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Bitcoin: A Study in Spontaneous Order

Nathaniel Popper’s Digital Gold is a wonderfully researched, fast paced narrative of the beginnings of Bitcoin.  As its subtitle, The Inside Story of the Misfits and Millionaires Trying to Reinvent Money, suggests, its emphasis is on the colorful cast of characters who got Bitcoin off the ground. In my last post, I described the mechanics of Bitcoin—a potential instrument of freedom from the state. In this post, I describe how the development of Bitcoin itself exemplifies another aspect of liberty– spontaneous order. Different individuals with different interests combine in ways no central planner could direct to transform an idea into a valuable commodity that may someday represent a sufficiently stable source of value to become a currency. It is the story of a Platonic form becoming a reality in the messy cave that is our world.

Bitcoin has no intrinsic value whatsoever. It began as an algorithm that generates tokens in cyberspace. Popper shows that in 2009 and 2010 computer geeks were the first group to take an interest. They mined coins and provided the computer power to verify transactions because they admired the algorithm not because they want to make money. It is an appreciation of beauty that gives Bitcoin its start,

These transactions remained more akin to a game with monopoly money. But another group—people who wanted to engage in illicit transactions– did find an actual value, exploiting the anonymity of Bitcoin.  Ross Ulbricht met this demand by creating Silk Road where people could trade Bitcoins for drugs.  He soon descended into even greater evil, offering contracts on the lives of potential informers. But his early adoption of Bitcoin demonstrates a strong version of Bernard Mandeville’s famous paradox: private vice can give rise to public virtue—helping foster a new repository of value.

Yet a third group provided further impetus to Bitcoin: ideological libertarians who liked the idea of a currency outside of government control.  They were joined by people who are libertarian by necessity, such as those who live in nations which have currencies whose value as regulated by the government are radically different from their real value. Bitcoin became a useful mechanism to evade such currency controls. And as the coin gained value, speculators joined the merry band of Bitcoin owners, hoping that its potential as a currency would propel it to greater heights. They deployed more powerful machines to mine it and verify transactions. By 2013, spontaneous order had pushed up the value from essentially zero to a thousand dollars per coin.

But then the very success of Bitcoin threatened its initial promise. Its speculative value retarded its progress as a currency, because some of those who used it for exchange now wanted to hoard it in the hopes of further rises. And its greater value forced users to confront another problem. Your ownership of a Bitcoin is only as secure as your control of its private key. If you kept it on a computer, your computer could be hacked. If you wrote it on piece of paper, that paper could be lost. And thus a demand was born for middlemen who would hold your coins in their secure wallets.

But such middlemen needed ordinary law to define their rights and their customers’ rights.  As Popper recognizes, the natural growth of Bitcoin, “a technology that has been designed in no small part to circumvent government power,” started to become intertwined with governmental authority.  It is hard to keep a private law—Bitcoin’s algorithm—separate from all public law, as the private law creates more and more value.

And the fringe characters who were the early adopters and middlemen of a fringe technology were then replaced  by sophisticated investors like the Winklevoss twins of Facebook fame and other veterans of Silicon Valley. But that replacement was necessary for Bitcoin to keep the trust of its users.  Through spontaneous order, a beautiful concept has become a commodity that is itself generating serious startups. In the next post, I will consider whether this commodity is likely to become an actual currency.

Reader Discussion

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on August 12, 2015 at 11:45:26 am

Russ Robert's "EconTalk" from the Library of Economics and Liberty has done several podcasts about Bitcoin that are interesting to listen to. One of his guests suggested that a Bitcoin worth about $250 today will be worth $1 million in ~15 years IIRC.

As I understand it, the reason Bitcoin works is that there is a huge network of people tracking the Bitcoins in exchange for an opportunity to "mine" new Bitcoins. Once all the Bitcoins have been mined, what incentive is there for people to remain on the network and what does that mean for the currency if a large number of them drop out?

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boxty
on August 12, 2015 at 15:32:30 pm

This is a fascinating and quite readable series, thank you, professor. I did not know anything about bitcoin before this.

From what I'm gleaning so far, I would expect that eventually something like an "atomic clock" of money would be developed. Something along the lines of bitcoin, but with better protections against abuse, and less opportunity for degradation as technology improves.

I have to wonder, what will happen to bitcoin values when, say, quantum computers can crack the security of a bitcoin certificate instantly?

The ongoing growth of technology should have a destabilizing effect on a technology-based medium. But then, would it be less stable than the current alternative in the US today, the dollar?

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Scott Amorian
on August 12, 2015 at 17:37:35 pm

They are still trying to get around this normal need of contract law through smart contracts. We will see how successful that is eventually.

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Devin Watkins
on August 12, 2015 at 17:41:37 pm

In the short to medium term, a quantum computer could break the Elliptic Curve Digital Signature Algorithm that Bitcoin uses to sign transactions. But there are other algorithms that bitcoin can move to that would be secure against quantum computers (at least using the algorithms that we know they can employ potentially other algorithms could break SHA). But if you do break the Elliptic Curve Digital Signature Algorithm that same algorithm is used by SSL, so potentially you could then break every online credit card transaction or bank access, so bitcoin would be the least of our worries at that point.

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Devin Watkins
on August 12, 2015 at 19:51:22 pm

I'm sure that's correct. It wasn't my point though.

My point is that with technology there is always a way to get around the rules. As one enterprise security exec once put it recently, every time you build a seven foot wall to keep the bad guys out, they figure out how to build an eight foot ladder to get over it.

There will always be an unknown challenge around the next corner, if not security, then technical obsolescence. If not technical obsolescence, then gaming of the system. If not gaming the system, then something else. That makes technology less than effective for exchanges that require high stability.

Contrast that with general stable real property such as gold or real estate. (Yeah, yeah, yeah. We all know about the problems with real estate.)

I would assume that digital money would be proper for certain applications, but not others. Likewise, gold has its place in some kinds exchanges, while commercial notes are preferred in others, and barter of goods works best in yet other circumstances. To understand the proper use of digital money we need to understand the circumstances where it is proper, and the circumstances where it is improper.

In cases like Argentina the bitcoin is more stable than the government notes, so digital money is good. In cases like the US dollar which requires a high degree of stability, security and credibility, not so good.

I would anticipate regulations and laws to address the boundaries between proper and improper use of these new forms of less stable moneys.

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Scott Amorian
on August 12, 2015 at 21:09:45 pm

Yes, but ultimately to be viable they WILL need to rely upon positive law for its support.

And as we both conceded in earlier post, as soon as you get (or require) government support, you have fallen into the spider's web AND if successful, our dear friends in government will not only come, if you build it, but they will take it!!!

Also, I would not be so optimistic about the ability of bitcoin (or Visa, etc. for that matter) to withstand a sustained assault upon their security. For goodness sakes, the CIA has been hacked (yes, I know they are probably *guarded* by some low level G6 functionary) - but still they were hacked.

I guess I have more confidence in the ability of "clever" miscreants" to find workarounds than in the ability and imagination of the defenders.

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gabe
on August 13, 2015 at 01:04:57 am

John may well be right that bitcoin is a "potential instrument of freedom from the state." And if states were purely institutions of tyranny, that served no purpose other than to bedevil and oppress libertarians, then this would be cause for celebration.

In his list of things that currencies accomplish, John left out something important. Traditionally, currencies served the important purpose of permitting nation states to sustain the military establishments requisite for nations to defend themselves from agression from other nations. The American Revolution, for example, was funded largely through currency finance. There is an obvious and direct correlation between a nation's ability to issue currency and its ability to defend itself.

We live in a dangerous world. I want our government to continue to be able to pay for the US Marines, for example. I take the armed services to be desirable features of our national existence.

I understand primarily the way nation states in the 18 th century funded their militaries. The relationship between currency, finance, taxation, and the military is considerably more complex now than it was 250 years ago. But if the ability to emit currency is, as I intuit, fundamentally connected to the ability of our country to defend my liberty, then I am not at all persuaded that the advent of bitcoin is something to be celebrated.

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Kevin R. Hardwick
on August 13, 2015 at 09:26:13 am

Yes its true that each currency has its advantages in different contexts. (Although "gaming of the system" at least of bitcoin itself seems very unlikely, but it is possible to exploit other systems to get bitcoins). Technical obsolescence is possible, there are other digital currencies that are challenging bitcoin. But I don't understand what kinds of regulations you are talking about to "address the boundaries between proper and improper use." There are already laws against selling drugs or things like that with bitcoin, but that has nothing to do with the inflation or stability of the currency.

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Devin Watkins
on August 13, 2015 at 09:33:40 am

Well, they will need to rely on positive law not prohibiting them, but they might not need any more positive law if they can get smart contracts that self-enforce to work well. Bitcoin is an open source protocol, anyone can read the source code (including myself). This is totally different. Any system attached to the web can be hacked, its only a matter of time to find the vulnerabilities that they are keeping secret. With bitcoin there is no secrets, everyone knows exactly how it works. So, yes it is possible that someone, someday will find a vulnerability, but that is very unlikely for the forseeable future. Can you tell me the last time that someone found a workaround to get around TLS ? We have been using it for a decade and a half to secure every online transaction (think of all the money there!), and yet no one has gotten around it yet. Open source software that relies on mathematical security is MUCH stronger then any system (even the CIA's) attached to a network relying on security by obscurity.

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Devin Watkins
on August 13, 2015 at 09:35:51 am

You can always issue credit or temporary currencies during wartimes. (and you can add more taxes if needed to raise funds)

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Devin Watkins
on August 13, 2015 at 09:41:55 am

Kevin:

Beautiful! How right you are. In an earlier post, I had made mention of the "heat" that the Bank of England had taken over a perceived inability or unwillingness to issue coinage and credit. This upset the up and coming merchant / industrial class. Yet, one of the principal reasons for the Bank's hesitancy was to provide for the Crown's needs for "defense of the realm." I had forgotten about that and the link between finance and the state's primary obligation to defend it's citizenry and territory.

Here is another thought for those who enthusiastic about this digital currency. (A simple point, yes, but...).
As Scott Amorian has indicated, one can expect that clever people WILL find ways around the various security "ladders." Compare the effects of such a scenario with the more common means of corrupting a currency, i.e., counterfeiting and devaluation / manipulation. A more than Herculean effort would be required, using common / current techniques, to so disrupt a currency as to make a) an economy tank and b) prevent the financing of military operations. It seems that digital currency manipulation, if successful, would be far more widespread and destructive than simple counterfeiting / manipulation.

I suppose I am just not quite as comfortable with placing our (and the entire global economy's) security, both economic and military, in the hands of some clever programmers. Remember, there is always someone more *clever* than you and me.

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gabe
on August 13, 2015 at 10:48:36 am

Yes, but the credit would be based upon what - an already corrupted bitcoin?

Again, why would another nation accept a temporary currency and into what would it be eventually redeemable - a corrupted bitcoin?

I don't know! I am far more suspicious and less confident about our ability to a) protect against security threats and manipulation of the new currency and b) our ability to respond.

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gabe
on August 13, 2015 at 11:31:31 am

Devin--

The ability of a government to fulfill its obligations to defend its people gets more complicated if there are multiple legal currencies competing with each other. I can say with some certainty that this is the problem that almost lost the American Revolution. How this functions in contemporary society is another matter entirely--although the intersection of sovereignty and currency is one of the central problems confronting the EU today, and at least some economists predict will cause the collapse of that experiment in confederation government.

I find it hard to believe that any government will make bitcoins legal tender. Are contracts that specify payment in bitcoins enforceable?

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Kevin R. Hardwick
on August 13, 2015 at 11:57:08 am

Devin:

Re: Credit card security - You mention that they have never been breached. I accept your statement (as I know nothing of SW / security; in fact, I can not even keep Explorer from crashing) as valid. However, have not users of credit cards, Banks, department stores and others been hacked?
What I am getting at is this. Are there not back doors that clever hackers can avail themselves of to access the main process. I recall you mentioned that each bitcoin owner has a personal secret code - could access to this code / key allow entry into the system for potential mischief. If so, how serious?

Again, I don't know enough about this - I suppose - only enough to be concerned about security and would like your thoughts on it.

take care

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gabe
on August 13, 2015 at 12:27:38 pm

challenging
-...

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Francesco Totino
on August 13, 2015 at 18:32:20 pm

Francesco:

I assume you were not talking about Explorer being "challenging" - although I certainly find it so.

Goodness gracious, the Chinese and Russian governments have hacked our most secure (supposedly) defense and intelligence agencies and there are those who would have us believe that some server at Bitcoin will not be hacked.
If they are correct, then perhaps we should turn over our defense and intelligence servers to Bitcoin - instead of the *Smart Diplomats* ( spies, administrators and programmers) of the Obama administration.

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gabe
on August 13, 2015 at 21:15:31 pm

Absolutely such contracts enforceable, just as contracts in gold or other commodities are enforceable. I don't care if a government makes bitcoin "legal tender" or not. Frankly legal tender is a bit of a joke that does almost nothing. If your debt isn't denominated in dollars they cant force you to accept a given exchange rate, so sure ill take 1 trillion dollars for that 1 bitcoin debt, what are you going to do? More important is that is you break a contract or refuse to pay a debt the court can order confiscation of money or assets of equal value and usually start with dollars (mainly because that is simple and straightforward for the court). But if you didn't have any dollars, they would try to take your bitcoins (or seize your computer that had the private keys). Legal tender or not doesn't matter at all. Much more important would be if a government decided to ban or regulate bitcoin, hard to say how much that is going to be done. It is already being done somewhat with licenses for money transfereres.

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Devin Watkins
on August 13, 2015 at 21:17:32 pm

What do you mean a corrupted bitcoin? If you mean the "temporary currency" then it is true that many people may not accept such a currency, but it depends on how much people think that such a government would transfer back to bitcoin (real bitcoin not a temporary one) or something more substantial later. They may not trust the government very much, but if it is offering 2 bitcoins later for 1 temporary bitcoin now, some people will take it.

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Devin Watkins
on August 13, 2015 at 21:20:46 pm

Yes, stores can be hacked. It happens with bitcoin just as much as any other online money supply like credit cards (see Mt. Gox as the biggest bitcoin hack with $436 million of bitcoin hacked). That not really a problem with bitcoin though, its bad security setup by that individual.

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Devin Watkins
on August 14, 2015 at 16:05:08 pm

[…] O. McGinnis reviews Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money […]

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Gold
on August 14, 2015 at 17:14:42 pm

Just one more comment before I move on.

Let's game the bitcoin system and destroy it. Let's do it fast and simple.

I will start by investing on a bet that bitcoin will lose half of its value.

I set up a duplicate bitcoin system. I use the same open source software used by the existing bitcoin system. I set up similar hardware. I hire a similar number of miners with a similar organization.

They generate the anticipated 12 million bitcoins.

There is a limited market for bitcoins. By doubling the number of bitcoins available in the market I have cut the value of a bitcoin in half and "win" on my investment bet.

Game over!

And this is just off the top of my head. If I thought about it a while I might come up game that is actually clever.

The problem with the bitcoin is that it isn't tied to anything real and limited. Gold and silver are real and (relatively) limited. That's why they were chosen as the basis for legal tender in the Constitution.

Real estate is real and limited. That's why real estate notes can serve as the basis for the dollar.

Bitcoins are not real or limited. They are easy to reproduce. Therefore, they cannot be the foundation for stable money.

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Scott Amorian
on August 14, 2015 at 17:54:28 pm

See http://heartbleed.com/

The problem in the most recent case was not in the technique. It was in the infrastructure supporting the technique.

(I used to work with computer security and I may again soon so I try to stay current.)

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Scott Amorian
on August 14, 2015 at 17:55:45 pm

Can you tell me the last time that someone found a workaround to get around TLS ?"

See http://heartbleed.com/

The problem in the most recent case was not in the technique. It was in the infrastructure supporting the technique.

(I used to work with computer security and I may again soon so I try to stay current.)

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Scott Amorian
on August 14, 2015 at 17:56:50 pm

[one more time to try to get this quote thing figure out]

Can you tell me the last time that someone found a workaround to get around TLS ?"

See http://heartbleed.com/

The problem in the most recent case was not in the technique. It was in the infrastructure supporting the technique.

(I used to work with computer security and I may again soon so I try to stay current.)

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Scott Amorian
on August 14, 2015 at 17:58:00 pm

[grrrr]

Can you tell me the last time that someone found a workaround to get around TLS ?

See http://heartbleed.com/

The problem in the most recent case was not in the technique. It was in the infrastructure supporting the technique.

(I used to work with computer security and I may again soon so I try to stay current.)

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Scott Amorian
on August 14, 2015 at 17:59:13 pm

[just put "blockquote" in brackets in front, and "/blockquote" in brackets at the end]

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Scott Amorian
on August 14, 2015 at 18:08:53 pm

I nominate Scott to take over for Janet Yellen - that is, of course, after the satoshi guys try to dump her! Scott is absotively correct. Bitcoin IS fiat money on steroids.

Fellas, you know all of these arguments are very interesting but it somehow strikes me that Bicoin and its ilk are psychologically similar to the "Hey, we gotta get the new I-phone phenomenon." We just have to have it - at least among a certain set! The fellow who created this ought to (does he?) work for a major marketing agency - he could make a mint (a real one) there.

Thank goodness, I can still get by with a "flip-phone" - I may be able to save enough money to eventually afford a couple of satoshi, one day!

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gabe
on August 16, 2015 at 11:53:19 am

Ulbricht was alleged to have attempted to hire hit men - by a prosecutor that was not willing to make that into a formal charge he would have to prove. It is unfortunate that you should swallow that bait and repeat a baseless allegation.

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juris imprudent
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Law & Liberty welcomes civil and lively discussion of its articles. Abusive comments will not be tolerated. We reserve the right to delete comments - or ban users - without notification or explanation.