Reading the tea leaves and Magic 8 ball

[Last week CoinTelegraph sent me a couple questions for an article that has not appeared (I will link to it if it does).  Below are the responses I provided.]

Q: “What can be inferred from the decline in Bitcoin price and market cap in the course of 2014? There are two downward trends, separated by a level period and slight uptick.”

A: I probably wouldn’t call it a “market cap” (due in part to Jonathan Levin’s cogent post) and in my view, an analysis of the self-reported bitcoin price is difficult because of the lack of transparency in the underlying trusted third parties.  Perhaps something like a Consolidated Audit Trail or “proof of non-collusion” will become the norm as the industry professionalizes but until then this space will likely be vulnerable to a bevy of manipulations which may be causing these types of trends (e.g., purportedly like Willy Bot did last year).  Furthermore, because bitcoin’s supply is based on a fixed, limited issuance the only way to reflect changes in demand is through it’s price.  Thus, the fluctuations this past year are based on a myriad of factors some of which are difficult to measure like perceived regulatory/solvency risk and future law enforcement activity.  And because it is still very illiquid, sudden shocks are absorbed / reflected through volatility.  Consequently I do not think the market price is a reflection of the value of bitcoin as a transactional medium but almost entirely a function of speculative demand.  This past May, Robert Sams spoke on this duality as did Yanis Varoufakis in a new book.

Q: “Bitcoin’s technical foundations have been stated as insufficient to support wide-scale adoption by Mike Hearn. Do you think price volatility could be directly influenced in future by improvements or failures in this area?”

A: Both Gavin Andresen and the Blockstream team have independently discussed some of the technical limitations this past week, reaffirming the challenges that Mike Hearn described on several occasions this past year.  They have all also proposed potential solutions to these solutions, some involving soft forks, hard forks and even closer partnerships between mining farms, pools and developers.  Fundamentally however I do not think that Bitcoin’s blockchain will be able to serve the vast majority of use cases that it’s proponents claim it will for a couple of intractable reasons.  The first is because of the physics of decentralization; it is a matter of spatial topology (distance, length and redundancies) not materials science.  Thus the more dense, the less lag which favors centralization.  This past summer Murat Demirbas briefly wrote about this: Distributed is not necessarily more scalable than centralized.  The other is costs to maintain (nominal) trustless decentralization though the proof-of-work mechanism.  As I have written about several times, contrary to the traditional narrative, there are in fact no mandatory fees to utilize the blockchain and/or its Sybil-protection scheme.  The direct fees users believe they are paying are better defined as donations, as fees are something that are mandatory.  Consequently, the way to calculate how much proof-of-work costs is through a metric that Blockchain.info has visualized over the past years and which has hovered around $20-$30 per transaction.  That is not a competitive price relative to other payment systems and will likely relegate Bitcoin to certain niches.  I also think we will see other alternative consensus mechanisms come into production-level environments, creating a type of “consensus-as-a-service” (CaaS) of which a proof-of-work-based blockchain, such as Bitcoin, represents one part of that spectrum.

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