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The Illogical Value Proposition Of Bitcoin


This paper has been doing the rounds on Twitter. Written by the pseudonymous “Mr. Game & Watch”, it purports to “demystify” the “value proposition” of Bitcoin. Bitcoin’s price has soared recently, and many people think that it is likely to crash. But this paper says that it could rise far, far higher. Should it be taken seriously – or does pseudonymous mean pseudo-science?

A man uses his phone as he walks past ATM machines (L and R) for digital currency Bitcoin in Hong Kong on December 18, 2017. Bitcoin has soared in recent weeks, breaking numerous records, and has risen more than 20-fold since the start of 2017. ANTHONY WALLACE/AFP/Getty Images

The paper starts by defining what it means by Bitcoin:

The word “Bitcoin” refers to two different things: a digital collectible, and a piece of technology. The collectible has a market price and individual owners, and in this way it is similar to physical collectibles such as gold, baseball cards, or oil. The technology, in contrast, is a software application that will attempt to connect to a peer-to-peer computer network over the Internet. If the connection is successful, the application will download messages, interpret them, and display them to the end user. Henceforth, we use “BTC” torefer to the collectible, and “the blockchain” to refer to the technology.

Now, this is not strictly true. The “coin” itself is indeed a collectible, but blockchain is only one aspect of Bitcoin technology, other critical components being cryptography, distribution (decentralization) and Proof of Work (verification). But I’m going to leave others to amuse themselves correcting the technical inaccuracies in this paper. For me, what comes next is much more fun.

The paper defines something that it calls “blockspace”, which it says is required in order to broadcast a message to the blockchain. Bitcoin (BTC) “rents” blockspace, thereby giving its owners access to the blockchain and enabling them to use it for transactions:

BTC’s intrinsic value is that it alone will allow the wielder to access the network’s blockspace. In turn, the intrinsic value of blockspace is that it, together with BTC, enables special USD transactions – we will call these “Peer-to-Peer Digital USD Payments”, or “PDUPs” (see Figure 1).

There is a huge problem with this definition. Whatever bitcoins are, they are not US dollars (USD). Unlike USD, bitcoins are not guaranteed by the “full faith of the US government”. Nor do cryptocurrency exchanges guarantee that they can always be exchanged for USD.

When I pointed this out on Twitter, someone disputed it, saying that describing Bitcoin transactions as “Peer-to-Peer Digital USD Payments” was merely a figure of speech. “It’s only like saying ‘pay twenty dollars’ worth of Bitcoin’, he said.

I’m afraid this won’t do. When Bitcoin is used as a means of payment, the transaction is double-ended. For example, suppose an American business wants to pay its Chinese supplier in US dollars, for same-day settlement. It can do so using Fedwire, or it could use Bitcoin. To use Bitcoin, it must first convert the invoice amount in US dollars to bitcoin at the prevailing market price, using a cryptocurrency exchange such as Coinbase or Kraken. It then sends the bitcoin to its Chinese supplier. The Chinese supplier must now convert the bitcoin back to US dollars, again using a cryptocurrency exchange. There is thus an FX conversion at both ends of the transaction. If the market price of Bitcoin moves between the American business buying bitcoin and the Chinese supplier selling it, the supplier will not receive the original invoice amount. Using Bitcoin for payment transactions involves FX risk for both the payer and the payee.

To be sure, this is no different from using a foreign currency as an intermediary in a USD payment. But if my American business chose to send the payment in Euros via Target2, no-one would call this a USD transaction, even if the Chinese supplier then converted the Euros to USD. Bitcoin transactions are not USD transactions, they are Bitcoin transactions.

Admittedly, the writer does warn that Bitcoin transactions (which he calls PDUPs) have disadvantages, including complexity, cost and volatility:

PDUPs (despite the name) require the user to interact with many new intermediaries, including at least one software provider and one exchange. Thus, PDUPs have a relative disadvantage on cost, speed, and convenience. PDUPs can also be unreliable, in that they can unexpectedly become more expensive during episodes of high exchange rate volatility.

But he unfortunately fails to note the real problem, which is that conversion of bitcoin to USD is simply not guaranteed at all. If exchanges run out of USD liquidity – as I have already warned is a possibility – my Chinese supplier would find himself the proud possessor of worthless tokens. If he had been told that receiving payment in bitcoin was effectively the same as receiving USD, he could sue. Bitcoin is not USD, and it is actually fraudulent to claim that a Bitcoin transaction is a USD transaction.

This article was curated from Google News. You can read the original article here.


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