- Bitcoin the protocol (with an upper-case 'B')
- bitcoin the 'currency' (with a lower-case 'b'), and
- the bitcoin blockchain (the history of bitcoin transactions, or distributed ledger).
The on-going volatility of the 'price' of bitcoins (in fiat or other digital currencies) is likely at least partly a reflection of the confusion surrounding these different concepts.
To be clear, 'Bitcoin' is a protocol which encapsulates a set of rules defined in software. The 'bitcoin' network represents the set of computers running the software that enforces those rules. While 'Bitcoin' the protcol may evolve over time, the 'bitcoin' network needs to agree by consensus to adopt any changes to the protocol. However, a parallel 'Bitcoin' network may be setup with another set of machines executing a different version of the 'Bitcoin' protocol. (These are called 'alt-coins'.)
A 'blockchain' is an immutable record of all digital transactions that have occurred on the bitcoin network. It is not stored in a single location, but rather exists on the network. A blockchain is also more generally seen as a way to maintain a reliable ledger of digital transactions using cryptography-based protocols, not just the Bitcoin protocol.
Bitcoin Users & Motivations
At the moment, there are primarily two types of users of bitcoin:
- People who want to use it as a unit of exchange, and
- People who want to use it as a speculative investment or store of value (i.e., buy/sell on volatility)
The more volatility, the less useful bitcoin is as a unit of exchange - in much the same way that the currency for a nation state which is suffering hyper-inflation becomes useless for everyday transactions when compared to relatively stable currencies such as the US Dollar.
But the more stable the price of bitcoin, the less interested speculative investors will be in buying the 'currency'.
However, while acknowledging the markets are rarely rational, taking a traditional 'currency' based view of bitcoin is likely to miss the point completely. As knowledge and understanding of bitcoin, Bitcoin and the (bitcoin) blockchain increase, the price of bitcoin should stabilise around one key concept: the value of having a transaction written to the bitcoin blockchain.
The Value of a Blockchain Transaction
The value of the bitcoin blockchain is that it is a (mathematically) irrefutable record of what has happened in the past, at particular points in time. Such facts are recorded and will remain forever on the blockchain, as long as the blockchain continues to exist.
There is growing recognition that there is considerable value for such digital immutable records - for specific types of applications in particular circumstances. But there is also considerable cost in writing a transaction to the bitcoin blockchain, as somehow, implicit in the transaction, is the cost of maintaining that record indefinitely.
Taken from this perspective, the 'value' of bitcoins should converge to the cost of maintaining the blockchain ledger, both over time and per transaction.
As it stands today, the bitcoin blockchain is optimised for capturing the fact that an exchange of bitcoin has occurred. However, it can also be used to capture additional information along with the record of the exchange actually having happened, and it is this information that can provide useful context to the exchange of bitcoin - i.e., which can justify the price paid to record the transaction in the first place.
In a rational world, the 'price' of bitcoin should match closely the cost of maintaining the bitcoin blockchain - i.e., the electricity and infrastructure costs of the bitcoin 'miners', as well as the network costs of shipping the blockchain around. This cost is clearly non-zero, and is actually quite substantial.
Beyond that, the value of bitcoin transactions should be related to the types of applications that use the bitcoin ledger, and the value they get out of having information stored immutably on the ledger for all time. As use cases mature, the value of bitcoin will converge around the most valuable use cases, and the benefit of continuing to use the bitcoin blockchain for many types of transactions will eventually disappear - especially as more 'traditional' systems of record (i.e., storing data with a trusted counter-party that has robust data management services) regain favour in terms of cost and convenience, and more viable bitcoin alternatives appear.
Future Applications of Blockchain
There are many ideas for what future blockchain-dependent applications could look like. Some interesting early players in this space include factom.org and maidsafe.net, as well as more sophisticated concepts such as Smart Contracts and Distributed Autonomous Companies or Organisations (DAC/DAO), as proposed by the folks at Ethereum.
Concepts such as API Coins are intended to enable monetisation of technology services without requiring users to give away information or distract users with advertising. While blockchain technology is still someway from efficiently supporting micro- or nano-transactions, API coins may perhaps be useful to efficiently capture entitlement, rather than as a direct exchange of value. API coins built upon more efficient blockchains (i.e., less dependent on proof-of-work, perhaps using side-chains) which can support nano-transactions may be feasible in the future, but for now the work in this space is still in the early stages.
This blog has also proposed potential applications that could be used to enforce or support regulatory compliance in a more efficient and economically beneficial way than traditional man-in-the-middle means - in particular, allowing multiple, independent service providers participate in a regulated process flow on behalf of one or more regulated entities.
In short, there will likely be no shortage of applications that would benefit from having a publicly available, decentralised immutable digital record of transactions.
The Rise of Application-specific Blockchains
As the value of putting transactions into the 'bitcoin' blockchain get increasingly more expensive (and valuable), there will be many applications for which the cost becomes prohibitive and where it makes sense to establish application-specific ledgers, optimised for a particular application or use case. In this circumstance, market participants need to agree standards and establish basic levels of trust, but otherwise the same economics apply - i.e., the non-zero cost of maintaining the ledger needs to be reflected in transaction cost. True 'trust-less' networks make less sense in this scenario, as the purpose of the network is narrower, and hence some element of trust is beneficial. It also mean market participants need to guarantee a quorum of 'miners' in order to make the blockchain viable.
In bitcoin terms, this may mean instantiating a new 'Bitcoin'-based network, within which its own miners support the validation of transactions on that network (i.e., an 'altcoin').
Some altcoins solve specific short-comings of the bitcoin network, but many seem to be seeking irrational 'commodity' pricing gains rather than targeted at solving specific needs that would directly benefit from yet another 'reliable' distributed ledger. All such altcoins rely on trustless miners, and have a very small number of such miners compared to bitcoin, and so are far more susceptible for 51% attacks.
Bitcoin sidechains, on the other hand, can have a subset of trusted participants that can utilise the wider bitcoin blockchain, while optimising for the application-specific purpose of the side-chain. However, alternative protocols such as Ripple may be more efficient and less complex for such scenarios, as they do not assume 100% trustless participants - although Ripple is optimised for financial currency use cases. Ethereum may also be viable if it can move its consensus-making from proof-of-work to proof-of-stake and scale effectively to support many different use-cases.
There will be continued volatility in the valuations of digital currencies until use cases and applications for distributed ledgers start to become more obvious and established. The cost of individual crypto-currencies will ultimately converge on valuations which will reflect the cost and benefit of maintaining individual blockchains. In effect, with respect to bitcoin, speculators are betting not on the commodity value of bitcoin, but on innovation around the creation and benefits of future bitcoin blockchain-based applications. In that sense, it is no more irrational than, say, buying shares in Google or Facebook, caveated with the understanding that 'bitcoin' will by no means be the only blockchain out there.