Things Ray Dalio Hasn't Learned About Crypto Yet

• It's not new money—don't bring the biases you have tied to government-issued currency—it's something far more powerful.
• Remember: it's still extremely early. In Internet terms, recall the days of the 14.4 KB/s modem. We can squint and begin to imagine Netflix playing on a iPhone, but we are still very far away.
• No one knows where this leads (this author included) — but it's important to understand why this is like nothing before.

What the internet is for information, blockchain tech is for transactions.

This is important. The Internet is, at it’s core, a series of protocols that allow people—who have no prior relationship—to move data back and forth. This goes from low-level things like semi-structured text all the way to streaming 360-degree video. But as soon as the smallest snippet of text was transferred, everything else could follow. What the internet also did—that wasn’t really possible in the previous world of proprietary machine data connections—was provide smart linkage between content. Example primitives here include embedding a photo and linking to a different web page.

How does this apply to transactions?

Bitcoin’s key “academic” revelation was the first practical solution to a long-standing (since 1982) problem—called the Byzantine Generals Problem.

This problem is as follows:

Several armies surround a castle they are going to attack. Each army faction is led by a general. However, they must all attack simultaneously to ensure success. It doesn’t matter what time they attack, so long as they agree. Since they are spread out, it makes communication unreliable. If two attack times were proposed, some generals might hear a different one first. And worse, some of the generals are traitors, and may relay an incorrect message (wrong attack time or similar) to the other generals. So how can the generals ensure a coordinated attack?

In Satoshi's (the pseudonymous founder of Bitcoin) own words:

They use a proof-of-work chain to solve the problem. Once each general receives whatever attack time he hears first, he sets his computer to solve an extremely difficult proof-of-work problem that includes the attack time in its hash. The proof-of-work is so difficult, it's expected to take 10 minutes of them all working at once before one of them finds a solution. Once one of the generals finds a proof-of-work, he broadcasts it to the network, and everyone changes their current proof-of-work computation to include that proof-of-work in the hash they're working on. If anyone was working on a different attack time, they switch to this one, because its proof-of-work chain is now longer.

After two hours, one attack time should be hashed by a chain of 12 proofs-of-work. Every general, just by verifying the difficulty of the proof-of-work chain, can estimate how much parallel CPU power per hour was expended on it and see that it must have required the majority of the computers to produce that much proof-of-work in the allotted time. They had to all have seen it because the proof-of-work is proof that they worked on it. If the CPU power exhibited by the proof-of-work chain is sufficient to crack the password, they can safely attack at the agreed time.

If you are new to crypto: a “hash” is basically a fingerprint—a secure, repeatable reduction of information. Imagine I send you a file via an insecure channel. Someone could tamper with the file. But if I’ve told you (offline, or another secure channel) what the “hash” is, then you can check to make sure the file arrived without tampering. With the solution for the Byzantine Generals in hand, “Money” as we know it is the easy demonstration app to build—akin to transferring plain text between computers in Internet terms. Bitcoin may not be the platform that captures much of the innovation yet to come, but it’s clearly benefitting from the network effects of being the first real-world deployment that demonstrates the power of this technology.

Never before could anyone build a monetary “country.”

Our locally-issued currency (“fiat” for short) is a relatively fragile, modern invention. We don't have to look very far into history to see how this method may well be ill suited for our future. Consider the Bretton Woods Agreement — named for international conference held in a New Hampshire town of the same name in 1944, at the end of WWII. In short, the agreement was that countries may set their own interest rates, so long as they artificially constrained and fixed exchange rates between each country.

Why? The goal was for countries to have sufficient yield in capital to rebuild war-torn Europe. If currencies were to be fluid, all the capital would go to the economy with the highest real yields (and likely be unavailable for lower-return, but still necessary projects.) The IMF and World Bank were established to finance shortfalls across member countries. But differences in inflation rates went on to rip this agreement apart by the beginning of the 1970s. Even at the size of nations, it's hard to keep anything static in markets. Even after further recalibration, the subsequent floating exchange rates put in place led to rampant inflation in the ‘70s.

In our modern age—with unlimited information and entirely geographically dispersed organizations—why would any organization tie themselves to their geographically-proximate neighbors? Ask anyone who has managed payrolls across currencies: it's an entirely different risk. Now with Crypto, anyone—whether a company, a protocol, a network (think EBay buyers and sellers)—can create their own monetary country. This new country's value, relative to more-commonly-traded-counterparts, may experience significant amounts of volatility.

It doesn't matter that Bitcoin's transactions aren't scalable: you don't have to carry only one physical currency to the global markets. It doesn't matter that it's highly volatile, relative to fiat currency: you will seamlessly be able to convert value to the economic “country” where you need to spend it. Some of these countries (maybe even Bitcoin itself) will eventually become incredibly stable. (Or maybe a monetary country will emerge that provides a simple future yield contract, with desired stability characteristics.)

Some of these “new countries” may badly draw their own borders and be unsustainable or disastrous. Existing nations may be hostile—and attempt to seize or shut down smaller crypto countries. As the Bitcoin project itself has shown—internal politics and inability to move quickly might be huge challenges within these projects. Regardless of an individual ecosystem’s success or failure, this is a new power we've never seen or experienced at scale.

It's a currency. It's access to the network. And it's equity in the project.

With the “real” rates (interest minus inflation) stuck at nearly zero for so long, there's just too much money seeking return. I've written before about the ICO phenomenon and the incredible volume (relative to VC as a whole) that is rushing into the system. At the core: the flexibility of the token system is allowing market demand for non-zero interest returns to seep into new technology projects. So what’s an ICO? Answer: it totally depends.

Chuck Reynolds

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