Virtual Economy Pioneer Edward Castronova Skeptical of Bitcoin (So, So Am I)

You might think that economist Edward Castronova, who basically innovated the study of virtual world economies from an academic perspective, would be enthused about Bitcoin, the virtual currency some have proposed as a transformative new money that will remake whole economies and bring down governments (at least the theory goes.) Turns out, however, Professor Castronova is quite skeptical, because here are three attributes of a stable virtual money:

• You get money only by doing things that can be interpreted as "productive work." No freebies or handouts, and nothing abstract. You don't solve puzzles to get coin, you run FedEx quests.
• Mild inflation. As in the real world, mild inflation makes people happiest. Small enough to be unnoticeable in the short run, yet gives people a sense over time that their wealth and power is rising (even if it isn't).
• It assumed that the currency will be hacked and exploited. A strong central authority is in place to seize illicit funds and roll back damage.

Since Bitcoins has none of these things (especially the last one), color Castronova skeptical. And since Castronova knows more about economies (real and virtual) than I will ever know, I follow his skeptical lead. This isn't to say all virtual world pioneers are jaundiced about Bitcoin; just last weekend, I had a long talk with a well-known virtual world developer who was still hugely enthused about the concept. Me, I go where the money goes. When I see Bitcoin being used to buy actual goods and services in the tens of millions of US dollars, I might be less skeptical. But curiously, Bitcoin's defenders seem to spend way more time defending Bitcoin in blog post comment threads than they do spending Bitcoins like it was, you know, money.

Comments

[Ann Otoole InSL]

How about that $500,000 ripoff that happened?

I.e.; it isn't secure. Swiss cheese security. May as well withdraw all your cash from the bank and ball it up with your credit cards and driver's license and Social security card and toss it out the window in a seedy part of town.

[Zauber Paracelsus]

Any secure system is only as secure as its weakest link. In this case, its the wallet file that you keep on your hard drive.

If a virus or remote hacker gets in and is able to access the file, they can either copy it or copy it and then remove it.

[qarl]

i think it's sorta pointless to debate this topic anymore - either you see how it's cool, or you don't.

but for what it's worth - today you can use it go online and buy items that your government has deemed to be illegal - and there's pretty much nothing the government can do to stop it.

surely you can see that this is, at least, technically interesting?

[Hamlet Au]

I do see how a universal non-government currency is cool, Qarl, I guess my skepticism flag started flying when well-known advocates like Jason Calcanis would make really grandiose claims about it bringing down governments and shit. The Bitcoin folks would be a lot better off if they spent more time using it and getting legitimate businesses to use it, than just talking about it.

[qarl]

well - yes. the tech industry does suffer often from extreme-over-hype. as we know all too well.

[Domchi Underwood]

You were right about the Bitcoin the first time, Hamlet. It does have a lot in common with SL, complete with controversies. And just like SL, if it manages to attract the critical mass, it'll be fine.

[Nyoko Salome]

seems it panned out that way; i was only an interested observer, but - didn't think it could pan out; we're not to 'federation credits' stage as the universal standard yet. ;0

[Danielle]

Bitcoin miners are doing "productive work", they are verifying blocks of transactions to ensure the history of transactions is valid. For this they get rewarded with a certain number of fresh coins. By design that reward will taper off over time, and is intended to be replaced by transaction fees. At the moment those fees are small because the number of transactions are small.

And in case you hadn't noticed, the Linden dollar has been mildly deflating ever since the wild early days.

[Ann Otoole InSL]

The L$ has been around 270 to the dollar as long as I can remember. The only people saying it changes are the ones gambling on the non LL money markets.

[Rasah Tigereye]

Regarding the central authority that will protect against hacking, that authority is the same one that keeps Linux more secure than either Windows or Mac. Bitcoin is open source, and has a large group of dedicated people working on making it more secure and user friendly. Things like wallet encryption to keep your money secure, and a more intuitive client, are already in the works, and should bitcoin come across other problems, they'll be there to fix those issues too.

[DF]

The value of the L$ has been the same since Anne can remember, but what has the value of the US dollar been doing in that time...?

[Davincij15]

This statement is a subject of debate...
"Mild inflation. As in the real world, mild inflation makes people happiest. Small enough to be unnoticeable in the short run, yet gives people a sense over time that their wealth and power is rising (even if it isn't)."

I can personally tell you I was VERY VERY upset when I learned how money is created 4 years ago. I felt cheated all my life and people like yourself help cheat me by keeping this secret. The only time I found out about this was when some random politician who at the time I thought was lying said "This system transfers wealth from the poor and middle class to the rich." I went out on a quest to prove him wrong and found out I was in the f-ing matrix of debt and knew nothing about money.

Anyone that supports this system of theft is a sociopath benefiting from it because they know that most people don't understand and take advantage of that fact.

As for the this post I think it could have pointed out real issues with bitcoin not keynesian statements that are clearly incorrect.

Example:
Grisham's Law

But liars and cheats are not interested in real discussions.

[Smartie Pants]

Guys an idiot.

Get a new look as well.

[Smartie Pants]

Just keep serving your 2nd life corporate task masters.....everything will be fine............

[carbonpenguin]

There are plenty of us doing commerce in btc, and but that aspect seems to get paltry press in comparison to the sexy drama of the exchanges. For instance, my t-shirt shop, which we're hoping to expand soon to host a whole community of merchants: http://www.iusecoins.com

[BitSerbian]

1.
"You get money only by doing things that can be interpreted as "productive work." No freebies or handouts, and nothing abstract. You don't solve puzzles to get coin, you run FedEx quests."

hahaha....nice one :)

but...To understand why you are wrong, you need to understand the genesis behind the idea of Bitcoion.

Interestingly enough, it started with the goal of stopping bulk spam. The reason why there aren't dump trucks backing up to your mailbox each morning to unload massive amounts of spam is because there is a larger cost associated with sending postal mail versus email. There's the cost of the ink, paper, envelope and stamp. This means that any spam that can't recoup those costs simply doesn't get sent. Contrast that with email which is orders of magnitudes cheaper, the price being whatever it costs to send a few bytes over an Internet connection.

So, the idea was to attach a higher cost to emails in much the same way that postal mail has a higher cost. There are several schemes. One of these is run by a company called "GoodMail". They convinced a bunch of email providers to give certain emails a special icon in your inbox. These icons only display if you pay an extra fee to send the email. This prevents spammers from having such a huge economic incentive for sending spam, if they want the special icon. The service still exists but it really hasn't caught on.

However, a precursor to this idea was called "HashCash". Instead of charging money outright, it is based on a proof-of-work system. Under this system, you run a program and it starts generating tokens by using CPU resources. You attach a token to each email you send and the recipient can verify your token for relatively no cost. This makes it easy for the typical user to send and receive emails while making bulk spam prohibitively expensive.

After this system was proposed, someone came to the natural conclusion that there would be individuals that wouldn’t want to run the program but instead would rather buy the tokens outright. This gave rise to the idea of an entire market based on buying and selling tokens. Fast forward over a decade later and the creator of Bitcoin says, “Hey, who cares about email? Let’s use this stuff for money!” The rest is history.

So, what's my point? My point is that Bitcoin is a proof-of-work system which has value as a good because people, even if not used as money, would still want to use Bitcoins to prevent bulk spam. I imagine that if/when Bitcoin becomes widespread, we will see an actual implementation of this where sending an email costs a tiny fraction of a BTC.

I really hope this will put to rest the myth that Bitcoin has no possible use aside from being a medium of exchange.

2.
"Mild inflation. As in the real world, mild inflation makes people happiest. Small enough to be unnoticeable in the short run, yet gives people a sense over time that their wealth and power is rising (even if it isn't)."

Milde inflation ? At genesis stage of currency ?

Do you really want me to explain this or u figurd out by your self that extreme volitality is necessary at this genesis stage...this will change onece it hits 21 000 000 BTC...

3.
"It assumed that the currency will be hacked and exploited. A strong central authority is in place to seize illicit funds and roll back damage."

Someone said, and compare it well...Windows and GNU/Linux os...try figure it out by yourself....and give my regerds to Mr.Romeo ....who by the way worked as an Assistant and later Associate Professor of Public Policy and Political Science at University of Rochester....and of course he thinks nothing can be done without strong central authority...i bet he is Windows user himself :))

p.s.
We will get ritch...whit or without u or mr.Ted Romeo Casalblanca, Casanova...investing in our noble cause to destroy central authority.

[Michael Hampton]

I spend all my bitcoins like they are, well, money. And I've never bought anything illegal with them. (Though that's a large market in itself...)

As for economists, you can always find economists who disagree with each other. There are two major schools of thought in economics these days: the Keynesian school and the Austrian school. Your friend Castronova sounds like a Keynesian.

At the risk of oversimplification, modern Keynesianism holds that an economy can be steered effectively by careful planning and monetary policy adjustments, while the Austrian school holds that since a market comprises all of the economic activity of every participant, designing a central plan to control the economy effectively is impossible.

Austrian economics has seen a resurgence since its proponents predicted with startling accuracy the housing crisis, economic crash and current recession while Keynesians were (and still are) saying everything is OK. If you've been doing your own grocery shopping for more than a year, I doubt you think everything is OK.

Back to Bitcoin: While it could be used in virtual worlds, Bitcoin is a currency intended for use in the real world. It has technical features which solve certain problems very well.

For instance, moving money internationally. If you do this via a bank, you are going to get charged $50 or so, have to be subject to government paperwork, and have to wait several days. Moving the money via Bitcoin takes less than an hour and costs about the equivalent of one US cent (or less; most Bitcoin transactions are free).

And even if you don't have to send money internationally, there's PayPal and credit card processing fees which eat a huge chunk out of merchants' tiny margins. A typical credit/debit card transaction costs the merchant over 2% plus 30 cents. A comparable Bitcoin transaction costs nothing in comparison.

While it's been around for over two years, Bitcoin is still in its infancy. You can expect lots of market volatility and plenty of drama in the press as Bitcoin and the services around it mature. But in the long term, the only thing that can really stop Bitcoin is a world nuclear war.

[Jeremy]

The problem with this analysis is that it sees Bitcoin as an isolated system. True, Bitcoin cannot succeed on its own, but it can in symbiosis with other technologies. Two such technologies are webs of trust and escrow services, which can demonstrably all but eliminate the fraud problem. Another is wallet security software. This ecosystem is still very young and those tools are in development stage. Bitcoin is just one part of the puzzle. I'm surprised that Castonova fails to see the bigger picture and gets caught up with relatively minor, solvable details (in the long term). He fails to understand that bitcoin is above all a protocol and not just a piece of software.

When the http protocol was invented, it was practically useless, until web browsers were developed and websites were written that those browers could visit.

[Mysty Saunders]

From the comments left by some of the bitcoin supporters here and on their own forum, it seems to that they value money over anything else in life. Bitcoin seems like an religion where its (early) followers are the chosen ones destined for glory and riches. I'm not a doctor and nor do I play one on tv but that does seem rather obsessive and borderline schizophrenic.

[dec]

@BitSerbian

Alal si ga opleo,
svaka cast :)

[Hamlet Au]

Wow, I write a post on Bitcoin which ends with me saying, "Bitcoin's defenders seem to spend way more time defending Bitcoin in blog post comment threads than they do spending Bitcoins", and Bitcoin's defenders respond by... defending Bitcoin in the blog post comment thread.

[Pablo]

I cash my bitcoins out for USD. bitcoins (READ: SUCKERcoins are for fools.

[CK]

With regard to the "mild" inflation requirement, it is possible that once all of the "high powered" bitcoins are mined (or before), fractional reserve lending in BTC will begin as a fork of the bitcoin project (a la namecoins). In this way the market can maintain an exchange rate between high powered BTC and "money multiplied" BTC. As economic confidence increases mmBTC/BTC ratio would increase, as it falls the exchange rate would fall. If a government somewhere adopts BTC as their high powered currency they could also influence this exchange rate, just as US$ were used while the US was completely and partially on the gold standard.

[BWB]

"You get money only by doing things that can be interpreted as "productive work." No freebies or handouts, and nothing abstract. You don't solve puzzles to get coin"

The implied assumption here, that hashing the block chain is just "make work" to meter bitcoin creation, is false. The hashing provides a critical accounting function securing the intregity and security of the system. So the miners are actually being paid for a useful and necessary service. The protocol allows a solver of the hash to add 50 new BTC to the chain. The first miner to solve the chain is the one that is recognized by the network.

[noone]

@BWB: "So the miners are actually being paid for a useful and necessary service. The protocol allows a solver of the hash to add 50 new BTC to the chain."

There is nothing in the protocol that forbids miners from solving useless blocks. The only reason why this is not happening today is because almost all bitheads are unskilled in the art.

[noone]

@Davincij15: "I can personally tell you I was VERY VERY upset when I learned how money is created 4 years ago. I felt cheated all my life and people like yourself help cheat me by keeping this secret."

Money is the quantum fluctuation of the economy. The stuff springs out of nothing and then disappears into nothing!

But while it is around, work gets done.

For example, when you finally get a job, move out of your basement (saving your Mom the electricity bill from your useless bitcoin mining), and buy a house, you will probably get a loan.

Poof! Money springs from the economic quantum vacuum!

Like in particle physics, there is the normal particle and it's anti-particle. You get one, the bank gets the other.

As you pay down the mortgage the money is slowly annihilated by exchanging a force carrier -- ie, your productive work -- between the pair.

Finally, when you pay the loan off, the money disappears completely. Do I really need to tell you where it went? Furthermore, if you think bitcoin is substantially different from this, you are seriously deluded.

[Gancor_]

@noone Hello from the future, this did not age well :)