by Omid Malekan, author of “Re-Architecting Trust: The Curse of History and the Crypto Cure for Money, Markets and Platforms“
Most of the conversation and controversy about Bitcoin focuses on the currency. Can it be considered a kind of money? Should ordinary people invest in it? How should people value it? As interesting as those questions might be, the currency could not exist without the unique infrastructure atop which it resides. Unlike any other currency, the Bitcoin currency could not exist without the bitcoin platform.
Technology platforms are increasingly of central importance to all our lives. They determine outcomes in everything from social media to online shopping and cab rides to online dating. They are also among the most valuable assets on earth, as demonstrated by the market values of the companies that operate them. Today, trust in many of these services is decaying as it becomes increasingly clear that what is good for management and shareholders is not necessarily good for users.
Bitcoin represents a different model for building and operating a platform. That platform cannot handle activities like rideshare or social media, but its architecture points the way to a more decentralized and egalitarian approach to online interaction. Most people consider its greatest success to be the value of its coins, but even more impressive might be the simple fact that it works. To see how, we need to understand the intricate relationship between the coins and the underlying platform — as seen through the lens of trust.
Trust is invaluable. Or at least, it used to be. The existence of a decentralized platform for value transfers — one that uses financial incentives to drive honest behavior — now enables us to put a price on trust. In the case of the Bitcoin platform, it currently stands at hundreds of billions of dollars, calculated by adding up the dollar price of all bitcoins in circulation — its market cap.
The price of Bitcoin has always been volatile, and is driven by multiple factors. But one input matters more than any other: the perceived security of the underlying platform, for security is synonymous with trust in a decentralized setting. Since there is no Bitcoin Inc. to hold liable if the network is breached, and no hope of a government bailout should the whole thing come undone, the platform must stand alone. Bitcoin, like every other myth that withstands the test of time, abides by circular logic. Its platform is only secure so long as miners are willing to expend resources to acquire its coins, but the coins are only worth acquiring if the platform remains secure. The blockchain secures the past while financial incentives drive the future. A decentralized platform is a perpetual motion machine of trust, with the coin supplying the magic needed to keep it going.
When Satoshi Nakamoto devised the clever solution of inventing a free-floating currency to incentivize honest behavior, he made a Faustian bargain with the ever-dueling forces of supply and demand. The Bitcoin platform would be secured by the value of the coin, but that value would fluctuate, in the way that all assets do. To give the coin a fighting chance, Nakamoto limited supply with an algorithmic inflation schedule, an economic decision that would greatly impact adoption.
Bitcoin mining is different from other kinds of mining because the amount of effort has no bearing on production. Unlike a physical asset such as gold, where spikes in price lead to greater supply being brought to market, and vice versa, the price of bitcoin has no bearing on production. Bitcoin miners have no power over how many coins are unearthed at any given moment in time. Miners can commit more resources to solving the puzzle — and many regularly do to gain an edge over their competition — but doing so has no bearing on new coin creation. The platform is designed to detect this kind of behavior and, should the aggregate amount of mining activity tick up, will adjust by making the puzzle harder to solve, akin to gold that magically moves further underground if someone brings a bigger bulldozer. While the sum total of resources committed to Bitcoin mining has increased drastically over the years, the rate of new coin creation has instead declined due to pre-programmed halvings of the miner reward every four years. One of the cleverer consequences of Nakamoto’s proof-of-work consensus mechanism is that more mining leads to greater security, but not more supply.
Demand is an entirely different animal. The main driver of Bitcoin volatility over time has been speculation, and that speculation is mostly driven by changing perceptions of both trust in the network and the perceived utility of the coin. Those swings, which at times have been vertigo inducing, have continued to settle at higher prices than the previous cycle, allowing us to make two conclusions: (1) trust has steadily grown in this decentralized platform for value transfers; and (2) that trust has steadily diminished in almost everything else on the internet, including the centralized platforms that still power—and in the case of individual users, often disempower — everything else.
Most people who are passionate about the future of Bitcoin are passionate about the coin. Far more important, as far as trust is concerned, is the future of the platform.
Omid Malekan is the Explainer-in-Chief of blockchain technology. He is an adjunct professor at Columbia Business School, where he lectures on blockchain and crypto. A nine-year veteran of the crypto industry, he spends most of his time as a consultant, educator, and advocate for this new way of building trust. He is also the author of “Re-Architecting Trust: The Curse of History and the Crypto Cure for Money, Markets and Platforms“.