Cryptocurrency: Fiat or Not?

You may have heard about cryptocurrencies in the news: Dogecoin, Litecoin, and most famously, Bitcoin. You may even own a few. You may even drive a stock car sponsored by a handful of Redditors donating Dogecoin. For those who missed the boat early on when the mining was good (yours truly included), cryptocurrencies are mediums of transaction that make use of the same kinds of cryptography that keep your credit card secure. People and businesses who trade cryptocurrencies take part in a distributed exchange network that validates transactions; the work of the validation, ostensibly, gives and ensures the value of the currency.  Weird, right?  Or at least different: Bitcoin started out as a proof-of-principle for alternative currencies in a 2008 research paper.


Sweet ride: 1970 Fiat 500

Techopedia logically asserts that cryptocurrencies are what is known as a fiat currency: money that is given and ensured value by a state authority without making use of a tangible commodity as the basis of the currency’s value. Long story short, most gold and silver backed currencies became fiat currencies in early 20th century to include the US dollar in 1933. Techopedia also observe, however, that it behaves similarly to those commodities like gold or silver with its value, measured against fiat currencies, rising and falling with a high degree of volatility. So what is it? In the traditional sense, it certainly isn’t a fiat currency; it isn’t backed by a state or international authority but neither is it backed by a tangible commodity. Supposedly its value is given by implicit social contract between all participants ensuring the network of exchange remains secure. But just because I can be assured that everyone is working to ensure virtual doppelgangers of Bonnie and Clyde don’t steal all my coins, how do I sleep easy knowing they’ll be valuable enough to purchase the gas for the Dogecoin car?


MFW I’m confused: I become Nicolas Cage

So what gives it value? Joules. No, not the science fiction author. I’m refering to the unit of energy joule, named for James Prescott Joule, who infamously disproved that the calories in my donut aren’t quite right and the so-called calories are probably an overestimate and… anyway, moving on. The act of ensuring that the transactions in a cryptocurrency network are true and secure are energy intensive. Many ‘miners’, or people who perform these calculations regarding the transactions are already well aware of this fact. But in order to get a broader understanding, let’s follow the life of a single bitcoin. We’ll name him Xavier.

tl;dr Xavier goes on an adventure through the block chain.

Pretend I’m Alice, and I’d like to give Bob custody of Xavier, a bitcoin, in exchange for goods and services. I, Alice, announce to the network that I’d like to give Bob a coin. Alice and Bob have things called public verifcation keys (known to everyone) and private signing keys (known only to each individual). Other folks on the network see this transcation announced from one public verification key to another along with a challenge value unique to this particular transaction of Xavier. Folks, who we call ‘miners’, on the network then perform a very difficult calculation (thanks Euler) to find an answer so-to-speak for when this challenge value, corresponding to the two public verification keys of Alice and Bob, is fed into a special cryptographic hash function. If Charlie the miner finds the correct answer and validates the transaction (announced to the network), then Charlie is awarded a small fee taken from Alice’s transaction to Bob. Khan Academy does a great overview of how the cryptocurrency bitcoin works here and you can take a look at Bitcoin’s specific documentation starting with a brief overview here.

So if you don’t want to shell out the some 300 US$ for 1 Bitcoin (as of today) and risk the volatility of the exchange rate, then mining would seem the best option. Mining itself is lucrative if you have access to sufficiently powerful hardware that can perform these transaction validation calculations. But the hardware isn’t cheap either. As the network of users grows, so too does the pool of available currency (which is eventually capped for Bitcoin, actually), the difficulty of the transaction validation calculations, and the number of these calculations being performed per second across the network.


The Miami School of Floating Point Operation

These calculations can be measured in a cool unit called FLOPS (floating point operations per second), which are used to measure how fast a computer can math. Dividing the number of FLOPS a computer is capable of achieving at peak performance by the maximum number of watts drawn by the power sources gives us the peak FLOPS per joule (operation / watt-second) of the machine. Ultimately, when purchasing large, powerful machines (we’re not talking your home Netflix box), the operating cost of the watts required to run the machine quickly overrun the cost of the machine itself.  It didn’t take long for cryptocurrency miners to notice that with exponential growth in difficulty of the validation calculation (due to how the currency is algorithmically governed) came serious implications in terms of the total energy consumption of the Bitcoin network. Bloomberg published this article a little over a year ago on the very subject. To cut to the Chase, the Bitcoin network alone could consume the energy equivalent of tens of thousands of households, even if it were run solely on these lean, green, adding machines.

But this is precisely my point. Watts aren’t free. Energy is the commodity that forms the value of cryptocurrency. Economists define energy as a commodity (like oranges or gold) when it’s the form of oil or gas, but here we take it in the explicit sense of joules–as in the joules that would be generated from burning one train car load of coal for example.  By this train of logic (all aboard!) cryptocurrencies are clearly not fiat, just backed up by the intangible end state of tangible energy commodities and very precisely ensured by the total body of participants. (I wonder if then these currencies are a medium by which to trade energy and not the object of trade in of themselves; the problem is that this energy has already been spent–an interesting conversation for another time).

Nah, man, you’re totally wrong.

One of my classmates pointed out in conversation that one day energy will essentially be free, or in other words limitless.  If cryptocurrencies were not fiat, and backed up by gold instead of energy say, you could imagine that everyone would have an arbitrarily large pile of gold backing up a single Bitcoin in their pocket.  I, on the other hand, argue macroscopically, that on a societal scale, what seems like limitless energy now will not be limitless energy when we are able to produce it. From our point of view the sun seems like a limitless source of energy, but the solar system’s point of view it’s just the right amount.

I Googled “anthropmorphized planets” for the purposes of my metaphor and found this page; my Google-fu is strong.

Additionally, different lines of research in the high performance computing community are leaning towards measuring efficiency with bits per joule, rather than flops per joule. As computing densities (in terms of watts/meter^3) increase and with the looming (hopefully) dawn of quantum computation, we’ll face more limitations in managing the heat generated by the I/O of the classically (in the Newtonian sense) observed data (thanks Heisenberg) coming out of a quantum computer.  But this further supports my point–the management of this heat incurs additional energy costs despite having more FLOPS than you could possibly measure.

I haven’t figured out how to work a “fix it again tomorrow” joke in. Something about quantum computers breaking RSA derivative cryptographic algorithms, maybe.


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