A lot of people are trying to make sense of what Bitcoin is.

Is it a commodity? A payment system? Is it money? Is it the antithesis to centralization?  Is it some way to build consensus? Ultimately, most people want to understand whether Bitcoin is something useful to them in their lives.

Potential

There are great ideas being brought forth now with the advent

of Bitcoin as an accepted payment system in e-commerce. The underlying technology that enable Bitcoin’s meteoric rise can be used to accomplish a leap into a more connected world where information and creative endeavors flow more freely.  It will have massive impacts on how we go about our daily lives.   Let us cover some of the basics.

Transaction Costs

Bitcoin’s original intention is to lower the transaction costs of payment networks that are dependent on trusted actors.  Taken to an extreme, everything has some value even information.  So if we need to pay for information, transaction costs act as a tax thus diluting the profits of creators and service providers.

Our society benefits when information (not misinforamtion) and services can be traded freely or at least at much lower cost of transacting.

Limits

With Bitcoin we have solved the issue of high transaction costs, but the system is not yet near mass adoption.  By a rough estimate blockchain.info, coinbase.com and many other Bitcoin wallet services or software have a few million users.  That is about 0.1% of the global households.  By no means is this anywhere near critical mass.  Furthermore, the system is limited by the types of payment transactions that can occur in a truly trustless fashion when two or more parties are involved.

So what is needed for critical mass?

Master Protocol

The development of the Master Protocol is intended to address some of the weaknesses in Bitcoin – stability and security. As well as extend the capability of the system of trustless payments beyond just bitcoins.

Why is that so important and what does it really mean?

Stability

Friedrich Hayek, a Noble Prize winning economist (there is a running joke to never listen to an economist for investment advice by the way, but he is no longer alive so we may be good) wrote a book called The Denationalization of Money back in the 1970’s after the US was taken off the gold standard.  Hayek postulated that private monies could compete for use, and that monies which are deemed by people using them to have stability would ultimately win acceptance.  Not everyone agreed with him on various facets of this arguments, but it indeed is hard to find people who want to hold money that devalues over time as they age.

With Bitcoin’s volatility some people in short term periods would elect to revert back to government issued monies in order to mitigate  risk of devaluation.  Consequently there is need for  mechanisms for hedging against wild ups or downs for participants in the Bitcoin network.  In the Master Protocol these are addressed with Escrow Backed Securities (i.e., an EBS backed by gold ro a basket of commodities used to gauge inflation) and Contract For Difference.  If you are interested in more reading check out the Master Protocol specification:

https://github.com/mastercoin-MSC/spec

Security

Another issue with or rather feature of Bitcoin is that transactions are no reversible. Usually this is great.  However, not for a store of value function.  Imagine if a nefarious hacker gets a hold of your secret Bitcoin key and siphons away all of your coins.  Or a family member who recently got sucked into an online gambling habit.  Those coins are long gone.

The Master Protocol includes the concept of Savings and Guardian Addresses, which allow for the reversal of transactions should a Savings Address become compromised.

Trustless Trading on Bitcoin

Today we can send bitcoins to each other and that is a great innovation reducing costs of value transfer.  But let’s say you wanted to trade some Dogecoin for some Litecoin, you have to trust an exchange.  Even if you know the person running that exchange and he or she is a real stand up person, you need to trust that they have some real security professionals locking that exchange down better than Fort Knox!

Bitcoin’s protocol can be extended to allow for the trading of multiple currencies or other property in a completely trustless manner.  Master Protocol addresses this and is the first to have trustless trades on Bitcoin’s network between two properties.  The first such trades occurred in November 2013 using Test Mastercoins and Bitcoins.

To be continued…