What is Bitcoin, Really.

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A Return to First Principles of Economics and Finance

One of the things we do at ONLI is called Aristotelian “first principles thinking”. First principles thinking is a mode of inquiry that relentlessly pursues the foundations of a problem. This means, rather than starting with something cool, coming up with a solution or even writing specifications, we attempt to thoroughly understand the why of something at the lowest level of detail before we set out to write a single line of code.

In this article, we are asking the philosophical question of what is bitcoin. In other words, when asked to produce your bitcoin, what is evident. We are not talking about what it is used for. We are not talking about the bitcoin system. There are separate components of that system: A unit of bitcoin is a “unit of account”, a denomination or number associated with a record. A method of recording information in a database in a way that is immutable. A method for keeping the database accurate through consensus. A means for providing infrastructure for processing transactions.  For the purposes of our exercise we are trying to answer the question of what a thing is, the evidentiary basis, in order to form a clear way to properly classify it. We are therefore not concerned with the components of the system but rather focused on the thing itself. Our subject is bitcoin, in economic terms.. If you ask 10 different people this question even 10 very knowledgable resources can give you 10 different answers.. Add the media hype and personal biases and you get something close to religious fervor. Our focus will be purely on the coming up with a clear economic definition that we can use.

Invented in 2009 by a group of researchers under the pseudonym, Satoshi Nakamoto, whose goal was a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. https://bitcoin.org/bitcoin.pdf? . The clear intention was to create a mechanism that was completely separated from any form of financial institution and by default any regulatory body. 

A bitcoin is a private key, an alphanumeric string, that controls an entry in a public ledger, stored as a chain of blocks, in a distributed database. On an evidentiary basis. a bitcoin is a  private key that embodies a benefit or right. The benefit is the access to make changes to the ledger. Practically speaking, I have bitcoin means I possess a private key. My asset is the key.. This key, a simple alphanumeric string, lets you make changes to that entry in the ledger. You can store information or make changes to the denomination. Private Key as used here is a term used in cryptography. It is an alphanumeric string. When asked to support the claim I have bitcoin, what I produce is an alphanumeric string. A bitcoin is a private key, an alphanumeric string. This is evident of a benefit, which is the ability to modify an entry in a public ledger. The ability to modify an entry in a public ledger,  in and of itself, is the intrinsic benefit.

The [ability to modify an entry in a public ledger] has market value, as any person looking to possess this benefit may be willing to exchange some value for the benefit. However is bitcoin, a store of value?  A ledger is a register of records. A ledger entry, in and of itself, is not a store of value. Strictly speaking a ledger in the economic sense is a record of financial transactions. From widkipedia: A store of value is the function of an asset that can be saved, retrieved and exchanged at a later time, and be predictably useful when retrieved. More generally, a store of value is anything that retains purchasing power into the future. Money is well-suited to storing value primarily due to its purchasing power. Money is a current medium of exchange in the form of coins and banknotes. This is because a coin, has an intrinsic value, the material it is made of and a banknote is a financial instrument which is a contract between the issuer and the bearer of the note (backed by the full faith and credit of the issuer). The [ability to modify an entry in a public ledger] is not in an of itself, a store of value, in the strictly economic sense. You can use a ledger in conjunction with several other methods, like a means of establishing ownership and an issuing body to enforce claims, both of which the Bitcoin system is expressly without, to realize a store of value. Something that you can retrieve purchasing power from at a later date. However without the foundational components of ownership and an issuing body the “ future” requirement of the definition is not present. One can argue that bitcoin, the system, taken as a whole, can realize the function of saved, retrieved and exchanged, based on market value alone and one need not include economic value in the definition of a store of value. Loosely speaking that would be correct. But for the purposes of our exercise, strictly speaking the [ability to modify an entry in a public ledger] is not a store of value and it does not possess the qualities of money. 

Strictly speaking, [ability to modify an entry in a public ledger] has no intrinsic value. The [ability to modify an entry in a public ledger] can have extrinsic value. In other words it has a price but not a value. In its most general definition, the intrinsic value is the value of something “in and of itself” or in its own right. –https://plato.stanford.edu/entries/value-intrinsic-extrinsic/. In economics the intrinsic value is the value that it has in and of itself without regard to its market value (the price someone will pay). Since bitcoin has a price (extrinsic value) but not a value, because the value is the benefit [ability to modify an entry in a public ledger], it cannot store any purchasing power that can be used in the future as any “value” would solely depend on the market.

Is Bitcoin a financial instrument? A financial instrument is a document (such as a check, draft, bond, share, bill of exchange, futures or options contract) that has a monetary value or represents a legally enforceable (binding) agreement between two or more parties regarding a right to payment of money. (http://www.businessdictionary.com/definition/financial-instrument.html ). A ledger entry is a record and can reasonably argue that it is a document but this document is not traded. What is traded is a private key.  A Private Key is a cryptographic key (an alphanumeric string), where the key represents the asset (the right or permission to make changes to the value of the ledger account). The key is the asset.  An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide a future benefit. https://www.investopedia.com/terms/a/asset.asp  The key concept here is owns or controls. Asset control is achieved through asset titling. At a basic level, a title is a document that indicates recognition of ownership. https://www.investopedia.com/terms/t/title.asp  A title is a bundle of ownership and possession, which can be mutually exclusive. In Bitcoin, the asset is [ability to modify an entry in a public ledger] evident by a private key. Bitcoin has no title as ownership is conflated with possession. Proof of ownership is established by the presentation of the private key. Two parties who jointly possess knowledge of a single private key don’t jointly share ownership as the owner is the private key. It is only during the use of the private key that ownership is established and it dissipates immediately after. Therefore, Bitcoin can not be a financial instrument as it is not a contract, and it possesses no verifiable evidence of ownership or title and represents no contractual basis for evidence of revenue.

Bitcoin is not, in and of itself, a store of value, money or currency, or a financial instrument. Is it a currency or a commodity?  You can use it as currency. You can use anything as currency. Currency as a function is applicable to any accepted medium of exchange. Bitcoin [ability to modify an entry in a public ledger] is a commodity. Simply put, A commodity is something that is “of use” and a currency is something “you use”, usually as a medium of exchange for the acquisition of something “of use”. The [ability to modify an entry in a public ledger] is clearly something “of use” therefore one can reasonably conclude that it is a commodity.

So what did we learn from our exercise. The common misconception that the uses of bitcoin, to transfer money (you can give and receive value using them), as a store of value (they can be saved and later swapped for something useful), as a unit of account (you can price goods or services in them), define it. However these are all extrinsic uses of the bitcoin system and specifically something that emerge from the use of the system. These are not in fact features of bitcoin itself. Bitcoin, strictly speaking is an alphanumeric string that gives who possesses it the [ability to modify an entry in a public ledger], which is a commodity. A commodity that is used as a currency in some applications. This commodity has features that arise from the method used to make entries in the database, from the trustless nature of using a distributed consensus method to keep a database accurate, from an incentive to aggregate infrastructure to process transactions, anonymity, among other benefits. These benefits are a commodity: a thing of use people will pay for. Bitcoin is not money and it is not a store of value, nor is it a financial instrument. Bitcoin has no title and no delineated ownership. This may seem like splitting hairs but it is really important to have a rock solid definition when you subject something to legal and regulatory standards. Bitcoin, as it is, is clearly missing many of the fundamental properties required to operate in conventional financial markets. This is as it should be because it was never intended to fit in. Bitcoin does have an extrinsic value. It does represent an opportunity for those who wish to operate outside the conventional financial system, for those who desire the ability to make transactions without a financial institution, because the benefit [ability to modify an entry in a public ledger] can be transferred. An aftermarket for this benefit is a booming business. The possession of an alphanumeric string (private key) is an asset. This key, gives the one who possesses it the [ability to modify an entry in a public ledger] in conjunction with the ability to decrement the value stored in that entry. This is an asset providing the market is readily available. This key in and of itself, is just a key and does not have an intrinsic value. It does have market or extrinsic value, that is someone is willing to pay for it. So it does not have a value but it does have a price. It can therefore be held as an asset.

This may seem like a very odd exercise. The open data economy, which is an economy built around aggregating micro work, has evolved into a sharing economy, where excess resources are aggregated and monetized. This business model is being applied to infrastructure, where infrastructure is aggregated using the incentive of an aftermarket for private keys or “coins”. Many are finding that model difficult to apply in the world of financial markets because they run up against a regulatory structure. We began 9 years ago at CloudMode (now Onli), with a clear definition of bitcoin and realized that a different business model would be required to make use of the technology. We see “first principles” thinking more than just a quirky thing that we do but rather as a competitive advantage.

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