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This Bitcoin chip is supposed to be the future of micropayments. I'm skeptical.

PayPal cofounder and Facebook investor Peter Thiel is an investor in 21 Inc.
PayPal cofounder and Facebook investor Peter Thiel is an investor in 21 Inc.
Steve Jennings/Getty Images

The 21 Bitcoin Computer, which was unveiled this week, is one of the most highly anticipated products in the Bitcoin world. The company behind it, 21 Inc., has raised $120 million from prominent investors like PayPal co-founder Peter Thiel and the well-known firm of Andreessen Horowitz. According to this list of Bitcoin investments, that makes it the most lavishly funded Bitcoin startup ever.

So this week's announcement left a lot of people confused. For $399, you can get a tiny computer with a customized chip that allows you to generate bitcoins. An incredibly small quantity of bitcoins, in fact — according to one back-of-the-envelope calculation, it will generate around 10 cents' worth of bitcoin per day if run constantly. And depending on where you live, the electricity required to power the device could cost more than the value of the bitcoins generated.

The backers of 21 believe that the ability to generate small quantities of bitcoins is going to become a standard component in digital devices — just as a wifi chip is today. They envision a future where digital currency serves as a lubricant for a wide variety of electronic transactions that aren't possible with today's computers. If 21's technology works, it could deliver something technologists have dreamed about for decades: a practical system for paying for content and online services with tiny payments. For example, 21's technology could be used to power a jukebox that plays ad-free music, or a camera that automatically rents its own online storage.

And 21 has built some impressive technology to help realize this vision. But the vision itself seems to have some gaping holes in it — holes so big that I'm skeptical 21's technology will take off.

21 is selling a chip to turn electricity into money

You've probably heard advertisements telling you to text to a certain number in order to make a $10 contribution to a particular charity. In this transaction, the phone company acts as the middleman, putting the $10 charge on your next monthly phone bill. That makes things more convenient for customers, who don't have to pull out a credit card at the time of donation — or worry that the credit card might get misused.

The technical details of how the 21 Bitcoin Computer works is complicated, but at a basic level, you can think of it as a clever hack for putting charges onto your electricity bill. Inside the 21 Bitcoin Computer is a chip that can efficiently engage in "mining": performing difficult mathematical operations that can generate new bitcoins. These bitcoins have real financial value, but the process isn't free — the chip consumes a lot of power.

The 21 Bitcoin Computer isn't designed for people who want to become professional Bitcoin miners — there are more sophisticated products for that already. Rather, 21 believes that the ability to generate a few pennies' worth of bitcoins per day will open up totally new types of markets that don't exist right now.

Imagine a jukebox that pays for its own songs

The device 21 is selling right now isn't the version of its technology that will eventually be offered to the general public. Instead, it's a proof of concept aimed at developers who — 21 hopes — will begin creating applications that use the 21 chip's capabilities. Over the next few years, they expect the chip will get smaller and dramatically cheaper, to the point where it can be built into a wide variety of third-party devices, much as chips from Intel are today.

Imagine, for example, buying a small speaker that acts as an ad-free jukebox system. You plug it in, name any song, and the device starts playing it. And you never have to pull out a credit card. Instead, the jukebox is generating a fraction of a penny for each song it plays and sending it to the relevant copyright owner. Average consumers never have to think about it — or even understand how it works.

Other 21-enabled products could work in a similar way. There could be a camera that automatically purchases enough online storage for the pictures and videos you take. There might be a tablet that automatically detects wifi networks that are willing to rent out anonymous access for a few pennies' worth of bitcoins. And maybe entrepreneurs can think of other clever ways to use small amounts of digital cash to make our lives more convenient.

As the number of connected devices in our homes and offices grows, 21's technology could help avoid an orphan device problem. That's a situation where companies stop supporting these connected devices, leaving them in a broken or — even worse — insecure state. If each device is able to generate a small Bitcoin maintenance fee each month, it could provide manufacturers the funds they need to continue supporting devices long after they were created.

21 hopes to enable practical micropayments

At this point, you might be wondering why anyone would want to buy a weird money-printing chip instead of making payments through the regular financial system. There are two basic reasons.

One is that for many applications it will be a hassle to input credit card information into a special-purpose device. The Bitcoin jukebox I mentioned in the previous section might not have a keyboard or screen, for example, and it would be convenient if you could just plug it in and have it start playing music.

The more fundamental issue, though, is that the transaction fees of traditional financial networks make very small financial transactions impractical. The overhead of credit card networks means that the smaller transactions get, the larger the fraction that gets eaten up by fees. This is why you rarely see online goods that are cheaper than the 99-cent songs in the iTunes store. Below a dollar, the economics of credit card payments don't work very well.

This is the real magic of 21's platform: The standard Bitcoin network isn't a great platform for micro payments either, but it's an open software platform. And 21 has apparently developed technology to use the Bitcoin network to make very small payments more efficiently than is possible with other payment technologies.

Why users probably won't like Bitcoin micropayments

Technologists have been dreaming of building practical micropayments for a very long time. There have been a number of attempts to build micropayment systems, and so far, none of these systems have really taken off. The investors behind 21 are making a big bet that Bitcoin is the technology that will finally make the concept work.

People have been trying to make micropayments work for so long that the internet theorist Clay Shirky wrote an article way back in 2000 explaining why the micropayment experiments of the dot-com boom hadn't taken off. More recently, as others have tackled the concept, he's written multiple follow-up articles on the topic since then.

In a nutshell, Shirky's argument is that micropayment systems fail because users find them annoying. "There is a certain amount of anxiety involved in any decision to buy, no matter how small, and it derives not from the interface used or the time required, but from the very act of deciding," he wrote. "Micropayments, like all payments, require a comparison: 'Is this much of X worth that much of Y?' There is a minimum mental transaction cost created by this fact that cannot be optimized away."

On the surface, it might seem like 21's micropayment technology actually could optimize away these transaction costs. After all, when consumers buy new household appliances, they don't spend much time worrying about how much power they'll consume. Why should customers worry about a new generation of devices that take a bit of extra power and convert it into money?

But if you think about how this would work in practice, it becomes clear that there would be some serious difficulties. Imagine a future where you have a dozen devices in your house with 21's bitcoin mining chip in them. One month, your electricity bill is suddenly $20 higher than you expected.

Maybe it was just a hot month and your air conditioning was running on overtime. Maybe some of your 21-based devices got hacked, and bad guys are stealing your electricity to generate bitcoins for themselves. Maybe your teenage son recently bought a new off-brand device that generates a lot more bitcoins (and wastes a lot more power) than it promised on the box — and sends the extra cash back to its sketchy manufacturer.

The problem is that you wouldn't know, and there would be no easy way to find out. It's not like your power bill will have an itemized list showing how much electricity each device is consuming. You'd be forced to start measuring the power consumption of the devices around your house — exactly the kind of accounting hassle 21's technology was supposed to eliminate.

In practice, few people are going to want to worry about this kind of issue. It's only going to take a few stories of devices being hacked — or unscrupulous manufacturers overcharging customers — for customers to decide they want to steer clear of devices with built-in bitcoin mining chips.

21 chips will get less and less efficient

The 21 approach has another big problem, too: Bitcoin mining hardware tends to become obsolete quickly. All of the Bitcoin mining chips in the world compete to win a fixed pool of bitcoins. As new, more efficient chips come on the market, the number of bitcoins won by older, slower chips will go down over time.

When you buy a shiny new 21-powered device, it might only cost 70 cents' worth of power to generate $1 worth of bitcoins. After a year, it might take $1.20 worth of power to generate $1 worth of bit coins. A year after that it might cost $2 to generate the same $1.

So devices with built-in bitcoin mining chips would have to be replaced every couple of years to avoid having them waste more and more electricity.

Of course, a device that only works for a couple of years could still be useful. But in that case, it might be more efficient to just load it with pre-generated bitcoins — or even better, just have the manufacturer provide the necessary services for free and charge an extra $10 or $20 for the device. Customers like clear and transparent pricing; effectively billing costs to your electricity bill is just the opposite.