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Cryptoeconomics Fundamental Principles of Bitcoin - Voskuil, Eric

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Matheus Puppe

· 36 min read

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Here is a summary of the key points about Cryptoeconomics from the provided material:

  • Cryptoeconomics refers to the study of the economic properties and principles underlying cryptocurrencies like Bitcoin. It analyzes topics like security, incentives, game theory, monetary policy, and more through a cryptographic/economic lens.

  • The book Fundamental Principles of Bitcoin by Eric Voskuil aims to outline and explain the core cryptoeconomic principles that underpin how Bitcoin works.

  • It covers a wide range of topics organized under sections like the security model, statism, mining, alternatives to Bitcoin, economics, money, price, and scalability.

  • For each topic, it analyzes fallacies, paradoxes, properties and other cryptoeconomic considerations related to how Bitcoin and other cryptocurrencies function or could evolve.

  • The goal is to provide a framework for understanding Bitcoin at a fundamental level based on cryptographic and economic theory rather than just technical implementation.

  • It was initially self-published by the author and illustrated by James Chiang, both contributors to the open source Bitcoin developer toolkit Libbitcoin.

  • The material evolved from online discussions and aims to reconcile both technical and economic perspectives on Bitcoin.

So in summary, it outlines and explores the cryptoeconomic principles, properties, risks and tradeoffs involved in Bitcoin and digital currencies through analyzing a wide range of related topics. The focus is on understanding Bitcoin’s economics rather than just its technical design.

  • Cryptoeconomics applies economic principles rigorously to analyze cryptocurrencies like Bitcoin, hoping to improve understanding of both. It aims to expose flaws in common understandings and simplify complex concepts.

  • Bitcoin represents a new type of money that is global, uncensored, and open to all for the first time in history. It has peculiar characteristics that require new frameworks of analysis.

  • Concepts from economics and evolutionary theory can help predict which types of crypto organizations will succeed long-term. K-selected organisms that specialize and mature slowly tend to outcompete r-selected ones over time. Also, the Red Queen hypothesis suggests constant adaptation is needed to survive in a changing environment.

  • The author has extensive experience with Bitcoin as a top developer, having written much of the Libbitcoin codebase. His background as a fighter pilot and martial artist also gave him insights into security threats. He aims to integrate economic, technical and security perspectives to better explain cryptocurrencies.

  • Cryptoeconomics establishes rational economic principles as the basis for analysis, aiming to identify flaws, make new discoveries, and simplify complexity in both Bitcoin and economic theory. It does not repeat opinions but provides dense conceptual content.

  • The author has over 30 years of experience working in computer science, founding technology companies, and investing in startups. He has expertise in computer security, software development, and economics.

  • He has uncovered security vulnerabilities in popular hardware wallets by reviewing documentation alone. He also published computer security advisories and advised the DHS on software patching.

  • In addition to his technical background, he has traveled extensively to over 80 countries, interacting with people from various economic backgrounds. This gave him insights into global economic realities beyond what is often presented.

  • His diverse experiences led him to study cryptoeconomics, which integrates computer science, economics, and the specific model used in Bitcoin.

  • He presents some of the core concepts in Bitcoin’s security model, including the “axiom of resistance” which assumes it is possible for a system to resist state control, and how transaction fees help enable censorship resistance by creating economic incentives for miners.

  • Centralization and mining pools weaken Bitcoin’s security by concentrating risk. Mechanisms like payment processors, wallets and APIs drive centralization by creating incentives to reduce costs and complexity for merchants and users.

  • There is a “fallacy” that dispersion can naturally occur to offset these risks, but in reality states can collaborate to control large mining operations, threatening decentralization.

Here is a summary of educed pooling:

  • Educed pooling refers to a consensus mechanism where each participant makes their own judgment on transaction validity rather than relying on a fixed set of validators.

  • In educed pooling, every economic actor involved in the Bitcoin ecosystem implicitly validates transactions through their willingness to accept bitcoin payments or trade in bitcoin.

  • There is no fixed group of “validators” - validation is distributed across the entire economy of merchants, buyers, miners, etc. As long as economic activity continues, consensus is maintained.

  • This model contrasts with a “fixed membership” consensus model where all members of a predefined group must explicitly agree. In educed pooling, consensus refers to the size of the overall economy/membership rather than an explicit agreement condition.

  • A larger bitcoin economy provides greater security through more broadly distributed risk. But there is no assumption that a larger economy guarantees security - other factors like regulatory barriers could still constrain the system.

In summary, educed pooling refers to the emergent consensus process in Bitcoin where validity is judged implicitly through ongoing economic activity, rather than requiring explicit agreement from a predefined group of validators. The security comes from the size and breadth of the overall economy.

  • Bitcoin operates without permission from any state as a decentralized system. However, states may attempt to suppress it through censorship since it undermine their control and taxation of currency.

  • A single state censoring Bitcoin may not be effective, but collaboration between states could pose a greater threat through the IMF. Censorship would be most efficient from a single location, but rogue states may not have the power to resist larger states.

  • Bitcoin is a form of resistance against state power and control over money/taxation. By distributing risk, it could potentially reduce inflation taxes without violence. But it does not eliminate the need for personal risk in expanding freedom against state power.

  • The conflict between states and individuals over control of money may go through phases - honeymoon, black market, competition, surrender. States may first try regulation, then outlawing, then competing through mining to conduct a 51% attack, with censorship and taxes rising over time.

  • Patents threaten the competition and anonymity of mining, undermining Bitcoin’s security. But the risk of mining already includes the risk of patent violations as threat levels rise.

  • Bitcoin’s value is based on operating permissionlessly without state authority. It therefore inherently operates as a black market money, and systems relying on it must also be black market.

  • There is no true prisoner’s dilemma for states considering Bitcoin vs their own currency. Using gold as an alternative reference point suggests states’ preferences do not actually form a dilemma between the two options.

  • Private keys secure individual units of bitcoin, not the system as a whole. Decentralized validation secures the overall consensus, even if some private keys are stolen.

  • Distributed mining hash power secures transaction confirmation through proof of work, but private key security is the responsibility of individual key holders.

  • There is a theory that merchants can control mining behavior by refusing to accept confirmations from certain miners. However, this theory fails to consider many factors.

  • Miners actually control transaction selection. While merchants control what they accept, they cannot necessarily force miners to behave a certain way.

  • If merchants were unsatisfied, they could start a new coin with a different mining algorithm, but this would not necessarily change miners’ behaviors and could reduce security. Existing large miners would still have advantages over newcomers.

  • The theory also fails to recognize that merchants need mining services to continue. Splitting the coin does not replace mining. It also ignores economic incentives that favor larger, more centralized miners.

  • So in summary, while distributed hash power provides confirmation security, private keys remain the responsibility of individual users, and the ability of merchants to control miners is more limited than commonly believed due to economic and practical factors. Both decentralized mining and private key security are important for the overall security of the blockchain system.

  • Bitcoin confirmation security depends on the number of miners and how evenly distributed the hash power is among them. The most secure/decentralized scenario is if all people in the world mined Bitcoin with equal hash power.

  • Security comes from activity (hash power), distribution of that activity among miners, and participation of miners as a percentage of humanity. More activity, better distribution, and higher participation means higher security.

  • Bitcoin relies on people willing to take on personal risk to mine and validate transactions. Decentralization helps share this risk among many individuals.

  • In a social network sense, Bitcoin nodes are individual people. Lose of individual participation hurts decentralization and security. A centralized system is vulnerable if a single person changes the rules.

  • Paradoxically, Bitcoin security is weaker when threats are low as individuals have less incentive to mine unprofitably or avoid censorship. Higher threats lead to higher rewards and improved censorship resistance.

  • The value of Bitcoin comes from resisting state control over money supply and censorship of transactions. This allows borderless, permissionless money and avoids taxes like seigniorage.

  • States may try to introduce “Fedcoin” alternatives that superficially mimic Bitcoin but preserve state controls like arbitrary inflation and transaction censorship. Resistance to such state-controlled forks is crucial for Bitcoin’s continued value proposition.

  • Rothbard argues in his book “What Has Government Done to Our Money” that inflation caused by seigniorage (money printing) leads people to prefer lower quality or less durable goods as prices rise. However, this presumption of objective value contradicts the subjective theory of value. There is no direct relationship between money supply and preferences for certain qualities in goods.

  • Greater wealth implies lower time preference according to the theory of marginal utility, but it does not necessarily imply a preference for lower quality goods. It simply implies a willingness to lend more capital. Rothbard makes a “subtle” error in assuming this link.

  • Inflation may cause people to favor “get-rich-quick” schemes due to rising prices, but sober effort is often still preferred. Changes in time preference due to inflation/wealth are complex and not well captured by Rothbard’s conjecture.

  • The theory that seigniorage makes people poorer and thus increases time preference also contradicts Rothbard, as any tax reduces wealth, not just seigniorage specifically.

  • Rothbard more rigorously analyzed taxation in his work “Man, Economy, and State” but still erred in claiming seigniorage uniquely reduces wealth or quality of goods. The complex effects of inflation and wealth on preferences and time preference are not well defined.

  • A reserve currency refers to what states hoard for settling international accounts. Gold served this purpose historically when citizens could redeem dollars for gold. However, reserves offer no direct benefit to citizens who must still use state-issued fiat currency.

  • The idea that bitcoin could serve as a reserve currency while citizens use state-backed digital currencies is invalid, as it would not prevent inflation/censorship of the state-issued currency over time. For bitcoin to be secure, decentralized use by individuals is required, not just holding as a reserve.

  • Central banks like the Federal Reserve can subsidize discounted loan rates through seigniorage, which is the profit earned from printing money.

  • The Fed has the power to order new money from the Treasury’s Bureau of Engraving and Printing. The Treasury performs the printing but the Fed pays the costs.

  • When the Fed lends to banks or buys Treasury securities, it is essentially providing discounted loans to member banks or the government. This process of creating money through lending precedes any actual printing of money.

  • As long as banks and the Treasury hold reserves at the Fed in the form of deposits or securities, there is no need for the Fed to physically print money. It only needs to print money when reserves need to be settled in cash.

  • The Fed earns interest on its lending and assets, and remits the profits to the Treasury each year. So the Treasury indirectly benefits from printing new money at low cost.

  • As the Fed raises rates and reduces lending, it can also destroy money by reducing banks’ reserves, thereby contracting the money supply. But this reduces the Fed’s profits and annual remittances to the Treasury.

So in summary, central banks like the Fed subsidize bank lending and money creation through the process of seigniorage, where new money is printed at low cost by the Treasury but ultimately profits the government.

Here is a summary of the key points made in the passage:

  • The supposed balance of power between miners and merchants is a fallacy, as their powers are orthogonal, not balanced in a checks-and-balances system. Miners control transaction selection while merchants control validity.

  • Power lies between individuals and the state, not between miners and merchants. With distribution of mining and merchant activities, it’s difficult for states to censor the Bitcoin market.

  • The relationship between miners and merchants is one of voluntary trade, not adversity. Merchants purchase mining services from miners for a mutually agreeable fee.

  • Byproduct mining does not actually reduce energy consumption. Any cost reductions enable more mining until costs return to previous levels, increasing total energy usage.

  • Assuming mining follows price is a causation fallacy, as mining must occur before prices are established. Miners necessarily anticipate future prices and demand.

  • Decoupling reward from transaction selection in mining pools does not actually increase decentralization or censorship resistance, as pool operators still control transaction selection.

  • Costs incurred by miners only contribute to security if they are dedicated costs required for optimal hash power generation. Extra unnecessary costs do not increase security.

The key ideas are critiques of common fallacies and misconceptions about the power dynamics, incentives, and economics of the Bitcoin system and mining activity.

The passage discusses several perceived flaws or fallacies related to proof-of-work blockchains like Bitcoin.

It argues that incorporating transaction processing costs into mining is not a problem if the resulting transactions have market value. Merged mining does not actually increase security for the secondary chain since hash power on one chain doesn’t directly secure the other.

It also argues that Bitcoin mining cannot truly become more energy efficient over time due to adjustments to difficulty that maintain the block generation time. Empty block mining is not actually an attack and doesn’t harm the system. Proof-of-work does not risk exhausting all available energy, and the value of a cryptocurrency does not come from “storing” the energy used in mining.

The level of security provided by proof-of-work is not actually wasted and is adjusted based on transaction demand and costs. Miners do not gain an advantage by including their own transactions since they forgo potential fees. In summary, it aims to rebut several perceived flaws or criticisms of proof-of-work blockchains.

  • A portion of each block reward is unpaid fees. However, the actual cost to miners is the opportunity cost of what they could have earned otherwise.

  • Fee estimation tools may overestimate required transaction fees because they assume a static relationship between historical and future fees. But fees can vary over time.

  • Some claim the bitcoin mining reward halving will create financial problems for miners and disrupt the network. However, difficulty adjustments, market forces like price changes, and competition ensure average miner profitability is maintained. Past halvings have not caused issues.

  • There is a theory that miners have no real power over the network because economic pressures will prevent disruptive actions. But this fails to consider threats from states sponsoring mining attacks for economic or political gain. Well-distributed hash power is needed to defend against state threats.

So in summary, the key points debated are around the impact of halvings, the role of economic forces versus state threats to mining, and assumptions made about fee rates and miner profitability over time. Market forces are generally seen as ensuring mining remains profitable on average.

  • Side payments or “off-chain” fees paid to miners by merchants are seen by some as potentially undermining the security of the Bitcoin system by distorting incentives.

  • However, there is no evidence such arrangements actually prevent other transactions from being confirmed or raise costs for others. Miners still have an incentive to include higher fee transactions.

  • Side fees may make it harder to determine an average historical transaction fee rate through chain analysis alone. But fee estimation already compensates for outliers, and actual fee levels are set by market competition.

  • Side fees could highlight certain transactions as being associated with such arrangements, but this does not represent a privacy loss since the arrangement is a choice made openly by the participants.

  • There is no impact on overall market fee rates or other users’ ability to get confirmations. Any deviation from market rates simply represents an unnecessary loss for the miner or merchant party.

So in summary, while side fees could affect analytics, they do not appear to undermine system security or harm other users as some theories have suggested.

  • Bitcoin provides an on-chain fee mechanism so that transactions can compensate miners without identity, preserving privacy. If miners and merchants choose to sacrifice privacy by taking on additional tasks, that is not considered undesirable.

  • Side fees offered to miners represent an opportunity cost for the miner if not at market rate. Consistent with market rates, side fees do not create new pooling pressure beyond existing on-chain fees. Subsidies or taxes distort the market.

  • The term “spam” is a misnomer when applied to Bitcoin transactions, as transactions are anonymous, fungible, and carry fees. There is no concept of legitimacy as with identity-based email.

  • Variance discounting encourages smaller miners to pool their hashpower, undermining the goal of distributed hashpower. Variance is an inherent flaw in Bitcoin’s consensus mechanism.

  • Bitcoin mining is a zero-sum game. Subsidies or taxes on miners affect all miners by shifting the competitive landscape. Distortions can be used to gain control over the majority hashpower.

  • The term “Bitcoin” is ambiguous and refers here specifically to the underlying cryptographic principles, not any particular implementation or community. Blockchains alone do not secure property claims against loss or third-party risks.

  • The theory that immutable claims provide security against loss is invalid, as the owner must still prove ownership to the custodian, requiring secret knowledge that could still be lost.

  • Referencing contracts does not mitigate loss risk, as it compounds it by adding additional contract data.

  • People are the ultimate basis of security, not technology. While immutability prevents loss of claim data, it does not mitigate attacks on or failures of the custodian.

  • Bitcoin is non-custodial, unlike claims that represent assets held by a trusted third party custodian. Merchants collectively act as custodians of Bitcoin’s value.

  • No single entity can control Bitcoin concepts, only specific implementations/chains which will evolve over time as different use cases emerge.

  • Splits reduce overall utility due to added exchange costs between coins, proportional to sizes of resulting economies. But reductions are not quadratic as sometimes assumed due to network effects.

  • A single implementation poses risks of divergent updates and global stalls analogous to genetic uniformity in living species. Diversity of implementations helps prevent weaknesses.

Here are the key points being summarized:

  • Both internal (within an economy) and external (outside the economy) updates can quickly and significantly impact the whole economy. A single widely deployed update poses more risk than multiple smaller updates.

  • With 10 separate implementations each supporting 10% of the economy, any given update risks at most 10% of the economy. But a universal implementation risks splitting the whole 50% economy.

  • The theory that a hybrid proof-of-work and proof-of-stake system provides more security than just proof-of-work is invalid. A majority stakeholder can censor blocks, making it no different from a proof-of-stake system with no added security from proof-of-work.

  • Maximalism refers to promoting one crypto over others for self-interested reasons, not technical merit. It assumes competitors cannot emerge but discourages adoption that could benefit the ecosystem.

  • Network effects don’t actually imply utility is halved by splitting an economy in two. Users can still exchange coins to access the combined utility of both networks.

  • Proof-of-work provides probabilistic proof of work done, not direct proof of other claimed attributes like energy used, cost incurred or reward earned. In a competitive market, blocks imply market cost was covered, but not in a monopolistic system.

  • Credit expansion refers to the multiplication of credit that results from fractional reserve banking and lending. It appears to create new money through bank loans, but this is sometimes seen as inflationary.

  • Saving can be hoarding (depreciating money out of circulation) or investing (lending to productive activities with no depreciation). Investment includes both debt and equity.

  • When a loan is made, the borrower, not the bank, owns the money lent. The borrower then lends out portions as needed, continuing the credit expansion process until all capital is hoarded.

  • Reserve requirements refer to banks keeping a fraction of deposits on hand, allowing the rest to be lent as credit. In the US, banks must reserve around 10% on average.

  • Estimates show total US dollars as money is around $3.3 trillion, while total credit extended in dollars including bonds, stocks, private equity is over $95 trillion. This represents a credit expansion of around 29x the original money supply.

  • True elimination of credit expansion would require eliminating credit and debt contracts altogether by only allowing equity-type investments, which is practically impossible in a modern economy. Bitcoin alone does not eliminate fractional reserve banking or credit expansion.

  • Bank credit is presumed to be “risk-free” due to taxpayer insurance of credits like money market accounts. However, this presumption only arises due to state intervention and insurance, not from free banking itself. All businesses are subject to failure.

  • Money market funds and money market accounts both aim to maintain a 1:1 value with money, but are discounted due to settlement/risk costs. Money market funds reflect investment losses in unit pricing, while money market accounts absorb losses and can lead to bank runs if reserves are insufficient.

  • Money market accounts are more fungible but also insured/regulated by the state and treated as bank credit. Money market funds spread losses evenly but units may decline in value.

  • Credit expansion is determined by individual time preferences, not whether an institution is called a “bank”. Eliminating credit expansion would require infinite time preference and no capital available for production.

  • The concepts of production and consumption are conflated. True consumption involves using/destroying a good, while holding/selling a good does not. Depreciation must be distinguished from interest.

  • The rate of wealth growth equals the interest rate minus the depreciation rate. All property depreciates over time. The economic depreciation rate can be derived by comparing observed interest and growth rates.

The passage critiques theories that claim fractional reserve banking is fraudulent or illegitimate. It argues that banks legitimately lend deposited funds, even demand deposits, as long as it is done voluntarily through contractual agreement.

The key points made are:

  • Deposits can be lent out as long as interest is paid or fees are reasonable, it does not matter if interest is explicitly charged.

  • People understand banking risks and contracts, it is paternalistic to claim otherwise. Fraud can be addressed individually.

  • Money substitutes like deposits are necessarily discounted compared to physical currency due to settlement costs.

  • Credit expansion itself does not cause inflation without expansion of the money supply or changes in time preference.

  • All capital lent originated from someone’s savings deposit. Distinguishing bank vs individual lending makes no economic difference.

  • There is no real distinction between demand vs time deposits from an economic or legitimacy perspective.

So in summary, the passage rejects theories that claim fractional reserve banking is inherently fraudulent or illegitimate on various conceptual and economic grounds.

  • The theory that banks can only lend against fully-insured deposits is invalid, as full insurance makes lending economically equivalent to no lending at all. Insurance is only possible through taxpayer subsidies.

  • The theory that free banking can create money “out of thin air” is invalid, as free banking confers no special privilege and if money could be costlessly created, it would not qualify as property. All forms of money incur some cost of production.

  • Advocating for both full reserve banking and lower time preferences is a contradiction, as full reserve implies infinite time preference by not allowing the transformation of short-term deposits into long-term loans.

  • Theories suggesting monetary inflation necessarily causes price inflation incorrectly conflate market money with monopoly money. Market money production proportionally consumes goods, preserving the money-goods proportionality and preventing price effects. Only monopoly money without competitive constraints can produce disproportionate monetary inflation and therefore price inflation.

  • Mises and others made errors in applying the valid Cantillon Effect of monopoly money seigniorage to theories of market money production. Their deductions become inconsistent and contradict the underlying money relation of supply and demand.

  • Increased demand for goods results from money being dishoarded (traded for goods instead of being hoarded). Unlike mining, dishoarding does not create new money but transfers it from hoarders to early spenders who obtain higher exchange value.

  • Increased hoarding gives an illusion of greater wealth but money must be traded for goods to have value. Hoarding reduces production by increasing the cost of capital via a higher interest rate. If hoarding persisted for long enough, significant value could be lost upon dishoarding due to reduced production.

  • A change in demand for a currency implies a proportional change in supply/demand for the goods traded for that currency. A currency’s value depends on it being exchanged for goods, as dictated by the money relation. Selling currency to others does not change this relation.

  • The value of commodity money also depends on production costs remaining constant. Changes in those costs would imply price increases/decreases not accounted for in the money relation, constituting speculative error.

The concept of a Pure Bank is used to demonstrate general lending behavior. A Pure Bank only borrows money, lends money, and hoards money as a reserve. It operates without state intervention or costs.

Key relationships for a Pure Bank include:

  • Reserve ratio determines capital ratio, debt ratio, and savings ratio.
  • Return rate equals interest rate times amount lent divided by amount borrowed.

When considering everyone operating as their own Pure Bank, the individual capital ratio (reserved capital divided by lent capital) fully determines the market interest rate. A higher aggregate capital ratio means a higher cost of capital and interest rate.

Real banks differ from Pure Banks in having operational expenses that reduce returns. Free banks have no state intervention but tax reduces returns for Real Banks. Central banks receive subsidies that increase returns.

The individual time preference that determines each person’s capital ratio collectively sets the market interest rate through supply and demand for loanable funds in the economy. The interest rate represents the price premium of present goods over future goods.

  • Interest or the price of time is determined by individual time preferences - how individuals value present vs future consumption of their savings.

  • An individual’s time preference is represented by their capital ratio, which is their level of hoarding (savings not invested) vs lending (savings invested) given the market interest rate.

  • By lending part of their savings at the market interest rate, an individual expresses valuing the future returns from lending more than keeping the full amount hoarded in the present. And vice versa for hoarding.

  • The capital ratio where an individual is indifferent between hoarding and lending reflects their time preference. It can change if the interest rate changes.

  • Savings can be either hoarded/unproductive or invested/productive. Applying hoarded savings to production or leisure through “dishoarding” is a consumption that requires time and thus saved capital.

  • Objective expressions of time preference occur through actual hoarding vs lending decisions in response to interest rates, not private thoughts. Subjective value determines an individual’s valuation.

  • Hoarding (saving/not spending capital) is a necessary consequence of uncertainty about the future. As uncertainty rises, people tend to hoard more either by restricting consumption or production.

  • Hoarding capital incurs an opportunity cost as the capital is not being used productively. The opportunity to invest and earn a return is lost. This opportunity cost is referred to as “liquidity” and allows people to have capital available if needed due to uncertainty.

  • The ratio of savings that is hoarded versus invested expresses an individual’s time preference. Higher time preference means preferring consumption now versus the future.

  • Hoarding represents the valuation that having the capital now is worth more than the opportunity cost/return that could be earned by investing it over time. This is called “speculation.”

  • Some level of hoarding is necessary due to uncertainty, but one can hoard beyond what is needed for liquidity purposes through speculation. The opportunity cost of excess hoarding is the return that could have been earned through investment/production.

  • Both hoarding and investing involve speculation - hoarding speculates on future needs, investing speculates on returns from productive activities. Hoarding represents speculative consumption while investing represents speculative production.

  • In summary, hoarding incurs opportunity costs while also being a necessary response to uncertainty about the future. Time preference expresses the balance between current vs future consumption/production based on this dynamic.

  • There is a theory that modern fiat currency like the US dollar is not actually money, but rather a “money substitute” or debt owed by the government. The theory argues the currency represents a claim on future tax revenues or obligations owed to the government.

  • However, this characterization is flawed. Money substitutes like gold certificates represent a definite claim to a set amount of money. Fiat currency does not represent a claim on any other good or future obligation - it represents whatever it can be traded for based on its status as legal tender.

  • When a government or business declares it will accept a form of money, this does not create a debt. Rather, it establishes that money as a generally accepted medium of exchange. The government does not take on debt by minting coins or printing notes and declaring them legal tender.

  • No money, whether fiat, commodity-backed, or otherwise, has intrinsic value. Value is subjective. So fiat is not meaningfully distinct from commodity money in that regard.

  • In summary, fiat currency cannot be accurately characterized as a “debt loop” or money substitute. It functions as money itself once established as legal tender by the government. The theory presented is invalid due to misunderstandings about the nature of money and money substitutes.

  • The term “Federal Reserve Note” on the U.S. dollar is anachronistic since the dollar is no longer redeemable for anything.

  • Money substitutes, like banknotes, arise from lending activities. They can be classified based on the degree of “debt regression” or progression of claims: no regression (money), single regression (representative money), finite regression (money substitute), infinite regression (impossible money).

  • A note or claim can represent money or another type of claim, but not represent itself, otherwise there is no regression and it is money. Examples of non-regression include gold, bitcoin, and the modern irredeemable dollar.

  • A direct claim on money is a representative money. An indirect claim through a finite series of others is a money substitute. An infinite regression of claims cannot exist.

  • The idea that an “ideal value index” like bitcoin could compel states to target low inflation is flawed. States utilize seigniorage (money creation) as a tax, so ideal money with no inflation means no tax collection by states.

  • Theories that an index could eliminate inflation assume people can freely choose currencies, but legal tender laws and capital controls prevent this. States will not freely give up seigniorage.

  • Claims that bitcoin avoids “subsidizing miners” through inflation are invalid - inflation does not necessarily impact purchasing power and mining returns investment.

  • Fiat money has no inherent use value, only utility because people accept it. Representative money is actually a money substitute as it represents something else.

  • The US dollar is a fiat currency, which means it has no intrinsic value and derives its value from government decree. Bitcoin is also a fiat currency in this sense, as it has no intrinsic value but derives value from agreement on its use as a medium of exchange.

  • However, the dollar depends on government monopoly over production, which allows limiting supply and extracting seigniorage (extra value from producing currency). Bitcoin does not rely on monopoly but is produced through open market competition, with supply controlled through consensus protocol rather than government decree.

  • Due to its reliance on government monopoly, the dollar can be considered “monopoly money” while Bitcoin is “market money.” Commodity money like gold is also market money as it does not rely on monopoly.

  • The regression theorem, which claims any currency must have originated from barter/commodity use to be considered money, is contradicted by Bitcoin which was intentionally created as a new form of money without prior non-monetary use.

  • The concept of a “risk-free rate of return” through lending Bitcoin while enforcing return of principal is invalid, as the loaned coins would have no value to the borrower due to guaranteed return to lender. True lending requires transfer of value.

  • There is a theory that fractional reserve banking inherently allows banks to create money “out of thin air” at no cost through credit creation. Supporters claim this is a consequence of banking accounting practices.

  • Proponents describe two views: 1) The “naive” view that money is created by miners/savers and lent by banks. 2) The “practical” view that banks create credit and money through fractional reserve lending.

  • However, through an example of a personal lending scenario modeled as banking, it is shown that all lending involves fractional reserves and money creation is not distinct from credit creation.

  • When the bank accounting entries are followed through to spending of the loan, there is no distinction between the “naive” and “practical” views - money and credit evolve together based on underlying money and time preferences.

  • Therefore, the theory that fractional reserve banking allows creation of money out of thin air is invalidated. All lending, whether personal or banking, involves existing money and credit backed by savings. The debate about money creation is resolved.

  • The debate between Plato and Aristotle regarding whether money is based on mining or credit is a false dichotomy, as money and credit are inherently dual concepts.

  • Bitcoin demonstrated that neither the metallist view (that money requires underlying use value like gold) nor the chartalist view (that money requires state support) are necessary. Money can operate on credit alone without state backing.

  • Banks cannot truly create money out of thin air. While they can expand credit through fractional reserve banking, they still need reserves to back deposits and settle accounts. Zero reserves means inability to satisfy withdrawals and default.

  • Inflation of the money supply ultimately comes from central banks acting as lenders of last resort to commercial banks that get into liquidity problems.

  • A fixed supply money like bitcoin can increase in purchasing power due to economic growth generating more demand for money, or through monetary substitution as demand shifts from other monies to bitcoin. But economic growth ultimately requires investment. Pure hoarding provides no investment and thus cannot indefinitely drive up prices.

  • Speculation and hopes of indefinite price increases through hoarding alone are economically irrational and contradict theoretical limits to monetary demand growth. Bitcoin’s long-term stability also argues against indefinite price increases.

  • The theory that Bitcoin’s fixed and scarce supply is the source of its value is flawed. Scarcity alone does not create value - there also needs to be demand for the scarce item.

  • Unlike the Mona Lisa, Bitcoin can be substituted with other cryptocurrencies or digital assets. This substitution possibility means its value is not solely determined by its fixed supply.

  • Scarcity is a function of both supply and demand, not an inherent property. Bitcoin’s fees create a negative feedback loop as demand increases, similar to commodities without fixed supply.

  • The stability of money refers to how demand dampens changes in supply, not constant prices. Money can be classified into market supply (commodities), monopoly supply (fiat currency), and fixed supply (Bitcoin).

  • Commodity money creates stability through competition limiting production in response to price changes. Monopoly money lacks this stability due to arbitrary supply changes from seigniorage. Bitcoin’s fixed supply avoids arbitrary changes but fees still provide a stabilizing feedback loop.

In summary, while Bitcoin has a fixed supply, this alone does not determine its value. Scarcity must be considered together with demand, and Bitcoin’s market properties still provide stability comparable to commodities. The scarcity argument is an oversimplification.

  • Protection of money’s value (its ability to resist reductions in purchasing power over time) comes from limitations in the supply. For commodity or monopoly money, this distinction comes from their economic properties.

  • When the supply of money is increased through seigniorage (the issuing of currency to generate seigniorage revenue), it causes inflation which decreases the money’s value.

  • This initially leads to capital flight as people move assets out of the declining currency. Governments may respond by imposing foreign exchange controls to limit capital movements.

  • The stock-to-flow ratio of money is commonly used to argue that currencies with higher ratios are less prone to inflation. However, this theory fails because it doesn’t consider that production/supply is determined by demand and profitability, not just inherent properties of the commodity. Flow depends on both supply and demand.

  • The scalability of Bitcoin transactions is inherently limited because only a finite number of transactions can be confirmed in each block period. This necessitates fees to prioritize transactions and remains limiting no matter how much hardware is used.

  • Layering can increase effective capacity but represents a compromise to on-chain security. Stability and non-scalability exist at any block size or layering level.

  • Substitutes put downward price pressure on Bitcoin by providing alternatives as its transfer fees rise with usage. Multiple similar coins could evolve but consolidation pressure toward a single coin still exists.

  • There is a minimum valuable transfer size due to security considerations. Rising fees will price out very low value transfers over time, necessitating substitutes or lack of use for those amounts.

Here is a summary of the key terms related to the set of weak blocks in bitcoin:

  • Orphan Pool: A misleading name for the set of weak blocks. Better termed the set of weak blocks.

  • Weak Block: A block that has less cumulative proof than another competing block. Also sometimes called an orphan block, though that is a misnomer.

  • Orphan: A misnomer sometimes used to refer to a weak block, though it is better to use the term weak block.

  • Cumulative Proof: The total amount of proof-of-work invested in a block and all previous blocks. The block or branch with the most cumulative proof is considered strongest.

  • Competing Block: When two blocks are mined at roughly the same height, they compete to be included in the main chain. The block with the most cumulative proof will become part of the strongest branch.

So in summary, the set of weak blocks, sometimes called the orphan pool, refers to blocks that have less cumulative proof than competing blocks and are unlikely to be included in the final main chain. Orphan is a misleading term, and weak block is a better descriptor.

Here is a summary of the key points about adox:

  • Adox is a multi-dimensional platform for decentralized media and communication. It aims to provide alternative options without centralized control.

  • Some of the principles it is based on include censorship resistance, protecting user privacy, minimizing centralized vulnerabilities, and distributing value/control as widely as possible among participants.

  • It uses blockchain and other decentralization techniques to achieve these goals. Content is stored using IPFS and interactions are facilitated through smart contracts.

  • Adox sees centralization of internet platforms as a risk due to the power and influence it concentrates in a few large entities. It aims to address this through a more distributed model where no single party is in control.

  • By decentralizing infrastructure and incentivizing widespread participation, it aims to be more resilient against attacks, censorship attempts, or political/economic coercion compared to traditional social media.

  • However, fully decentralized systems also face technical challenges around scalability, usability, and coordinating governance/evolution over time without centralized steering. How well adox balances these tradeoffs will determine its long-term feasibility.

So in summary, adox presents an alternative approach to internet communication through decentralization, but also comes with inherent challenges that decentralization alone does not fully solve. Its success depends on navigating those challenges effectively.

Here is a summary of the key points from the blog post “A Definition of Bitcoin” by Gavin Andresen:

  • Bitcoin is defined as a cryptodynamic system that derives its monetary properties solely through cryptography, peer-to-peer networking, and proof of work.

  • It has properties of money like censorship resistance, soundness, safety from seizure, portability, divisibility, limited supply.

  • Bitcoin adheres to principles like cryptodynamic principles, censorship resistance, depreciation, value proposition, money taxonomy.

  • It rejects fallacies like proof of stake, full reserve banking, thin air money creation, dumping, side fees, seizure risk, energy waste, zero risk returns.

  • Bitcoin mining is governed by economic incentives rather than legal tender laws or central authority.

  • Bitcoin acts as a substitute for other forms of money and competes based on its monetary properties through principles like substitution and consolidation.

  • Fractional reserve banking and fiat currencies are argued to create unintended economic distortions through credit expansion and monetary inflation.

  • Key concepts discussed include monetary inflation, time preference, production and consumption, Gresham’s law, regression theorem, risk preferences, and more.

The post aims to philosophically define Bitcoin based on Austrian economic principles and contrast it with characteristics of other monetary systems. It analyses Bitcoin as sound money governed purely by cryptography and economic incentives.

Here is a summary of the chapters and articles:

  • Inflation Principle: Discusses how inflation erodes the value of money over time.

  • Time Preference Fallacy: Critiques the idea of time preference in determining interest rates.

  • Speculative Consumption: Examines consumption driven by speculation rather than use-value.

  • Magic Internet Money: Traces the early development and popularity of Bitcoin on online forums like Reddit.

  • Money Taxonomy: Categorizes different types of monies and their properties.

  • Depreciation Principle: Explains how the value of money tied to commodity can decrease if supply increases.

  • Stability Property: Discusses the importance of stability of value for a good money.

  • Could Bitcoin Reach $1 Million?: Article speculating on potential future value of Bitcoin.

  • Gross World Product: Background on total global economic output to put Bitcoin’s market cap in context.

  • Modeling Bitcoin’s Value with Scarcity: Attempts to model Bitcoin’s value based on its scarcity profile.

  • Stock to Flow Fallacy: Critiques using stock-to-flow ratio to predict Bitcoin’s value.

  • Reservation Principle: Explains how people hold money based on anticipated future needs.

  • Reserve Currency Fallacy: Critiques the idea that a currency needs to be widely used internationally to be a good money.

  • Catallactics: Overview of Austrian school of economics that studies market exchanges.

  • Man, Economy, and State: Chapter from Rothbard discussing central banking and money.

  • Credit Expansion Fallacy: Critiques notion that central banks can expand money supply without costs.

  • Central Bank: Background on role of central banks in managing money supply and interest rates.

  • Settlement: Overview of process of settling financial transactions through the banking system.

  • Debt Loop Fallacy: Critiques the idea that government debt can be continually rolled over.

  • Money Supply: Data on different measures of U.S. money supply over time.

  • Permissionless Principle: Discusses how open access is important property for digital monies.

  • Seigniorage: Background on seigniorage as a source of revenue for central banks.

  • Mona Lisa: Used to illustrate substitution principle with an iconic non-monetary asset.

  • Subjective Theory of Value: Summarizes Austrian view that value is determined by individuals.

  • Supply and Demand: Background on basic economic concept showing how price is determined.

  • Damping Ratio: Concept from engineering used to analyze stability of bitcoin supply schedule.

  • Venezuela Halts Indicator: Article on Venezuela stopping publication of economic indicators.

  • State Monopoly: Critiques government monopolization of monetary role.

  • Capital Flight: Overview of fleeing of capital from a jurisdiction during instability.

  • Exchange Controls: Background on controls some governments place on exchange of foreign currencies.

  • Utility Threshold Property: Discusses minimum usefulness threshold for something to be treated as money.

  • Scalability Principle: Importance of ability to easily transact large values for digital money.

  • Centralization Risk: Risks that arise fromtoo much concentration of control over a currency.

  • Opportunity Cost: Economic concept of cost of alternatives forgone in a decision.

  • Consolidation Principle: Concept of diverse structures consolidating into hierarchies over time.

  • Bitcoin Labels: Terms commonly used within the Bitcoin community.

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About Matheus Puppe