Friday, December 28, 2012

Fear Not Deflation

By Jon Matonis
Sunday, December 23, 2012

We should not be afraid of deflation. We should love it as much as our liberties.  --Jörg Guido Hülsmann

Deflation in the context of bitcoin has been cited frequently in the popular press as a detriment to its widespread adoption. For example, famed Keynesian economist Paul Krugman ridiculed the bitcoin cryptocurrency saying "it reinforces the case against anything like a new gold standard – because it shows just how vulnerable such a standard would be to money-hoarding, deflation, and depression."

Krugman could not be more wrong. Deflation is not a problem in the traditional monetary system and it will not be a problem in the bitcoin economy.

As over 99% of bitcoin's possible 21 million coins will be mined by 2031, the fixed mild inflation will effectively cease and a period of non-inflation will commence. Although the supply of cryptographic money will be relatively static with the exception of attrition through permanently lost coins, I will refer to the monetary phenomenon as deflation because as bitcoin's asset value increases compared to political numéraires, its effect on price expression will be seen as deflationary.

Contrary to the central banking and political class insistence that deflation must be prevented at all costs, an economy with a monetary unit that increases in value over time provides significant economic benefits such as near zero interest rates and increasing demand through lower prices. Let's look at some remarks from leading thinkers on deflation.

In responding to an article in The Economist, Doug Casey points out that "in a free-market economy, without central banks and without fractional reserve banking, both inflation and deflation as chronic events are really not possible." Casey states:
"Deflation is actually a good thing, because in a deflation prices drop and money becomes more valuable, so deflation encourages people to save money. Deflation rewards the prudent saver and punishes the profligate borrower. The way a society, like an individual, becomes wealthy is by producing more than it consumes. In other words, by saving, not borrowing. And during a deflation, when money becomes more valuable, everybody wants money. They want to save. Whereas during an inflation, you want to get rid of the money. You want to consume. You want to spend. But you don’t become wealthy by spending and consuming; you become wealthy by producing and saving."
Jörg Guido Hülsmann is a German economist and author of Deflation and Liberty, an important monograph that demolishes the myth of monetary intervention to prevent the cleansing effects of deflation. Hülsmann writes:
"Deflation is not inherently bad, and that it is therefore far from being obvious that a wise monetary policy should seek to prevent it, or dampen its effects, at any price. Deflation creates a great number of losers, and many of these losers are perfectly innocent people who have just not been wise enough to anticipate the event. But deflation also creates many winners, and it also punishes many 'political entrepreneurs' who had thrived on their intimate connections to those who control the production of fiat money.
Deflation puts a break--at the very least a temporary break--on the further concentration and consolidation of power in the hands of the federal government and in particular in the executive branch. It dampens the growth of the welfare state, if it does not lead to its outright implosion. In short, deflation is at least potentially a great liberating force. It not only brings the inflated monetary system back to rock bottom, it brings the entire society back in touch with the real world, because it destroys the economic basis of the social engineers, spin doctors, and brain washers."
Former president of the Mises Institute, Doug French, writes in the essay In Defense of Deflation:
"Lower prices increase demand; they do not reduce or delay it. That's why more and more people own flat-screen TVs, cellular telephones, and laptop computers: the prices of these goods have fallen, and people with lower incomes can afford them. And there are more low-income people than high-income people."
In A Plea for (Mild) Deflation, George Selgin rightly distinguishes between malign demand-driven deflation which is an unfortunate secondary effect of a central bank-manipulated, inflationary malinvestment phase and benign deflation which is the result of an increase in productivity:
"The Great Depression dealt a near-fatal blow to such common-sense thinking about prices and the price level. A new generation of economists became so obsessed with avoiding the bad kind of deflation that they all but forgot about the good kind. Followers of Keynes advocated inflationary policies, which have been the norm ever since. Having paid penance for the Great Depression by suffering through six decades of inflation, it is time for us to revive old-fashioned logic concerning the potential benefits of deflation.
Recognition of the possibility of benign deflation should have a salutary effect on the thinking of the world’s central bankers. By helping them to overcome their fear of falling prices, it will encourage them to deal a deathblow to the worldwide scourge of inflation. But that is only the beginning. Once the possibility of benign deflation is fully appreciated, zero inflation itself will come to be recognized as an overly expansionary policy—that is, as a mere steppingstone on the way to something even better."
Fear not deflation. Ultimately, the market will reach an equilibrium between investment and savings because in the absence of an equilibrium the benefits of a savings-only strategy would evaporate. Proper economic growth through sound investments will lead to a productivity-driven deflation.

Friday, December 21, 2012

U.S. Secret Service Bans Certain Gold and Silver Coins On eBay

By Jon Matonis
Saturday, December 15, 2012

eBay was contacted by the U.S. Secret Service sometime last month to remove the Liberty Dollar precious metal coins. Citing consistency with eBay's general policy of not listing counterfeit items, eBay spokesperson Ryan Moore confirmed the ban with Coin World.  The following email was sent to affected sellers when the systematic removals began:
"The United States Secret Service has requested the removal of all Norfed Liberty dollars on the eBay site as counterfeits. … Please do not relist this item(s). We appreciate that you chose to list this coin on our site and understand there was no ill intent on your part. Your listing fees have been credited to your account."
Real is fake and fake is real. That's pretty much the monetary world that we live in now as we are coerced to trade and pay taxes in the designated and one 'legitimate' State currency. Certainly, the U.S. Secret Service wouldn't want anyone purchasing pure (.999 fine) gold and silver medallions mistakenly thinking that they might be getting official and real money issued under the authority of the United States.

Deriving its authority from Title 18 of the United States Code, Section 3056, the United States Secret Service is one of the nation's oldest federal investigative law enforcement agencies and it was originally founded in 1865 as a branch of the U.S. Treasury Department to combat the counterfeiting of U.S. currency. In addition to its mandate of protecting the president, vice president, and others, the U.S. Secret Service is responsible for maintaining the integrity of the nation's financial infrastructure and payment systems:
"The Secret Service has jurisdiction over violations involving the counterfeiting of United States obligations and securities. Some of the counterfeited United States obligations and securities commonly investigated by the Secret Service include U.S. currency (to include coins), U.S. Treasury checks, Department of Agriculture food coupons and U.S. postage stamps."
Rather than the beginning of a second wave of gold confiscation, this action to remove coins at eBay and other sites is aimed directly at NORFED Liberty Dollars issued from the now defunct mint of monetary architect Bernard von Nothaus who was convicting of counterfeiting in 2011. For those that haven't followed every twist and turn of this landmark case, I would recommend the amicus curiae brief filed by GATA, the brilliant piece from Lew Rockwell, and the possible implications of the von Nothaus case on other attempts to start a new currency.

The State's nervousness with alternative money creation extends far beyond the lookalikes and the replicas. It goes to the heart of creating a new monetary system evidenced by the targeted shut down of systems that achieve significant market adoption or present an embarrassing dilemma. At issue in the von Nothaus motion to set aside his conviction is the larger constitutional question of whether the government has the power to outlaw the private coinage of money.

Presiding over one of the most egregious assaults on monetary freedom in history, District Court Judge Voorhees still has not set a date for the von Nothaus sentencing. In announcing the verdict, U.S. Attorney Anne M. Tompkins declared:
"Attempts to undermine the legitimate currency of this country are simply a unique form of domestic terrorism. While these forms of anti-government activities do not involve violence, they are every bit as insidious and represent a clear and present danger to the economic stability of this country. We are determined to meet these threats through infiltration, disruption, and dismantling of organizations which seek to challenge the legitimacy of our democratic form of government."
"It's a loser's game to suppress private money that is sound in order to protect government-issued money that is unsound," writes Seth Lipsky in the Wall Street Journal.

For budding monetary entrepreneurs that may be seeking legitimacy to avoid von Nothaus' fate, Robert Murphy of the Mises Institute points out the folly of searching for legal loopholes because "if any attempts to circumvent the dollar actually got off the ground, then the government would find some legal pretext to shut it down." If a competing system posed a genuine threat to its monopoly on money, the government would find a way to prosecute it, "meaning no entrepreneur would spend the resources and time trying to launch an alternative system."

Decentralized and digital currencies without a single point of failure are starting to show some resiliency to arbitrary and capricious shutdowns.

Political freedom can only be preceded by economic freedom which is preceded by monetary freedom. And, critical elements of monetary freedom are currency competition and the right of private coinage. We need more entrepreneurs that rely on the free market, not the law, as their weapon of legitimacy.

For further reading:
"Thoughts On The Liberty Dollar Debacle", Brandon Smith, undated

Saturday, December 15, 2012

Bitcoin’s Greatness Not Realized By Succumbing To Regulation

By Jon Matonis
Sunday, December 9, 2012

Last Thursday's news that French company Paymium and their exchange division, Bitcoin-Central, partnered with a licensed and regulated Payment Services Provider (PSP) ignited a heated debate within the bitcoin community. Eventually, Bitcoin-Central tempered their overly-enthusiastic initial announcement.

"It feels like these French dudes are bringing saltpeter to a rave," declared Daniel Stuckey, a writer at Motherboard ridiculing the company for dismissing the founding concepts of bitcoin.

Not singling out the Paymium effort, there is a powerful undercurrent rejecting the notion that bitcoin exchange companies should seek approval to operate within the existing regulatory framework at all. That undercurrent has some validity. That is if larger forces at work don't settle the issue before then. However, it is the jurisdictions that they elect to operate within plus the specific exchange types that determine the level of required compliance. Legal counsel willing to challenge the status quo is sorely needed for the days ahead.

Floating-rate, rather than fixed-rate, exchanges are going to require the holding of customer funds in national currencies. Exchanges for actual delivery, rather than cash-settled futures exchanges quoted only in bitcoin, will also require holding customer funds in national currencies. Customers with large balances simply aren't going to use exchanges that don't identify their legal jurisdiction, delineate funds, and adhere to some type of recourse for insolvency and stolen funds. So, certain jurisdictions and their financial regulators tend to get involved. This is also the case with Mt.Gox being based in Japan.

Here's the real issue -- regulation in this context is only a bad thing if it leads to crony capitalism or if it suggests that "still-in-beta cryptographic play money" bitcoin requires regulation similar to a national political currency.

While an individual's bitcoin transactions may still be semi-private, the auditable address links on the block chain and identity requirements for entering or exiting the exchange will remove any doubt as to how much bitcoin was spent or earned. Also, the case can be made that, despite bitcoin's basis in mathematics and being devoid of ideology, graph theory analysis of the block chain can be significantly improved by having more 'regulated' data points thus cumulatively degrading the privacy of all bitcoin transactions. Bitcoin address logs for a bitcoin exchange are like IP logs for a VPN.

Yes, debit cards with a bitcoin logo are cool and they can facilitate easy movement of funds associated with bitcoin balances. But legacy debit cards are institutionalized vehicles of identity and they promote half-way measures. Any role for current financial institutions in the societal wealth transfer to cryptocurrency will come from embracing bitcoin on its terms. If banks want to participate in a meaningful way, they will have to adapt to Tor exit nodes, coin mixing services, escrow provisioning without identity, and underwriting private insurance on balances.

Bitcoin's great promise lies in its potential ability for both income and consumption anonymity. It is this feature alone that allows users to maintain the same financial privacy as physical cash today and it is this feature that will also lead to liberating advancements such as a thriving and interconnected System D, unhampered and undiluted freedom of speech, and superior asset management that can truly be said to be off-the-grid.

Those who support the antithetical overlay of  bitcoin on the current financial system ensure us that it will only be temporary and that we must build bridges. That would be nice but it's a fairy tale. It reminds me of the Marxist theory of historical materialism and the Marx-Engels ideology that if we only tolerate the bourgeois state during the transitional advancement to a higher phase, we will see the complete "withering away of the state."

True revolutionary transformations just don't evolve that way. Linux didn't first co-exist within the Microsoft DOS and Windows environment and then decide to spin-off into a competing operating system. File sharing under the BitTorrent protocol didn't conduct a Hollywood outreach program and explain what the technology would mean for the film and recording studios.

One doesn't request freedom, one claims freedom. As Bitcoin Forum member btcbug stated about bitcoin's acquiescence to legality, "It's kind of like a bunch of slaves breaking out and then running straight back because they were so brainwashed they didn't even recognize freedom." However, the sad reality is that most of the slaves don't really want to be free which is exemplified by voting for ever-increasing State services that have to be funded through confiscatory levels of taxation and inevitably that means diminishing financial privacy.

Get real people! This is about more than just "agreeing to disagree" when it comes to stricter regulation being a good thing. Bitcoin without user-defined anonymous transactions is a neutered bitcoin. Paper cash comes with more financial privacy. In circular logic fashion, the pro-regulation adherents must then answer to their success, "what have we really accomplished?"

For further reading:
"Necessary conditions for the long-term success of Bitcoin", ShadowLife, November 7, 2012
"Problems with State Money Transmission Laws Generally", Letter from Aaron Greenspan, November 7, 2012
"FaceCash Founder Claims New Financial Regulation is Unconstitutional", Elise Craig, February 2, 2012

Bitcoin Presentation at DeepSec 2012

Thanks to all my friends at DeepSec in Vienna. It was great to meet you in person during the November 27-30th, 2012 conference.

The Evolution of e-Money (DeepSec) from Jon Matonis

Tuesday, December 11, 2012

Prediction Market 'Bets Of Bitcoin' Available To U.S. Customers

By Jon Matonis
Thursday, December 6, 2012

Launched in August 2011, Bets of Bitcoin is an anonymously-operated prediction market using the cryptographic money bitcoin. Users from anywhere in the world can place bets on the yes or no outcome of future real world events, such as will gold surpass $1,800 per ounce by December 31, 2012 or will the existence of extraterrestrials by confirmed officially by the U.S. government before the end of the year.

The openness and accessibility of the betting site has become more important now that the Commodity Futures Trading Commission (CFTC) has taken legal action against non-anonymous Dublin-based Intrade for unlawfully soliciting and permitting U.S. customers to buy and sell options predicting whether specific future events would occur. Ridiculed as useless and obsolete, the CFTC appears to have raised the bar on doublespeak as they persecute markets with actual integrity and simultaneously reinforce the corruption in the so-called 'officially-sanctioned' markets.

Intrade bowed to pressure from regulators on November 26th and announced that it was closing its doors to U.S. bettors. In a stunning justification of global policing power and indicating a particular annoyance with prediction markets, David Meister, the Director of the CFTC’s Division of Enforcement, explained why even foreign operators can and will be regulated:
"It is against the law to solicit U.S. persons to buy and sell commodity options, even if they are called ‘prediction’ contracts, unless they are listed for trading and traded on a CFTC-registered exchange or unless legally exempt. The requirement for on-exchange trading is important for a number of reasons, including that it enables the CFTC to police market activity and protect market integrity. Today’s action should make it clear that we will intervene in the ‘prediction’ markets, wherever they may be based, when their U.S. activities violate the Commodity Exchange Act or the CFTC’s regulations."
Prediction markets like Bets of Bitcoin and Intrade have been popular for betting on the outcome of political elections, winners of Hollywood Oscars, winners of sporting events, and even scientific breakthroughs. According to Wikipedia, certain kinds of prediction markets may also create controversial incentives.

Other real-money prediction markets operate in Gibraltar, New Zealand, and the United States. There is also an innovative binary options broker based in Cyprus that was denied U.S. regulation when sought.

Regardless, regulation by CFTC or any U.S. regulatory body should not even be the objective of prediction market sites. Without anyone being victimized, regulating the ability of individuals to play games or trade on predicting future events violates free speech. Prediction markets have become a valuable research tool and "one big thing these markets can do is allow researchers to test the hypothesis of the 'wisdom of crowds'," says Rajiv Sethi, a professor of economics at Barnard College.

The binary option and derivatives trading site Nadex was recently turned down for regulation when it attempted to include political event contracts in its already-regulated range of markets for financial contracts.

Instead of seeking regulatory approval, Bets of Bitcoin focuses on financial privacy and anonymity so that it's irrelevant where the customers are geographically located. Anyone can create a bet statement and new bets are vetted by moderators to eliminate unwanted bets or bets whose outcome can't be easily determined or is easily manipulated.

Granted, Bets of Bitcoin differs from Intrade in several other ways, most notably in the way that the instruments are constructed. Intrade offers a full trading platform so you can get in and out of positions even before the expiration date whereas Bets of Bitcoin offers an allocated payout of losing bets based on weighted time of entry and shares commission with the bet creator. Liquidity is of course better on Intrade since it has been around much longer. The largest bet currently listed on Bets of Bitcoin involves a total of ฿258.55 (equivalent to $3,490.43) on whether the price of gold will or will not exceed $1,800/oz by December 31, 2012.

Online gambling is still illegal in the United States through federal laws and many state laws, but operating with "play money" like Bitcoin rather than "real money" could enable relationships with U.S. players to be cultivated. Due to regulations in the U.S. that restrict what U.S. residents can do with their cards, Intrade would not permit the use of U.S.-based credit or debit cards. However they did require customers to agree that it is legal for them to participate in the prediction marketplace.

Intrade says that non-U.S. customers will continue to have access to the company's real-money prediction markets and they promise that "in the near future we'll announce plans for a new exchange model that will allow legal participation from all jurisdictions - including the U.S."

Why wait? In the meantime, test your predictive skills at Bets of Bitcoin and turn your wisdom into bitcoins.

Saturday, December 8, 2012

Digital Currency: A New Worry for Tax Administrators?

By David D. Stewart and Stephanie Soong Johnston
Monday, October 29, 2012

Controversies surrounding presidential candidates are old hat in any given election year, but 2012 could very well be the first time that hackers, presidential tax returns, and a mysterious digital currency called bitcoin all had starring roles in one of the oddest politically motivated tax capers in recent memory.

In early September it was reported that a group of hackers claimed to have broken into PricewaterhouseCoopers's Franklin, Tennessee, office in late August and copied Republican presidential candidate Mitt Romney's sought-after tax returns to thumb drives.

The hackers then said they had sent the thumb drives to local Democratic and Republican offices, along with ransom notes demanding that $1 million -- all in bitcoins -- be paid by September 28 to one of two accounts to destroy or release the cyberkey required to access the files contained on the thumb drives. (For prior coverage of the hacker incident, see Tax Notes, Sept. 10, 2012, p. 1253, Doc 2012-18670, or 2012 TNT 174-2.)

That deadline has since come and gone, and the incident was declared a hoax by many. But the news certainly accomplished one thing: shining the spotlight on bitcoin, a decentralized, peer-to-peer Internet currency that has been growing in popularity and prominence in the digital age -- and in doing so has raised a series of legal questions, especially in the area of taxation.

A 'Bit' of History

The currency was created in 2009 by Satoshi Nakamoto -- likely a pseudonym for the programmer or programmers responsible for developing the system. It is distinct from virtual currencies used in online gaming communities. Virtual currencies, such as World of Warcraft gold, function within the universe of the game but may be bought and sold using real-world currency. The function of virtual currencies is limited by their utility to other game players. (For discussions of the tax implications of virtual economies, see Tax Notes Int'l, Jan. 15, 2007, p. 149, Doc 2007-997, or 2007 WTD 10-8; and Tax Notes Int'l, Nov. 21, 2011, p. 579, Doc 2011-22984, or 2011 WTD 224-18.)

Bitcoins function as a unique currency with its own free-floating exchange. It has no government and no central bank and is intended to be used worldwide. Think of it as the Esperanto of currency.

Coffees from San Antonio-based BitBrew can be purchased
only by using the bitcoin system.

Users can also send and receive bitcoins using unique Internet addresses and store their bitcoins -- each of which is broken down into 100 million units known as satoshis -- in a virtual wallet. The stored bitcoins, which offer some degree of anonymity to users, can then be used to buy everything from coffee and T-shirts to LSD tablets and drug-fueled energy drinks.

Tax Analysts sought out members of the bitcoin community as well as tax experts to identify what the implications are for tax administrators. Some believe that the system could be used to facilitate tax evasion, while others contend that the open nature of the transactions would deter such evasion. All believe, however, that bitcoins raise significant questions. For tax administrators, the challenge is how to approach a system that is outside the traditional streams of commerce and finance. For users, the challenge is how to navigate an ambiguous regulatory climate in which guidance is difficult to come by.

Monday, December 3, 2012

Payments Startup Balanced Innovates In Wrong Direction

By Jon Matonis
Monday, November 26, 2012

Under the maxim that there's no such thing as bad publicity, only publicity, the Balanced startup team will not mind this analysis of their uninspired approach to payments innovation. The explosion in collaborative consumption is indeed transformative, but Y Combinator-backed Balanced is a step in the wrong direction precisely because it extends and supports the legacy infrastructure rather than offering a true peer-to-peer payment solution.

Receiving an investment of $1.4 million from celebrity Ashton Kutcher, SV Angel, Airbnb CEO Brian Chesky, Reddit CEO Yishan Wong, and others, Balanced aims to empower the P2P marketplace movement by providing a two-sided payment platform for online marketplaces.

Balanced and Stripe both rely on the credit card giants for source of buyer funds; however, the target customer for Balanced is the marketplace whereas the target customer for Stripe is the merchant. Primarily, all other differences stem from that difference. Their main innovation appears to be the notion of offering disparate existing functionality on a locked-in platform.

In managing the funds collection and funds transfer, Balanced will maintain funds in an escrow account for the marketplace to settle with merchants and the marketplace will be responsible for any chargebacks and collecting information from merchants. To facilitate large-value transactions and to assist in returns and merchant chargebacks, Balanced intends to add an option for bank ACH credits and debits as a payment choice in the near future.

Available only to US-based marketplaces and sellers, Balanced charges 2.9% plus $.30 per transaction. They also charge $.25 per next-day ACH deposit to the seller.

Just imagine if this extraordinary flood of software development talent could be deployed in the decentralized digital currency space where it would lead to reduced transactional friction, shorter clearing times, massively lower processing fees, optional buyer anonymity, and finality of merchant payment.

Yann Rachere, the Finance Director of Anthemis Group in Geneva, Switzerland, thinks that the "current frenzy is temporary" because ultimately "P2P marketplaces need scale to succeed." He also emphasizes that controlling payments is a key component of the strategic plan for achieving scale as eBay and Etsy demonstrate. Control of the payment infrastructure and individual payment choices allows for competitive differentiation among online marketplaces. This is valuable.

On the positive side, I like that Balanced considers themselves an escrow agent in an agora setting. This is the lynchpin area for peer-to-peer marketplaces because it deals with trust -- either your real identity trust or your avatar identity trust. If one can learn anything from futuristic and successful peer-to-peer marketplaces like Fancy, Silk Road and bitcoin-OTC, the lesson is that reputations matter and exploiting the reputational component opens up breathtaking advancements in payments and P2P exchange.

On a reddit post, Stephen Gornick hints at the possible redundancy of the Balanced offering and the potential for bitcoin solution integrators:
"Each of Balanced's customers is a potential Bitcoin merchant. Zaarly is using Balanced to provide payments handling for its peer-to-peer task market. Instead of Zaarly having to build its own, it can used Balanced's API. With Bitcoin there is a little different flow. You can't pull funds from a Bitcoin user. Bitcoin is push only. But Balanced also handles the payout component. And that is a push transaction. Balanced could just as easily offer Bitcoin payments as it could ACH.
But Balanced shows what is needed by the marketplace -- a path that a Bitcoin variant could follow. Balanced is offered in the U.S. only. A bitcoin-variant could operate globally."
Bitcoin, without an intermediary, already solves P2P marketplace payment issues with a decentralized P2P digital currency that is both fair to buyers with optional anonymity and fair to sellers with finality of payment. What a global online marketplace operator needs more is reputation management APIs and bitcoin payment modules for a broad range of e-commerce shopping cart platforms. Certainly, that is functionality that a payments handling platform could provide. Reputation is how you decide who to business with -- Bitcoin is how you pay and get paid.

For example, leading marketplace and shopping cart software that is open source includes Magento, OpenCart, osCommerceSpree, and Zen Cart. Extensions for multi-vendor support are usually available so building a proprietary marketplace platform for both buyers and sellers is not always necessary. Companies that are advancing the integration of the bitcoin payment choice into these popular e-commerce platforms are WalletBit, Paysius, and BitPay. Also, newcomer BitWasp is an open source anonymous marketplace built to leverage the features of bitcoin and lower the barrier to entry for launching an agorism-based marketplace on Tor or I2P. All could easily incorporate the escrow and reputation functionality.

Sadly, even though Balanced see themselves in an escrow role for buyers and sellers, that is where it ends because they still depend on transactions and chargebacks flowing through the monopolistic credit card networks. Balanced is merely a pass-through for the money. They do not leverage their potential as a reputation aggregator for buyers or sellers in an online marketplace and unlike Wordpress they ignore a vast swath of the world where banks and credit cards are simply unavailable.

I would like to conclude by saying that I wish Balanced much luck in their success, but I can't. I really hope that I never see any of these types of startups again. Overall they are detrimental to global payments innovation and they reinforce the paradigm of declining transaction anonymity coupled with increasing bank fees and restricted merchant segments. At best, they point out the ridiculous pricing and chargeback structure of the quasi-government credit card systems. At worst, they suck investment capital away from more promising projects and distract mind share from where it is most needed.

Update: Balanced has opened a github discussion on the topic "Support Bitcoin as a Payment Method."

Thursday, November 22, 2012

Why Support The Bitcoin Foundation

By Jon Matonis
Bitcoin Foundation
Monday, November 19, 2012

Since the nonprofit Bitcoin Foundation launched in September 2012 I have been asked many times by potential sponsors, "Why would our organization want to support bitcoin and the foundation?" The answer lies in the primary benefits that bitcoin enables in society and those benefits are not always so easy to recognize at first.

As a decentralized and nonpolitical cryptographic money, bitcoin acts as both payment platform and unit of account. In other words, it is both the train track and the train which is what gives bitcoin the ability to function smoothly without third-party intermediaries.

Why is this significant? Without intermediaries, bitcoin is not subject to being appropriated or usurped by governments for their political agendas in the way that monarchs assumed the privileges of minting and stamping the gold coins of the realm, which were eventually 'clipped' and later morphed into lower grade metals. Historically, civilized society has not seen an opportunity like this before nor what kind of economic revolution can be sparked by a sustainable, independent monetary unit.

The Bitcoin Foundation is an educational and software research organization offering annual memberships and a standard donation program. The donation program can be anonymous and is open to any group or any individual and the funding is put to work in the same way as membership funding. Corporations from a broad range of industries, NGOs, and other nonprofit organizations are likely benefactors to the Bitcoin Foundation. Through a collaborative alliance, we can extend your organization's reach and enhance your stated mission. Below I outline some of the significant initiative areas where we are already having a measurable impact:

Human Rights and Social Justice

Citizens from many countries are blocked out of the typical payment channels like PayPal and credit cards simply because they lack access to a bank account. Sometimes, even those that have banking infrastructures within their countries are blocked out due to poor credit histories or insurmountable fees. Around the globe and including remote parts of Africa and Asia, bitcoin combined with mobile technology is providing a means for previously disenfranchised consumers to enter the worldwide marketplace. With the liberating power of bitcoin, responsible individuals can take control of their own financial lives and operate as both consumer and merchant. Now that is real financial empowerment.


Financial privacy is a fundamental human right but lately it has become as vulnerable as email privacy or data privacy. You cannot take your privacy for granted -- you have to claim it. As governments and law enforcement increasingly use money channels as a way to track identity, they give up on the original crime that they were investigating and everything becomes a potential monetary crime. No one is immune to getting ensnarled in that type of fishing expedition. The ends do not justify the means. Free speech advocates and political dissidents can be identified and persecuted simply because of a payment that they made to a certain group or company. Bitcoin restores some of that balance back to the individual in that it permits user-defined anonymity and user-defined traceability.

Sound Public Policy

Public policy efforts should aim for freedom of choice in currencies for several economic reasons. Quantitative easing is a sophisticated sounding term made up by the politicians and bureaucrats. It really means inflating the money supply but that phrase sounds too negative and irresponsible. If the sovereign treasuries around the world can endlessly purchase their own debt and inject liquidity into the economy via monetary and fiscal stimulus, then why do they need taxes? Unfortunately, we suffer both taxation and growing inflation. Average working people and the elderly are impacted the most through the inevitable devaluation of the currency. Since Bitcoin is not the liability of anyone else and cannot be devalued, an easy and safe store of value is provided so that someone's life savings cannot be inflated away by the whims of a political class.

Math and Science

Advanced mathematics and science propels innovation and enhances the standard of living for everyone. Technology and the Internet have already made things possible that we never thought we would observe in our lifetimes. I look forward to more breakthroughs and greater accomplishments. Through its freely-available, open source software bitcoin educates individuals about cryptographic money, public key cryptography, and distributed computing. In just under four years the bitcoin p2p project has become the world's single largest distributed computed project.

We welcome your support in advancing the common goals that we share. For further information, please reach out to me ( or our Assistant Director, Lindsay Holland (

Wednesday, November 21, 2012

What’s Your Bitcoin Strategy? WordPress Now Accepts Bitcoin Across The Planet

By Jon Matonis
Friday, November 16, 2012

Best CEO Toni Schneider in 2007
I awoke to incredible news this morning. Leading web publishing service announced that they will begin accepting the nonpolitical cryptographic money Bitcoin as a payment method for various upgrades.

Then I remembered that powers our online publishing platform. It also powers the blog platform for The New York Times, CNN, Reuters, Mashable, NBC Sports, GigaOm, TechCrunch, ELLE Girl, RealClearPolitics, TED, National Football League, General Motors, UPS, eBay, Sony, and Volkswagen.

Not only does this strategic move bring new unserved customers into the WordPress fold, it paves the way for the online publishing platform run by parent company Automattic not to be restricted by the choices of its payment partners. Companies doing business and accepting payments globally are subject to increasing fees and sometimes arbitrary chargebacks which no doubt impact their bottom line. WordPress would probably not even mind if a large chunk of their mainstream payment processing migrated to bitcoin.

Over 57.8 million WordPress sites are written in 120 different languages creating nearly 32 million new user posts each month.

Criticizing the centralized bankcard associations and citing payment method deficiencies, WordPress spokesperson Andy Skelton said, "Unlike credit cards and PayPal, Bitcoin has no central authority and no way to lock entire countries out of the network. Merchants who accept Bitcoin payments can do business with anyone." And thus the planet becomes immediately open to their products and services.

"PayPal alone blocks access from over 60 countries, and many credit card companies have similar restrictions," continued Skelton. "Some are blocked for political reasons, some because of higher fraud rates, and some for other financial reasons. Whatever the reason, we don’t think an individual blogger from Haiti, Ethiopia, or Kenya should have diminished access to the blogosphere because of payment issues they can’t control." [Note: updated their original blog post which mentioned Cuba and Iraq.]

Vitalik Buterin of Bitcoin Magazine brings up an equally significant reason for accepting payment in Bitcoin, "Another argument which WordPress did not mention is anonymity. Many bloggers that operate in restrictive regimes do so using pseudonyms for their own protection, and traditional payment methods like credit cards and PayPal are unusable for those bloggers because they expose the payer’s physical identity." With user-defined anonymity and identity privacy, bitcoin offers unparalleled safety to dissident bloggers and free speech advocates.

Initially, processing will be managed by payment service provider BitPay, Inc. of Orlando, Florida. BitPay shields WordPress from having to handle actual payments by immediately converting and transferring sales proceeds into a WordPress merchant bank account. This minimizes the currency risk for the accepting merchant. An important configurable option also allows the merchant to retain Bitcoin balances for their own account and subsequent usage.

Although WordPress states that they are not waiting for a sufficient number of confirmations from the bitcoin block chain, it is largely irrelevant for e-services since upgrades can simply be deactivated or reversed due to a failed payment.

WordPress may not stand as the lone giant for very long since Reddit CEO Yishan Wong hinted last week at the social news site's willingness to begin transacting in Bitcoin for Reddit Gold subscriptions. Reddit is a subsidiary of Condé Nast's parent company, Advance Publications.

As the bitcoin juggernaut continues to roll forward absorbing merchants and customers globally it leaves archaic and unsuspecting payment methods in its wake. As one bitcoin forum member articulated, merchants will increasingly be asked: "What's your Bitcoin strategy?"

Monday, November 19, 2012

Currencies of the Future

By Douglas French
Laissez Faire Today
Tuesday, November 13, 2012

Many people complain about government control of currency, but only a few do something about it. I’m not talking about movements to “audit the Fed” and such. I’m talking about real innovation that makes an end run around the government’s iron grip on the monetary system.

A few of us old folks might like to return to the days of slapping a silver dollar on the bar for a shot of whiskey, but the younger techno-savvy generation sees paying for their Negroni cocktail with virtual currency from their hand-held device. To serve this market, a new world of virtual currencies has popped up spontaneously.

In a debate, Mitt Romney said, “You couldn’t have people opening up banks in their garage and making loans.”

Really? Some people are thinking precisely along these lines and even going further to create new units of accounting.

You might think these people are crazy. After all, to be a proper money, a currency must have a nonmonetary value, a high value per unit weight, a fairly stable supply and be divisible, durable, recognizable, and homogeneous. Gold and silver fit the bill perfectly. But does that mean something else (or a variety of things) can’t?

Money develops from being the most marketable good that in turn is used for indirect trade. Historically, that has been gold and silver. However, governments have worked very hard to demonetize gold and silver with taxes on precious metals and legal tender laws. And while a few people swear by storing their wealth in gold and silver, in relation to all other financial assets, the percentage of portfolios invested in precious metals is only 1%.

The idea that government is going to re-shackle its currency to gold anytime soon, when the only way federal governments are staying in business is with an unfettered printing press, is naive. Governments always have driven and will keep driving the value of their currencies to the value of the paper. It may take decades, it may take centuries, but it will happen eventually.

The answer to the currency question may not be to reform government in a way that it can’t reasonably be reformed, but to turn loose entrepreneurial genius to solve the problem and create a quality product. There are plenty of government roadblocks, but every new innovation encounters government resistance. Entrepreneurs persevere. However, this is a particularly risky area. There are currency entrepreneurs sitting in jail for competing with the government.

In 2009, Japanese programmer “Satoshi Nakamoto” (not his real name) was designing and implementing Bitcoin. It’s not for the faint of heart. It’s proven to be highly volatile. But it’s also proven to be very useful in a digital age.

Some people in the free-market community don’t know what to think of Bitcoin and have dismissed it. They say no currency can exist that doesn’t have a prior root in physical commodity.

That is because, as Robert Murphy summarized Ludwig von Mises: “We can trace the purchasing power of money back through time until we reach the point at which people first emerged from a state of barter. And at that point, the purchasing power of the money commodity can be explained in just the same way that the exchange value of any commodity is explained.”

The naysayers contend Bitcoins never had a nonmonetary commodity value. The case for it is then dismissed without thought or argument. However, Mises built his “regression theorem” on the work of Carl Menger, the father of Austrian economics and subjective value.

In Menger’s view, economizing individuals constantly look to make their lives better through trade. These individuals trade less tradable goods for more tradeable goods. What makes goods more tradeable, Menger emphasizes, is custom in a particular locale.

“But the actual performance of exchange operations of this kind presupposes a knowledge of their interest on the part of economizing individuals,” Menger writes. But Menger goes on to explain that not all individuals gain this knowledge all at once. A small number of people recognize the marketability of certain goods before most others.
These might be considered currency entrepreneurs. They anticipate consumer needs and demands, and as is the case with any other good or service, these entrepreneurs recognized more salable goods before the majority of people.
"Since there is no better way in which men can become enlightened about their economic interests than by observation of the economic success of those who employ the correct means of achieving their ends, it is evident that nothing favored the rise of money so much as the long-practiced and economically profitable acceptance of eminently saleable commodities in exchange for all others by the most discerning and most capable economizing individuals."
For example, cattle were, at one time, the most saleable commodity and were thus considered money. Although cattle money sounds unwieldy, the Greeks and the Arabs were both on the cattle standard. This currency had four legs that could move itself, and grass was everywhere, so feeding it was inexpensive.

But then the division of labor led to the formation of cities, and the practicality of cattle money was over. Cattle were no longer marketable enough to be money. Cattle still had value, but, “They ceased to be the most saleable of commodities, the economic form of money, and finally ceased to be money at all,” Menger explains.

Then began the use of metals as money: Copper, brass and iron, and then silver and gold.

But Menger was quick to point out that various goods served as money in different locales.
"Thus money presents itself to us, in its special locally and temporally different forms, not as the result of an agreement, legislative compulsion, or mere chance, but as the natural product of differences in the economic situation of different peoples at the same time, or of the same people in different periods of their history."
So while people contend that money must be this or must be that, or come from here, or evolve from there, Menger, the father of the Austrian school, seems to leave it up to the market. When a money becomes uneconomic to use, it loses its marketability and ceases to be money. Other marketable goods emerge as money. It’s happened throughout history and likely will continue, despite government wanting to freeze the world in place to its liking.

Which brings us back to Bitcoin, what the European Central Bank (ECB) calls in its latest report “the most successful — and probably most controversial — virtual currency scheme to date.”

Ironically, while some economists are pooh-poohing Bitcoin, the ECB devotes some of their lengthy report to the idea that the Austrian school of economics provides the theoretical roots for the virtual currency. The business cycle theory of Mises, Hayek and Bohm-Bawerk is explained in the report and Hayek’s Denationalisation of Money is mentioned.

The report writers indicate that Bitcoin supporters see the virtual currency as a starting point for ending central bank money monopolies. Like Austrians, they criticize the fractional-reserve banking system and see the scheme as inspired by the classic gold standard.

Bitcoins are already used on a global basis. They can be traded for all sorts of products, both material and virtual. Bitcoins are divisible to eight decimal places and thus can be used for any size or type of transaction.

Bitcoins are not pegged to any government currency and there is no central clearinghouse or monetary authority. Its exchange rate is determined by supply and demand through the several exchange platforms that operate in real time. Bitcoin is based on a decentralized peer-to-peer network. There are no financial institutions involved. Bitcoin’s users take care of these tasks themselves.

Additional Bitcoin supply can only be created by “miners” solving specific mathematical problems. There are somewhere around 10 million Bitcoins currently in existence, and more will be released until a total of 21 million have been created by the year 2140. According to Bitcoin’s creator (whomever he or she is), mining on Bitcoin provides incentives to be honest:
"If a greedy attacker is able to assemble more CPU power than all the honest nodes, he would have to choose between using it to defraud people by stealing back his payments, or by using it to generate new coins. He ought to find it more profitable to play by the rules, such rules that favour him with more new coins than everyone else combined, than to undermine the system and the validity of his own wealth".
The ECB’s report explains that Bitcoin supply is designed to grow in a predictable fashion. “The algorithms to be solved (i.e., the new blocks to be discovered) in order to receive newly created Bitcoins become more and more complex (more computing resources are needed).”

This steady supply increase is to avoid inflation (decrease in the value of Bitcoins) and business cycles caused when monetary authorities rapidly expand money supplies.

Bitcoin has become the currency of the online black market. For instance, The Silk Road (the Amazon of the illegal drug trade that can only be accessed through private networks using the IP scrambling service called Tor) only accepts payments in Bitcoin. However, as the ECB report points out, there are only about 10,000 Bitcoin users, and the market is illiquid and immature.

So why does the ECB give a damn about Bitcoin and other virtual currencies? The central bankers are worried that they are not regulated or closely supervised, that they could represent a challenge for public authorities and that they could have a negative impact on the reputation of central banks.

At the same time, the report makes the point that “these schemes can have positive aspects in terms of financial innovation and the provision of additional payment alternatives for consumers.”

The report says big players in the financial services arena are purchasing companies in the virtual payments space. VISA acquired PlaySpan Inc., a company with a payment platform that handles transactions for digital goods.

American Express (Amex) purchased Sometrics, a company “that helps video game makers establish virtual currencies and… plans to build a virtual currency platform in other industries, taking advantage of its merchant relationships.”

This would dovetail with American Express’ entry into the prepaid credit card business. Banking industry insiders are upset with Amex and Wal-Mart, that also is offering prepaid cards, because these prepaid accounts would amount to uninsured deposits, according to Andrew Kahr, who wrote a scathing piece on the issue for American Banker.

Kahr rips into the idea with this analogy:
"To provide even lower ‘discount prices,’ should Wal-Mart rent decaying buildings that don’t satisfy local fire laws and building codes — and offer still better deals to consumers? And why should Walmart have to honor the national minimum wage law, any more than Amex honors state banking statutes? With Bluebird, Amex can already violate both the Bank Holding Company Act and many state banking statues."
Kahr is implying that regulated fractionalized banking is safe and sound, while prepaid cards provided by huge companies like Amex and Wal-Mart is a shady scheme set up to rip off consumers. The fact is, in the case of IndyMac, panicked customers forced regulators to close the S&L by withdrawing only 7% of the huge S&L’s deposits. It was about the same for WaMu and Wachovia when regulators engineered sales of those banks being run on. Bitcoin supporters, unlike the general public, are well aware of fractionalized banking’s fragility.

Maybe what the banking industry is really afraid of is the Amexes and Wal-Marts of the world creating their own currencies and banking systems. Wal-Mart has tried to get approval to open a bank for years, and bankers have successfully stopped the retail giant for competing with them.

However, prepaid credit cards might be just the first step toward Wal-Mart issuing their own currency — Marts — that might initially be used only for purchases in Wal-Mart stores. But over time, it’s not hard to imagine Marts being traded all over town and easily converted to dollars, pesos, Yuan, or other currencies traded where Wal-Mart has stores.

Governments are destroying their currencies, and businesses know it. Entrepreneurs won’t just stand by and theorize. They’re doing something. They recognize a market opportunity. The banking industry realizes it. As Mr. Kahr concluded his article that calls for an end to all uninsured deposits: “Otherwise, we might have an unregulated Facebook or Google of payments, even PayPal, quickly becoming both highly vulnerable and TBTF. (It could actually be run by someone wearing a hoodie, without tie or even white shirt!)”

Here at LFB, we don’t know what tomorrow’s money will be. Digits and computer algorithms? Silver and gold coins engraved with someone wearing a hoodie, perhaps? What we know for sure is that we’re rooting for enterprising entrepreneurs to give the government a run for their money in the money business. Watch this space.

Douglas E. French is senior editor of the Laissez Faire Club and former president of the Mises Institute. Reprinted with permission. 

For further reading/viewing:
"Jeffrey Tucker on the future of private money" (video), Goldmoney, November 12, 2012

Sunday, November 18, 2012

The General, The Biographer, And Unencrypted Email

By Jon Matonis
Tuesday, November 13, 2012

The newest poster couple for encrypted email is General David Petraeus and his ‘embedded’ biographer Paula Broadwell. One of the more curious aspects of this episode is why the nation’s spy chief couldn’t figure out the basics around email cryptography or why a West Point graduate and lieutenant colonel in the U.S. Army Reserves who also worked with the FBI Joint Terrorism Task Force wasn’t aware of Tor for IP masking.

It all started with the trace of an apparently anonymous email sent by Broadwell to Petraeus’ friend Jill Kelley that was traced back to Broadwell’s hotel room at the time via email location metadata. This email was the original message that led to the eventual discovery of the sexually explicit emails between Petraeus and Broadwell.

Obviously for readability reasons this original message could not have been encrypted (also Tor does not provide encryption), but it could have been anonymized as to location and that is precisely what Tor was designed for. Originally a U.S. Navy project for shielding location data and defending against traffic analysis, the Tor Project utilizes a layered router protocol which obfuscates the sender’s IP location. Even a rudimentary VPN (Virtual Private Network) that religiously deleted IP log files and accepted anonymous payments would have been sufficient. Oh well…live and learn.

Beyond that, everyone seems to be asking the obvious question about email encryption, especially in today’s surveillance state. If they can do this to each other, what are they doing to us? But let’s examine how email encryption might have been used under these circumstances and if it would have proven effective.

Assuming that the connection between Petraeus and Broadwell would still have been discovered, what other precautions could they have taken besides the old terrorist trick of sharing a draft version that each party separately logged into?

For starters, the couple could have used stress-tested PGP (Pretty Good Privacy) for point-to-point encrypted email which involves installing a separate piece of client software and the exchanging of public keys. Also, they could have used a simpler web-based OpenPGP-compliant service such as Hushmail, which would have at least protected their historical retained messages provided neither one of them logged on again and made their password vulnerable to a court-ordered java applet spoofing.

So then, are the involved parties safe from anyone discovering the contents of their encrypted messages? Would the investigation have stopped at the discovery of Paula Broadwell as the anonymous email sender? I’m afraid it isn’t as simple as that. Many factors are at play here dealing with individual or third-party data retention policies sometimes beyond your control as well as continued usage of the same private encryption key and password.

Federal agents have many tools in their arsenal, some legal and some not-so-legal. If IP location details were not protected, the linkage could have been established between Petraeus and Broadwell proving at a minimum the existence of some encrypted correspondence. The question is whether or not additional investigative actions beyond that would be warranted, or even approved. At that point, it’s all about the strength of the password and obtaining it either through password cracking or password observation if the password is sufficiently strong.

When law enforcement has the advantage of tracking someone without their knowledge, software and hardware keyloggers can be an effective method to obtain password credentials. Keyloggers come in many forms but they are typically installed between the keyboard and the computer to capture and record a computer user’s keystrokes, including passwords. Hardware keyloggers have an advantage over software keyloggers as they can begin logging from the moment a computer is turned on.

Alternatively, an ultra-small camera can be mounted above usual computer locations, such as an office desk or table. A wireless camera would be able to relay the images of the user typing a password thereby eliminating the necessity of physical re-entry.

Failing that, and failing waterboarding of the suspects, contempt of court charges could be invoked by the government since there is no specific law regarding key disclosure in the United States. One of the parties would first have to be charged with a criminal offense before the government can demand that they surrender their private encryption keys. Relevant case law has revolved around the Fifth Amendment privilege against self-incrimination.

Ironically, the global encrypted communication service Silent Circle just launched last month targeting government and corporate enterprise customers. It was founded by a world-renowned cryptographer and a former U.S. Navy SEAL sniper and communications security expert. I suspect this whole sordid story will made an excellent advertisement for them.

For further reading:
"E-Mail Security in the Wake of Petraeus", Bruce Schneier, November 19, 2012
"Petraeus case triggers concerns about Americans' online privacy", Jessica Guynn, Los Angeles Times, November 15, 2012
"Surveillance and Security Lessons From the Petraeus Scandal", Chris Soghoian, November 13, 2012

Monday, November 12, 2012

Department Of Homeland Security To Scan Payment Cards At Borders And Airports

By Jon Matonis
Wednesday, November 7, 2012

Typical wireless electronic card reader
Travelers leaving or entering the United States have long had to declare aggregated cash and other monetary instruments exceeding $10,000. Now, under a proposed amendment to the Bank Secrecy Act, FinCEN (Financial Crimes Enforcement Network) will also require travelers to declare the value of prepaid cards that they are carrying, known now as "tangible prepaid access devices."

Expected to be finalized by the end of this year, the cross-border reporting modifications stem from a broader October 2011 definition of payment methods and form factors that replaced the term "stored value" with the term "prepaid access" in an effort to more accurately describe the process of accessing funds held by a payment provider.

Enforceability falls to U.S. Immigration and Customs Enforcement and U.S. Customs and Border Protection both within the Department of Homeland Security, which is already developing advanced handheld card readers that can ascertain whether a traveler is carrying a credit card, debit card, or prepaid card. This differentiation is important because only prepaid card balances will need to be added to declaration report forms.

Acknowledging that many questions still remain and that enforcement may not be straightforward, Cynthia Merritt, assistant director of the Retail Payments Risk Forum at the Federal Reserve Bank of Atlanta, had this to say about the handheld readers:
"Furthermore, according to the comments, the enforcement challenge is not new, nor is the concept of a device or document that can be used to access value. The current challenges are similar to those presented in the past with other monetary instruments such as checks, money orders, and traveler checks."
Merritt also stated that, "When law enforcement takes possession of a cash or monetary instrument at the border, they are effectively holding the funds, but not so with a prepaid card or other device. Holding the card does not provide access to the underlying funds."

Other questions to be settled include how to determine mobile phone wallet and key fob balances that can function in a manner similar to card swiping, how to distinguish between reloadable and non-reloadable prepaid cards, how to distinguish between bank-issued and non-bank-issued prepaid cards, should closed loop gift cards be included in the cross-border reporting requirements, what to do about cards that clear customs with a minimal balance but are then subsequently reloaded with an amount in violation of the reportable limits, and what to do about a large number of nonpersonalized, unembossed cards.

Also, would a traveler have legal recourse for damages if agents seized a proper debit card in the mistaken belief that it was a reportable prepaid card?

These complications and others imply that FinCEN's NPRM [Notice of Proposed Rule Making] may yet undergo some revisions in order to bring the regulations in sync with the realities of the prepaid card industry.

In the meantime, travelers with a memorized Bitcoin private key can breathe a sigh of relief, because according to an important April 9th, 2012 letter to FinCEN Director James Freis from Homeland Security Investigations it appears that intangible brainwallets are safe for the moment:
"Should the border declaration apply to codes, passwords and other intangibles as well as to any tangible object that is dedicated to accessing prepaid funds?"
"HSI believes that border declaration should not apply to codes, passwords and other intangibles. Identification and verification of intangibles in the context of border enforcement poses logistical and potential legal issues that are not contemplated by currency and monetary instrument declaration regulations. The structure of the currency and monetary instruments declaration regime, hinges on the existence of a physical object. The language requires something that can be passed from one individual to another in order to be presented to a third party for execution/payment."

Thursday, November 8, 2012

ECB: “Roots Of Bitcoin Can Be Found In The Austrian School Of Economics”

By Jon Matonis
Saturday, November 3, 2012

The ECB (European Central Bank) has produced the first official central bank study of the decentralized cryptographic money known as bitcoin, Virtual Currency Schemes. Ignoring for a moment the ECB's condescending and derogatory use of the virtual currency phrase and scheme phrase, the study produced at least one landmark achievement.

In claiming that "The theoretical roots of Bitcoin can be found in the Austrian school of economics," the ECB forever linked Bitcoin to the proud economic heritage of Menger, Mises, and Hayek as well as to Austrian business cycle theory. This recognition is also a direct testament to the monetary theory work of Friedrich von Hayek who inspired many with his 1976 landmark publication of Denationalisation of Money.

Bitcoin fully embodies the spirit of denationalized money as it seeks no authority for its continued existence and it recognizes no political borders for its circulation. Indeed according to the report, proponents see Bitcoin as "a good starting point to end the monopoly central banks have in the issuance of money" and "inspired by the former gold standard."

Economists from the 19th and mid-20th centuries can be forgiven for not anticipating an interconnected digital realm like the Internet with its p2p distributed architecture, but modern economists cannot be. From their own conclusions (on page 48) which inaccurately lump Bitcoin together with Linden Dollars, here is what the modern-day economists at the ECB are still not getting:

1. ECB concludes that if money creation remains at a low level, bitcoin does not pose a risk to price stability. This is incorrect on two levels. One, the creation of new bitcoin is capped at 21 million with eight current decimal places so it grows through adoption and usage rather than monetary expansion. And two, as with gold, silver, and other commodities having a monetary component, price stability is a function of the market not central planners;

2. ECB concludes that bitcoin cannot jeopardize financial stability due to its low volume and limited connection with the real economy. Conversely, bitcoin will tend to increase financial stability and overall soundness. Bitcoin's connection with the real economy is only a concern for the regulated and taxed economy, whereas bitcoin independently may thrive in the $10 trillion shadow or "original" economy. Besides, with its repeated market interventions, no one has done more to jeopardize financial stability than the ECB itself;

3. ECB concludes that bitcoin is currently not regulated and supervised by any public authority. It would be more accurate to say that State-sponsored regulation is largely irrelevant because of the inherent design properties of a peer-to-peer distributed computing system. But happily, this is still a conclusion that I can agree with and recommend that it remains the case;

4.  ECB concludes that bitcoin could represent a challenge for public authorities, given the legal uncertainty and potential for performing illegal activities. While public authorities will certainly be challenged by the introduction of a monetary unit that cannot be manipulated for political purposes, bitcoin in some cases does have the ability to provide tracking capability that far exceeds that of national cash or money substitutes. What authorities will find most troubling though, with bitcoin, is that money flows between individuals and businesses will no longer be exploitable for purposes of unlimited identity tracking and unconstitutional 'fishing expeditions';

5. ECB concludes that bitcoin "could have a negative impact on the reputation of central banks, assuming the use of such systems grows considerably and in the event that an incident attracts press coverage, since the public may perceive the incident as being caused, in part, by a central bank not doing its job properly." Pretentious as it may seem, the ECB is stating here that central banks as protector of the general public with respect to payments have a role to play because it is their reputation that suffers in the event of a bitcoin-related security incident. Firstly, that is an assumed responsibility -- not a delegated responsibility; and reputational impact aside, I would prefer to rely on lex mercatoria;

6. ECB concludes that bitcoin does indeed fall within central banks' responsibility as a result of characteristics shared with payment systems. Of course it does not. Central banks are a form of centralized economic planning so their stated responsibilities are suspect from the outset. Bitcoin represents an intangible math puzzle whose existence is solely restricted to transfer rights on a cloud-based public ledger. It more closely resembles an air guitar than a payment system for purposes of oversight.

Now, in affirming the superior attributes of bitcoin in the role of financial innovation, the ECB correctly identifies why the profligate issuers of national fiat currencies will ultimately feel threatened by such a decentralized nonpolitical unit. The report acknowledges the following with respect to bitcoin: (a) "higher degree of anonymity compared to other electronic payment instruments," (b) "lower transaction costs compared with traditional payment systems, and (c) "more direct and faster clearing and settlement of transactions" from the absence of intermediaries.

Overall, the fear of the monetary overlords is palpable as the study concludes by basically promising continued scrutiny and oversight. Also forecast for the plebeians is a possible remedy to the global scope and unclear jurisdiction of the regulatory challenge:
"One possible way to overcome this situation and obtain some quantitative information on the magnitude of the funds moved through these virtual currency schemes could be to focus on the link between the virtual economy and the real economy, i.e. the transfer of money from the banking environment to the virtual environment. Virtual accounts need to be funded either via credit transfer, payment card or PayPal and therefore a possibility would be to request this information from credit institutions, card schemes and PayPal."
However, Michael Parsons, a former executive with Emirates Bank (Dubai), Moscow Narodny Bank, and KPMG Moscow, believes that those efforts will prove futile and he explains, "Bitcoin is 'regulated' by its peers and mathematics. And Bitcoin is not a currency like fiat money. It is a value  transfer system which is given value only by its users. So the ECB, FED, etc. have no mandate to control a 'virtual currency' just because they call it (bitcoin) that! It will just go underground. Bitcoin is like Light and Air. Free to use and transfer. Owned and issued by the people and NOT the State!"

It evokes an image of central bankers huddled comfortably on the safe shoreline as they look out into the horizon and see the dangerous, unstable virtual currencies approaching. The opposite is actually the truth because it is the central bankers who are floating precipitously out at sea. As James Turk famously said about bitcoin's analog cousin, "When standing in a boat and looking at the shore, it is the boat (currencies) – and not the land (gold) – that is bobbing up and down."