BTC-DPD: Bitcoin Distributed Price Discovery

As you may have seen during the last seventy two hours, problems at a single exchange, the popular MTGOX, have unleashed mass confusion amongst the computer illiterate Bitcoin watchers, as they falsely claim that people have “lost money” or that Bitcoin has “crashed”, or that the “Bitcoin Bubble” has popped.

There isn’t much we can do to make the computer illiterate literate, and really they should not have to understand how Bitcoin works in order to use it successfully to make a simple purchase, any more than they should be expected to understand how SSL works in order to make a credit card purchase privately with their browser.

The recent MTGOX problems are however a serious warning of the flaw inherent in centralized software services in an environment that is under sophisticated military grade attacks from both the State and malicious or curious entities who know how to use a command line.

In the same way that file sharing went through several iterations that took it from centralized index servers (Napster) to distributed content discovery and indexing (Magnet Link powered Bittorrent), Bitcoin price discovery must quickly move to a decentralized model so that there is no single point of failure that can disrupt people’s Bitcoin activities as they use it to interface with the offline world.

As long as there is a single very large price setting node calling the shots and broadcasting dictated prices for Bitcoin that are considered (rightly or wrongly) authoritative, the entire Bitcoin economy is at extreme risk of systemic confusion or even shut-down. Right on que, MTGOX has just announced that it is suspending trading for 24 hours to allow people to ‘cool off’:

[blackbirdpie url=”https://twitter.com/MtGox/status/322355614414147588″%5D

They are the owners of their service, and they have an absolute right do do whatever they like with it. What this means however, is that at the will of a single company, for whatever reason, the entire price discovery mechanism has been suspended for an arbitrary amount of time. This is not acceptable to anyone who wants to use Bitcoin in a serious manner, without any randomly imposed restrictions or self interested corporate oversight.

Something must be done.

The solution to the Bitcoin price discovery problem is the similar to the problem that Bitcoin itself solves; move the discovery mechanism into a P2P network that no one owns and that is invulnerable to a crippling attack from any source.

Here is how it could be done.

Rather than rely on the a small number of large, very exposed and vulnerable one to many exchanges, what is needed is a system of price discovery that is distributed and not vulnerable to DDOS, infiltration, insider manipulation (that is to come, for certain in the present arrangement) or the predation of the State.

Since all Bitcoin users know when they need BTC and are on the network, we can connect them via a P2P app that allows them to:

  1. Make a request at a price and amount
  2. Transmit that request to all other users and nodes
  3. Calculate the current price from aggregate demand
  4. Use GPG web of trust to keep spam out and users honest

When this is done, it will be impossible to disrupt the price finding mechanism because it will be completely distributed and un-attackable.

Since no large files are being transmitted, as in the case of P2P file sharing, the responsiveness of this application should be very high at all times. Also, there is no need to store long term historic data in the network, so there should be no synchronization problems; this system will be “instant on” once your node is discovered and connected.

Built-in public key cryptography via GPG and users signing each other’s keys will keep the aggregated quoted prices free from tampering. The web of trust will reward honest people and push down the system spammers. Successful trades could be detected and used to shape user reputation and ad to users trust score by querying the blockchain and matching the requesters recipient address and the senders address. Ill leave it to you to think up your own mechanisms for verifying and certifying bids and successful trades.

There isn’t a single reason why this or something like it cannot be done, and why the price discovery cannot be real time and completely distributed.

I’m sure that someone somewhere is thinking along these lines, or along better lines; its so obvious in the light of all the file sharing experience, it is inevitable that someone is either building it or is considering building it.

Of course, if it is done right, the people who build this system could charge a tiny fraction of a Bitcoin to participate in it, without having a hand in its day to day, moment to moment functioning. The source of the software clients in their different versions would need to be secured, maintained and improved and this costs money.

Price discovery is something that needs to be addressed urgently. Its a very complex task in terms of software development and the precise model and logic that needs to be used, but the groundwork has already been done in terms of the basic P2P concepts. The question is, who is going to put it together and release it?

If and when it is done, it will be possible to test this software directly in the real world to see if it is reporting the price of Bitcoin correctly, by comparing what it returns, to the prices quoted at the centralized exchanges. Once it is seen that there is a high correlation, then the old price discovery mechanisms can be permanently abandoned for the new robust system I’ve very roughly sketched out here.

Once again, the only proper solution to this price discovery problem is one based on software. There is no need for the State, regulation or anything other than software. The only questions are who is going to write it, release it and how is the maintainance of it to be paid for.

In case you didn’t already understand. the State is not needed to ensure that MTGOX is on-line and available and cannot shut down at its owner’s whim. The State is not needed to protect exchanges from DDOS attacks. The State is not needed for anything. They had no hand in building Bitcoin and the services built on it, and they are not needed now, no matter what happens.

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