Some Thoughts on Cryptocurrencies and the Block Chain

Much of the discussion about cryptocurrencies has naturally centered around Bitcoin. Also, this discussion has been particularly focused on the role of Bitcoin as an alternative currency. However, I think that the most important aspect of Bitcoin (and cryptocurrencies more generally) is not necessarily the alternative currency arrangement, but the block chain. It seems to me that the future viability of cryptocurrencies themselves is not as an alternative to existing currencies, but as assets that are redeemable in a particular currency with payments settled much more efficiently using block chain technology.

For those who know little about cryptocurrencies, the block chain can be understood as follows. A block chain is a date store, or computer network in which information is stored on multiple nodes. In the case of cryptocurrency, such as Bitcoin, the block chain is used as a ledger of all transactions. Since every node has access to the block chain, there is no need for any centralized record-keeper or database. Transactions that are carried out using Bitcoin have to be verified by the nodes. A successful transaction is then added to the block chain. Individuals using the system must therefore have balances of the cryptocurrency recorded on the transaction ledger in order to transfer these balances to someone else. In addition, once the nodes verify the transferred balance, the transaction is time-stamped. This avoids scenarios in which people try to double spend a given balance.

This technology is what creates value for Bitcoin. One explanation for why money exists is that people cannot commit to future actions. The lack of commitment problem makes credit infeasible. Money is an alternative for carrying out exchange because money is a record-keeping device. The block chain associated with Bitcoin is quite literally a record-keeping device. It has value because provides a record of transactions. In addition, this simplifies the settlement process and therefore reduces the cost of transfers and settlement.

The benefit of using Bitcoin is thus the value of the record-keeping system, or the block chain. However, in order to be able to benefit from the use of the block chain, you need to have Bitcoins. This is problematic since there are a number of reasons that you might not want Bitcoins. For example, maybe you are perfectly happy with dollars or perhaps you’ve noticed that there are not a whole lot of places willing to accept Bitcoins just yet. Also, you might have noticed that the exchange rate between Bitcoins and dollars is quite volatile.

So if you are unwilling to trade your dollars for Bitcoins, then you don’t have access to the block chain and cannot take advantage of the more efficient settlement. This, it seems to me, is a critical flaw with Bitcoin.

Nonetheless, the technology embodied in Bitcoin is available to all and can therefore be adapted in other ways. Thus, the critical flaw in Bitcoin is not a critical flaw for cryptocurrencies more generally. The value of these cryptocurrencies is in the blockchain and the true value of the block chain is in figuring out how to use this technology to make transactions and banking better and more efficient. There are two particular alternatives that I think are on the right track, NuBits and Ripple.

Think back to pre-central banking days. Prior to central banks, there were individual banks that each issued their own notes. Each bank agreed to redeem its bank notes for a particular commodity, often gold or silver. Bank notes were priced in terms of the asset. In other words, one dollar would be defined as a particular quantity of gold or silver. This therefore implied that the price of the commodity was fixed in terms of the dollar. In order to maintain this exchange rate, the bank had to make sure not to issue too many bank notes. If the bank issued too many notes, they would see a wave of redemptions, which would reduce their reserves of the commodity. In order to prevent losses to reserves, the banks would therefore have an incentive to reduce the notes in circulation. The peg to the commodity therefore provided an anchor for the value of the bank notes and represented a natural mechanism to prevent over-issuance. Thus, fluctuations in the value of the bank notes tended to result from changes in the relative value of gold. (The U.S. experience was actually much different. Due to the existence of a unit banking system, notes often didn’t trade at par. Again, let’s ignore that for now.)

The way that NuBits work is a lot like these old banks worked (without the lending – we’ll have to get to that in a different post). The NuBits system consists of those who own NuShares and those who own NuBits. Those who own NuShares are like equity owners in the system whereas those who own NuBits are like holders of bank notes. The NuBits are redeemable in terms of U.S. dollars. In particular, one dollar is equal to one NuBit. If I own a NuBit, I can redeem that NuBit for one dollar. So how does NuBit manage to do this when Bitcoin clearly experiences a volatile exchange rate? They do so by putting the trust in the equity owners. Owners of NuShares have an incentive to maintain the stability of this exchange rate. If nobody is willing to use NuBits, then there is little value of ownership in the protocol and the shares will have little, if any, value. Thus, the NuBits system provides an incentive for NuShares holders to maintain the stability of the exchange rate and gives these shareholders the ability to do so. For example, if the demand for NuBits falls, this will be seen by a wave of redemptions. This is a signal that there are too many NuBits in circulation. In order to maintain the exchange rate, NuShares holders have an incentive to reduce the quantity of NuBits in circulation. They can do this by parking some of the NuBits (i.e. preventing people from using NuBits in transactions). This is not done forcibly, but rather by offering interest to those who are willing to forgo engaging in transactions. Similarly, if there is an increase in demand then new NuBits can be created.

But while NuBits has solved the volatility problem in a unique and interesting way, they still suffer from the same problem as Bitcoin. In order to be able to benefit from the technology, you need to hold NuBits and there is perhaps even less of an incentive to hold NuBits since it is much harder to use them for normal transactions. Thus, until cryptocurrencies like NuBits can be used in regular everyday transactions, there is little incentive to hold them. Thus, NuBits gets partially where the technology needs to go, but still suffers from a similar problem as Bitcoin.

This brings me to Ripple. Ripple is a much different system. With Ripple, one can set up an account using dollars, euros, Bitcoins, and even Ripple’s own cryptocurrency. One can then transfer funds using block chain technology, but the transfers do not have to take place using Ripple’s cryptocurrency or Bitcoin. In other words, I can transfer dollars or euros just like I transfer cryptocurrencies in other systems. I can do this by setting up an account and transferring the funds to another person with an account through an update the public ledger that is distributed across the nodes of the system. This streamlines the payment process without the need to adopt a particular cryptocurrency. One can even use dollars to pay someone in euros. The way the transaction is carried out is by finding traders on the system who are willing to trade dollars for euros and then transferring the euros to the desired party. This service seems to be immediately more valuable than any other service in this space.

So where do I see this going?

Suppose that you are Citibank or JP Morgan Chase. You could actually combine the types of services that are offered by NuBits and Ripple. You have the deposit infrastructure and are already offering online payment systems for bill paying and peer-to-peer exchanges. The major banks have two possible incentives. First, they could offer JP Morgan Bits (or whatever you want to call them) and have them redeemable 1-for-1 with the dollar. They could then partner with retailers (both online and brick and mortar) to offer a service in which JP Morgan deposit holders could carry around something akin to a debit card or even an app on their phone that allowed them to transact by transferring the JP Morgan Bits from the individual to the firm, charging a very small fee for the transfer. They could partner with firms for online bill paying as well. Alternatively, they could skip the issuance of their own “bank bits” and simply use their block chain to transfer dollar balances and other existing currencies. Whether or not the banks decide to have their own cryptocurrency for settling payments would be determined by whether there are advantages to developing brand loyalty and/or if retailers saw this as a way to generate greater competition for developing cheaper payments while maintaining the stability of purchasing power with the “bank bits.”

The basic point here is that banks could see a profit opportunity by eliminating the middleman and transferring funds between customers using the block chain. The payments would be faster and cheaper. In addition, it would provide retailers with much better protection from fraud.

Citibank is apparently already exploring the possibilities, developing a block chain with a cryptocurrency called “Citicoin.”

Regardless of what ultimately happens, it is an interesting time to be a monetary economist.

18 responses to “Some Thoughts on Cryptocurrencies and the Block Chain

  1. “The NuBits are redeemable in terms of U.S. dollars. In particular, one dollar is equal to one NuBit. If I own a NuBit, I can redeem that NuBit for one dollar.”

    Are Nubits redeemable in one dollar or one dollar’s worth of NuShares?

  2. “The benefit of using Bitcoin is thus the value of the record-keeping system, or the block chain.”

    I don’t need to use (i.e. hold) bitcoin to get the benefit of the record-keeping system. I can see the entire blockchain with something like even though I’m not a bitcoin owner. Yes, the blockchain has value because provides a record of transactions, but that doesn’t explain why an individual bitcoin, which is littler more than a spot in the ledger, should have some positive value.

    • According to their site, 1 NuBit is equal to $1. Here is a quote from their homepage:

      “Imagine you see a cup of coffee selling for $1.79 US. How much will it cost in NuBits?

      1.79 NuBits of course. No complex math at the point of sale is needed. Buying and using NuBits at $1.00 US means you will no longer need to keep track of tax gains or losses on each purchase too, unlike other digital currencies like Bitcoin, Litecoin, or Dogecoin. Buying products and services using digital currencies has just been made easier with NuBits.”

      Also, regarding Bitcoin, I was making perhaps a different point (albeit poorly). I was making an implicit comparison to something like Ripple. The point I was trying to make is that in order for me to take advantage of the lower transaction costs associated with the block chain, I need to first purchase Bitcoins whereas with Ripple, I can open up an account with dollars, euros, Bitcoin, etc. and still use the block chain.

      • “I need to first purchase Bitcoins whereas with Ripple, I can open up an account with dollars.”

        Ok. Although you still have to sell your conventional dollar deposit and buy a dollar-denominated Ripple IOU, incurring transaction costs. But at least you get a stable-valued IOU rather than crazy bitcoin.

  3. JP: NuBits aren’t really redeemable. Their value fluctuates on an open market. However, their value is stabilized by those in the NuShares market. Here’s a neat process map. You can also access the white paper there.

    • Will,

      I suppose that they’re not redeemable from NuBit, but you can sell your NuBits in a market, no? And if the shareholders are doing their job probably, the dollar price should be approximately $1.

      • Correct. If transaction costs were zero, the mechanism would guarantees NuBits exchange for $1 (if people are using it) or $0 (if not).

        Still, a NuBit is not a redemption claim. It just has an interesting supply mechanism that tends to stabilize its value.

    • I’ve tried to read nuBits marketing material before and find it confusing. The odd thing with nuBits is that the supply can’t be reduced. You get the uncomfortable result that when people decide that they no longer want to hold the stuff, the incentive that is supposed to tilt them back towards holding nuBits is to pay higher interest, ie to offer them even more nuBits. There is a whiff of indeterminacy here.

      bitUSD also maintains a peg. I find it much easier to understand and wrote about it here.

      • “The odd thing with nuBits is that the supply can’t be reduced.”

        This is actually no longer true. The ever increasing supply of NuBits due to parking interest was identified as a major problem soon after Nu was launched. Since then we’ve taken steps to change the design of the system. Parking interest can still be used to entice people to remove their NuBits from circulation, but if interest needs to be provided for longer periods of time or the rate needs to be raised ever higher, it’s a clear signal to NuShareholders that the NuBit supply is too high and needs to be decreased.

        What happens then is shareholders will vote to dilute themselves by increasing the supply of NuShares, auction them off and use the proceeds to purchase back NuBits and destroy them, thus permanently reducing the supply. This method of decreasing the supply has already been used. There used to be 1.8 million NuBits. Shareholders reduced the supply to under 550k.

        When demand picks back up again once our decentralized exchange is released, we will most likely have to create more NuBits to satisfy the demand increase. Once these new NuBits are sold to buyers, the proceeds will then be used to purchase back NuShares and destroy them, thus returning the value to shareholders that was taken from them due to NuShare dilution.

        This new feature is now mentioned in our price stability section…

        It’s also talked about greatly in our history section, which explains all the major events and design changes the Nu network has undergone since its launch in 2014…

      • “The odd thing with nuBits is that the supply can’t be reduced.” is not true. There’s a burn mechanism that has already been successfully used.
        If there’s an oversupply of NuBits they are bought by Nu and burned (permanently destroyed). The money for that is available by issuing NSR (the shares of Nu) and selling them.

      • “There’s a burn mechanism that has already been successfully used.”

        I haven’t been able to find a precise explanation for the rule that determines when NuBits are burned.

      • You can find an explanation of the tiered liquidity model of which NBT burning is a part here (tier 6):

        Regarding rules for when to burn is here an example:

        In general: burning NBT or other financial decisions are in the hands of the Nu shareholders (owners of NSR). It is their responsibility to keep NBT stable. So this motion to burn the NBT was voted for by NSR holders. It passed. NSR got sold, NBT bought and burned.
        If the NSR holders fail, the value of NSR plummets, likely close to 0.
        So they have a very strong incentive to do all that is necessary to keep the peg stable.
        That includes diluting the shares by (issuing and) selling new shares to provide Nu with the money for an NBT buyback (to burn them) in times of NBT oversupply.

  4. Josh: It seems we are more or less on the same page. I see little hope for bitcoin (and other altcoins). But the odds that the blockchain technology is widely adopted to process transactions seems quite likely (provided that it is, in fact, a cost-reducing technology… as it seems to be at the moment). A lot of financial firms are looking into the blockchain technology. Even the Fed has considered it! I’ve written up some thoughts along these lines in a forthcoming paper at Independent Review.

    • Great. I’ll check it out.

    • ” (provided that it is, in fact, a cost-reducing technology… as it seems to be at the moment).”

      Yes, that’s key. I’m not sure that distributed ledgers are necessarily cheaper than centralized ones when it comes to processing transactions, but I can be convinced. I worry that the main cost that a money transmitter faces is complying with regulations. Who cares if a decentralized transactions technology is a bit cheaper if 99% of the remaining costs are regulatory and can’t be cut?

  5. Hi Josh. We appreciate you writing about NuBits. We thought we’d point out that we’ve made several additions to our design since the original white paper was released, which is what your commentary appears to focus on.

    In particular, we’ve added a mechanism that finally allows NuBits to be destroyed and permanently removed from circulation, using the issuance of new NuShares. It is designed to be a last line of defense in the event of a major negative demand shock.

    As well, our group liquidity pools have created a competitive element to providing liquidity to the network to ensure that the cost competitiveness of the network is increasing over time.

    You can read about some of our new price stability innovations here:

    And for a full up-to-date history of the Nu network, check out

    We enjoy reading your work! Thanks for your impartial analysis of our network.

  6. This is one well-written article about what really is the thing with Bitcoin: it created a way to transfer value without any trusted participants beyond the sender and the receiver.
    Your assessment of the current situation of NuBits is correct: “Thus, until cryptocurrencies like NuBits can be used in regular everyday transactions, there is little incentive to hold them.”
    But Nu is still in its infancy.
    Developments which improve the utility of NuBits are in the making. Some are already quite usable.
    For example NuDroid is a mobile wallet with that you can pay with NBT, but with BTC and lots of other crypto assets as well. NuDroid stores NBT and uses to convert them at the point of sale to whatever is requested as payment method (needs to be supported by, though…).
    Or “Blocks & Chains Decentralized Exchange” ( is just being created. As this exchange will be truly decentralized it will not have direct access to fiat systems. NuBits will be the USD equivalent for trading pairs.
    …the future of Nu has just begun – using blockchain technology invented by Bitcoin and refined (in terms of sustainability) by Peercoin.

  7. The Greek money crisis should be averted by the introduction of New Drachmae. This could be designed to work in the same way as proposed here, without the need for any more dealings in Euros. Money would be able to circulate again in Greece without the need to borrow any more, and since outsiders would not recognize the new currency there would be no loss by corruption and spending abroad.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s