Security Notes: The Lure of Self-Referential Money In a Cryptocurrency Age

In retrospect, Bitcoin had to be expected. Secular humanism challenges God-centered culture, and quantum physics redefines reality to what we humans measure—nothing more. So money that is hinged on nothing external to itself is a natural followup. But if this self-anchored philosophy is wrong-footed, then as it rises to dominate the global exchange of value, it becomes a ticking time bomb. That give us much to worry about.

The Financial Times in a recent article declared that Bitcoin is worse than a Madoff-style Ponzi scheme. Quite a few highly credentialed observers agree, but reality laughs in their face. Self-referential money led by Bitcoin has entered triumphantly into its second decade, and every day more skeptics plunge in.  The arguments in favor of Bitcoin being a gigantic, long-lasting Ponzi scheme are solid. But if the “Big Bang” was created from nothing, and the universe simply runs on its inertia, why can’t money do the same?

Theoreticians are working on it. The most promising idea to establish a firm foundation for self-referential money like Bitcoin is to add to the protocol a price-stability tax. The death scenario for Bitcoin is as follows: afraid of missing out, more and more speculators buy the currency; the price goes up and dissolves the hesitancy of those holding back; and a mad feedback cycle gets the price into ridiculous heights until it flips, dropping into a free fall. It turns out that the Bitcoin protocol can be tweaked to prevent this “death scenario.” The network will designate a threshold price for the coin, and will prevent the coin from exceeding this threshold by dumping enough coins into the market to tamp down the price.

But where will these coins come from? From the network acting as a “government,” taxing the coinholders. One peculiar feature of Bitcoin is the fact that all outstanding coins are exposed to the public. Their owners hide in the complexities of the mathematics, but the coins themselves are completely visible. It is therefore possible for the protocol to chip a cut from each coin, say 1.5% of its value, and siphon these “chips” to a Price Stability Fund, from which they would be dumped in sufficient quantity to prevent the price from exceeding a preset threshold.

Ideally, the coin will have a fund of its own money and a fund of the money it is priced for, say the U.S. dollar. However, there is no theoretical way to manage a dollar fund through an automated protocol, so this stability tax, being protocol-limited, is only possible one way: to prevent an out-of-bounds price hike.

When the price of the coin inches toward the preset intervention value, speculators will lose interest and drop out. The currency is then left for traders to treat it as money per se. The longer the period of time this coin stays stable—close to the designated threshold—the more inertia develops, confidence builds up, and the currency looks like money, not like a get-rich-quick scheme.

The designated threshold must be voted on by the traders. And, since anyone can open as many accounts as he wishes, the only fair way to allocate voting power is by ownership of the currency. Alas, Bitcoin, as an example, is a currency with an extreme concentration of owners: 0.01% of traders own about one-third of the currency. What the currency is worth will be their call.

If history is any guide, the essential innovation inherent in self-referential currency will be recast as a digital currency hinged on human assets that have a presence outside the trading protocol.

—Gideon Samid, gideon@bitmint.com