Russ Roberts

Nathaniel Popper on Bitcoin and Digital Gold

EconTalk Episode with Nathaniel Popper
Hosted by Russ Roberts
Continuing Education... Martin... Adam Davidson on Hollywood and...

Nathaniel Popper of the New York Times and the author of Digital Gold talks with EconTalk host Russ Roberts about Bitcoin. Can Bitcoin make it? What went wrong with Mt. Gox? Why did Ross Ulbricht, the creator of Silk Road, just get sentenced to life in prison? Why are venture capital firms pouring millions of dollars into companies promising easier ways to use Bitcoin? Popper discusses these questions along with the technical side of Bitcoin to help listeners understand why so many investors are excited about the potential of Bitcoin.

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Podcast Episode Highlights
0:33Intro. [Recording date: May 28, 2015.] Russ: Your book is a history of Bitcoin, which of course is unfolding in real time right now. So we're going to talk about that history. Even though it's brief it's pretty momentous. There's a lot that's happened in the short life of Bitcoin. Early on in the book you list a 5-step process for a bitcoin transaction. What are those 5 steps? Guest: Sure. So, each bitcoin transaction begins with a person and their bitcoin address, which is a string of letters and numbers, initiating a transaction by signing off with their private key. So, the sort of base of the whole Bitcoin system is each person having their address and their private key. And only they have their private key. And with their private key they can say, 'I want to send 2 bitcoins to that bitcoin address.' And that gets the process rolling. They broadcast--a person doing that--Alice is the name that cryptographers frequently use so I'll call her Alice as well--Alice initiates that transaction by signing off with a private key. And then broadcasts that information to all the other users of the Bitcoin network. And the key difference between Bitcoin and other financial institutions is that there's no central institution to complete the transaction. Instead, it's all the users of the network who are processing the transaction. So, Alice sends that transaction, signs off with her private key to the other users of the network. And all the other users of the network are making lists of the new transactions as they come in. So, at 10:30 one transaction comes in. At 10:31 Alice's transaction comes in. And they add it to their list of transactions, which is known in Bitcoin as a 'block.' And the computers on the network, all of them are creating this list with the same transactions, and they are running that whole block of information through a very specialized function known as a hash function that spits something out the other end. And essentially what they are looking for is a very specific outcome to come out the other end, that is in essence a winning lottery ticket. And if other users on the network put their block, including Alice's transaction, through this hash function and it spits out a winning lottery ticket, they get--that computer gets--a block of new bitcoins--actually it's called a bundle of new bitcoins, 25 bitcoins. And that list which was fed through the hashing function becomes the official list of all the transactions. And is added to what is known as the block chain. And so Alice's transaction, we will remember, is in that list, in that block. And that block, with all the transactions is added onto the blockchain, which is a chain of all of these lists of transactions going back to the very first day of Bitcoin. Russ: The entire history. Guest: Right. So, what you end up with is that Alice's transaction is on there, is made official; the transfer is made from Alice's bitcoin address to the recipient's bitcoin address; and the computer that processed that is granted a new bundle of bitcoins. So that's how the transactions are processed and it's also how new bitcoins are created. And then the whole thing begins again. And that process of creating new bitcoins, new bundles of bitcoins, a computer is supposed to win about every 10 minutes or so. And if they are doing it more frequently than that, the system actually makes the problem a little bit harder so that it--and there are winners less frequently. But the idea is that a new bundle of bitcoins is going to be released to a user of the network something like every 10 minutes. And with that all of their transactions, their list of transactions, is added to the block chain.
5:36Russ: So, a couple of clarifying questions. We've done a number of interviews on Bitcoin in the past, and a number of those interviewees show up in your book, which is a lot of fun for me, and it will be fun for our listeners. We'll talk about them when we get to them. But I want to get to this technical side, go a little deeper than we have in the past, and your book does it very well. So, first, the private key--that's just a password. It's just a very, very long, complex, 64-digit--is that correct?--password. Guest: It's generally 64. It doesn't actually have to be, but that's generally what it is. Sixty-four letters and numbers. Russ: And when I open a Bitcoin account, I get assigned that; and that's mine; and it is a very, very valuable piece of information because it allows people to transfer bitcoins--it allows me to transfer bitcoins. And so it's extremely important. We'll talk later about the issues surrounding that, because that's fascinating to me. But I want to understand the has function a little bit and the winning lottery ticket. The point of the exercise that some computers on the net are going through--what they are doing I assume is verifying--I'm not quite sure what they are doing. In other words--it's called mining. And you earn bitcoin by doing some kind of algorithm that's running in the background on your machine that is processing transactions as they come to you. So, Alice transfers her 2 bitcoins to Fred. Guest: Bob. Russ: No, no. Fred. It's got to be Fred. Guest: Okay. Russ: I don't know why. No, we can make it Bob. So, Alice transfers her 2 bitcoins to Bob. And I see that--my computer sees that. It looks at it. What's going to happen that is going to result in that being verified, and why is it important? Because it's important. It's not just a dance that the system goes through. And this was the part I really hadn't appreciated until I read your book. A number of things. But this was one of the things. Which is that the stability and veracity of the system comes from computers racing to create the next updated version of the blockchain. Try to go into that a little more deeply. Guest: Okay, well let's see if I can. Russ: Not too much more deeply, by the way. Guest: Yeah. Right. Russ: I'm just trying to get the idea of it. Guest: This is very impressive, because you are certainly starting at the most difficult part of the whole Bitcoin system, which is how transactions are actually verified and how new bitcoins are actually created. I frequently try to skip over this part if possible. But you are right that it is exactly in this crux that the real kind of conceptual beauty of this system lies. Russ: And the reliability of it. Guest: Right. Russ: And I do want to assure listeners: We are going to get to the Dread Pirate Roberts, which I'm pretty sure is no relation, as well as other exciting--the [?] of hit men and other things. So there's good stuff coming. Just hang in there. Go ahead. Guest: Yeah. At each of these steps there's some very sophisticated math going on. Even at the level of your bitcoin address and your private key, they are not just two sort of randomly generated series of letters and numbers. They have a mathematical relationship. That means that your private key--you can verify that you have your private key without sharing it with anybody else. And that's a very kind of tough thing to get your head around. But it's one of the elements of cryptography that makes this system work. The other big-picture thing that makes this system work is that all the computers on the network that are doing this work keep a copy of all of these records going back--keep a copy of the blockchain with all the transactions. And so, because the computers have that, when Alice says, 'I'm going to send 2 bitcoins from this bitcoin address to Fred,' they all can go scan back through the history and make sure that Alice really has that money. And so, that was actually something I left out in the description earlier, but that's a crucial step, because all the computers are checking that Alice really has the money that she's trying to send. And once they do that, only then do they add Alice's transaction to the list of all the other transactions to create these blocks. Now, one of the other difficulties that has long plagued efforts to create new financial systems, new types of money, especially new decentralized types of money like bitcoin, is this question of whose record is the official record? If you are decentralized, you have all these different people, what if one person over in Argentina disagrees with how much money Alice has? Disagrees with another computer that's trying to do the same work in London? And the purpose of this system, the purpose of creating these blocks and computers racing to win the lottery, is that when they win the lottery, their record becomes the official record for the last 10 minutes. And so you just have one record. Even though it's a decentralized system, that person's record becomes the official record. And everybody else's record for that 10 minutes are sort of struck from the record. And everybody can agree: 'Okay, that is what happened for the last 10 minutes.' Russ: Let me just get the winning of the lottery part, because I think that's the only part I'm still a little confused on. I think I finally see it. When a computer on the system verifies having gone through the ledger that Alice does have 2 bitcoins to spare and that Bob has now received them, the verification of that is what wins you the lottery, essentially, and allows you to be the new official ledger that everyone else will now build off of. Guest: Right. Essentially. Yes. Russ: The part that I still don't get--of course there's a lot I don't get; that's not important, though--is: There's an issue of 51%--that some majority of the computers on the system doing the verification have to agree with my new version of the blockchain [block--Econlib Ed.], and that is what prevents a malicious attack by a single rogue machine. Guest: Right. Russ: So, try and explain that. Guest: Right. So, the winner of each new block--the way you win this lottery is by feeding your list of transactions through a hash function that's on your computer. And it spits out a winning ticket, essentially. And really what that means is it spits out a series of letters and numbers with a specific number of zeroes at the beginning: everybody is trying to find something that they can feed into the hash function that will spit out something with, say, three zeroes at the beginning. And so, the winner, sends their winning response around so that everybody can see: 'Yes, I am going to add their block to my blockchain that I am keeping on my computer. And I'm also going to grant that guy 25 new bitcoins.' So, the question that comes up is, well, what if there is a malicious attacker who gets 20% of the--who has a lot of computing power and he gets a lot of people to agree with him that, 'Okay, you didn't get the winning ticket but I'm still going to add his bitcoin to the network and give him the new 25 bitcoins.' That's dangerous because you don't want it to be possible for somebody to just wantonly generate new bitcoins. That would kind of ruin the system; it would ruin the faith in the system. So the way the system works is that 51% of the computers, at least, have to agree that somebody won. And only once 51% agree does their--do they become the official record. Now, generally, this isn't an issue. Generally there's a winner; the winner sends it around; everybody agrees; and you really have 100% of the computers that are agreeing on what the recent transactions were, who gets the bitcoins. But this is designed so that one rogue player can't just start granting him or herself new bitcoins. You have to win over the other people on the network in order to get new bitcoins. Russ: So it's like peer grading. You answer the question and then your peers assess whether it's correct enough. And they are using the same methodology of course that you claim to have used to have generated the correct number. Guest: Right.
15:26Russ: So, we've talked about it before; this is just sort of background. The spitting out of the 25 is limited so that ultimately there will never be more than 21 million bitcoins in existence. Period. And the growth in bitcoins is declining at a declining rate--there's fewer and fewer issued each year. Correct? Guest: Well, every 4 years the number of new bitcoins every 10 minutes is halved. So, we started at 50. We're now at 25. I think it may be some point next year, we know it will go to 12.5, and so on down to the time when there are 21 million in the world, which is expected to be some time in the year 2140. If everything goes as planned. Russ: Really. That's a ways. Okay--that's interesting. Guest: And Russ, just--this is an interesting place to start that's getting into really digging into the details of how this system works. And I think it's something that you hear most people who are involved in Bitcoin say that it really took them months to grasp this. And I think part of what is so alluring about Bitcoin is that it does have all these complicated parts that are harnessing advanced cryptography and so forth, but they come together into this system that has a somewhat sort of simple outcome and simple, smooth functioning. And that people can take part in this even if they don't necessarily understand each of these steps, the software is set up to make it possible for people to start doing this without them understanding what necessarily a hash function is or how blind digital signatures work. But it's one of these systems that's very complicated under the surface but the sort of conceptual advances that it allows are somewhat straightforward and really do allow something that was impossible before. And so, it's this--it's another one of the sort of mysteries of Bitcoin that draws people in and makes people want to understand this: How is it doing this and just what is it that is new about the system? Russ: Well, it solves--we've talked about this before, but it really is extraordinary because it solves two--it appears to solve, and what you just went through in some detail is how this could possibly be--two important problems that arise in any type of monetary system. One is: How do you prevent the issuer of money from debasing the currency and exploiting the current holders of the currency? So, the limit on the rate of increase and then the ultimate limit of 21 million is rather effective at that. But the second is, and this is the one that Marc Andreessen talked about when he was a guest on the program, which is the ability to transfer funds at very low, very, very low cost, because you don't have to worry about whether the funds you are receiving are going to stick. So, as you point a number of times in the book, and if you get on the web and start reading about Bitcoin, it's kind of just mentioned over and over again: Once you've transferred your bitcoins, it's over. There's no, 'Well, it wasn't my credit card; I didn't really buy that item; the merchant defrauded me.' When you pay, you know you've been paid. And that part of it, which is what that conversation we just had is all about, is really what's the remarkable part of this--that at very, very low cost you can verify that money has changed hands. And that's really pretty spectacular, as it turns out. Guest: Right. And even on a slightly broader conceptual level, the notion is that because of this math and cryptography and what makes what you just said possible, is that transactions go through without needed any central player to verify that they went through. They just, through the magic of math and cryptography, transactions just happen; and once they happen they are sort of locked in by cryptography. Sometimes when people hear that the significance of that isn't clear. But it has all of these implications that get people so excited about this idea. And really for me, the genesis of this book was less the conceptual beauty and more seeing just how excited this made people and how many people, once they grasped this system, essentially left their old lives behind to kind of chase this promise and try to make it work. And so my book is filled with all of these people who sort of have become these converts in an almost religious way to the idea, the promise of Bitcoin.
21:03Russ: Let's get into some of those. So, one company that drew a lot of attention, in a negative way, was Mt. Gox. So, explain what a Bitcoin Exchange is, why people were using it, and what went wrong there. Guest: Well, a Bitcoin Exchange, in the simplest sense, the reason they came about is because people all wanted to buy bitcoins. And you can mine them-- Russ: They didn't want to mine them. Guest: Right. You can mine bitcoins. But the system is set up so that as more and more people are trying to mine bitcoins, it becomes harder. And so, somewhat early on in the game, about 2 years in, there were enough people trying to mine that it became hard to do so--hard to win any bitcoins--if you just had your laptop or your home computer. And so people who wanted bitcoins needed a way to buy them. And people who had bitcoins wanted a way to cash out and sort of secure value that they could use, you know, at a McDonald's or somewhere that didn't take bitcoin. So people created exchanges where you could buy bitcoins with dollars or euros. And the way these exchanges function most simply was for a central exchange--really a central person--to collect people's money; and then people, when they wanted to buy bitcoins, would have credit. And the money would be transferred to somebody who was selling bitcoins. And so this exchange became much like a brokerage, e-Trade, that has your money and facilitates trades for you, and has people on both sides, who are buying and selling. But, you know, what became clear pretty quickly with these exchanges was that they were becoming the very sort of centralized institution that Bitcoin had been created to try to move beyond. Bitcoin, the idea of the decentralized system was that you didn't have to rely on bank and governments any more to hold and transfer your money. That was the beauty of this. And yet, very quickly bitcoin moved back to a world in which there were these centralized institutions--the biggest one for a while was Mt. Gox--that held everyone's money. And it held both their dollars and their bitcoins. And now--so now here you were sort of back at the very situation that you'd been hoping to move beyond when bitcoin was created. And the reason bitcoin hoped to move beyond that was because when you have a central institution it's hard to trust that central institution. It's hard to trust that they are going to provide the necessarily security. It's hard to trust that they are not going to take your money and run off with it. And what we saw time and time again with bitcoin was that these centralized institutions that were holding people's bitcoins couldn't be trusted. You know, when it comes down to money, it's just very hard to trust other people to hold onto their money for you. Russ: So those of us who are on the outside or hadn't been paying much attention, when Mt. Gox--talk about, before I ask the question--what the denouement, the end game for Mt. Gox was and what went wrong. Guest: Yeah. It ultimately went down in early 2014. At that point it held something like a half a billion dollars' worth of bitcoins. At that time each bitcoin was worth something like $800. And they--it was very clear that there were problems at Mt. Gox. People were having trouble getting money out, and nobody knew quite what the problem was. And finally the owner of Mt. Gox, a guy named Mark Karpeles, who was a Frenchman who was living in Tokyo, who was a kind of reclusive guy who rarely spoke with people--and he had a staff but he really sort of ran the thing himself. So it was a centralized institution with a central figure who--it was kind of as concentrated authority as you could get, and it was with this guy Mark who it turns out wasn't a particularly advanced programmer; wasn't particularly good at operating this company; wasn't a great--on Mark's part, because he didn't take input from those around him. And he eventually came out and just admitted that he didn't actually know where the money was. It wasn't in their wallets. All the bitcoins that he was holding for customers, that customers thought they had, Mt. Gox itself didn't know where the money was. And quite frankly that's more or less still where we are. We don't know whether it was stolen, embezzled, hacked, lost. There are several investigations looking at this. I think a lot of people think there was some--somebody who was sort of slowly stealing money from Mt. Gox's bitcoin wallets over time, and it may have been somebody inside the company. I think most people don't think it was Mark Karpeles himself. But Mark Karpeles, what people do blame him for is general incompetence. And the immediate thing is that he had shown himself to be a rather poor manager of this business several times, and people still kept their money with Mt. Gox. And so there were certainly several warning signs that you should not have your money with this company. But as is so frequently the case in financial markets, Mt. Gox had liquidity. It had buyers and sellers. And that was the most valuable thing to people--they wanted to move in and out of bitcoins very quickly and so they stuck with Mt. Gox despite all the problems that surfaced again and again. Russ: What I was going to ask before was, when that happened, when that was a headline--I remember it pretty vividly--a lot of people thought, well, that's it. Bitcoin is done. It's supposed to be safe; you lose your money. But as you point out and as you've said, this was not a Bitcoin problem per se. This was a problem with somebody who was processing bitcoins. It wasn't an inherent problem with the Bitcoin software. But I don't--what I don't fully understand is: Let's say I'm a miner; I've got a lot of bitcoins and I want to turn them into dollars because I want to buy something from somebody that doesn't take bitcoin. So I go on the exchange and there's a transaction. I transfer my bitcoins--do I transfer them to Mt. Gox, that transfers them? I mean, how did that work so that people were holding large amounts of bitcoin in Mt. Gox's coffers? Because there's no coffers. There's no real. There's no vault. There's no wallet, really. It's all virtual. A better way to say it is: What did I trust Mt. Gox with that they betrayed? Guest: Well, essentially a person, when they wanted to use Mt. Gox, did transfer their bitcoins from their own bitcoin address, which they controlled with their key, into their Mt. Gox account. And what Mt. Gox did when they got those bitcoins was not what a typical bank would do. Obviously banks, generally, keep money in segregated accounts so each person, each person's account, is separate. And the banks' own money is separate from its customers' money. At Mt. Gox, people were transferring their money into their Mt. Gox account so they could sell it. And sell those bitcoins, or buy more bitcoins. And Mt. Gox sort of had these big omnibus wallets. They were essentially Mt. Gox's own bitcoin addresses. And Mt. Gox then had control over that money. I mean the person could log in and ask to transfer bitcoins out. And people did not need to keep their money with Mt. Gox. And one of the fascinating things is that people seemed to want to keep their money with Mt. Gox. And that's been an issue again and again in Bitcoin's history--is that it was designed to give people control over their own money so they didn't have to rely on any other institution. But it seemed time and time again, even the people who were the biggest advocates for that ideal, often didn't trust themselves with their own money, and they wanted to trust some outside institution to hold their money for them. And so, it was somewhat unnecessary for people to keep money with Mt. Gox in the way they did; but people just didn't want to deal with holding that money themselves, keeping track of their password. They didn't trust themselves, essentially. And so Mt. Gox had that money in their own bitcoin wallets. And its hacker had to, and did find the weakness in Mt. Gox's system.
31:00Russ: Well, you tell the story of Mark Karpeles working on pieces of paper, I think, that had private keys written down on them. And one of the issues is that, it's great that your 64-digit number is safe. It's great that cryptography is not the name of--it's not your birthday or something that people can figure out when they get on your laptop. But it's a very large number. So it's hard for most people to memorize it. So, you have to write it down. Now, once you do that, you are kind of in trouble. So, you talk about people who put the number in their laptop; took their laptop off the Internet, put it in a safe deposit box. Guest: Right. Russ: These are smart, savvy people. So one of the challenges it seems to me with Bitcoin is it has this incredible security feature, but if you forget your private key, it's not like you can call up the website and say, 'I forget my password. Please send me another.' Guest: Right. Russ: It's gone. That's it. Guest: Gone. Russ: So, the virtue of the system becomes one of its challenges-- Guest: its flaws, yeah-- Russ: because how do you keep track of that? And so, talk a little bit about that and what some people are trying to do to make that a little easier. Guest: Well, you're absolutely right that the private key is essentially the most valuable thing in Bitcoin. It is essentially your money. If you give somebody else your private key to your address, they have access to all of your money and can immediately transfer it to their own address. In fact, when you are paying for bitcoins to have bitcoins transferred to you, sometimes the easiest way to do it is just to hand over the private key. You know, written on a piece of paper. Now, obviously a piece of paper is not the best way to secure it. A piece of paper can blow aware, can burn up; the ink can run. And so people have been working on these new systems to secure those private keys. It's also a problem, though, if you store your private key on a computer. Somebody hacks into that computer, finds your private key: once again, your bitcoins are gone, and that's happened many times. People have lost millions and millions of dollars when a hacker got access to their computer, got their private keys, and transferred their bitcoins out. So, what people have moved towards is systems where they keep those private keys essentially offline, in a place where no hacker would be able to access them. And you've gotten increasingly ambitious efforts to secure those private keys; and you will secure the private key with another private key that's stored in another vault somewhere. And perhaps the most ambitious company doing this these days is a company called Xapo, which is where a lot-- Russ: X-a-p-o. Guest: which is created by a relatively young Argentinian entrepreneur who lives out in Silicon Valley. This is a guy who got a lot of the big names in Silicon Valley excited about Bitcoin. His names is Wences Casares. And a lot of those guys came up against this problem: They got excited about Bitcoin; they bought bitcoins; but they said: 'Okay, how do I store this $10 million dollars' of bitcoin? And Wences, working with a tech team that he's used in the past, has created this very ambitious system in which these keys are essentially stored in vaults under mountains on different continents and you have to have two of the keys from different continents in order to move the money. When you get into it and when you see how you have these computers stored under mountains, it does raise the question, you know: Is this any different than gold, which you also have to secure under mountains and never touch, and becomes a very elaborate, time-consuming, expensive process? But it hints at just how valuable these private keys are. Russ: What's fascinating about it for me is--gold has no identifying characteristic. You find a piece of gold; you can't say, 'Oh, that one's mine.' It's like cash. Cash, you can't say, 'Well, that was my $100 bill' if somebody finds it. You have no way of proving it's yours. The whole beauty of bitcoin is that there's an underlying anonymity to it. But once you create that underlying anonymity, that means that if somebody does hack my private key and steals my bitcoins, there's no way of finding out where they went. You can't say, 'Those were mine, that were in my account. Those have my stamp on them'. There's no way to deal with that. And I assume for example that if you die, if you don't tell your heirs your private key, the money is gone. Guest: Yes. Absolutely. And if you're alive and you store your key somewhere--and, yeah, it's all about that private key. I think there is one wrinkle here, which is you have this blockchain--is essentially a public record of all the bitcoins in the world and what address they are assigned to. And everybody has that record. So you can see--if you know your address, you can see if somebody transferred bitcoins from your address--hacked in and transferred bitcoins: You can see those 50 bitcoins that were stolen went to that address over there. And so you've had that kind of analysis done, in the wake of Mt. Gox. People determined, okay, these were the addresses that were Mt. Gox's bitcoin addresses; and you can see when the bitcoins left those addresses and went to this address. And people sort of try to trace the movement of money around and try to find a place where you can identify: 'Oh, I know that address belongs to this company so it must have finally exited the system here.' And that--people have talked about that as a very promising tool within Bitcoin that you have that transparency. But ultimately it's been very hard to track money down when it has gone missing. You know, you may know that it went to this address, but you have no idea who that address belongs to. And so, once again: people have these situations in which money has been stolen, it's been very hard to track down what became of it.
38:08Russ: Speaking about anonymity, let's talk about Silk Road and the Dread Pirate Roberts, which is an incredible part of--just unbelievable; you couldn't make it up. You could put it in a movie. I'm sure it will be a movie. Guest: Yeah. Russ: Talk about how Silk Road got started, and again, how it unwound. Guest: Yeah. It was started by this young kid who had gotten into Austrian economics, he's sort of a young hippie kid from Austin, Texas named Ross Ulbricht. And he dropped out of grad school--Penn State, he was studying physics, chemistry. And he had this vision for creating an online market, a sort of e-bay for all the things that you can't buy on e-bay. So, drugs. He began actually by renting a cabin out near Austin and growing a bunch of psychedelic mushrooms that were the first product offered on the site. And Bitcoin--he understood that bitcoin was absolutely crucial to making this work. Before this, if you wanted to buy drugs online, you needed to use VISA or PayPal; and as soon as the cops got wise to this, they'd just subpoena the records from VISA or PayPal, and they would know exactly who did the purchasing and who did the selling. Russ: Which is why most drug transactions take place locally. On corners, with cash, where you personally take the money and there's no record of the transaction. Guest: Right. And Ross Ulbricht saw, understood, that bitcoins could make this possible, because as long as somebody kept their bitcoin address anonymous, the cops could know the transaction that took place and that resulted in heroin being purchased, but they wouldn't have any idea who people were on either side of that transaction. Russ: Except [?] Guest: And in a sense, this was the perfect first experiment in Bitcoin. For the first two years of Bitcoin, really nobody was using it for anything. People were kind of sending it around; it wasn't really worth much. And people had asked throughout the first two years of Bitcoin: How do we find something that people can buy with bitcoin that they can't buy with the traditional financial system? And even before Silk Road came around, people were aware that it was likely to be illegal transactions that were going to be the first sort of use case for bitcoins. This was going to be something that wasn't possible before. Because if you could already buy things online with dollars, why are we going to move to bitcoin, even if it was a little bit cheaper? Why is it worth it? But here, with illegal transactions, with something you couldn't do before and that people very much wanted to do--and so the Silk Road took off. And it really, I think in ways that a lot of people want to downplay, showed that Bitcoin actually worked. Because people were sending hundreds of dollars around the world to pay for drugs, and it was going through, every time. Nobody ever complained that the bitcoin payments didn't work or that the bitcoin payments weren't going through. And really the system did maintain the anonymity of its users in the way that Bitcoin initially imagined. Ultimately, 3 years down the road, Ross Ulbricht was caught. This became a massive enterprise, with millions of dollars of purchases a day; and Ross Ulbricht was making millions of dollars himself in commissions with these purchases. One of the fascinating things--he became this wanted criminal with Federal agents across the country, trying to track down who is Dread Pirate Roberts. 'Dread Pirate Roberts' was the name that Ross Ulbricht used on the site; and he never revealed who he was in real life; and he used several different technologies to obscure his identity, and among them Bitcoin. What's amazing is that when they finally got to Ross, it actually wasn't because of a weakness with Bitcoin. It was because Ross had early on posted his email address, his personal email address, in connection with some postings about the Silk Road. And ultimately they caught on to that and figured that out. People have said that Bitcoin is less anonymous than it was initially advertised; and I think that's true to a degree. But I think that part of what's so amazing about the Silk Road experiment was the degree to which it did actually work as intended. And I think it did, to some degree, prove that Bitcoin worked. And it was that first use case. And in some sense, I think Bitcoin is still looking for another use case that is as unique and valuable as what Bitcoin made possible with this Silk Road. Russ: One part of the Silk Road thing that I don't understand is related to Bitcoin's reliability. So, if I wanted to buy an illegal substance via Silk Road, I'd have to have it mailed to me, usually an anonymous Post Office box, because that would be part of the problem, also. Guest: Right. Russ: So, if I'm receiving it anonymously--what if the quality is awful? With e-Bay, an amazing thing about e-Bay is it relies on some inherent level of trust to start with, as well as, of course the ratings of vendors by the users. Was there something in Silk Road? Because otherwise--when did the bitcoins change hands? When I received the drugs? When I ordered the drugs? There's a big trust issue there that I've never [?] understand. Guest: Right. And that was a--there are two points there. One, on the latter question of when did the bitcoins change hands in Silk Road: the one thing Silk Road did provide that was very valuable was essentially an escrow service. The buyer of the drugs would transfer the money when initiating--when ordering the heroin from Amsterdam. And essentially the Silk Road would hold onto that money until the drugs arrived and the buyer said, 'Okay, I got them; the money can go through.' And if there was some dispute--if the buyer said, 'I got here but there's less than I expected' or 'It was poor quality,' they could dispute the transaction. So the Silk Road did in some sense serve as that central organization that eBay does, or that a bank does-- Russ: Amazon-- Guest: when you dispute a transaction with your credit card, VISA or American Express credit card to determine whether your dispute is legitimate, or your complaint is legitimate. So it wasn't a totally decentralized system. But it was decentralized in the way that eBay was in that it was the customers who were rating all of the products, not eBay--or Silk Road. So you have really very much the same system that eBay uses, which is that when you buy heroin from, you know, some guy in Amsterdam who has a screen name, that screen name-- Russ: his brand-- Guest: becomes a very valuable brand and identity. And people rate the products that come from them. And a screen name that gets bad reviews, people stop buying from them. And what was amazing was that something like 99% of the products did get the highest rating. And it was very hard, it is on eBay, for new sellers to get started, because they don't have a reputation. And so new sellers, if they were trying to establish a reputation would offer better deals-- Russ: Yep. Guest: would offer cheaper goods. And so it did in that sense work very much like eBay does.
47:08Russ: This story took a very dark twist and I'm interested in the journalism side of this as well. But Ross Ulbricht, unbeknownst to him, asked an FBI agent, who he thought was a buyer and seller of drugs but who was actually a plant, to kill somebody for him, according to your book. But yet he's not being charged with that. He's in jail, right? Guest: He is. He's actually in jail. He's actually being sentenced tomorrow. So, he has been found guilty by a jury on all the counts that he was-- Russ: Money laundering-- Guest: Boy, it's a long list. But interestingly, though, as you point out, none of the chargers were murder for hire. Which were some of the most explosive charges when Ross was initially arrested. According to the indictments and according to affidavits, Ross actually, as Dread Pirate Roberts, commissioned several murders for hire. And when they got Ross's computer, his laptop when they arrested him, he had actually kept the logs of his chats with these people, these assassins who he thought he was hiring. So they got all the records of these conversations when they arrested him. And according to those records he did this several times. People who he was worried were going to compromise the system or compromise the identity of buyers, or people who seemed to be stealing money from customers or from the Silk Road. He hired people who he thought were assassins. It seems that in the end most of these people were either law enforcement agents or scammers. And so it does seem that nobody in the end was killed, as far as we know. But equally importantly the prosecutors decided not to push those charges against Ross. I think there was a sense that--I think there were a couple of things that probably led prosecutors to make that decision. One is that it seems that nobody did actually die, and so it would be harder to convince a jury perhaps to find somebody guilty if they commissioned a murder but it wasn't against a real person. But the other element here, and this is where it even takes a more bizarre twist, is that the undercover law enforcement agents were themselves breaking the law by blackmailing Ross and by stealing bitcoins that they were getting in the course of their undercover work. So, these two law enforcement agents--I think one was with the FBI; one was with the Department of Homeland Security--last month or quite recently were themselves arrested. And so this was actually after Ross's trial. But I think if these murder-for-hire charges had come up in court, the government would have had to deal with the fact that the Federal agents who were commissioning, who were involved in this, were themselves corrupt. And it became such a quagmire that I think prosecutors decided that it wasn't worth dealing with and they would just get him on all these drug charges. Russ: So, this will come out--this will be released on the web when you are listening to this, listeners, the sentencing presumably will have already taken place; we'll put a link up to that story as to the fate of Ross Ulbricht.
50:54Russ: What's amazing about this whole Bitcoin story is there's new stuff all the time. There's still a lot of uncertainty about whether it's going to make it or not. I wonder if you could talk for a minute about how you accumulated the information--that you're willing to talk about. Of course, when you read a book about Bitcoin, there's an inherent secrecy about it that I find somewhat charming, and weird, and interesting. So, you for example, you write that Gavin Andresen, a former guest on this show, was the third person to alter the source code--which is open source, by the way--for the whole Bitcoin system. That's another issue that's pretty amazing. How do you know? There's a lot of things in this history--and I just need to tell the listeners: this book is an incredible page turner. It reminded me a little bit of The Frackers--could have been called 'The Hackers'. The reason is that the people who are involved are so colorful, so entertaining to read about; and you write about it so well. Guest: Thank you. Russ: So, how did you get--any one of them would have made an interesting book. And we've got 8 of them, 10 of them. How did you get the information? What was the reporting process and how do you know that some of the things you talk about in this book are actually true? Guest: Well, you know, this sort of goes back to the fact that Bitcoin-- Russ: Oh, and I forgot. Sorry to interrupt. But we do have to mention--not everybody knows this--that the creator of Bitcoin, Satoshi Nakamoto, nobody knows if he's real, who he is, his identity. And that just adds another layer of mystery about the whole thing. Guest: Right. That's a whole 'nother conversation in itself. And the book provides my sort of best guess and my best estimate for who it likely is and who people within the Bitcoin community sort of think it is at this point. But it's certainly not decided. But, you know, Bitcoin does in one sense it has this incredibly secretive, anonymous element; and on the other hand it offers this radical transparency. You have this log of every transaction that's ever happened. And the open source software, there are records of every change that's ever been made, and who made them. And of course the people who are making those changes can decide to remain anonymous. But often particularly among the developers who are working on the software, there isn't that same desire for anonymity. So, you can really go back and look from Day 1 who made each change. And for the first year or so, it was mostly Satoshi Nakamoto, and then actually a young Finnish kid, a college student, started helping Satoshi, and he made a bunch of the next changes to the software. And then Gavin Andresen got involved and he started making changes. And you can see each one he made and what he did to the software, if you look at those logs. So, to a degree, this is all there to be double-checked. But in order to get the stories from these people, of course I had to win their trust, essentially. I could know that Gavin made that change, but he needed to tell me why he did it, why he got involved. And so I spent 6 months reporting out this book, I traveled around, I went to Tokyo, I went to meet Mark Karpeles who is running Mt. Gox, and another guy who lives in Tokyo named Roger Ver, who is known as 'Bitcoin Jesus'. And I went to China, where Bitcoin has had some big ups and downs and met the major players there. And I'll say that as a reporter, it was actually a surprisingly easy world to penetrate because these people-- Russ: well, it's small. Guest: It's small--that's part of it. And the other part of it is that the people who are involved in this care so passionately about it that they are very proud of what they are involved in. Not everybody: Satoshi Nakamoto remains anonymous. But many of the people who have played the most crucial roles in this are incredibly proud of having played that role. And so they opened up about their stories; they shared emails. And obviously even some of the less attractive sides of what they did, once they started talking and I had emails from somebody, then I could, you know, pull a little bit more out of somebody else. And I ended up getting a pretty well-rounded picture of the central characters. Part of what is amazing was that many of them were totally open about their use of this: they weren't actually involved in this in order to sort of remain anonymous. That was one element of the system, but a lot of the people who are most involved are very transparent about their use of it and why they are excited about it. And so that was a boon to me as a reporter.
56:08Russ: So, when Bitcoin was started--and you write about this quite a bit in a very thoughtful way in the book--there were a lot of libertarians who were excited about the possibility of a non-governmental currency. And a lot of people dismissed it early on because it wasn't likely that that was going to work: it wasn't going to be an alternative to the dollar. Then there came this surge of interest from Silicon Valley: it's not the fact that it's going to be an alternative currency; it's going to be a payment system. The blockchain allows this low-cost way to transact across space and it's really an amazing feature. And of course Bitcoin is going to evolve. There are other digital currencies; there may be, I suspect there will be regulatory things put in place as well as people willing to give up some of the anonymity in return for other benefits. There will be other ways that some of this technology is going to evolve and we have no way of knowing what it is. But it strikes me that where we are right now, it's as if we lived in a world where there are hundreds and hundred--maybe a few thousands of people who would have, say, a UNIX operating system on a laptop, but no Mac, no Windows, no user interface except for technologically sophisticated people; and those people start playing with computers and the Internet and they are having a great time and they say, 'Hey, this thing's going to be big.' And the rest, when we get a taste of it, go, 'This is too unfamiliar to me. This is too weird for me. I'm going to sit back and wait till it gets better.' And it seems to me we're right at the cusp of that right now. We're right at the point where--and of course Bitcoin struggles with the fact that it has no "underlying value"--neither does most money; neither does gold, really, not in any real sense. But if enough people start to believe that it's worth using, and that's, I think, part of the really extraordinary culture of Bitcoin, it will make it. People will start using it as a way to buy and sell stuff. And we're right at that cusp now. Do you agree with that? Do you think--what do you think the future--give me the near term future and the longer term future. So, you'll have a paperback coming out in a year or so that will have a whole new chapter because there will be a whole bunch of stuff to talk about. Are we going to get over the hump? Guest: I think it's probably going to be slower than the real fanatics think. A lot of the people in this book imagined that by now, bitcoin would already be a global currency. And it's very far from that. All the bitcoins are worth something like $3 billion--a tiny little company. We joke that Yahoo could just buy bitcoin--but all of the outstanding bitcoins in a moment, as could Apple. And so I think it's still a long, long way from real mainstream use. And I think it is a useful comparison to think about other technologies in early days. Oftentimes people compare this to the Internet--it's a new protocol that allows for something new. But the Internet--it did take companies' finding a way to make it accessible. It took the first web browsers and it took the first really good search engines to make this new information network useful. And I think Bitcoin is still really looking for the companies that will make this new way of transferring value around useful. And there are a lot of companies around out in Silicon Valley that are trying to do that. There have been a lot of venture capital money that has gone into this space supporting companies that promise to do all kinds of things with Bitcoin. Some of it is just buying and selling bitcoins. Other companies are trying to use it to facilitate remittance transfers to the Philippines, to India, to Mexico. Other companies are trying to use this to serve as a ledger for other kinds of transactions, for stock transactions. NASDAQ (National Association of Securities Dealers Automated Quotations), right now is doing an experiment using the blockchain as a way to settle and clear stock transactions. So, I think it's going to be a whole while before this becomes something that ordinary people come into contact with. I think probably the most hopeful near-term success, or the most hope for near-term success, probably does lie with these big financial institutions that are trying to find a way to harness Bitcoin. And oftentimes what they are trying to harness is the blockchain and this new way of instantly settling transactions. So, that's why you've seen Goldman Sachs recently making investments and a former top JPMorgan executive started a Bitcoin company that wants to do this sort of thing. So I think quite frankly that's the place where there might be the most movement, just because you have to win over less people to get--if a bank starts using this in some way, that's going to be more money than if you've got a million people excited about this. So, if you just get that one bank, that could make all the difference. Something that would take 10 years of convincing individuals. I think that may be where there is movement in the near future. But I do think this is going to take a lot longer than a lot of the Bitcoin followers want it to. Again, I think the Internet--we're 6 years into Bitcoin. That's maybe 1995, 1996 for the Internet. And not too many people were using it at that point; not too many people saw the value in it. These things take time. And it's certainly possible that it takes time and it goes nowhere; that the incumbent systems are entrenched enough that this doesn't supplant them. But it certainly seems like this is already starting to get people thinking about money and how money works in new ways.
1:02:39Russ: So, if you are listening right now, and you say, 'Oh, this is kind of fun. I want to be a part of this,' tell me what a current non-technical person, a non-miner--I can't mine. I don't want to figure out what a hash function is and I don't have the computing power to win that lottery ticket. So, I need to get some bitcoins; my employer pays me in dollars. I've got to go buy some. And then I want to use them. So, what are my options right now in May of 2015 if I want to do that? Guest: Well, I think the easiest companies to use in the United States, the companies that are most consumer-friendly here, are probably Coinbase and Circle, both of which had big funding from big venture capital firms. Coinbase is actually quite a bit bigger at this point. Circle is a interesting company because they make it relatively easy to buy bitcoins. Their big push is to get people to use bitcoins for peer-to-peer transfers. So, essentially if you were going to send a check to your sister or your friend, it's a rather clumsy process. Circle is trying to make it so you can instantly transfer them money, in the way that right now is also possible with PayPal or this startup called Venmo. But bitcoin does make it quite a bit cheaper and simpler to do that, and it makes it also possible to do that across international lines--you can send money instantly to a relative in Argentina or Europe. So I think Circle is sort of an interesting company that is trying to experiment with ways in which bitcoin might allow something that isn't so easy in the current system. Russ: So, I've got some now. What can I do with them other than admire them and look at my ledger now and then and realize I still have them--no one's got my private key? What can I actually acquire with bitcoin right now? Guest: There are many significant American companies that have taken the plunge and are accepting bitcoins. The most famous ones are Dell, Overstock--Overstock is where I'm offering my book so that people can buy it for bitcoin. Expedia. There are several companies where I think you can buy things. Quite frankly, I think for buying things online, for a consumer, particularly an American consumer, Bitcoin doesn't offer any great advantage. There's no real reason for an American consumer to use bitcoin instead of their credit card. It's often said that Bitcoin took off in the places that needed it least. The United States--financial system works pretty well. The currency is pretty stable relative to other countries. And so there isn't so much of a need for it here. I think in the course of my book, what I found was that the places where people did see some real value in this were places where there were less stable currencies, where there was less access to credit cards in the financial system. So the most interesting place for that is Argentina, which was really essentially the only place where I saw ordinary people using bitcoin for sort of everyday transactions--because it was better, cheaper, faster than the alternatives. And these people didn't understand the underlying technology, they didn't care about the politics. They just wanted something that was cheaper and faster. And in a place like Argentina, a bitcoin is cheaper and faster than the existing banking system. So I think a lot of the interesting experiments are going on in places like that, where the credit card systems and everything don't work as well as they do in the United States.

COMMENTS (29 to date)
Buzz writes:

At banks like Mt Gox, why not have one wallet per account ? The bank would let the customer know its public key, so he could verify at any time if the money is still there. More headache for the bank, but me as a customer would sleep much better.

Buzz writes:

Payment with BitCoin at Overstock and Dell are still very rudimentary. It gives me the impression that it was done for PR, and not business purposes. Asked Customer Support in both places what USD to BTC exchange rate they were using, and neither places had that information. They both literally told me: "you have to ask BitCoin" :)

Warren writes:

Thank you for a very interesting discussion. I've been lightly following bitcoin for a few years because I would very much like to have available an uncontrolled currency. This discussion gave more information than I've previously learned. One topic that was not covered that I'd like to learn more about is the Tor network used by the Pirate.

James Liu writes:

Wait, no, when you put money in a (normal) bank account, the bank doesn't segregate your money from everybody else's. When you deposit money with a bank, the money belongs to the bank and you are a creditor of the bank. Sure, you have priority over bondholders and shareholders when the bank goes bust, and the FDIC guarantees repayment. But it's not your money, it's the bank's. They just owe you that amount to you on demand.

If this weren't the case, bank runs couldn't happen. Nor could banks be intermediaries between savers and lenders.

Michael Byrnes writes:

Interesting podcast. A couple of questions:

1. Russ pointed out that what Bitcoin "miners" are actually doing is processing transactions. Some critics have cited all of the processing power used by miners as wasteful, but it isn't - the system could not function without them, they are how transactions are added to the blockchain. OK, so what happens after the 21 billionth bitcoin is mined. After that, there will be no more bitcoins to compensate people who process transactions. What then? Presumably people will still need to be compensated for doing that work - how does that happen? Will there be some sort of "tax" on bitcoin transactions in order to incentivize people to continue "mining"?

2. What about competition? Bitcoin is sort of the first of its kind, or at least the first of its kind to be well known, anyway. Compare it to an original iPhone. An original iphone was an incredible device compared to what had come before it, but next to an iPhone 6 it is a piece of junk. Then there are all of the Android phones now that didn't exist when iPhone first came out. It's a common pattern - a new product comes out and over time it gets improved upon - by its original producer and by competitors. That's a key driving force behind technological advancement. How does that happen with Bitoin, though - it more or less "is what it is". If it is not perfect (and what first generation technology is ever even close to perfect), how does it get improved on? Competitors? How much room is there for competition in the cryptocurrency space? At some point does it all - or at least just the early versions - become worthless? Or could the makers of Bitcoin roll out Bitcoin 2.0 by offering a fixed exchange rate with Bitcoins?

Tyler Cowen had a really interesting blog post at a while ago. He argued that the more bullish one is on cryptocurrency in general, the more pessimistic one should be on the long-term future of Bitcoin specifically. Because, right now, only a tiny fraction of people own and use Bitcoins. If, eventually, everyone is going be using cryptocurrency, then there is a lot of space for competitors and Bitcoin's network effects are weak. On the other hand, if the market for cryptocurrency is saturated or near saturated with just Bitcoin, ie most of the people who will eventually use Bitcoin are already using it, then there is less room for competition and Bitcoin's network effects are much stronger.

Ah, here is the post from Cowen:

Note that the more “optimistic” you are about Bitcoin, presumably you should also be more optimistic about its future competitors too. Which means the theorem will kick in and you should be a bear on Bitcoin price. Arguably it’s the bears on the general workability of cryptocurrencies who should be bullish on Bitcoin price because a) we know Bitcoin already exists, and b) we would have to consider that existence an unexpected and unreplicable outlier of some sort. Yet the usual demon of mood affiliation denies us such a consistency of reasoning, and the cryptocurrency bulls are often also bulls on Bitcoin price, as too many of us prefer a consistency of mood!

Buzz writes:

Michael Byrnes:

The initiator of a transaction can add a processing fee to it, which will go to the person who processes it (makes it part of the blockchain). If none is added, then the miner can choose not to include the transaction in the next block, so it will never be verified. See for more details.

Competition to BitCoin is more akin to competition to Facebook. There is a huge first mover advantage. You can come up with NewBitCoin and it'll displace BitCoin if it has features that make it more appealing. The fixed conversion rate is an interesting idea; it might entice people to switch over.

Michael Byrnes writes:

Buzz wrote:

"Competition to BitCoin is more akin to competition to Facebook. There is a huge first mover advantage. You can come up with NewBitCoin and it'll displace BitCoin if it has features that make it more appealing. The fixed conversion rate is an interesting idea; it might entice people to switch over."

Sure, but the "first-mover" advantage is very different under these two scenarios:

1. 90% of potential users are already on board.

2. <1% of potential users are already on board.

In the first case, Bitcoin's first-mover advantage is much, much greater because a competitor would actually need to entice Bitcoin users to switch to something different.

In scenario #2, a competitor competitor could write off Bitcoin users entirely... and they would still have a huge market.

[broken html fixed. You can't use the keyboard symbol for less than.--Econlib Ed.]

Gary W writes:

Recently, Politico had an article on Bitcoin 2.0 entitled, "Bitcoin vs. the SEC."

It provides a nice addition to Mr. Popper's interview.

mtipton writes:

Seems using the private key is to keep the system anonymous (personal identity free). Is this good or bad? Does this make the system less secure because there's no recourse, there's no way to know who has or took the money, there's no relationship between the key and real personal identity.

Buzz writes:

Michael Byrnes:

Your second scenario seems to have been lost in the ether.

bnewm writes:


To borrow Russ Robert's oft used phrases "that's a feature not a bug". Anonymity can offer greater security depending on what you are doing. For example if you are making a transaction that could get you in trouble with the authorities anonymity offers security from the transactor's perspective (as with Silk Road, but you can think of more socially acceptable examples: say someone purchasing a banned book while living under a repressive regime).

But the beauty of having that choice as the default way to transact, you can always decide to transact only with people who you have verified your identity with in some other way. Even write contracts that ensures recourse.

It's really not that much different than traditional cash. People have always had ways to transact anonymously with cash (e.g. dead drops, sending cash through the mail). Bitcoin just makes that the simplest default: which is nice because it's harder to construct anonymity from de-anonymity than the other way around.

Buzz writes:


You have to trust the other side in a transaction (seller or the escrow) if you are paying with BitCoin. They can be sure that the BitCoins they get are valid, but you cannot be sure that the goods you buy are not defective. This is an asymmetry that goes against the buyer. It is mentioned in the podcast that in countries with a functioning monetary/credit system, it makes little sense to use BC for regular purchases. I'd rather have Amex behind me and get 2% back, than pay with BC and no recourse.


BC is very different from cash wrt anonymity. Every single transaction is in the blockchain. So if your drug dealer sends you his public address over text, which the police intercepts, then they would just need to seize your cellphone to see what your public key is to see exactly how much you paid him. Compare that to mailing cash to a PO Box...

bnewm writes:


In the case you gave anonymity was already assumed to be compromised outside of the bitcoin system (cops seized the phone). Yes, there is a trail that can be picked up on, but something needs to go wrong outside of the bitcoin system in order for an adversary to pick up on that trail (those trails can also be easily compartmentalized, so picking up on one trail leads adversarys to a dead end fast). And the trail is limited to only the person whose anonymity was already compromised absent other information outside of the blockchain. The cops still have no way of knowing who the drug dealer is. It's a highly secure, and "anonymizing", system taken by itself.

bnewm writes:


to add one thing: I think there is a distinction to be made between the level of anonymity on the one hand and the memory (or lack thereof) of the system on the other. True unlike cash bitcoins have a traceable record (memory), but it's seems that is not strongly related to the level of anonymity it offers. Again, anonymity needs to be compromised in the first place to identify those records with an individual---and even then it wouldn't seem too hard for the individual to make sure only some records are compromised if any at all are compromised.

Buzz writes:


When dealing with security, you cannot look at parts of a system in isolation. If you assume that everything outside of BC is secure, then BC won't be the weak link, that's true. But that's a huge "if". Slip up once with BC, and you're really screwed, while you're only moderately screwed if you slip up using cash. There are services to anonymize your BC, but you have to trust them and you lose a few percent. You you're back to square one with relying on a central authority.

PCM writes:

[Comment removed for supplying false email address. Email the to request restoring your comment privileges. We'd be happy to publish your comment. A valid email address is nevertheless required to post comments on EconLog and EconTalk.--Econlib Ed.]

rhhardin writes:

We're right at the point where--and of course Bitcoin struggles with the fact that it has no "underlying value"--neither does most money; neither does gold, really, not in any real sense. But if enough people start to believe that it's worth using, and that's, I think, part of the really extraordinary culture of Bitcoin, it will make it.

What makes money real, say as opposed to counterfeit, is that the guy who pays with it is willing to accept it back as payment, albeit on another good (with the reversed consumer surplus).

So long as the counterfeiter accepts it back, it's real money. Everything else is a turf war.

Warren writes:

I think that what makes money real is that it takes work to produce or collect it. For example it takes work to grow crops or animals or collect shells or rare feathers or mine gold or silver. It takes a lot of work to mine gold or silver.

Bitcoins are also mined. It takes electricity (computer) to mine bitcoins, and the work produced by that electricity costs money.

But actually not very much money. I also think that when the Treasury 'rolls the presses' that the bills produced have no value. Yet rolling the presses also requires electricity, probably more electricity that the bitcoin-producing computer does.

So maybe I'll have to adjust my thinking on this. Maybe bitcoins have rarity (like gold) but no or little work-value, unlike gold but like Treasury bills.

Mort Dubois writes:

I must have missed mention of the wildly swinging value of Bitcoin against real currencies, which makes it useless for commercial purposes. And with the low number of Bitcoins to be issued, and the ease of losing Bitcoins, it seems that this is a currency with a built in deflation, which again makes it very hard to use.

bnewm writes:


You are in good company for thinking that. Adam Smith took exactly that view. (Also not-so-good company as Karl Marx also took this view.). It's called the labor theory of value, and despite a few smart historical people thinking it is true it is probably the wrong way to think about money and I think most non-marxist economic philosophers (I think) reject it today for good reason.

The problem is "work" doesn't imply value and value doesn't imply work which would be needed to associate value with work in this definitional way the labor theory of value aims to do (even if your aim wasn't to strictly equate the two). Work is neither necessary nor sufficient for value. Work seems to imply value (it seems sufficient) because people don't generally work on things unless there is a good chance the product will turn out to be valuable---but it's not really the work that created the value it's the thought that went into it, the work is just *usually* necessary in the execution. People are put to work all the time on tasks that produce very little value---even negative value (think about a the work that goes into a senseless war).

Is work necessary for value? It's possible to create enormous value with very little work so long as someone else hasn't had the same idea. Of course most people have figured out and executed any low-work high value tricks by now---it's rare to find a low-hanging fruit, which adds to the confusion about work implying value because it's true most valuable things you have to work hard for, but by no means is it impossible to create high value with very little work.

So how to think about value if it doesn't necessarily come from work? I think the best way I've seen is to think of money as tradeable IOUs. Imagine a small village, where people can benefit enormously from doing things for one another---but they have a problem of the coincidence of wants. The butcher needs milk, but the milkman doesn't need meat. But the fencemaker needs meat and the milkman needs a fence. They can devise a system of IOUs and all trade them with each other so everyone gets what they need from the other. The IOUs are money (note money represents "indebtedness"---that is money is a debt instrument). Any monetary system is roughly this just scaled up. You lose some of the precision and the community knowledge of exactly how much is "owed in aggregate" that would be easier to determine in a small village, and the system can be gamed in the short run (say by the government printing money that doesn't really represent debt), but tracking the level of "indebtedness" is the aim of a monetary system. The use-value of money gets pegged through the availability of goods---which doesn't necessarily correspond to work done (it's highly correlated, but it's not necessary, nor sufficient for that matter). This is a very rough way to think about it, but the upshot is it's not really about work.

Think of Bitcoin as just a giant community verified ledger for these IOUs. Go back to our small village an imagine instead of trading notes they all kept a copy of a ledger. Everytime someone traded something they all met and updated how much debt (money) each one owned in each of their ledgers. This is unwieldy of course so originally people used physical possesion of notes or tokens to keep track of how much debt each person owned.

With modern computing the ledger method has been possible, but there were privacy issues and until recently not everyone had constant internet access to update the giant community ledger. So we used a mixed note and community ledger system (involving notes and the electronic bookeeping of banks). Bitcoin mostly overcame the privacy issues by anonymizing transactions in the ledger and most people have regular access to the internet. Now we can have a giant community verified ledger and privacy. The value of bitcoin is being transferred from the value conferred on currencies in exchanges. It's value is resting atop the value of traditional currencies for the moment.

Buzz writes:

Mort Dubois:

BC does have value for commerce, as evidenced by Silk Road. It's also the best game in town if you want to send remittences to far away places. BC is horrible as a value store. Very few people think that BC will displace dollars and euros as the everyday currency that people use, and those who do are nuts IMO :)

Warren writes:


Thank you for your response. Thinking of money as a debt, intrinsically, is an anathema to me. I was taught that money fulfilled 3 purposes: 1) as currency, i.e. a medium of exchange, 2) as a unit of account, 3)as a store of wealth. How can you have a store of wealth when the thing you are storing is debt? And when it is a debt owned by a government which is adding to it at the rate of 5-20% a year? (I don't believe their 2% inflation.) Specifically, when a prospector mines for gold he goes into debt in order to live and work. But when he finds gold he pays off that debt and his result is gold coins of positive value that can be stored into the future with no degradation in value (assuming no government ownership). Of course his venture is risky; he may never find gold of pay off his debt.

Fabergé eggs are of value, I think, both because of the ideas expressed and because of the work and skill involved. I agree that much work, especially senseless work, is of no or little value. So it is not precisely the expenditure of work-calories that determine value. Likewise not all ideas are of value, in fact most are of no value. And the value changes over time, over years, decades and over centuries. I agree “Work does not imply value”. OK, then how about “value is created in me by my desire for some good or condition’. That desire may be a result of a need of mine or of a herd-following or individualistic behavior. And the degree to which I desire it is equivalent to the degree of value I give it.

You said “Any monetary system is roughly this (indebtedness accounting) just scaled up - - tracking the (total) level of "indebtedness" is the aim of a monetary system.” But didn’t Popper say ‘that the other big-picture thing that makes this system work is that all the computers on the network that are doing this work (mining) keep a copy of all of these transactions. And so, because the computers have that, when Alice says, 'I'm going to send 2 bitcoins from this bitcoin address to Fred,' they all can go scan back through the history and make sure that Alice really has that money. And so, that was actually something I left out in the description earlier, but that's a crucial step, because all the computers are checking that Alice really has the money that she's trying to send. And once they do that, only then do they add Alice's transaction to the list of all the other transactions to create these blocks.’ Bit coin is not keeping track of the total debt or total indebtedness, rather, bitcoin is keeping track of how many bitcoins each individual has (more like the IRS than the Fed), so that when a request for payment comes in for an individual, bitcoin can determine if that request can actually be paid (whether what is being paid is positive or negative value).

You give the example of the small village economy, which is similar. But your wording, positive and negative, throws me. If I, as a farmer, trade 2 cows into the community, and take out only 1 cows worth of value and a number of gold or sliver coins, do not those coins have a positive value to me?

Warren writes:

Mtipton, bnewm, Buzz and others,

Bitcoin does not provide anonymity. Bitcoin provides confidentiality and authenticity. To do this Bitcoin uses asymmetric key algorithms. Please see and note near the bottom of the page the inclusion of Bitcoin in the list of examples of protocols using asymmetric key algorithms.

Popper says “So, each bitcoin transaction begins with a person and their bitcoin address, which is a string of letters and numbers, initiating a transaction by signing off with their private key. So, the sort of base of the whole Bitcoin system is each person having their address and their private key. And only they have their private key.”

Your ‘bitcoin address’ is not your internet address. Specifically in the Bitcoin protocol, your ‘bitcoin address’ is your public key, and your private key is just that.

mwerb writes:

Late to the party because I got behind on podcast listening this week. But it's the internet, so here's my 2 cents (or my 0.00008 bitcoin).

1. As a programmer, I understand the encryption and block chain technology. The technology works. Bitcoin can be virtually as anonymous as the 2 parties of an exchange wish it to be. It's still not as anonymous as unmarked bills, but close and easier to send.
(Also, a point not really made on the podcast is that I can have as many key pairs (private+public) as I want. It's trivial to create a new one. So hypothetically I can have a key on my phone for mobile payments, one on for online payments, one or more keys I keep offline or in a "wallet" on my PC - and I can easily move money among them. If one key is compromised, it doesn't affect the others.)

2. As an investor, I see cryptocurrencies as a valid market response to the inflationary inevitability of fiat currencies. Bitcoin is not perfect, but it's the best cyrptocurrency available today. So just as I have some commodities and metals in my portfolio, I now have about 1% of my investment portfolio in bitcoin. It's money at risk as a hedge.

3. As a business owner, I understand the importance of low-cost, low-friction payments. Banks can't hold a candle to bitcoin on this score. The obvious challenge to this today is that not many of my customers or vendors want to exchange bitcoin, but it doesn't stop me from using it with those who do.

Mt. Gox was both horribly mismanaged and conceptually flawed. Check out Coinbase as a pretty good model of how a bitcoin "bank" should work. Not saying it's perfect, but a portion of my bitcoin are there.

B writes:

Bitcoin does in fact offer a unique and highly useful intrinsic property: a tamper-proof, distributed information ledger (the proof-of-work blockchain). But the blockchain requires mining to preserve its correctness; which is not free, and therefore the underlying asset (bitcoins) must have real monetary value such that miners are incentivized to secure the ledger's validity with computing power.

Buzz writes:


Re your multiple wallets scenario: you realize that the blockchain contains every single BC transaction ? So if one of your wallets are compromised, then all others will be under suspicion too.

mwerb writes:

Yes, I do realize that. Not sure if I understand the scenario you are proposing - you mean if I were under a Federal indictment or something like that? If someone is money laundering, evading taxes, or transacting illegal goods, that's way outside my area of expertise. I bet, though, if one used enough bitcoin keys and a smart strategy of moving funds, it would be pretty close to impossible to track. Not my bag, but I can imagine how it might be done.

For me, the point of multiple bitcoin wallets is to keep a small amount in a couple convenient wallets for everyday use and the rest in other less accessible (and therefore safer) wallets. I'm comfortable maintaining my own offline wallets because as an IT professional, securing and tracking multiple private keys is no problem - I do it all the time for data encryption keys. For the general public I suppose using 1 or more of the bitcoin services would make more sense.

If Coinbase goes the way of Mt Gox, I don't have all my bitcoin there. Or if the bitcoin key on my mobile phone is compromised, that wallet has only a small amount. And it's pretty easy for me to move the money from one wallet to another. (Okay, actually I'm getting hypothetical there - I briefly had a bitcoin wallet on my phone but had no use for it, so it's removed.)

I guess I'm making this point because I heard Russ and Mr. Popper mostly refer to one's bitcoin key or wallet in the singular, which might give a newbie the impression that each person has just one. And of course if that were true it would be much riskier. Russ and Popper didn't say anything wrong, but I think this point is worth emphasizing.

Buzz writes:


I understood that by "compromised" you were referring to the anonymity of a wallet, since that's what your #1 is about. I guess you meant whether the private key is stolen. For that scenario you definitely want to have multiple wallets.

J Mitch writes:

As I was listening to the podcast I was wondering if bitcoin might be a way to get around currency controls and an unstable currency situation (i.e. - Greece after it exits the Euro).. Although I understand the value of bitcoin is not stable, it is potentially more stable than the Greek drachma. So, if you are living in Greece and you are concerned about your money in the Greek banks and the government restricts your ability to access your Euros/drachmas, could you use your coinbase account to move your Greek bank held Euros to coinbase and then if you wanted from coinbase to a non-Greek bank. As stated in the podcast at this point BC really might be quite useful in countries where is central authority does not have a stable fiat currency.
Also, Russ I would love to hear a podcast about the Greek situation - how did the country get here, and what might happen in an exit from the Euro, etc.

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