Your friends are wrong about crypto

Why proof-of-work is more important than a fixed supply

There seem to be four major camps with regard to cryptocurrency — all of them are wrong.

One camp holds that cryptocurrency and blockchain technology is the way of the future — that blockchains should be used in everything from supply chains to CBDCs.

One camp seems to be simply ignoring crypto — as if it isn’t already remaking the world.

One camp holds that all crypto will go to zero, and you should buy gold.

And the last, the “Bitcoin maxis,” hold that Bitcoin is the only real cryptocurrency — and what is most important about it is its fixed limited supply.

All of these are wrong.

TL;DR: Blockchains don’t solve every problem. Crytocurrency will change (is changing) the world like the internet has. Anything that kills crypto in the near/medium future would destroy the entire internet. Scarcity doesn’t mean fixed, limited supply — proof-of-work is much more important.

I’m not some kind of “enlightened centrist” on pretty much any issue, but each of these “extreme” views seem to have serious problems for me, though they also get some things right. I’m going to go through the first three fairly quickly, but feel free to ask questions an perhaps I’ll circle back around to those in a later article.

For the “blockchain bros,” yes, cryptocurrency and blockchain technology is “new” and we should try to explore all the possibilities for its use. But, in the end, a blockchain is just a database that can only be written to. Eventually, storing the whole sequence of edits to a database can get rather expensive. Blockchains, being expensive, should really only be used where they are necessary.

Those who support “proof-of-stake” as a consensus mechanism and CBDCs (central bank digital currencies) understand some of the efficiencies of blockchains — particularly the proof-of-work consensus. But these “solutions” are only trade-offs or developments that destroy what is best about cryptocurrencies. A “proof-of-stake” blockchain might be useful for something, but for a censorship resistant currency it isn’t.

For those who are still ignoring crypto — well, that’s their prerogative, I guess. I suppose there were people who accepted the existence of the automobile, airplane, computer and the internet with a shrug. Perhaps they are just much more interested in other things, perhaps it’s hard to see into the future, to see how these things will develop and grow. But I urge you not to ignore a technology which is already changing the world.

For those who think that all crypto will go to zero — maybe you’re right. But as far as I can tell, there are only a few scenarios for that to happen — all of them unlikely in the near future. One possibility is the development of powerful quantum computing. This would break the current common method of public key encryption — but this would affect the entire internet, every single login that you have, not just cryptocurrency. Also, we already have other methods of public key encryption — they are just more expensive, less tested and haven’t been implemented. One possibility is a giant solar flare that destroys all our computers (or some other catastrophe) — in this case, cryptocurrency will be the least of our worries. In short, I don’t see any reason for cryto to completely fall in the short/medium term, given the use case of transferring value without an intermediary, without enormous changes to other sectors.

And for the gold bugs who say nothing is backing crypto. Cryptocurrencies have about as much backing as gold does, namely people subjectively value it. If someone needs a technological use case for their own personal subjective value, crytocurrencies have that too — they provide a very robust timestamp service.

Finally, for the “Bitcoin maxis” who seem to think that most important element of Bitcoin is the limit of 21 million coins — a hard limit on supply is not what “economic scarcity” means. Gold is economically scarce — yet more is mined every year. Lumber is economically scarce — yet it literally grows on trees. Even (some) fiat money is economically scarce — and it’s basically created from nothing.

What is important about Bitcoin (or any cryptocurrency) is not a hard limit on supply (which is neither a good nor bad thing), but that it cannot be duplicated — this is the essence of economic scarcity. How does Bitcoin achieve this? Bitcoin achieves this using the blockchain, yes, but this is secured by the proof-of-work consensus mechanism.

Bitcoin is almost unique among cryptocurrencies in having been completely open from the beginning, in having a proof-of-work mechanism allowing anyone to enter the network and in not having a “pre-mine” of coins going to the creators/developers/backers.

The fact that Bitcoin is open to any new miners to join the network, without the permission of the rest of the network (by buying tokens, for example), means it will be much more difficult for any centralized oligarchy to maintain control of the network. Proof-of-stake fails at this, where proof-of-work, with an open protocol, succeeds.

There are those who seem consider inflation inherently a bad thing … and those who consider deflation inherently bad. Not so.

First, we have to distinguish between “price inflation/deflation” and “supply inflation/deflation.” Since this isn’t meant for economists, I’ll use the qualifiers throughout. “Price inflation” means that the prices of goods and services are mostly rising with respect to money, “price deflation” would mean that the prices of goods and services are mostly falling. It should be clear that price inflation tends to be painful for the average consumer, but that price deflation, particularly of services (i.e. wages), can be somewhat scary too.

“Supply inflation,” on the other hand, refers simply to an increase in the supply of money, while “supply deflation” refers to a decrease in the supply of money.

This article is already getting a bit long, so I won’t go into the arguments about how “price inflation” is linked to “supply inflation” — but the link is strong.

Most Bitcoin maxis seem to have internalized that “price inflation” is bad and so “supply inflation” is bad and the opposite, that “price deflation” is good and so “supply deflation” is good. Yet, while the price of goods decreasing (price deflation) would be welcome — this does not depend entirely on supply deflation. Also, as mentioned, price deflation can also mean a decrease in wages, certainly not a welcome thought for many people.

On the other hand, while there are some minor difficulties with price inflation involving planning (though the same could be said of price deflation), the main evil of “inflation” comes from the method of “supply inflation” in the fiat money system. Under the current system, the creation of money is centralized by a central bank (mostly a banking cartel), and this system, via the Cantillon Effect siphons value from the general population to the cartel (and those close to it, including the government and certain businesses).

What is wrong here is not so much that more money can be produced, again consider that more gold and lumber can be produced (though these are somewhat different from money, having other uses), but that the cartel/government uses force to exclude others from production and uses the power of creating money from nothing to siphon value from the populace.

Bitcoin, via proof-of-work, solves this by opening the mining to anyone with a miner, while limiting production. Proof-of-stake simply creates a cartel.

Yes, limiting the production of a cryptocurrency is important for maintaining economic scarcity, but a hard limit of a certain number of coins is not necessary.

If mild supply inflation, as long as it’s not from centralized and unlimited production driving the Cantillon effect, isn’t bad, let’s see why deflation isn’t necessarily good.

First, as we’ve mentioned, price deflation for goods sounds great to most people. But price deflation can also apply to services/wages, which is a scarier prospect. However, changes in prices, whether inflation or deflation, at least partly depend on the market, not just monetary supply. Let’s consider the pros and cons of monetary supply deflation.

First, the pros. Honestly the only real pro is that it can lead to price deflation and, if one has savings, this can lead to one’s savings gaining value. This is the siren call that many “Bitcoin maxis” hear. They want to buy some Bitcoin, save it, not have to risk in investment or other creative endeavors, and live rich in the future.

But how can monetary supply deflation actually be effected? Well, supply deflation can only occur if money is removed from the system. But there are only a few ways to do that: one is to tax and then burn the money, and another is for people to lose their money.

First, it should be clear that I don’t support forceful taxation in order to have a deflationary currency. Second, it seems unlikely that anyone will willingly adopt a currency which has deflationary taxes (whether on transactions or holdings) built in — in fact, such a cryptocurrency exists … as a joke.

So, finally, Bitcoin is only “supply deflationary” in the second way. That is, the supply decreases when someone loses their Bitcoin. And while this may very slightly increase the value of the other held Bitcoins (in terms of goods and services, i.e. price deflation), this is hardly a good for the person who loses their money. (Further, Bitcoin is still undergoing supply inflation — and won’t reach the full 21 million coins for more than 100 years.)

So, there is no universally “good” way to have supply deflation, and even price deflation is a mixed bag that depends on the development of the market.

Summing up: blockchains have only a few uses. CBDCs are scary and will be used to siphon even more value from the populace, or control their spending — more or less like welfare. Crypto is changing the world — learn something about it. Buy some gold, just in case, but crypto probably isn’t going away — take advantage of it. A fixed supply isn’t the best thing about Bitcoin. First, it doesn’t currently have a fixed supply, second, what’s more important is the proof-of-work consensus mechanism which is open to anyone to join. There are a few other coins which are similar in that respect, Monero among them.

Best,

ihaphleas

Public key: npub1ty8pwacr4thgz5e5n7t52l5p4fe5cm8707nqnvrmlxfexqs09m3spvpx4u