Saturday, November 25, 2017

Government backed blockchain for currency

Bitcoin, and blockchains in general, threaten a government's ability to enact monetary policy. This creates a rift between bitcoin and governments that will likely prevent its universal adoption in its current form. However, we can take the advantages of a blockchain and modify them in a way to create a government sanctioned and controlled blockchain that is still, to a degree, distributed and takes advantage of the efficiency of a digital and secure currency.

A government sanctioned blockchain based currency would need to have the government act as a central authority. What this means is that the government entity would be able to modify the rules of the blockchain to allow it to control the money supply, invalidate/reverse transactions, assign addresses to users, and possibly other ways.

A central authority would have access to private keys that would assert its identity. Using these keys, it could sign certain actions (special transactions) that would be recorded in the blockchain. For example, a government signed transaction could generate coins with no proof of work required (unlike how it is traditionally created through mining blocks). This would allow the government to "print money". Additionally, transactions signed by this authority could remove coins from an address, effectively erasing coins. Also, it could use its authority to possibly grant each citizen an address(es) that it approves of, tying that citizen to an address for tax purposes or other reasons.

Another powerful tool would be the ability to reverse transactions. Addresses of known criminals, or those who owe money to the government, could have their coins forcefully removed/garnished from their addresses. An advantage of this is that if someone was ordered to pay an amount, they could simply send the agreed amount to the recipient's address, proving publicly they paid the debt owed. This would also allow the government the ability to track transactions, monitor fraud/laundering, etc.

Several technical challenges exist with this setup. A single private key owned by the government would be susceptible to a rogue employee effectively destroying the economy if he had access to the key (as it could print money and take money from anyone). Actions signed by the central authority would have to be distributed across multiple agencies, where all agencies would be required to sign the action/transaction before it would be acknowledged and added to the blockchain. Additionally, the government entity would need to be able to revoke and grant keys. Perhaps only require a majority signed for a transaction (to avoid the issue of one lost key preventing the government from being able operate the blockchain).

The government entity would need to provide a significant amount of the mining power for the blockchain. It would need to in order to prevent attacks by foreign governments, and to assert the reliability and secureness of its digital currency. To encourage mining by the public, the government entity could arbitrarily control both the transaction fees and reward for mining a block. Since the govnerment entity provides a large portion of the mining power for the blockchain, it could pick up slack when temporarily lowering block rewards and fees it would accept. The large amount of mining power provided would also allow the government to prioritize government signed transactions.

An additional advantage of a central authority running a blockchain is that it would adapt very quickly to technical challenges. Things like controlling how often a block is created (to increase verification speed), how large a block is (to control the number of transactions verified in a given time span), control the block reward to control inflation, and even adopting new standards to modify how the blockchain fundamentally operates.

Blockchain based currency is still in its infancy stages and still needs time and heavy research to determine how to be utilized in a way beneficial to a government and its peoples, but the above are possible solutions to this problem that will allow a government to adopt a digital currency in a secure yet controlled manner.

Saturday, November 11, 2017

Bitcoin can't compete with fiat currency

Bitcoin's most important achievement is that it solves the double-spending problem. This allows, on a distributed and decentralized platform with no single authority, for digital credits to be spent in a verifiable and reliable manner. This means that if a transaction occurs using Bitcoin, you can verify that the credits spent only went to the address you specified.

The ability to avoid double-spending without a central authority means that trust is no longer needed to make transactions and assert identity. This allows you to do things such as sending digital credits to someone on the other side of the world without any concern over multiple banks communicating to transfer from one bank account to another and making sure it all occurs successfully. Additionally, blockchains inherently enforce identity by requiring a near impossible-to-break private key that only the owner of the credits has. This key allows the owner to publish transactions on behalf of the address they represent, asserting that they are who they say they are. This means that fraud cannot occur as long as your private key is secure.

While a powerful tool, blockchains suffers drawbacks that prevent it from being used as a mainstream currency. First and most importantly, is that it completely nullifies a country's ability to use monetary policy. This is dangerous as it prevents a government from working to prevent an economy from entering a recession or from overheating. To add to this, bitcoin is deflationary. The supply of Bitcoin is limited and by 2036, 99% of bitcoins that will ever exist will have already been mined. This results in hoarding (and less spending), real debt increasing over time, and a possible deflationary spiral.

Another vulnerability to bitcoin is that it is susceptible to a panic. All it takes is one time, and if bitcoin's price were to ever sharply dip (due to other reasons like adoption of other coins, government sanctions,  etc), it could create a panic where people start to sell en masse to avoid losses until the price went back up. This feedback loop would cause even more to sell until bitcoin were to eventually lose all value. If an economy relied on bitcoin for everyday business, this would cause an economic crisis.

Finally, Bitcoin has the problem of early adopters having a disproportionate amount of bitcoins. The original adopters were earning as much as 50 bitcoins every 10 minutes (worth roughly $360,000 now @ $7200/bitcoin). Large amounts of these bitcoins are tied up in addresses and have not been touched in years, causing uncertainty over the true money supply of bitcoins. The uncertainty of hundreds of thousands of bitcoins possibly flooding the market at any time could create a large disruption in the economy. The founder of bitcoin alone is estimated to have access to roughly 1 million bitcoins, or 5% of the entire bitcoin supply.

While bitcoin has value in being used as a currency, its inflexibility and inability to be controlled by governments will likely prevent it from ever reaching a scale that can compete with fiat currencies. In the same way that gold was banned from ownership and money moved to fiat in the 30s, so too will governments ban blockchains that threaten fiat currency and the government's ability to control the money supply. It is possible however, that governments will adopt a form of blockchain that uses a central authority (similar to IOTA for example) to both allow for a more efficient form of currency while still retaining control over it. Additionally, blockchains will continue to have value outside of monetary uses.