The Nature of Bitcoin

But Bitcoin is at odds with these concepts at a fundamental level. Because “bitcoins” don’t exist.

“UTXO stands for the unspent output from bitcoin transactions. Each bitcoin transaction begins with coins used to balance the ledger. UTXOs are processed continuously and are responsible for beginning and ending each transaction. Confirmation of transaction results in the removal of spent coins from the UTXO database. But a record of the spent coins still exists on the ledger.”

It’s these UTXOs that are measured in a unit called “bitcoin”, but this is more akin to measuring how space is used on a hard drive than bars of gold in a vault. UTXOs are just the occupants of Bitcoin’s information space.

Bitcoin private keys are another type of Bitcoin information. Through cryptographic processes outside the scope of this article, private keys can derive a corresponding public key that acts as an address for receiving UTXOs. The private key then exercises control over all the UTXOs it has received. UTXOs are transferred as inputs in messages when they are cryptographically signed by the private key with authority to do so.

Another viewpoint commonly employed to explain Bitcoin is to say that it is “backed by energy”.

The reason why is that roughly every ten minutes, blocks of Bitcoin “messages” are confirmed by competing computers (“miners”) employing a huge amount of energy to meet the rules set out by the protocol. These ten-minute blocks are Bitcoin’s bandwidth. Only a certain amount of Bitcoin “messages” can be transmitted in each block, called the block-weight. Taken together, this process of adding message blocks to increment the “block height” by miners is called proof-of-work, and to simplify it gives the Bitcoin network some important features:

Because expended energy is so core to Bitcoin’s security and viability, the concept that “Bitcoin is backed by energy” has emerged as a useful concept for understanding why this communication protocol works at all. Taken to its literal conclusion, this line of thought has led some to argue that this energy creates Bitcoin’s value and that Bitcoin is therefore a commodity — captured energy.

Rather, it is the energy expended for security in combination with Bitcoin’s use of information space that is why the network accrues value. Put another way, if the information space occupied by Bitcoin UTXOs could be classified as a commodity, then space rented on Amazon’s AWS servers would also be a commodity. Like the Bitcoin network, AWS relies on expending a lot of energy to function, and the computing resources rented by businesses and individuals represent information space in the virtual world. But it would be absurd to classify AWS as a commodity, and so it is with Bitcoin.

Indeed, it’s the separation of value from commodities that makes the Bitcoin communication protocol so uniquely valuable. As Conner Brown has written, Bitcoin has no intrinsic value as a commodity — an observation often used as a criticism — but that is a feature, not a bug. A commodity-based value transfer system, such as the gold standard, not only finds its value subject to the market fluctuations caused by changes in supply and industrial demand, but it also inflates the price of the underlying commodity by increasing its demand. This monetary premium means that a commodity like gold is much more expensive than it otherwise would be, and this distortion in the price signal hampers its use in goods such as cheaper electronics.

Without needing to grasp for financial definitions, commerce enabled by the Bitcoin value-transfer protocol will still be commercial activity. If the distributed Bitcoin ledger helps to conduct commercial activity between a shop and a consumer, that shop is still going to file a tax return with profit based on the fiat value of goods sold.

Monetary systems are savings technologies that ultimately serve to transfer value in time and space, a tool for the farmer selling his year’s output in Fall to be able to purchase new shoes six months later when he has nothing to sell. Having lacked a logical system to keep track of everyone’s market contributions until now, this value transfer role has traditionally fallen to the economy’s “most tradable good” — typically something exhibiting beneficial properties such as durability, portability, divisibility, and hardness (hard to produce more of it and debase it).

If something becomes the most tradable good, it can function as money. Bitcoin is text, but its properties might allow it to fulfill a monetary role for those demanding scarce information space in the form of UTXOs. We can’t say exactly where Bitcoin might be on its way to being used as a monetary system — that’s for each individual market participant to decide for themselves — but early adopters are using it in that role already. With Bitcoin’s help, the economy might just become a little more like entering a global barter system — a ledger system to keep track of everyone’s market contributions. Rather than being the world’s most tradable good, Bitcoin is the world’s most tradable information.

Because Bitcoin is text, it fundamentally sits outside of existing financial definitions and regulations. But that doesn’t preclude its information space from exhibiting monetary characteristics. In fact, it’s in part because of all of this that Bitcoin is so valuable. And things that are valuable need to be protected.

Obviously, since Bitcoin’s information space has accrued value, it is in the best interest of those who exercise control over a portion of it to keep the private key out of others’ hands. To exercise exclusive control over replicable information requires competence at protecting a secret.

This demonstrates the “not your keys, not your coins (UTXOs)” meme. Possession of the secret enables the bearer to exercise control over the valuable information space; at the protocol level, possession, control and ownership can not be separated. As Daskalov, CEO of KNØX, put it, “the Bitcoin protocol is necessarily amoral, governed by an uncompromising set of rules.”

This is creating demand for an optional Bitcoin key storage layer that might allow businesses to delegate possession to a trusted key storage provider while maintaining unquestionable ownership in the legal sense, and control in the technical sense. Such is the burden of holding these secrets that exercising control over private key information is more a liability than an asset. Most companies holding Bitcoin keys are required to do so out of operational necessity but would rather offload that liability from their books, as they do not monetize it.

Private key storage is more like managing a password than anything else. When a hard drive is locked by ransomware, most people without an adequate backup are likely to pony up the ransom to retrieve access to their information. This digital information is not property in the legal sense, but it’s certainly valuable to the individual who previously exercised possession and control over it.

Bitcoin is just information, so it is difficult to place it inside existing financial definitions and regulations. But with its information space being the first example of truly scarce information, it has accrued substantial value thanks to evolving narratives.

Under no circumstances should any material on this post be construed as an offering of securities or investment advice. The reader should consult with their professional investment advisor regarding investments in securities referred to herein.

Services and products are offered through KNØX Industries Inc., headquartered in Montreal, Canada. KNØX Industries Inc. is not engaged in the offer, or sale of securities or bitcoins, and does not provide investment, tax or legal advice.

Investments and holdings of bitcoins are speculative and highly volatile, involving a substantial degree of risk, including the risk of complete financial loss. ‍

© 2020 KNØX Industries Inc. All rights reserved.

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