Critique of Nassim Taleb's Bitcoin Blackpaper

November 1, 2023

Nassim Taleb is a deservedly well-regarded statistician, ruthless Twitter user, and author of “The Black Swan”. I, a humble technowatermelon, will go through Taleb’s Bitcoin Blackpaper and attempt to point out his arguments I agree and disagree with. You can find Taleb’s paper here: https://www.fooledbyrandomness.com/BTC-QF.pdf

  1. “Note that the entire ideological basis behind bitcoin is complete distrust of other operators”

This is a minor point, but it’s hard to ignore the bias in this statement. What if I said “the entire ideological basis of HTTPS is complete distrust of other operators”? It’s ideology to assume bad actors exist in a system?

  1. “Gold and other precious metals are largely maintenance free, do not degrade over an historical horizon, and do not require maintenance to refresh their physical properties over time. Cryptocurrencies require a sustained amount of interest in them”

State-sponsored currencies across the world degrade due to inflation, degrade due to the natural life-cycle of nations, and also require maintenence. State-sponsored currencies also require a sustained amount of interest in them, tied to the preception of that state’s stability and power. A state-independent currency (like Bitcoin) is resistant to these trappings.

  1. “A central result (even principle) in the rational expectations and securities pricing literature is that, thanks to the law of iterated expectations, if we expect now that we will expect the price to vary at some point in the future, then by backward induction such a variation must be incorporated in the price now…if we expect that at any point in the future the value will be zero when miners are extinct, the technology becomes obsolete, or future generations get into other such “assets” and bitcoin loses its appeal for them, then the value must be zero now.”

The first part of this makes sense. The second, where Taleb is saying since there exists a non-zero chance that Bitcoin fails for some reason the price should be 0 now, seems wrong intuitively. Everything will cease to exist when the heat death of the universe arrives. The value of any asset (Bitcoin, stocks, Pokemon cards) implicitly prices in some chance of market disaster for the foreseeable future.

  1. “Path dependence is a problem. We cannot expect a book entry on a ledger that requires active maintenance by interested and incentivized people to keep its physical presence, a condition for monetary value, for any period of time — and of course we are not sure of the interests, mindsets, and preferences of future generations.”

Not sure what Taleb means by “path dependence” here. Also don’t understand why he stresses physical presence. Most USD exists digitally, not as cash. We trust various incentivized institutions to maintain those ledgers despite our inability to be sure of the interests, mindsets, and preferences of future generations.

  1. “…technologies tend to be supplanted by other technologies (>99% of the new is replaced by something newer), whereas items such as gold and silver have proved resistant to extinction”

Software can be updated. Bitcoin has been updated. Also I think it’s fairer to label Bitcoin a currency in this context than a technology.

  1. “Furthermore bitcoin is supposed to be hacker-proof and is based on total infallibility in the future, not just at present. It is crucial that bitcoin is based on perfect immortality; unlike conventional assets, the slightest mortality rate puts its value at 0.”

If I can mathematically prove that it would take me the computational energy of the sun to crack one Bitcoin address, it seems fair to assume it’s pretty secure. It’s hard to grasp how big 2^256 is, let alone 2^512 and beyond. There are other risks with Bitcoin, like if some pool of miners controlled more than 50% of the mining power and coordinated to do something (I forget)…but from what I can tell, all the economic incentives exist to not do this. If the network ever did become compromised, the value of Bitcoin would go to 0 instantly.

  1. “If any non-dividend yielding asset has the tiniest constant probability of hitting an absorbing barrier (causing its value to become 0), then its present value must be 0.”

Taleb labels this Principle 1. Principle 1 is the only principle in this article; there’s no Principle 2. If the crux of Taleb’s position hinges on this, it seems shaky. The category “asset” seems important here to Taleb. I think it’s fair to say Bitcoin is being used as an asset and a currency. Any state-sponsored currency has some probablity of going to zero based on a variety of things (hyper-inflation, war, societal collapse), so to say something should have a value of 0 today because it has a non-zero chance of being worthless in the future, whether that’s in 10 years or 10 thousand years, seems wrong. Otherwise why don’t we do that with state-sponsored currencies?

  1. “More generally, the fundamental flaw and contradiction at the base of most cryptocurrencies is, as we saw, that the originators, miners, and maintainers of the system currently make their money from the inflation of their currencies rather than just from the volume of underlying transactions in them. Hence the total failure of bitcoin to become a currency has been masked by the inflation of the currency value, generating (paper) profits for a large enough number of people to enter the discourse well ahead of its utility”

At some point the block reward will become 0 and the only reward miners will collect will be from transaction fees. But I don’t understand why this is a catastrophic design flaw. The mining network expands and contracts with the natural incentives that are there. What’s the problem?

  1. “Transactions in bitcoin are considerably more expensive than wire services or other modes of transfers, or ones in other cryptocurrencies. They are order of magnitudes slower than standard commercial systems used by credit card companies —anecdotally, while you can instantly buy a cup of coffee with your cell phone, you would need to wait ten minutes if you used bitcoin. They cannot compete with African mobile money. Nor can the system outlined above —as per its very structure —accommodate a large volume of transactions — which is something central for such an ambitious payment system.”

It’s true that Bitcoin transactions are slow and expensive compared when compared to using a credit card to buy a coffee. But what about for larger transactions? If I wanted to send >$1M worth of money to someone anywhere in the world, is there a faster or cheaper way to do that than through Bitcoin? If I wire just $10k, I have a $20-$50 wire charge, I have to spend 30 minutes talking to Bozo 232 at the bank (I appreciate you Bozo), and then the wire can take up to another 24 hours. When dealing with large amounts of money and international payments, Bitcoin suddenly becomes much more attractive.

People are working on a cheaper and faster way to make Bitcoin work for small payments (lightning network) but I don’t have much experience with this.

  1. “To date, twelve years into its life, in spite of all the fanfare, but with the possible exception of the price tag of Salvadoran permanent residence (3 bitcoins), there are currently no prices fixed in bitcoin floating in fiat currencies in the economy.”

An irrelevant point.

  1. “There is a conflation between “accepting bitcoin for payments” and pricing goods in bitcoin. To “price” in bitcoin, bitcoin the price must be fixed, with a conversion into fiat floating, rather than the reverse.”

Another irrelevant point. Who’s conflating this? Why is this significant?

  1. The root of the confusion lies in the prevalent naïve-libertarian illusion that a transaction between two consenting adults, when devoid of coercion, is effectively just a transaction between two consenting adults and can be isolated and discussed as such.

I don’t know why Taleb feels the need to take a jab at Libertarians here. Sometimes in math people simplify things to clarify a problem. In physics we might represent a bicycle as a point mass. Or even naively assume friction doesn’t exist. It would be helpful if Taleb mentioned specifically what is lost by simplifying the problem as he describes it.

  1. “But one must consider the ensemble of transactions and the interactions between agents: people happen to engage in contractual agreements with others; for them a specific transaction is just one piece.”

Why? What has been lost?

  1. “To be able to regularly buy goods denominated in bitcoin (whose prices fixed in bitcoin but floating in U.S.$ or some other fiat currency), one must have an income that is fixed in bitcoin. Such an income must come from somewhere, say, an employer. For an employer to pay a salary fixed in bitcoin, she or he must be getting revenues fixed in bitcoin. Furthermore, for the vendor to offer a can of beer in fixed bitcoins, she or he must be paying for the raw material, and have the overhead fixed in bitcoin. The same applies to the mismatch of assets and obligations on a balance sheet. All this requires a parity in bitcoin-USD of low enough volatility to be tolerable and for variations to remain inconsequential.”

This sounds like Taleb is arguing against a strawman that Bitcoin should be a day-to-day currency.

  1. Furthermore, to use a quantitative finance analogy: the seller of an item priced in fixed bitcoin, yet available elsewhere in fiat currency, would be short a currency option struck at the initial exchange rate. If a vendor prices goods in bitcoin, and the value fluctuates from the initial fixing, the price will be directly or indirectly arbitraged: when the conversion rate to fiat is favorable, customers will buy from the bitcoiner; when it is unfavorable they will either buy elsewhere (indirect arbitrage), or if possible, return previously purchased goods (direct arbitrage). For the price to not be arbitrageable requires the good to be unique and unavailable elsewhere at a price fixed in another currency –in this case it becomes, simply, a proxy for bitcoin.

I had to use ChatGPT to help me understand what Taleb is saying here:

ChatGPT: This argument is highlighting the risks and complications for a seller who prices their goods in Bitcoin while those same goods are available elsewhere in a traditional fiat currency. Here’s a breakdown of the argument:

Ok, if ChatGPT is right Taleb is saying pricing goods in Bitcoin can be risky. Yes this is true. Irrelevant with regards to the question of whether it’s value should be 0 or not.

  1. “More generally, the reasons multiple currencies exist (in the absence of pegs) is because there is not enough globalization and markets are not entirely free between currency zones. And some goods and services, “such as haircuts and auto repair cannot be traded internationally”; they are not, to use the language of quantitative finance, arbitrageable.”

Irrelevent, but “not enough globalization” made me chuckle. Also, “the reason {phenomena} exists is because there is not enough {thing 1}, and {thing 2} is not ideal. And {thing 3}.” Are you sure there aren’t any other things?

  1. “Now bitcoin, as seen in Fig.1 has maintained extremely high volatility throughout its life (between 60% and 100% annualized) and, what is worse, at higher prices, which makes it’s capitalization considerably more volatile, rising in price as shown in Fig. 2 — is it too volatile to fail?”

This is true. Looking at a chart of Bitcoin volatility since 2010, volatility is trending down. It seems fair to assume the longer Bitcoin exists, the more stable and less volatile it will become. Perhaps some economic force exists that keeps it volatile.

  1. “This does not mean that a cryptocurrency cannot displace fiat –it is indeed desirable to have at least one real currency without a government. But the new currency just needs to be more appealing as a store of value by tracking a weighted basket of goods and services with minimum error.”

Here Taleb seems to suggest that he has no problem with cryptocurrencies so far as they are pegged to some real world good or service. Not sure why he makes this a requirement. Clearly the USD does not peg itself to any good or service (eggflation).

  1. “Displacing fiat is not easy…”

Bitcoin doesn’t need to displace fiat. The two can exist alongside each other, like they do today.

  1. “Libertarianism is fundamentally about the rule of law in place of the rule of regulation. It is not about the rule of rules — mechanistic, automated rules with irreversible outcomes. The real world is fraught with ambiguities and even Napoleonic law (far less mechanistic than crypto rules) cannot keep up — to wit, as a risk management directive, most commercial contracts traditionally prefer forums of dispute resolution to be under the more flexible Anglo Saxon common law (London, NY, Hong Kong) that rules on balance, intent, and symmetry in contracts. This applies of course to quantitative finance products such as complex derivatives contracts for which one needs to minimize the legal risk.”

This is definitely a fair critique of Bitcoin as a payment system. The lack of a trusted 3rd party between payee and payer does add some risk. Moreoever there’s the risk someone mismanages their private keys. However there’s a similar danger with wire transfers; if you enter the wrong bank account number or routing number, there’s not much you can do to get your money back as far as I’m aware.

  1. “The experience of March 2020, during the market panic upon the onset of the pandemic, when bitcoin dropped farther than the stock market —and subsequently recovered with it upon the massive injection of liquidity is sufficient evidence that it cannot remotely be used as a tail hedge against systemic risk.”

This point seems to reiterate why Bitcoin’s volatility is bad. Bitcoin’s volatility is trending downward.

  1. “The slogan “Escape government tyranny hence bitcoin” is similar to advertisements in the 1960s extolling the health benefits of cigarettes.”

I agree with the sentiment of this point. I have an aversion for the wishful and childish hope crypto proponents often speak with. I went to Smartcon 2022 in NYC and felt sick.

  1. “Fallacy of the Agency problem: One might have the impression that, by being distributed, Bitcoin would be democratic and reduce the agency problem perceived to be present among civil servants and bankers. Unfortunately, there appears to be a worse agency problem: a concentration of insiders hoarding what they think will be the world currency, so others would have to go to them later on for supply. They would be cumulatively earning trillions, with many billionaire “Hodlers” — in comparison the “evil civil servants” behind fiat money make, at best, lower middle class wages. This situation represents a wealth transfer to the cartel of early bitcoin accumulators.”

This is another good point. To me, this is the other side of the coin to deflationary currencies (USD). As time approaches infinity the value of the dollar approaches zero (bad), and the value of Bitcoin goes to infinity (also bad).

  1. “…we have done still close to nothing with the blockchain.”

I’ll refer you to Scott Alexander’s Why I’m less than infinitely Hostile to crypto: https://www.astralcodexten.com/p/why-im-less-than-infinitely-hostile

  1. “We only judge a technology by how it solves problems, not by what technological attributes it has.”

A transparent, global, state-independent, cryptographically secure currency does solve a problem.

Anyone reading this: please let me know if anything I said doesn’t make sense, is wrong, or is missing. Thanks!