How we could "back" bitcoins with something of value

[kwhcoin]

Although the Bitcoin concept, software, and community are valuable, the actual bitcoins people own are not backed by anything of value like gold, silver, rice, gasoline, kilowatt-hours, or even dollars. I have noticed myself pointing this out quite a bit so I wanted to propose a potential solution to this perceived problem so I am not just being critical.

My approach in this post to "back" bitcoins with something of value is guided by a desire make Bitcoin a better currency without really changing the existing Bitcoin system. In particular, the approach presented keeps the total Bitcoins over time curve unchanged. Unfortunately, preserving this curve makes it difficult to back the currency in the classical sense, but it is still possible to "back" bitcoins by giving each bitcoin a guaranteed minimum value.

The one change I find necessary to make would be to make it so miners don't get all the newly created bitcoins. I would still have a portion of the new bitcoins go to miners, but I would have the other portion auctioned off with the proceeds going towards backing bitcoins. I am assuming it would be possible to offer less incentive to mining without compromising the security of the network, but if I am incorrect in my assumption then the existing Bitcoin transaction fee system can be used to help incentivize mining to fulfill their key role of securing the network while still allowing some of the new bitcoins to be auctioned.

Here is an example of what this backing might look like if bitcoins were to be “backed” by dollars. In the total bitcoins over time graph, bitcoins are currently being created at a rate of 2,625,000 per year. Suppose over the course of the next year it were decided that half of these 2,625,000 bitcoins needed to keep being given to miners to keep the network secure, and that the other half could be sold at auction. If the average market price received at auction for the year were $20, then the amount of revenue added to the backing fund during the course of that year would be $26,250,000. Since at the end of that year the total number of bitcoins would be around 9,200,000 bitcoins, then the amount of guaranteed backing per bitcoin at the end of that one year would be $2.83. Note: This isn't the market value of bitcoins, but rather the guaranteed minimum value of each bitcoin promised by the backing account. Over time this guaranteed backing amount would keep increasing with each new bitcoin sold at auction until all 21,000,000 bitcoins were created.

Here is an example of how this backing might be implemented in practice. The backing account could be an mtgox account where each day the newly created bitcoins designated for auction would be sold on mtgox and the proceeds from the sales go to the bitcoin backing fund. The guarantee part of the backing could take the form of an open buy order by this mtgox account at the guaranteed bitcoin backing amount which is calculated by taking the total amount of value in the bitcoin backing fund and dividing by the current total number of bitcoins. In the example from the paragraph above, the guaranteed value after one year was $2.83 per bitcoin. Of course, if the current market value of bitcoins were $20 and the guaranteed price was $2.83 then nobody is going to try and sell their bitcoins at the guaranteed amount of $2.83. However, market conditions may change for various reasons and the market price for bitcoins may become the guaranteed price. The reassurance of a guaranteed minimum value is helpful to users, merchants, and developers.

In the example above I backed bitcoins with dollars, but the same approach could be used to back bitcoins with other thing such as gold or silver.

There are still some issues and details that need to be worked out, but I wanted to put the idea out there as a potential solution to a problem I see with the current Bitcoin system.

Even if you think "backing" bitcoins with something of value is pointless, you have to admit that many people desire this feature in a currency so providing a guaranteed minimum can only increase the demand for bitcoins.

[evoorhees]

You propose backing Bitcoins with something of value, and then suggest the USD as that backing? One of the primary draws of Bitcoin is that it's an alternative to the dollar, which is manipulated at whim by the Federal Reserve System. The dollar is fiat - it's mandated to have value by the coercion of government. Bitcoin is not fiat, because it is chosen openly in a free market as money.

Further, your proposal is not actually backing Bitcoin in the meaningful sense of the term. For something to be "backed" it means there is a guarantor of another good for the one in question. When the dollar was backed by gold, the US government guaranteed to hand you a fixed amount of gold for your dollar. Unless I misread your proposal, no party is guaranteeing payment of dollars in return for Bitcoins.

Further still, the notion of "backing" is silly, unless you're using something like paper as a substitute for another good that has "real" value. Bitcoins has "real" value by itself, because it offers a revolutionary distributed payment system, and is allegedy secure, and is fast, and almost free to use, etc.

Further still again, gold is not backed by anything, and yet remains a great and valuable money commodity.

A great money doesn't need backing, because it IS valuable in its own right. Bitcoin is indeed valuable, for the distributed payment mechanism (among other features) mentioned above.

[5grainsilver]

Gold has unique physical properties.  It "backs" itself. 

Backing btc requires a central organization to implement, which defeats the purpose of btc.

[vector76]

I agree that bitcoins need to be backed by something.

To me this means that bitcoins need to be readily convertible into the thing backing them.

The problem I see is making it decentralized.  With a single choke point a government can shut the whole thing down, which defeats the purpose.  Physical metal is excellent in terms of decentralization because it's impossible to track and impractical to confiscate, but it doesn't travel over the internet very well.

Here is a wacky outline of an idea:  A trusted party buries an ounce of gold at a random location in the Nevada desert and records and encrypts and digitally signs the location into a token.  Then through some cryptographic magic, this information is passed along in encrypted form as the token is spent.  To redeem the digital currency for gold, some other cryptographic magic allows the token to be decrypted and there is a public registry of redeemed tokens to prevent spending a redeemed token as if it were not redeemed.  And as with bitcoin, also a registry of transfers to prevent multiple spending.

You would have to trust the initial burying/certifying party, just as you would have to trust the backing account holder or the reserve against which a note is written.  But if they are out of the loop when the redemption occurs then it is not feasible for a government to kill the currency by holding the backing hostage.

I don't know if cryptographic protocols exist that would enable the magic as I outlined it.  Maybe we'll have to invent one.

[evoorhees]

Gold has unique physical properties.  It "backs" itself. 

True. And similarly, Bitcoin has unique properties. It shares some of these properties with gold (divisibility, homogeneity, scarcity, etc) and has unique ones additionally (instant transfer across thousands of miles, a billion dollars-worth can be put in your shoe, it's not subject to supply fluctuations, etc.).

Both gold and btc are valuable as money precisely because of their unique properties. Neither needs to be, or ought to be, or even can be, backed by another commodity.

[5grainsilver]

Gold has unique physical properties.  It "backs" itself. 

True. And similarly, Bitcoin has unique properties. It shares some of these properties with gold (divisibility, homogeneity, scarcity, etc) and has unique ones additionally (instant transfer across thousands of miles, a billion dollars-worth can be put in your shoe, it's not subject to supply fluctuations, etc.).

Both gold and btc are valuable as money precisely because of their unique properties. Neither needs to be, or ought to be, or even can be, backed by another commodity.

I wish this was true.  But the bitcoin system can be duplicated.  In a week you could have namecoins, and a week later funcoins.  Gold can't be reproduced like that. 

[imperi]

Gold has unique physical properties.  It "backs" itself.  

True. And similarly, Bitcoin has unique properties. It shares some of these properties with gold (divisibility, homogeneity, scarcity, etc) and has unique ones additionally (instant transfer across thousands of miles, a billion dollars-worth can be put in your shoe, it's not subject to supply fluctuations, etc.).

Both gold and btc are valuable as money precisely because of their unique properties. Neither needs to be, or ought to be, or even can be, backed by another commodity.

I wish this was true.  But the bitcoin system can be duplicated.  In a week you could have namecoins, and a week later funcoins.  Gold can't be reproduced like that.  

It's only "replicated" if a massive amount of people choose to use the other versions, which aren't connected to all the trading websites, don't have thousands of machines mining, and a worse development team. It's very inconclusive whether people would want to use two different P2P currencies.

[kwhcoin]

You propose backing Bitcoins with something of value, and then suggest the USD as that backing? One of the primary draws of Bitcoin is that it's an alternative to the dollar, which is manipulated at whim by the Federal Reserve System. The dollar is fiat - it's mandated to have value by the coercion of government. Bitcoin is not fiat, because it is chosen openly in a free market as money.

I used dollars because it was a simple way to illustrate a concept but I mentioned you could use gold, silver and other things as well.

Further, your proposal is not actually backing Bitcoin in the meaningful sense of the term. For something to be "backed" it means there is a guarantor of another good for the one in question. When the dollar was backed by gold, the US government guaranteed to hand you a fixed amount of gold for your dollar. Unless I misread your proposal, no party is guaranteeing payment of dollars in return for Bitcoins.

I mentioned I couldn't find a way to "back" the bitcoins in the classical sense like the gold for dollar example you bring up because I wanted to preserve the total bitcoins over time graph. However, I have another topic where I do talk about backing a Bitcoin-like currency in the classical sense.

Further still, the notion of "backing" is silly, unless you're using something like paper as a substitute for another good that has "real" value. Bitcoins has "real" value by itself, because it offers a revolutionary distributed payment system, and is allegedy secure, and is fast, and almost free to use, etc.

Whatever value bitcoins have have would be increased if they were backed by something with proven long term value.

[kwhcoin]

Gold has unique physical properties.  It "backs" itself. 

Backing btc requires a central organization to implement, which defeats the purpose of btc.

Bitcoins can be backed and still be decentralised just like it is now. Nothing would have to change with the transactions. The only thing centralized would be the backing and that could also be decentralized to some degree. Anyway, if the backing worked your better off with it than without it, and if the backing failed it would be the same as if you didn't have it.

[evoorhees]

I wish this was true.  But the bitcoin system can be duplicated.  In a week you could have namecoins, and a week later funcoins.  Gold can't be reproduced like that. 

That is not duplication of Bitcoin. Namecoins and funcoins are different commodities with different properties. Just like silver and copper are alternatives to gold, but are not the same. The marketplace will observe all alternatives and value them as it wishes.

Unless there is some bug in the code of Bitcoin, and coins can be "printed" at whim, then it is a valid, scarce commodity. Similarly with gold, unless some chemist creates a way to cheaply produce artificial gold (which would be no different than real gold since both are the same element) then gold will remain a valid, scarce commodity.  Both gold and bitcoins are limited, and both have alternative substitutes in the marketplace.

[kwhcoin]

Gold has unique physical properties.  It "backs" itself. 

True. And similarly, Bitcoin has unique properties. It shares some of these properties with gold (divisibility, homogeneity, scarcity, etc) and has unique ones additionally (instant transfer across thousands of miles, a billion dollars-worth can be put in your shoe, it's not subject to supply fluctuations, etc.).

Both gold and btc are valuable as money precisely because of their unique properties. Neither needs to be, or ought to be, or even can be, backed by another commodity.

I wish this was true.  But the bitcoin system can be duplicated.  In a week you could have namecoins, and a week later funcoins.  Gold can't be reproduced like that. 

I agree it can be duplicated and it will and I think many of them will be backed by something and at least one will be backed by gold.

[vector76]

Bitcoins do have cool features, but the features serve no purpose other than in the role of a medium of exchange.  Silver is useful for making mirrors and photographic film and wires and so on.  So the non-medium-of-exchange value of silver or any other commodity "backs" its use as currency.  Bitcoins have no non-medium-of-exchange value.

Because bitcoins have no usefulness other than as a medium of exchange, the value exchange ratio relative to goods and services is completely arbitrary.  For currencies that can be converted into commodities, the non-financial utility gives it some tether to stable price levels.

For fiat currencies with no tether at all, active manipulation is required to achieve stable price levels, but with bitcoins this is impossible by design.

[Mageant]

The best way to "back" bitcoins is to make it more widely used.
The more goods and services you can buy with bitcoins the more valuable and stable it will be.

[kwhcoin]

The best way to "back" bitcoins is to make it more widely used.
The more goods and services you can buy with bitcoins the more valuable and stable it will be.

The more people sell things in bitcoins the better. However, these goods for sale are not really backing bitcoins. For example, earlier today went to the alpaca sock website linked to from the Bitcoin wiki's alpaca page and here is what it said:

“Each pair of socks is 2.5 BTC delivered to your door, no extra fees for shipping within the U.S. This price may fluctuate in the future depending on the current BTC exchange rate.”

The fact that the “price may fluctuate” means bitcoins are not backed by alpaca socks. There is not a promise but only a temporary promise to exchange alpaca socks for 2.5 BTC and that temporary promise can change at any time. There is no guarantee for any meaningful duration of time.

[evoorhees]

Bitcoins do have cool features, but the features serve no purpose other than in the role of a medium of exchange. 

False. You're forgetting that Bitcoin is also a software system that allows ledger transactions to be sent and validated with no central authority. THAT in itself is a huge achievement, and provides a great deal of that "purpose" you seek.  It's easy to confuse these things, of course, because Bitcoin is the name for both the software system and the currency used in that software system. The two should be understood separately, and the latter derives its original value from the former, and it's long-term value from the supply and demand of that original value. Make sense? =)

Gold and silver have use as jewlery and in industrial purposes. Bitcoin has use as a recording and validation mechanism for transactions.  Gold, silver, and Bitcoin all additionally have value as monetary instruments due to their properties.

[billyjoeallen]

If YOU want to back Bitcoins, offer to sell some commodity at a fixed rate. Why make it more complicated than that?

[Jaime Frontero]

i propose backing Bitcoin with:

AssCoins!

i mean, as long as you're going to be pulling stuff out of it...

but it is still possible to "back" bitcoins by giving each bitcoin a guaranteed minimum value

which decentralized entity would do this?  oh wait.  you?

but I would have the other portion auctioned off with the proceeds going towards backing bitcoins

let me guess - by the government?

In the total bitcoins over time graph, bitcoins are currently being created at a rate of 2,625,000 per year.

well, no.

The guarantee part of the backing could take the form of an open buy order by this mtgox account at the guaranteed bitcoin backing amount which is calculated by taking the total amount of value in the bitcoin backing fund and dividing by the current total number of bitcoins.

and who would be...

ah, never mind.  i'm bored now.

[bitcredit]

I'm John Kerry and I approve this message.

[FreeMoney]

How about instead of one 'trusted' backer we all just offer to back to whatever extent we can and want and let that determine the value?

[vector76]

Bitcoins do have cool features, but the features serve no purpose other than in the role of a medium of exchange. 

False. You're forgetting that Bitcoin is also a software system that allows ledger transactions to be sent and validated with no central authority. THAT in itself is a huge achievement, and provides a great deal of that "purpose" you seek.  It's easy to confuse these things, of course, because Bitcoin is the name for both the software system and the currency used in that software system. The two should be understood separately, and the latter derives its original value from the former, and it's long-term value from the supply and demand of that original value. Make sense? =)

Gold and silver have use as jewlery and in industrial purposes. Bitcoin has use as a recording and validation mechanism for transactions.  Gold, silver, and Bitcoin all additionally have value as monetary instruments due to their properties.

To me this seems to reaffirm what I said, yet draw the opposite conclusion.  With regard to the distinction between software vs currency, I could envision the software having utility outside of the bitcoin universe, but the software is not what is being exchanged or priced.  I think the key thing is what you called original value of the currency, which I am interpreting as utility in some role other than as a medium of exchange, like jewelry or industrial purposes.  But I'm not seeing how the units of currency have any such utility.

I will grant that the software does have value and does add utility to the currency.  And I will grant that the currency derives all its value from the software, but I maintain that the software only adds utility to the currency in its role as a medium of exchange.

A security strip in a Federal Reserve Note improves its usefulness as an exchange medium but it does not give the currency any industrial value.