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Bitcoin: A Technology of Law, A Technology of Liberty?

A currency has three important functions. It provides a medium for exchange, a measure for the cost of goods, and a store of value. It is one of the most important technologies ever invented and like all technologies might be improved. It is also a matter of intense public concern, because the power over money brings with it immense political power.

The computational revolution is bidding to transform our relation to money by replacing fiat money with a digital currency. Fiat money consists of token issued by the government, like the dollar. Its success depends on trust in the government to maintain the currency as a stable store of value. But governments face political temptations to debase the currency for political ends. Just ask people in Argentina how well the peso has operated as a store of value. Even the dollar has dramatically fallen in value, as in the inflation of the 1970s. Moreover, fiat currencies of today often impose substantial transactions costs in the process of exchange. Banks make substantial profits from these transactions.

Thus, a stable currency outside of the control of the state without substantial transaction costs might well both make the economy more efficient and limit the power of government. It could be a wonder of the modern world. That is the potential promise of a digital currency—a form of money that is created and exchanged in cyberspace. The most famous such currency is Bitcoin and Nathaniel Popper has written a superb book, Digital Gold, chronicling its birth and wild rise. In the next post, I will review the book, which has a cast of characters to rival the most improbable of picaresque novels.

But first a short and necessarily simplified summary of the complex mechanics of Bitcoin: Bitcoin is the brainchild of Satoshi Nakomoto, a figure himself still shrouded in mystery. Nakomoto figured out how to solve the greatest problem with a digital currency—how to determine who possessed it without relying on any central authority, because any single authority would be difficult to trust. His brilliant idea was to link the creation of the currency to verifying transactions in the currency. To simplify: When someone wants to transfer Bitcoin to another person he sends the Bitcoin from his digital wallet (a kind of encrypted computer file) to the other person’s digital wallet. The digital wallets are identified by public keys, but the sender can release the Bitcoin by a private key known only to him. The transaction is then broadcast publicly so it can be verified in way that everyone can know that the sender has the private key but cannot see the actual key. The verification process requires the solving of complex computer equations that are linked to the particular transaction. Through solving the equations with computers individuals called “miners” can then verify that the transaction. For those who want more detail than possible in a brief post, please consult this excellent primer on Bitcoin.

The miner who most likely verifies the transaction by adding it to the “block chain” (a public ledger) of all Bitcoin transactions, and gets paid in Bitcoins for his work.  Other miners agree by essentially majority vote as measured by computation power which miner has triumphed. Thus, the creation of new currency is linked to the process of verifying it. In other words, the process itself gives incentives to deploy the substantial computer processing that keeps the system going and is so large that it cannot be taken over by any single person.

The computer program that creates the currency  determines the amount of payments and indeed reduces the amount of payment overtime.  The program assures that the total number of Bitcoin available will asymptotically approach 21 million as the payment for verifying transactions is reduced.

Thus, Bitcoin is fascinating concept. It is a technology of pure law, where the law is the algorithm devised by its founder. Unlike the Federal Reserve or other central banks, there is no human discretion to vary the money supply for political or other reasons. The supply is even more fixed than gold, because gold is a commodity subject to the vagaries of physical mining. In a subsequent post, we will consider the prospects of a technology of pure law also becoming one of  liberty.

Reader Discussion

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on August 10, 2015 at 12:21:10 pm

As a software developer for a decade, I was very interested in how bitcoin works. You did a good job trying to explain what is a fairly complex process. What I most fear is that as Bitcoin becomes successful, it will put such fear into the Federal Reserve that it will pressure the government to enforce Money Transmitters license requirement at the state and federal levels. https://coincenter.org/2015/04/what-is-money-transmission-and-why-does-it-matter/

This means any business's payment processors or any business that exchanges dollars for bitcoin at the very least, but potentially any business that uses bitcoin could require special permission from the state to do so. If the state is, how shall we say, less then forthcoming on licenses under pressure from the Federal Reserve, that could really hurt digital currencies.

By the way, I doubt that bitcoin will be the final/best/most successful digital currently. It has an average blocktime of 10 minutes meaning it is at least 10 minutes (but to an hour) before a retailer can be sure that they got the bitcoins. Litecoin with its 2.5 minute blocktime seems a little better. Although maybe something like dash with its InstantX and stronger privacy protections will win out.

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Devin Watkins
on August 10, 2015 at 15:03:45 pm

And why is this digital currency not also considered 'FIAT" currency.
It seems to me that it is "steroidially" enhanced fiat currency having no ultimately exchangeable material value and being equally as dependent upon trust in the issuer as the fiat US dollar.

Whether I, as a retailer, let us say, wait only 2.5 minutes as opposed to 10 minutes, we are still missing one of the essential requirements of effective exchange (currency) - instant gratification - now that is something that we Americans relate to.

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gabe
on August 10, 2015 at 15:06:46 pm

In some ways it is a fiat currency in that it is not backed by a physical object of intrinsic value (like gold). But it is different then normal fiat currencies in that inflation is fixed. There is no ability for anyone in the system to inflate the currency by printing more of it like in most fiat currencies. So in that way it provides significant advantages over prior fiat currencies.

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Devin Watkins
on August 10, 2015 at 15:09:38 pm

If instant gratification is really important then look at Dash and its InstantX algorithm which can usually verify a transaction in seconds potentially just as fast as a credit card would be: https://www.dashpay.io/instantx/

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Devin Watkins
on August 10, 2015 at 15:28:30 pm

Devin / John:

You and john are correct in the anti-inflationary features of this *currency* - BUT that is, to my mind, it's principal deficiency.
You will forgive my usual obscure humorous comments, such as "instant gratification" above, I hope, because there is a serious defect present in this mode of exchange.

If as John has indicated both the capability and the desire exist to combat inflation via the restriction of Bitcoins to 21 million, then we must immediately ask: "Who will have these wondrous devices (digital though they may be)? In a nation with something in excess of 250 million persons capable and desirous of engaging in commercial activity, are we to restrict those so engaged to 1 in 10 persons? Even were we to increase the number (Oops, inflation?) we would still not have a sufficient supply to support the level of commercial exchange that a) we have grown accustomed to and b) that a vibrant economy requires.

Recall, if you will, that one of the main problems affecting the British economy, as well as early American colonial economies, was the absence of sufficient coinage. This placed a significant damper on commercial activity with the Bank of England, in the first instance coming under significant criticism for its failure to issue sufficient coinage (and, yes, credit) and lead to significant distortions in most economic indicators / sectors. The Colonies also suffered greatly and much of those economies were reduced to,or could not rise above simple barter economies.

An additional problem may be found in the fact that more than one *issuer* may create such currency. Again, recall the problems in both ante-bellum and post Civil War America arising from the multiplicity of State and Local banks issuance of currency.

Inflation is one thing - but stability is also important in an effective currency as is availability and immediate conversion of the specie / coin, etc. for the goods and / or services desired.

All this may be resolved, I don't know - but I think you are right about the grasping hands of the Fed - if you build it, they WILL take it.

take care
gabe

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gabe
on August 10, 2015 at 17:46:47 pm

So your problem I think has to do with a misunderstanding of how things like Bitcoin work. While it is true that there are only a maximum of about 21 million bitcoins, like a dollar is divisible into cents, a bitcoin is divisible into satoshi (the smallest unit of exchange for Bitcoin). A satoshi is 0.00000001 of a bitcoin. So that means you have 2.1x10^15 units of measure within bitcoin. So lets say in the crazy far off future each satoshi was worth a dollar today. Currently there are about 17 trillion dollars world wide in the M3 Money supply, which is about 1.7x10^13. so that would mean you could express every dollar in the world today 100 times (including all bank stores, not just physical dollars). But there is no limit for how "valuable" a satoshi could become, so there is no real limit to how much value bitcoin could express. (But it might get a bit unwieldy to have to do transactions in only 100 dollar bills for instance.) And that is only bitcoin, another virtual currency might allow even more division (or the protocol could be rewritten in the future to allow this, which wouldn't be all that hard to do as long as you can get 95% of the miners to agree which for something like that would be easy).

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Devin Watkins
on August 10, 2015 at 21:30:49 pm

Yes, but 17 trillion is nothing, right, if you include francs, marks, drachmas, etc etc etc. and when you break it down to that small a unit are you not increasing the likelihood of inflation (the smaller the base, the easier to inflate / adjust). This would, however, increase the velocity in theory but there are still transaction costs (more importantly transaction "actions) that are still, at least superficially, cumbersome.
I ain't saying it can't be done - I am just curious as to the impact and no matter how you slice it you still have the problem of *immediacy of exchange* and having several creators /miners of the currency.
One can just imagine exchanging satoshi for the French equivalent, and then hopping on a train and doing the same in the UK.

I am thinking I'll stick with my $10 bills - unless, of course, they put that socialist hag, Eleanor Roosevelt on it. Then have the satoshi boys gice me a call!

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gabe
on August 11, 2015 at 09:49:27 am

Oops! - I was speaking rather than writing in the 9:30 post and the *inflected* question mark does not appear after the word "right"
Don't know what the total world money supply is?

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gabe
on August 11, 2015 at 10:50:41 am

I don't know what the total worldwide M3 amount is in all currencies (which includes bank accounts and electronic non-minted currency). But in terms of printed currency, the total worldwide minted currency is somewhere a bit above 4 trillion USD (that was 2008).

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Devin Watkins
on August 11, 2015 at 10:53:02 am

Oh an actually, no inflation would not be affected by that at all (and would likely be FAR less because of it). Inflation in terms of printed Bitcoins is fixed, inflation in terms of floating measure of "value" would fluxuate, but the larger the population using a currency the lower the variability in expected value. If everyone in the world was using Bitcoin, it would be incredibly stable in terms of value because it would require a worldwide change in belief as to its value to change.

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Devin Watkins
on August 11, 2015 at 10:54:47 am

There are different definitions of "money supply." If you are talking M1 (printed currency), worldwide it is worth a bit above 4 trillion USD (that was 2008). https://en.wikipedia.org/wiki/Circulation_(currency)

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Devin Watkins
on August 11, 2015 at 10:56:09 am

Actually that may be considered M0 (M1 considers travelers checks and whatnot).

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Devin Watkins
on August 11, 2015 at 16:23:53 pm

Devin:

Hey, thanks for the info. Seems right!

Another question for you and Scott Amorian if he is reading. Remember Scott's comment on s/w security re: developer builds 6 ft wall - hacker then builds 7 ft ladder- and on and on.

Do you have any concerns about someone busting into little satoshi land and making mischief. Heck, at least Ft Knox has armed guards (not that the gold is serving any real purpose other than to pay off foreign debt if ever demanded). How tall and slippery are the walls that Bitcoin, etc. have built?

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gabe
on August 12, 2015 at 17:32:50 pm

So bitcoin is almost perfectly secure until someone implements a sufficiently powerful quantum computer. They currently most advanced quantum computer (D-Wave Two) is a 512-qubit, if that were to become powerful enough it could break the Elliptic Curve Digital Signature Algorithm that Bitcoin uses to sign transactions. That means that every time you send money, from an account the NSA with a super quantum computer could take the rest of your money in that bitcoin address. So everyone would need to send their money to a new bitcoin address every time they wanted to spend any money to remain secure. Its theoretically possible a quantum computer could break the SHA256, but that would be much harder and we really don't have the quantum algorithms for that. If the Elliptic Curve Digital Signature Algorithm were truly broken, they could swap it out for another algorithm based entirely on hash signatures (assuming they can get 95% agreement of miners) that would likely remain secure from quantum computers at least in the short run. Other then that, with currently available technology its practically infeasible to "break into" bitcoin. And likely the first people to be able to do it will be the NSA. And if the NSA can do this, they can break into every online bank transaction and credit card purchase. So... at that point you are talking MASSIVE changes to the online marketplace, and bitcoin will be the least of our worries.

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Devin Watkins
on September 01, 2015 at 16:59:03 pm

Bitcoin is a digital, decentralized, partially anonymous currency, not backed by any government or other legal entity, and not redeemable for gold or other commodity. It relies on peer-to-peer networking and cryptography to maintain its integrity.

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Ruben Lozzi

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.