An
October 7, 2014 working paper prepared by staff of the Washington D.C. Federal
Reserve as part of the its Finance and Economics Discussion Series (FEDS)
reaches some important conclusions regarding the current status of the Bitcoin
network. The full paper is available here.
The
primary purpose of this essay is to ponder the potential future significance of
what I believe to be the paper's two most important findings:
1)
That, as of "the beginning of 2014", there were an estimated 100,000
unique daily users of Bitcoin (p. 17), and
2)
That the number of unique daily users doubled every eight months over the three
year period ended the beginning of 2014 (also p. 17).
A
second purpose of this essay is to challenge Bitcoin's detractors to explain
why the trend identified by the FEDS working paper is unlikely to persist.
Implication
of the FEDS Findings
Extrapolating
the two numbered statistics above into the future has potentially extraordinary
implications. (Set aside, for a moment, the question of whether it is
reasonable to extrapolate from these statistics. I will return to this
question in a moment).
First,
if the growth trend identified in the FEDS paper has continued unabated since
early 2014, then the current number of unique daily users of Bitcoin stands at
over 200,000 (since more than another 8 months has passed since then).
Furthermore, we are only 14 more doublings away (400k, 800k, 1.6M, 3.2M, 6.4M,
12.8M, 25.6M, 51.2M, 102.4M, 204.8M, 409.6M, 819.2M, 1.6B, 3.2B) from nearly
half the world's population using Bitcoin on a daily basis. For fun, I
will call this date "Worldwide Domination Day", or WDD. Extrapolating
from the FEDS' calculated trend rate (doubling every 8 months), WDD is about
9.5 years away and will happen in early 2024.
Even
if the FEDS’s estimate of the number of UDUs is off by a full order of
magnitude (e.g., because its sorting algorithm fails to sufficiently account
for multiple transactions by the same user in a day)--that is, if there were
only 10k unique daily users at the beginning of 2014 rather than 100k--the time
necessary for Bitcoin's worldwide domination only extends an additional 1.5
years from the present, or until late 2025, if the growth trend is nonetheless
correct. Again, that's if the FEDS calculated trend is accurate and
it holds for all future time periods. There are, of course, many reasons why
the trend rate could decelerate or accelerate appreciably, so extrapolating
from the FEDS’s report is far from certain.
Turkey
Fallacy?
Projecting
the present trend into the future is a dangerous endeavor. Nassim Taleb
has famously dubbed this all-too-common human habit the “Turkey Fallacy”.
A turkey, you see, may come to believe based on present experience that
humans are benevolent and will continue to be so in the future. After all,
humans reliably provide the turkey with food and care each day such that it
grows healthier and plumper over time. But, of course, the turkey is
wrong, and only discovers the terrible truth on the day of its slaughter.
Are
my projections above regarding the date for Bitcoin’s WDD simply another
example of the Turkey Fallacy? Maybe. Perhaps that’s even likely.
But, as we shall see, the world of technology is different from the world
of turkeys in important ways.
To
be precise, there are "rules of thumb" (none of which are infallible)
often employed by the tech community to forecast future technological trends
with reasonably accuracy. Applying those rules of thumb to Bitcoin, as I
do below, requires us to at least consider the possibility that Bitcoin’s
Worldwide Domination Day is coming, and sooner than we think.
Rules
of Thumb
The
first such rule of thumb is the "Zero to One" principle, articulated
recently by tech legend Peter Thiel. Among other things, it stands for the
proposition that getting a venture from zero to one is much more difficult than
getting it from one to two or two to four. Said another way, creating a
revolutionary new technology or product, and furthering its adoption, is
infinitely more difficult than making marginal improvements on existing ones.
For instance, creating the airplane and getting people to use it was
much, much more difficult than simply creating a faster train.
One
implication of the Zero to One principle is this: A revolutionary tech
business that is successfully gaining users at a fairly consistent exponential
rate has likely already overcome its most difficult challenge--getting from
zero to one. By “revolutionary”, I mean one that satisfies the 10X Principle (as
discussed below).
Thus,
with tens of thousands of daily users and growing fast, Bitcoin is almost
certainly past it's “zero to one” phase. This means that its most
difficult days are likely behind it.
The
second rule of thumb is Ray Kurzweil's "law of accelerating returns", or LAR for
short. To simplify, the LAR states (among other things) that, once
something becomes an information technology, once it's digitized, its usefulness
or its “returns” (measured in terms of price-performance, availability, rates
of adoption, rates of expansion, or whatever) grows exponentially, and often at
a very predictable rate. From basic calculations based upon this premise,
Kurzweil was able to predict in 1990 that a computer would, in 1998
(precisely), be capable of defeating even the world’s top chess players,
something most every other technological expert in 1990 thought was many
decades away (at a minimum). Just a few month earlier than predicted, in
1997 IBM’s Deep Blue famously defeated Russian Chess Grandmaster Gary Kasparov.
For numerous additional examples of the LAR in action, see the many
charts at the link in the beginning of this paragraph.
So,
how does the law of accelerating returns apply to Bitcoin? Well, although
it may be hard for newbies to grasp, Bitcoin represents nothing short of the
digitization of trust. Bitcoin technology has turned human trust into an
algorithm, an information science, allowing it for the first time to be
immutably programmed into software. As a result, the Bitcoin technology
eliminates, or at least significantly reduces, the need for certain trusted
third-party intermediaries--brokers, exchanges, registrars, escrow agents,
clearing houses, banks, etc.-- by permitting these intermediaries’s business
models to be hard-coded into inexpensive software that no central party
controls or practically can control, not even governments.
It's
no surprise then that we see clear evidence of the LAR's applicability to
Bitcoin. Not only is Bitcoin's exponential growth evident
in statistics offered in the FEDS paper, but in numerous other places as
well. Consider, for example, the number of daily transactions on the block
chain (excluding common addresses). Or, the number of unique bitcoin addresses used. Or the
average number of transactions per block on the block
chain. Or the hash rate (security) of the decentralized
bitcoin network. Or, finally, the number
of users of blockchain.info's wallet service. Note that each of the
above-linked charts are logarithmic and begin with
Bitcoin's inception in 2009. Since Bitcoin represents the initial
digitization of something very, very important--that is, trust--it would be
shocking, and seemingly a violation of the LAR--if we were not witnessing exponential growth patterns such as these.
There
is one other very important implication of the LAR: Once a
revolutionary technology starts down the exponential path, exponential growth
generally continues indefinitely, only slowing after achieving saturation, upon
hitting a hard limit of physics (as Moore’s Law seems poised to do), upon
experiencing a catastrophic technical failure, or upon encountering a competing
technology that is much, much better (such that the public abandons the former
in favor of the better alternative). Baring a catastrophic failure of
the Bitcoin technology itself, its difficult to see how Bitcoin's adoption rate
slows except for one of these three other reasons.
Furthermore,
observers have noted that certain types of information technologies grow doubly
exponentially, meaning that the time it takes for their “returns” (usefulness,
adoption, etc.) to double decreases at an ever-increasing rate. For
example, if Bitcoin is such a technology, then we can expect its user base (a
proxy for its usefulness) to double next year in less than 8 months, and
a little faster the year after that, and so on.
“Network
effects”, which is our third rule of thumb, often explains the doubly
exponential growth pattern of many such technologies. The "network
effect" explains that certain goods or services, or especially certain
information technologies, are only useful provided that multiple people use
them, and that they become exponentially more useful as each new adopter is
added. For instance, a hammer is useful to me whether or not other people
know of and use the technology, so hammers are not subject to network effects.
This is not so with, say, telephones. A telephone is useless to me
if I am the only one who owns one. It's an exponentially more useful if
at least one other person owns one and uses it, and its exponentially more
useful still if a thousand people own and use them. Further, the more
useful the telephone network becomes, the more new adopters are incentivized to
begin using it, increasingly its value exponentially more each time, thereby
incentivizing even more adoption at an even faster rate. This phenomenon
explains the doubly exponentially growth pattern so common with these
technologies.
Network
effects are particularly profound with languages and currencies, for obvious
reasons. A language is useless if I’m the only one who speaks it, and a
currency is similarly useless if nobody else accepts it. Recognizing that
Bitcoin is both a language (a communications protocol that for the first time
permits the programming of nearly full-proof trust into a decentralized network)
and, arguably, a currency (medium of exchange), we would expect Bitcoin to
exhibit network effect behaviors. So far, it seemingly has.
Importantly,
network effect technologies, especially open source ones like the Internet and
Bitcoin, tend to exhibit the same indomitable characteristics as other
information technologies subject to the law of accelerating returns.
Actually, even more so. That is, after achieving a
certain critical mass, network effect technologies tend to continue with
their doubly exponential growth in adoption until they either hit a hard limit
of physics, experience a catastrophic technical failure, run up against
something much, much better, or saturate (dominate) their market.
Given
that there seems to be no hard limits of physics hindering Bitcoin’s growth and
adoption anytime soon, and that there is little reason to date to expect
catastrophic failure of the technology, the rules of thumb discussed so far
suggest that Bitcoin will either come to dominate its market (which, given its
open source nature and nearly infinite number of potential applications, is
really, really broad), or it will ultimately perish at the hands of a far
superior competitor.
With
that in mind, how much “better” must such a competitor be in order to stop
Bitcoin's growth trajectory? This brings us to our fourth and final rule
of thumb, which is the "10X" Principle. The 10X Principle is
the idea, commonly accepted in technology circles, that any tech with radical
potential must be at least ten times better than what came before if it is
to gain traction and overcome the public's inertial preference for the
status quo. Incremental improvement, or even being five to eight times
better, isn't usually sufficient enough catalyst for the public to change its
habits en masse, at least not in any reasonable amount of time.
Bitcoin's
unique attributes make it far more than 10 times better than anything that has
come before, at least for certain use cases. In fact, Bitcoin technology
makes possible a great many things that were previously not possible at all,
such as:
•
sending
micropayments and tips from person to person over the Internet with no
intermediary
•
engaging
in permissionless, cross border peer-to-peer financial transactions at low to
no cost (including but not limited to remittances)
•
storing
and transporting wealth at little to no cost and without fear of liens,
seizure, or theft
•
provably
fair online gaming
•
provably
sound financial institutions (with proof of reserves visible on the block
chain)
•
"trustless"
financial transactions of an infinite variety
•
widely
accepted supranational medium of exchange
And
those are just a few of Bitcoin's use cases that have no prior parallels in finance.
There are many others, almost too many to count, that I've not listed.
And
there are yet other things presently doable with our financial system's current
technology that Bitcoin will do ten times better/cheaper/faster in the future
(such as clearing checks or securities transactions in 10 minutes rather than
three days, and at virtually no cost, to name just one). And lastly,
Bitcoin has a nearly infinite number of non-financial use cases that were
impossible with prior technologies (like incontrovertible proof of existence of
digital documents, provably fair voting, decentralized identity, an
uncensorable and incorruptible historical database, smart contracts, smart
property, etc.).
But
my opinion that Bitcoin is 10 times better isn't what matters.
Its the numbers that matter. That Bitcoin has over the last five
years experienced nearly uninterrupted exponential growth in measures of use
and adoption is the most powerful evidence that Bitcoin meets the 10X
threshold, at least for certain important purposes.
But,
the 10X principle has one other important implication for Bitcoin: Any
would-be usurper of Bitcoin's place as King of the Programmable Trust must be a
full order of magnitude better than Bitcoin to interrupt its trajectory.
Mere incremental improvement is likely not enough. This is,
perhaps, why none of the hundreds of other altcoins launched since Bitcoin have
experienced anything approaching Bitcoin's success, at least not over any
appreciable length of time, despite that some of them represented clear, though
only incremental, improvements upon original.
Some
argue that certain contenders for the cryptocurrency throne that are still in
development will ultimately represent a 10X improvement over Bitcoin, at a
least for certain use cases. That's possible. But, given the hugely
ambitious (and therefore significantly more fragile) nature of these coming
alternatives, significant doubt remains as to whether they can live up to the
hype.
And,
even if they do, it will be at least a few more years (lets say at least three)
before any of them are truly ready for prime time. By that time, and if
current trend holds, Bitcoin’s user base will have had at about four more
doublings, putting its unique daily users at around 3.2 million. Since,
per Metcalfe’s Law, the value and usefulness of a network is equal to the
square of its number of users, the Bitcoin network will be extraordinarily
valuable (do that math) and useful by that time, and growing exceedingly
quickly. For an alt coin contender coming out of nowhere and
prove itself ten times that useful, a minor miracle may be
required.
Consequently,
Bitcoin may remain King of Programmable Trust for quite some time, perhaps
decades, and perhaps indefinitely for certain important use cases. With each
passing day, WDD looks, at the very least, to be a possibility.
[Forgive
me while I take a moment to note an interesting coincidence (and that’s all
it is): Per the Fed study, Bitcoin had an estimated 100,000 unique daily
users as of the beginning of 2014. Squaring this number in accordance with
Metalfe’s Law tells us that the “value” of the Bitcoin network at that time was
therefore at least $10 billion (100,000^2). The market cap of all
bitcoins in circulation at that time was indeed about $10 billion.]
Conclusion
Many
Bitcoin critics have offered up an infinite variety of rationales for why
Bitcoin’s growth trend is a fluke that cannot persist. And, to date,
they’ve been completely wrong. Not only have rumors of Bitcoin’s death
been greatly exaggerated (to paraphrase Twain) over the last many years, but
it's never even had a close call, at least not in terms of the growth in
its adoption measures. Nothing thus far has managed to even
appreciably slow these measures--not the Mt. Gox fiasco, not the Silk Road
publicity, not bitcoin's incredibly volatile price (declining nearly two-thirds
over the last twelve months), not 2013’s “hard fork” of the block chain, not
Charlie Shrem's arrest and prosecution, not the FinCEN guidance, not the IRS
guidance, not Warren Buffett's or Paul Krugman's or Jamie Dimon's criticisms of
the technology, not Russia's ban, not China's skepticism, not the threat of
governmental regulation, and not the rise of an infinite variety of copycats
(“altcoins”), just to name a few.
We
must be ever cautious of falling for the Turkey Fallacy. However, at the
same time, we must recognize that there are innumerable examples within the tech
sector where the Turkey Fallacy seemingly doesn’t apply (for instance, Moore’s
law, TCP/IP, Linux adoption, the spread of Internet nodes, mobile phone
adoption, and Facebook use, just to name a few).
So,
is Bitcoin more like a turkey, soon to see its growth interrupted by
slaughter or abandonment? Or is Bitcoin more like the many examples of
information technologies noted above that benefit from the Zero to One
Principle, the law of accelerating returns, network effects, and the 10X Principle?
If the latter, then we must consider the possibility that Bitcoin may continue
growing at predictable exponential rates indefinitely.
Regardless, as the above demonstrates, the time has past when those who understand Bitcoin should feel compelled to respond to every ignorant criticism of it. Rather, the burden now lies on Bitcoin's detractors to explain why its consistent five-year exponential growth trend will suddenly end or even appreciably slow. I ask detractors this: If none of the great tragedies and threats in Bitcoin’s five-year life have thus far constituted so much as a speed bump on its path to WDD, then what, exactly, do you believe eventually will?
By:
Sean King, JD, CPA, MAcc
General Counsel, Tennessee Bitcoin Alliance
General Counsel, Tennessee Bitcoin Alliance
