Several things about bit coins that I am just not comprehending.
The biggest question I have is where does a virgin just created bit coin get its value? Does the creator of that bit coin receive that value? I understand how attractive and even valuable it might be for people to use bit coin. But I can't comprehend who gets the initial value if it before it has even been used??
I can vaguely comprehend that say a genius bit coin creator can create a $1,000,000 a month in bit coins, he is the fastest and thus a superstar. An average joe genius bit coin creator is good for maybe $25,000 bit coins a month.
Does currency ever enter into the cycle to be shown as income or profit?
It does not take brains to succeed as a bitcoin miner, it just take lots of available computer power. Also, I am pretty sure that no individuals are currently able to male anything remotely like the values you mention by bitcoin mining. The bitcoin system is designed so that they get harder to mine (in the sense of requiring more powerful computers run for longer and longer times) as more are produced. In the early days of bitcoin, when mining them was much easier and their dollar value was much lower, some people accumulated quite a few of then, which, by now (the value having shot up due to speculation) may have a high dollar value, but no individual today is getting rich just by mining them (as opposed to speculating in them).
If you want to make real money, like dollars, from bitcoin, you sell your bitcoins to someone else for dollars. Of course, you will be kicking yourself if you sell, and the dollar value of bitcoin continues to rise. Then again, you will be kicking yourself even harder if the dollar value suddenly plummets.
The thing that baffles me about bitcoin is why, when they were getting started, anyone was willing to take them in payment for anything at all.
And yes, I know that dollars and most other modern ‘legit’ currencies are fiat currencies too. That is not the point. Before they went fiat, other currencies had had long histories, during which they were backed by precious metals over which to build up trust for themselves (or they were connected with other currencies that had such a histoy), Bitcoin never had anything like that. Why, at the beginning, was anyone dumb enough to accept it in payment?
Which of course has nothing to do with its vehement defense by the geek squad. Of course showing off massive, hairy, steaming computing testicles “adds value” to any result generated. Anyone who disagrees must have, you know, a Pentium or something.
So many aspects of the Bitcoin movement are pure cargo cult it will become the source of many sociology doctorates. (“They do X and say it ‘has value’; fine, we’ll do Y and therefore it ‘has value’ too.” - without any apparent understanding of why X is accepted as a medium of value.)
There’s an important point about Bitcoin mining which a lot of people don’t realize: creating new Bitcoins is not the primary purpose of mining; it is just a side effect. The miners are actually doing useful work, and getting paid for it. At some point in the (far-off) future, no more new coins will be created but mining will still be needed.
Bitcoin is basically a distributed database (“the blockchain”) containing every transaction that has ever taken place – a digital ledger. Every participant in the system maintains a copy of at least a portion of that database. All the clients in the Bitcoin network are constantly sharing the latest transactions with each other.
Now, we can’t just let anybody add transactions as they please, since that would allow for all kinds of mischief. And we don’t want a central trusted party either, because de-centralization is what Bitcoin is all about. Therefore, the ability to add new transactions (grouped together in “blocks”) to the database, must be shared by a large number of independent parties, all keeping each other honest. If one of those parties attempted to do something funny, such as paying money to party A and then try to distribute a new version of the blockchain in which that same money is paid to party B instead, that attempt would fail because the other participants would already have been adding new blocks to the older version, and distributing that one. (I’m simplifying quite a lot here.)
Now, how do we encourage such a healthy ecosystem of independent parties maintaining the database, and prevent a single party from effectively owning the blockchain? That’s where the mining comes in. When you “mine bitcoins”, what you’re really doing is adding new blocks to the database. By requiring a difficult computation to be performed for each new block, a competitive playing field is created in which no single party can take over the blockchain – currently the total amount of computing power spent on Bitcoin mining is more than what the top-50 of supercomputers in the world could produce, and anybody trying to take over the blockchain would need to amass more than 50% of that power by themselves!
Of course, doing those computations costs hardware and electricity, and the miners are not going to spend those costs for the fun of it. So, every time somebody mines a block, they are allowed to add one transaction to that block which creates a bunch of new Bitcoins out of thin air, and award those coins to themselves. In addition, miners also charge fees for adding transactions to the blocks. In the future, the number of Bitcoins awarded per block will gradually be reduced, until at some point (well into the next century) it is reduced to zero and the miners will have to subside on transaction fees only.
So in addition to encouraging healthy competition between miners and preventing a hostile takeover of the blockchain, this also answers the question of how, when new money enters the system, the initial allocation of that money should be done. The miners are getting paid a salary for doing the work of maintaining the database which Bitcoin is based on.
Of course, an unfortunate side effect of this system is that huge amounts of energy are (arguably) wasted on performing computations which have no other useful purpose (e.g. they can’t be simultaneously used to do SETI or protein folding or whatever). But so far nobody has found a better way to solve the above problem of maintaining the ledger while keeping the whole system fully de-centralized and not requiring any special trusted parties to decide whether a transaction is valid.
Thank youWalton Firm, that was very interesting. It helps explain why mining is necessary to Bitcoin. I’m still at a loss to understand why Bitcoins are necessary.
I read your post slowly, three times, and no answer made itself evident. In real simple words, because I might be stupid…
What, exactly, is the “useful work” the miners are doing?
I vaguely discern that mining, and continued mining, supports Bitcoin value… but other than that circular purpose/explanation, what “value” does the “useful work” have? How is it different from a warehouse full of workers moving blocks from place to place and keeping careful track of the movements?
Was Linux necessary, given that we already had Windows? Was Firefox necessary, given that we already had Internet Explorer? Were Uber and AirBnb necessary, given that we already had taxicabs and hotels?
Each of these is an attempt to create a grassroots, decentralized alternative to something that already existed. And for at least the first two, I personally consider them, in their latest versions, to be superior to the alternative. Your mileage may vary, of course. Likewise, I consider Bitcoin, even in its current fledgling state, to have important advantages over e.g. credit cards and Paypal.
Will it eventually become the dominant means of making payments online and perhaps even offline? Will it become accepted as a real currency, equivalent to the dollar and the euro? (Probably not. :p) Will it fail? Will it fail, but pave the way for some other kind of open-source based virtual currency which does not share Bitcoin’s technical flaws? It’s too early to say, but it’s certainly a cool idea and a very fascinating experiment…
For a certain definition of “useful,” the useful work they are doing is finding a cryptographic hash to validate a block of transactions in the ledger. The first miner to validate the block broadcasts this information to the rest of the network, who check the work. This is known as a proof-of-work system; the idea is to have some way of knowing that information being broadcast to the network constitutes valid transactions and not fake ones.
The way the Bitcoin proof-of-work system works is by chaining a series of cryptographic functions together (the infamous blockchain.)
Here’s how that works (very oversimplified):
Nodes from all over the bitcoin network broadcast transactions. (User A gives amount X to User B, etc.) Mining nodes gather a group of recent transactions into a block. The nodes then all look for a number which, when combined with the block and run through a difficult hashing algorithm, produces a result with a certain number of leading zeroes. (It’s difficult to predict these results, so the only way to find them is to just try a lot of numbers until you get lucky.)
The node who finds the number that produces this result broadcasts it to the rest of the network. As an incentive for doing this work, the winning node gets to add its own transaction to the blockchain which gives the owner of that node some bitcoins.
The key is that the cryptographic calculations on each block in the chain are a function of the block being worked upon and all previous blocks. That’s why it’s a chain. This assures that everyone on the network will eventually end up with a version of the ledger that contains all of the same transactions.
Maintaining the system which keeps Bitcoin working, in the same way that bankers, money truck drivers/guards, mint operators, etc, work together to keep the regular monetary system working. Of course, if you do not agree that Bitcoin has value (in the same way that e.g. Paypal has value) then you will not agree that this work is “useful”. (On preview: hadn’t seen your response to friedo yet when I wrote this!)
I think it’s a red herring to try and search for some “real value” which is represented by a certain amount of Bitcoin. It would be wrong to say that Bitcoin is “backed by” the computations spent on mining, because those computations aren’t worth anything by themselves – that would indeed be a circular argument.
Money is a unit of exchange. A Euro coin has value to me, not because it is backed by a government or by precious metal, but because I trust that I can receive various goods and services for it. And the people who provide those goods and services, accept my Euro coins for the same reason, and eventually some of their money makes its way back to my employer, who pays me my salary, and the circle is complete. Once such a system exists and enough people participate in it, there is no reason why it couldn’t be self-sustaining: anybody who wants to unilaterally opt out of it, will hurt themselves more than they hurt the rest of us.
Of course, the hard part is getting things started: getting a large enough group of people to agree to standardize on a single currency, and to work out among themselves how much value to assign to a single unit of currency. Traditionally, the answer to that is to have a government pick a currency to use on its territory, and to at least initially have the currency be backed by something which is already regarded as having value by itself, such as precious metal or an already-existing currency of a different country. Bitcoin is an attempt to see if this process can work itself out in a grassroots way instead.
Bitcoin mining doesn’t “create the value” of a bitcoin. Bitcoins, just like dollars, are only worth whatever people will give you for them. In that sense, they are no different than euros or gold bars or mint-condition baseball cards.
Why do bitcoins have value? Because people are willing to give you stuff for them. Why are they willing to give you stuff for them? Because they have value.
Replace bitcoins with dollars and the exact same analysis applies.
The mining process is simply a clever mathematical trick to regulate the supply of bitcoins without the involvement of central banks or government fiat.
But accountants, guards, mint operators etc. do NOTHING to establish the value of the currency. It could be said they play some microscopic role in maintaining established value - at most.
Vast numbers of people running computers to validate each others’ calculations do not create value of any kind.
Quite - *quite *- seriously, have you read up on cargo cults lately? Does anyone in the Bitcoin believer world understand that arbitrarily going through the motions and equating financial terminology does not create value, equivalence or validity? At what point did all you people swallow whole the notion that “Government money is just fiat, so we can fiat just as good”? Why on earth is the symbol for Bitcoin not a stylized tulip?
According to whom? You? Because the people trading stuff for bitcoins clearly disagree, or they wouldn’t be doing it. Now, one can certainly argue that bitcoins are overvalued (I would agree) or that the market for them is not especially rational (I would also agree), or that a highly speculative market does not make a particularly healthy foundation for a currency (ditto) but stating that something has no value while people right in front of your nose are trading for it is nonsensical.
What, in your opinion, creates value, equivalence, or validity?
The goal of bitcoin is to have a decentralized electronic currency that supports transactions in a way that people can’t just create fake transactions and get away with it.
The value of miners is that they are the mechanism that verifies the validity of transactions.
Miners allow the system to exist, without them you would have all kinds of people just making fake transactions, claiming they own your bitcoins, etc.
I can’t argue any of this, but it applies to video game credits just as well as - or better than - it does to real-world media of exchange. I get it. Bitcoins are rare, the next thing to finite, and with distributed computing validation, not forgeable.
Unfortunately, that’s only half the equation of meaningful currency. The other half is that some number of people greater than two have to agree that the tokens have value. Okay, so some uncounted and anonymous number of Bitcoin holders have chipped into that agreement. There are only three possible futures, however. The first is that none but the smallest possible circle of users will ever consider Bitcoins of value, creating a microeconomy not much different from that of stamp, coin, autograph and Ferrari collectors.
The second is that the whole [del]experiment[/del] [del]practical joke[/del] phenomenon will collapse of its own accord because amorphous, anonymous, baseless entities can’t create fiat value.
The third is that Bitcoin will grow every accretion, limitation and characteristic of existing currencies, out of utter necessity - making it an interesting economic option but hardly the revolutionary/government-breaking/masses-empowering savior it’s made out to be.
My opinion doesn’t matter in the least. But then, I’m not sure the opinion of an anonymous, arbitrary and amorphous group that claims their product has value, equivalence to other currencies and validity as a medium of exchange does, either - except as something akin to mass delusion or the ingrained belief of every revolutionary cabal that they’re “right.”
I get it. Bitcoiners can fiat just as good as anyone else can fiat.
However, having gotten past first-semester economics and the staggering shock that “money isn’t really worth anything,” and having spent considerable time in the real world, and having a deep interest in radical economic structures… I am no longer so dimwitted as to believe that the US Treasury’s “fiat,” Parker Bros Monopoly “fiat” and arbitrarily-defined digital currency “fiat” are equivalent.
Correct! The miners are not the ones creating value. When Bitcoin gains value, people realize that Bitcoin mining is profitable, so more people start mining and the system auto-adjusts the difficulty level in order to keep the growth of the money supply at a constant rate. When Bitcoin loses value, some miners find that it is no longer profitable, so they drop out. In equilibrium, the amount of hardware and electricity spent on Bitcoin mining, should roughly equal the value of the new coins entering the system.
So the miners are following the value of Bitcoin, they are not the ones creating or determining that value. In fact, just forget about the miners, they’re a red herring. The only thing that matters is that the money supply grows at a predictable rate. If the demand for Bitcoins grows faster than the rate at which they get created, the value (as measured in dollars or whatever) will go up, otherwise it will go down. At some point, hopefully, things will stabilize and it will be possible to predict with reasonable accuracy how many microBitcoins you’ll need to pay for a medium cappuccino three months from now.
So why would people want to own and use Bitcoins in the first place? Well, speaking for myself: a) because it’s cool, b) because I think credit cards are horrible and Paypal is not much better. For many people there’s also c) because of the pseudonymity it affords them. (Note that desiring pseudonymity does not necessarily imply that you’re planning to do something illegal or immoral.) Oh, and d) Bitcoin is designed to be deflationary rather than inflationary, which is an idea which appeals to a lot of people, but I’d rather not touch that particular can of worms right now if you don’t mind, thankyouverymuch…
And why not?
You know what, let’s start yet another currency, just for the fun of it. Imagine that there are just three parties involved: me, the local spareribs restaurant, and a currency exchange service offering to convert between RibCoins and Euros. Since we’re the only people involved, we can pick whatever arbitrary value we want – let’s say one RibCoin per plate of spareribs.
I purchase a bunch of RibCoins from the exchange service with my credit card, which is annoying because I hate creditcards, but I only need to do it once and I trust them more than I trust the restaurant. Then, I spend those coins at the restaurant, which is much safer and more convenient than giving my CC number to the restaurant directly, thanks to all of the wonderful crypto technology used in RibCoin. The restaurant takes my RibCoins and turns them straight back into Euros at the exchange. (The exchange charges a little overhead for their trouble of course, similar to what PayPal or Mastercard would charge.)
There you go: we just created a new currency, with a very well-defined value of one plate of spareribs per unit! As long as everybody is happy with the arrangement, we could just merrily keep doing this forever, even if nobody else agrees that RibCoins have any value at all.
Of course, the more people take part in the system and agree on a single currency, the better it works – the overhead costs of the exchange service can be shared among all the users, and the obvious question of “what have you gained since you still need to use your credit card initially” becomes easier to answer if you need to pay with CC only once and can then spend your RibCoins in lots of different places. In fact, if the system really takes off, the restaurant might at some point be able to just pay its employees in RibCoins directly, instead of everybody going through the exchange all the time…
