Interesting piece by Beautyon from 2016...as much as things change, nothing changes...
This piece was originally written for the magazine Foreign Affairs.
Math has learned a new trick
Bitcoin is deeply confusing. It takes on the aspect of a beautiful Fata Morgana to all observers of the technology horizon, with the exception of elite software developers. It simultaneously appears to be money, a permanent tamper proof general database, a way to register Copyrights, a means of paying for your morning Starbucks, or a tool to do to banking what Amazon did to book stores. Everyone has a different image of Bitcoin depending on their background, but the true nature of what Bitcoin is is in fact quite straightforward. Bitcoin is a solution to one of the most interesting problems in computer science: The Double Spending Problem. Utilizing a tour de force concoction of old and arcane software techniques, it is the precise nature of this innovation that needs to be untangled and put in context.
Journalists normally concentrate only on the sensational uses of this new tool, none of which are unique to Bitcoin. Academics tend to either make a circumstantial case against Bitcoin, not being able to address it on a technical level, or if they try to use economics as the attack vector the Austrianism vs Keynesianism approach is used, which is broadly the Appeal to Tradition Fallacy. These attempts to define and contextualize Bitcoin fail because they don’t take into account the history of software. They also fail to address the economic principles that underpin Bitcoin, which would provide key insights into how this phenomenon needs to be addressed across all parts of civil society.
There have been several attempts in the 20th Century to create a system like Bitcoin, both through software and in the physical world through money tokens — The Totnes and Brixton Pounds, Mondex, DigiCash, and more recently as an answer to Bitcoin, the Royal Bank of Canada’s “Mint Chip” — and the United States and Great Britain both have long histories of private monies like the Birmingham Button maker’s private coinage in the mid 18th Century. Some of these attempts were and are very successful. All of them were borne out of a market need. Academics and journalists attempting to get to grips with what Bitcoin is, try and circumscribe the scope of Bitcoin, but they often fail to address it objectively, because they are ignorant of the history and current state of private monies and software.
Dismissing Edge Use Cases
In order to take a correct — and more importantly, objective — position on Bitcoin, it is crucial to have a grounded, clear and complete understanding of its nature and basic principles. First, edge use cases must be dismissed as irrelevant. By edge use cases — and there are potentially an infinite number of these because there are an infinite number of economic activities where money is the mediator, plus all the ancillary uses that any database, tool or data structure can be put to — we mean every use case touching illegal activity, no matter what it is. Second, we must address Bitcoin by its nature with a pure description of its utility: “Bitcoin is a single shared database where entries can be made by its users but not changed after they are made. The purpose of this database is to simulate money by infallibly storing who has exchanged and controls which entries.” At first glance this sounds simple, but it is in fact a profound and world-changing achievement that is the culmination of a quarter century of work by some of the greatest software developers and mathematicians, with an extraordinary mastery of economic, mathematic and software principles that took everyone by surprise, so much so, that many people who first heard of Bitcoin could not believe that it had been successfully done.
State actors should be minded to take a rational approach to Bitcoin, and the lesson of Copyright violation and attempts to stem it are directly analogous, and direct comparison appropriate. Setting aside the ethics of Copyright, all attempts to stop the distribution of Copyrighted materials have been a complete failure since the rise of the popularity of the Internet. Many billions of files containing Copyrighted material have been shared, without restriction, the majority on a voluntary basis. Police actions and show trials have been completely ineffective as a deterrent, and all public awareness initiatives have utterly failed to inhibit the torrent of files spreading across the network. Now replace Copyrighted materials with user controlled money that has become immaterial. The incentives, drives and human need for money to transact with — and this time on a global basis — are larger by orders of magnitude than the desire to consume films without paying. When Bitcoin is on every phone, it will be literally impossible to stop or control. The only rational position to take for State actors is to embrace this sea change, and benefit from it by joining the network as peers. The power of kings is empty and worthless in the face of math, and taking a King Cnut posture will not hold back the tide of this change.
Because Bitcoin had solved a long-standing and very hard problem in computer science — The Double Spending Problem — people familiar with software were sceptical. Economists reading about the 21,000,000 coin limit were sceptical for that reason alone; devotees of Keynesianism — the idea that the supply of money should increase with the size of the economy — believe that Bitcoin can never work. Socialists and Democracy advocates alike were dismissive because in Bitcoin, the State is told explicitly that it cannot be responsible for the form, management and manufacture of money, and Bitcoin is designed to not be “accountable” to Democratic authority. All of these groups are absolutely wrong about Bitcoin, and their incorrect conclusions are borne out of a profound misunderstanding of what Bitcoin is. Furthermore, they accept all the tools used to create Bitcoin in other contexts, but rail against Bitcoin because it uses these same tools in an unfamiliar one.
Monetary Theory as Distraction
The most popular theory of money in force today comes from the mind of a single man; the economist John Maynard Keynes. His monetary theory requires that the state be in charge of the form and supply of money, and that the money supply should not be fixed, but should instead, keep growing over time, because subsequent generations will not be able to hold previous generations directly accountable, “In the end, we are all dead anyway” was his reasoning. Increasing the supply of money over time is defined as inflation and anyone who saves in a Keynesian money system is impacted by it. The official target rate of inflation in the UK for example, is arbitrarily set at 2%. A person storing their wealth in the fiat currency inflating at that rate is guaranteed to lose 2% of their spending power per year, by design.
Bitcoin’s designer, as do members of the Austrian School of Economics, correctly classify inflation as a form of theft. It is perfectly reasonable to assume that if you put a four legged chair into storage, that when you take it out after ten years, it will have four legs. The Keynesian claims that it is perfectly normal for your chair to have three legs after having been stored. Gold, being a naturally occurring element of a fixed supply for all intents and purposes, cannot be inflated at the whim of any man. It is an ethical money that when you store it, does not change its nature over time. The price of gold fluctuates against fiat, but that has nothing to do with the nature of gold, and has everything to do with a broken market and the form of money that is required by legal tender laws. Bitcoin in the context of money is “more gold than gold”. Its supply can never increase. It has no physical properties; it is a purely abstract system constructed exclusively in math. This is part of the staggering breakthrough of Bitcoin, created by someone with the nom de plume “Satoshi Nakamoto”, who found a way to cause data to behave as if it has the physical properties of matter. Data — which simply means information, like the name of this publication — is by its nature unlimited. The title of this publication can be repeated an infinite number of times in any context — spoken, written, semaphore or Morse Code — without any loss or incurring of cost. It is by the unlimited nature of data that the information revolution has taken place. Bitcoin breaks this law of nature by creating a new class of information that cannot be copied infinitely without detection inside a single context. In Bitcoin, man can own data.
The reason why Bitcoin was created is important, but more important than the animating inspiration is the broad scope of the inevitable changes the solution to “The Double Spending Problem” will bring to society, and how people will accommodate those irrevocable changes. Bitcoin, because it is so new, has created a unique set of new problems, mostly of perception and its relationship to the law. Bitcoin is entirely novel, yet made of — at least in internet timescales — ancient technology. There is strong legal precedent in democratic societies for the protection of public access to tools like it, and it is unambiguously a form of protected speech covered by the First Amendment of the Constitution of the United States of America. The question being asked in many quarters given the protections Bitcoin affords to its users due to its nature is, “What are we going to do about Bitcoin?”
The Correct Legal Interpretation
The correct position to take on Bitcoin, in terms of ethics, the law, economics, and national interest, whether it is being used privately or in business that interacts with the public, is to treat it exactly as Microsoft Excel is treated. Bitcoin is a database programme in the same way that Excel is, only with a different set of rules and form of storage. No one would dare suggest that all copies of Microsoft Excel should require a license to operate, and that companies running it on behalf of others to provide services to them be licensed and bonded, and yet this is exactly what New York’s insidious “BitLicense” requires. Worse than that, people who develop software that uses code that connects them to The Bitcoin Network are, under BitLicense, required to submit their fingerprints and other egregious, anti-American regulations that no one would dream of applying to any other software. When pushed to explain why this software in particular should be subject to regulation but other software that protects billions in e-commerce is not, the advocates of BitLicense have no answer. For example, the implementation of Secure Sockets Layer Certificates — “SSL” the software that provides the little green lock in your browser telling you your connection is secure from eavesdropping when you make a credit card transaction — is not subject to any regulation of any kind. The software is not audited by a special department of the State, the people who write the SSL software are not subject to government audit, positive identification, security clearance or financial or criminal vetting. No one knows who they are, and every website operator is left alone to implement this crucial software as they see fit, without any oversight. The question is why? Why is this software that is exposed to hundreds of millions of people and billions of dollars in transactions not regulated, but Bitcoin, which has a market cap that is tiny in size compared to all credit card transactions online, subject to intrusive and irrational regulation?
The answer is there is no rational reason for this position, and every rationale given for the current treatment of Bitcoin is a pretext. Bitcoin is software, just like any other software, and it does not need regulation to keep people safe. There are already sufficient statutes to effectively deal with any sort of fraud perpetrated by companies offering services, but in New York it seems, these facts have been missed. Bitcoin was misrepresented to the regulators as something that they should be responsible for, rather than just another type of software. Other jurisdictions, either because they had more time to consider the matter or were more insightful, have taken the correct approach. Hong Kong has explicitly said that it will not seek to regulate Bitcoin at all. This is the enlightened, rational approach and conclusion that all logical and ethical people arrive at when the truth of Bitcoin is placed before them; Bitcoin is software like any other, and it should not receive nor does it require any special treatment under the law.
Slowly, the American legal system is catching up. In the case of The State of Florida v Michell Abner Espinoza, Miami-Dade Circuit Judge Teresa Mary Pooler found — correctly — that Bitcoin is not money, and that therefore, Mr. Espinoza, who was set up in a sting operation by government agents masquerading as honest men who simply wanted to buy Bitcoin, was not guilty of any crime. This correct judgement has profound implications for Bitcoin in the United States. First of all, it nullifies all Bitcoin rules drafted on the assumption that Bitcoin is a commodity or money. Those definitions of Bitcoin are figments of the imaginations of lobbyists trying to build a Bitcoin Regulation Industry for themselves, with their offices as the gatehouses. Indeed, the author of the BitLicense is now offering consultancy services navigating the regulation he drafted, following the example of the author of the RICO statutes, G. Robert Blakey. These regulations, having been struck down in court, will unleash the potential of Bitcoin in the United States, which should as a matter of policy have the explicit aim of becoming the beginning and end point of all Bitcoin transactions, just as all the global social media giants based in Silicon Valley are. Imagine the consequences of Twitter, Facebook and WhatsApp all being run somewhere other than the United States, and then multiply that scenario by the power of money. It is impossible that any patriot of any country would want such a powerful force to be run in a foreign land, and in fact China has its own home grown and very large social media networks — Sina Weibo, Qzone, RenRen, PengYou, Diandian, Jiepang with 579,980,000 users, making it the world’s largest social media landscape — for precisely this reason. These critical communication tools cannot be left in the hands of a single nation, and the power to block what are in effect bank accounts, puts Bitcoin in the national critical infrastructure class along with the Internet.
The Importance of the History of Software
The prospect of companies eschewing New York or California for other capitals is very real. Not only are entrepreneurs faced with the threat of arbitrary, unethical and un-American profit sapping legislation like New York’s BitLicense, but they are also faced with the threat of Software Patents — that do not exist in the European Union, US Software Patents being completely unenforceable — and the possibility of being obliterated by lawsuits. Advocating for the end of Software Patents is beyond the scope of this essay, but we can say categorically that any law or regulation drafted specially for Bitcoin will cause companies to incorporate in other jurisdictions, making those places the beginning and end points of Bitcoin transactions, where the taxes will be levied. American companies may be able to boast that they are in many jurisdictions, but that has nothing to do with their profitability, and they are often unwilling to repatriate profits due to swingeing taxes. Other companies that are more agile and with lower running costs will easily outflank the current crop of Bitcoin companies, many of whose business models are fundamentally flawed and who are following regulations that are not even on the statutes. There are no Bitcoin regulations on the statutes that anyone can follow, save the BitLicense and some half hearted, ripe for challenge, unconstitutional, US only agency guidance put in place at the prompting of misguided American lawyers and lobbyists. Other jurisdictions that are explicitly pro innovation have global internet access indistinguishable from American internet access. Bitcoin can flow to and from these countries just as it can from anywhere on Earth; this is all invisible to users of Bitcoin, who see only a number on their devices that corresponds to how much Bitcoin they are permitted by the network to move or transmit.
America has a well established culture of software development. Many world class software products from Twitter to WhatsApp were developed there. It is rational to expect a Bitcoin company with the perfect business model to emerge from Silicon Valley. This cannot happen under the current climate of hysteria, fostered by lawyers and lobbyists trying to cut out a niche for themselves. Working on the assumption that other countries are run by rational actors, there is no reason to conclude that the judgement in the State of Florida v Michell Abner Espinoza case will not be repeated in the courts of those countries with free speech protections, where they even arise to go to court in the first place. Those countries that don’t have free speech protections, will be motivated to come to similar findings simply to prevent Bitcoin settling in enemy territories from where they will be dominated.
Critical to all of this is the understanding that there can only be one Bitcoin, just as there can only be one Internet. All countries on Earth are connected to the same global Internet, operating on and obeying the same basic rules — its protocols. Bitcoin is similar, but with an important twist; Bitcoin’s size is important. Without diving into the details, the bigger the Bitcoin network becomes, the more secure it is as an impenetrable computer network, making successful attacks on its record of transactions impossible. It is also a vitally important fact that multiple Bitcoin networks are not interoperable. If a country opts to have its own private Bitcoin clone network as an adjunct to its national currency, that “Sovereign Bitcoin” cannot be exchanged on The Bitcoin Network, because their databases are separate, incompatible transaction records. We can safely predict, given the history of the Internet and what we know about “first mover advantage”, that there will only be one Bitcoin. It will be global in reach, with everyone everywhere connecting to it. Just as users connect to the Internet through Internet Service Providers to send email, people connect to the Bitcoin network through either a service provider or software they can run themselves. Once again, no one in a democratic society would dare suggest that providers of email services should be registered and their fingerprints taken; that is the preserve of totalitarian states like North Korea, but this is exactly what the BitLicense does, in of all places, New York.
What the Bitcoin Future Could Look Like
What would a pro Bitcoin jurisdiction look like after the inevitable global adoption of the The Bitcoin Network? We can speculate that it would have large benefits to the jurisdiction that earns the moniker, “The Silicon Valley of Bitcoin”. It would go something like this…
“After a massive, historic and unprecedented influx of money and brains — due entirely to the Bitcoin revolution — the Bitcoin friendly jurisdiction would become one of the most wealthy in the entire world, in the same way that Switzerland and Lichtenstein are after providing ethical banking for generations.
Rather than taking generations, this change would happen almost overnight — in “internet time”. The Bitcoin friendly jurisdiction would become known as a global centre of commerce, just as the City of London or Wall Street are centres of the old financial system. Being synonymous with Bitcoin, all companies would have a presence there so they could be in the middle of the action, and have access to the pool of world class software developers needed to extend and secure their complex systems.
Since all Bitcoin transactions flow thorough this jurisdiction, the taxes raised by the local government are substantial even at low tax rates. The amount taxed is sourced from commerce taking place globally, and not just locally. Fractions of pennies are levied on each transaction in real-time, and this is possible because each Bitcoin is divisible into a million pieces. Bitcoin circulates like The Water Cycle in nature; the same amount of Bitcoin is used over and over again in a frictionless system where nothing is ever wasted. This is why the astronomical estimates of the true value of Bitcoin are so high; when you take into account its permanently limited supply, its frictionless data nature and its near infinite utility, the current prices on exchanges are absurdly low. Either the speed at which Bitcoin is exchanged must speed up to accommodate the amount of goods transacting on the market, or the price must increase, since the supply is fixed by mathematics. The speed at which Bitcoin circulates has an upper limit, and therefore the price must increase.
The use of government money for all goods and services is now optional. It is unthinkable to enforce legal tender laws, and forbidding Bitcoin is also completely out of the question. The State is receiving billions in taxation from Bitcoin companies both directly and by all the myriad ancillary activities related to it. The State has resorted to accepting Bitcoin in payment of taxes. This act — by itself — attracts companies that are not directly involved in Bitcoin but who use it as money because it is efficient, secure and inexpensive, incorporating and paying taxes in the jurisdiction for the savings they will make. This is a reinforcing feedback loop that brings great prosperity to this forward looking country, whilst draining human and capital resources from other jurisdictions. It is too late to set up copycat environments in other capitals and to repeal bad law like the BitLicense. The first mover advantage that has entrenched the Internet is working to keep all Bitcoin businesses in one place, and that place isn’t New York. No other country can ever catch up, just as they can’t ever hope to compete with Silicon Valley.
The game is over.”
This sketch of how a Bitcoin friendly state might emerge is not unrealistic. There have been many examples of the aggregation of an industry in a single place on different scales; cities have diamond districts, clothing districts, meat districts. It is a commonly seen phenomenon, and Bitcoin will be no different, pushed by the same economic laws that are a part of nature.
The Dystopian Alternative
The alternative to the scenario outlined above is the backward country that has its agenda set by computer illiterate Luddites and legal professionals. They are not interested in the big picture, or the national interest, and are instead, only motivated to carve out a space for themselves where industry needs them to navigate regulation. This market toxic activity is called “Compliance” which is the muscle of the black heart of Crony Capitalism. Companies use the State to enforce regulations that make it nigh on impossible for new entrants to penetrate the market, keeping prices artificially high and stifling innovation. Software has never had to suffer attacks like this — except in the form of software patents, which are explicitly used to attack market entrants and suppress competition — entrepreneurs and software developers have always been free to write programmes and release them for free. That is exactly how the incredibly successful GNU Plus Linux started in the bedroom of Linus Torvalds and offices of Richard Stallman at Carnegie-Mellon University. There are many stories similar to GNU Plus Linux — companies succeeding from literally nothing but an idea typed out by a single man, Instagram being one of the most recent. There cannot be an “Instagram of Bitcoin” coming out of New York, because its BitLicense makes it literally illegal to write and release software there.
Hong Kong on the other hand, being without a Chinese version of BitLicense, has developers who can write whatever software they want for release into the global market, where it will live or die on its merits. This will happen many times over, as people seek the perfect mix of features that will make up Bitcoin’s “Killer App”. Even if this crucial experimentation is done in New York, the New Yorker who does the work will relocate to Hong Kong where he has a chance to succeed; staying in New York means $2,000,000 in compliance costs before you have your first customer. No one will put up with it, and why should they?
BitLicence and the toxic, innovation killing climate of “Compliance” are guarantees that America will lose in the international competition to be Bitcoin’s natural home. America has lost before in a scenario just like this with the adoption of GSM as the global cellphone network standard. Today we have a picture of this happening again with Internet Poker, which is illegal in the United States, while thriving online without American businessman owning the companies or making the profits. There are enough people online to keep these services very profitable, and of course, the potential scope of Bitcoin is exponentially larger, because it is used for all conceivable transactions and not just gambling. Even if it replaces 20% of cross border currency exchange business, it will represent an enormous market, and of course, it will be much bigger than that, especially with the breakthrough of the Lightning Protocol, which increases Bitcoin’s throughput to hundreds of thousands of transactions per second. Abundant and instant microtransactions are soon to become the new normal in Bitcoin, and the web, replacing advertising as publisher’s main source of income.
The Horse and Buggy Lobby
Lawyers and legislators must not be permitted to set the rules for something they don’t have the capacity to understand. Furthermore, since the end uses to which Bitcoin can be put are still being discovered, it is impossible for anyone to know exactly what Bitcoin will be used for in the future with any certainty. Only seven years ago, a system like Bitcoin was widely believed to be impossible. Now not only is Bitcoin here and stronger than ever, but people are actively searching for different ways — most of which are unsuccessful flights of fancy of the sort seen in the first Dot Com Bubble — to leverage its core concepts in almost every industry. This work will be carried out in the jurisdiction where most of the activity — software development — is taking place. Naturally this would be Silicon Valley, but since arbitrary and irrational regulations that treat this software differently to all other software are being proposed, Silicon Valley will be impossible to work in, due to the astronomical, debilitating, anti-capitalist burden of “Compliance”.
The right to develop software — which is just writing — is indivisible; it cannot be split into two parts, depending on the use the writing is put to. It is akin to making a claim that Foreign Affairs must be subject to regulation, but Newsweek should not. There is no construction, no rationalization, no form of logic that can be made to argue that publications that feature only writing should be treated differently to each other, and an understanding of the nature of software is crucial to making this connection.
Clearly, at this nascent stage of Bitcoin’s development, the nation state’s priority must be to capture all Bitcoin businesses, entrepreneurs and software developers so that the inevitable robust ecosystem that is going to develop is in your jurisdiction. Anything that prevents this should be at the very least temporarily set aside. A market obeying condition is important for all entrepreneurs, who need leeway as they take on risk, experimenting with business models, security systems and infrastructure, iterating over and perfecting them. Recent events in the cryptocurrency world shine a light on what this means in practice.
Out of the Ether
The cryptocurrency and Bitcoin competitor Ethereum was launched entirely without permission from Zug, Switzerland. It radically extends Bitcoin’s capabilities in a new separate database, and was seen for a short time as the inevitable market winner over Bitcoin. One of the largest Bitcoin exchanges, Coinbase even took the risk of offering its native token “Ethers” to their customers. One of the capabilities Ethereum enables is the ability to create Smart Contracts; agreements based entirely in software that execute rules — loosely speaking its clauses — entirely in code. Smart contracts are an extra-legal way of parties agreeing on how business is conducted and matters settled. It is radical, extremely exiting, and the biggest Smart Contract ever, The DAO the first “Decentralized Autonomous Organization” attracted over $140,000,000 in investment from people around the globe.
And then it was hacked.
But it wasn’t really hacked. An attacker found a fundamental flaw in the DAO’s software contract clauses, and contractually drained $59,000,000 worth of Ether from it, into another contract beneath it. “Ethers” are the equivalent of Bitcoin in the Ethereum public database and software ecosystem. In response to this attack, Ethereum, which is the skeleton that the DAO was built on, had its permanent record reversed by the developers who control it, to reimburse investors who lost Ether in the DAO. This is anathema to people in the crypto currency space, causing a group to “fork” Ethereum at the point in the transaction record at which the DAO contract hack took place. Forking means the new developers made a complete copy of the Ethereum transaction record, and started recording their own, separate records of transactions on to the end of it. There are now two diverging Ethereae — one called “Ethereum” and the other, “Ethereum Classic”. Both of the database records of these systems are identical up to the DAO event, their native tokens float freely on exchanges, and as of this writing, both have essentially collapsed to the same price of almost nothing.
By any metric, it is a fiasco.
Rather than seeing this as a perfect example of why what are now called Cryptocurrencies require regulation, the DAO is in fact a perfect example of why Bitcoin and software should not be regulated. This DAO hack has cost a statistically insignificant amount of money to teach a powerful lesson to all market participants, including companies like Coinbase. Without an expensive lesson like this, markets would be less efficient and more vulnerable due to the speed of iteration being slower. Bear in mind these experiments would be taking place in other jurisdictions, and some of them are guaranteed to succeed, like the Segregated Witness extension to Bitcoin. If the addition of Segregated Witness was subject to regulation, the pace of Bitcoin improvement would slow to a crawl. An example of this innovation stifling in the medical industry are the over 4,000 medicines awaiting FDA approval in the United States. This backlog is directly analogous to new Bitcoin business models — software — being blocked from release to the public. This is exactly why no Bitcoin regulation or legislation must be passed, or even considered openly, as it will signal to entrepreneurs that they are better off in another jurisdiction, just as people travel to free countries to try experimental treatments when all FDA approved medicines have failed to cure their disease. The risk of Bitcoin is spread evenly to the people who voluntarily choose to work with it. Trying to control Bitcoin pushes a far greater risk of a generational national loss on all citizens, that can never be recovered from once the centre of Bitcoin is captured and rooted in place.
In order to foster innovation and to allay any fears of a possible explosion of legislation that will make turning a profit in Bitcoin impossible, the jurisdiction that wants to win the battle for Bitcoin businesses should enact a single law; a 150 year moratorium on any legislation that touches Bitcoin.
The rate at which Bitcoin is released into the market by the miners is halving regularly by design. The last Bitcoin will be generated in approximately the year 2140. By that time, Bitcoin will be everywhere, or nowhere, and the world centre of Bitcoin will be well established, or Bitcoin will be a part of the history of computing. No one can say definitively, but what we can say for sure is that the same thinking behind the 150 year long laissez faire lease that made Hong Kong into one of the top five most prosperous states on Earth, if applied to Bitcoin, will result in a bejewelled prize collected by the State that nurtured and grew it.