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Free Minds & Free Markets

Bitcoin vs. Big Government

How the virtual currency undermines government authority.

Interest in Bitcoin has surged along with its valuation. Last week saw its exchange rate soar past $100 for the first time ever, landing the virtual currency on the front pages of The Washington Post and the Financial Times. Yet the media frenzy, which has focused on the rapidly rising valuation and its possible causes stemming from the bank crisis in Cyprus, is overlooking Bitcoin’s true radical significance—that it can’t be controlled by government.

In his new book, This Machine Kills Secrets, Andy Greenberg recounts the history of the 1990s cypherpunk movement that paved the way for WikiLeaks and Anonymous. The early Internet’s crypto-anarchists foresaw a future world in which widely available cryptography secured personal anonymity and privacy to such an extent that it threatened the authority of the state. Their key insight, Greenberg explains, is that anything that can be done cryptographically can be done without government oversight.

Before eBay or WikiLeaks, cypherpunks like Tim May imagined online markets for information in which buyers and sellers transacted anonymously using untraceable digital cash. Anything from state secrets to private credit reports would no doubt become available for the right price. These ideas were notoriously taken to the next level by the radical libertarian Jim Bell who proposed a system  for anonymously crowdfunding the assassination of corrupt government officials.

While almost all the technology necessary for such black markets was available when the cypherpunks were writing, there was one conspicuous exception: true digital cash.

Until Bitcoin, virtual currencies have in one way or another relied on a third party intermediary, such as a bank or a credit card company, to prevent “double spending.” In the physical world, if I give you a $20 bill, I will no longer have it. You can’t be as sure of that, however, when the cash is a digital file that can be easily copied. The solution has been to have a trusted intermediary keep a ledger of balances and deduct a transaction’s amount from the payer’s account, and add it to the payee’s.

Intermediaries, however, are the regulatory chokepoints at which government can apply pressure. For example, after WikiLeaks released its trove of State Department cables, payment processors such as Visa and MasterCard succumbed to political pressure and refused to transmit donations to the group. PayPal even froze its account so that the group couldn’t access funds it had already collected. As as a result, WikiLeaks has been driven to near bankruptcy.

Today, online gambling is illegal under federal law and the prohibition is enforced through payment processors, which are not allowed to send money to offshore casinos. The infamous Stop Online Piracy Act (SOPA) also targeted financial intermediaries and would have banned payments to suspected pirate websites.

Bitcoin is revolutionary because it solves the double-spending problem without employing an intermediary; there is only the payer and the payee. The system accomplishes this by distributing the ledger of transactions across a peer-to-peer network of users, much like BitTorrent. This allows a record to be kept of all transfers so that the same cash can’t be spent twice, but because it’s distributed, there’s no one central authority keeping the ledger. This makes bitcoins true digital cash. Like dollar bills or euro coins, if you hand them over to a payee, you will no longer have them. And because there is no third party running the ledger, there is no one for the government to pressure or regulate.

(Article continues below video "Bitcoin & the End of State-Controlled Money.")

Much of the discussion around bitcoin today centers on whether it will work as money. Money has three functions: it serves as a medium of exchange, a unit of account, and a store of value. Because Bitcoin is distributed, there is no central banker that can decide to inflate the money supply. Some argue this makes it a good store of value, like gold or Picassos, while others counter that Bitcoin’s historic volatility make it a poor store of value and an unreliable unit of account to boot. Given the public’s fear of currency devaluation in Europe and the U.S., the question of whether you can stash your wealth in bitcoin to avoid capitol controls and inflation is what has been driving much of the media’s coverage of the currency.

Time will tell whether the gold bugs or the skeptics are right, but what’s being overlooked is that it doesn’t matter whether Bitcoin makes it as a store of value or a unit of account for it to work as a medium of exchange. Even if the Bitcoin market remains volatile and never pans out as a good store of value or unit of account, one can imagine users converting their dollars or euros to bitcoins for just long enough to make a transaction; perhaps just minutes. And as long as it works as a medium of exchange, it is the true digital cash that was missing from the cypherpunks’ predictions.

With a little bit of effort, today you can purchase bitcoins anonymously with physical cash. You could then do all sorts of things the government doesn’t want you to do. You could buy illegal drugs on the notorious Silk Road, an encrypted website that has been operating with impunity for the past two years facilitating annual sales estimated  at almost $15 million. You could gamble at various casinos or prediction markets, buy contraband Cuban cigars, or even give money to WikiLeaks. Dissidents in Iran or China can use Bitcoin to buy premium blogging services from WordPress, which now accepts payment in the currency. Perhaps more importantly, Bitcoin makes the cypherpunks predictions of markets for stolen secret information and even assassinations feasible.

Last month, the Treasury Department issued guidance on how it plans to regulate Bitcoin exchanges. This is good news for the currency since it implies the government is looking to regulate its use rather than prohibit it. Confronted with Bitcoin’s potential, it’s not reasonable to expect that Treasury’s money laundering cops would simply let it be. So it’s a sensible approach for them to take because Bitcoin, much like BitTorrent, can be used for both licit and illicit purposes and would in any event be difficult to shut down.

Today physical cash is anonymous, which helps keep one’s purchases private. Cash is also difficult to control: a $100 bill never gets “declined.” As we move to an all-digital world, we should ensure that we retain some type of digital cash that is not tied to a financial intermediary that can spy on or control transactions—even if, just like physical cash, it is put to nefarious uses. The real question facing Bitcoin today, then, is whether law enforcement and regulators will continue to show as much restraint as they have so far.

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  • ||

    Last month, the Treasury Department issued guidance on how it plans to regulate Bitcoin exchanges. This is good news...

    Stop right there. My understanding is that businesses that accept Bitcoin and converts it to paper money for their own use has to register as an MSB (Money Service Businesses) and report all transactions to the government, not to mention open them up to all sorts of additional regulation and filings they otherwise wouldn't have to put up with.

    This isn't the Feds playing nice. They know they can't just straight up shut it down without horrible optics, so they'll go the backdoor route of making it as irrelevant and narrow in use as possible.

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  • WomSom||

    I remember whe nE-Gold thought they were all that. Then the US Government shut em down! I lost A LOT of money in E-Gold.

    www.SurfinPrivacy.tk

  • Corneliusm||

    I realize this may be the first time replying to an anonbot in earnest, but this isn't a centralized currency like e-gold, and there's no way to seize assets or subpoena institutions (beyond the exchanges) to see what people are hiding. Their only shot at discovering wallet contents are mapping transactions or cracking into client machines.

    Also, unlike e-gold, there seems to be a growing number legitimate businesses accepting BTC, and not just porn, drugs, and shady e-marketing scams.

  • A Secret Band of Robbers||

    People keep saying that the government can't shut down Bitcoin, and while that's technically true, they can enact laws that would destroy the domestic value of BTC and devalue it.

    If the US government decided to destroy Bitcoin, they could do it OVERNIGHT simply by reforming the Federal Reserve to make it transparent and accountable, and legalizing major contraband such as marijuana.

    Disclosure: I am long on BTC.

  • A Secret Band of Robbers||

    Three issues that people often overlook:

    1) Shutting down Mt. Gox would cause a temporary but major disruption of the Bitcoin economy since 60%+ of the USD/BTC transactions go through there.

    2) The average Bitcoin user doesn't maintain the kind of informational hygiene needed to hide his dealings from the IRS, should they take an interest.

    3) The value of Bitcoin can't sustainably exceed the total value of the assets you can buy with it. The closest thing to a backing BTC has is drugs. Technically, since it's trivial to buy currencies with it, that isn't of critical importance, but should, say, the US and EU jointly crack down on BTC offshoring and money laundering, targeting major exchanges, devaluation could be fairly disasterous. To stabilize the situation, more vendors need to be able to accept BTC, but the big ones that matter are likely to stay out until they can be sure it isn't an IRS liability.

  • Torontonian||

    1. Bitcoin relies on distributed computing power over a peer-to-peer network solving encryption problems to authenticate the block-chain (transaction history) of every bitcoin in existence. The contributors of this computing power (miners) are rewarded in the form of new bitcoins credited to their accounts. However, the creation of new bitcoins will be scaled back over time, and eventually capped. When there is no reward for contributing computer power, how exactly will bitcoins be authenticated then? You don't know.

    2. While the supply of bitcoins is regulated by an algorithm to max out at 21,000,000 BTC, what prevents other digital currencies from proliferating and increasing the world's virtual money supply? You don't know.

    3. How exactly will you collect, store, redeem or transfer your digital bitcoins, when the government has cut off your internet connection? You don't know.

    4. How exactly does bitcoin's encryption work? You don't know.

    5. Who is this "Satoshi Nakamoto" guy who created it and where exactly did he vanish to? You don't know.

    6. How do you know this extremely smart and equally anonymous dude hasn't rigged some way to profit at your expense? You don't know.

    Good luck.

  • Cytotoxic||

    1) We'll find out in 2040.

    2) There is no 'virtual money supply' since it's not homogeneous.

    3) Well gosh I guess we'll just have to hope the government doesn't detonate an EMP over the US. How will you access your normal cash in those circumstances?

    4, 5, 6) The software is explained online.

    Fisked.

  • A Secret Band of Robbers||

    2. While the supply of bitcoins is regulated by an algorithm to max out at 21,000,000 BTC, what prevents other digital currencies from proliferating and increasing the world's virtual money supply? You don't know.

    That's by design.

    I doubt Bitcoin was ever intended to be more than a demonstration. It certainly wasn't intended to be a multigenerational store of value like gold. In order to encourage adoption, it was made deflationary by design. In order to encourage the development and adoption of other cryptocurrencies, it allows for a certain degree of planned obsolescence.

    It's a piece of open source software, which is supposed to be copied and improved upon. If cryptocurrencies are designed well, they won't run into money supply problems.

    Remember, representative currencies and even precious metals have these kinds of money supply problems, but gold didn't get devalued when platinum was discovered.

    Cryptocurrencies don't conform perfectly to our understanding of how fiat or representative currencies have worked historically. Predicting this market is going to take a lot more creativity than mainstream finance is giving it at the moment.

  • neonvirus||

    Great essay. Thanks for taking the time to research. I wish I could say the same for some of the commenters. ; )

    It certainly wasn't intended to be a multigenerational store of value like gold.

    Nonsense. The network is programmed to release its last coin in 2140. Bitcoin took about a year and a half to write and a year or so to test before it was released to the world in 2009.

    Every Bitcoin naysayer has been proven wrong in the past four years. Keep naysaying. You'll be working for bitcoins in three years.

  • A Secret Band of Robbers||

    It certainly wasn't intended to be a multigenerational store of value like gold.

    Just because that isn't its primary purpose doesn't mean it won't work that way. I should have been more careful in what I said because I have no idea whether Satoshi Nakamoto intended Bitcoins to be long-term value stores; however, that isn't the primary cryptocurrencies, or ANY currencies. Currencies are for exchange primarily, and short-term value stores secondarily, and longer-term as a last resort. That doesn't mean it won't work in long-term--to some extent, while gold is an industrial commodity, it's mostly just a currency with a tremendously successful track record--but that's beyond the scope of currencies. Especially one with a minimum value of zero.

    And even if Bitcoins take off in the next three years, I won't be working for them. In fact, I won't need to work anymore, period.

  • AlmightyJB||

    It certainly wasn't intended to be a multigenerational store of value like gold.

    Not an expert on Bitcoin at all, but I would think that it's main value is transactional and not as a long term store of value. It maintains it's value to the extent people use it for trade. If everyone buys them up just to hold on to them, why would businesses want to bother to start using them, because the holders aren't using them. It seems that the holders would end up with a bunch of pet rocks.

  • TheZeitgeist||

    Nonsense. The network is programmed to release its last coin in 2140. Bitcoin took about a year and a half to write and a year or so to test before it was released to the world in 2009.

    Can you own a fraction of a Bitcoin? If you can't, the twenty-one million cap is a huge liquidity problem.

    Also, any P2P crypto-currency with distributed transaction blocks is going to generate huge files and need mongo bandwidth for each distributed client if its actually being used in any approximation to the scale of modern fiat currencies.

  • don quixote||

    Yes. A bitcoin can be divided down to 8 decimal places. So if a bitcoin were worth a $1 million (Bernanke Bucks) then it's smallest fraction would be worth 1 penny.

  • A Secret Band of Robbers||

    6. How do you know this extremely smart and equally anonymous dude hasn't rigged some way to profit at your expense? You don't know.

    This isn't a minor problem, but it's mitigated by the fact that there are a LOT of people who stand to lose money if bugs/hacks in Bitcoin aren't fixed promptly. The model works pretty well for most open source.

  • dinkster||

    If "he stealz all dem bitcoinz" the currency will quickly become worthless.

  • Mizchief||

    It's that you don't know. Go educate yourself.

  • jili5||

    It's number 1 that I'm most worried about because no one has a clear answer for that. If it's not sustainable then why trust it now? Because if it's not sustainable then oh wait there's another form of currency just like that...fiat currency! So I really want to know how this will work when there's no incentive for miners.

  • setTHEline||

    IMO, BTC is doomed to be crushed by the iron fist of the DOJ. I know I know, it's anonymous and decentralized etc. etc. I'm a big fan of bitcoin, but here is the simple gameplan they will likely use(the same basic outline they used to shutdown online poker).

    1. Make processing transactions to BTC exchanges illegal for some BS reason.

    2. Banks will stop doing business with payment processors to avoid litigation(i.e. bitinstant etc.).

    3. Once processors are on the financial rocks from not being able to process transactions, file lawsuits against them to curb stomp the hell out of anyone who resists.

    While this might be a pessimistic look at the future of BTC, it would be naive to think that government would just allow BTC to out-compete the USD indefinitely.

    IMO the only way for BTC to survive is to have a complete economy in BTC. As long as BTC is still converted to USD in order to produce goods, pay rent, pay salaries, etc. IT IS VULNERABLE.

  • A Secret Band of Robbers||

    IMO the only way for BTC to survive is to have a complete economy in BTC. As long as BTC is still converted to USD in order to produce goods, pay rent, pay salaries, etc. IT IS VULNERABLE.

    I tend to agree. If BTC becomes useful to a large enough number of people for it to survive, it will outcompete other instruments, possibly including major currencies. The question is, will the governments of the world squash it first, or will they move too late?

    Ideally, some country will see the benefit of Bitcoin and adopt it as an official currency of some kind. The first mover will benefit, but it involves getting their central banks to give up. If there's enough of a crisis of confidence in a place like Cyprus without a history of a strong central bank, we might luck out.

  • Stilgar||

    Bitcoin has no intrinsic value so in that regard it is a large fail. Further, because bitcoin can be "mined" there is nothing to prevent a rapid inflation in the supply of bitcoin in "circulation" if individuals or governments direct computing resources at that effort. Likewise, Moores law alone provides inflation to bitcoin.

    An often missed downside is that once bitcoin cirulation is maxed out it will enter a deflationary spiral as there become too many goods chasing too few bitcoins. That it may increase in relative value is immaterial if there are no other competing currencies. And the house you paid BC100K for will be worth less, in BC terms thus forcing you to take a loss, again in BC terms.

  • setTHEline||

    "Further, because bitcoin can be "mined" there is nothing to prevent a rapid inflation in the supply of bitcoin in "circulation" if individuals or governments direct computing resources at that effort."

    That's simply not true. The more computing power directed at mining BTC, the harder it becomes to mine BTC. Do you really think they wouldn't have thought that through? There are some great wiki's on BTC if you really want to understand it.

    Also, don't buy into the whole "deflation is evil" schitck that Keynesians push. I could understand someone hating deflation if they bought a 500k home with no money down and no job (you know, 2005 type stuff). Heaven forbid people's savings actually appreciate.

    Oh and one more thing, you know that USD, JPY, RMB, etc. etc. have no intrinsic value right?

  • billy_ran_away||

    Intrinsic value is something that something has useful by its nature. Gold's intrinsic value is that it looking pretty and some industrial applications. Bitcoin's intrinsic value is that it can zip around the globe nearly instantly and can't be duplicated. Put another way, it is token you can't duplicate and when you transfer it, the transfer can't be traced. You can do a lot of useful stuff with a token of that flavor.

    If it was a solid thing, you could make it teleport into someone's pocket with neither the sender or receiver having to know who sent it and you could sub-dived and recombine the tokens infinitely. It would be wildly useful.

    This isn't just numbers. This is the very nature of a bitcoin. The inability to duplicate it and the finite nature of them are built into their existence. Normal currency tried to copy this property, but it does it imperfectly. Bitcoin does this by its very nature.

    This very essential nature of a token that can't be duplicated but can be transfered without either party knowing each other makes it wildly useful for conducting black and grey market transactions, and perfectly fine for conducting normal market transactions.

    Bitcoins have intrinsic value, it just isn't the more mundane type you are used to.

  • Copernicus||

    " Bitcoin’s true radical significance—that it can’t be controlled by government."

    Unicorns enjoy this same immunity.

  • Baal||

    Unicorns, pshaw. Don't you keep up with the young'uns ? It's all quadricorns and lasercorns now.

  • MarkTT||

    Buying Bitcoins in the UK, directly without intermediators on ebay or other pages (with huges fees) is very difficult , I made this guide with a simple process:
    http://howtogetbitcoinsuk.blogspot.co.uk/
    Best

  • MoreFreedom||

    Given a choice among currencies, strong currencies will drive out the bad ones - often to the dismay of politicians who like to print money to spend.

    Here's to more currency choices! I hope bitcoin survives.

    My concerns with it are the ability to pay bills (mortgage, rent, utilities, food, etc.). As most vendors only accept dollars, it's the currency exchanges that government will target. Government can also prohibit trade using bitcoins (admittedly it won't affect those who transact business using bitcoins) but until I can pay a significant enough portion of my expenses using bitcoins without going thru a currency exchange, I'll likely be on the sidelines. Let me know if I'm wrong.

  • RFID||

    Sadly, this isn't the case when legal tender is involved. When the aspect of legal tender exists, the worst currency is what rises to the top.

    https://en.wikipedia.org/wiki/Gresham's_law

  • obd2works||

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