Bitcoin's Asymmetries

Asymmetry pervades Bitcoin. Here are four examples.

There are several asymmetries in Bitcoin. The first and most obvious is the asymmetric payoff. Becoming a new base layer money for the world will either work or won’t. And the current price of Bitcoin at any moment in time is the market’s belief on whether it will succeed at that mission. Asymmetric bets are the hallmark of radical innovations and have high volatility in the short and medium term. The asymmetric payoff has attracted much of the early investor interest in Bitcoin, many for the conviction that it will be the store of value of the future.

The second is asymmetric cryptography, also called public key cryptography. Symmetric key cryptography simply would not work, as sending and receiving bitcoins fundamentally relies on the notion that a private key generates a unique public key, and therefore can unlock the funds to spend bitcoin. This asymmetric cryptography is at the heart of how bitcoin functions. Bitcoin addresses are hashes of public keys, so without those public keys, no transactions would be possible!

The third is asymmetric innovation. Version 0.1 of Bitcoin that Satoshi released contained 95 percent of the innovation within Bitcoin. There have been advances since its release, but all of the following were in the initial version: the structure of transactions, the blockchain, the mining tournament and proof of work, the network of nodes, and the difficulty adjustment. Since then, the Bitcoin Improvement Proposals have may improved the usability of Bitcoin, but they have been small tweaks rather than major advances. The downside of this is that there isn't much room for innovation on the protocol layer, but the upside is most of the innovation will be on the application layer. An added plus is that the main barrier to Bitcoin adoption, namely Bitcoin education, can be overcome by explaining version 0.1.

The fourth is the asymmetry between adoption and issuance. Today over 93% percent of Bitcoins have been issued, but worldwide adoption is much smaller. So, the adoption rate has vastly trailed issuance. This means that if the world does eventually move on to a Bitcoin standard, Bitcoin will be in the somewhat inconvenient position of everyone racing for ownership over the remaining 1.5 million coins.

This by itself is not a problem since Bitcoins are divisible. But the initial owners of Bitcoin will have substantial economic power. I personally do not object to this because the early buyers and miners of Bitcoin took a bet on the nascent technology, and therefore have the right to capture the returns from that risk. This is like the ownership of gold, where legacy owners who acquired large holdings through inheritance or conquest have large starting endowments. But such asymmetry tears at the social fabric and gives ammunition to the Bitcoin skeptics who will claim that the large sums held by the early adopters are unfair. I don't buy this argument myself, but I do expect this argument to surface as those early Bitcoin whales emerge, if and when they do.

But the most important area where there is no asymmetry is information. This is the starkest difference between Bitcoin and the legacy financial system. Because the Bitcoin protocol operates on a network of distributed nodes, all parties at the protocol layer have the same information. The only asymmetry is by design, namely, a user’s knowledge of their private key that is necessary to spend bitcoin.

This certainly dominates traditional finance, which has been rife with asymmetric information since its inception. CEOs have more information on their companies than outside investors, investment banks have more information on the companies they are underwriting than institutional investors, and institutional investors know more than the retail investor, who often draws the short end of the stick. In fact, the voluminous regulatory apparatus around Wall Street — ranging from the securities and commodities regulators, to the Fed and the bank regulators, to the accounting standard setters, to the credit rating agencies — all emerged as a way to combat the inherent asymmetries of information across the finance industry. But they’ve created more problems than they’ve solved.

Operating a new financial system on top of Bitcoin may introduce new information asymmetries. As entrepreneurs form companies, those companies may form cartels, and those cartels may fight to stifle competition and bend regulation to their favor.

But at least Bitcoin offers the chance to hit the reset button.