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Understanding Bitcoin’s Scarcity

Bitcoin is obviously scarce. And it seems to be becoming scarcer over time. 

But, perhaps due to the current bull run, doubts about both of these propositions are seemingly on the rise among bitcoin skeptics. Criticisms come in a few different flavors. The main one that I have seen argues that bitcoin cannot be scarce because it is highly divisible. Recently, that particular line of reasoning was subject to some particularly colorful discussions on Twitter

In this article, I want to clarify bitcoin’s scarcity. Let’s start with what the concept of scarcity actually means.

What Is Scarcity?

Scarcity is a core concept within economics. This is attested to by the concept’s frequent appearance in characterizations of the discipline. 

Thomas Sowell, for instance, characterizes economics as “the study of the allocation of scarce resources with alternative uses” in his book “Basic Economics.” 

Somewhat more elaborately, in the book “Economics,” Paul Samuelson characterizes the discipline as “Economics is the study of how people and society end up choosing, with or without the use of money, to employ scarce productive resources that could have alternative uses, to produce various commodities and distribute them for consumption, now or in the future, among various persons and groups in society. It analyzes the costs and benefits of improving patterns of resource allocation.”

Both Sowell’s and Sameulson’s characterizations borrow from the famous characterization of the discipline made by Lionel Robbins in his “An Essay on the Nature and Significance of Economic Science” in the early twentieth century: “The science which studies human behavior as a relationship between ends and scarce means which have alternative uses.”

The concept of scarcity in all of these characterizations of the economics discipline can be roughly summarized in the following way: 

Humans have a variety of wants, such as living by the beach, playing Nintendo every day, eating great food, socializing with friends, having the latest gadgets, becoming a good basketball player and so on. Both material and non-material resources are required for realizing these wants: time, money, labor, raw materials, land, mobile phones, refrigerators and so on. 

In some contexts, the resource(s) we require to achieve our wants are in abundance

For instance, everyone desires to breathe in order to live. On Earth, that just requires the air which covers the surface of our planet. While the air might be limited in a physical sense, it is essentially limitless given human wants. Hence, air is not scarce, but abundant. (One might argue, of course, that “clean air” is not abundant.)

By contrast, most human ends require resources that are scarce: that is, they require resources which are limited given all of the human wants that it might support in fulfilling. It is important to understand that we are not just talking about some physical limitation here — air to breathe is also physically limited in this sense. Instead, the resource must also be limited with regards to what humans actually desire.  

Importantly, scarcity and abundance are contextual concepts. While air might be abundant in our standard human setting, it might not be abundant for a human colony on Mars. It certainly is not abundant for a deep-sea diver. 

Similarly, while oil might generally be scarce in the modern world, it was not really scarce for most people before the 19th century when applications for it began to emerge. Farmers that discovered it on their lands probably thought it was a nuisance. 

To understand the concepts of scarcity and abundance more clearly, lets work through an example that Sowell makes in “Basic Economics”:

Many people in principle would want a house by the beach. But there is only a limited amount of land by the beach. So, even if we constructed houses on all of the suitable land next to our beaches, we would still not be able to meet everyone’s desires with respect to having beachfront property. Hence, land by the beach is scarce. Some demand for it will have to be left unsatisfied. 

But the limitations experienced from the land next to our beaches extend further. It, for example, can also be used for creating natural parks, oceanic research facilities, hotels, recreational facilities and so on. Dedicating all of the land that is suitable to beachfront property impinges on these latter human wants that are also common. 

Why is this all so important to economics? 

Scarce resources with alternative uses mandate an economic system: that is, a system which makes decisions on production and distribution in order to meet human wants. Whether a free market, a feudal system or a communist utopia, every society must make these choices given scarce resources with alternative uses. 

If resources were not scarce, there would be no need for economies or a scientific discipline to study them. Hence, the centrality of the concept of scarcity within the discipline. 

Compare various economics textbooks under a microscope and you will probably see that they do not use the term “scarcity” completely consistently. But all roughly mean something as explained above with the term and that is sufficient for our purposes. 

Is Bitcoin Scarce?

Given the characterization of scarcity above, we must conclude that practically all of the resources we commonly use are scarce. Something like air is the exception, rather than the rule. And so it should not come as a surprise that bitcoin is scarce. 

To put it fairly simply, I would be very happy with 1,000 bitcoin. My guess is that I could probably find quite a few other people that would be happy with 1,000 bitcoin. So many, in fact, that we cannot all own 1,000 bitcoins. 

Given the wide variety of ends we can achieve with our bitcoin — buying a house, a car, a holiday, storing our wealth or whatever — this desire to hold bitcoin should be obvious. All money that is in relatively common use — even if it experiences more monetary inflation than bitcoin — is also scarce. 

Importantly, the fact that bitcoin, as most other monies in common use, is highly divisible — a precondition for being decent money, I would argue — does not make it abundant. It will still be no problem to find more people that want to have 1,000 bitcoin than there are bitcoin in existence. 

Consider the following for an illustrative comparison: Suppose a group of people is walking in a desert with a bucket of water and a syringe that can easily divide that amount of water into very many, very small amounts. Does this somehow make the water non-scarce? Of course not. Surely, they have less than what they ultimately want in the burning sun. 

Bitcoin Is Becoming Scarcer

Scarcity is not just a binary concept. It seems that we can also sensibly speak of resources becoming more or less scarce. That can be the product of both supply and demand changes.

For instance, suppose that heavy earthquakes destroyed much of the beaches in a particular area, so that there is less land by the beach available. As long as demand for land by the beach stayed relatively consistent, we are fairly reasonable in stating that “land by the beach has become scarcer.”

Put differently, “less scarce” in this example just means that the amount of land relative to our desires for that land — for creating beachfront property, oceanic research facilities, hotels, recreational facilities and so on — has decreased. 

In what direction has bitcoin’s scarcity been heading? And how will it develop in the future?

At the moment, bitcoin still experiences a small amount of monetary inflation — about 2 percent per year. This was even higher in the past and has been a decreasing factor on its scarcity from the supply side. People also lose and find previously lost bitcoin. It’s difficult to state how this has impacted the historical trend of bitcoin’s scarcity. 

Sometimes bitcoin is charged with having monetary inflation through the backdoor: one can, after all, copy the code, change some parameters and start a new digital currency. That criticism, of course, makes no sense. No one would argue that printing monopoly money somehow creates monetary inflation for the U.S. dollar. 

Most importantly with regards to bitcoin’s scarcity, the desire for bitcoin has been increasing over time — though admittedly with heavy fluctuations. This growth in demand has surely outweighed any of the impact from changes in Bitcoin’s supply. Hence, bitcoin’s scarcity has been increasing with time. 

And I am somewhat expecting this trend of increasing scarcity to continue. 

Bitcoin has a transparently encoded supply function which currently has low monetary inflation, and this monetary inflation will decrease further over time. Given the strong consensus over this production function, it is unlikely to change in the future. Bitcoin also offers people new means for financial freedom and sovereignty. 

All this is fairly interesting in a world where the money supply is not particularly transparent, unpredictable and subject to extensive surveillance and control. It leads me to think that demand for bitcoin will continue to increase over time. Given the rigid supply function, I would, therefore, not be surprised to see bitcoin’s scarcity continue to increase. Many people will probably only be able to own a small amount of bitcoin in the future.  

This trend, of course, is not an inevitability. Perhaps something could still break Bitcoin’s production algorithm and produce rampant monetary inflation. Or perhaps demand will start decreasing consistently after this current bull run and never recover. While I do not deem such scenarios likely, they are surely not impossible.

Divisibility And Scarcity

We have already established that bitcoin’s divisibility does not make it non-scarce. However, we need to explore the issue a bit further, as divisibility does impact the degree of scarcity.

Imagine, for instance, that there was only one bitcoin in existence and that it was completely indivisible. That would not make for very good money, so I would expect there to be little to no demand for bitcoin in that case. Hence, bitcoin would not be as scarce as it is now.

Alternatively, suppose that there were 21 million bitcoin, but that you could not divide them any further. Suppose further that demand conditions were relatively similar to those currently dominating the market. Assuming decreasing marginal utility from bitcoin ownership, it might be the case that bitcoin is actually scarcer in this situation as compared to the current situation.

Teasing out the relationship between divisibility and scarcity for bitcoin — or really any other resource — can be a bit complicated. In any case, while we can acknowledge that the current level of Bitcoin’s divisibility impacts the degree of scarcity compared to alternatives, it is surely inaccurate to claim that the current level of divisibility negates its scarcity entirely.

Conclusion

Bitcoin is scarce. That fact is not changed by its divisibility.  

Of course, I am making those claims against the standard economic understanding of the term “scarcity.” But I think that any other reasonable sense of the term would have to draw the same conclusions. It would certainly require a rather strange understanding of the term “scarcity” to claim that bitcoin is not, in fact, scarce. One that is likely to be meaningless and unproductive for scientific analysis. 

Bitcoin scarcity also has been increasing over time, despite that the system has been subject to monetary inflation. This is because demand for bitcoin has increased over time (though admittedly with some severe volatility). 

I would expect this trend of increasing scarcity to continue, as its transparency, predictability, consensual nature, and censorship resistance make bitcoin a unique monetary asset. Though all of that is certainly not a given.

This is a guest post by Jan-Willem Burgers. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

The post Understanding Bitcoin’s Scarcity appeared first on Bitcoin Magazine.

Source: Bitcoin magazine

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A Commentary On FinCEN’s Proposed KYC Requirements

Policy Division

Financial Crimes Enforcement Network

P.O. Box 39

Vienna, VA 22183

FinCEN Docket No. FINCEN-2020-0020, RIN 1506-AB47

January 4, 2020

Dear Sir or Madam,

The proposed regulations on currency transaction reports and record-keeping seem to require that banks and money services businesses (MSBs) be able to prove that an identified counterparty to a transaction indeed owns one or more particular cryptocurrency addresses, when that counterparty uses an unhosted wallet and the transaction is over $3,000 in value. (The $3,000 mark would invoke the record-keeping requirement, while the $10,000 mark would also invoke the currency transaction report requirement.)

The proposal makes no explicit distinction between withdrawals and deposits, so I assume that the aforementioned proof of ownership requirement would apply to both types of transactions if they exceed $3,000 and involve a counterparty with an unhosted wallet. 

From here on out, I will call any procedure or measure that attempts to prove the ownership connection between a counterparty’s identity and one or more cryptocurrency addresses, as an “address verification procedure.” I will refer to the general process itself as “address verification.” 

In my country of residence, the Netherlands, the central bank rushed through address verification last fall for those transactions from exchanges and custodians which involve withdrawals to an unhosted wallet. By contrast to your proposal, address verification is required in the Netherlands on withdrawals in these cases regardless of the transaction value. Address verification is not a requirement for deposits from an unhosted wallet. 

As a long-time consultant and educator within the cryptocurrency ecosystem, I have given extensive consideration to the practicality and desirability of address verification in light of the measures that have recently been taken by the Dutch central bank (De Nederlandsche Bank NV). And I want to share with you my thoughts on these matters.   

Overall, my conviction is that address verification is unlikely to be very productive in fighting financial crime, and that it carries significant costs to commerce and innovation, and customer privacy and security. 

In this letter, I would like to set out why I am so skeptical of the practice of address verification and why I deem your proposal unworkable and disproportionate. Before starting, I would like to make three comments regarding the scope of my critical feedback. 

First, neither from your proposal nor from any additional commentary on your part have I been able to ascertain exactly what types of measures you propose for address verification. I would assume, however, that you have in mind similar procedures as those that are currently recommended by the central bank in the Netherlands to our custodians and exchanges.

Hence, I will take its suggested procedures as a guideline for formulating my criticisms of address verification. These suggested procedures are as follows:

  • For customers to take screenshots of their wallets with the destination address
  • For the customer and the business to video conference during the transaction
  • For customers to digitally sign the destination address with the associated private key 
  • For customers to return a little of the bitcoin they have received to the exchange or custodian
  • For the business to supply the customer with an address (presumably by possessing an extended public key of the former)

Second, I will limit my examples to cases in which money is withdrawn to an unhosted wallet. The same criticisms can be leveraged against the case in which money is deposited from an unhosted wallet. In fact, address verification is an even bigger practical problem in the case of deposits, as cryptocurrency transactions typically involve multiple unspent transaction outputs as their inputs (meaning that you would have to connect an identified counterparty to multiple addresses, not just one). 

Third, your regulation also proposes address verification in cases where the counterparty’s wallet is hosted, but the bank or MSB of which the counterparty is a client is located in certain foreign jurisdictions. I only restrict my commentary to cases in which the counterparty uses an unhosted wallet. 

Unproductive In The Fight Against Financial Crimes

The proposal intends for address verification to combat a wide variety of financial crimes. In the executive summary, for example, the proposal states:

As explained further below, U.S. authorities have found that malign actors are increasingly using CVC to facilitate international terrorist financing, weapons proliferation, sanctions evasion, and transactional money laundering, as well as to buy and sell controlled substances, stolen and fraudulent identification documents and access devices, counterfeit goods, malware and other computer hacking tools, firearms, and toxic chemics. In addition, ransomware attacks and associated demands for payment, which are almost exclusively denominated in CVC, are increasing in severity, and the G7 has specifically noted concern regarding ransomware attacks ‘in light of malicious actors targeting critical sectors amid the COVID-19 pandemic. 

I cannot possibly discuss address verification procedures with regards to all of these crimes. So, instead, I will just limit my discussions to some financial crimes that are at least a major part of the concerns with these proposed regulations: money laundering, terrorist financing and sanctions evasion. 

These are structurally very similar crimes, even though they differ in terms of their legal underpinnings and substances. And address verification procedures are going to have little effect on combating them for the same reasons, in my opinion. 

Suppose, for example, that the customer of an exchange is intent on laundering money for a drug cartel via bitcoin, and that the exchange implements address verification by having customers take screenshots of their wallets. How exactly would this stop the customer from participating in money laundering activities? 

The customer could easily circumvent the requirement in the following manner: 

  • Create an address in their own wallet and take a screenshot. After the exchange confirms the transaction and the customer receives the bitcoin, they can transfer them to the criminal organization. 
  • Receive an address directly belonging to the criminal organization and incorporate it into a watch-only wallet. The customer takes a screenshot of this watch-only wallet and the destination address. The exchange confirms the screenshot, and directly transfers the bitcoin to the criminal organization. The customer never has access to the bitcoin. 
  • Receive an address directly belonging to the criminal organization and create a fake screenshot, such as with the Bitcoin Wallet Screenshot Generator. The exchange confirms the customer’s screenshot, and sends the bitcoin directly to the criminal organization. The customer never has access to the bitcoin.

Sometimes customers are tricked into being money mules, rather than intentionally supporting a criminal organization. Even for such customers, however, it would not really change much about my reflections above. If a customer can be tricked into becoming a mule for a criminal organization, it is unclear how a screenshot might help prevent their stupidity.

And these conclusions can be made more generally about most other address verification procedures. I didn’t just cherry pick the screenshot implementation of address verification. Many other practical implementations — such as making digital signatures or sending back some of the funds — would experience a similar level of fecklessness. 

Overall, address verification procedures really seem to offer no additional tangible benefits with regards to combating money laundering, terrorist financing and sanction evasion when standard customer due diligence and transaction monitoring procedures are in place. 

I am not much convinced that address verification fights other types of financial crime well either, at least not in any way that could not also be done in a less invasive manner. I believe the comments above are enough to show the types of effectiveness problems address verification will experience in practice. 

The Costs Of Address Verification Procedures

Address verification also comes with significant costs. Precisely what these costs are will depend on the exact measures taken by the banks and MSBs that have to implement it. But I want to emphasize two major concerns that, to different degrees, will probably apply to some extent for any practical implementation of address verification.    

First, address verification procedures present a hurdle to commerce and innovation. 

Suppose, for instance, that an exchange required all counterparties to draw a connection between their identity and their cryptocurrency address(es) on an unhosted wallet via a digital signature over the address(es). (I set aside for the moment the concern that this would be an ineffective proof of anything.) 

Most customers have no idea how to make digital signatures and this will create an overload of customer complaints and requests. It would also require customers to obtain software and hardware that could relatively safely allow them to make these digital signatures. A lot of business will probably be lost as a consequence of the chaos of implementing such an address verification procedure. 

Some possible implementations of address verification, of course, might be slightly less invasive to commerce, such as a screenshot of a wallet (again setting aside the concern that this would be ineffective proof of anything). But even here, we have to recognize that some costs or complications to commerce and innovation will materialize. 

For instance, as cryptocurrencies are programmable, you can also send them to addresses governed by decentralized protocols, not human beings. While these decentralized protocols are largely experimentation at the moment, they may prove to have very interesting and valuable use cases. 

But how exactly could these decentralized protocols fit into the proposed address verification requirement? 

In my view, the proposed regulations cannot accommodate this kind of use case: decentralized protocols do not have identities or physical addresses after all. So, even a relatively simple measure to implement address verification by a bank or MSB, such as a wallet screenshot, will have negative consequences to commerce and innovation. 

Second, address verification is likely to hurt customer privacy and security. I will just run through a couple of the possible implementations to make the point. 

To start, a screenshot reveals what type of wallet a customer is using and potentially further information, potentially about the type of operating system or device. A video conference will reveal even more about the customer’s personal storage arrangements. 

This type of information is very dangerous in the wrong hands. We do not ask customers of precious metal merchants where they store their gold and silver. So why do this with bitcoin customers? 

While I recognize that bitcoin is much more liquid and introduces additional risks with regards to financial crimes, the higher the risks for customer privacy and security are in my opinion not proportionally weighed with address verification procedures. 

Another likely candidate for address verification is making a digital signature over the counterparty’s address. It is a well-established best practice within the Bitcoin industry that you only reveal your public key when making a transaction (hence, why you should only use an address once). This type of measure would directly contravene industry best practices. 

Conclusion

In conclusion, I am doubtful that address verification procedures, as required for those contexts prescribed by these regulations, will make any real contribution to fighting financial crimes. At least, I have not really seen any sound implementation of them that would make me think otherwise.

In addition, address verification procedures come with costs to commerce and innovation, and customer security and privacy. Surely these costs depend on how exactly you implement them. But costs they will have, at least in any way that I can envision their implementation.  

I, therefore, urge FinCEN to stop moving with this proposal in its current form. Any revised proposal must in my opinion answer three key questions:

  1. How exactly will address verification have to be implemented by banks and MSBs? 
  2. How exactly will those procedures for address verification combat the wide variety of financial crimes mentioned in the proposal? 
  3. What exactly will be the costs to commerce and innovation, and customer privacy and security of those address verification procedures?

Sincerely,

Jan-Willem Burgers

The author would like to thank Daan Kleiman for his critical feedback on an earlier version of this letter.

This is a guest post by Jan-Willen Burgers. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

The post A Commentary On FinCEN’s Proposed KYC Requirements appeared first on Bitcoin Magazine.

Source: Bitcoin magazine