WBD200 Audio Transcription

Beginner’s Guide #15: Bitcoin FUD with Nic Carter

Interview date: Saturday 29th February 2020

Note: the following is a transcription of my interview with Nic Carter from Castle Island Ventures. I have reviewed the transcription but if you find any mistakes, please feel free to email me. You can listen to the original recording here.

In this interview, I am joined by Nic Carter, a partner at Castle Island Ventures, and we discuss and dispel the myths, untruths and FUD that Bitcoin faces.

“Anything the government doesn’t like, from a transactional perspective, they will claim it is used by evil people.”

— Nic Carter

Interview Transcription

Peter McCormack: Nic, welcome back! Very quick turnaround to come back on the show.

Nic Carter: Thank you very much. I think this is my fourth time now on the show.

Peter McCormack: Yeah, but the second time in a few weeks. Look, I had to do this one with you. I originally had you pencilled in for this. So I've been working with Hasu and doing some of the planning. We knew we had to have a FUD show, and I originally had you planned in, and then I had to have you for the history of altcoins, which by the way, was a really popular show, people loved that one.

Nic Carter: All right, that was a moment that catalyzed me to learn just to refresh my memory on so many of those things. So it was a great moment for me as well, I've got to just do a couple of weeks' worth of homework.

Peter McCormack: Fantastic. I also just did my own show, I forced myself to do the recap show. I decided last minute I was going to have a go and it was really interesting being the other side of the mic because I'm happy to answer questions on Bitcoin, but I knew the subjects were going to be technical. You have to hold yourself up to quite a high bar when you're explaining technical items because if you get something wrong, you have a lot of responsibility there. I didn't enjoy it!

I've got to say I felt very nervous. I don't know how you feel doing these interviews? You seem pretty natural, but I felt very nervous, and I don't think I'll do that again, but I did feel it was a useful exercise in filling some gaps in my knowledge because one of the things I realized is that knowing something is one thing, but trying to articulate it and explain it in both an accurate and factual way is actually quite difficult.

Nic Carter: Yeah, that's right. The best way to learn something is to teach it.

Peter McCormack: Anyway I think I've done 14 or 15 of these Beginner's Guides now, I've got 3 shows left and one of them is to cover FUD because one of the things that might happen for new people coming in, is they get all excited, they learn a bit about Bitcoin, and they start jumping on Reddit or Twitter, start Googling, and they might end up reading things which could be misleading, misinformation.

So I had to cover this with you because you did create your legendary FUD dice, which I know we can't get anymore, but you did create your legendary FUD dice. So you have been down this rabbit hole, as well as the altcoins one. As a starting point though, some people might not even know what the meaning of FUD is. So do you want to explain what FUD is first before we start going into it?

Nic Carter: Yeah, I actually don't use the term very much anymore because I sound like a Ripple shill, as if you say "FUD", it's like, "ugh!" It's a marker of someone that can't accept any criticism whatsoever, but yeah, it stands for fear, uncertainty, and doubt. It's a term leveed at people that issue critiques typically of financial assets. So if you like Tesla stock and someone says, "Elon Musk is a cult of personality and he's going to go to jail for securities fraud," you might say, "that's FUD." So that's FUD. FUD is an accusation you throw at people that you feel are unfairly maligning the asset of your choice.

Peter McCormack: Would you agree though, that some items that are thrown as FUD or considered FUD, actually are things that still are worth debating?

Nic Carter: Oh yeah, 100%. I don't want to dismiss any critique of Bitcoin, I think we actually should be very self-critical. I think that's very, very important. There certainly are some items, which have been debated ad nauseum hundreds and hundreds of times, things that we've covered, which maybe aren't as potent critiques as people might think they are. So maybe you could call those FUD, but yeah, I think generally speaking, being super critical, very introspective is a very good and important thing. So I guess this show has a light-hearted tone, but I also do want to engage with some of these critiques in a really serious way.

Peter McCormack: Fantastic. Well we might do on some of these, I've got a list. Most of it was derived from your FUD dice. I found some nice photos of them. I managed to figure out some of them from the angles of the 12-sided dice. Some of them are a couple that I'm aware that I've thrown in, but let's walk through them all. So I'm going to start with one of the most common used criticisms of Bitcoin. This tends to come, I think, more from no-coiners or people who don't really understand too much about Bitcoin. You tend to see this from the bankers and the finance people, but that Bitcoin itself has no intrinsic value because there's no central authority. Why is this FUD?

Nic Carter: Why is that FUD? Okay, so the reason that Bitcoin can't be centrally managed or controlled is the reason that it exists. Bitcoin is a reaction to centrally administered central banks and centrally administered monetary systems. Satoshi has a quote about this. He says that there's a centrally controlled nature of those systems that doomed them, referring to other digital cash schemes. So Bitcoin was meant to be decentralized across many different verticals, so it's meant to be decentralized at the administrative level, at the node level, and at the protocol level.

If there was a critical point of centralization in there, if there was some entity which could be targeted, then presumably, governments, which might object to the creation of a new monetary system would use that as a locust of control. They would arrest the founder or arrest whatever entity was managing the system. So Bitcoin by design couldn't have a single point of control and that has meant that some things are a little bit more difficult, like coordinating upgrades, but it's also what gives it its resilience.

Peter McCormack: Okay, so what about the term intrinsic value itself? I've heard some people say the term itself is nonsense because nothing has intrinsic value.

Nic Carter:Well yeah, Austrian economists would say value is subjective and that there's no intrinsic value. Objects in the universe, they require someone doing valuer, for there to be a value assessment. So before humans came along, nothing that existed on Earth had a financial value, we were the ones that foisted that value upon those things, not to get super philosophical about it. If you look at stocks for instance, stocks are assumed to have some intrinsic value because they are claim in a discounted set of cashflows effectively dividends, which should accrued to the shareholder.

So you can add up those dividends and back out a financial valuation of that stock, which I guess makes sense. So then people look at Bitcoin and they say, "well there are no cashflows, there's no dividends, there's nothing even remotely resembling that, so it can't have value." I think that's fine. Bitcoin's value comes from the market, so it's quite pure. The value comes from the fact that people desire to use it as a means of exchange, and a means of wealth storage for the long-term. So in a sense, the fact that Bitcoin has value is quite magical.

At some point, it went from zero to one. It was worth nothing, and then it was worth something and it's been worth something for over 10 years now. So I would say that that's actually more resilient, and that's a sounder basis of value than relying on some external cashflows as the thing that is the value-giver. So I'm not that persuaded by the no intrinsic value argument. You could also say gold has no intrinsic value. Gold is just valued because civilization places some monetary value on the existence of a monetary commodity. It sounds circular, but these things are valued because society at large finds their traits to be valuable.

Peter McCormack: Their value is whatever somebody is willing to buy off you from. So if you go into an exchange right now, the price will be around $8,600. That is the value of Bitcoin. Intrinsic value doesn't come into it. It's whether someone's willing to buy from you.

Nic Carter: That's right. Some people... Aswath Damodaran, who's a well-known maven of equity valuation says, "Bitcoin is a currency, and currencies cannot be valued, they can only be priced." Maybe that's a bit of a semantic quibble, but yeah, Bitcoin has a price 24 hours a day, it's always evident. So there can really not be that much negotiation over what it's worth. What it's worth, you can find that out just by looking at the price.

Peter McCormack: Well maybe the next point then is to talk about volatility, because that price is volatile. We've seen it in the previous week drop around 20%. We've seen times in the market where it's shot up and shot down. So if Bitcoin is so volatile, it can't ever really perform the role of money.

Nic Carter: Yes, so this is actually probably the number one critique that you'll hear from economists in the context of Bitcoin because Bitcoin has an interesting characteristic in that there is no supply elasticity of demand. So what does that mean? That means that if there's a lot of demand that rushes into Bitcoin, the supply can't really respond to that. Now if you think about it in the context of gold, let's say a lot of people want to get exposure to gold, the price of gold goes up. What happens is people start to mine a little bit more gold because it starts to be really profitable to mine gold, so the rate of gold production increases slightly. It doesn't increase a lot, but increases a little bit. So that's supply elasticity.

Now Bitcoin doesn't have this characteristic because Bitcoin has a difficulty adjustment, which I'm sure has been covered by other guests in the series. Basically meaning, that Bitcoin is issued at a very predictable rate regardless of how much effort is being put into creating it. So what that means is that all new demand, demand shocks, demand increases or decreases, those are reflected in the market cap solely through the vector of price. So there's no monetary basic expansion in response to new demand. Now if you compare that to sovereign currencies for instance, sovereign currencies almost never appreciate. That's not really the mandate of the central banks that manage them.

So if there's a whole bunch of new demand that's evidenced by GDP growth, the central banks will just issue more of the sovereign currency. But that can't happen with Bitcoin, right? There's no central bank that says, "wow! The Bitcoin economy has grown. Let's issue more Bitcoin." That doesn't happen because Bitcoin is so totally predictable in its issuance. So what this means is that Bitcoin is super volatile, maybe more volatile than any assets of its size because of this supply inflexibility. Lots of people say, "well if you want a monetary-based asset, if you want to make loans denominate in this asset, it's not going to work because if the thing is too volatile, there's no predictability.

You don't know what it's going to be worth a year from now or six months from now." So the idea is that it can never serve as the basis of trade and it could never be a reserve asset, which it's actually not a bad point. I would say it's a fairly convincing point. The challenge to Bitcoiners would be to show that maybe over time Bitcoin's volatility will decrease. I can't guarantee that's going to happen, but yeah, it's definitely one of the most compelling points against Bitcoin.

That said, people still find it useful to hold and use Bitcoin despite the volatility. So you could say that the volatility is the cost and it's the trade-off you have to make to get access to the system. There's no way to manage the volatility, so that's just the nature of the beast.

Peter McCormack: Do we have to consider liquidity with relationship to volatility?

Nic Carter: Well there's no guarantee that more liquidity temps down volatility, Bitcoin's been super volatile from inception. I think its annualized volatility is over 100% right now. Feel free to fact check me on that, and it's super liquid, but the problem is that Bitcoin has this unique supply characteristic. So new demand movements are perfectly manifested in price. So I would say that maybe the creation of derivatives and futures markets, which give participants more creative ways to express their views on Bitcoin, that might help with volatility somewhat. Allowing miners to hedge might help a little bit, but I can't sit here and guarantee that Bitcoin's volatility is going to decrease.

Peter McCormack: Okay, so are you really saying with this, that volatility is a fair criticism of... Well it's a fair area of debate regarding Bitcoin, but really, because of the unique characteristics of Bitcoin, that is something that might be something people accept to gain those benefits by holding the asset?

Nic Carter: Well I think it's a young monetary asset, right? We'd never really seen a new monetary commodity become monetized in real-time like we have with Bitcoin. Gold, its monetization process took thousands of years. I'll point out that gold was super volatile in the '70s after the gold standard was abolished in the US, so I don't think that volatility is anything intrinsically wrong with the financial asset. Plenty of assets that we use everyday are volatile. Oil is super volatile, right? There's trillions of dollars of oil floating around. So it's not a disqualifying feature.

It just means that maybe as a base reserve asset, Bitcoin has some ways to go before people are comfortable saving in it. That said, there is a Bitcoin economy. People do save, some people make loans in Bitcoin terms, these things happen. So I think it's just a necessary cost you have to bear, there's no way to escape it. If you want to avoid volatility, then you should prefer sovereign currencies, but that desire to suppress volatility is what a lot of people would say is the cause of financial crisis. In fact, it makes them worse when they occur. So to me, it's an unnatural thing to try and suppress natural volatility. I think it only leads to worse crisis down the line.

Peter McCormack: Okay, so the next thing we're going to talk about is one of the first things that when I got into Bitcoin, made me question it, which is that Bitcoin doesn't scale. I had to go through that journey of considering all kinds of alternative projects, and their proposals for faster, cheaper transactions. So that is quite a common thing, and we've lost some good people to this area of debate.

Nic Carter: Yeah, I'm not going to be able to give it a full treatment here.

Peter McCormack: Well I've covered this on previous shows. In the history, we covered the scaling debate, but a shortened Nic Carter version would be very useful.

Nic Carter: So I'm going to give you a pretty different answer than what most people would tell you actually. So in my view, I think the scaling problem is a misstated problem, not to say that it's not a problem, but I think the way we normally think about it is wrong. We use the wrong words to describe it. If you really think about what Bitcoin is of its core, we're talking about a ledger, a history of transactions, and a current state of transactions, the UTXO set, which is replicated to tens of thousands of computers worldwide. So the hierarchy of the system is flat, everybody has the same ability to validate every transaction because each transaction that's included in the ledger is replicated out to every member of the system.

What this means is that you have to design a system such that the people with the worst internet connections and the most mediocre computer hardware can still be valid participants in that system, because if you don't, you're just creating a system which is Venmo or PayPal, where you have one super node the basically controls everything. So Bitcoin, by its very nature, was designed to be flat in hierarchy. So in the context of that, we have real physical limits on how much data can be pushed through the pipes that we've built basically. The limits are bandwidth, there are computational limits in terms of how much work your computer can effectively do per unit time, how much data can be written to a disc and there's storage limits, right?

These hard drives only store so much information. In practice, the bottleneck for Bitcoin and for cryptocurrency generally, is the disc writing activities. So it's just you have to write lots of data to the disc to get up to the current chain tip and there's not a lot that can be done about that. There's just a certain threshold where if you exceed that, normal hardware cannot validate the state of the ledger. Now if you want everybody to be able to validate the ledger up to the chain tip and get that UTXO set in a trust minimized way, you have to design it such that the data requirements are not so great. So Bitcoin just passed 300GB of data. That's actually not a lot, and that's very deliberate, right? Nobody wants the blockchain to be terabytes and terabytes.

I can attest to the fact that if you get a blockchain which is the size of EOS or Ripple, you're going to have an extremely hard time as an individual actually validating that ledger. This is a genuine problem. We've reached these limits with some other blockchain systems. So they've demonstrated to us that there is a limit where normal folks can run a full node and validate the chain. Now if you throw out those requirements, if you say, "well, we can delegate that trust to certain entities to do the validation for us," then you're not subject to those requirements, but that's a totally different trust model. At that point, you're just back to the old trust model of trusting banks and central banks, right?

So we're trying to do something new here. We're trying to do something interesting and new, which is allow normal folks to be equal participants in the system. So that's a very long preamble, I promise I'll get to scalability here. So the way that blockchains work is everybody is ingesting the latest changes to the ledger all the time. What that means in practice and Bitcoin, is about a maximum of 2.4MB of new data every 10 minutes, and that works out to maybe four-ish transactions per second. There really is a limit there. To call this a problem is I think to be a little dismissive of what we're accomplishing here, which is allowing the entire world to come to agreement over the state of a transactional ledger.

So I don't think we're ever going to be able to magically expand the amount of data that our computers can ingest per unit of time. Of course, computer technology gets better, but it won't get better by a factor of a million in the next 10 years, right? So we're not going to be able to get normal devices to ingest a gigabyte for every 10 minutes in the near future, that's not going to happen. So in the context of bandwidth being expensive, hard drives being expensive, and hard drives being able to only write so much information per unit of time, there are just inherent limitations to a system like that.

Now of course, you can design an alternative system where you have 10 nodes that are trusted, that's how EOS or Ripple works, right? They have to work that way because normal folks wouldn't be able to participate. That's a completely different system. That's basically the old system where we have banks or trusted service providers and that's the root of all the problems. That's why Bitcoin is created as a reaction to that. So anyway, extremely long-winded, but I think the scalability problem is essentially misstated.

Now I do think there are ways to improve the efficiency to bundle more information into those bytes, which everybody has to store. So those are your scalability "solutions" or enhancements, but there is an essential constraint here. That's my point.

Peter McCormack: So really, the solution that these alternative cryptocurrencies use when they're attacking Bitcoin and they're saying, "well Bitcoin is slow, Bitcoin is expensive, we have on chain scaling," they're really trying to solve the problem of allowing us more value, high volume transactions. We often talk about the cup of coffee, but really, you don't want a blockchain for this purpose.

Nic Carter: Yeah, absolutely not. Why would you? Why would you want to store your coffee transaction on the nodes of every participant in perpetuity and in an immutable way? To me, that seems totally misaligned, right? If we're going to force this information onto every node for every participant in the system, you better hope that it's an important transaction. Now that's not to be dismissive of small value transactions, it's just that for low stakes transactions, you can bundle those together and then you can have larger settlement transactions.

So Lightning works this way and side chains work this way. So that's the idea, and this is how it's always worked in the payments industry. You don't have one ledger, which records every transaction. You have many, many different ledgers with a hierarchy. So in the normal payments industry, you have systems like Fedwire, where the average settlement transaction is in the millions of dollars. You have Swift, these are big transactions. Then you have sub-ledgers, where PayPal maintains their own internal ledger, and then they periodically settle up with banks, and credit unions, and so on.

So you have this deferred settlement idea, this is totally normal. Credit cards work like this. You don't settle up after every single transaction, you have a deferred settlement. So the very systems that people are building on Bitcoin for scalability, they embrace the same idea of deferred settlement with periodic settlement transactions. I think that's the way it's going to work. That's the way it's basically always worked, and that's mindful of the fact that you want to reserve the ledger for larger, more important transactions.

Peter McCormack: Exactly, it's not like the biggest thing that Bitcoin can solve is to improve e-commerce and improve the buying and selling of goods online. It's actually to create better money and get away from the fuckery of central banks.

Nic Carter: It would be great if Bitcoin could service all of the tiniest transactions out there, but that would require making everyone aware of even the smallest transaction for targeting billions of people on Earth. So because we want to retain this flat hierarchy and make all these nodes equal partners in the network, we have to restrict the amount of data that's going into the system. That's totally fine, that's a new system. I think it's great and it's just that we're going to have to do a little bit of work to figure out how to build trust minimized, deferred settlement systems on top of that.

Peter McCormack: Also, if people want to find out a little bit more about altcoins and alternative projects, if they're thinking of investing in those because they do believe on chain scaling, I would recommend go and check out the other show I did with Nic; Altcoins, A History of Failure, my provocative title to wrap around Nic's great content. If you didn't listen, go and check that one out because I think you will learn a few lessons there from alternative projects. The next thing I do want to cover though, is something I know you've looked at. So I've covered this in previous shows talking about the block subsidy for miners.

I think I did this with Dan Held when we talked about Bitcoin's monetary policy, that we have a halving every four years and the block subsidy is reducing. I think it's 2140 we estimate the block subsidy will end, but on that path, the block subsidy is getting smaller. I think in May, we estimate around May 20 this year that we'll have another halving and we'll go down to 6.25 Bitcoin and so on every four years.

As the block subsidy drops, the miners are going to increasingly rely on probably transaction fees, but there are people out there saying, "well, there's not going to be enough transactions, so there's not going to be enough transaction fees for the miners. Therefore, the miners aren't going to be able to provide the security. Therefore, Bitcoin won't have security." I know you've looked at this, right?

Nic Carter: Yeah, so I gave a talk at the MIT Bitcoin Expo in 2019 I believe, possibly 2018, discussing the various ways that people have described this problem. This is probably the number one critique you'll hear of Bitcoin from sophisticated people that have looked at the system. So what Bitcoin is trying to do here is something really quite audacious, which is to create a monetary system, which is effectively capped and where there is no permanent inflation, right? Every other monetary system that exists, there's some amount of inflation either to encourage people to spend, it's considered to be a good feature by the dominant economic theory.

So Bitcoin is responding to this and it says, "no, we want everyone to know exactly what their stake in the system is. In perpetuity, we want it to be predictable, we don't want to have inflation." But how does Bitcoin stomach this cost because Bitcoin needs to pay the miners? So the miners were paid out of the issuance, out of the block subsidy for the early issuance, for the bootstrapping phase of the network. Then as Bitcoin matures, the issuance is going to decline. As you say, it declines by half every four years, and eventually declines to almost nothing. So I think something like 85% of all the Bitcoins have already been issued. So when the subsidy is gone, we're going to rely on fees to pay the miners.

Now people say, "well actually, if you do the math, 4,000 transactions per block, and 144 blocks per day, and fees right now are only a couple of cents, so you add that all up and you get a miner revenue, which is less than the current miner revenue because today's miner revenue is derived mostly from the subsidy, from the fact that each Bitcoin block produces 12.5 new Bitcoins." So people are nervous about this. The claim is that because of the fee-driven model, security will be unstable in some way and the security itself will be volatile because the fees might change. There might be congestion at some times, no congestion in others.

There's a school of thought where there's... Well not within Bitcoin, but supporters of other coins will say, "well, we should just add permanent inflation. Maybe we should have 2% inflation every year to pay for the security of the system." Now it seems to me that Satoshi did intend Bitcoin to be capped in its issuance of 21 million. If you look at the first post where he's describing the Bitcoin system on Bitcoin.org, he lists the essential features of the system, and one of them is that it's capped in supply, that only 21 million units will ever exist.

So if you change the issuance, I don't actually believe that that's Bitcoin anymore. I know some people will disagree with me, but I think one of the things that Satoshi intended Bitcoin to mean was a system with the number of preordained units that he had written into the code. Now it may be the case that a more functional and better system is one that has inflation, that may well be the case. That might be something that we'll learn. I don't think that will be Bitcoin. So I would say it is inherent to Bitcoin that the supply is capped. Now the question is, can we tune the system such that it provides an appropriate amount of security to miners?

The problem is we actually don't know what the correct amount of security is, right? There's not been any consensus as to, "well, miners should be earning this or that." The truth is that Bitcoin worked fine when miners were earning a tiny amount back when Bitcoin was worth very little, and it works fine now. So nobody has an answer as to what the correct amount of security should be. So we still have a lot of work to do in terms of trying to determine how much security is appropriate.

Now I happen to think that as long as Bitcoin is considered a valuable way to send money, there's always going to be demand to fill the block. I think we're going to get better and better at compressing those transactions into smaller and smaller informational payloads, which are included on the ledger. So as long as we do that, and as long as there's still demand to use Bitcoin, there's always going to be people that are willing to pay fees to transact. It's not that difficult to do the math and back out a state of affairs where the miner revenue is roughly similar to what it is today just from fees.

Now some people might say, "oh no, people will just use alternative blockchains, they don't like the high fees." I think there's something that's unique about Bitcoin block space. I certainly think there's something special about it relative to other blockchains. I think the security provides is better, I think the system overall is more credible and so I do think people will value that in the long term, but it's certainly an open question what the level fee is going to be, whether it's sufficient. I would say this is probably one of the best critiques, but to be frank, nobody knows.

So lots of people will say, "oh well, we know that Bitcoin's security is going to be insufficient in the future," and then you ask them, "well, what is sufficient? What constitutes sufficiency to you? What is your security model? What's your model of security of a proof work blockchain?" and they don't have an answer. So I would say both the doomsday theorists that believe that the system is inevitably going to collapse 20 years from now, and both the super optimists who say, "I'm certain the security is going to be fine," I'd say they're probably both wrong.

Maybe this isn't the answer that people would want me to give here, but I happen to believe that as long as Bitcoin is a valuable and useful system, there's almost always going to be some level of fees in there as people are willing to transact and happy to pay for the privilege. So I happen to believe that there will be some revenue for miners in the long term. The question is how much and what constitutes sufficiency.

Peter McCormack: There's no firm cut-off date, we have essentially blocks of four year cycles to see the block subsidy drops, see whether there's an increase in fees to actually monitor this and see how the system evolves over these halvings.

Nic Carter: Yeah, so if you look today, the daily fees are about $215,000. So you might say that's not a lot, you might think that's a lot. It's certainly a lot less than the subsidy-driven miner revenue. The subsidies are dropping, the fees will inevitably grow as a percentage of miner revenue. I think we have a lot of work to do in terms of building in these, you can call them second layer, I might call them deferred settlement systems. Those are what allow us to package. They basically give Bitcoin more bang for its buck, right?

You package many, many transactions into one single base layer transaction and that means you can amortize those fees across many transactions. To me, that means it's more likely that people would be willing to pay higher fees for block space. Think about Lightning, closing a Lightning channel. If you have 100,000 transactions in that Lightning channel and you do one periodic settlement to the base layer, to me, that means that people would be able or willing to tolerate higher level of fees because this single on-chain transaction is accounting for many, many off-chain transactions.

So if we can build systems like that to build on top of this base layer that extend the block space in interesting ways, I think that means that it's much more likely that there's a robust block space market at maturity. So I'm very optimistic at this.

Peter McCormack: Good! Also in there, you talked about the 21 million hard cap. Now people often refer to this as deflationary, and I was taught in economics that deflation is bad. With deflation, people stop spending, they start saving as things will be cheaper in the future and therefore, this causes the economy to grind to a halt. Therefore, if Bitcoin is deflationary, it is bad economics.

Nic Carter: Yeah, that's something we'll refer a lot of times. I would probably object to the framing, actually. So Bitcoin is only deflationary if the Bitcoin economy is growing faster than the supply of money. So I know that I'm quibbling a little bit here, but deflation is a situation where money becomes more expensive, and the price of goods falls in real terms. If the Bitcoin economy were to shrink, Bitcoin wouldn't be deflationary at that point.

Again, semantic debate, but yeah, Bitcoin's monetary system technically speaking is dis-inflationary, it has issuance and then the issuance declines over time. Then the problem is lots of economists will tell you this, "well if you have an economy with debts denominated in that unit, if the unit is becoming more and more valuable over time, people's debt load becomes really big over time." So typically in Western economies, we do the inverse. We have inflation, so that people's debt load becomes less in real terms over time.

This is meant to be a good thing. It's meant to encourage people to take out loans and spend and lots of Bitcoiners totally object to this. They say, "this is a Keynesian idea. We don't need to encourage people to spend, they'll just spend to buy goods naturally. There's a natural rate of expenditure. We don't need to encourage them specifically to do it." To be frank, all of that is besides the point. The world is not denominated in Bitcoin today, so this isn't really a problem because nobody is really making or taking Bitcoin-denominated loans, and that's where the problem comes in.

So I wouldn't say that's an issue. That's almost like if Bitcoin is a wild success and every transaction is denominated in Bitcoin, maybe this becomes an issue. For Bitcoin to be relevant, I don't think it has to underscore all global commerce. I think it has to be a valid alternative monetary system that coexists with other systems. So the framing of this question presupposes the Bitcoin has achieved prominence as the world's sole monetary asset. I don't think anybody really thinks that's particularly likely. So yeah, I find it a strange question to ask. It's like, "well what if all credit is denominated in Bitcoin?" Well at that point, Bitcoin is an unbelievable wild success.

Peter McCormack: Yeah all right. This is a lot of people's favourite subject I'm going to cover now. I've covered this recently, especially on my other show, Defiance. I've been looking at climate change and whether it's human caused. I think you particularly like this subject that Bitcoin is boiling the oceans and killing polar bears, the amount of energy used by the miners to provide security to the network. I don't know what country we're at now, was it Ukraine we surpassed now?

Nic Carter: Yeah I don't keep track, some small nation.

Peter McCormack: Bitcoin's annual energy use is surpassing that of certain nations. People say that this is wasteful, and this is leading to the boiling of the oceans and the killing of the polar bears.

Nic Carter: Yeah, so Satoshi actually anticipated this way back in the day, in 2009 I believe, talking about gold. So Satoshi made reference to gold quite a few times, even in the white paper. This is telling I think, in terms of the way that Satoshi at least thought about Bitcoin. Not saying this is the absolute truth or anything, but I think it's a good way to think about it. So what Satoshi said, I'm paraphrasing, was that it's costly and some people even might say wasteful to get all this mechanical equipment and dig gold out of the ground.

Some people might think that's wasteful. It's like, "what? It's just an inner rock, you're digging it out of the ground, and then you put it in a vault, and you look at it." Satoshi says people value gold, and so even that activity is wasteful, not having gold would be the net waste because gold has this quite profound use, which is a non-sovereign way to store value, and a universal way to market value.

So Satoshi certainly envisioned Bitcoin to be something similar, an asset which is outside of the control of the state, which is global, which is transmissible, natively digital. So that's something special and new, that didn't exist before 2009. So the fact that we're allocating energy to creating new units of Bitcoin, that's what miners do, they put lots of effort into it, some people might say that's a waste, but to me, it's a totally moot point. It's worth having Bitcoin and the world certainly seems to think so.

This $200 billion or so, roughly speaking, worth of capital, which is represented by Bitcoin, so the world is placing a non-zero value on the thing, that is a signifier that the world considers Bitcoin to be important and valuable, and it's been growing steadily for the last 10 years. So the fact that there's some energy or cost required to create those units, you could characterize that as wasteful, but at the same time, the world values the existence of the thing, so not having it would be the waste. There aren't very many non-state monetary systems or monetary alternatives.

So I think it's good and important that Bitcoin exists, so I'm very happy to tolerate the cost of bringing those Bitcoins into existence. That's something I'm totally okay with. Now the question is, what are the externalities of bringing them into existence? What are the costs that are foisted on the world in return for creating those Bitcoins? Some people would say they're quite significant. There's carbon emissions, some Bitcoiners mine with coal. The truth is lots of Bitcoiners mine with hydro. Part of the reason for this is China actually really overbuilt their hydro capacity in places where there was no population nearby.

The thing about electricity is you lose it as you transport over great distance. So if you're trying to transport electricity over hundreds of miles, it's going to be a very lousy transmission. So what you end up is these pockets of energy creation and that energy gets wasted if you can't transport it to a city for people to use it. So they call that curtailment. So you have this otherwise curtailed sources of energy and one of the biggest ones is hydro, which effectively, people will just release the water from the dam if there's no one to consume it once the dam gets full. So this is one of the reasons why there's so much Bitcoin production in China is because China overbuilt.

There's all this spare energy capacity and then some smart entrepreneurs realized that they could put that to use for mining Bitcoin. So to me, that's actually a really positive thing. We had this energy which was going to be wasted and instead, we used it to create this monetary commodity. That's pretty cool to me! Hydro, there's no significant climate impact of running a hydroelectric dam.

Now undeniably, some Bitcoiners mine with coal. The estimates on this differ and it's actually quite hard to get a reliable estimate on the energy mix of Bitcoin because miners tend to be quite secretive, but ultimately, I think it's a system which lots of people value. So it's hard to call that wasteful. You can look at plenty of other systems that seem trivial, watching Netflix, putting up Christmas lights, anything really.

Civilization uses energy! So to complain about a single usage of energy and to ignore all the other ways energy is used, often in many more trivial ways, it seems to me like some people just want a reason to complain about Bitcoin. There's plenty and plenty of ways out there that people use electricity frivolously. I happen to think that Bitcoin is actually one of the most serious things that we can do with our electricity, but some people are just natural opponents of Bitcoin, and they're not taking the broader tact there. They fixate on these electricity figures and they use it as a stick to bash Bitcoin with.

Peter McCormack: I released a show yesterday with the CEO of Buda, a South American Bitcoin exchange and they've just announced that they're the first exchange to allow you to offset your carbon footprint from your Bitcoin purchases on their exchange. I'm not sure if you're aware of this.

Nic Carter: That's quite funny yeah. So there's some other things I didn't talk about here, where there's a growing industry where people take otherwise vented methane from mining because often times, mining releases methane as a by-product, and they combust that methane, and they use it to run a generator, and they mine Bitcoin with that. I'm aware of three or four entrepreneurs doing this. The thing about methane is it's about 30 times worse than carbon dioxide in terms of its environmental externalities, so that's actually a net improvement.

That's the broader concept here! Bitcoin is a buyer of energy at a fixed price globally regardless of where you are. Energy is distributed across the globe in little pockets and oftentimes, it's wasted when you can't get it to population centres. So what we have now is a situation where many entrepreneurs are taking these excess sources of energy and deploying it into Bitcoin. It just so happens that in many cases, these are green sources of energy generation or they actually ameliorate the climate change situation as with the methane that would be otherwise vented.

So Bitcoin is a buyer of energy globally, it doesn't really care what you're using to mine it. This means that in practice, it's mined with otherwise vented methane and in some cases, wind and solar. I don't think that's a huge part, but in some cases, it's mined with geothermal and a huge fraction of the network is mined with otherwise curtailed hydroelectric. So it's quite an interesting situation if you really look into it. I think the critics probably don't spend enough time taking a serious look at it.

Peter McCormack: Fantastic, good answer Nic! Okay, a couple of things left and another one which is quite popular. This is often used by the Bitcoin haters, usually the government central bank people, and they claim that Bitcoin is just used by terrorists and criminals, but we know this isn't true, right?

Nic Carter: Well yeah, we know this is not true. I look at what Bitcoin is used for everyday, that's what my start-up does. We evaluate the various usage types of Bitcoin to try and get some ground truth there. The broader point here is that anything the government doesn't like from a transactional perspective, they will claim it's used by evil people. In some sense, that's true. You can't stop evil people using your system if it's an open system. Bitcoin exists now, it's permissionless, so anybody can have access to it. We have to tolerate evil people using the system, people we don't like.

That's basically cost of doing business here. I think governments have become very accustomed to using the financial system as an enforcement mechanism to enforce against crimes they don't like. Instead of actually going after the crimes themselves, they go after the money. So this is what sanctions are, the government doesn't want to go to war, so instead of going to war, they just cut off a whole country's financial infrastructure, and everyone will stop doing business with them.

So it's very convenient for them to use the financial rails as an alternative to force. I think this means that governments also get very lazy. So instead of going after crimes now, they just go after the bank account's criminals and they say, "well, if you strip away our ability to surveil every single transaction, we're not going to be able to do this anymore." My response to that is, "well tough! Go actually prosecute these crimes, go do some investigations instead of just lazily relying on the financial system to enforce against this."

The US, at least since 1970, since the Bank Secrecy Act was passed, the surveillance capacity of the government in the context of financial transactions has increased massively. We actually have it pretty good here in the US compared to China, where virtually everything is surveilled from a financial perspective. I don't really want to live in a world where every single cost of activity is wholly surveilled. To me, that's a situation where individual liberty is not present anymore because if someone has control over your finances, they can control your life. We've seen this happen.

So in 2013, the Department of Justice had this operation called Operate Choke Point, where they used the FDIC to pressure banks to de-platform businesses that they didn't like. These weren't businesses that had committed any crimes, they're just businesses in insalubrious used cases, so payday lending, things like that. So the government unconstitutionally went after these businesses through the vector of the banking system. In fact, what happened was they actually lost in court and this was proven to be unconstitutional, it's against the Fourth Amendment. It's the violation of due process because no crime had been committed. So this shows the government's eagerness to use the banking and the financial system to apply the leverage to things they don't like.

I would much prefer to live in a world where there is some transactional privacy. That's what cash gives us, physical cash. We have autonomy, and we have privacy when we use cash. That's not really present in a digital context. Bitcoin promises to potentially restore that standard of autonomy and privacy that we enjoy with cash, but in a digital format. Of course, the cost there is that it's permissionless and it's open, and evil people will use it. I think that's a cost that society should bear because the alternative is much, much worse. The alternative is one where we have no individual liberty, whatsoever.

Peter McCormack: If the government can't track it Nic, they will just ban Bitcoin, and we won't be able to use it anyway.

Nic Carter: They're welcome to try!

Peter McCormack: China has tried.

Nic Carter: They have, but people still use Bitcoin in China. Ultimately, I think banning Bitcoin in the west means suspending property rights. Bitcoin is treated as property in the US according to the IRS, so if they ban Bitcoin, if they somehow try and eminent domain everyone's Bitcoin or perform civil asset forfeiture on everyone's Bitcoin, that's violating the property rights of millions and millions of Americans. Obviously, I'm just talking from an American perspective here. That's something that is pretty contrary to at least American value. So maybe authoritarian states can do that, but I don't think it would fly here in the US. I think their opportunity to ban Bitcoin has passed.

Although they can certainly apply pressure to exchanges and so on, but, again, that's a pretty easy way to destroy innovation, push all that tax base and all that productive financial base overseas, I don't see why the US would want to do that either. What about with regards to the protocol itself and the code? We know essentially Bitcoin is just a big pile of code that's been developed over a number of years by the developers. Could a catastrophic bug destroy Bitcoin? Could developers install a backdoor? What is the incentive structure for developers to keep developing Bitcoin?

Well there is no strict incentive structure. They're not compensated by Bitcoin or anything. The way it works with the most high-profile developers is a patronage model, where their work is financed by non-profits and organizations that benefit from the existence of Bitcoin. For the most part, these core developers have free reign, so they can work on whatever aspect of the protocol they want. Luckily, we're in a state of affairs where there's six or seven well-financed organizations that support core developers

 So this is a priority for the Bitcoin community, and we're very lucky that this is the case. So you've got Square Crypto, you got Blockstream, you have Chaincode, I know Xapo funds a developer, I believe BitMex does, several other exchanges, the MITDCI, so all these organizations pay developers to work on Bitcoin without very much oversight. Square Crypto is a bit different. They have some specific objectives, but for the most part, these developers are just being paid to work on Bitcoin and to look for bugs and keep it as secure as possible.

So actually, if you compare with the way that other cryptocurrencies are administered, it's very good situation for Bitcoin because there is no corporation that controls the whole thing, there's no foundation that controls the whole thing. Aside from that, there's a lot of developers that work on Bitcoin just on the goodness of their own hearts because it's prestigious, because they're interested, because they like Bitcoin. It's a free and open source development philosophy. So the way that we ensure that there aren't any catastrophic bugs is just by having a very exhaustive process of peer review and having all the code be open source, so that anyone can evaluate it for themselves.

So far, that's served us fairly well. There have been bugs, there've been a number of bugs and the thing to remember is that the values supersede the code. So some people might disagree with me for saying that, but Bitcoin has a feature that I would call value primacy. So historically, there's a case where there's a value overflow bug where lots and lots of Bitcoins, I think something like 92 billion Bitcoins were accidentally created, thanks to a bug. We didn't just throw up our hands and say, "well I guess there's 92 billion Bitcoins now", what we did was, we coordinated a change to delete those, and go back to prior state where the normal schedule is being upheld.

So what happened there was the value of having this core value inherent Bitcoin of supply being capped, that was upheld at the expense of the code. So the bugs don't prevail in those situations. Effectively, the social contract prevails because everybody is already bought in to this idea of Bitcoin as having these core essential features, so we have value primacy. So if there was a catastrophic bug, my guess is that we would just return. We would figure out how to remediate it, and return to the core features of the system.

So we wouldn't give up at that point, there is still human involvement in this thing, it's not fully automated. That's fine, you need human stewardship for a young novel protocol. Maybe over time, changes will be much more infrequent, and maybe at some point, the whole system will solidify and it will just be a protocol and there'll be no more alterations, but currently, there still are updates and alterations planned and it is a very deliberate and slow process.

So we haven't really had a significant update the protocol since Segregated Witness in 2017, and here we are in 2020 and it's not even clear. The next update, Schnorr signatures and Taproot will come this year, so it is a slow process, but I think that's a trade off that everyone is okay with in terms of making sure that it's secure.

Peter McCormack: All right, the last question! The last point is that Satoshi, whoever he, she, they are, is meant to hold a million Bitcoins, and at some point, Satoshi might come out from hiding or come out from wherever they are and dump those coins in the market and crash the price of Bitcoin.

Nic Carter: Yeah, so one thing I will say is that the estimates of Satoshi's coins are not precise and actually, there's a degree of uncertainty. So Sergio Lerner did the first analysis, I think he found 1.2 million. Other analysis have found stuff in that range. BitMex research did an analysis, they found it was closer to 600,000, so it's not clear how many coins are mined by Satoshi. There's about 2.5 million Bitcoins that were mined in 2009-2010 that haven't really moved, so it could be any number of coins.

Nobody really knows whether Satoshi is still around or intends to sell their coins. Aside from a couple of test transactions, Satoshi never really moved any of his coins. So if I had to guess, I would say Satoshi was trying to make a point by saying, "okay look, out of necessity, I had an early advantage in terms of mining. I mined a lot of coins, but out of respect for the system, I'm not going to use them. I'm not going to take advantage of my reward." That would be my guess. It's obviously not clear. Maybe those coins will move after 10 years, who knows? Would that kill Bitcoin? I don't think so.

I think the market would absorb those coins. Who wouldn't want to own some vintage Satoshi coins? I think a lot of people would come online and start buying them up if they knew that Satoshi was dumping. For sure, that would be a significant fraction of supply or probably have an adverse effect price-wise, but Bitcoin is volatile anyway in the first place. So if someone were to market sell those million coins, yeah the price would probably fall, but it wouldn't be the death of Bitcoin. It would mean that we're free from the influence of the creator and I think that would be a good thing.

Peter McCormack: Wow, it's another fantastic show Nic! Every time you come on, you deliver a lot of high value. I think you've answered these way better than I ever could, which is why I prefer to ask the questions these days. So thank you again. I hope you have a great weekend, I'm sure we'll catch up soon and just remind people again if they haven't heard from you on the show before, how do they find you? How do they get in touch?

Nic Carter: Sure, the main way would be following me on Twitter, that's @nic__carter, that's two underscores. You can find me on Medium and I'm now a columnist for CoinDesk, which is a new thing.

Peter McCormack: Wow!

Nic Carter: So that's actually fun because that means that I have editors telling me that I can't write these 5,000 word pieces anymore and that I actually have to make them accessible for normal people! But yeah, you can find me on there as well. My fund is Castle Island Ventures, so if you have a start-up working on cryptocurrency and you'd like to seed stage financing, you can reach out to me. Our website is castleisland.vc. Thanks again for having me on, it's always fun to try and condense these issues into bite-sized chunks, and always a fun challenge!

Peter McCormack: Great! Well hopefully, the coronavirus won't see the MIT Expo cancelled this year, so hopefully I'll see you soon.

Nic Carter: Yeah, that would be great. I love the Expo, it's my favourite Bitcoin conference.

Peter McCormack: Yeah me too! I think it's a great event. It was my first time last year. Anyway, have a great weekend Nic, really appreciate your time, take care!

Nic Carter: Thanks very much!