Saturday, August 23, 2014

CFPB Warning Ignores Bitcoin’s Consumer Protections

By Jon Matonis
Monday, August 18, 2014

Last week's advisory from the US Consumer Financial Protection Bureau (CFPB) warning consumers about the risks of virtual currencies such as bitcoin diligently listed several obvious risks, but simultaneously omitted the very consumer protections provided by certain cryptographic monies.

Citing malicious hackers, potentially high mark-up fees, exchange-rate volatility, lack of governmental insurance, and risk of private key loss is laudable given that so few market participants conduct proper due diligence before jumping in to a new alternative. The majority of companies involved in the bitcoin ecosystem have been highlighting these risks for years.

To be fair, the CFPB charter may not include stressing the particular benefits of some payment methods over others. However, when the words 'financial protection' are in your agency's official name, it appears disingenuous to intentionally omit features from what may be one of the world's most protective financial instruments ever designed.

Who benefits most?

Bootstrapping a competing free-market alternative in a field of national currencies with so many pre-existing and unfair legal tender advantages resembles the solving of the great chicken-or-the-egg debate: which came first, the merchant or the consumer?

A recent New York Times article on bitcoin merchants sparked an instructive debate about whether bitcoin was mostly a payment method benefiting merchants or if consumers also gained substantial benefits from the digital currency.

Merchants need an incentive to accept the new currency before consumers can spend the new currency. And similarly, consumers need reasons to hold the new currency before merchants can accept it. The CFPB advisory warning does little to instill confidence in the latter.

Therefore, in order to better assist consumers, I will describe some of bitcoin's superior attributes in the area of financial protection:

1. Protection from counterfeit bank notes
As the most counterfeit-proof currency in existence today, bitcoin protects consumers from the risk of accepting or receiving counterfeit bank notes in commerce, which continues to plague the world's fiat note issuers. By virtue of the innovative bitcoin block chain, transactions are chronologically recorded in a shared database preventing double-spending and it is computationally impractical to modify once recorded in the chain.

2. Protection from financial surveillance
Just as massive digital surveillance of our email correspondence, telephone conversations, instant messaging, and web surfing habits has escalated in the last 20 years, so has surveillance of our income, spending, and financial transactions. Individuals and corporations are under the financial microscope now more than at any time in history – a fact that has significantly eroded any remaining vestiges of financial privacy. As we move from a paper money world to a digital money world, maintaining our analog equivalent rights becomes a necessity.

Governments crave this information in the name of preventing money laundering, fighting terrorism, collecting taxes, and fighting the drug, gambling and pornography wars. Bitcoin restores the balance with financial privacy and financial sovereignty by placing responsibility for how transparent we want to be in the hands of the user where it belongs, hence user-defined privacy. This is also permission-less privacy and, if opted for, it includes total balance privacy in addition to transaction date, type, amount, and recipient privacy.

3. Protection from identity theft
Bitcoin provides excellent protection from both identity theft and fraudulent charges, primarily because it functions as a push-method rather than a pull-method for personal financial details. Since account details and identity are not transferred to the merchant for payment purposes, the potential for malicious hackers and internal corporate security breaches are reduced to zero. With current payment methodologies, however, identity theft and resulting consequences to the victims are significant negative issues.

4. Protection from physical loss of assets
In this sense, bitcoin is virtual, however the comparison is to trusting the safekeeping of your assets to a third party like a financial institution or wallet provider. Of course, when utilizing a third-party, a host of new risks is introduced which government regulation and government deposit insurance seek to address. But, not using bitcoin because it doesn't come with government assurances is like not flying because you might fall out of the sky.

Bitcoin possesses the option of simply not having to trust a third-party intermediary and, in this way, it resembles a digital bearer instrument such as gold or paper cash. However, bitcoin's unique exceptions include the ability to safely backup your assets multiple times and to transfer them digitally without sacrificing their bearer nature.

5. Protection from cross-border restrictions and excessive fees
Some money services businesses and financial institutions charge exorbitant fees just to execute a simple monetary transfer often preying upon those that are most financially vulnerable. Other countries severely restrict the amount and type of national currencies that may enter their borders causing hardship for many American citizens and residents needing to transfer living funds to family members overseas. Without requiring an intermediary, bitcoin insulates individuals and businesses from these detrimental restrictions and fees.

6. Protection from payment blockades
Blockades such as these are typically enacted in the name of 'political correctness' as witnessed by the aggressive payment blockade against WikiLeaks in 2011. As the US government leaned strongly on payment processors Visa, MasterCard, and PayPal to discontinue donations to the whistle-blowing site, donations in bitcoin continued to provide a valuable method for WikiLeaks to maintain an ongoing financial stream for operations.

7. Protection from government-sponsored inflation
As the so-called 'hidden tax', inflation represents one of the most insidious methods ever devised by governments to boost their wealth at the expense of the fleeced middle-class. Without significant assets to appreciate and keep pace with government-induced inflation, it is the poor and middle-class that suffer the most during inflation, despite the fact that the decline in purchasing power may only be noticeable over a longer time horizon. Bitcoin, with its fixed and predictable supply, provides a store of value alternative to the currency of nations with printing presses run amok.

8. Protection from confiscation
Arbitrary and capricious confiscation of assets has emerged as a new trend among debt-saddled countries in the euro zone. Cyprus and Spain are two examples, but any government with control over its banking system assets has the potential to enact a 'deposit levy' or a 'wealth tax' if revenues from taxation are insufficient to meet ongoing government obligations. The protections afforded by bitcoin in this area prevent loss of wealth due to random government asset seizures.

Let the buyer beware

Today, I was reminded that Confucius once said: "The beginning of wisdom is to call things by their proper name." So, let's not forget the ongoing bitcoin word game played by governments and other wordsmiths.

Confucious said, “The beginning of wisdom is to call things by their proper name.” - See more at:
Confucious said, “The beginning of wisdom is to call things by their proper name.” - See more at:
Confucious said, “The beginning of wisdom is to call things by their proper name.” - See more at:
Confucious said, “The beginning of wisdom is to call things by their proper name.” - See more at:
While we should definitely heed the risks within a digital currency environment, just as we heed the risks inherent with physical money, we should be equally aware of the additional financial protections provided by bitcoin that are so critical for maintaining a free society. Caveat emptor!

Tuesday, August 5, 2014

Bitcoins Affected by New York's BitLicense May Trade at Discount

By Jon Matonis
Wednesday, July 30, 2014

With New York's BitLicense scheme officially three months away, sophisticated traders are already devising strategies to profit from the potential arbitrage opportunities.
If implemented in the regulation's final version, the physical address and identification requirements (Sections 200.12 and 200.15) for both sides of a transaction will dilute the inherent privacy of the overall bitcoin network.

Due to potential IP address blocking and other techniques to identify and block New York-based traders, the exchanges operating within the jurisdiction may end up 'ring-fencing' themselves and their customers' bitcoin.

Of course, this was not New York's intention, but if other parties begin to shun 'New York' bitcoins, then those parties that do choose to accept them may only accept them at a discount, making it costly to transfer 'non-private' bitcoins out of New York.

Tainted by government

Typically, we refer to a loss of essential fungibility occurring as a result of some type of positive coin validation required by the government. In this case, it would be the government-approved coins that would be tainted. Perhaps, New York could mandate complete fungibility of their exchanges' coins through legislation, but that would imply subsidizing the exchange rate.

Arthur Hayes, CEO and co-founder of BitMEX (Bitcoin Mercantile Exchange), who has strong derivatives experience with an institutional trading background, explained:
"These regulations are going to make some savvy traders a lot of money. Because there is a premium placed on privacy, the 'clean' coins trading on exchanges with BitLicenses will trade at a discount to coins trading on exchanges that operate in more laissez-faire jurisdictions. Traders with the ability and risk appetite will be able to arbitrage the price differential."
Based in Hong Kong, Hayes is launching a bitcoin futures and options exchange similar to the currency futures exchanges that sprouted up in Chicago after the 1971 collapse of Bretton Woods.

Hayes recently participated on CoinSummit's derivatives panel in London, where he said he is counting on large speculators and commercial hedgers to utilize exchange-traded futures and options as a risk management tool for bitcoin.

Jurisdictional differential

Just as WTI (West Texas Intermediate) crude oil contracts vs North Sea Brent crude oil contracts trade at a differential and Chicago wheat contracts vs Kansas City wheat contracts trade at a differential, certain jurisdictional bitcoins can trade with a differential. For now, only a single-type bitcoin futures contract will be traded on BitMEX.

Indeed, newly mined 'virgin' bitcoin have commanded a premium for some time now in certain circles. In 2013-14, Mt. Gox coins frequently traded at either a premium or discount to other bitcoin depending on politics and exchange liquidity.

With physical bitcoin over the counter or with person-to-person trading, Hayes describes a likely scenario:
"The best example would be citizens of New York who wish to anonymously buy Bitcoin. Buyers will need to pay an increased fee to a trader who does not possess a BitLicense. The fee will cover his or her costs of acquiring coins outside of New York, and extra profit for the trader compensating him or her for the extra risks taken."

Bitcoin black market

Free markets solve political and structural problems to increase liquidity, and currencies are no different.

Today, one of the best examples of this is the 'blue dollar' exchange rate in peso-ravaged Argentina, which trades at a 60% premium to the official US dollar exchange rate with the central bank.

The BitLicense-based exchange rate may be the closest thing to an official central bank rate for bitcoin and maybe this is a conscious attempt to develop an institutional wholesale market.

Ultimately, it could be a bonanza for those that find themselves with the unofficial bitcoin, just like the happy tourists to Argentina.

It's quite possible that, at the end of the day, we will see a three-tier rate structure for bitcoin:
  1. Virgin bitcoin
  2. Free market bitcoin
  3. Tainted jurisdiction official bitcoin
Hayes added, "At the end of the day these regulations will do nothing but push more trading off exchange and make it more expensive for honest people to obtain financial privacy."