20 December 2013

Bitcoin and quantitative easing

Update 2015-08-16: People told me I was wrong, and Bitcoin could never be forked. And then suddenly, Bitcoin was deliberately forked

Update 2017-12-01: Bitcoin was forked again, and the fork was a success (i.e. it kept value). So now, inevitably, there are half a dozen more forks planned.

Original 2013 article follows:

It’s frequently stated that Bitcoin is finite, that there can be exactly 21 million Bitcoins, and that’s it. Bitcoin fans like to point this out to distinguish it from normal currency, where the central bank can just print more money.

The claim that Bitcoin is finite is technically correct, which as we all know is the best kind of correct. However, it’s seriously misleading, to the point of not really being true at all. To understand why, you need to have been following the Bitcoin saga for a while.

In March 2013, Bitcoin forked. It turned out that versions 0.7 and 0.8 of the software behaved slightly differently, and after a particular block of data the ‘block chain’ (the registry of all bitcoin transactions) split into two: the 0.7 block chain, and the 0.8 block chain.

This was resolved by the community deciding that everyone who had mined or traded bitcoins on the 0.8 chain was out of luck — nobody was going to accept their coins as valid. So not only did Bitcoin turn out to be less finite than people had hoped, it also turned out that people could have perfectly valid Bitcoins taken away from them by fiat.

Of course, taking people’s Bitcoins wasn’t the only option. The Bitcoin protocols could have been extended to include a block chain indicator, which would specify whether each coin was a 0.8 chain coin, or a 0.7 chain coin. But that would have suddenly dramatically increased the number of Bitcoins by over 50%. The Bitcoin community values the idea of there being only 21 million of them, so collectively it decided that a better option was to effectively seize and invalidate the new coins of those who had adopted the new version of the software.

Since Bitcoin is just software, the block chain indicator idea could be extended further. You could start a new block chain each year, just like most national currencies have a year of issue on their coins and banknotes. Each Bitcoin would be labeled with the year of issue, so the software would know which block chain to transact with.

And effectively, this has happened. Except instead of a year of issue or some other numeric version fork of the block chain, people have come up with a new name for their Bitcoin fork, and usually made a few tweaks to the algorithms. Anyone can do it. Already there are dozens of them — Litecoin, PPcoin, Megacoin, Betacoin, AnonCoin, PhenixCoin, and so on. There’s even a satirical Dogecoin. And the Dogecoin community has decided to allow inflation.

Just as Bitcoin 0.7 only remained limited to 21 million coins as long as everyone agreed not to use the 0.8 block chain, so Bitcoin in general is only immune from currency expansion as long as everyone agrees not to use any of the forked alternative crypto currencies. So far, it doesn’t look like that will be the case — everyone’s hoping that by picking a new fork, they can get in on the ground floor of a bubble just like the Bitcoin one.

The Bitcoin series:

  1. Explaining Bitcoin
  2. The future of Bitcoin
  3. Bitcoin and Quantitative Easing
  4. Other dissenting voices
  5. Bitcoin: where the impossible takes slightly longer
  6. Bitcoin update for 2016

© mathew 2017