starla wrote: ↑Mon Mar 01, 2021 4:49 pm
I don't understand fully how bitcoin is mined, and why running algorithms on a computer should translate into money. Who is getting value out of whatever the miners are doing? This is what has prevented me from ever buying any, recent runup not withstanding. And I think the lack of understanding on the part of most non-SWE folk is what prevents wider appeal and adoption.
That is the biggest problem I see with bitcoin specifically: that the work has no inherent value and is bad for the environment.
Not sure if you are looking for an explanation of cryptocurrency, but here's my unsolicited long-winded version from first principles (thought I'd manage to keep it short, but I was off by a smidge).
Back in the old days, we had
commodity money, like gold or silver coins. Its value were based on the inherent value of the material is was made of. But then people started to mess around by debasing the currency, reducing the amount of gold and silver, maybe by folks taking tiny chips off of many coins, or by the government defining the standard gold coin to have less gold in it so they would have more coins to pay people with (causing inflation, as prices go up to adjust). Also it was presumably a pain in the ass to store or pay large sums of gold or silver.
So rather than deal with physical commodities,
representative money came along, which is paper money (bank notes) backed by a fixed amount of a commodity in a way that the amount could not be reduced, and the money could not be debased (though of course the value of the underlying commodity might fluctuate, its quantity is fixed). Basically you could now trade money that entitled you to withdraw a certain amount of a commodity (backed by a government). This was the money used in the U.S. until 1971, where each U.S. dollar was backed by 1/35 of a troy ounce of gold (mostly held in Fort Knox).
Eventually, representative money gained sufficient traction that governments could do away with the need for some Fort Knox-style repository of gold to back the currency with, and just continue with the paper (dollars) itself. Superficially, little changed for the folk on the street; they go about business as usual paying with dollars, just that now, the money is not pegged to gold. The US dollar is now
fiat money: a currency that has little or no inherent value (like the paper in a 100 dollar bill has no value), and that cannot be exchanged in a guaranteed way for a fixed amount of a commodity with inherent value (i.e., is not tied to the value of such a commodity), but is still backed and controlled by a government. The main change is that fiat money allows the government to generate as much money as they like (which again can lead to inflation) without having to stockpile more gold in Fort Knox.
Enter
cryptocurrency: a new type of money that, like fiat money, has almost zero inherent value, but, unlike fiat money, it is not backed by a government or political union. But it has to follow some of the same principles as the other types of money (commodity, representative, fiat). Namely, money needs to be based on something
scarce: it would be impractical to have money based on grains of sand as they are so common that only massive amounts could have value;
durable: it would be impractical to have money based on some fruit or some radioactive stuff that will decay quickly as you could not store wealth;
verifiable: you need, for example, to be able to verify that a dollar note is real, and to ensure it cannot be easily faked;
portable: you need to be able to move it around; etc.
Actually, cryptocurrency easily fits most requirements for money (e.g., it's portable over the internet) except scarcity, and convincing people it's actually money without a history of commodity/representative money to instill faith, and/or a government telling them it's worth something.
For scarcity, cryptocurrency works off a similar principle to how the passwords work online: based on ideas from cryptography, and in turn on number theory. An analogy is that we can create digital locks and digital keys (just numbers basically) so that only a tiny fraction of keys will open a given lock. So it is very hard (in some cases impractical) to find the key for a given lock unless you already know it. The only option you have otherwise is to try lots and lots of keys until you find one that opens the lock.
Bitcoin was designed so as to view each new bitcoin (or some fixed amount of new bitcoins) as a lock that only a certain small fraction of keys can open. The process of mining is then to computationally try lots of different keys until you find one that fits and opens the lock. The first key that is found (with some minor exceptions) then becomes the new bitcoin. (In this case, the lock more precisely encodes a history or block of transactions, so once a key is found, it becomes part of the blockchain -- the official log of transactions -- and the miner who finds the key gets paid a certain number of bitcoins -- currently 12.5BTC -- for completing the block with its key.) You can then pass the key around to other people in the network to verify that it is the right one: it is easy for anyone to try the key in the lock and see that it works. All bitcoin have been generated in this way, based on finding a key in a haystack.
Why was Bitcoin designed this way? It creates
artifical scarity based on the fact that it is hard to find a key and thus to create new bitcoin. Based on current values, we can say that it costs
at least $50k on average -- in terms of the electricity and computational machinery -- needed to find a key
first. The word "first" here is important. If you find the key second, it is (in most cases) worthless. If you could find a key first, on average, for less than $50k, then more folks will join the mining process as they pay less than $50k to gain $50k, which in turn makes it harder, and more expensive, to find a key first. So the mining process strikes a balance regarding market value. More value, more miners; less value, less miners.
But we don't want to tie value to the costs of mining. If bitcoin has a high value, more miners will come, but that doesn't mean that we necessarily want more bitcoin to be generated, as that would reduce scarcity and the value of bitcoin. On the other hand, it is important that mining continue as it is the process by which transactions are recorded. There are thus some valves that can be used to offset the costs/value of mining, like how much new bitcoin is paid out when someone finds a key to unlock a block of transactions; this value is constantly going down, and will eventually go to zero, at which point no new bitcoins will be created, and supply will be fixed at 21 million bitcoin in circulation. These values were defined at the outset of bitcoin and are not controlled by any government or whatever. Another factor is the number of valid keys that will unlock new bitcoins, which is adjusted based on how long it took all the miners to unlock the last block so as to keep the average time to around 10 minutes. These measures together mean that the market value determines the cost of mining, not the other way around; scarcity finds a balance to match the value of the market. (Also the difficulty is important to avoid there being lots of different competing blocks emerging at the same time, which would lead to competing forks of the blockchain, something that happens rarely given the current difficulty adjusted to generate a new block every 10 minutes.)
Just because something is scarce though, doesn't mean it's worth something. None of this is worth anything unless folks actually believe it is worth something. This is the intangible part and the volatile part. The actual mechanics of Bitcoin are well understood, transparent, and fairly predictable. What is not predictable is the market value in terms of how accepted Bitcoin will become as a currency you can buy things with. Bitcoin is believed to satisfy all the necessary criteria for money, but it's not money unless people believe it is.
Why might people believe it has value? Well, we believe the US dollar (or whatever traditional currency) has value, fundamentally, because not only is it useful for us to believe that, we have a vested interested in believing that. It is useful because it is better than having to cart around beaver hides everywhere we go to trade for something. We all have a vested interested in upholding that belief because our bank accounts use US dollars as their measure, and if we lose that belief, we (at least if we have a positive amount) lose our wealth. (Here, "we" is not an equal reference; those with more dollars have more of a vested interest and tend to wield more political power in terms of controlling regulation, monetary policy, etc.)
So is Bitcoin useful to believe in? Well it is not backed by any government, and can theoretically be used for anonymous payments across political borders, without interference or control from financial institutions (with a big caveat: this is subject to the laws and regulations of particular governments). Also we buy more and more things online, so the infrastructure and culture is already in place for bitcoin to prosper. So people see this as a useful feature that means that it will be useful for us to believe in Bitcoin as money. Aside from that, the whole idea of cryptocurrency has its roots in crypto-anarchism, meaning being able to operate individually beyond the government sphere of influence using cryptography to make oneself anonymous and beyond prosecution (so long as the system itself, e.g., Bitcoin, is allowed to continue). In terms of vested interest, this is why Bitcoin sees peaks when "established players" jump on board. As more and more powerful players come on board, vested interests increase, and so too does political power and influence in terms of potential regulation, as well as the credibility of the cryptocurrency in terms of actually being money.
Now the key problem with Bitcoin is the ecological effect, which may be unnecessary. In general, to mine a new block/set of bitcoins, quintillions of keys have to be tried (in the space of 10 minutes), which requires massive computational resources that are constantly operating, using up energy, and creating pollution. As bitcoin's market value goes up, the number of miners goes up, and the difficulty in terms of the number of keys that have to be tried also goes up, which worsens the effect. This process creates the (artificial) scarcity that Bitcoin depends on, but is a massive waste of computational power. It has increased the prices of GPUs, increased the prices of electricity, has a negative effect on the environment, and is potentially unnecessary. It would be like saying, hey, let's use orphan blood as the ink for our new US dollar bills.
So if there were a way to create a more ecologically-friendly cryptocurrency, with some other form of artificial scarcity that doesn't waste massive amounts of computational power, but doesn't require some political power to prop it up, that would be the next step. I know there have been proposals along those lines, but not sure if any have taken off.