A Network Analogy for Currency

Continuing my recent currency posts, I want to provide an analogy for what Bitcoin is as I understand it. This analogy may exist elsewhere on the web. To those authors who’s ideas I may be infringing upon it is not intentional and please notify me so that I may give the appropriate credit.  I read a great deal and don’t know where ideas come from, weather inside or outside my head.

Bitcoin is not so much a currency as it is a network protocol where the number of packets that can be exchanged grows at some fixed rate to a defined maximum. There are rules for how the packets are exchanged on a peer to peer basis to ensure that packets aren’t duplicated or lost. This is the genius of Satoshi Nakamoto. This is what he created. In this context the lines with what Bitcoin can become are very blurry. As I understand there are portions of the original source code that leverage the network analogy.

We can see the adoption of Bitcoin as competing network protocols between specie, fiat, and Bitcoin (I am lumping all crypto’s under Bitcoin’s moniker for simplicity). Each of these protocols has certain properties and constraints upon them. Specie has fixed quantity, but as we are seeing in the runs on the bullion banks has virtually unlimited potential for rehypothecation. Fiat, well, let’s just say, when in doubt print and is the least constrained protocol grounded in belief of restraint. At this point I can’t call it “trust of restraint”. Fiat has gone far past any realm of reason and is now rooted in the word of the Oracles (central bankers). Fiat also relies upon third parties to prevent double accounting. Bitcoin has fixed rate of growth eventually capping out with an unknown potential for rehypothecation. We will eventually figure out a way, most likely through another asset class/currency. Please see my previous post on the bullion bank runs to understand why. Bitcoin, like specie does not need third parties to prevent double counting, this feature is built into each protocol.

What does a network protocol do? Each protocol, like TCP/IP has a set of rules and exchanges packets of information. Each packet contains some measurable quantity of information. Where, based upon the informational content in each packet a particular value (marginal utility of the contained information) can be attributed. This marginal utility is not intrinsic to the packet it is determined by what others are willing to exchange for that packet. I want to make this point very clear. There is no such thing as intrinsic value. Value is measured and determined through various interactions. Value is determined by what is given in exchange.  This value in exchange determines the marginal utility of the information.

With TCP/IP packets each packet contains a maximum of 65,535 bytes, which is the maximum number of binary questions needed to fix the information in the packet. With currency, the informational content, assuming indistinguishably of a particular currency, that is to say 1 oz of gold is 1 oz of gold or 1 BTC is indistinguishable from any other BTC. The informational content of each currency is determined by its marginal utility. Hayek rightly identified that price signals carry a measure of information about each specific item at a specific time and at a specific location. If we take price in natural units (utility) then each currency has a price, with its distribution of price a function of location and time.  Thus whenever we buy something with currency we are sampling its value. Usually, we have fairly consistent ideas as to what this value is, and often times we don’t.

With TCP/IP the number of packets is unconstrained. Thus as network bandwidth increases and the number of packets increase, their marginal utility falls. In this regard the TCP/IP packets are a public good (non exclusive and difficult to price) provided by every sector, we all create and consume packets. Because the quantity of TCP/IP packets is unconstrained they have little to no value other than the specific information that they contain between the sender and receiver. In this regard TCP/IP packets are currency. With Bitcoin the number of packets allowed in the network is constrained to a maximum (21 MM BTC) with each BTC divisible into 10^{-8} parts. This represents 2.1\, 10^{15} packets, with an informational content of each packet determined by the users of the currency. To place this into scale if the world economy was $100 trillion and we could divide all this down to the penny, that is 10^{13} packets.

When we aggregate the “value” of a currency we obtain its market capitalization. As we have no clear measure of utility yet, these values are described relative to currencies/commodities. Bitcoin’s market capitalization is around $1B USD. This market capitalization represents the “bandwidth” of the currency, quite literally how much information is it capable of transmitting based upon it’s marginal utility. The network of users represent that currency’s network.

Bitcoin really was made for the internet, and it has a great deal in common with it. In this regard, Bitcoin clearly does not represent a ponzi scheme as much as any other currency. It is simply a protocol. To regulate or restrict a information protocol is to regulate or restrict the flow of information. I doubt the Supreme court will ever take up a legal challenge to the AML laws, banking regulations, and capital controls we have in place as restricting freedom of speech. Libertarians are correct in seeing inseparability between our civil liberties and our economic liberty. They are exactly the same and for the same reasons.

As always I look forward to your feedback and comment on this post. The blog portion of this experiment represents a place to float ideas before going even pre-alpha.

3 responses

  1. Pingback: A Network Analogy for Currency « Statistical Economics | BitcoinMagazine.org

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