The Bullish Case for Bitcoin (part 1 of 4)

Genesis and the origins of money

With the price of a bitcoin surging to new highs in 2017, the bullish case for investors might seem so obvious it does not need stating. Alternatively it may seem foolish to invest in a digital asset that isn’t backed by any commodity or government and whose price rise has prompted some to compare it to the tulip mania or the dot-com bubble. Neither is true; the bullish case for Bitcoin is compelling but far from obvious. There are significant risks to investing in Bitcoin, but, as I will argue, there is still an immense opportunity.

Genesis

Never in the history of the world had it been possible to transfer value between distant peoples without relying on a trusted intermediary, such as a bank or government. In 2008 Satoshi Nakamoto, whose identity is still unknown, published a 9 page solution to a long-standing problem of computer science known as the Byzantine General’s Problem. Nakamoto’s solution and the system he built from it — Bitcoin — allowed, for the first time ever, value to be quickly transferred, at great distance, in a completely trustless way. The ramifications of the creation of Bitcoin are so profound for both economics and computer science that Nakamoto should rightly be the first person to qualify for both a Nobel prize in Economics and the Turing award.

The Origins of Money

In the earliest human societies, trade between groups of people occurred through barter. The incredible inefficiencies inherent to barter trade drastically limited the scale and geographical scope at which trade could occur. A major disadvantage with barter based trade is the double coincidence of wants problem. An apple grower may desire trade with a fisherman, for example, but if the fisherman does not desire apples at the same moment, the trade will not take place. Over time humans evolved a desire to hold certain collectible items for their rarity and symbolic value (examples include shells, animal teeth and flint). Indeed, as Nick Szabo argues in his brilliant essay on the origins of money, the human desire for collectibles provided a distinct evolutionary advantage for early man over his nearest biological competitors, Homo neanderthalensis.

The primary and ultimate evolutionary function of collectibles was as a medium for storing and transferring wealth.

Collectibles served as a sort of “proto-money” by making trade possible between otherwise antagonistic tribes and by allowing wealth to be transferred between generations. Trade and transfer of collectibles were quite infrequent in paleolithic societies, and these goods served more as a “store of value” rather than the “medium of exchange” role that we largely recognize modern money to play. Szabo explains:

Compared to modern money, primitive money had a very low velocity — it might be transferred only a handful of times in an average individual’s lifetime. Nevertheless, a durable collectible, what today we would call an heirloom, could persist for many generations and added substantial value at each transfer — often making the transfer even possible at all.

Early man faced an important game-theoretic dilemma when deciding which collectibles to gather or create: which objects would be desired by other humans? By correctly anticipating which objects might be demanded for their collectible value, a tremendous benefit was conferred on the possessor in their ability to complete trade and to acquire wealth. Some Native American tribes, such as the Narragansetts, specialized in the manufacture of otherwise useless collectibles simply for their value in trade. It is worth noting that the earlier the anticipation of future demand for a collectible good, the greater the advantage conferred to its possessor; it can be acquired more cheaply than when it is widely demanded and its trade value appreciates as the population which demands it expands. Furthermore, acquiring a good in hopes that it will be demanded as a future store of value hastens its adoption for that very purpose. This seeming circularity is actually a feedback loop that drives societies to quickly converge on a single store of value. In game-theoretic terms, this is known as a “Nash Equilibrium”. Achieving a Nash Equilibrium for a store of value is a major boon to any society, as it greatly facilitates trade and the division of labor, paving the way for the advent of civilization.

What an extraordinary episode in the economic progress of man that age was … for any man of capacity or character at all exceeding the average, into the middle and upper classes, for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages. The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep

Part 2…

Part 2 of this article will be published tomorrow and linked from Twitter (follow me). In part 2, I will cover the attributes that make a good store of value and how Bitcoin compares to other monetary goods, such as gold and fiat currencies, across these attributes.

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Vijay Boyapati

Vijay Boyapati

Tu ne cede malis, sed contra audentior ito