Bitcoin is a journey, not a destination, and everyone is on their own path. Lockdown has been helpful in that over the past 2 years I have been looking deeper into the inner workings if the code required to run the bitcoin protocol, the idea of it being a store of value and a host of other themes and disciplines. This truly is a remarkable time to delve into this fascinating subject.
Below is a list 4 of the most revelatory pieces of the bitcoin protocol that I have adapted from the Stone Ridge Investor Report.
1) Salability across time, this is why people call it an inflation hedge.
Gold has been a reliable store of value because of its scarcity and historically low annual supply growth of only 1-2%/year. There has never been a “gold hyperinflation.” Indeed, gold has held its value over the centuries, while hundreds of other stores of value have come and gone. However, gold’s supply is not impervious to its demand. If, hypothetically, gold went to GBP100,000 tomorrow, we can be sure enormous resources would immediately shift to gold mining, and the miners would find some way, somehow, to accelerate its supply growth, driving its value down. However, there will only ever be 21 million Bitcoin. Bitcoin’s annual supply growth approaches zero over time, is now down to about 1%, on par with the historical annual growth in the supply of gold. While far from perfect, gold is Bitcoin’s closest real-world analogy. However, the ultimate supply of Bitcoin is fundamentally limited by the design of the protocol itself and cannot be increased regardless of its value or the level of demand. Bitcoin is the first store of value in history for which its supply is entirely unaffected by increased demand. From this perspective, Bitcoin is better at being gold than gold – it is even more ‘salable’ across time.
2) Salability across space, this is why people call it decentralised.
As we moved beyond traveling by foot and horse, beyond the development of affordable commercial air travel, and then, especially, beyond the internet’s explosion of network power, gold’s low spatial salability became an acute flaw. Gold is simply hard to transport and is awkward to hold. This is where traditional currency, shines. Though traditional currency’s periodic, human-nature-induced hyperinflations made it a huge step backward in terms of salability across time, it was a substantial leap forward in terms of salability across space.
Bitcoin moves much faster across space than traditional currency, increasing the capacity for long-distance international payments by 500,000 transactions a day, and completing that settlement in about an hour, rather than the current state-of-the-art 3-5 days, or longer, for final international currency settlement (fintechs in the UK have sorted this with almost instant local transfers). Bitcoin’s protocol and network topology renders national borders irrelevant, which is especially empowering to the world’s most vulnerable and unprepared for fiat hyperinflations (think: Zimbabwe, South Africa, Venezuela, Turkey and Lebanon today).
Do not confuse the speed of your Visa or Mastercard payment with its final settlement. No settlement occurs when you buy your coffee at Starbucks. Rather, your bank and Starbucks’ bank generally settle 2-3 days later, with each bank taking credit risk to the other along the way, with rare, but occasionally disastrous results. Bitcoin safely settles about every hour and, as a bearer instrument, credit risk is not a concept. From this perspective, Bitcoin is better at being fiat than fiat – it’s even more salable across space and, because it’s not debt like fiat, has no credit risk. Unless you need settlement to be instantaneous which no-one has managed to really crack. Developers are working on this as I write.
3) The Difficulty Adjustment and Mining, this is what keeps it stable.
Everything Satoshi did in inventing Bitcoin was non-original – his genius was in seeing how combining a specific set of previously solved problems could, together, solve certain unsolved problems – except the Difficulty Adjustment. The Difficulty Adjustment, entirely original, is, in my opinion, Satoshi’s most under appreciated breakthrough, a truly genius application of game theory, and the fundamental reason why Bitcoin’s network has always been secure. So what is it?
Suppose Bitcoin’s price rises, creating an incentive for more Bitcoin miners to mine (remember, successful mining results in Bitcoin rewards, thus the continuous link between Bitcoin’s price and the total worldwide mining incentive). In this case, the Bitcoin protocol will automatically raise the difficulty of mining, such that the creation of new Bitcoin, and the timing of transaction verification, does not accelerate beyond its preset schedule (about every 10 minutes). Instead, suppose Bitcoin’s price falls, and subsequently higher marginal cost Bitcoin miners rationally turn off their machines. The Bitcoin protocol will automatically reduce the difficulty of mining, such that the creation of new Bitcoin, and the timing of transaction verification, does not decelerate below its preset schedule. Genius. This happens every two weeks by the network with no need for any consensus or human intervention. Super smart.
How does the protocol do this? Imagine that I tell you that the product of two prime numbers is a certain three-digit
number and I ask you to guess the two primes . There is no closed-form solution to the question, which is a fancy way of saying you have to randomly guess until you figure it out. Since I told you the product of the primes is only three digits, you’d probably be able to guess the two primes fairly quickly. However, suppose I told you the product was five digits? How about ten digits? How about twenty digits? You can quickly see how much harder and harder, and then way, way, way harder the random guessing can become.The Difficulty Adjustment is akin to adjusting the number of digits of the product of the primes as a function of how much mining power is on-line at any given time. The more miners, the greater the number of digits of the product of the primes. The fewer miners, the smaller the number of digits such that, even if all commercial Bitcoin miners, and their combined super-computing power, suddenly went off-line overnight, hobbyists mining on laptops at Starbucks in London would keep the entire global Bitcoin network just as secure, and just as quick. The Difficulty Adjustment was the “missing piece” of decades of previous attempts at decentralized electronic money. It ensures that every 10 minutes a new Bitcoin block is rewarded and all transactions in the interim are accurately and immutably verified. It is what drives Bitcoin’s salability across time discussed above: even amidst periods of surging demand for Bitcoin, Bitcoin miners have no ability to mine Bitcoin faster, making unexpected inflation impossible. Forever, its written into the fabric of the protocol.
Typical of Satoshi’s understated style, the Difficulty Adjustment was described in just two sentences in his original
Bitcoin whitepaper: “Mining difficulty is determined by a moving average targeting an average number of blocks per hour. If they are generated too fast, the difficulty increases.” As an aside, the Difficultly Adjustment also serves to limit wasted mining energy, further incentivising miners to mine, but that benefit pales in comparison to
its impact making Bitcoin inflation-proof.
The Difficulty Adjustment has now been continuously tested for twelve years, at total global network power levels ranging from a just a few laptops, all the way up to enough energy to power New York City, and with lots of total network power volatility along the way. The total network power volatility is what requires the Bitcoin protocol to continually adjust the mining difficulty, akin to continually adjusting the number of digits of the product of the two primes. And, astonishingly, just as Satoshi designed, no matter the global mining capacity, or its variability, a new block is verified every 10 minutes…every 10 minutes…every 10 minutes.
4) Bitcoin’s Use of Energy, the clamour around this has been increasing recently.
This narrative has increased to the negative most recently and needs to be seen from both risk and reward perspective. The amount of energy Bitcoin consumes is the sum total of the energy consumption of all the mining machines that, secure the network. While hard to know exactly, a good estimate of the global total consumption is about 8-10 million people worth of energy. There is no question that this is absolutely enormous. In a warming world, how can this be good? First, the principle: Bitcoin is a better technology for performing central banking than the current government monopolies on central banking. In the same way that cars consume far more energy than the bikes and horses they replaced, and electric lights replaced candles, and central heating replaced chimneys, and computers replaced typewriters, Bitcoin’s better monetary system consumes far more energy than the current banking system (watt for watt). Throughout history, energy use has grown whenever free people making free choices have decided for themselves that the price of the extra energy for the new technology they wanted was worth it. Today, every day, 24/7, Bitcoiners around the world make the decision that the price of Bitcoin’s energy use is worth it because Bitcoin is better technology for money.
Bitcoin mining is the only profitable use of energy in human history that does not need to be located near human settlement to operate. The long-term implications of this are world changing. Before Bitcoin, the problem of energy has never been its scarcity, but only our ability to channel it geographically where it is needed most. Before Bitcoin, that was exclusively where humans lived. In contrast, Bitcoin’s mining energy is solving a different problem. Because of satellites and wireless internet connections, Bitcoin mining can be located anywhere.
Remote areas blessed with moving water can monetize their natural resource good fortune by creating clean, hydro energy and using it to mine Bitcoin. Thus, Bitcoin can make monetizable isolated energy sources all over the world – like waterfalls, running rivers, or dams – now entirely untapped because they would be cost prohibitive to connect to electric grids close enough to residential or industrial areas. In doing so, Bitcoin can fundamentally change the economics of energy by introducing a highly profitable use of electricity that’s location independent. The world has never had a profitable use of energy that’s location independent. Now it does. And since fossil fuels are already too expensive to be a profitable source of Bitcoin mining energy, hydro may be the answer, who knows but in principle it make sense.
Imagine a future with Bitcoin mining firms, unsubsidized, in extraordinarily isolated locations – visualize a waterfall in a largely population-free part of a country – easily connected to the Bitcoin network, building serious energy infrastructure to monetize the local clean energy source for mining. However, once the industrial-strength, profitable infrastructure is in place, let’s extend it. Let’s build roads. And housing. And schools. And hospitals. Ultimately leading to human settlement. The net result can be people locating around new, Bitcoin-driven hydroelectric energy infrastructure, with more and more of humanity clustering around cheap, clean energy sources. Historically, our energy challenge has been to move the power to the people. With Bitcoin, we can move the people to the power. Consider that the world’s major population centers – think New York, London, Paris, Tokyo – each developed where they are geographically because of natural seaports, waterways, and trade routes. Energy was a nonfactor because placement of these cities was all pre-energy (i.e., pre-fossil fuels). As Bitcoin finances the for-profit development of cheap, clean energy infrastructure on a massive scale, it can lead to a future in which more and more of the world’s population lives near abundant energy with an extraordinarily low marginal cost of production. This matters because cheap energy equals human flourishing. In summary:
Cheap energy = societal flourishing.
Beyond the revolution in monetary policy that Bitcoin already represents, Bitcoin may also represent the biggest catalyst the world has ever known for developing abundant, clean, cheap energy. And, therefore, one of biggest catalysts in the world for societal flourishing.
Can you tell why I’m all-in?
I have zero issues if you come to Bitcoin for the price but think about staying for the principles. Bitcoin is far more important than a speculative punt.