a private electronic key to digitally “sign” for transactions. Say that key was on a thumb drive that you wore around your neck on a lanyard, and it broke at Burning Man and disappeared into the windrows of alkali dust and—well, you’re plumb out of luck. Your account will remain forever frozen.
This may help explain how Bitcoin is used. But there still remains the central question: What is it? Specie-based currencies are easy to understand: They are backed by the value of gold and silver reserves. It’s also possible for your average hominid brain to grasp how fiat currencies—like the U.S. Federal Reserve note—work. They aren’t buttressed by bars of valuable metals, but they do have the assets, infrastructure, real estate, economic output, and political and military power of sovereign nations to support them. But Bitcoin? Depending on whom you talk to, it is a medium of exchange, a store of value—or perhaps a unit of account (a monetary measure to establish the value of assets and services).
Or maybe it incorporates all three of these functions. Or none.
James-Lubin contends that Bitcoin certainly fulfills the definition of a medium of exchange, in that it’s accepted by large numbers of people, and many large companies such as Amazon. As for the exchange rate, as of this writing, one Bitcoin is worth about $385.
“The last time I checked, transactions were something on the order of 80 thousand Bitcoins,” he says. “That’s not insignificant. Whether it’s a ‘legitimate’ currency may depend on your definition. But people are accepting it for real services and products.”
Further, says James-Lubin, the value of Bitcoin can be computed in terms of the energy, hardware and labor that “back” it. Remember, Bitcoins are generated by “mining” (puzzle-solving)—which involves a great deal of electricity, dedicated computer time and human input. To a degree, this is not unlike the “reserves” that back Federal Reserve notes: The strength of the U.S. dollar is predicated largely on the productivity of the American people, which in turn is determined by human labor, energy consumption, asset utilization and time.
Which points to a real Bitcoin downside: environmental impacts. It might be inferred, perhaps, that an electronic currency shouldn’t adversely affect the global ecosphere; you aren’t chopping down trees to make paper notes, after all. But it takes a lot of electricity to mine a Bitcoin. When the exchange rate hit $1,000 USD in 2013, a then-extant watchdog group, Bitcarbon.org, calculated Bitcoin production was responsible for 8.25 megatons of CO2 emissions annually from fossil fuel-burning power plants. That was about .03 percent of the global total.
James-Lubin acknowledges the big carbon footprint of Bitcoin, and suggests there may be ways to mitigate the problem.
“A lot of that electricity is used for super cooling (the computer complexes that mine Bitcoins by solving mathematical conundrums over specific periods of time),” he says. “At a certain point, it might make a lot of sense to move production facilities to colder latitudes, where cooling needs would be minimal.”
Another bedeviling quality of Bitcoin is its extreme volatility. When James-Lubin’s dad first discussed the cryptocurrency with him, it was pegged at $30. By the time James-Lubin started studying the phenomenon in earnest, it was down to $3. It reached an all-time high (so far) of $1216.73 on November 17, 2013. In short, it has bounced around like Daffy Duck since its inception, and there’s no sign that’s going to change anytime soon. Opinions on the causes vary, from the inherent structure of the issuance schedules to poor liquidity to the simple suspicion that there’s no real there there – that Bitcoin has yet to prove it has any real, sustained value.
And yet, with Bitcoin’s current market capitalization standing a skosh under $6 billion, it’s apparently not going to disappear anytime soon.
“Right now, there’s about a trillion dollars in Federal Reserve notes circulating, with more outstanding in obligations,” says James-Lubin, whom O’Reilly Media enlisted to co-chair its Bitcoin conference Jan 27th in San Francisco. “Do I expect to see Bitcoin’s market cap hit one trillion? No. But I wouldn’t be surprised to see it to grow by many billions. It could ultimately provide something of a challenge to fiat currencies, simply because many people find its qualities—personal anonymity, quick transfers, public visibility of transactions through the ledger—so attractive.”
And along with enriching (or ruining) currency speculators, Bitcoin may have the potential of providing broad economic benefits to the planet’s impoverished billions.
“In most of the world, people don’t participate in any banking system, so their access to capital is non-existent,” James-Lubin says. “But at the same time, ‘dumb’ cell phone technology is now widely dispersed. More than two billion people, many of them extremely poor, have dumb phones, and these are completely adequate for participating in Bitcoin transactions. Between cell phones and Bitcoin, billions of disenfranchised people could gain access to capital, bypassing the corrupt systems of governance and financing that are so common in the developing world.”
Posted on November 18, 2014 - 1:28pm