TIP185: THE BITCOIN DEBATE (PART I)

W/ TUUR DEMEESTER & ERIK TOWNSEND

7 April 2018

In 2017, we saw Bitcoin grow by over 1300%. Ever since the start of the new year, however, things have been pretty ugly, with a year to date performance of -50%. So what in the world is happening? Is bitcoin still the darling new asset class that so many people believe in, or is something more frightening on the horizon? Well, on today’s show, we are going to have a little discussion that covers both sides of the argument. In one corner we have Tuur Demeester. Tuur has been an investor in Bitcoin since the early days when one coin was only $5. Since his initial position, Bitcoin has grown by 132,000%. Tuur has a huge following with over 159,000 twitter followers because of his in-depth ideas and comments about cryptocurrencies. On the other side of the argument, we have the talented Erik Townsend. Erik is the host of a very popular investing podcast called Macro Voices. Erik got his start as a computer programmer and by the age of 17, he was already an independent software development and design consultant. Erik is an entrepreneur that has built successful tech companies and he’s also the founder of his own global macro hedge fund.

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IN THIS EPISODE, YOU’LL LEARN:

  • Why the Bitcoin community is so focused on the distributed ledger.
  • Why the bitcoin blockchain consumes so much energy and why it’s important for the security of the blockchain.
  • How Cryptocurrencies in the future likely have different layers of centralization.
  • If governments eventually will take over with their own cryptocurrencies.

TRANSCRIPT

Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Preston Pysh 0:00
In 2017, we saw Bitcoin grow by over 13 100%. Ever since the start of the new year, however, things have been pretty ugly with a year-to-date performance of negative 50%. So what in the world is happening? Is Bitcoin still the darling new asset class that so many people believe in or something more frightening on the horizon?

Well, on today’s show, we’re going to have a little discussion that covers both sides of the argument. In one corner, we have Tuur Demeester. Tuur has been an investor in Bitcoin since the early days when one coin was only $5. Since his initial position, Bitcoin has grown by 132,000%. Tuur has a huge following with over 159,000 people online because of his in depth ideas and comments about cryptocurrencies.

Then on the other side of the argument, the bear side of the argument, we have the talented Erik Townsend. Erik is the host of the very popular investing podcast called Macro Voices. Erik got his start as a computer programmer. By the age of 17, he was already an independent software development and design consultant. Erik is an entrepreneur that has built successful tech companies and he’s also the founder of his own global macro hedge fund.

This is part one of a two part episode so whether you’re a bull or a bear on the future of Bitcoin and cryptocurrencies, we hope you enjoy this thoughtful discussion from two very intelligent individuals.

Intro 0:00
You are listening to The Investor’s Podcast where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected.

Preston Pysh 0:44
I am really pumped to have Erik and Tuur on the show. Before we start, guys, I want to embarrass you a little bit. Erik, I’m a huge fan of your show. I haven’t had an opportunity to tell you this, but I listen to your show all the time. You guys have such a quality product. This is really exciting for me to have you on The Investor’s Podcast and be talking to you. I really appreciate you taking time out of your day to be here.

Tuur, I stalk you on Twitter. I’m just going to say it like it is. I follow your Twitter very closely, probably closer than almost anybody else that I follow.

It’s an honor to have you back on the show. I’m a huge fan. You’re obviously brilliant in the crypto space. We are very excited to have you here.

Let’s go ahead and dive right into this. Cryptocurrencies are built on top of an enabling technology. That’s called a distributed ledger. Let’s start there.

Erik, in your opinion, how do you understand distributed ledger? Why do you think it’s so important?

Stig Brodersen 2:33
I think it is super important, Preston. The reason is, and this is no exaggeration, since the beginning of time, a limitation that we’ve had in all information systems, when I say the beginning of time, I mean, before computers going back 1000s of years, any information that you had…

Erik Townsend 2:47
Let’s use the ledger for a bank account, as the example, had to be controlled by somebody. There was somebody in charge of that. That meant that whoever that somebody was could be a bad guy. They could commit fraud and they could steal money and do all sorts of bad things.

Now, in the beginning, it was actually a ledger. It was written on a piece of paper and it was kept in a locked room somewhere in a bank. When we got mainframe computer systems in the 1960s, now it was on a transaction processing system on a mainframe. Eventually, it found its way on to distributed database technologies, more 80s to 90s kind of technology.

That would solve a few problems in the sense that it would solve redundancy issues. If one computer failed, it would save a copy of it on another computer. There would also be a lot of enhancements to security in the 80s and 90s, that protect us against outside bad guys, hackers and so forth.

However, if you’ve got an inside job, if the management of the bank is corrupt, they can control that data and the idea that there’s data somewhere in a network that no one person has authority over, that nobody can hack and that never existed, really until Bitcoin’s blockchain invented this idea of a distributed ledger.

The idea is basically that information is stored in a distributed network in a way where there is no one party that can control it. It is based on a system that uses consensus of a number of different actors in the network.

If it is properly implemented, it can truly be hack proof. Even the management of the bank can’t hack its own system. That really is a huge improvement so I think it is going to change the world in a big way.

However, the big huge caveat that I put on this, and I likened blockchain which is the distributed ledger underpinnings of the Bitcoin cryptocurrency… I think of it like the Wright flyer, the first airplane that ever flew a huge history making thing. It was super duper important. It’ll never be forgotten.

Though, when you go to the airport today, you don’t see a lot of Wright flyers parked out on the tarmac. We’ve come a long way since then. The technology has gotten better. There’s no smart reason to go fly one of those things anymore.

My contention is that because of some specific design limitations, particularly something called proof of work, which we should come back to later.

Blockchain is designed in a very limited way that makes it not super duper scalable, not at all scalable, I would argue.

I liken it to the Wright flyer, simply because it’s super important in history. I think that the invention of the airplane was obviously important. The invention of the distributed ledger was important. The first airplane had some serious limitations and so does bitcoins blockchain.

I think that’s where Tuur and I probably disagree. Certainly blockchain is the only thing going that has achieved what blockchain has achieved.

I think that other things are going to be soon supplanted and that’s going to cause real problems for the Bitcoin cryptocurrency. This idea of mining, particularly, you don’t need that. There are better ways to do it.

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Stig Brodersen 6:05
Let’s hear Tuur’s thoughts here, specifically on distributed ledger. I’m kind of curious if you see it a little bit different than Erik. Then we’ll dive into all these other things about the scaling and stuff a little bit later.

Tuur Demeester 6:16
Yeah, so let me try and take a stab at this. I think it’s important to understand some of the history.

To me what serves Bitcoin and then later, I noticed that people started isolating this idea of a ledger that’s distributed. That became kind of the blockchain focus of almost an entire industry by now.

The initial project that was behind Bitcoin was this challenge, like how do we find a way to create a private digital currency? One of the first things you run into and one of the first problems is how do you prevent double spending, because something that’s digital obviously can be replicated.

If I have a balance of a certain amount of tokens, then I should be able to just create copies. So how do you make something tamper evident, tamper resistant or even tamper proof? That to me is where it gets interesting.

Bitcoin has its own solution for that, which we’ll talk later about as proof of work. But so in my view, a lot of the current approaches to these distributed ledgers, I worry that they may not be thinking enough about whether their approach really needs true decentralization.

If it does, I worry as well that they’re maybe not thinking enough about the real cost of true decentralization. That’s what you need to get that immutability and temporary resistance in your system, that censorship resistance.

When I talk about cost, I always call blockchain the world’s worst database. It means that you store everything forever. That’s what it is. You have a ledger that goes back to the Genesis moment, the very first transaction all the way until today. So you really have to think hard, like, do I need that? Or can I just use a MySQL database, a server client model?

That being said, I think it’s possible that there are some benefits to federated, proprietary blockchains. However, at this point, they’re a little bit unclear to me. Maybe it does offer higher auditability, accessibility transparency, but I worry about what those features really are, if the distributed ledger we’re talking about is not fundamentally immutable or censorship resistant?

Stig Brodersen 8:27
Yeah, that’s a very interesting argument, you bring up their Tuur. Do we really need to go through this energy expenditure and all the costs are really wrapped around this tedious process of having a blockchain.

Let’s talk more about this proof of work concept. The distributed ledger is built around proof of work. Erik, could you explain the concept to us?

Erik Townsend 8:49
Well, let’s go back first to how it is possible to decentralize a ledger. The old system was that a central party, let’s say the bank in the case of a bank, ledger was the owner of that data. That meant they could do anything but other people were not allowed to tamper with it.

If we want to make it so that even the owner or the originator of the data, such as the bank, is unable to tamper with it, the obvious answer is some kind of consensus based model where different actors in the network have to agree to allow a transaction to go through.

Well, if it’s based on consensus, and that means that a majority of the different participants in the network could vote to overrule everybody else… If you think like Goldman Sachs, you just say, “Hey, let’s buy more computers than anybody else and we’ll just be bigger in terms of how many network participants we are. We’re going to create 200,000 Bitcoin mining players that appear to exist on the network, when really it’s just one guy who’s behind it.”

That’s known in the computer security world as a civil attack, where you pretend to be 1000s of different people in order to gain voting advantage and a consensus system. There has to be some way to thwart civil attacks and to prevent them from taking over the network.

Proof of work was originally invented as a deterrent for spam email. The idea was to say, let me do some really complex math problem, which is going to consume a huge amount of computing resources. On my side, I’m basically proving to you as the recipient of the email, I not only sent you this email, which a spammer might have been sending to a million people, but I went through a whole very expensive process to calculate the answer to this math problem to prove to you that I really wanted to send you this email.

I can’t afford to do that math problem over a million times to send it to a million people. So you can trust that this email really is a one to one that’s from me to you and not just junk mail that’s being sent by a spammer.

That’s what proof of work was invented for. It’s basically going through a very time consuming and compute intensive operation in order. Essentially, when you think about it, to basically prove that you’re willing to waste a whole bunch of electricity and computing resources.

It’s really just to make it impossible for anybody to be able to afford enough computers to launch a civil attack against the rest of the network.

Now, in blockchain, the way that transactions are validated, is they have these kind of volunteer guys in the network that sign up to say, “I’m willing to look at the transactions that are being processed through this system, make sure by checking the ledger, that they’re not double spending the same Bitcoin over again. In exchange for doing that, I’m going to get paid in Bitcoin for helping to secure the network.”

That process is called mining. What the miners have to do is compete with one another in order to put the next block into the blockchain.

The way they compete is essentially to say, through this proof of work algorithm, who is able to waste the most electricity and the most computing resources in the shortest amount of time to solve this complicated math problem to prove that they’re not just one of 1000s and 1000s of guys that one person has put on the network, but that they’re actually putting all of their computing resources behind this.

It’s really important for people to understand the high complexity, the high compute power that’s required for miners, is not because there’s some super duper secure encryption algorithm that makes Bitcoin safer. The process of encrypting the blockchain and making sure that all the transactions are legitimate, and that no bitcoins have been double spent, it really doesn’t consume very much energy at all.

What consumes a huge amount of energy is this arbitrary math problem that says, “I am proving to the network that I’ve basically dedicated all the computers I can find to solving this arbitrary problem and trying to beat everyone else.”

Now, that works fine and a proof of concept. If you’re in a laboratory, you have five guys demonstrating this idea, it’s no problem. When you try to scale that to a global payment system, you end up literally consuming more energy than entire countries use with everybody competing to put the next block on the blockchain.

Blockchains are actually designed so that the complexity of this arbitrary math problem gets harder. If more blocks are being put on the blockchain too quickly, they make the problem harder until it slows the network down.

So this whole idea of proof of work is slowing the network down with arbitrary work that doesn’t need to be done for any reason, other than to deter against civil attacks.

Well, the obvious question is, surely there must be a better way to guard against civil attacks and to prevent bad guys from faking out the network, pretending to be a majority of the network participants when they’re really just one bad guy?

Stig Brodersen 13:59
All right, Tuur, I’m really curious to hear your thoughts on a response to that.

Tuur Demeester 14:03
Yeah, that was so eloquent and well put, Erik. I always try to do this *inaudible* strategy where you find the best argument of the other side. I feel like you’d nailed it. Like it was a great presentation of proof of work skeptical argument.

There’s a lot I agree with, and how you technically explained the concept. I’m not going to go over that. It’s true that you prevent civil attacks by requiring work to be done.

There are two words in particular that jumped out for me: waste and arbitrary. So calling the proof of work mechanism wasteful, depends on your perspective, right?

If you look at where proof of work is used, and I want to stress that but proof of work is not something that was conjured up or invented by brilliant as the concept in the digital world is, it’s basically something that exists in nature and that’s just reapplied in the digital world.

In nature, it’s often known as the handicap principle, where animals will develop features that seem wasteful for the outside observer, but then when you really look at it, it really serves a function.

For example, the peacock has this very elaborate feather pattern that takes a lot of energy to produce. What it does is that not only is it able to prove that it’s a strong individual animal, but it’s also a feature that is extremely hard to imitate from a predator’s point of view.

You see over and over where these features are actually security features that are present in these animal species. Proof of work, you can also see, for example, in the behavior of bees with a queen bee is going to fly extremely high, until only one male is able to follow her. That will be the one that mates with her.

It expends what you call wasting energy, but really, it’s spending energy to then convert it into something else. Usually, that’s security.

By the way, gold, you could call gold as well a distributed ledger. In that sense, I disagree with you that this is the first time in the history of the world that we’ve seen this.

I would call gold, a distributed ledger. It’s unearthed by the expenditure of work. The way gold is distributed, in some ways, is going to reflect how value is distributed. It’s a ledger to keep track of transactions and value in the world.

Just to add to the idea that proof of work is wasteful and Bitcoin mining is wasteful. If people talk about how mining consumes as much as an entire country, I’ve heard a recent estimate that said, as much as the state of Massachusetts. Keep in mind that miners can be installed pretty much anywhere on the planet.

What you see is that they go to, for example, the country of Georgia, they go to Iceland, they go to places like Washington State, where you have extremely cheap energy that nobody wants and then they convert that into financial reliability. That is what they do.

Another way to look at proof of work is to think about whether you want to preserve a secret, because that’s basically what you do. If you want to protect information that’s in the ledger, you want to preserve a secret. It is kind of like hiding a treasure.

One of the most successful ways that people have hidden treasures in the past is to build a pyramid on top. If you want to get hold of that treasure, the energy that you need to expand at the bottom of the pyramid, like in the middle of it, is going to be proportional to the energy that was spent to construct it in the first place. That’s another way to look at it.

Then if you think about the alternative approaches that have been suggested, proof of stake in particular and other ones, they almost always boil down to some political construct where we try to reach consensus by some form of voting. Then you are going to penalize the people that are in charge.

I imagine if the Egyptians had come up with the political system to protect their mummies, I think the chance would be very low that we would still be able to see them in museums today.

My answer to a lot of the proof of stake proposals, my suspicion is that it’s kind of the equivalent of alchemy, where, in the Middle Ages, people tried to create gold. They didn’t want to have to dig it out of the ground, because that costs so much energy. They wanted to find a shortcut and create gold out of other elements. They never succeeded, of course.

I think that to try and bypass and try and spend a lot less energy to get the same amount of security, I think that’s going to be proven a fallacy. But of course, I’d love to be proven wrong and I’m open to see what the future is going to bring.

Preston Pysh 18:38
Alright, so blockchain has been around for almost a decade now. There are some people on Erik’s side saying that proof of work has been criticized and Tuur is saying that you need proof of work for security.

I’m kind of curious how you guys see this going forward, if there’s going to be a new technology that emerges and whether there’s something in the works that could potentially replace proof of work. I’m just kind of curious to hear your thoughts.

Erik, take it away.

Erik Townsend 19:02
I definitely think that this is the major breakthrough that we’re waiting for. And we need to see and it is the distributed ledger system that is decentralized and is just as secure, if not more secure than the proof of work based blockchain distributed ledger is.

But it doesn’t have miners. It doesn’t rely on proof of work. It is orders of magnitude faster and more efficient, because it relies on some other mechanism besides proof of work to assure that you don’t have civil attacks and other vulnerabilities that security experts tend to look at.

I absolutely believe that that’s possible. I can’t help but observe that the smartest Bitcoin guys with the trend right now are going off and working on other distributed ledgers and commercial products which are not part of Bitcoin. They’re trying to get rid of mining. They’re trying to get rid of proof of work and find better ways to skin this cat.

I absolutely think that they are going to succeed and it’s a matter of time. I think a lot of what Tuur has said. Is it wasteful or not? Well, if your car breaks down and you’re supposed to go on a date with a girl who lives eight miles away and you walk to her house, instead, you’re going to impress the girl. But I still would argue that you wasted a lot of energy doing that.

I think that’s really what proof of work is. It is going to take a huge amount of energy consumption to prove something that could be proven more effectively in other ways.

I think that it is going to be achieved. Now there’s a really important aspect of this to understand, which is how hard is it to do a decentralized ledger without proof of work?

The answer to that question is, if you truly mean to be completely decentralized, in the Bitcoin definition of decentralized, where there is no central control whatsoever, and it’s totally peer to peer, well, it’s hard to achieve that. I think we can all agree that it’s hard to achieve it technologically.

It gets much, much easier to get rid of proof of work and get rid of proof of mining, if you have some degree of centralization.

What if you said the goal was no longer to be completely decentralized, but we still want to make sure that no one actor in the network can hack the system. So in the bank if there’s control fraud, and everybody on the board of directors and management of the bank is dirty, and they’re trying to commit a crime, they can’t do it, because the system is secure against it.

However, the network itself has some centralized components. Well, the Bitcoin crowd would say, “No way on anything centralized, because the goal of Bitcoin is to make sure that it is impenetrable by governments.”

You can have the Bitcoin network, and governments might not like it, they might try to outlaw it. It’s going to keep working, whether the government likes it or not.

What if someone else said, “You know what, my goal is not to usurp the power of government. My goal is just to make sure the bank can’t hack the system. I’m willing to accept a small degree of centralization, just in terms of how this protocol works for figuring out who has a proof of stake or who has control of the system, as long as no one actor can corrupt the data without the consensus of everybody else.”

The Bitcoin crowd would say, “That’s no good, because as soon as there’s any centralization, we’re giving power to the government. We don’t want the government to have power, screw them.”

That’s the Bitcoin perspective, I personally happen to agree with that. I think it would be great to keep the government out of our lives. That’s my own view. I think a lot of other people are going to say, “Hey, if we don’t focus on preventing governments from being able to control this thing,” which unfortunately, I think they’re gonna control anyway, “then we can solve this proof of work problem much more easily if we don’t have to be truly decentralized in the most rigid definition of that term decentralized.”

So I think that’s going to play a key in this is, what do you mean, by decentralized ledger? Do you mean that you decentralize it in the sense that the bank can’t commit the control fraud, or you fully decentralized it in the sense that no government could ever interfere with it, even if they had the legislative power that supposedly said they could? Those are very different questions. I think that’s an important distinction.

Stig Brodersen 23:22
Thank you, Erik. Very interesting questions. Tuur?

Tuur Demeester 23:26
Yeah. So there’s a lot to comment on. First of all, I think that we have already seen in the past 100 years, a lot of experiments with how to improve upon central banking, people organizing it and committees, the Federated systems like ECB, and then there’s like supervisory organs and those kinds of things.

Yet, at the same time, financial policy is, *inaudible* money printing just keeps happening. From a point of view of reliability, I would say there is improvement possible there.

If you want a more gold like asset as a currency, I think then you probably don’t want to go with proof of stake. So let me backup a little bit and just give my brief view on what proof of stake is.

the idea is that rather than letting anybody vote arbitrarily on what the state of the ledger is, you’re going to say, “Well, if you can prove that you own a certain amount of tokens that represent a share of the money supply, then you get an accordingly large vote as to what is going to be the final version.”

So whenever there’s a disagreement on who is going to vote based on the people that have the most money, basically. Of course, there’s criticism that it’s kind of like an oligopoly and things like that. I don’t think those are the strongest.

I think from a security point of view, it’s very concerning because it’s obviously optional to vote or not. If only 10% of the money supply, for example, is staked, so it’s used to vote, that means that 90% is floating around and is available for other people to borrow. Then for a brief amount of times, launch a massive attack on the network.

Something that’s not often reported is that a proof of stake attack means that you can change the entire ledger. It’s almost like a coup d’etat. No matter what the constitution was, if you run in there and you gain control, you can go back and change even the very earliest transactions, which is not possible, or at least not as cheap in the proof of work world.

The big problem of proof of stake systems is who is going to guard the guardians? You can always say, “Oh, no worries, we have all these systems in play.” Then it’s like, “Well, yeah, but what is the supervision?”

Then you basically get a bureaucratic system, which is very expensive.

My argument is, then well, aren’t you just creating an obfuscated proof of work system where tes, a lot of energy is spent to maintain security and to the extent that you don’t do it, and you don’t have all your checks and balances in place, you have huge vulnerabilities where, for example, you can say, “Oh, well, the stakeholders are very reliable. We can trust them.”

Okay, well, what if somebody steals the private key, then all of a sudden another actor has control over most of the network?

Another argument I heard Erik say is that the smartest people in Bitcoin are moving to these alternative ledgers. I want to take issue with that.

For the past four years, for example, I’ve been looking around to see, and I’m trying to say this in the most objective way possible, which developer of high pedigree is working on a theory, for example… With high pedigree, I mean, people who have significant recognized performance in a domain other than Ethereum, because Ethereum is kind of like self reinforcing.

You need some external standard, like do they have achievements in the area of cryptography, or memory compression, which is a big issue in blockchain systems, building the internet, for example? Have they built components of the existing decentralized internet? Just to see if there are any skills that they’re bringing along?

The answer was it was basically crickets. I didn’t find anyone and I’m still open.

I then compare that to Bitcoin, for example. One of the earliest people who ran Bitcoin, the first person to run Bitcoin was Hal Finney. He was one of the earliest PGP developers. He created the first reusable proof of work system. Adam Back, of course works on Bitcoin, the inventor of the proof of work mechanism. He was credited in the Tor white paper. I mean, Tor.

I think that’s another example of a successful decentralized project. Nick Szabo is the inventor of smart contract terminology, the digital gold concept. He recently presented research on improving Bitcoin network resilience.

Alex Morcos, co-founder of Hudson River Trading, which is responsible for 5% of all stock trading in the US and is the largest sponsor of Bitcoin Core development,

Christopher Allen, co-author of the HTTPS standard used by 30% of web traffic globally. I mean, I could go on and on like. These are the kinds of people that are working on Bitcoin specifically. That’s the kind of pedigree that I would be looking for, if I want to see a resilient system.

Stig Brodersen 28:11
Tuur, I just want to ask you, Nick Szabo always talks about security. If you don’t understand security, you don’t understand Bitcoin. What does he mean by that?

Tuur Demeester 28:21
Well, I don’t know if I can speak for him, because I definitely don’t want to put words in his mouth. But I totally agree when he says that trusted third parties are security holes.

Basically security is the foundation of everything. If you have a ledger, if it’s compromised in any way, then potentially billions or trillions of value is at risk, like the Bitcoin blockchain. I don’t know what the size is. I think it’s smaller than five gigabytes. It’s just a file. It could be on anybody’s desktop. If you can find a way to hack into that and compromise it, it’s the biggest of issues.

If you think about… We want to build this future, maybe like a decentralized internet. We want to unbundle financial services and kind of do it differently and give more autonomy to the user, but the basis of that is that the bottom layer, the anchor, is going to have to be security, right?

If you want the public at large to entrust any thing of economic significance onto this ledger, you better make sure it’s pretty much unhackable. That’s what comes up when I hear that.

Preston Pysh 29:23
Erik, what’s interesting, is your argument saying that you don’t need the proof of work to be fully distributed here. What I find interesting is your point was maybe it’s just like quasi-fully distributed, and you still get a lot of the security aspects with the proof of stake.

What I find interesting is what’s happening in Bitcoin right now if you’ve got the lightning network that’s being stood up. It’s almost like a hybrid between what both of you guys are saying, but at the very foundational level, you still have proof of work.

I’m kind of curious whether you think that that still would work. If you think that that approach is kind of solving this scaling issue that you brought up earlier? Or do you think that there’s just going to be this alternate coin that’s proof of stake and it’s going to triumph over that model that the Bitcoin communities are trying to use as their scaling solution?

Erik Townsend 30:11
Well, I think a key to that answer actually goes back to what Tuur said just a minute ago. I want to come a little bit further back.

What Tuur said before is, “Hey, the real heroes, the guys who seriously have credibility, and credentials are working on Bitcoin.” I agree very strongly with what Tuur said, but I’m going to put it in a slightly different perspective.

The guys he’s talking about are the proven heroes of the movement to use computers and encryption technology to protect us from the overreach of government. People who design something like PGP, one of the first private security tools for encryption that allow people to keep the government out of your email, so the NSA can’t read your emails, as we all heard about from Ed Snowden…

All of the heroes protecting us from government overreach are working on Bitcoin. I agree wholeheartedly that Bitcoin is where it’s at, in terms of the effort to insulate average people from government overreach, allow them to control their own finances, and keep the government out of it.

The guys who are heroes in that space are all working on Bitcoin. I think they will continue working on Bitcoin.

I want to be clear, too, I personally think that’s great. I hope that they win, that the Bitcoin effort is successful at protecting us from government overreach and changes the world. I think that’s the best outcome.

I therefore hope to be proven wrong on everything else I’m going to say for the rest of this interview. But unfortunately, if you don’t have the agenda that those guys have, if you’re not worried about protecting us from overreach of government, if you just want a distributed electronic payment system, a digital currency system, which doesn’t allow any one actor to hack the system, but it has some degree of centralization that governments still and can oversee the system, it gets a lot easier technologically to overcome the requirement for proof of work, if you’re willing to accept that limitation.

Unfortunately, what I think is going to happen is, we’ll get to it, if governments have more power than all of these guys who are so smart about inventing things like PGP. They can outlaw first generation cryptocurrency like Bitcoin if they want to.

I think we’ll eventually get to state back to digital currencies that are going to have very different characteristics. We should probably save that for later on when we get to that point. Let us start with the Bitcoin currency first.

Preston Pysh 32:39
Well, I’ve got a question for you, Erik. Do you feel like the longer that we have these other financial products like derivatives and soon we’re going to have ETFs that stand up around the cryptocurrency that makes it that much harder for governments to shut it down?

I kind of feel like the longer that we go down this path and government doesn’t step in, the harder it is for them to kind of be in it *inaudible*. I’m kind of curious to hear your thoughts on that.

Erik Townsend 33:04
I don’t think so. Unfortunately, I mean, to some extent, it’s true that the more that you have these things, the harder it becomes for them.

However, I think that the world is going to change in dramatic ways. The big enabler is not so much is there an ETF or not? It’s when governments get their heads around what they could do, using technology to advance their agenda, which I contend is going to be very opposite to the Bitcoin agenda.

I have said the future is not the Bitcoin currency. It’s a different digital currency that I called the Orwell and it has all the opposite features of Bitcoin. We haven’t really gotten into the features of Bitcoin yet.

However, my view is that the government invents something that’s opposite. They outlaw Bitcoin, and they go with what they want. It doesn’t have all the same features of Bitcoin.

One of the aspects of not having true decentralization. It’s a requirement of Bitcoin because Bitcoin needs to circumvent the ability of governments to control it. If you’re not trying to achieve that the technical challenges are much less and it’s going to be easier technologically to build to that government controlled network, then it’s going to be to build a government immune network, which is what Bitcoin sets out to do.

Stig Brodersen 34:19
Alright, so let’s go back here and talk about Bitcoin.

Bitcoin is built on top of the blockchain distributed ledger that we started out this interview talking about.

Tuur, let me throw it over to you. You’re obviously a fan of Bitcoin and you are a long term bull. Could you explain why, and let me just stress you’re a long term bull on Bitcoin, we’re not talking about having the next 3, 6 to 12 months.

Tuur Demeester 34:45
Sure. Bitcoin really, in the essence, is a proof of energy spent. It’s a protocol that converts electricity into financial reliability. It’s a digital gold.Really, that’s what it does.

Despite the problems it has and the risks that are associated with it, I would say Bitcoin has done a damn good job the past nine years. The uptime, for example, of the Bitcoin network is higher than 99.992%. That’s higher than most currencies.

The network has never been hacked. Despite all the worries about Chinese miners, being in control, to our knowledge, no code, and this is verifiable, no code from Chinese miners or other special interests have ever been inserted into the Bitcoin protocol.

So the financial policy of Bitcoin is pristine. It’s totally intact and predictable. It will be for the next 50 years.

It’s true the main layer of Bitcoin is slow. It can only process seven to 15 transactions per second. But in my opinion, it’s a fantastic first layer as a value anchor for a stack of protocols that will be built on top.

To me, that’s the answer to all this confusion about Bitcoin being digital gold? Is it digital cash, which one is it? My argument is that it’s both. It’s just that you have different functionalities, depending on where you are in the stack.

The lightning network, those bitcoins, they’re real Bitcoins that are circling there. They have different features. They’re a lot faster and have a little bit higher security risk than the bitcoins in the main chain.

The lightning network, a smart contract layer, can process 1000s of transactions per second. Also, it offers much better privacy, actually. It’s almost infinitely scalable.

I think the Lindy effect is really at play here, where the longer something gains hold, the lower the chances are that it’s going to go away. To me, the real breakthrough is proof of work. That’s why people also call me a Bitcoin maximalist.

I don’t think we need 100 different blockchains that use proof of work because really, you’re trying to convert electricity into financial reliability. You’re going to have positive network effects. And so, it’s likely that Bitcoin is going to remain the most dominant currency.

Then in terms of government control, I see it as the BitTorrent of the financial world in the sense that just like BitTorrent, you can shut it down. At some point, BitTorrent had almost 70% of web traffic, but what you can do is you’re trying to build an alternative answer to and maybe like an iTunes or something like that.

I do think that governments are going to come up with their answer, whatever that might be to Bitcoin. I think that’s going to change the shape of the world. We are going to have that action going forward.

Preston Pysh 37:28
If a government comes up with let’s say, the US government comes up with their own crypto coin that’s the dollar at that point, the government still has complete control over the protocol. And so, if they want to adjust the monetary baseline, they can still adjust the monetary baseline.

Whenever I see these countries that are saying that they’re going to do their own crypto coin, I just kind of smile and think that’s kind of missing the whole point of all this. The whole point is that it’s completely decentralized. I’m assuming you agree with me, Tuur. I’m curious to hear Erik’s take on that idea.

Erik Townsend 38:01
Unfortunately, I think it’s even worse than you imagine because you’re right, that the goals of Bitcoin, which are to be totally decentralized, and to prevent governments from doing things they shouldn’t be doing….

I think governments will look at this space and say, “Hey, wait a minute, we can engineer a totally different kind of digital currency that enables us to do things that we couldn’t do previously.”

They can’t use substantially negative interest rates as a monetary policy tool in the current system, because that encourages hoarding of cash. You get cash hoarding, and it potentially creates a run on the entire fractional reserve banking system.

However, if you design a global replacement for the US dollar as reserve currency, which is a digital currency designed by and for central bankers, it basically outlaws cash. It enables negative interest rates as a monetary policy tool.

There’s lots of things that they can do that give governments even more power to do the things that Bitcoin was designed to prevent them from doing, but it’s a question of who’s in charge.

I think of this, like a space race or an arms race. If you see Bitcoin doing this, I think governments take the other side and say, “Wait a minute, how do we use all of these cool digital technologies that the Bitcoin crowd has thankfully showed us how to use what they’ve done a huge amount of innovation and pioneering work here.. How do we turn this all around into something that advances the government’s interest rather than the interest of people who want to protect individuals from the overreach of government?”

The answer is they can do a lot. There’s so much that they can achieve with digital currency that they can’t do with conventional currency systems.

Stig Brodersen 39:44
How would you think through let’s say that some of these large governments come out and they ban it, they make it illegal. But then, how many countries there are in the world, not all of them are going to take that same approach. That means that Bitcoin might continue to exist in some of these smaller countries or even large companies that wouldn’t ban it.

Do you see that as a likely scenario, that we’re going to have some countries that won’t ban it and still be using Bitcoin?

Erik Townsend 40:09
Oh, I think that what’s likely to happen is Bitcoin and other cryptocurrencies that we see today will be around and will be allowed to continue to exist until governments have an alternative. But why would you take on the political flack of shutting down Bitcoin until you have something to gain by saying our government backed digital currency is the thing that we’re going to use instead?

I think that first generation cryptocurrencies, which is what I’m calling Bitcoin and Ethereum, and all the other things that are based on a blockchain, I see them continuing to exist.

Eventually you get to the point where governments say, “Okay, what we need is a government backed thing. We’re going to create Bitcoin and Ethereum. These are the tools of terrorists who scare everybody. Terrorism bad. We need to protect you, the people, from terrorism, so we’re going to outlaw Bitcoin.

Those few libertarians who made so much money on it, we’re going to punish them so you can get even with those people you felt jealous of or having bought Bitcoin before you heard of it. Then we’re going to have government backed cryptocurrency that’s fair and safe, and it prevents tax cheats. It prevents drug dealers and terrorists from using it.”

That’s all a bunch of BS as far as I’m concerned, but I think it will sell very well. I think that it will enable governments to get away with taking over the crypto space with something designed by governments. The currency that I envision, I call it the Orwell, it’s the opposite of Bitcoin. Every single transaction is traceable, and controllable by the government. Every single payment has to have the tax ID of both the payer and the payee. Every single transaction can be voided or clawed back by the government if they want to.

It’s the opposite, the antithesis of Bitcoin. I’m not advocating this. I think it’s a horrible, horrible thing. I’m predicting a libertarian Holocaust. I hope that I’m wrong but that’s the way I see this going.

Preston Pysh 42:08
Let me ask you this. I see what you’re describing playing out in some countries, but I don’t see it playing out in every single country.

Let’s just say, I’m going to go through a scenario here. Let’s say that I’m from the Cayman Islands there. I can control what happens in the Cayman Islands. And I say, “Hey, if you’ve got Bitcoin, we’re Bitcoin friendly in this country.”

Now, I might be wrong about this, but I think if it would be banned or outlawed in any country, there would have to be some type of grace period, especially as we got derivatives and all these other financial products. That’s what we saw in China, where it was 30 days or whatever, this is all going down.

I think if you had people that had substantial wealth in this stuff, guess where they’re going? They’re going to go to these countries that would facilitate this. Then the battle would begin at that point.

Let me throw it over to Tuur. Is that how you would see something like this playing out? Do you see something completely different than what I’m describing or what Erik’s describing? I just want to hear your thoughts.

Tuur Demeester 43:02
Yeah, first of all, I think the scenario that Erik is painting is very bleak. If any attempts were to happen in that direction, I would see that as a bearish phase in an overall secular trend towards basically what technology has done for hundreds of years, which is to empower the individual.

To me, civilization is creating order in a chaotic environment. Technology amplifies that, like mobility is getting cheaper, safer, easier.

The things that you’re describing of some safe haven countries or those effects should become pretty readily visible. You already see that in Iceland, for example, where I think 5% of the electricity consumed in Iceland is now going to Bitcoin miners. They’re starting to get political clout.

In some countries, information flows a lot cheaper and faster so remote working is easier. Legacy systems are continually being disrupted. I really liked this term by Fred Wilson from ABC, he talks about unbundling.

So for example, there were the television stations, there may be five stations. Then now we have YouTube where there’s basically a million television stations.

In the same sense, I think that medical care is being unbundled, financial services will be unbundled, energy production and storage, and so on. That’s the overall trend I’m seeing and Bitcoin empowers the individual, because whereas in the past, if you were some kind of refugee, you had to hide maybe gold coins in your shoes, or diamonds in your coat.

Now you can just remember a brain wallet. You can just remember a phrase, and that will give you access to your funds, no matter where you go. And so, I think that the fact is there, and especially if Bitcoin keeps growing, because right now, I mean, let’s be honest, Bitcoin is tiny. It’s $150 billion. It’s the money supply of the ruble. That’s where Bitcoin is.

I think that it’s going to have a disciplinary effect on the world, just like BitTorrent had a disciplinary effect where people were just fed up with paying $20 for a CD. The industry change and now you pay what is it like $5 for almost unlimited music a month?

I’m an optimist. I do think there will be some backlash and there will be attempts to come up with an answer but usually governments are not very good at creating appealing technology.

I think Bitcoin is really opening up this market for currencies where people are going to decide how I want to use this currency… It’s an ICO. I don’t really care if it’s a government, Fortune 500 company or a startup. I’m going to try and judge it by the technology rather than who’s bacing it.

Preston Pysh 45:40
This is where we’re going to stop the tape for this week. I hope you guys come back and join us for the second part discussion between Tuur and Erik.

As you can see, these guys are absolutely brilliant in their own right on both sides of the issue. Hopefully we’re not confusing anybody with providing both sides of the argument. We just kind of feel like if you can hear two strong arguments on both sides, you can form your own opinion internally as to how you see this. Hopefully this conversation is really helping you determine that on your own. We appreciate you guys listening in and we look forward to having you guys back next week.

Outro 46:14
Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP Network. Written permission must be granted before syndication or rebroadcasting.

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