What is the 51% Problem?

With the sudden rise of GHash.io as the number one mining pool, the 51% “problem” has again come to the forefront of people’s attention. It’s about time we pay attention ourselves and think clearly about this issue. At the outset, I have to say that I think this is a non-issue. What is surprising to me is how it is even an issue in the minds of the leaders of the Bitcoin movement themselves.

Now why do I think it is a non-issue?

Technically speaking it is clearly a problem: whoever controls the simple majority of hashing power CAN control the network. The question is, will the individual or group of individuals who gain such control ruin themselves? In the end, that is precisely what it means to bypass the rules that the network enforces on everybody: if you control the simple majority of hashing power, bypassing the rules is tantamount to ruining yourself.

Say you own 51% of a successful company. Will you do anything to ruin that company? I am not surprised that a lot of people think so. A lot of people think that capitalists are prone to fool people by building up the reputation of that company thereby increasing its price, and then all of a sudden sell its shares just to make a profit. Well, this does happen sometimes, but it very rarely happens to companies with a solid reputation.

The fact is that, in the short history of Bitcoins, one mining pool or another has been the number one. Previously the number one mining pool was btcguild.com. I believe that Btcguild could have attained 51%, but the Bitcoin community urged them not to, and Btcguild heeded the call. I had no problem with Btcguild gaining 51% or even more, and I don’t have a problem with GHash.io gaining such control now.

I believe that attaining 51% is untenable anyway. The natural tendency is for there to be several business entities (not a single entity) who dominate any sector of the economy by more than 50%. Such is the nature of competition when prices are in equilibrium: if attaining 51% is so profitable, the second best entity in the race won’t be far behind.

Looking at it from a philosophical perspective, in the long history of capitalism, the issue of 51% has always been there. It has come in several forms, but this persistent fear of a dominant force has appeared now and then. It has been a central thesis of most philosophers who have come and gone to attack capitalism, foremost among them being Karl Marx.

This fear of a dominant force is now even part of the body of ineffective laws that big companies in the U.S. have to comply with, in the form of the so-called Anti-Trust laws. I call these laws “ineffective” because these have been used mostly by lagging competitors to bludgeon highly successful companies. These laws have mostly not accomplished what these were intended for.

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The Concept of “Pure Money”

Recently I read about Alan Greenspan’s comments about Bitcoin to the effect that it’s nothing but a bubble phenomenon. Crypto-currencies are a bubble because these things have no “backing”.

What Alan fails to understand (and what I failed to understand back in 2011) is that money does not need backing. It used to be that fiat money was indeed backed by the government that issued it. It used to be backed by gold, and gold has its natural value as metal. Nowadays, which country can claim that its fiat currency is backed by gold? In reality, fiat currencies are just like any crypto-currency in this regard: no backing.

Ludwig von Mises, in his magnum opus, “The Theory of Money and Credit” teaches that there are two important components in the value of money: its natural use value (i.e., gold *as* metal), and its value when used as a medium of exchange. When gold deflates, its natural value diminishes with respect to its value as medium of exchange. When it inflates, its value as money can decrease to the point that people start using it more for filling teeth and as conductors in integrated circuits.

Crypto-currencies have no natural use value. Crypto-currencies are just numbers stored in their respective networks. They’re not worth anything. They have no “backing”. It does not mean however, that they have no money value. In fact, they are very useful as media of exchange. And therein lies their value: Crypto-currencies are a form of “pure money”.

It’s interesting to note that Ludwig von Mises himself did not conceptualize such “pure money” to be possible. I can’t blame him because computers and the internet have not come of age in his time. I do fault Alan Greenspan, though, for not understanding what crypto-currencies are. I expect more from him because he used to be the Fed Chairman.

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Total Market Breakdown

It took a couple of days after typhoon Yolanda has left for people to realize how devastating she has been. The hardest hit was the island of Leyte in which more than a thousand dead have been recovered, and the casualty count is still climbing as more dead bodies are found. This morning I tried to explain to my nine and ten year old how it is like to survive the typhoon itself in that island. I asked them to imagine that we were in that island right now, and that we all survived, in spite of what happened there.

My wife objected to the scenario I was painting: “But don’t you think we would have flown to the island of Mindanao or even to Manila even before Yolanda struck?”

“Remember that we here in Cebu City got the same warning”, I explained. “We got the same Storm Signal #4 as Leyte. Why did we decide to stay? The fact is that there was no way to predict how hard Yolanda would hit any one island. The inhabitants of Leyte stayed, just as we would had we lived there. The path she took was not exactly as predicted because predictions are just that, predictions. The path you saw drawn on TV in vivid colors before she hit any island was a probability map, not an accurate navigational map of a ship. We need to understand that.” She nodded her head in agreement.

Let’s imagine we are in that island right now. I want to paint a picture how horrible it would be, how difficult it is to keep surviving in a situation where there is nothing you can buy, and there is total market breakdown, for that is one after-effect of a calamity, total market breakdown.

In the morning after the typhoon, we find the ground floor of our apartment filled with mud. There is no electricity, and so we try to save as much food as we can from the refrigerator. We realize that by tomorrow, we will be out of food and water, and so our first instinct is to go buy food at the nearby grocery. But one of our neighbors tells us that she had gone there, and the neighborhood grocery is all in shambles. People have looted whatever was left, and there was absolutely nothing to pick up, much less buy, by the time she got there in the early morning light. It does not take long for us to realize that the same fate has befallen all groceries in the city. We hear on the radio how a big grocery store was attacked by swarms of hungry people. The lone guard attempted to control the crowd, only to be killed himself. We can only imagine how his family is now suffering in his absence.

We need to decide what to do. Our prime objective is to get food and water. How? Our car still has some fuel left. May be we can drive to where there may be some food left. However, we hear on the radio that the whole island is devastated, and we can easily run out of fuel in the middle of nowhere looking for food and water. We decide to stay put. We cannot do anything but pray. In the evening, even starting the fire for cooking is not easy. We find out that our cooking gas fuel tank is empty. We gather wet twigs and branches to start a fire.

In the following couple of days, we start to feel the pangs of hunger. The kids are crying all the time. We start to smell this terrible stench of dead bodies still uncollected. There are dead cats and dogs all over the city, not to mention dead human bodies still undiscovered in some crevices and abandoned houses. Why is it taking so long for the rescuers to reach us, we wonder. I suggest that we start thinking about catching mice that somehow start to proliferate everywhere. I ask our maid whether she knows how to cook freshly caught mouse. She grimaces and says she will never cook a mouse, much less eat it.

Pre-Calamity Functioning Market

Indeed, why is it that help is always slow to arrive in any calamity? Before the calamity, when everything is normal, we take for granted so many things around us: businesses that literally put food on our table. We forget that when we go to the grocery, food does not just get there on the shelves for us to pick up, but that is what it seems. We don’t realize the sheer number of people involved to get all kinds of food on the grovery shelves. Early in the morning on any normal day, trucks would arrive at the grocery to deliver both perishable produce and packaged goods. Every food item is delivered from somewhere else, may be middle men who have boght the items from some other supplier, may be farmers. Imagine the number of people involved to produce each item. How does it all happen? How do the producers know exactly what kind of item to produce, and how can they get their produce to the market on time? How do the distributors and middlemen organize themselves so that every item is delivered and distributed to all grocery stores on a daily basis?

In a functioning market, there is nobody coordinating the truckers, the distributors, the middlemen, and the producers. It’s all based on the idea that each one of these market participants are in it for the money. The better each one of these participants serve their markets, the more profits they get. By its very nature, the market rewards those who can deliver food from the farmer to the consumer in the most efficient manner. How does this happen, as if by magic? Each one of us participates in this phenomenon: by simply choosing to buy the best that our money can buy at the grocery on a daily basis, by doing so we reward those who can deliver the best product for the least cost. The price of each item in the market serves as a signal, a feedback to the producer, how much of it to produce.

Helping Is Not Easy, and Neither is it Simple

When a calamity like typhoon Yolanda hits the islands, we get a taste of how it is like to live without the market. We cannot expect goods to be delivered as efficiently. People think that giving is all that is involved in helping. I take my family to a donation center and donate food and water. I remind them how complicated and difficult it is to deliver and distribute what we just donated to the victims. In order for every donation item to get to its intended recipient, think of all the logistics and planning that has to happen first before such endeavor can even begin. What you are doing is basically substituting a hierarchical logistical system for the most efficient delivery and distribution system a market can provide. The substitute system will have to be centrally planned and coordinated. If not, you may miss an area and the consequences would be severe for that area. Or you can simply deliver the wrong goods to the wrong place. People would greatly suffer while a vast quantity of food can lay rotting in some storage building. No wonder you need a regimented, obey-all-detailed-commands type of organization like an army to replace all the logistics of a well-oiled market.

A news item relates that PNoy walked out of an organizational meeting out of frustration. We complain about the inefficiency and think that PNoy as president should get down and dirty to get it all done. It’s not that simple. It’s more like formulating a strategy for war than anything else. There are strong disagreements among the different government agencies. Any meeting to formulate strategy can easily turn into a shouting match. None of those C-130s would be of any help if you don’t have the goods all ready to be delivered. None of those hundreds of millions of dollars donated by other countries would be of any help if an agreement cannot be reached how best to use them. I am sure that, given the climate of mistrust of government right now, none of PNoy’s more reputable cabinet members would want to handle such large amounts of money. It is a political hot potato.

I Propose an Emergency “Market”

To the degree that the authorities suppress the market, hunger and starvation on a mass scale can occur. The most efficient organizations, like the Red Cross, are huge, well-managed organizations. Executives of these organizations are skilled in running such big organizations, especially during an emergency. These skills require a market, and indeed these organization reward their leaders well. Some of us think that these people should not be so rewarded, thereby killing the market for organizational talent in these big organizations. If this happens, and organizational skills become lacking in charitable organizations, hunger and starvation can happen in the time it takes to distribute food and water.

Our instinct is to reward charitable people and punish the profit seekers, especially during a calamity. Such instinct is nt necessarily beneficial. For example, we have laws that punish “profiteering” or “price gouging” during a calamity. Our Christian instincts lead us to promulgate such laws. My opinion is that such laws can be very harmful. Imagine, again, being in Leyte right now. What you need is food more than anything else, because you happen to have a large tank full of rain-water in your backyard. How can the authorities know this fact? They have no way of knowing that you need food more than anything else. Or may be what you need most of all is medical supplies because your wife is badly bruised and just need some ointment to heal the wound and prevent infection. There is no way that the authorities can know all of these circumstances for every family. No way. So you would be very lucky to receive exactly what you need in a centrally planned distribution system.

Now imagine that instead of delivering goods outright, the authorities focus on establishing an emergency market. Prices are not controlled, and profiteering is not prohibited in any way. Money is then distributed, instead of goods. It is easier to distribute money than goods: in the worst-case scenario, a charitable organization can just distribute money by throwing bills in the air from a helicopter. People can then buy goods from a market that will find its way among the ruins to deliver. Calamity victims would then decide, based on their individual circumstances, what to buy from the emergency market. Those businesses that deliver first to the hardest-hit location will be rewarded. Of course, charitable distribution systems would still be allowed, to ensure that those not strong enough to even pick up money dropped from helicopters are taken cared of. I am not claiming that such a system would prevent horrible tragedies, but I do claim that the current system of total market breakdown is more catastrophic in terms of the sheer number of people dying because they did not receive exactly what they needed.

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The Future is Here, and It’s Wonderful

This is an illustration of what it’s going to be like when Bitcoin or something like it becomes more dominant than any fiat currency.

At the end of every month, from work you get paid in Bitcoins, say 100 miniBits. (A miniBit is one-thousandth of a Bitcoin, a microBit is one-milionth.) That money doesn’t get “directly deposited” in a bank. The Bitcoin infrastructure does not need banks. Instead, that money gets “deposited” by your company directly to your Bitcoin account. So on the first day of the following month, you check your account by opening a simple app on your smartphone, and verify that indeed, 100 miniBits have been deposited. (To simplify the illustration, let’s omit taxes and other possible monthly deductions.)

You work mostly from home, driving to the company office only when there is a meeting. Just before leaving for a meeting, your wife asks whether you can drop by the grocery store. Sure, you say, and asks her to send you the grocery list in a text message later, preferably after the meeting so you are also reminded by her message. The text message has the following list, together with maximum prices beyond which she instructs you not to pay, but instead to drive to another store for those.

One ten-kilo bag of rice – 25 microBits
Two kilos of Tilapia fish – 135 microBits
One small bag of ground coffee – 5 microBits
One dozen eggs – 12 microBits
One liter of milk – 23 microBits

The total being 200 microBits. As you enter the grocery store, the Bitcoin program in your smartphone detects that you are in a business establishment, and automatically gets ready for any payment you may make to the Bitcoin receivable account number of that establishment. It does that whenever you are in the vicinity of any store registered with the Bitcoin network, just in case you decide to buy anything.

You pick up the items one by one, and as you pick up each one, an RFID detector on your smartphone identifies what you pick up, prompting the Bitcoin paying program to ask you for permission to pay. The Tilapia item costs 140 microBits, but you tell your smartphone to pay it anyway. As soon as you say “Yes, pay”, the Bitcoin program credits the grocery account 140 microBits. One liter of milk costs 18 microBits today, so the total comes out to the same, 200 microBits.

No check-out counters! As you head out of the store, your smartphone flashes an image of your receipt. You take a glance, thinking how wonderful it is that by now your wife has received an email with a copy of the same receipt.

All those credit cards in your wallet are gone. In fact, you don’t need a physical wallet anymore. Your smartphone serves both purposes now, including a hundred others.

All of the above will be visible to users of the Bitcoin infrastructure. What is not visible is the tremendous benefit we will all gain from a system that is NOT under any centralized control. No central banks to decide how much Bitcoins should be worth! We all decide ourselves how much each item we buy is worth, in terms of Bitcoins. All these billions of decisions every second, in turn, determine also the value of every Bitcoin.

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The Miners’ “Greed” will Save Bitcoin

It just occurred to me that the Bitcoin system of production does not need to be controlled at all, not pogrammatically, not even by any rule. What will limit production is the profitability of miners. At this stage of development, Bitcoin is increasing in value, and mining is very profitable. It cannot remain so forever, if production is not limited by absolute quantity. Assume for the sake of discussion that there is no limit. Every miner, to increase profitability, would produce as many Bitcoins per second as he could. There will be over-production, and subsequent inflation (inflation in quantity, and then eventually reduction in value [the alternate "definition" of inflation]). As the value of Bitcoins come down, naturally the profits of miners will come down also, if measured in terms of how much a Bitcoin can buy. The system will tend towards a state of equilibrium, one in which the profitability of miners is throttled by inflation (in the second sense), and the value of every Bitcoin stabilizes.

This absolute limit on quantity is fictitious anyway, and I daresay it is GOOD that it is fictitious.

Let’s say that the miners “collude” among themselves in order to remove the absolute limit on quantity. As the moderator of this forum pointed out here: https://bitcointalk.org/index.php?topic=145475.msg1543280#msg1543280, there is really nothing that can stop the miners from changing the quantity rule, except the wallets in everybody else’s possession. What if the miners themselves also start distributing their vesion of the wallet, with compelling advantages to the user? (For example, a version with a much pruned Merkle tree, so that everybody with a smartphone or any handheld device can use it.)

So now the question to ask is, if the limit on quantity is fictitious, what sets Bitcoin apart from any fiat currency in use today? Every fiat currency is controlled by some monopoly, a monopoly necessarily sanctioned and enforced by the state. In Bitcoin’s case, such monopoly does not exist. In Bitcoin’s case, its own market will control its quantity, while any fiat currency is prone to hyper-inflation because its monopolistic structure does not present a feedback mechanism to limit production or “printing”.

The two worries I expressed in my previous blog are in reality no cause for concern. I now believe in Bitcoins much more than I ever did. If a version of the wallet that can run on a handheld becomes available (as I am sure it will, soon enough), then its proliferation will further enhance its own integrity, as I explain here: http://ctapang.wordpress.com/2013/01/30/more-on-bitcoins/.

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Would Bitcoin Suffer a Similar Fate as that of Unix on the Desktop?

I have seen the Grand Canyon of Arizona, and I am still smarting from its effect on my perception of reality. Its grandeur reminded me of a paradox, the paradox of what I would call “chance and permanence”: nature works mostly by chance, but what it has wrought so far is almost permanent. In the beginning, I am sure the path of the mighty Colorado river that formed the Grand Canyon was determined mostly by chance. As time went by, and the canyon went deeper, what was determined by chance is now almost permanent. Every twist and every turn, every steep cliff that formed, every rock that stayed put and not washed away is there by chance, and yet now permanent. It would take great effort, time, and money to change the path of the Colorado river. So we, as observers of the Grand Canyon, can appreciate how its path was formed mostly by chance, but can also appreciate its permanence. And so it is with the rest of the universe.

We can consider even human institutions in terms of the same paradox. Sure, we’d like to think that all our institutions are there by design, and not by chance, and that is true. But there are certain important aspects of our institutions that become permanent purely by chance. We cannot possibly know beforehand which little twists and turns in our lives become very important later, but there is no doubt in my mind that the sum total of those decisions can make each one of us successful or lose out and simply become a statistic. It certainly makes sense to leave less to chance, and the less we leave to chance, the better.

Just as an example, let’s take the Windows operating system. It has now become an institution. It is very difficult to replace precisely because it has become an institution. We can appreciate the fact that until now, despite the presence of free (and some say even better) alternatives like Linux, Windows remains the most widely adopted operating system, by a wide margin. It is not that the proponents of Linux have not tried enough. A huge effort is being spent, not just by the Linux community, but also by the Apple OS community, to dislodge Windows from its position as number one, but so far to no avail. This is what I mean by becoming an institution, mostly by virtue of Windows’ virtues, but also partly by chance. There were crucial steps that Microsoft took, during its early days, that caused Windows to be an institution. Some of those steps, like partnering with IBM in the early days, did not happen by chance. What was left to chance was which little OS to start with, during the earliest epoch called “DOS”.

(Microsoft started not with an OS of its own making, but bought out some OS from an obscure company. Incidentally, it would be wrong to conclude from this that Windows won by great marketing alone. It had to be a good OS also, limited only by available hardware, and had to continue to compete by being the best. Being a good OS is a minimum requirement, and by now that should be obvious.)

Now I have no doubt that Bitcoin will become an institution, something that maybe very difficult, if not impossible to change in the near future. I would not invest in it myself if I did not believe in it. But there are a couple of things that worry me, and I am writing this to see what other serious thinkers would say.

There have been several attempts to bifurcate the path of transactions. Let us remember that these attempts had a sinister purpose. I believe it is also possible to bifurcate the path of transactions, to have more than one set of transaction files, simply by distributing another branch of the software. The system is designed to protect itself from invalid transactions with a sinister purpose. However, if this is done NOT with a sinister purpose, but in order to come up with a better currency, then politically such new branch would be adopted by a large number of users, which would then cause the path of transactions to bifurcate. We would end up with not one database of transactions, but several incompatible databases. The Bitcoin currency would then bifurcate several times to spawn several other currencies, all competing against each other.

Remember Unix? I believe that Unix should have been the number one OS instead of DOS/Windows. It was certainly better, by any measure, than DOS. It did not win out because it bifurcated several times into different versions, all incomptible with one another. Would Bitcoin suffer a similar fate?

The other thing that worries me about Bitcoins is the rule that puts a hard limit to its quantity. I believe that this is reason enough for it to bifurcate. I still have to hear from a reputable monetarist thinker that a hard limit on quantity is good. Here is why I think it is bad.

What makes gold still THE number one standard currency is the fact that its quantity cannot be increased by a simple human decision. It has to be mined. There have been times when its quantity increased by more than the world economy can sustain, and it inflated just like fiat currency (during the Gold Rush, for example). However, there is no hard limit to the quantity of gold in circulation, and I think that the reason it remains the best currency is because it continues to be mined and so continues to increase in quantity. In the end, I think that it’s not the increase in quantity of a currency per se that’s bad, it’s HOW it increases in quantity. I believe that the best currency is one that increases in quantity in relation to worldwide economic activity. In the future, gold cannot remain the best currency because its increase in quantity is not necessarily a good arithmetic function of worldwide economic activity.

A currency is only as useful as how convenient and beneficial it is to use as a medium of exchange. In this regard, Bitcoins are far more useful than gold. Gold has other values apart from its use value as currency. It has jewelry or ornamental value, it has industrial value (as electronic connector in integrated circuits), and monetary value. Its monetary value has now exceeded its two other values because the U.S. dollar is failing in this function as worldwide currency. Contrast this with the pure monetary value of Bitcoins. Bitcoins have no other value than its use for exchange. We can say it has pure exchange value. One of its attractions is that, by being based on the power of the Internet, it is money that can travel friction-free from one point in the world to another. Very much unlike gold, which weighs so much it takes not just some reliable means to transport, but also a secure one. It takes a lot of money just to transport gold; it takes almost zero to transport Bitcoins.

However, and this is a big caveat, even a Bitcoin itself can see its exchange value reduced. It can reduce in exchange value precisely because its perceived value, or market value, is increasing. As it increases in market value, many holders will start to hoard it. (Like me: I plan to hold on to as much quantity of it as long as I can.) Now when it is hoarded and stashed away, the total count of Bitcoins in circulation necessarily goes down. Hoarding necessarily affects the count of daily transactions that occur per quantity of Bitcoins: its so-called net velocity goes down. When the velocity of a currency goes down, we can say its usefulness as currency goes down also. Therefore, what we may see happen is a long-term trend upwards in market value, but punctuated by violent fits of steep drops in price, as the exchange value compensates for market value, and vice-versa. This is precisely what we want a currency to fix: the occasional steep drops, the violent business cycle.

I propose that the violent cycles of ups and downs can be avoided, simply by increasing the quantity of Bitcoins, not asymptotically as it is now, but as a function of velocity. (It should not be a function of market price because market price by definition is always in relation to another currency, like the U.S. dollar, which can also be volatile.) Velocity is easily measured by the count of transactions per minute or per hour or per day even. Note that “velocity” is different from speed (as in elementary physics). Velocity includes the component of direction, not just speed; so for example, a million transactions that occur only between two accounts contributes less to velocity than transactions that occur between many different accounts.

I am a programmer by trade, and I can go in there and make this modification myself, and come up with a different distribution. If enough people believe that my version is better, then the database of transactions will bifurcate, which is not good. Rather than do that, I have chosen to discuss this matter with the Bitcoin community. Even just two currencies competing at this early stage can be fatal. We have a world to conquer out there, and we don’t want to end up like Unix. Rather, we want to be like the Colorado river, cutting deep into the very foundation of world commerce. However, we want Bitcoin to be successful less by chance like the Colorado, and more by conscious decisions like Microsoft’s Windows OS on the desktop.

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More on Bitcoins

I mentioned Bitcoins in “What is Money?” a blog I wrote almost two years ago. In that blog I predicted that by itself, Bitcoins would not gain wide use, that it needed a backer for it to gain the necessary trust of people. Boy was I wrong. Bitcoin has become so popular since I wrote that blog. It has had its ups and downs, but I think it is slowly but surely gaining adherents. I am now definitely a believer.

There are two things about Bitcoins that are quite remarkable.

The data that holds the blueprint for our biological being is stored in our DNA. Now each DNA strand is a very fragile thing. The absolute genius of the design is that the same data is stored not in a single DNA strand, but in billions of copies of the same data storage DNA. The whole organism will have to die in order to lose this data, but even then it is possible to retrieve it. It is even possible to retrieve it from anything the organism has touched.

What has this got to do with Bitcoins? This same idea of a distributed, highly redundant design has been applied to the Bitcoin system. The database that holds all past Bitcoin transactions are stored in a set of files that are distributed in every corner of the world. So the reliability of this database is unprecedented, in that it is truly distributed. It is scattered all over. Once you use Bitcoins, your computer system (whatever it is, a PC, a tablet, a cell phone) will be storing this database. This means that, as it gains wider use, it becomes more resilient. In order to destroy the database that holds Bitcoin transactions, the whole world would have to be annihilated along with it.

Our DNA is somewhat static in that in doesn’t change in our lifetimes, so duplicating it a billion times is trivial. The Bitcoin database, however, is very dynamic, and so computers that store it use the Internet to update each other constantly. The update process itself is complex because a million different versions of the same database can exist at any one time.

Amazing, isn’t it? Bitcoin may be the solution to the coming fiat money crash. It is very decentralized, and so is not controlled by any entity nor any country. The only way that any government can control it is by prohibiting its use, but even then enforcement would be almost impossible. It has now gained a free life of its own.

The other thing that’s remarkable about Bitcoins is its use of cryptography. Of course, the distributed database of transactions is fully encrypted, in blocks. But the more interesting question to ask is, How can I own Bitcoins? How does the system know I own, say 23 Bitcoins? Each of us can have as many Bitcoin “account numbers” as we need. A Bitcoin account is just a long, unique pattern of computer bits, such as

17Wym1bjWKuQ2WhVtgZxvLzFohGp9tDPws

Which happens to be one of my accounts, and which is now useless (more on that in a minute). This pattern of bits is also called a Bitcoin address, and it can be both a destination (payor account) or a source (payee account). For this particular address or account to receive payments, nothing else is required other than this account number itself. Anybody can send Bitcoins to this account. However, because I lost my private key to this account, I can’t use any of the Bitcoins that may be credited to it, and nobody else can, either. One needs a PRIVATE KEY in order to send from one’s Bitcoin account. This is no different from needing a password in order to access your email account. If nobody else knows that password, you can be assured that only you are able to read your emails. If you forget that password, and the email system you use does not have a password retrieval system, then all your email is lost.

The PRIVATE KEY is the Bitcoin system’s only way to determine ownership of an account. You can claim ownership of the account above if you know its private key. Simply trying to guess it is next to impossible, because it’s about as long as the account number itself. Lots of computational power will have to be applied in attempting determine that key, which is akin to dropping a safe from a window in order to open it. But even then there is only a small chance of determining that private key and thereby gain ownership of the account. (Some accounts can have more than one private key, just like you can open a bank account that needs two or more signatures to withdraw.)

An account is therefore useless without its private key. This has two implications:

1. The account owner better be sure that this key is safe, specially if the account already holds Bitcoins. Any thief can steal all your Bitcoins by somehow obtaining your private key. If you plan on using Bitcoins, this is one aspect that you have to be extra careful about. Because this private key is not easy to memorize, you will have to store it somewhere. You can encrypt it, but then you will have to remember the key you used to encrypt it. (This is like hiding a key in a drawer, and holding on to the key to that drawer.) Bitcoin trader sites like MtGox.com store this key in their servers, which I think is problematic. It’s not that I don’t trust MtGox.com, but if anybody lays their hand on those private keys, they would be certainly tempted to run away with all those Bitcoins. I would never allow any of my private keys to be stored anywhere else except in something that is in my possession. However, even storing it in any of my personal computers can carry a certain risk because cyber thieves can possibly get hold of them. I think the safest way to protect an account that holds some considerable amount of Bitcoin money is to encrypt the key using another key that is very easy to remember but very difficult for others to guess, copy the encrypted key to a USB thumb drive, and then hide that thumb drive in a safe.

2. It is quite possible for an account that holds lots of Bitcoins to get lost, like I lost my key to the above account. My understanding is that, Bitcoins lost in this manner are lost forever. In other words, if I inherited millions of Bitcoins from my father, and he dies without giving me the private key, there is no way for me or even my descendants to retrieve those Bitcoins.

I may be wrong on this, but I think this also means that, the absolute count of Bitcoins can decrease in time. This happens to real coins too, and so minting of real coins is a regular affair. However, in the case of Bitcoins, it seems that “minting” new coins is not possible. (Bitcoins can be “mined”, but the total quantity that can be mined is also limited.) Even though each Bitcoin is divisible into billions of parts, the value of each Bitcoin, and each of its billions of parts, can only increase and never decrease. No inflation! But deflation maybe just as bad as inflation. This certainly is worth looking into more closely.

Nevertheless, in the current state of affairs, Bitcoin has certainly exceeded expectations. I believe it will continue to do so in the foreseeable future.

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