Tuesday , July 17 2018
Home / David Andolfatto: Macro Mania / The Trust Machine: The Story of Bitcoin

The Trust Machine: The Story of Bitcoin

Summary:
I came across a presentation of Bitcoin the other day called The Trust Machine: The Story of Bitcoin.  I thought it was very nice and I encourage anyone who's interested in Bitcoin to view it (less than 25 minutes). What I offer below are questions and comments that came to my mind as I listened to the narrative. I'd recommend listening to the entire presentation first and then reading my comments below. The bold numbers represent the corresponding time in the video to which the remark pertains. 1:04 Before Bitcoin, the only way to make electronic payments over the Internet was via your bank. However, over 2 billion people in the world do not have access to a bank account.   Sure, but why is Bitcoin the best solution for this problem? Nobody was connected to their bank accounts

Topics:
David Andolfatto considers the following as important:

This could be interesting, too:

Bradford DeLong writes John Maynard Keynes (1926): Trotsky on England: Weekend Reading

Greg Mankiw writes The most important book I’ve read this year

Scott Sumner writes Bubble world is here

Tyler Cowen writes Facts about British exports (and imports)

The Trust Machine: The Story of BitcoinI came across a presentation of Bitcoin the other day called The Trust Machine: The Story of Bitcoin.  I thought it was very nice and I encourage anyone who's interested in Bitcoin to view it (less than 25 minutes). What I offer below are questions and comments that came to my mind as I listened to the narrative. I'd recommend listening to the entire presentation first and then reading my comments below. The bold numbers represent the corresponding time in the video to which the remark pertains.
1:04 Before Bitcoin, the only way to make electronic payments over the Internet was via your bank. However, over 2 billion people in the world do not have access to a bank account.  
Sure, but why is Bitcoin the best solution for this problem? Nobody was connected to their bank accounts electronically prior to the Internet. The solution was to get people connected. Most people are now connected. Why is the solution not to remove the barriers that prevent the rest from getting connected?
1:35 And even those who do have a bank account aren't exactly free to send money to anyone anywhere online (Fidel Castro graphic). If two governments don't get along, money simply doesn't flow across their borders. Digital cash would connect people economically in a way never before possible.
First, just to be clear, electronic money does not "flow" across borders. Electronic money lives in a ledger. The question is who gets to use the ledger. Not being able to "send money" from the U.S. to Cuba means that Cubans (living in Cuba) are not permitted access to the ledgers created by U.S. banks and Americans are not permitted access to the ledgers created by Cuban banks. There is a communication barrier.

Second, given such a communication barrier, it's hard to see how digital cash would help connect people economically--by which I mean that if money is "flowing" in one direction, goods are flowing in the other. How does digital money help lift a trade embargo? It does not. Digital money could be used, however, to facilitate international remittances.

1.59 Antonopolous remarks that Bitcoin can do for banking and finance what cellphone technology did for communications and empower billions of people around the world. Brito remarks that Bitcoin for the first time makes possible P2P transactions without the aid of intermediary.
I have a lot of respect for both these guys. But I'm still not sure how Bitcoin (or blockchain technology more generally) is supposed to facilitate banking and finance (I elaborate here). As for the contention that Bitcoin does not need a third party to clear transactions, this is, strictly speaking, not true. The third party in Bitcoin consists of the miners--no P2P transaction can be cleared without their help. So, no, Bitcoin is not "just like cash" (which truly does not depend on any 3rd party).
5.16 Within a small trusted group like a family, you really don't need money. Money actually starts as a shared memory.
I'm really happy to see this key insight--known to anthropologists and economists for a long time--is starting to catch on. See: Why the blockchain should be familiar to you.
5.40 But this kind of written money works only if we trust the people we are making promises with. 
Well, this is not exactly correct. In fact, memory (e.g., credit histories) are a part of the solution to the lack of trust problem. Reputations rely on memory. And we expect cooperative play from noncooperative agents concerned about protecting their reputations. The need for conventional money arises because memory (the shared communal ledger) does not scale given the limitations of a network of human brains communicating verbally. Money permits anonymous agents to transact and can therefore scale beyond local confines.  An anonymous person is someone for which we have no personal history. But we're still willing to grant them a favor if they show us the money. Money is a substitute for the missing record-keeping technology. (For more detailed and technical explanation, see here.)
11.50 This leads us back to the problem we face online. The Internet connects people globally, yet people are largely restricted to using local currencies. Who is going to make the digital "tickets" for the Internet? And who will we trust to be in charge of them? 
This is clearly leading up to the suggestion that Bitcoin is a natural global currency. The idea of a single global currency has a lot of appeal. The closest thing to this we have today is the U.S. dollar. But because not everyone has USD accounts, there are the usual inconveniences and inefficiencies associated with uncertain nominal exchange rates. How big of a deal is this? I do not know, but I suspect that among all the factors that contribute to the advancement of material living standards, having a common currency is not at the top of the list. We might get some handle on this issue by asking how much better off are the people of the EMU since the adoption of the Euro? (See: How Much Does the EMU Benefit Trade?)
12.22 The key to Bitcoin is the way Satoshi flips the traditional model of trust on its head. Instead of letting a bank control the ledger, you share it with everyone. 
This is subtly (and importantly) misleading. Control of a ledger does not map simply into whether it is shared or not. For any ledger, read and write privileges need to be separately specified. It is true that in today's banking system, banks possess both read and write privileges and that they limit the read privilege severely (you can only look at the account balances in your account and no one else's). Note that there is no technological reason for why conventional bank ledgers cannot be made open for public viewing. Doing so would effectively make the ledger "shared" and "distributed" (if it could be freely copied). That this does not happen reflects the preferences of bank customers. We don't want the world having full viewing privileges over our personal bank accounts. But there is nothing right now with current technology that prevents people from publishing their diary online (rendering is shared and distributed).
12.45 This shared file model is more secure than any bank ledger could ever hope to be.
If every student in a classroom can see what the school teacher scribbles on the blackboard, then it'll be very hard for the teacher to later claim she did not write it. Say something stupid in public and you'll never erase the public record. This is the power of a shared ledger. But banks already have the power to share their ledgers. Their bank customers do not want them to. Perhaps bank customers wouldn't mind so much if their accounts were anonymous (like the old Swiss bank accounts). I'm sure that Paypal would love to offer Swiss-style bank accounts. If it was legal. Which it is not. But if this is what people truly want, then why not have them lobby their respective governments to reinstate the anonymous bank account? Bitcoin is a "solution" in this regard only insofar it circumvents the law (which it's very good at doing, since it's a decentralized autonomous organization).
12.50 Bitcoin is a piece of shared software that everyone runs together instead of having one trusted computer do it (Graphic shows bank with one copy of ledger and Bitcoin with multiple copies). 
First, there is nothing that prevents a bank from keeping multiple backup copies of its ledger (Fedwire has multiple back up computers, for example).  Second, I'm not sure what it means for "everyone to run a shared software together." I presume it means that the agents or agencies that have volunteered to operate as miners collectively agree to follow the protocols laid out in a particular version of the software. Sure, and banks within the banking system collectively agree to abide by banking regulations. The software evolves over time in accordance with the wishes of the broader community--miners can "vote" on which version of the software to use--code patches that benefit the community are adopted. Banking regulations also evolve over time in accordance with the wishes of the broader community via choices made by elected representatives.
13.57 There is no center to the network, no central authority, no concentration of power. It's exactly how ant and bee colonies function.
To say that there's absolutely no concentration of power is overstating things. The core developers likely have more say than others. Those agencies that have invested heavily in mining equipment have more say than others. Concentration of mining power is a concern. (Miners themselves have avoided overly concentrating power for fear of destroying the franchise value. This is, ironically, the same force we expect to discipline conventional banks.) And as for ant and bee colonies, they have hierarchical structures, including a queen. From outer space, humanity looks like an ant colony. So yes, Bitcoin functions just like an ant colony--governed by protocols--as does everything else.
14.44 Description of blockchain. 
This is done very nicely. There is something beautiful about the blockchain, to be sure. And while I have some quibbles with what is said in this section, let me step back and comment on the broader picture.

The key innovation of blockchain is in terms of how the write privilege is governed (in particular, the read privilege is not the innovative part; see my discussion above). The conventional solution to the scaling problem is to delegate the write privilege to a reputable agency (which itself is governed by the laws of society). Judging by the way world commerce has expanded over the centuries, the conventional model has been a huge success.

Of course, the conventional model is not perfect. It has been and continues to be a work in progress. Why not concentrate our efforts on continuing to improve this conventional and successful model? As far as I can tell, this is what corporate "blockchain" solutions are offering (as part of the broader effort to improve information management systems more generally). They are not offering (again, as far as I can tell) bona fide "blockchain" solutions--they are offering "blockchain inspired" innovations in data management (for example, increased transparency and more extensive sharing of the ledger).

The spirit of Bitcoin is based on the more ancient model of collective recording-keeping via a communal consensus protocol. That this is now possible on a global scale is the work of genius (much the same way double-entry book-keeping was a stroke of genius).

But extending the write privilege communally comes at a cost. This is because individuals will always find it in their interest to rewrite history in a manner that benefits themselves at the expense of the broader community. How to guard against this? People somehow have to earn the right to write history, so to speak. The Bitcoin consensus protocol uses a Sybil control mechanism called Proof-of-Work (PoW) that dictates who earns the right to "vote" (i.e., who gets to add a given paragraph of script to an ever-growing novel).

Essentially, the write-privilege in consensus protocols have to be gamed. The question is whether the game in question generates good outcomes (where "good" is to be judged by network members). Bitcoin has shown us that consensus-based record-keeping on a large scale is feasible. But it is also terribly inefficient along many dimensions (note: I say this as a matter of fact, not as a matter of passing judgment since conventional banking systems are also terribly inefficient along many dimensions). There is the hope, however, that advances in the design of consensus algorithms will render consensus-based record-keeping more efficient. But the same hope exists for database management systems more generally.

And so, in true Darwinian fashion, we are witnessing a struggle between competing species. Will there be a clear winner in the end? Or, as is more likely in my view, will there be a peaceful (but still competitive and ever-evolving) coexistence?

Related Reading: Blockchain: What it is, What it does, and Why you probably don't need one.
My other musings on the subject available here in case you're interested.

David Andolfatto
The views and opinions expressed by me in this blog are my own and should in no way be attributed to the Federal Reserve Bank of St. Louis, or to the Federal Reserve System.

Leave a Reply

Your email address will not be published. Required fields are marked *