Aug 252013
 

Mohandas Gandhi famously noted in the context of revolution, “First they ignore you. Then they laugh at you. Then they fight you. Then you win.”

In late 2013, Bitcoin has entered the “…Then they fight you…” phase of its existence, and the modus of many detractors takes the form of a barrage of rhetorical ‘what if’ scenarios accompanied by unsubstantiated assertions offered as if they were tested and proven conclusions and prophesies for which the pundit has nothing to lose if his or her prescience is astigmatic.

One typical example of this is Ari Zoldan’s “Bitcoin: Society’s Boon or Bane?” on the Huffington Post website.

According to Betteridge’s Law of Headlines, when a headline ends in a question mark, the answer is, “No.” With a total value in circulation that is less than 2% of Carlos Slim’s personal portfolio, or ¼th of the World Trade Center’s reconstruction cost, Bitcoin poses no threat to the US dollar, fiat currency in general, gold as a reserve asset, or the nation-state. Similarly, Bitcoin will not free the oppressed any time soon, neuter military adventurers, democratize despotic regimes, or make all of your wildest dreams come true. (You have to vote for Pedro for that to happen.)

Bitcoin is a protocol. It is not a revolution, a philosophy, or a political movement.

To ascribe motives to Bitcoin is to heed the public statements of vocal activists to a degree in excess of their importance. My experience over the past few years is that, among Bitcoin users, for every anarcho-libertarian fanboy motivated to bring Sauron crushing to his knees, there is an apolitical yuppie out to make a quick buck and a social democrat out to help the poor of the world gain access to the global marketplace. When one adjusts for the value one’s Bitcoin holdings, I suspect that the apolitical yuppies are in the lead with the social democrats not too far behind and the fanboys in their mothers’ basements.

In spite of this, some individuals take the time to write “J’accuse…!” screeds that, left unchallenged, might confuse the naive and those unfamiliar with Bitcoin (much as the authors themselves seem to be). To wit:

“Bitcoin would have an extremely deleterious effect on our society if its broader economic role were to increase to substantial levels.”

This prophesy of doom is based on the premise that people are predominantly evil and that ubiquitous surveillance of their transactions is all that stands between the status quo and chaos. Given that ‘our society’ is dominated by corporatist governments and firms, this statement is technically true. Widespread use of Bitcoin among the global middle class just might—one day in the unknowable future—erode the influence and power of ‘Quantitative Easing’ (aka inflation), large multinational banks, the World Bank and IMF, and OECD finance ministers among the 83% of humanity that lives in the Middle Income countries.

Whether this is ‘good’ or ‘bad’ is a matter of personal taste and beyond the scope of this essay.

However, this would be relevant only if Bitcoin’s “broader economic role were to increase to substantial levels,” and hedge fund managers, investment bankers, NGO executives, etc. did not adapt to the new reality, which is exceptionally unlikely.

“Bitcoin is a completely anonymous, decentralized currency. It runs on and is monitored by its massive online public network.”

<double-take /> Either Bitcoin is completely anonymous, or it is not. Given that it “is monitored by its massive online public network,” then by definition it is not, as anyone who actually understands how it works can illustrate with a piece of chalk on a sidewalk (pavement). (In the meantime, refer to The Big Book of Bitcoin, which isn’t really all that big.)

Every Bitcoin transaction that has ever been confirmed is recorded for anyone, including law enforcement professionals, to review and analyze. Granted, the identifiers are strings of random characters that begin with the digit ’1′, but each uniquely identifies a Bitcoin account. Should investigators’ Big Data software tie a particular Bitcoin account to, e.g., an exchange or an individual, then all other accounts that transact with that account can be traced. While this might be tedious, it easily can be automated, and it does not require the securing of warrants, jurisdiction-by-jurisdiction across the globe, as is the case with tracing payments through the international banking system.

“Bitcoin could potentially harm our society in three particular ways: by significantly increasing crime, by causing a drastic decrease in social development investment, and by destabilizing economies due to lack of government control and regulation.”

Such scattershot assertions should not be ignored, lest those who are unfamiliar with Bitcoin assume that they have any merit. Let’s take each in its turn.

Significantly Increasing Crime

Several categories of crime exist, including violent crime, political corruption, property crime, financial fraud, administrative crime (e.g., tax evasion), and victimless crime. (Money laundering, like conspiracy, is a derivative meta-crime that requires an underlying crime. Without an underlying crime, neither money laundering nor conspiracy exists.)

“Bitcoin could readily serve as an easily accessible global network for drug dealing, gambling, bribery, insider trading, and money laundering. In the words of Timothy B. Lee, a Forbes contributor, Bitcoin could very well become ‘the new Swiss bank accounts’.”

Notwithstanding how easy it is for investigators to trace the flow of Bitcoin transactions, Zoldan’s tacit assumption seems to be that defending oneself from confiscatory taxes, political oppression, and the threat of violence when corrupt local bankers identify large account holders to organized criminals (a problem in many parts of Eastern Europe and Latin America) is a bad thing, and that the Swiss respect for personal privacy is thus also bad.

However, those who live in glass houses should not throw stones, as the USA is the world’s biggest tax haven for non-US residents. To castigate Switzerland in this context is hypocritical, unless one is prepared to repudiate direct foreign investment into the USA.

Furthermore, Timothy B. Lee is generally supportive of Bitcoin, and to cite this statement out of context is disingenuous. The full passage from his Forbes article dated 1 April 2013, “Bitcoin Is a Bad Currency but It Might Be a Good Platform for Financial Innovation” reads:

So far, Bitcoin innovation has largely focused on legally dubious activities like gambling and drug sales. Bitcoin is ideal for this because its lack of intermediaries makes it hard to regulate. In the long run, Bitcoin may become the new Swiss bank accounts, letting people park wealth offshore where the authorities can’t get their hands on it.

But while legally questionable activities are the lowest-hanging fruit for Bitcoin, there’s no reason to think those are the only possible applications. I’ve pointed to international money transfers as one promising application for the technology. There are doubtless others I haven’t thought of.”

So, yes, criminals can transact in US dollars, euros, and laundry detergent. And the point is…?

[I address this red herring in more detail in a separate post, "Bitcoin Reduces Crime".]

Causing a Drastic Decrease in Social Development Investment

“Bitcoin is virtually impossible to tax. There is no way for governments to know who owns what, who is paying whom, what is being sold, who is buying what, and how much income a Bitcoin owner has… This could mean the end of programs like Medicare, Medicaid[,] and social security [sic].”

I address this red herring, as well, in “Bitcoin Reduces Crime.” The problem of taxing what is easily hidden is not a problem with Bitcoin, but a problem with applying policy designed for a 19th Century capital/labor economy based on large, centralized organizations and physical plant seated in nation-states to the 21st Century knowledge/service economy based on ever-changing, headless, transnational networks.

Rather than cling to outmoded tax codes, like a monkey with its fist caught in a hollowed-out coconut, policy makers should shift their focus to things that are very difficult to hide, like roads, land, buildings, physical imports, and cars.

And, with that, I just saved Medicare, Medicaid, and Social Security. Send your donations to:

1PEQniaE8Jrm8Ghtxk4RwmAPqRPBVMXAo1

Destabilizing Economies Due to a Lack of Government Control and Regulation

“Because Bitcoin’s currency is completely decentralized with no particular individual or body in control, governments would no longer regulate and control the economy.”

Never mind the Panic of 1907, the Great Depression in the 1930s, the end of the gold standard in 1971, the OPEC oil price shocks in 1973 and 1979, the gold bubble in 1980, Black Monday in 1987, the Savings and Loan Crisis in the early 1990s, the Long Term Capital Management bailout in 1998, the Dot.Com Crash in 2000, and the Crash of 2008, and seemingly countless financial crises worldwide in the 20th Century.

If anything, financial crises have been worse and come at higher frequencies as government control of the economy has increased.

“Although the economy is currently not doing particularly well and currency issues certainly do exist, there still remains the possibility of governmental regulation and control of the economy to try to improve the circumstances.”

Granted, and although public health is a major concern worldwide, the unexpected discovery of a cure for cancer, the eradication of cholera, malaria, and tuberculosis, and the successful cloning of a strain of mammoths that tolerate the heat could lead to improved living conditions and something fun to look at. However, passing off hypotheticals as foregone conclusions is not the same thing as analysis.

“Bitcoin has no central authority or controlling governing body to monitor and regulate the currency according to the economic climate.”

And yet, Bitcoin community members rose to the occasion during the February 2013 Fork, and interest has continued to grow, in spite of two breathtaking bubbles, endless fearmongering, and soul-crushing regulatory uncertainty.

To promote central authority as a financial panacea so soon after the Crash of 2008, three rounds of Quantitative Easing, the PIGS Euro Crisis, and the Cyprus Bank Holiday wouldn’t have been my first rhetorical choice in this context.

“For many people, Bitcoin has a negative image due to its being a hotbed for criminal activity. It is popularly perceived by many to be a crime-ridden market for illegal dealing. Also, the sheer oddity and innovative design of Bitcoin can easily frighten a more traditional and conservative investor.”

Then again, a more traditional and conservative investor would not have bought an Apple ][, trusted PayPal in its early days, or used a credit card in the 1950s. By their nature, traditional and conservative investors wait until early adopters have tested the waters before they jump in. Considering that Bitcoin really hit the mainstream only six months ago (early 2013)—although I was lecturing on Bitcoin internationally two-and-a-half years ago in early 2011—these are still early days. Give us another six months before you completely write us moneypunks off.

"The very idea that it is literally 'backed by nothing and not regulated by anybody' will certainly scare off many people."

Granted, but in a world of 7 billion humans, 'many people' are scared off by many things. Believe it or not, some people outside of Arizona, Florida, and Texas are scared of certain types of Constitutionally protected personal and home security devices.

"Felix Salmon, a financial journalist, also agrees that Bitcoin is a bubble. He writes that 'Bitcoin is less a currency and more a highly volatile commodity.' The extreme change and fluctuation in market value could cause high rates of inflation and deflation, which would adversely affect the economy."

Felix Salmon also has written:

[B]itcoin is a combination of two things: it’s a very interesting payment mechanism, and it’s also a highly stupid and speculative store of value… This is an asset that senators want to ban, an asset which is probably illegal under US law, and an asset that is mainly known for its ease of facilitating money laundering, tax evasion, and the purchase of contraband material.

For the record, over the seven weeks between when Salmon wrote those words, and I wrote these, the Reserve Bank of India has taken a hands-off approach to Bitcoin, the German Finance Ministry has declared Bitcoin to be ‘private money’, and the USD price of Bitcoin has increased by about 33%. [For more on Bitcoin regulatory issues, click here.]

“As Salmon poignantly notes, Bitcoin is fundamentally based on mistrust, as it was designed to evade governments and central banks. This is a significant obstacle in Bitcoin’s growth, as economies, and in particular currencies, revolve around trust.”

That unbacked fiat currency requires a great deal of trust, in order for users not to lose faith in it, is a fact that holders of US dollars, which have lost 98% of their value in terms of gold since 1971, euroskepctics, and Cypriot bank depositors can attest to, although many of them come to rather different conclusions from Salmon’s and Zoldan’s.

But, just in case these prophesies fail to come true, Zoldan fires off a quick hedge: “Nevertheless, if Bitcoin ultimately does become a global economic force, it would then possess the power to significantly disrupt and deleteriously affect our society.”

So, there we have it: Bitcoin cannot work, but if it does, then it is evil. Let’s check back sometime in early 2014 and see how all this worked out. Who knows? Maybe Salmon and Zoldan are right.

Invest accordingly.

Prof. Evans

Aug 252013
 

When individuals discuss crime, they often behave as if this category were homogeneous and that every act deemed to be illegal by authorities were morally wrong. However, given the differences among local and national statutory codes, not to mention legal traditions—Common Law, Code Napoleon, Shari’a, Chinese Law, Canon Law, etc.—what is criminal in one location often is legal in others. Likewise, what is criminal at one time often is legal at other times in the same jurisdiction. Morality should not be so mutable.

Nonetheless, many individuals conflate ‘crime’ into a single syllable and act as if its meaning were universal. One sees this particularly in discussions about Bitcoin, in which pundits—who have nothing to lose if their prophesies are inaccurate—predict that Bitcoin specifically and cryptocurrency in general will increase the likelihood and severity of crime. Below are several reasons why such prophesies could be grossly in error.

Crime comprises several very different categories, including violent crime, political corruption, property crime, financial fraud, administrative crime (e.g., tax evasion), and victimless crime. When one looks at each of these sub-categories in turn, one could argue that widespread use of Bitcoin might reduce crime in some instances and have no impact in others.

Acts of pointless violence generally are not financially motivated. Bands of disenfranchised youth out looking for trouble most commonly are looking for trouble and not Bitcoin private keys. Even if Bitcoin wallets on mobile phones became targets of thieves, this already is a problem in areas where smartphone apps enable mobile access to users’ bank accounts. It would be difficult to blame Bitcoin, per se, for mobile phone thefts. The same can be said for murder, rape, road rage, and most other violent crime. Bitcoin neither facilitates nor hinders such acts.

In many parts of Eastern Europe and Latin America, one major problem is that bank employees identify large account holders to organized criminals, who then target the wealthy. With widespread Bitcoin use, kidnapping for ransom becomes more difficult, as kidnappers cannot map an individual to his or her Bitcoin holdings easily, especially if the potential target distributes the wealth across a large number of Bitcoin accounts (a common practice among Bitcoin users that is much easier than opening multiple bank accounts). Likewise, bank robberies become less common when individuals conduct most of their transactions online.

Bitcoin wallets enable users to create accounts that require more than one signature to initiate a transaction. Such multi-signature accounts are rare among banks, and most commonly used only by some businesses, but almost never by households. Bitcoin has the potential to reduce embezzlement, if not eliminate it entirely.

By far the most common source of financial crime in commercial settings is theft from merchants in the form of credit card fraud, identity theft, and to a lesser degree shoplifting. Theft by merchants is rare, and it is dealt with relatively easily through the courts. Bitcoin turns transactional risk around 180 degrees. Bitcoin is 100% free of chargebacks, which represent a huge cost to merchants and credit card processors. Merchants can reduce their chargeback risks to 0% by switching to Bitcoin and converting it daily to dollars using a service like BitPay

With regard to fraudulent lending practices by unscrupulous consumer, mortgage, and commercial lenders, Bitcoin’s net impact should be negligible. Whether lending paper bags full of cash or sending cryptocurrency to borrowers’ smartphones, loan sharks will ply their trade, and the threat that they represent is orthogonal to their choice of medium of exchange. Likewise, sub-prime mortgages led to the Crash of 2008, before the first Bitcoin test-transaction even took place.

As for dire predictions of things like international arms merchants, those already are a problem that cannot be attributed to cryptocurrency. As discussed below, Bitcoin’s open recordkeeping should be anathema to those who populate the shadowy underworld.

With regard to administrative crime, tax evasion could be eliminated tomorrow, if authorities taxed things that are difficult to hide, like roads, cars, physical imports, and real estate, rather than things that are increasingly easy to hide in a global knowledge/service economy. The specter of income tax evasion is the reddest of herrings and a smokescreen for policy that has passed its expiration date and is ill-suited to a post-capitalist society.

Political corruption is generally large-scale or small-scale. Large-scale corruption in the form of political influence, pork-barrel projects, crony contracts, etc., already is widespread and unlikely to increase or decrease as a result of widespread Bitcoin adoption. Small-scale bribes to police officers, border guards, customs agents, low-level bureaucrats, etc. currently are paid using local government fiat. Given that very few are calling for the elimination of cash, in order to combat petty corruption, calling for restrictions on Bitcoin for this reason is inconsistent.

One area where those who are unfamiliar with Bitcoin sometimes try to claim victory is the trade of information goods, the production of which involves victims, including child pornography, snuff films, etc. However, this is where Bitcoin’s greatest strength for good reveals itself. Remember, every Bitcoin transaction is memorialized indelibly in the transaction record—known as the blockchain—at the heart of the Bitcoin protocol. For trade in this kind of product or service to flourish, it has to avoid attracting the attention of investigators (i.e., remain small in scale), and all parties to the transactions must maintain a very high level of financial hygiene, which is a lot to ask of any target market. The likelihood that some sleazy pervert would slip up somewhere is non-trivial, and investigators or vigilantes would be able to follow the chain of transactions backward and forward in time until they could connect the transaction chain to an identifiable person.

Even if the supplier maintained a separate account for each transaction, he, she, or they would want to spend the Bitcoin eventually, and the only way to get rid of it anonymously would be to dribble it out as small face-to-face transactions for cash. In other words, Bitcoin is ill-suited for large-scale organized crime rings, except those run by individuals who are very technically adept. Even if Bitcoin were eliminated somehow, such individuals should have little difficulty coming up with alternatives. Again, the problem is not with Bitcoin, per se.

This leaves the elephant in the living room: victimless crime, including recreational drugs, moonshine, gambling, prostitution, etc. While anti-Bitcoin activists point to Silk Road and other similar sites, they ignore the fact that drugs are easy to acquire even in prison, ‘escort’ agencies advertise with impunity in US cities and accept payment online via credit card, gambling is legal in many jurisdictions, and all without cryptocurrency. To allege that Bitcoin is going to enable more individuals to engage in activities that injure no one is to complain about something that is difficult to construe as a problem worthy of state action rather than public education and social activism.

While it is true that one can use Bitcoin for illegal purposes—as one can use US dollars, euros, and laundry detergent—many of those purposes are illegal only because someone in power has declared them to be. In a democratic republic, when large numbers of individuals routinely violate a victimless crime statute, this suggests that the statute is in error and not the people. With regard to activities that injure others, Bitcoin and other blockchain-based cryptocurrencies should be seen as a boon to investigators.

None of the foregoing should be misconstrued as glibly ignoring human tragedy. Quite the contrary, widespread Bitcoin adoption could facilitate investigation where the jurisdiction-based international banking system does not. Those who criticize Bitcoin as a financial medium for criminals do Bitcoin users and crime victims a grave injustice.

Invest accordingly.

Prof. Evans