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back to article Spam and the Byzantine Empire: How Bitcoin tech REALLY works

Why does Bitcoin work? Fraudsters should have left it in cinders years ago, and might have done, if it wasn’t for two things: spam and the Byzantine Empire. A Bitcoin is basically an entry in a ledger that is distributed across a network of computers. Bitcoins are transferred between parties by noting the transaction in the …

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Windows

Nice... no mention of how the very first Bitcoins were minted though?

There was a recent Planet Money podcast that gave an entertaining layman's explanation of Bitcoin. It went into a bit more depth on how such a digital currency could be bootstrapped from nothing. Basically, at the start, anyone could generate their own Bitcoins once connected to the Bitcoin server, using their own computers. Like the Big Bang of the universe, at the beginning it was fast, then as more coins got generated it got progressively harder until it was easier to purchase them rather than generate new ones. Hence the 'Gold Standard' type concept - you just cannot 'print' new ones, even the founder of Bitcoin cannot.

Apparently there are some as yet unminted Bitcoins to be 'discovered' out there but the computational power and time needed to do it is getting phenomenally rare.

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Re: Nice... no mention of how the very first Bitcoins were minted though?

Not strictly true. Bitcoin mining for the end user is still viable, providing you have an AMD graphics card. They are just miles better than Geforce for this task. There are ASICS boxes being shipped now which hash at more than 5GH/sec being priced at about $300 at present drawing about 5 watts. To give that some context, an AMD 7970 on the market for about $400 can do about 700Mh/sec drawing over 200 watts.

When these units flood the market in the next 6-12 months - it will make the end user using his graphics card for mining completely pointless. It currently takes about a month for a 500Mh/sec card to mine a single coin, which market prices currently retails for about $140, but in 12 months it will probably take 2 months to mine one.

This is because the "difficulty" to mine a coin increases exponentially to prevent the market flooding. It's possible that the bitcoin hash will change to give smaller users more power and to prevent large organisations with MASSES of GPU power from hoarding them all, because all they need to do is change the way the hashes are done, and all the ASIC and FPGA cards will be useless because they will have to be reprogrammed.

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Re: Nice... no mention of how the very first Bitcoins were minted though?

Not strictly true either. The difficulty of mining Bitcoin doesn't increase exponentially. The difficulty of mining is automatically adjusted - either up or down.

Essentially, the next hash is computed from, amongst other things, the hash of the previous block's transactions - which can't be predicted ahead of time - so work on mining the hash which comes after the next one can't be done ahead of time.

That 'next' hash which is being mined needs to have a specific number of leading zeros. The number of these leading zeros that is required varies depending on, essentially, how much world-wide computing power is dedicated to the task of mining. If the protocol detects that megatons of computer power is applied, the number of leading zeroes is increased, making the mining operation much more difficult, and keeping the rate at which these hashes are found constant (at about one every ten minutes.

If the amount of computing power which is mining was decreased (meaning that it would take longer to stumble upon a hash that fits the requirements), then, after a while, the protocol will decrease the number of leading zeros required in the 'next' hash - making the mining operation easier.

All that effort/time/money people put into mining simply makes the mining difficult and much more expensive. The rate at which someone can find Bitcoins remains relatively constant. The number of Bitcoins found each time will be reduced as time goes on. After a while, mining operations will produce no more Bitcoins.

At that time, all these mining operations will stop, and the hashing requirements will be relatively easy.

Copy'n'pasting from the Bitcoin FAQ at https://en.bitcoin.it/wiki/FAQ

== How does the proof-of-work system help secure Bitcoin?

==

== To give a general idea of the mining process, imagine this setup:

== payload = <some data related to things happening on the Bitcoin network>

== nonce = 1

== hash = SHA2( SHA2( payload + nonce ) )

==

== The work performed by a miner consists of repeatedly increasing "nonce" until the hash

== function yields a value, that has the rare property of being below a certain target threshold.

== (In other words: The hash "starts with a certain number of zeroes", if you display it in the

== fixed-length representation, that is typically used.)

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Megaphone

Re: Nice... no mention of how the very first Bitcoins were minted though?

Its bad enough the stupid world financial system is already siphoning off our best minds to invent super complex financial instruments of mass destruction whose main purpose is to hide money from regulators, auditor, investors, etc. But now possibly a lot of the world's computing power will be diverted to a largely arbitrary useless task as well? We need those minds and computers to cure cancer, explore the universe, discover scientific breakthroughs, hell even finding energy sources is a more worthwhile endeavor for humanity. Typical game theory, personal greed over society prospering.

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Headmaster

Re: Nice... no mention of how the very first Bitcoins were minted though?

>Like the Big Bang of the universe, at the beginning it was fast,

Understatement of the day: Rapid exponential expansion of the early universe by a factor of at least 10^78 in volume in a time interval that is at least 15 orders of magnitude smaller than the smallest time interval science has ever been able to measure. Basically a time interval so small that comparing it to a blink of eye would be greater than comparing the blink of an eye to the age of universe.

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Re: Transaction fees

Transaction fees, which are what will power bitcoin mining after the initial distribution of coins are done, amount to 0.025% of the transaction value they are based on. That is not an excessive overhead for running a financial network. Miners, therefore, will not use more computing power and electricity than that 0.025%, because they would be losing money on the task.

As far as total power use, if everyone used ASIC type mining rigs, the entire bitcoin network would consume 820 kW. You can compare that to the 19 MW Apple uses for their North Carolina data center.

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Re: Transaction fees

According to my (admittedly vague) understanding, transaction fees are paid to miners, and higher transaction fees get processed faster than lower ones. Transactors are responsible for setting the transaction fees. This allows a competitive marketplace to drive the current transaction fee lower if ample miners are operating or set it higher to get a quicker response if needed. This seems to me quite ingenious.

I derived this understanding from the statement on my first Bitcoin wallet (from bitcoin-Qt) that asked me to set what I wanted my transaction fee to be. In the Settings field, I find "Optional transaction fee per kB that helps you make sure your transactions are processed quickly. Most transactions are 1kB. Fee 0.01 recommended." Then, there is a field that I can set that says "Pay transaction fee [0.00000000]" -- the field allows 1 satoshi transaction fee. Up-down arrows controlling that field increment/decrement in 0.001B amounts. I can, however, set it lower or higher if I choose.

As I have not yet actually "spent" any Bitcoins, I have not had to decide the transaction fee I am willing to pay, and have not yet really inquired of the Bitcoin community if my understanding is correct. It truly appeals to me, though, to have transaction fees set by market supply/demand (of transaction validation) rather than a rather arbitrary 0.025%. I am currently paying a much lower percentage for each of my Dwolla transactions, so .025% looks high - particularly in view of my initial BItcoin wallet recommendation (assuming the .01 in the wallet quote means .01% - this is a bit ambiguous).

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Good explanation of the technical side

I now know how it works...

though I'm still unsure as to what it's for. Unless you attach some real money/goods to it

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Anonymous Coward

Re: Good explanation of the technical side

I had to use BitCoins to buy a subscription to an NZB index site that Paypal, Visa et al refused to process payments for them. I believe some filesharing sites also use them.

Then there's the Silk Road ....

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Re: Good explanation of the technical side

I'd recommend looking up the original paper written - its concise and well written.

What I like about BitCoin (theory - I don't "own" any) is that it challenges you to think about what a currency is, and why, for example, the problems that immediately come to mind with BitCoin don't (or do?) apply to Pounds, or Dollars.

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Re: Good explanation of the technical side

People exchange about US $30 million a day of real goods and services for bitcoin. As the article explains, bitcoin is just the ledger for tracking exchanges between people. The network of real items that people exchange back and forth is what gives a balance on the ledger value.

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Happy

What it's for

Like any currency, different things to different folks.

It's the seed of a currency that is not under the control of a government or any other human agency. in that respect it's a hard currency like Gold. But physical gold is expensive to safeguard and validate and impossible to use for e-transactions, and "paper" or e-Gold is vulnerable to fraudsters (who basically sell the real gold out of whatever vault it's supposed to be in, leaving a hollow shell of un-backed paper gold.

As for who is using Bitcoins: all sorts of people, but I fear Bitcoins are of greatest utility to those with most to hide. Apparently there are shops out ther in cyberspace on the Tor network, that supply illegal substances. You buy using Bitcoins, untraceably, and a packet may later arrive in the post which may contain your choice of illegal drug. Buyer beware, but E-bay has proved that the straightforward sort of fraud is not profitable. You can't maintain a reputation while ripping off many of your customers. Especially not for low-value transactions that promise repeat purchases. It's better to cultivate the repeat business. What works for legal products appears to work for illegal ones. (All allegedly ... I have no idea beyond what I've read about it).

It seems to me that the more governments gain access to our transaction histories and employ "big data" computing, the more attractive the Bitcoin will become. I don't mind Tesco having a record of everything I've ever bought at Tesco (except the cash no card transactions!), but a world where the government's computers analyze every single purchase and financial transaction that I've ever made is not apealing. Enter many more Bitcoin users?

Which is one reason governments hate Bitcoins and would like to kill them off if they could. Their propaganda (with more than a grain of truth) is that Bitcoins aid money launderers and tax evaders. Their other reason is that if Bitcoins flourish, it will be at the expense of all governments' ability to print their own money, and thereby rob (or tax) us all by inflation.

We live in interesting times. (Smiley face just worked out that the circle on the inside of the empty envelope is the bit he's supposed to eat).

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Re: What it's for

"Which is one reason governments hate Bitcoins and would like to kill them off if they could. Their propaganda (with more than a grain of truth) is that Bitcoins aid money launderers and tax evaders. Their other reason is that if Bitcoins flourish, it will be at the expense of all governments' ability to print their own money, and thereby rob (or tax) us all by inflation."

An old friend used to work at BACS.

They had a project to see how fast transactions could be made across the globe.

When the team did a presentation showing they could easily do it in under 20 seconds the project was pulled as there wasn't enough time to bounce the money around in order to generate sufficient profits.

It isn't the money but the movement of it that generates the swill for the trough.

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Re: What it's for

[flameproof trousers on - I'm about to say something that genuinely isn't trolling but won't go down well]

I know it's fashionable to be rude about politicians. And there's a lot to be rude about.

But few governments are actually evil. And most are trying their best to do the right thing, incompetence permitting. For a given value of right, in that people do tend to forget that their own interest is different to their voters' interests, and end up doing stuff to suit themselves. Putting this caveat in to say I'm not a naive idiot, and realise politicians screw-up and both politicians and civil servants sometimes conspire against the voters.

But the UK government (for an example) isn't trying to rob us with inflation. Firstly 2.4% inflation isn't desperately high. In fact it's low by recent historical standards. What they're trying to do is to keep the economy from melting down, and a bit of inflation is a perfectly acceptable price to pay for that.

One of the problems of deflation, is what it does to debt dynamics. This is a major reason why there likely won't be a proper banking system in BItcoin. If economic growth/slump + inflation is lower than zero, then the value of an economy's debts compared to the size of the economy grows. This is what's happening to Greece, and is the reason that Japanese government debt has hit 250% of GDP. It's a disaster. Because eventually you have to default. So even when the economy isn't growing, a bit of inflation stops your debts getting bigger than your income. If on the other hand you have deflation money is getting more valuable than the things it can buy, so debt becomes harder to pay off. This would rewards savers, but not in the normal way. Because you don't need to lend your savings to get interest, you can stuff them under the mattress (or digital equivalent in the case of Bitcoin). Which is all well and good for you, but means the economy can't use that money in the meantime, and so can't do stuff with it. Like invest. Therefore you won't be able to take out a mortgage in Bitcoins, and as that's the largest transaction any of us is likely to make, that'll keep us trading in our own national currencies. Plus no investment = no R&D.

Finally, don't be so rude about taxes. Sure I'd like to pay as little tax as possible. But if we don't pay any tax, then when we have that heart attack, there'll be no nice ambulancemen to come along and jump up and down on our chests until it's going again. Just like bailing out the banks was the best of a bunch of bad options, a bit of inflation 'taxing us all' to save the borrowers is also better than writing that debt off and having to bail out the banks again. Or not bailing out the banks and losing our savings. The trick is to have higher interest rates in the boom, and governments not to spend more than they raise in tax - for which politicians are surely at fault, but so are voters.

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Unhappy

Re: What it's for

few governments are actually evil. And most are trying their best to do the right thing, incompetence permitting.

I'd tend to agree, except that they've convinved themselves that they are doing good in a circumstance where there may be nothing good to be done. We're now the subjects of an unprecedented experiment in economics. (If you think the 1930s were the precedent, remember that led to WW2, so I very much hope not). Power corrupts. Government is forever taking more power. We know what is proverbially paved with good intentions.

UK govt. has "printed" £375 billion by QE in recent years. That's over £6,000 per citizen. Some day, it will come flooding out into circulation. When that happens, I fear that the 1970s will be seen as a mere dress rehearsal for what is still to come.

I can remember the 1970s. I hope I'm wrong.

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Re: What it's for

Well the official 2.4% inflation rate is no more than a guesstimate since it is actually very hard to measure the cost of "a basket of goods", not to mention the question of what gets included in the basket (housing costs?).

Mind you, even 2.4% is actually pretty high compared to the state of the economy; this is down to government and BoE actions over the last 4 or 5 years which have been aimed at keeping the financial industry zombies 'alive' rather than worrying about inflation targets that have now been exceeded for 40 months in a row.

Still not to worry; I see that one of the senior Fed Reserve board members has been telling the US mortgage industry that they should ease their qualification rules on how much to lend and to whom, so its all going to be tickety-boo again soon.

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Unhappy

Re: What it's for

"I can remember the 1970s. I hope I'm wrong."

Probably not wrong. The incoming governor of the Bank of England has recently been quoted as saying that Europe faces a lost decade (or two) if it doesn't copy Japan's latest efforts to kick start the motor. And to be specific, Japan's latest effort has been deliberate attempts to ignite retail inflation, and to devalue the huge debts that hang around the Japanese economy's neck. The UK is not that far behind Japan in the ranks of Hugely Indebted Economies.

That's a big hint that he's all for more retail inflation. As you note, QE merely inflated asset prices, with the retail impact so far largely due to the depreciation of sterling. If he's setting out to cause inflation, then expect broad money supply inflation, exactly the scenario that Maggie inherited, and likewise the ultimate result of years of Labour party financial ineptitude and mismanagement. But who will undo the damage in future?

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ST7

I ain't Spartacus - with all due respect

I ain't Spartacus - with all due respect, you're wrong.

As the monopoly currency issuer a Government doesn't need to borrow any money in order to spend.

The fact that they do so has its roots in the gold standard (whereby a King had to have gold in his treasury in order to wage war)

The Bank of England was set up by a private group of wealthy men specifically for the purpose of financing, at interest, the Government of the day.

Today the BoE is wholly owned by the Government, any interest gained by the bank on loans made to the Government are returned to the Government in the form of BoE profits.

The Government spends money into existence and taxes it out of existence (net neutral)

The inflation that you speak of is coming from the private banking sector, they create money in the form of credit/debt (credit from the word credo meaning faith). The bank creates £100 (at todays value) which it lends to you, there is now £100 extra in circulation and so the currency is devalued, the interest you are charged covers both the risk of not getting it back plus the reduction in value (otherwise the interest rat would be the inflation rate)

eg. the bank lend you 100 units to purchase 100 carrots but the increase in the supply of units means that each carrot increases in price to 1.1 units, in order to pay back the bank you must give them 110 units plus the insurance premium.

All that is missing from BitCoin is a credible futures market (paradoxically, gambling on the future price of a commodity creates stability)

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Re: What it's for

>"I can remember the 1970s. I hope I'm wrong."

Yeah the late 1970s and early 80s were bad in the US as well (was a kid then but remember) not to mention the early 90s but honestly I think the combination of the Dotcom crash (and 9/11) and the Great Recession put it to shame in most of the Western world. This generation has seen things only their grandparents have seen in modern history (only buffered from far worse by making our grandkids pay for it). Not saying things can't get worst but if they do its going to be far worse than the 1970s stuff minus perhaps the oil embargos.

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Re: @ST7

Really?

There was a nearly perfect testbed for this theory. Soviet Union.

Its government had nearly unlimited power over the financial system, and not just that - pretty much all the means of production were state-owned, or at least tightly controlled. There was no private sector to worry about. Especially no private banking.

The Iron Curtain was very effective against any foreign influences to the currency. Until the 70's, foreign trade was extremely low - most of the necessary goods were produced domestically.

And still, every time they printed money on the grand scale, it resulted in a heavy inflation:

- after WWII, which was obviously a difficult time

- before and after 1961 currency reform (this new currency was nearly destroyed by the inflation, which was one of the factors leading to the 1964 regime change)

- at the end of 70's, when war in Afganistan and Olympic Games needed financing

This last money-printing affair was so extensive that SU never really recovered from that. Inflation grew much worse during the 80's, ending with the true hyperinflation.

Of course, there were other factors to the economic collapse, but money-printing and excessive spending were definitely the worst culprits. And, to remind once more, in a relatively isolated environment.

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Devil

Re: What it's for

"few governments are actually evil. And most are trying their best to do the right thing, incompetence permitting."

It's not the govts that worry me. It's the evil buggers in the background, controlling the govts.

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Re: What it's for

Um so why haven't govs killed of notes & coins cash yet?

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Re: What it's for

"Um so why haven't govs killed of notes & coins cash yet?"

Do you think they pay for those billion dollar projects in cash? Its an interesting exercise calculating the volume of currency required for <INSERT DEBACLE HERE>

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Anonymous Coward

Bitcoin isn't as stable or free as it's proponents claim

A major shortcoming is that the ability to change the protocol isn't as hard or farfetched as you mention in the article. It would, indeed, require "operators of the vast majority of the computing in the Bitcoin network (to accept) a new version of the protocol." But the operators of the vast majority of the computing power as it stands now are a few individual mining pools, and ASIC mining companies. And they are very likely to act in their own self interest.

I expect that in a few years, they are going to argue that deflation is damaging bitcoin, and that "for the good of community and the stability of bitcoin" it will be necessary to continue to mint coins at the current rate, and to disregard the scheduled block reward halving.

Or if those few ASIC miners and pool operators received a court order requiring that transactions from a certain bitcoin address should never be included in a block, you can bet they'll comply. They have no economic interest in fighting the order, or relocating themselves (and their controlling minds) offshore to avoid a contempt charge. Better to comply, and continue raking in the money.

Thus the centralisation of bitcoin computing power in such few places renders the purported stability and imperviousness to government regulation rather suspect.

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Anonymous Coward

Re: Bitcoin isn't as stable or free as it's proponents claim

Hi!

As it stands, the miners are not the only users who have a say when it comes to changes in the system. The whole broadcast network, ie. most users, need to have a consensus on the rules.

As seen in the past, when mining pools start gathering too much power, users leave them and establish new pools. Further, there is also a P2P pool.

If a pool is regulated by authorities, you can be sure that people will establish a new pool perhaps in the Tor network that readily includes all sorts of transactions. It does not matter if a pool operator has economic interest in whatever, because they do not own the computing power.

Any sort of changes in the rules are generally very difficult to make. While in theory you can say that a majority agreeing is enough, even if a few percent of users disagree to something fundamental, it will deliver a huge blow to the network's credibility, because, what if the next day the majority votes for something that YOU don't agree on? Not a very nice system, is it - perhaps you should better leave it because you don't know what rules are changed next? It would crash the perceived security of the system. And this is why the sort of changes you talked about, are not likely to happen.

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Anonymous Coward

Re: Bitcoin isn't as stable or free as it's proponents claim

Most users mine via a pool. Much like how individual small shareholders delegate their vote to the chairman at AGMs, these miners are delegating their hashing power to the pool operators. This isn't a case of one pool becoming too strong and people leaving to balance things, it's a case of there being a small enough number of pools and mining companies for it to be feasible for a set of court orders to be delievered, or a consensus to be reached among them regarding block reward rules.

In your counterexample, anyone including 'banned' transactions would find their own blocks rejected and orphaned, so long as 51% of the network complied with the court orders. Call me pessimistic, but given my own understanding of human nature, I believe most people (especially those motivated to spend money on mining hardware in the first place) place aquisition of wealth over abstract notions such as maintaining the freedom for suspected terrorists and money launderers to operate. Which will no doubt be the excuse used for those court orders.

I guess time will tell which of us is right. But I maintain the centralisation of mining power into a countable and concentrated number of spots, rather than promoting hundreds of thousands of nodes solo-mining, is a weakness. And expecting people to 'do the right thing' if such spots begin to be attacked is being optimistic about how humans respond when principles and making money conflict.

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Am I the only one who notices the flaw? It's all well and good to use progressively more difficult computational work to underpin bitcoin but that work uses not just real world time but energy.

We've just created an incentive to turn fossil fuels into nothing but hot air (literally). Is this an elaborate joke being played on us to teach us the futility of capitalism system? Why drive to work, develop ideas, make products in order to make money when you can get a machine to turn energy into money directly without all that complicated and confusing economic activity in the middle.

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Happy

Sunshine -> Money

Well, you could always hook your mining rig up to a bunch of PV panels and turn sunshine into money instead!

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Happy

Fossil fuels are made from once living things and burning them releases their joy back into the world.

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Same as other curencies!

It's all well and good to use progressively more difficult computational work to underpin bitcoin but that work uses not just real world time but energy.

The main reason gold is a store of value, is that mining more of it is expensive.

As for government paper, what is the energy cost of all the enforcement mechanisms needed to prevent forgers and fraudsters devaluing the currency? (Fraud squads, auditors, bankers all consume energy). Much harder to quantify, but it would be fair to say that if it wasn't substantial, the currency would be sunk pretty fast.

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Happy

@ Thing

A more philosophic answer to your question is two fold:

1) Bitcoin is a natural extension of capatilism as people attempt to increase the value of their possessions to give them greater security and options. It falls under the 'innovation' category 'try it and see if you get money'. I'm betting it won't work (due to vested outside interests and governments) but that too is a part of Capitalism.

2) Even if we lived in a Star Trek type environment where money wasn't necessary the vast majority of people would still go to work (of some sort). Having a mission is a pleasing mission to Humans. The difference being right now most people are forced to do jobs to provide lives for themselves outside of poverty. If Humans could work at what they enjoyed (instead of what pays bills & medical costs) the world would probably be much more effecient & happier place but you'd still go to work.

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Trollface

Re: @ Thing

Of course money is unnecessary in Star Treks universe as the entirety of it's society's economic activity and output is consumed by it's bloated military industrial complex and it's endless series of expansionist wars with people who are 'evil' and by complete coincidence also look a bit funny.

... but that's is a meta-economic discussion for another day :-)

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Re: Sunshine -> Money

Like growing cabbages.

Except people can actually eat cabbages.

The problem with this whole mining idea is that it is not even a real mine. Some folks decided "let there be a virtual mine" with scarcity. We can mine it easy in the beginning and basically do a huge land grab.

What is there to stop someone else coming along and saying "well bitcoin was a bit of a scam. We've stated a new currency that does it slighty differently and more green/democratically/whatever." Bitcoin goes out of fad and the next one takes over.

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"Fossil fuels are made from once living things and burning them releases their joy back into the world."

and their sorrow :(

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@Sunshine -> Money

Many of the ideal locations for solar/wind/wave/etc. power are too remote to get power out of efficiently. While we still use non-renewable energy for power generation then bitcoin mining at those locations and using the funds to offset the non-renewable costs would be far more efficient. 100 miles of 1 gigawatt cabling could be replaced by a USB key.

This energy usage argument comes up a lot but the bitcoin network is already more powerful than the worlds top 500 supercomputers combined yet it uses only a few percent of the power used by the worlds ATM machines thanks to dedicated hardware.

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The problem with real-world currencies is not governments

It's banks. Banks create money when they create loans, and they now create the vast majority of money (estimates range from 95-98%). Unless you are prepared to have 100% reserve banking, preventing banks from creating money, you cannot base an economy on BitCoin without completely debasing the currency. There are many sources for this, here's one: http://www.webofdebt.com/articles/dollar-deception.php

The fact is, fixed currency standards don't work; they cannot scale to the level of growth in the economy without increasingly mining an ever greater amount of whatever commodity you pegged it to, and having to store it. Gold was useful here because it doesn't obviously degrade, and has few uses (its use in electronics, of providing a tarnish-free and reasonably conductive coating to ensure good contact for connections made and broken repeatedly, was decades away when we went off the gold standard). Failing to keep up with economic growth causes deflation, which is generally considered a bad thing: http://krugman.blogs.nytimes.com/2010/08/02/why-is-deflation-bad/

Fiat currency allows the supply of money to approximately match the aggregate demand of the economy, without uselessly mining a resource that you're not going to use. Central banks can wield a few levers to try to keep the supply slightly ahead of demand, in order to get a little inflation, which helps devalue debts as well as savings. The problem we've had for a decade or so is that the economy is very imbalanced, with consumer electronics largely in deflation, cancelling out some very high inflation in house prices (not measured in the favoured 'consumer price inflation' metric) and other commodities.

Really, money is just a medium of exchange: something that has wide acceptance in exchange for other things. It's just our IOUs to each other: I owe you a day of software development, you owe me an Xbox. By assigning numbers to these IOUs, I can transfer your IOUs so that Samsung owe me a TV. You have to think of money's value being in terms of what it can buy. Instead of thinking that a sandwich costs £2.50, you say that a pound is worth 4/10ths of a sandwich.

The major problem for government is that politicians do not understand how money is created, and how differently it behaves under a fiat currency system compared to a pegged system ('gold standard'). Too many economists - and, unfortunately, the ones that the politicians are listening to - still make their predictions based on ideas from the gold standard era - that there is a finite amount of money.

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Re: The problem with real-world currencies is not governments

The trick is that people have to TRUST the money for it to be useable. Inflation degrades that trust because it diminishes the value people have on hand. If inflation grows too high, you start a vicious cycle towards hyperinflation which inevitably removes trust in the currency. That's why many people liked pegged or 100% reserved currencies: there was a surety of the money being backed that you can't get with floating or fiat currencies.

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Bronze badge

Re: The problem with real-world currencies is not governments

The trick is that people have to TRUST the money for it to be useable.

An oversimplification. A currency is used, and valued, to the extent that people believe it's a reservoir of value. That means trust isn't required; what's required is the belief that return will tend to outweigh cost, where cost is a function not only of risk ("trust" here being the absence of risk) but of convenience, opportunity costs, etc. In practice, people will use a currency even when it's clearly not trustworthy, if they think it's cheaper to use it than to seek an alternative or do without.

That's why people continue (reluctantly) to use currencies even when they're suffering hyperinflation, and why Somalia's currency came back into circulation even when there was no central bank or effective government to guarantee it.

For ordinary users, the value of a currency is basically (nominal value at the moment for goods I want) x (how much I expect it to lose value before I spend it on those goods) x (likelihood I can exchange it for those goods) x (1 / cost of finding an alternative acceptable to my trading partners). Then of course there are currency speculators, who also figure in their estimate of the likely rate of return, versus the likely returns for other investments.

The issuer of a currency does try to promote trust in it, or at least a high degree of confidence, because that helps make the currency popular and relatively stable. But plenty of people use currencies they don't trust, either because they have enough confidence in it, or because it's cheaper and more liquid than the alternatives.

My point is that "trust' suggests an absolute attribute of a currency, and in reality that's not how things work. Sure, with a major, stable currency, most users likely don't even think about whether they trust it. But when things start to fall apart, history shows that even ordinary users become quite canny at evaluating how they can use a currency as a medium of exchange while preserving as much value as they can.

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Holmes

@ Mike Dimmick

"The fact is, fixed currency standards don't work; they cannot scale to the level of growth in the economy"

and what if the economy doesn't grow ?

"Banks create money when they create loans, and they now create the vast majority of money (...) Fiat currency allows the supply of money to approximately match the aggregate demand of the economy"

Correct, except that you are missing here the interests : when a bank creates money by making a loan, the amount of money created is equal to the amount of principal of said loan, but the amount of money corresponding to the interests is not created. So how are you supposed to pay something that hasn't been created ?

Duh !

Therefore, in such - our - monetary system, the amount of money must always grow, but when the economy cannot grow (because of the physical limits of resources for example), the system gets out of control. The interest should then become negative, but it cannot because then all investors take their money out of the banks and keep cash, and the fractional reserve banking collapses for lack of deposits.

This is the root of what we are witnessing today: a giant (150 years old !) Ponzi scheme unraveling.

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Re: The problem with real-world currencies is not governments

Seems to me you failed to understand the article you quoted. Somalia's currency came back into circulation precisely because there was a limited amount of it and no more could be printed. The whole argument in favor of a quite rigid supply of money is beautifully articulated in von Mises "Theory of Money and Credit" - Krugman's nonsense to the contrary notwithstanding.

The article asks "Why, then, are Somali shillings, issued in the name of a government that ceased to exist long ago and backed by no reserves of any kind, still in use?"

It answers:

"One reason may be that the supply of shillings has remained fairly fixed. Rival warlords issued their own shillings for a while and there are a fair number of fakes in circulation. But the lack of an official printing press able to expand the money supply has given the pre-1992 shilling a certain cachet. Even the forgeries do it the honour of declaring they were printed before the central bank collapsed: implausibly crisp red 1,000-shilling notes, with their basket weavers on the front and orderly docks on the back, declare they were printed in the capital in 1990."

This is precisely what von Mises articulates in his book. The real key is the money supply is STABLE. It is the "LACK OF A PRINTING PRESS ABLE TO EXPAND THE MONEY SUPPLY" that does the job.

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Anonymous Coward

Money isn't the bank - neither should bitcoin

The services that were hacked had nothing to do with the infrastructure of the bitcoin network, or really bitcoin itself. Just as any service can be hacked, they were, and it just happens that they were targeted because they hold sums of BTC, and thieves love money.

What needs to take place to stabilize things (and they are more or less stable at $111-$130USD/BTC right now) is for exchanges to put into place some market manipulation protection.

If the average price of bitcoin is $100 and someone tries to sell volume through the exchange at $20/btc, it drives everyones wealth down. This should not be allowed by the exchanges. Wells Fargo was involved in exchanging for a short while, but banks quickly realize this currency is designed to circumvent them, and their fees.

Digital currencies are a way to fight back against the banking system, my money is MINE - I should NOT have to keep my money in your box, pay you a fee for it while you make money off of it, then pay you more fees to transfer or spend it. Banking fees should be going down, not up - theres nobody at the counter anymore!

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Anonymous Coward

Re: Money isn't the bank - neither should bitcoin

Someone offering to sell at $20 isn't selling bitcoins at $20, that's merely the price they're indicating they're prepared to accept. Any existing bid orders will be matched first... so first they'll sell a chunk at $120, then a chunk at $119.95, then a chunk at $119.92. Unless they have so many bitcoins that they can exhaust the exchanges entire order book, the price won't go anywhere near $20.

And if it did? Everyone who bought low would immediately relist their cheaply aquired bitcoins back at $120, probably while laughing at the sucker who just sold a chunk at such a silly price.

What the exchanges actually need right now, is some infrastructure (Gox is a joke) and regulatory stability. Pretty hard to have confidence in a currency, if you're living in constant fear of the exchange having its servers yanked in response to a money laundering investigation.

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Re: Money isn't the bank - neither should bitcoin

Indeed, regulatory stability is a requirement. And regulatory stability is one thing I would love to be able to expect from our government.

As long as MtGox keeps to the legislation under which it operates, the government will prosecute a crime any attack on it. After all, there is real money involved.

The recent impounding of the cash held by the transfer agent between MtGox and Dwolla appears to have been that it allegedly failed to comply with FinCEN rules regarding registration as a money exchanger (if I got it right). If so, it seems to me likely that the outcome is going to vindicate MtGox, Dwolla, and the transfer agent.

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Boffin

Creating stable and local money is easy

Making it suitable for more than 2% of the economy is harder but should be possible.

I spend and earn some local money every month. Nothing to do with Bitcoins. In addition to UK Pounds a small amount of my (currently all post tax because it's not regular) income and expenditure is in Covs. We (Coventry LETS) are a group currently of about 50 people who support each other and trade and keep score, though we've had about 400 people in and out using our books over the 20 years we've been in operation. We don't need complex cryptography either. We started paper based, and now use a web application to keep score. The currency is issued by those creditworthy enough within the community for trading partners to be happy to hold a negative balance. It's all double entry bookkeeping. It stays local because that's how far good reputation extends. It stays stable because the money is as good as the reputation of those issuing it. Money earned on our system 20 years ago is spendable today based on our agreement that 1Cov is nominally equivalent to £1.

Why we need unconventional competition for global money, other than for criminal or gambling networks, is something I don't figure, because conventional money works quite well at preferring global trade to local trade. Those who trade globally don't pay taxes, those who trade locally do. Consequently the global trading space isn't where the real gaps in the economy exist. Becoming less dependant upon money as a national monopoly system where people think there can only be one kind of money requires a mechanism allowing local moneys to multiply and expand into taxable areas of income and expenditure, while retaining boundaries giving these currencies advantages in the trading contexts where local currencies can do well. These boundaries (like cell walls) require taxes on income/profits/value added in respect of local currencies becoming payable to the local authority or charities and exempt from taxes due in conventional money - with taxes on local money paid as transaction taxes and as an inherent function of the transaction occurring on the books where the local money exists.

Once currency exchange requires taxation as an inherent feature of the transactions, a more stable boundary between pairs of currencies is created because speculation and arbitrage can only occur based on genuine end-user requirements and never as an activity in its own right unconnected with such.

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Pint

Re: Creating stable and local money is easy

What is the advantage of this system if it is pegged to the pounds value though? appreciate it keeps the currency between the small group of traders but you could easily do the same thing with any currency even the pound.

The article is a bit lacking in places. There are sights to borrow and lend BTC (bitfinex is one) which allows trading on margins or borrowing at various intrest rates. It was quite fun during the last bubble cashing out and then lending the $ at 400% intrest. You can lend in pure BTC as well but the liquidity is smaller.

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Bronze badge

Looked at from the right point of view, in the long term Capitalism is theft. It keeps moving around, but the over the 300-odd years of its history, the successful countries have succeeded for a while by skimming the cream off a flow of wealth. So Britain made huge amounts of money by moving wealth through the City.

Yes, there is the industry which can be built as a side effect. Capitalism started as a way of sharing risk. Whether capitalism is the only way of organising a society to do that is still open to debate. Communism failed, but can we seriously claim it was the only alternative?

Bitcoin isn't a good answer, for various reason enumerated in the article, but does it need the mechanisms of capilalism to be useful? The bank is older than capitalism, and Islamic practices have found alternatives to interest. The speculator, buying and selling on a market, is far older than we might think, and doesn't depend on the instruments of the modern financial markets.

E-bay, and the importance of reputation, have been mentioned above. The City and modern banking sometimes seem to be making "My word is my bond" into a hollow jest.

What next is a very good question.

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Anonymous Coward

@Dave Bell - Interesting opinion

As a person who had the (mis)fortune to spend what could be the half of his life under a communist regime and the rest in a capitalist society, I find your post pretty much on the spot. I always believed each of the two systems has a good and a bad part and that maybe a right combination of the two would move humanity towards a better era. Unfortunately I strongly believe the human race is running out of time.

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Bronze badge
Headmaster

Little known fact:

Little known fact: Mt Gox isn't named after a mountain, it originally stood for "Magic: The Gathering - Online eXchange".

The more you know...

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Holmes

Re: Little known fact:

Actually, that's pretty well known.

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