Automated Banking, With Bitcoin: PART FOUR
PART FOUR – BAD INCENTIVES, GOOD INCENTIVES, RANDOM NUMBERS
The following is an ongoing series we are calling Automated Banking, With Bitcoin.
The aim of this series is to offer a clear and full picture of Bitcoin for all ages and levels of adoption from nocoiner, to precoiner, to remnant pleb, in the context of fiat, and with an eye towards the inevitable outcome currently in progress. We hope you take the time to share and discuss this series as it unfolds with family and friends.
Enjoy.
RECAP
PART ONE - BITCOINS THREE COMPONENTS, AND AUTOMATED FINANCIALS
PART TWO - AN ERA OF FRAUD, AND IMMUTABLE LEDGERS WITH FIXED SUPPLIES
In Parts One and Two we looked at various aspects of Bitcoins singular, public, and at all times, immutable, ledger, and we contrasted that with the current state of the art corporate, governmental, institutional, and banking systems multiplicative, private, and sometimes tragically fraudulent, ledger systems.
In Part Three we looked at the infinite non custodial supply of bank reserves and contrasted that with the fixed custodial supply of Bitcoin tokens.
BAD INCENTIVES
In this Part Four we’re diving into some technical aspects of Bitcoin to better understand how, mechanically, the Bitcoin tokens can be self custodial. This technical understanding will serve us well in future Parts when we look into the transaction mechanics of bitcoin.
But first, a brief tour through the bad incentives that arise in an unlimited money environment.
In this clip from Peter McCormack’s excellent podcast, What Bitcoin Did, Darin Feinstein explains the reasons as to why something like Bitcoins immutable public ledger hasn’t arrived sooner, since after all, the current accounting system that everyone uses is actually a 700 year old antiquated technology that works great…for corrupt individuals.
You see, nobody has been incentivized to fix the fraudulent private accounting system, at least, nobody in powerful positions at governments, central banks, and global corporations. (And that’s why Bitcoin is a ground up movement. A truly decentralized, and voluntary, opt in system, that doesn’t care what those in power have to say about it or try to do to stop it. We just aren’t interested in anything that system has to say about the Bitcoin system.)
Bottom line, if people can get away with fraud they will give it a try. If the reward is perceived to outweigh the risk, people will take the bet, it’s human nature to push the limits. Everyone wants to work less to get more.
Bad incentives lead to fraudulent financials and fraudulent financial statement audits inevitably result in the implosions of companies like Silicon Valley Bank, followed by more money printing. While the implosions are in and of themselves not so devastating, what is most devastating over time is the money printing that is conducted to “save” the investors and the depositors of these banking institutions through FDIC insurance, or some new fangled central banking “facility” for the sorry saps.
Let’s return to Lyn Alden’s March 2023 Newsletter:
From a depositor perspective, banks are basically highly-leveraged bond funds with payment services attached, and we treat it as normal to keep our savings in them.
To help normalize that and make it seem less weird, the FDIC provides insurance against deposit losses up to $250,000 which mitigates some of the risk. However, at any given time, FDIC only has about 1% of bank deposits’ worth of insurance in their fund. They can protect depositors against individual bank failures, but they don’t have enough to prevent against system-wide banking failures, unless they draw in aid from elsewhere or are backstopped by Congress with a fiscal bailout.
FDIC bank insurance is not insurance in the normal sense where the owner of the policy pays annual premiums to cover the cost of the insurance. Instead, if depositors are bailed out, it is the entire worlds savings and the purchasing power of their labor that covers the cost of FDIC insurance, through central bank money printing.
Nobody thinks much about it because the insurance cost is spread to essentially the entire world, to not just those that took the bad risks but to those that did not take the risks at all. With the losses spread to everyone, the amount everyone loses up front seems miniscule. But over time the price inflation from the money that was printed adds up. Moreover, this money printing is becoming incessant, because these bailouts are becoming incessant, and the printing is starting to really add up now, not just in the developing world, but in developed countries too.
This is socialized insurance, where those that are requesting the insurance are not the only ones that are paying for the insurance.
This is a process of allowing those that make mistakes with their investment strategies, and those that make mistakes with their deposits, to have little fear of consequence to their actions, as those that did not make those mistakes are also pulled into pay the costs of those actions through future purchasing power debasement of savings and labor via money printing.
This is a recurring theme with government and central bank coordinated bail outs.
The 2008 financial crisis was no different. People made the calculation thinking they would be better off with a home they couldn’t afford, they took the big home loan bet if they could get away with it.
Both, the individuals signing for those home mortgages, who knew they couldn’t afford them, were as at fault, as the bankers that financed those mortgages. But rather than allow only the home owner and the mortgage owner to pay the cost of their bad bets, it was the home owner and the rest of society that ended up paying the cost. The bankers with the worthless home mortgages were bailed out, through government and central bank coordinated money printing to buy the worthless mortgages from the banks that made the bad decisions.
The money printed to cover the cost of those bad decisions was and continues to be paid for by the rest of the world in debased savings and earnings through wages that now afford less food housing and energy as more dollars in the economy chase the same amounts of goods and services available.
Banks and their executives who earned massive bonuses for their bad investments were financed by socialized losses via money printing.
This is the rigged game that nobody is incentivized to fix. It’s nothing new, it has been going on for the last 700 years. (And frankly we simply didn’t have the technology to enable a viable alternative solution until computing, computing enabled cryptography, and the internet, allowed for a solution to emerge after 50 years of research and development into cryptographic decentralized monetary systems.)
If people think they can pump their stock price and use that market cap increase to borrow boat loads of money to pay themselves massive share compensation packages, and leave the public on the hook, they will do it. The WeWork fraud is a great example. WeWork founder Adam Neumann received $245 million in company stock and $200 million in cash as part of an enormous buyout package with SoftBank that had the shitty real estate business valued at nearly $50 billion in early 2019, down to less than $5 billion by 2022.
So who paid for it?
SoftBank reported over $32 billion in losses from its Vision Fund for year end March 2022, mostly from WeWork’s epic implosion. The SoftBank Vision fund is backed by a $45 billion investment from Saudi Arabia’s PIF.
Who or what is PIF?
The Public Investment Fund or PIF is the sovereign wealth fund of Saudi Arabia. It is among the largest sovereign wealth funds in the world with total assets of more than $600 billion. It was created in 1971 (surprise, surprise) for the purpose of investing funds on behalf of the Government of Saudi Arabia.
And where pray tell did Saudi Arabia’s fund get its money from? Lol. Strangely enough, Saudia Arabian oil must be purchased with US dollars, and since those dollars are created by government deficit spending and federal reserve purchases, all financed by peasant bank depositors around the world, in a round about way, you, silly peasant, were the exit liquidity for Adam Neumann’s $500 million scam.
Congratulations, you played yourself.
Bad individual incentives lead to bad market incentives where bailouts are the norm, expanding the money supply, debasing everyone’s savings and labor, year after year, after year, after year.
Enough already.
Anyone that keeps any government issued money around, or places their savings in illiquid assets like real estate, equities, or debts, is simply a frog in a pot of warm water, slowly getting boiled to death at this point, either by their bank rug pulling them directly, or by some executive getting stock package payouts through round about monetary debasement, or any number of scams that you have no protection from so long as you hold monetary assets in their system. They will slowly, and sometimes suddenly, siphon off the value of your monetary savings and your labor in some sly round about way whether you like it or not, unless, you opt out of their system, and into a better monetary system!
The only way out of a system designed with bad incentives, is to opt into a system designed with good incentives, into a monetary system with a public immutable honest ledger, anchored to a fixed denominator of 21 million units, not more, not less.
A system built on good individual incentives leads to good market incentives, where life just keeps getting better, with more and more opportunity over time.
GOOD INCENTIVES
Remember, money is just information. More money does not create more stuff in the world, it only produces more demand for the same amount of stuff, forcing prices higher. If money can be created, people will create it for themselves, and force everyone else to pay for the value of that new money through higher prices. So the only solution is to build a system with a fixed supply, that nobody can take control of for their benefit at the expense of everyone else. What is needed is a public good for everyone, controlled by no one, favoring no one, no matter what, without exception.
Good individual incentives are created through personal responsibility.
Rather than relying on fraudulent auditors or maligned SEC regulators or Federal Reserve folks with, perhaps at best, good intentions, we can build automated systems for those processes, removing the human corruptible element, and in doing so we remove the bailout option. With the bailout option gone, if an investment is a bad investment, then the investors alone will pay the price through their loss of purchasing power, not anyone else’s.
Mt. Gox, Celsius, Tron, FTX, (and probably the BlackRock ETF at some point in the future, lol) are just a few examples of the great outcomes of the Bitcoin future, where there are no bailouts, and where people learn what Bitcoin is, that it is designed for personal self custody, where there is nobody’s fault but your own, which creates a stronger more robust monetary system and economy over time.
Good personal responsibility incentives, force the use of bitcoin properly, with self custody. The long term benefits of not being able to bail people out is a fixed supply that grows in value relative to the productive growth of the economy over time such that the purchasing power of the underlying fixed supply token increases annually by leaps and bounds in lock step with the innovative progress of the enduring human spirit.
With self custodial bitcoin, the possibility of investment by everyone is unlocked. This is hugely underappreciated.
In the current banking system, everyone’s savings is locked up in 401k’s, pensions invested in corporate and government debts, and the monetary premiums in our homes. None of these assets are liquid or divisible enough to enable us to invest our money into other projects that we deem worthwhile. The only way to monetize the savings in these assets is to borrow against them, which is a self defeating cycle of more money printing, increasing the money supply and pushing prices higher for everyone.
And equally important, because there is no available monetary liquidity by any of us peasants to invest with, there are none of us peasants seeking out entrepreneurial endeavors with the support of our fellow communities to invest in our endeavors.
Imagine for the moment a future where all of your monetary wealth is held in highly liquid and appreciating bitcoin, available for you to spend or invest, with the click of a computer mouse, or the swipe of a smart phone screen as you see fit. Imagine a Craigslist or a Facebook market place where your local community posts investment opportunities in a new local bakery, butcher shop, dairy farm, fruit orchard, ice cream parlor, musical instrument manufacturer, carpenter services, security services, arbitration services, tutoring services, or any countless other ventures that you and your neighbors are free to engage in because your savings has grown in purchasing power, to free up your ability to invest, and because your labor has grown in value allowing you more free time to take up a hobby for profit.
What a self custodial monetary network enables is precisely what we all yearn for, a purposeful and intimate fulfilling life, where our own unique attributes are enabled in our communities, where specialization and trade are cherished gems, and where foreign customs are invited and celebrated.
The sterile dead corrosion of conformity and standardization that the fiat western society has brought to the world has reached its high watermark. The pendulum has begun to swing back, and we are returning to our historical roots, with self custodial and investible real money, with bitcoin, and its honest ledger.
Are you sick and tired of the amount of control your national or state government has over you? Do you wish they could be held more accountable?
With a self custodial monetary system, where only consensual investing and lending is possible, your national and state governments will need to demonstrate to you their worthiness of investing in them. The amount of money governments are going to be able to drum up through bond offerings will be dramatically less in the world of Bitcoin that is fast approaching. Unable to turn the money printers on, to fund their insane pet projects, our national and state governments will become accountable useful services for the people, no longer able to lord over us as our dictators. They will become our servants once more, not the other way around, as us their servants which is the current horrific situation with our money under their control in their systems of control, with best intentions paving a path to hell.
All of the benefits of Bitcoin is only possible because of the self custodial feature of the bitcoin monetary units. And so, from a technical perspective, how exactly can you begin to self custody your bitcoin?
IT JUST BIG RANDOM NUMBERS, THAT’S IT
As discussed in Part Three the modern banking system has a very small percentage, less than 1% of physically custodial tokens, of bills and coins, with the remaining 99% non custodial, unable to be custodied by the alleged owners, the bank depositors, us peasants.
Whereas with Bitcoin, as the foundational backbone component of its design, it has a 100% supply of custodial tokens at all times. There is no other way to hold a bitcoin. It is at all times custodied by the owner, which means, if your bitcoin are held by an exchange, then you are not the owner of that bitcoin, the exchange is, and this is why exchanges will always take the bitcoin from their customers, it is as inevitable as the rising price.
So how does Bitcoin create its custodial tokens?
Well, we could dive into elliptic curve cryptography but we don’t really need to. Let’s keep it simple. It’s like driving a car, put gas in and it goes. You actually don’t need to know all the mechanics of the internal combustion engine to drive a car. Bitcoins custodial model can be understood in similarly simple terms.
Bitcoin tokens, the bitcoins, are simply random numbers assigned to other random numbers, that’s it. It’s just that simple. Pick a random number, and have someone assign their bitcoin from their random number to yours. That’s it. If gas is all you need to know for your car (or an outlet for you electric car degens), then random numbers is all you need to know for your bitcoin.
The only complication is that the random number needs to be big. Sort of like your car gas needs to be a certain octane, but you don’t really need to know any of that detail to drive the car or to operate bitcoin. But just in case you might want to better understand Bitcoin, making sure the number is random, and figuring out what to do with the big random number once you create it, because the random number you need for your bitcoin needs to be a really big number, is where the perceived complexity arises, but it need not. It’s just foreign to everyone at first, like how to put gas in your car or how to fill out a bank check. Sort of complicated at first, but super simple after a couple tries.
How to get randomness for Bitcoin?
The randomness is easy enough to solve with some coin flips.
Because there is the possibility that the coin you use has some bias towards heads or tails, to resolve this minor nuance we simply turn one flip into two flips. Each two flips of a coin becomes one flip. And if the two flips turns up a heads heads or a tails tails, then those two flip are thrown out. If instead a heads and then a tails is tossed, then the result of those two flips is a heads. Conversely, if a tails and then a heads is tossed in succession, then the result of those two flips is a tails.
This will take a little longer to flip the coin as many times as needed, but it will provide certainty that even a biased coin will provide a random result for your bitcoin.
You can thank John von Neuman and his 1951 paper Various Techniques Used in Connection With Random Digits for this insight into randomness.
Now, with regards to the size of the number you will need. Brace yourself. You’re going to need to do a lot of coin flips to get the size of random number needed for Bitcoin. I mean its a huge number. Something like 2^256 or something like this number:
115,792,089,237,316,195,423,570,985,008,687,907,852,837,564,279,074,904,382,605,163,141,518,161,494,337
Why something this big?
Well because that is the size of numbers that bitcoins cryptography uses, as published by the nonprofit group Standards for Efficient Cryptography (SEC) organization in their paper SEC 2: Recommended Elliptic Curve Domain Parameters under the section entitled ‘2.4.1 Recommended Parameters secp256k1’.
Lastly, after you spent the afternoon completing your 300 or so coin flips and written down the heads or tails, you’re going to need to translate that information into something intelligible, like a list of 12 words.
Wait, we can translate 300 coin flips into 12 words?
Now I bet you are confused! Don’t be. Don’t over think it.
In the same way “ciao” is equal to “hello” given some language translation standard, we can translate numbers into words using some number translation standard. And so that’s what some Bitcoiners did. With a set of 2,048 specified words, anyone can translate their big random number list into a short list of 12 random words. And with that you can take self custody of your bitcoin, and out of the hands of the exchange that will eventually take your bitcoin, if you leave it with them.
Here’s the english list of the 2,048 words. There’s other languages available, because Bitcoin is a global phenomenon!
https://github.com/bitcoin/bips/blob/master/bip-0039/english.txt
Don’t want to do coin flips, or translate that big number into words?
No problem, hardware wallets will do the work for you. But you are adding some unnecessary trust into your bitcoin custody solution by trusting hardware wallet manufacturers. You’ve been warned.
At any rate here are a few manufacturers that have worked well, so far…
And if you do have an interest in learning more about these big ass random numbers, you might find these resources helpful:
Introduction to Blockchain’s Bedrock:- The Elliptic Curve secp256k1
Bitcoin 101 - Elliptic Curve Cryptography - Part 4 - Generating the Public Key (in Python)
At any rate, what is important to note here, is that Bitcoin can and should be self custodied, and over time as people learn this, either the easy way or the hard way, all the world will come to this realization, and with it, the ability to hold our monetary wealth, forever, Laura, will be secured. And as that is achieved, equally important is the ability to send any amount of that value to anyone, at anytime, anywhere in the world. Which naturally brings us to our next topic, Permissionless and Uncensorable bitcoin transactions. But that’s for another day…
Until next time, cheers!
Great piece again!