Bitcoin as Digital Gold

Presented at the United Nations Department of Economic and Social Affairs

Development Policy Seminar on the Frontier Issue of “Understanding Bitcoin, Blockchains and the Crypto Economy”

Transcript

1. Bitcoin as Digital Gold Ferdinando M. Ametrano ferdinando@ametrano.net @Ferdinando1970 Bitcoin and Blockchain Technology Università Milano Bicocca Politecnico di Milano United Nations Department of Economic and Social Affairs New York, February 1, 2018
2. Bitcoin as Digital Gold 1. Introduction 2. How Does It Work? (i.e. the Double Spending Problem) 3. Bitcoin as Digital Gold 4. Bitcoin in The History of Money 5. Blockchain Beyond Bitcoin © Ferdinando Ametrano 2018 2/56
3. Bitcoin Is Hard to Understand At the crossroads of: 1. Cryptography 2. Distributed systems (networking and data transmission) 3. Game theory 4. Economic and monetary theory Mainly not a technology, a cultural paradigm shift instead © Ferdinando Ametrano 2018 3/56
4. • Decentralized digital currency • Not backed by any government or organization • Instantaneous peer-to-peer transactions • No need for trusted third party • Cryptographic security • Synergic economic incentives • Efficient low-cost banking for everybody everywhere https://bitcoin.org/en/faq http://www.coindesk.com/information/ © Ferdinando Ametrano 2018 4/56
5. The Information Economy • Data is transferred with zero marginal cost • Why pay a fee to move bytes representing wealth? • Why only 9-5, Monday-Friday, two days settlement? • Who (and when) will gift humanity with a global instantaneous free p2p payment network? BANK © Ferdinando Ametrano 2018 5/56
6. Bitcoin • Decentralized: no central authority, no intermediaries • Permissionless: no regulator • Censorship resistant: no frozen funds • Open-access: no discrimination, no amount limits, 24/7, 365 days • Free: negligible transaction costs • Borderless: no geographic limits • Transnational: no specific jurisdiction applies • Secure: non falsifiable, non repudiable transactions • Resilient: nothing has been able to stop it or break it © Ferdinando Ametrano 2018 6/56
7. Bitcoin as Digital Gold 1. Introduction 2. How Does It Work? (i.e. the Double Spending Problem) 3. Bitcoin as Digital Gold 4. Bitcoin in The History of Money 5. Blockchain Beyond Bitcoin © Ferdinando Ametrano 2018 7/56
8. Double Spending Problem • To securely transfer value using digital means has been possible for decades • In digital cash schemes, a single digital token, being just a file that can be duplicated, can be spent twice • A centralized trusted party has always been required to prevent double spending © Ferdinando Ametrano 2018 8/56
9. Mining • All network nodes validate and clear transactions; those nodes also providing the computational power for settlement are called miners • Miners compete to validate a new block of transactions: the winner providing proof-of-work is rewarded with the issue of new bitcoins in a special coinbase transaction included in the block • Miners solve the double spending problem: – conflicting transactions spending the same coins would invalidate the block – an invalid block would be rejected from the network – the bitcoin reward would be removed from transaction history – miner would have wasted his work © Ferdinando Ametrano 2018 9/56
10. Distributed Consensus • How do miners reach consensus on the transaction history? • Consensus in an asynchronous network with faulty (or malicious) nodes is proved to be impossible • A problem known as Byzantine General Problem © Ferdinando Ametrano 2018 10/56
11. Nakamoto Consensus • Nakamoto achieves Practical Byzantine Fault Tolerant consensus using (game theory) economic incentive for the mining nodes to be honest. Bitcoin – solves double spending without a central trusted party – can resist attacks of malicious agents, as long as they do not control network majority • Miners are compensated for their proof-of-work using seigniorage revenues, i.e. with issuance of new bitcoins • Seigniorage revenues subsidize the network, making transaction almost free © Ferdinando Ametrano 2018 11/56
12. Virtuous Cycle Hashing Power Bitcoin Security Bitcoin Price Mining Reward © Ferdinando Ametrano 2018 12/56
13. Network Hash Rate https://blockchain.info/charts/hash-rate?timespan=all 100,000s times more powerful than the world top 500 supercomputers © Ferdinando Ametrano 2018 13/56
14. Bitcoin as Digital Gold 1. Introduction 2. How Does It Work? (i.e. the Double Spending Problem) 3. Bitcoin as Digital Gold 4. Bitcoin in The History of Money 5. Blockchain Beyond Bitcoin © Ferdinando Ametrano 2018 14/56
15. Validation Process: Block Generation The proof-of-work difficulty is adapted to the overall available computing power to ensure an average of one block every ten minutes © Ferdinando Ametrano 2018 15/56
16. Bitcoin Monetary Rule • 2009: 50BTC per block, every 10 minutes – halving every 4Y • This is the only way new bitcoins are released • It is called mining because of its similarity with the progressive scarcity of gold extraction • Supply free of discretionary intervention © Ferdinando Ametrano 2018 16/56
17. Bitcoin Inelastic Supply: Deterministic Decreasing Rate chart © Ferdinando Ametrano 2018 2029: 96.88% of all BTC issued 2141: last satoshi (0.00000001 BTC) will be issued 17/56
18. What Makes Bitcoin Special? • Digital and scriptural: it only exists as validated transaction • Asset, not liability • Bearer instrument • It can be transferred but not duplicated (i.e. it can be spent, but not double-spent) • Scarce in digital realm, as nothing else before • Mimicking gold monetary policy • More a crypto-commodity then a crypto-currency Bitcoin is digital gold this is the groundbreaking achievement by Satoshi Nakamoto © Ferdinando Ametrano 2018 18/56
19. Bitcoin Relevance If one thinks about the role of physical gold in the history of civilization, money, and finance the digital equivalent of gold could be disruptive in the current digital civilization and the future of money and finance © Ferdinando Ametrano 2018 19/56
20. BTC/USD Exchange Rate http://bitcoincharts.com/charts/bitstampUSD#tgWzm1g10zm2g25 • BTC Market Cap: about $150B (USD M0 1959-2017 average has been $680B) © Ferdinando Ametrano 2018 20/56
21. Risk Measures • Price dynamic is the discovery process of value, the value of digital gold being hard to grasp • High return (x10,000 in 7 years) → high risks Daily Returns, July 2010 – October 2017 © Ferdinando Ametrano 2018 BITCOIN GRAIN WTI IND.METALS GOLD MSCI BRIC EUROSTOXX50 S&P500 XBT Curncy SPGSGRP Index CLA Comdty SPGSINP Index XAU Curncy MXBRIC Index SX5EWK Index SPX Index Mean 0,83% -0,02% -0,03% 0,00% 0,01% 0,00% 0,01% 0,04% Standard deviation 6,99% 1,41% 1,29% 1,24% 1,02% 1,12% 1,57% 0,92% Volatility 133,61% 26,87% 24,67% 23,60% 19,44% 21,47% 29,97% 17,62% Skewness 123,36% 20,68% 3,89% -13,38% -58,48% -26,23% -3,53% -37,00% Excess kurtosis 1482,10% 245,42% 421,23% 240,23% 566,63% 252,24% 522,26% 478,54% Minimum return -45,17% -5,88% -6,86% -6,49% -8,97% -6,69% -11,02% -6,66% Maximum return 67,71% 7,35% 7,17% 5,69% 5,20% 4,87% 11,81% 4,74% Value-at-Risk at 99% confidence 17,27% 3,69% 3,46% 3,19% 2,83% 3,20% 4,39% 2,67% Expected Shortfall at 99% confidence 25,99% 4,80% 4,66% 4,36% 3,95% 3,97% 5,67% 3,60% Worst Absolute Drowdown -93,07% -61,27% -59,51% -57,82% -44,58% -51,05% -44,33% -19,39% 21/56
22. A New Uncorrelated Asset Class Field = Last Price, Data Type = Pct Chg (1D), Log Type = None, Periodicity = 1D, Currency = Dflt, Start Date = 24/07/2010, End Date = 13/10/2017 BITCOIN GRAIN WTI IND.METALS GOLD MSCI BRIC EUROSTOXX50 S&P500 XBT Curncy SPGSGRP Index CLA Comdty SPGSINP Index XAU Curncy MXBRIC Index SX5EWK Index SPX Index XBT Curncy 100% 4% 1% 4% 0% 1% 5% 4% SPGSGRP Index 4% 100% 19% 22% 14% 16% 15% 16% CL1 Comdty 1% 19% 100% 37% 15% 31% 31% 36% SPGSINP Index 4% 22% 37% 100% 32% 44% 48% 37% XAU Curncy 0% 14% 15% 32% 100% 12% 9% -1% MXBRIC Index 1% 16% 31% 44% 12% 100% 58% 49% SX5EWK Index 5% 15% 31% 48% 9% 58% 100% 63% SPX Index 4% 16% 36% 37% -1% 49% 63% 100% © Ferdinando Ametrano 2018 22/56
23. Bitcoin Potential Upside Bitcoin Market Cap (as of today): about $150B • Asset Under Management, Worldwide: $100T – If 2% is invested in BTC, price might increase x13 • Gold capitalization: $8T – For BTC to reach a similar level price might increase x53 • Metcalfe's law: the value of a network is proportional to the square of the number of users – Estimated BTC investors is about 50 millions; with a forecast to 350 millions price might increase x49 © Ferdinando Ametrano 2018 23/56
24. Bitcoin as Digital Gold 1. Introduction 2. How Does It Work? (i.e. the Double Spending Problem) 3. Bitcoin as Digital Gold 4. Bitcoin in The History of Money 5. Blockchain Beyond Bitcoin © Ferdinando Ametrano 2018 24/56
25. Trade Economy From Gold Standard to Fiat Money • Gold: the commodity money standard – scarce – pleasant color, i.e. resistant to corrosion and oxidation – high malleability – relative easiness of its purity assessment • Gold purity certification • Representative money • Fractional receipt money • Fiat money and legal tender © Ferdinando Ametrano 2018 25/56
26. Money As A Social Relation Instrument 1. Human beings are born into a gift economy 2. Enlarged relationship circle requires exchange economy 3. Barter economy: coincidence of wants 4. Trade economy: money as medium of exchange 5. Global information economy: supranational digital money © Ferdinando Ametrano 2018 26/56
27. Friedrich August von Hayek Denationalisation of Money • history of coinage is an almost uninterrupted story of debasements; history is largely a history of inflation engineered by governments for their gain • why government monopoly of the provision of money is regarded as indispensable? It deprived public of the opportunity to discover and use a better reliable money Blessed will be the day when it will no longer be from the benevolence of the government that we expect good money but from the regard of the banks for their own interest A Free-Market Monetary System, Gold and Monetary Conference, New Orleans, Nov. 1977, https://mises.org/daily/3204 Hayek, F. A., Denationalisation of Money, The Institute of Economic Affairs, http://www.mises.org/books/denationalisation.pdf © Ferdinando Ametrano 2018 27/56
28. Permissionless Innovation Fast and Effective • No centralized security mechanism, no barrier to enter, no editorial control – Email has not been designed by a consortium of postal agencies – Internet has not been developed by a consortium of telcos • Will a decentralized transactional economy be shaped by a consortium of banks? © Ferdinando Ametrano 2018 28/56
29. Explain Money to an Alien fiat money • No intrinsic value (legal tender, social contract) • Currency based on paper/ink security • Discretionary governance • Wicksellian interest-rate approach bitcoin • No intrinsic value (digital gold) • Currency based on math/cryptographic security • Algorithmic governance • Deterministic supply © Ferdinando Ametrano 2018 29/56
30. Money Comparison Medium of Exchange Store of Constant Value Unit of Account Live cattle Diamonds Gold Fiat coins and notes Bitcoin • swappable • fungible • portable • divisible • recognizable • resistant to counterfeiting • reliably saved, stored, and retrieved • retain usefulness over time • Maintain its storage properties • non-perishable or with low preservation cost • relative worth unit of measure • stable value for stable price comparison • supply must be controlled in some way © Ferdinando Ametrano 2018 30/56
31. Unit of Account: Money as Numeraire • Money is the unit of account against which the value of every other good is measured • The price system measures the value of goods relative to the value of money Good money should provide stable prices to best perform its role as unit of account © Ferdinando Ametrano 2018 31/56
32. Bitcoin is Digital Gold Not a Good Unit of Account • no salaries, no mortgages, no stable purchasing power • successful at getting rid of a centralized monetary authority, it has given up the flexibility of an elastic supply of money © Ferdinando Ametrano 2018 32/56
33. There are worse situations… Since the establishment of Federal Reserve in 1913 the US dollar has lost 96% of purchasing power © Ferdinando Ametrano 2018 33/56
34. Bitcoin as (Digital) Gold in the History of (Crypto)Money gold • Its adoption was not centrally planned • For centuries it has been the most successful form of money • It has bootstrapped all monetary systems we know of • It has been surpassed by other kind of money without becoming obsolete bitcoin • Its adoption has not been centrally planned • It is the most successful form of cryptocurrency • It will bootstrap new monetary systems • It might be surpassed by more advanced type of cryptocurrencies without becoming obsolete © Ferdinando Ametrano 2018 34/56
35. Hayek Money: A New Generation of Cryptocurrencies • The cryptocurrency monetary standard of elastic non-discretionary supply • Price stability paradigm with respect to a given reference basket • Concurrent cryptocurrencies will compete in monetary policy definition and reference basket choices © Ferdinando Ametrano 2018 35/56
36. Hayek Money Implemented as Dual Asset Ledger Split transactional and speculative money demand with two non-fungible assets: • (stable) transactional coins • (unstable) speculative shares Blockchain technology tracks ownership and transactions for both: dual asset ledger © Ferdinando Ametrano 2018 36/56
37. Reserve Asset Bank IPO • Raises bitcoins as reserve asset in quantity Better to avoid non-crypto reserve assets: a custodian legal entity would be required, re-introducing centralization • Issues coins and shares, backed by : ∙ + ∙ = • Operates on the market stabilizing the coin: – selling reserves to buy coins – acquiring reserves when selling coins © Ferdinando Ametrano 2018 37/56
38. The Bitcoin Standard Bitcoin As Reserve Asset • When used as reserve asset, its qualities are magnified! • Its limits are lessened. No more need to: – scale to huge (cash + bank accounts + credit cards) number of transactions – support economically inefficient micropayments – lower confirmation time © Ferdinando Ametrano 2018 38/56
39. The Ultimate Fate of Bitcoin: To Serve as a Reserve Currency https://bitcointalk.org/index.php?topic=2500.msg34211#msg34211 Hal Finney (1956–2014) was a noted cryptographic activist. He was the second PGP Corporation developer hired after Phil Zimmermann. He created the first reusable proof-of-work. He was an early bitcoin user and received the first bitcoin transaction from bitcoin's creator Satoshi Nakamoto. © Ferdinando Ametrano 2018 39/56
40. Gold is not loved • 1933 Gold Act "forbidding the hoarding of gold coin, gold bullion, and gold certificates within the continental United States". • 1972 Nixon shock: unilateral cancellation of the convertibility of the United States dollar to gold. • 1966 Greenspan: “This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.” © Ferdinando Ametrano 2018 40/56
41. The New Wild West © Ferdinando Ametrano 2018 41/56
42. Bitcoin as Digital Gold 1. Introduction 2. How Does It Work? (i.e. the Double Spending Problem) 3. Bitcoin as Digital Gold 4. Bitcoin in The History of Money 5. Blockchain Beyond Bitcoin © Ferdinando Ametrano 2018 42/56
43. What About Blockchain? “When a wise man points at the moon the fool examines the finger.” (Confucius) “When a wise man points at the bitcoin the fool examines the blockchain.” (Ametrano) © Ferdinando Ametrano 2018 43/56
44. “Blockchain – not bitcoin – will prove revolutionary in banking” http://www.economist.com/news/leaders/21677198-technology-behind-bitcoin-could-transform-how-economy-works-trust-machine © Ferdinando Ametrano 2018 44/56
45. Bitcoin in 2014 Is Like Internet in 1994: Weird and Scary Marc Andreessen: American entrepreneur, investor, and software engineer. Coauthor of Mosaic, cofounder of Netscape https://twitter.com/pmarca/status/677658844504436737 © Ferdinando Ametrano 2018 45/56
46. The Walled Garden Model • Controlled access to web content and services • Offered in the late ‘90s and early ‘00s by Compuserve, AOL (and to some extent MSN) • Corporates wanted to go online, but not in the wild unregulated internet, populated by anonymous agents • They eventually realized that perceived risks, which are real, are outweighed by benefits © Ferdinando Ametrano 2018 46/56
47. What is The Blockchain? [A hash pointer linked list of blocks] • An append-only sequential data structure • New blocks can only be appended at the end of the chain • To change a block in the middle of the chain, all subsequent blocks need to be changed • Very inefficient compared to a relational database © Ferdinando Ametrano 2018 47/56
48. Blockchain Without Bitcoin Does it make sense? No bitcoin No asset available to reward miners Appointed validator officials required Central governance is required! Why should validators use a blockchain, i.e. a subpar data structure, instead of a database? © Ferdinando Ametrano 2018 48/56
49. Radioactive fallout In the nuclear explosion of bitcoin applied cryptography is the radioactive fallout It can be used to harden existing business processes Databases on cryptograpic steroids © Ferdinando Ametrano 2018 49/56
50. Blockchain Beyond Bitcoin: Blockchain Timestamping • A generic data file can be hashed to producing a short unique identifier, equivalent to its digital fingerprint • Such a fingerprint can be associated to a bitcoin transaction (irrelevant amount) and hence registered on the blockchain • Blockchain immutability provides time-stamping, proving data the file existence at that moment in time in that specific status BTC Transaction data file t3 t4 t0 t1 t2 Genesis block Hash function Hash value 610b0a4b2769898674a2624e9330fbd60bbee200db2b57514be49d9a8b63dc25 © Ferdinando Ametrano 2018 50/56
51. Time-stamping is Notarization • An unlimited number of documents can (should) be organized in a Merkle Tree and timestamped with a single transaction • Calendar services can provide aggregation and attestation • The process has been standardized to allow for third party auditability, making it suitable for regulatory prescriptions © Ferdinando Ametrano 2018 51/56
52. © Ferdinando Ametrano 2018 52/56
53. Anchoring: A New Security Paradigm • Bitcoin blockchain network security is preserved by a computation power unparalleled in human history • Other transactional networks can tap into this security via anchoring (i.e. periodic time-stamping of the network status) • Any “stateful system with global memory” can outsource its security to the bitcoin network, piggybacking its resilience • Bitcoin miners as global outsourced decentralized security of the future © Ferdinando Ametrano 2018 53/56
54. Digital Gold Jewelry • What jewelry is for gold, timestamping and notarization could be for bitcoin, the digital equivalent of gold: not essential, but effective at leveraging its beauty • Bitcoin seigniorage revenues might provide security for all transactional networks © Ferdinando Ametrano 2018 54/56
55. Bibliography • Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System (2008) https://bitcoin.org/bitcoin.pdf • Ferdinando Ametrano, Bitcoin, Blockchain and Distributed Ledger Technology: Hype or Reality? (2017) https://goo.gl/Z9OeHt • Ametrano F., Hayek Money: the Cryptocurrency Price Stability Solution, http://ssrn.com/abstract=2425270 • Ametrano F., Cryptocurrency Price Stability With Seigniorage Shares And Reserve Bank, http://ssrn.com/abstract=2508296 • Ferdinando Ametrano, Bitcoin and Blockchain Technology, YouTube videos, https://goo.gl/qDvKXi © Ferdinando Ametrano 2018 55/56
56. Conclusions 1. Bitcoin is hard to understand: it is not a technology, a cultural paradigm shift instead 2. Bitcoin solves the double spending problem (distributed consensus), allowing for the decentralization paradigm 3. Bitcoin is digital gold: – could be as relevant as physical gold for the history of our civilization and the future of money & finance – a new asset class with no correlation with other asset classes: investing in bitcoin is rational diversification 4. Bitcoin is bootstrapping new monetary systems 5. There is no blockchain without bitcoin, but there is a blockchain beyond bitcoin: notarization and anchoring © Ferdinando Ametrano 2018 56/56