Bitcoin Signal In This Noisy World – Bitcoin Magazine

garretschoenbergSeptember 9, 2022

A version of this article was originally published here.

In any new and developing space, there is bound to be a lot of noise. New solutions both compete for a new market against existing monopolies — which currently own the market, and against other technologies trying to displace them.

Hard To Understand

This is especially true in those breakthrough innovations/discoveries that change our world and force us to use a new lens to understand it. Prior biases make us less likely to investigate the new innovations on a first principles basis. Data is a legacy of our existing models — not these new ones. New ones need to be intuited to predict what will happen instead of forecasted using historical data. We simplify the models in our brains to save time and as a result, most people fall into the trap of predicting their future behavior by looking back at their past.

It is the same reason that when using a Blackberry phone when the iPhone was released, we couldn’t predict how our minds would change — and our minds changing because of new value created, would change an industry. We move instantly when given something of greater value, and it’s impossible to predict that move before we’ve “seen” it.

It is the same reason why Kodak was destroyed by the very digital camera that Kodak created, and Blockbuster failed to see the threat of Netflix until it was too late.

And it is the same reason why all monopolies fail when misunderstanding the value creation delivered to society by a new technology. Technology adoption is most often bottom up versus top down. Why? Simply because the people furthest away from monopoly power have the most to gain, and the people closest to the monopoly have the most to lose.

Add to this that there are always far larger numbers of people farther away from the monopoly than close to it, and it becomes easy to see how fast something that creates more value for those people can take hold and get stronger — rendering a monopoly impotent in fighting it.

Note: This framework is important to consider regardless of whether the monopoly is within an industry, or whether it applies to money itself.

Harder To Understand

It is even harder to understand general purpose technologies like artificial intelligence that affect all industries or predict their rate of progress. Because these general purpose technologies apply to most value creation over time, we can easily underestimate the corresponding impact on every business and, in turn, our lives. For example, pretending that a narrow or general artificial intelligence won’t negatively impact our job one day is something we want to believe, which ensures narratives that support that line of thinking are popular — even if untrue.

Hardest To Understand

But the innovations that are hardest of all to understand are open, decentralized, protocol-level technologies. These protocols create value in the form of a new foundation that emerges slowly and methodically. Protocols are built in layers, which means we can’t generally see what is possible on the next layer until it is already built. The base layer technology protocol (Layer 1) that allowed computers to be networked together is called the transmission control protocol, and the internet protocol (TCP-IP) and was developed by the Defense Advanced Research Projects Agency (DARPA) in the late 1960s. It wasn’t until 1989 that Tim Berners-Lee invented the hypertext transfer protocol (HTTP) on Layer 4, which would link those computers and webpages and would form the world wide web.

Which is why if you tried to explain the TCP-IP open protocol layer that allowed previously isolated computers to talk to each other or even HTTP to someone in the early 1990s, or tried to tell them that one day that same technology (largely unchanged) would give rise to the iPhone, Google, Zoom, Amazon, and everything else we take for granted today, their eyes would roll over in disbelief.

We experience value through products and services that give us value instead of trying to understand the intricate details of the plumbing that gives rise to those products and services.

I am going to attempt to use a framework for considering how this applies to Bitcoin, and the predictable rise of altcoins, decentralized finance (DeFi) Web3, Metaverse and the entire blockchain space.

But before we go there, we must start at a higher level because the higher-level abstraction effects and amplifies everything else.

We must start at money. We must start there for the same reason stated above.

Namely:

We experience value through products and services that give us value, instead of trying to understand the intricate details of the plumbing that gives rise to those products and services, and
Money is the foundation layer that gives rise to everything else.

Therefore, when money breaks down, standing your ground when the ground gives way will provide little in the way of safety.

Money Is Just Information

This might be hard to see because it is important information, but we don’t desire more pieces of paper (or the digital units it represents). We desire the feeling we get from having those pieces of paper and what it can buy us. Regardless of whether that “buy” is a feeling of safety, a legacy in the form of giving to your children, a vacation, status, a home or freedom. Money is just the information (a ledger) that allows us to measure what we have, and what it will take (in our own minds) to achieve our desired result. Fear, greed and the human desire to want more comes on top of that ledger and comparison to other people.

It makes logical sense then, that one, if money is just information and two, money is being manipulated by central banks at an unprecedented rate to avoid a credit collapse of the system, then misinformation must be growing throughout the system. (A second order derivative of that misinformation is that trust must be declining throughout the system.)

But that is the unfortunate system we live in, and it has vastly negative consequences. Because we measure a system from within the system, for most of the population, it would make the truth virtually impossible to see. Similarly, every company, organization and political party are made up of similar people measuring the system from the system, while every member of our society writ large each believes that they can see through this misinformation better than others.

(Caveat emptor: Although I do my personal best to go deeper on issues to understand both sides and where I might be wrong, this includes me, and the words on this page.)

By consequence, it is completely logical to see conspiracy theories, confusion, polarization, in-group, out-group bias and social chaos reign.

That misinformation in the form of money wouldn’t just create polarization. Because money connects value between people and nations, it would drive a tremendous misallocation of capital and resources as individual actors in the system all made the system worse with their actions to make enough money to escape the system. Chasing ever higher returns, it wouldn’t only be the general public. Even pension plans, which need certain growth returns to stay solvent to pay liabilities in the form of retirement benefits would search for higher “real” returns — all of them, and us too, searching for ways to solve a growth problem to escape the very system creating the problem.

In a world that looked like this, it would be easy to fall into a trap of pyramid and get-rich-quick schemes to escape. In fact, the very structure of manipulating money (information) and corresponding incentive structure would ensure a market grew to abuse it — both in crypto and the overall market. Everyone measuring and trying to create value from this system would unknowingly contribute to greater insecurity. No one would be exempt. All, searching for a higher return to escape the existing debasement of currencies, crowded into markets that in turn, hurt others.

With this one, misinformation as a backdrop, and two, a new protocol layer technology emerging, (remember that open protocols provide the most value to society and are the hardest to understand) it would be extraordinarily difficult to see why Bitcoin alone stands out as a breakthrough technology and where it is heading. By extension, it would be relatively easy in this environment for ill-informed or bad actors to conflate Bitcoin with crypto, Web3, DeFi, blockchains, Metaverse and other naming conventions to gain an advantage for their offering. A public market that one, believed these were similar and watching a meteoritic rise in Bitcoin over the last 13 years (while they were concurrently losing purchasing power in their own currencies) and two, lacked the time to do deep research, would be easy targets for copycats, fraudsters and even well-intentioned actors who might be misinformed, promoting the next big thing.

This would act to amplify the cycles of highs and lows in Bitcoin and obfuscate its true nature. Firstly, by bringing more leverage, hypothecation and rehypothecation into the overall space by leveraging bitcoin (which has no counterparty risk) as a pristine bearer asset and amplifying the price of bitcoin on the way up. And secondly, as each of the altcoins and DeFii schemes tied to them, then fell due to that same leverage, creating “bank runs” that would amplify bitcoin’s fall in price (in USD terms) as the pristine bearer asset (BTC) was sold into a failing market to cover losses.

As the vastly bigger market of money broke down, (the world balance sheet is approximately four orders of magnitude larger than bitcoin market cap today) and the Federal Reserve and other central banks eased or tightened in fiat terms, it would only amplify the entire process described here and create additional confusion.

With that as a backdrop, I will provide a simple framework to explain why Bitcoin is without equal in its design so others can use that framework to decide for themselves. My hope is that by understanding the necessary trade offs required in the design of any blockchain, a general public, and/or policy makers can more accurately understand the trade offs and see the signal through the noise. In doing so, I’ll also show why the rise of competing blockchains and altcoins are predictable, the advantages and disadvantages of them and why, in my opinion, each will fail in the end.

Choose any two of the three sides of the triangle. But only choose two.

Decentralization, Security, Scalability

Bitcoin (on Layer 1) solved decentralization and security. Never in history has society had decentralization and security together. Thirteen years after its discovery/invention by the pseudonymous Satoshi Nakamoto and no matter the amount of nation state, economic challenge, or fear, uncertainty and doubt (FUD) thrown at it, it remains decentralized and completely secure. This is a bigger deal than it seems at first glance. Because society throughout time could never rely on decentralization and security together, it needed to rely on trust in institutions and the rule of law (to keep those institutions in check) for protection, the Magna Carta, Declaration Of Independence and many other such frameworks over time enshrining rights to citizens from unchecked power over them by their rulers. The problem is that over a longer time horizon, money surpasses laws, so laws alone cannot solve trust. Laws change over time ensuring those with access to money either re-write the laws or prevail in court. A reflection of the world we live in shows this unfortunate truth, i.e., where money is most broken, rule of law breaks down!

The rule of law doesn’t protect citizens from the manipulation of money. It protects those closest to the manipulation.

Bitcoin remains decentralized and secure because of its design. Two critical design elements led to this outcome: One, a limited block size and two, using energy to secure the network through proof of work. (Additional elements of design connected to these two design elements remain critical to the security and decentralization of the network. For the reader who wants to go deeper, these will be explored later in this post with links to some great thought leaders and content.) It is important to remember, Bitcoin is open source which means it is open to everyone (to audit or use freely), controlled by no one and freely available for anyone to change through a fork to try to design in a different way that creates more value for users.

By designing in such a way, Bitcoin over the last 13 years became an excellent store of value, but also remained largely unviable to be used as a currency or broader technology stack due to its lack of transaction speed at five to seven transactions per second (on the first layer). The transaction speed wasn’t the only limitation. By keeping block size small to ensure continued decentralization, Bitcoin left an opening for competing blockchains/altcoins to do more on Layer 1. Venture capital, entrepreneurs and developers raced into this ecosystem because one, inventing a new coin that could compete with bitcoin would achieve massive short-term profits for its founders and venture capital backers, and two, with a larger block size and more permissive blockchain, more could be done. These competing blockchains would give rise to smart contracts, non-fungible tokens (NFTs) and “decentralized” finance.