2013-05-20

Bitcoin Was Designed To Be Regulated

The most disruptive innovations often clash with existing legal frameworks. Bitcoin may have been designed with that idea in mind.



By Bitcoin standards, it's been a fairly low-key month. Yes, there's been some new and almost certainly wrong speculation that Bitcoin's creator might be Japanese mathematician Shinichi Mochizuki. And yes, the Department of Homeland Security seized the Dwolla account of a Mt.Gox subsidiary for failing to register as a Money Service Business, effectively cutting off the easiest way for U.S. consumers to transact in Bitcoin.

But the government's action against Mt.Gox is of particular note for being a relatively mundane development. Far from being an attempt by the government to shut down Bitcoin, the action appears to be in response to Mt.Gox's failure to comply with the regulations that make the currency legal. Yes, this means that businesses who want to deal with Bitcoin in the U.S. will have to deal with the country's regulations, but this should not have been surprising to Bitcoin adoptees. In fact, it's likely something Bitcoin's creators were counting on all along.

Rather than trying to work within legal frameworks, the most disruptive innovations often outpace the law. Bitcoin is a bet that fiat-based national currencies no longer make sense in a world economy dominated by global trade. Precisely because Bitcoin isn't controlled by any central power, the U.S. must be extremely careful about how it regulates the currency, or risk giving other, more entrepreneurial countries opportunities to use it against the dollar. Writing in Daily Forex, Quantitative Strategist Alan Edwards explains:

If western financial interests continue their program of regulation to squelch Bitcoin, expect other markets to step up to the plate, adopt crypto currencies, and provide markets. Imagine if the Asian axis Hong Kong adopted Bitcoin as standard, essentially weaponizing cryptocurrencies against western currencies. Imagine rebel BRICS deciding to use Bitcoin as their currency of choice for trade. The ‘game’ of Bitcoin is not controlled by any nation, its regulators or its banks, it is a GLOBAL phenomenon, one entering existing currency wars.

This is the true power and purpose of Bitcoin. The crypto-currency was deliberately designed to mature too slowly for most people to recognize its potential before it was too late to stop. Now, enough money flows through the system that governments must take it seriously if they wish to keep collecting taxes, for example. But if they regulate it too aggressively, the capital now invested in Bitcoin--both in the currency itself and the startup ecosystem surrounding it--provides ample incentive for more open markets to emerge to route around attempts to block it.

Most importantly, the people trading in Bitcoin understand this. Throughout all of this turmoil, the price of the currency has remained remarkably stable, and as Edwards notes, there's increasing quantitative evidence that the Bitcoin market is largely driven by economics, not media attention. Today, 1 BTC is hovering around $120.50. The 30-day weighted BTC average is $120.07. Since Bitcoin's 70% crash in mid-April, the largest single-day movement has been just over $20. For a currency that oscillated between $220 and $170 in a single day last month, the significance of this relative stability cannot be overstated.

The next few months may determine Bitcoin's long-term fate. If it maintains its recent run of stability despite further regulation attempts, it may be here to stay.



What The Hell's A Bitcoin?

Bitcoins are a decentralized virtual currency that rely on public-key cryptography. If you buy something with a Bitcoin you're simply transmitting a symbolic token stamped with a complex number that transfers ownership to someone else. Unlike traditional banking, which keeps customer information private, Bitcoin transactions are transparent so the "market" knows when a Bitcoin is spent but not the owner's identity. Money supply is increased by users who "mine" Bitcoins by dedicating computer processing power to the Bitcoin network. Bitcoins are not regulated by any government or bank, and the currency has seeped into criminal activities. As a result, legislators are threatening crackdowns, and some claim it is a vast scam.

From: The Bitcoin Crypto-Currency Mystery Reopened by Adam L. Penenberg October 11, 2011.


Previous Updates

Bitcoin may be the world’s most permanent digital record-keeping system. Thanks to a quirk in Bitcoin’s design, any miner can add data to a newly minted block, and anybody can embed a message into a Bitcoin transaction if they don’t mind their money becoming useless.

Bitcoin miners and experimenters have been using these methods to embed data into the system for years. In fact, the first Bitcoin block ever mined contains a message from its pseudonymous creator, Satoshi Nakamoto, that alludes to the inspiration for the crypto-currency:

The Times 03/Jan/2009 Chancellor on brink of second bailout for banks

Looking for messages hidden inside the blockchain is trivially easy. All you need to do is download the original Bitcoin client and execute a simple unix command called “strings” on any of the blockchain database files the client downloads from the network. It turns out that many users have stored information in the blockchain, going back to the beginning of the network. In some sense, these messages are the real-time history of a new kind of money coming of age. If Bitcoin survives into the far future and becomes the currency of record, you can imagine historians sifting through the strange mix of IRC-like chatter, artifacts left behind by machines and embedded messages for insights into how the currency developed. They won't come away disappointed.

One of the most popular examples is a tribute to engineer Len Sassaman, which security researcher Dan Kaminsky entered as part of an experiment with transactions in 2011:

View on GitHub

Here’s another example from before Bitcoin’s recent popularity. Mining pool Eligius, run by a Bitcoin contributor known as “Luke-Jr,” embeds prayers and Bible verses into its blocks. Many of Bitcoin’s atheist devotees objected to Luke-Jr’s religious embeds by calling him out both on Bitcoin forums and in the blockchain itself, where you can see the prayers interrupted by random strings, insults and even a rickroll:

View on GitHub

As Bitcoin became more mainstream and blocks harder to mine, in-fighting in the blockchain became nearly impossible. Embedded messages became less frequent and less human, reflecting the massive, organized mining pools now needed to discover new blocks:

View on GitHub

Recently, however, users have found a new use for Bitcoin’s messaging capabilities: Distributing controversial information. On April 6, 2013, a user deposited code for a python program designed to embed files into the blockchain, which was used to embed 2.5MB of WikiLeaks documents two weeks later.

In this way, Bitcoin is starting to become more than just a currency: It’s a permanent, distributed publishing system. Because of the way the network verifies transactions, every single user must download the entire ledger (or use an online wallet that stores a copy) to use it. The upshot of this is that if you need to send a message that’s hard to trace but can’t ever be deleted, Bitcoin is the perfect system. Assuming you do it right, your message will be downloaded and shared by hundreds of thousands of clients around the globe - more redundancy than any cloud storage system - and be a part of the blockchain for the rest of the currency’s existence.

Embedding data like WikiLeaks cables into the blockchain is an ingenious way of making sure no government ever deletes it. But the practice has some users worried because of other things someone might embed.

Yesterday, a long-running fear among Bitcoin enthusiasts was realized when someone embedded a page from The Hidden Wiki containing Tor network links to child pornography. As a result, what started as a platform for embedding relatively innocent insider arguments into the network is now a serious problem for the currency.

At the very least, it poses a publicity problem for Bitcoin as it tries to become more mainstream. There are many who will balk at knowing that merely by sending money over the network, they’re potentially downloading and distributing links to illegal material.

The worst-case scenario is far more dire. In most countries, it is illegal to possess and distribute child pornography. By uploading and downloading the blockchain, every user of the system is in some sense guilty of sending millions of others links to illegal material.

Whether or not a government could actually prosecute an individual for downloading the blockchain is one issue, and we’ve reached out to some legal experts for opinions. Some of the more paranoid Bitcoin users are already worried that governments could use the links as an excuse to issue a warrant for and seize any computer that has Bitcoin installed.

Here’s a more interesting and, if you’re a Bitcoin enthusiast, scary thought: the person behind the embedded data probably knows all of this. What if one of Bitcoin’s coolest hidden features just became an attack vector?


Will paying with Bitcoin soon be as simple as clicking a link? Maybe. The Web Hypertext Application Technology Working Group (WHATWG), which maintains one version of the HTML5 specification, has whitelisted the "bitcoin": URI scheme. This means that browsers conforming to the WHATWG spec can allow websites and OS-level binaries to register themselves as handlers of bitcoin: links, similar to how browsers currently allow mail apps to handle mailto: links.

Christopher Mims, writing in Quartz, thinks this could be a big deal for the currency:

Imagine you’re buying socks or more likely, since this is bitcoin, assault rifles stuffed with heroin. On the checkout webpage, the “buy” button could use the “bitcoin:” link, which would automatically pop open your bitcoin wallet, which might reside in an external application, on another website, or even in your browser itself. In any event, it would make paying with bitcoin dead easy and absolutely universal.

I'm not sure if it's a major development. Yes, it makes payment easier, but the learning curve remains steep: You still have to set up and learn how to use a wallet, download the entire blockchain, and figure out a secure way to convert to and from other currencies. Moreover, there are hundreds of officially recognized URI schemes ranging from the commonplace (http:, https:) to the obscure (tn3270:, z39.50s:). Recognition doesn't automatically lead to widespread acceptance and usage.

What is interesting is the mere fact that Bitcoin can be officially recognized, whereas payment services like PayPal and Google Checkout cannot. Hacker News user munimkazia summarizes the difference:

Both paypal and googlecheckout are implemented in one way. It is not a protocol. Only the service's website can handle the request for payment in those currencies. Bitcoin is decentralized. The user can install/associate any service/application to send bitcoins, much like emails using mailto:

If nothing else, the recognition underscores one of Bitcoin's key strengths over traditional currencies: It was designed with Internet infrastructure in mind. Much like email, anyone can build a client that handles transactions. Future creators of networks of all kinds would be wise to learn from this example and build their products to be compatible with underlying web infrastructure rather than trying to lock users in.


April 15-17, 2013

So, Bitcoin Crashed. Now What?

Writing about Bitcoin is difficult because it's hard to determine what's actually news. Since I last wrote, Bitcoin rose above $200, proceeded to lose over 70% of its value, and is now trading at around $85 after a small recovery. Part of the reason I didn't cover these movements was that I was on vacation, but I also hesitated because Bitcoin has always been subject to wild fluctuations. Keeping track of these movements is important if you're trying to make money on Bitcoin or buy and sell products using it, but it's not really anything out of the ordinary given the history of the currency. In fact, it would be more newsworthy if, all of the sudden, it stopped fluctuating wildly.

Instead, the tumultuous movement makes Bitcoin a risky investment, and most of the people who follow it simply aren't convinced of its long-term utility. The experts I talked to are all still waiting for Bitcoin to stabilize at a predictable price point over a 30- to 60-day period, which doesn't seem likely to happen anytime soon. Other analysts are far more bearish, and see the crash as a sign that the experiment with Bitcoin is over.

Mirroring concerns I wrote about two weeks ago, Washington Post economics columnist Neil Irwin advanced a theory that Bitcoin's built-in deflationary tendency caused the bubble because the ecosystem was unable to cope with demand rising much faster with supply. This could be a major, lasting vulnerability. Because Bitcoins are produced at a reliable rate of one block every 10 minutes, there is effectively no way to use monetary policies that might counteract speculation. Further compounding the problem, there is still no easy way to short-sell Bitcoin, making it difficult to determine whether a rapid rise in price is a bubble or an actual increase in value.

In addition to structural problems, both Irwin and New York Times columnist and Nobel Prize-winning economist Paul Krugman pointed to a philosophical problem with Bitcoin: By attempting to be completely free of human intervention, it may be impossible for it to ever meet the definition of currency.

Money is, as Paul Samuelson once declared, a “social contrivance,” not something that stands outside society. Even when people relied on gold and silver coins, what made those coins useful wasn’t the precious metals they contained, it was the expectation that other people would accept them as payment.

This point becomes especially important when you look at how drug traders on Silk Road, still the most popular use of Bitcoin, have adjusted to the currency's movements: Surprisingly little according to Forbes writer Andy Greenberg, who collected quotes from traders and the site's founder. For users of the site, the value of the currency isn't that it "stands inside society," but in fact the opposite: It operates on the fringes and this, combined with the anonymous nature of transactions, allows for more secure trading of illicit merchandise than any traditional currency can provide. Although Greenberg found that some dealers are ceasing trade in the hope that the currency's appreciation will make money faster than selling goods, the site has seen little disruption because most users don't value the currency itself. They just want drugs.

For law-abiding citizens, what is Bitcoin good for right now? At the moment, probably just gambling. If that changes, I'll let you know.


April 4-7, 2013

Bitcoin Attacks Increasing

Last week, several Bitcoin experts told us they're looking at Bitcoin's ability to withstand attacks as a sign that the crypto-currency is maturing. With Bitcoin now hovering at around $190, hackers are increasingly trying to take advantage of potential profits.

At the end of last week, popular online wallet service Instawallet was forced to shut down due to unauthorized access to its database. Leading Bitcoin exchange Mt.Gox says attackers trying to manipulate the price of Bitcoin are targeting it with increasingly powerful DDos attacks. Meanwhile, Kapersky Labs reported the spread of malware which, among other things, enlists the infected machine's CPU as part of a Bitcoin-mining botnet.

If the currency maintains its value despite these attacks, it will be a very good sign for Bitcoin and its supporters.


April 3, 2013

"The Harlem Shake of Currency"

To date, our coverage of Bitcoin has been primarily bullish. Not everyone views it that way. Heidi Moore of The Guardian, for example, believes that Bitcoin is being blown out of proportion by finanicial media due to its spike in value.

The article contains some debatable claims, including that it was created "to do things on the internet without getting caught," when its author claims it was designed as a reaction to the 2008 fiscal crisis, and that miners "release Bitcoins at their own discretion." Still, Moore's right that despite the hype, relative to the global economy, very little value-- about $1.4 billion at the moment--is tied up in Bitcoin. It could very well just be a passing fad. Even if it is, our take is that it's worth discussing because of the way the nascent crypto-currency is forcing the world to consider the shortcomings of traditional sovereign money.

Why Bitcoin Doesn't Behave Like Money...Yet

“When drug dealers and smugglers use your currency, it's a stamp of approval," says market analyst Nicholas Colas. So why doesn't Bitcoin behave like money?

April 1, 2013

The Race To $100

On Monday morning, Bitcoin climbed above $100 for the first time on the Mt.Gox exchange. The currency now has a market capitalization over $1 billion, making it more valuable than some sovereign currencies. Bitcoin's continued resiliency is remarkable given that even its basic infrastructure is still far from stable. Over the weekend, Mt.Gox was hit with a "stronger than average" denial of service attack that shut down trading and the currency briefly fell to a low of $75 on Friday on news that Cyprus will allow banks to reopen.

What If The Bitcoin Bubble Is Real?

Bitcoin might well be overvalued. But what if it's overvalued for the same reason that any currency or commodity can sometimes be subject to a bubble, and not just because it's a fashionable and fascinating alternative currency?

We spoke with Eli Dourado, Research Fellow with the Technology Policy Program at George Mason University's Mercatus Center, on what is driving Monday's spike in value. Dourado said there are many factors, but there's "good evidence" that the situation in Cyprus is on trader's minds, even if they aren't in the island nation.

It could even be people in the U.S. realizing that Spanish people are interested and so they preemptively bid up the currency. So it could be complicated series of events driving up the price even if it's Cyprus.
-Eli Dourado

Last week, a suggestion by Euro Group President Jeroen Dijsselbloem that Cyprus's handling of the crisis might be a "model" for other countries caused markets to drop. Dourado believes this announcement may have triggered increased interest in Bitcoin, but he doesn't think the crypto-currency's sudden popularity is different from any other hedge investment.

I think it's only a good hedge if at some point there's a way to spend it. If they didn't think there was going to be a good way to spend it they would probably buy gold.

Dourado was also quick to dispose with the notion that Bitcoin is enabling small investors to escape regulations.

The people who are moving money around in response to this crisis are probably not your grandmother worrying about her bank balance and saying, "I'm going to buy Bitcoin with my bank balance." These are more sophisticated people likely to be targeted by these government haircuts.


March 27-29, 2013

More Companies Line Up To Support Bitcoin

Expensify, the plucky San Francisco-based travel expenses startup, announced that they will offer Bitcoin as an option for payouts. The feature is designed to give employees a way to avoid costly transaction fees for converting currencies. Expensify is the largest and most mainstream enterprise company so far to adopt Bitcoin.

OkCupid, one of the world's most popular online dating sites, may be the next major, mainstream company to accept payment in Bitcoin. In email screenshots posted to Reddit, the company's support team appears to have already accepted at least two manual payments using Bitcoin and says it's hoping to support the crypto-currency "in the next couple of months." We have reached out to OkCupid and are waiting for comment.


March 25, 2013

Bitcoin ATM To Launch In Cyprus

Following on the heels of a tabletop Bitcoin ATM demonstrated in New Hampshire in February, self-described anarcho-capitalist and Dollar Vigilante Editor-in-Chief Jeff Berwick announced plans to deploy the first public Bitcoin ATM in Cyprus. Still trying to stave off financial ruin, the country has limited cash withdrawals from the island's two biggest banks to 100 euros per day.

"If we did this now, and we are moving quickly to make this so, we would be the only functioning ATM on the island," writes Berwick.


March 22, 2013

Alberta Man Tries To Sell House For Bitcoin

"I just thought it would be cool to sell it for bitcoins," says Taylor More of Alberta, Canada.


March 18 - 20, 2013

Why The U.S. Government Wants To Regulate

Although it doesn't mention the currency by name, new guidance published by FinCEN, part of the U.S. Treasury Department, details how it plans to regulate virtual currencies. The guidelines require exchanges, which allow users to buy and sell Bitcoins, and miners, who "find" and sell Bitcoin for other currencies, to register as "Money Services Businesses" (MSBs). MSBs are required by the government to institute anti-money laundering programs and report suspicious activity on their networks.

How The Software Industry Is Adding Legitimacy

Bitcoin users are skeptical about the guidelines, but the biggest players in the budding industry are surprisingly positive. Timothy B. Lee at Forbes thinks the move shows that the U.S. government doesn't see the currency as a threat and won't act to shut it down. Mt.Gox, the popular Bitcoin exchange that recently partnered with Silicon Valley-based startup CoinLabs to make trading more liquid in the U.S., says the guidance is "a good step forward for Bitcoin."

How Bitcoins Can Rival Fiat Currencies

Just days before the FinCEN guidelines were released, the Cyprus government announced a now-abandoned plan to tax personal savings accounts in an effort to raise enough euros to keep the country solvent. In response to the announcement, downloads of Bitcoin apps shot up in Spain, another country threatened by Eurozone instability. Because Bitcoin transactions do not go through a central authority, they are difficult for governments to tax.



Previous Coverage on Fast Company

[Image: Flickr user Marcel Grieder]