Bitcoin’s Evolution toward Self-Destruction

By Dan Kervick

John Gapper, writing in the Financial Times, argues that Bitcoin enthusiasts need to grow up, and that Bitcoin itself needs to grow out of its obsessive adolescence. He writes in the aftermath of last week’s Newsweek story purporting to identify Bitcoin’s creator, and following the recent collapse and bankruptcy filing of the Mt. Gox Bitcoin exchange. In regard to the first event, which has sparked an outburst of hysterical resentment from the Bitcoin community, Gapper writes:

The hysteria undermines Bitcoin’s chances of graduating from a hobbyists’ obsession to a mainstream technology. You cannot challenge fiat currencies and disrupt the global payments industry while reacting to any uninvited scrutiny like an adolescent whose parent has opened the bedroom door without knocking. It does not work that way.

And Gapper also has some advice about the evasions of Bitcoiners in response to the Mt. Gox debacle:

In the case of other exchanges, and perhaps Mt Gox, Bitcoin payments were settled as intended but hackers then altered identifying information on the transactions to fool exchanges into believing that Bitcoins had not changed hands. Mt Gox, the argument goes, was a victim of its own sloppy online bookkeeping rather than a Bitcoin flaw.

To the average consumer, this is a distinction without a difference. Being able to trust “Bitcoin” as a technology but not to be sure that your own Bitcoins are safe does not mean much. The basic function of a bank is to store its depositors’ cash more securely than keeping it under the mattress and if Bitcoin cannot match it, little else matters.

Gapper’s piece is a plea to Bitcoin fans to act like grownups, and to get to work restoring Bitcoin’s credibility. But I’m afraid the non-grownup features of the crypto-currencies that Gapper now bemoans are not just remediable accidents of their current stage of development, but are inherent in their basic setup, which has always reflected a very naive understanding of the social and institutional nature of currencies and monetary systems, and a juvenile affection for the online virtual world of masks and shadows. The processes by which the crypto-currencies  might be rendered more safe, stable, well-regulated and legally transparent are the very same processes which are gradually removing whatever features once separated those would-be currencies from conventional currencies, and which will destroy them as viable alternative systems for anything but a small residual volume of black market transactions.

Any advantages cryptographic currency platforms might provide over conventional digital currency platforms employing state-backed, third party bank currencies and public currencies will eventually be mimicked or absorbed by conventional systems, or else out-competed by equally low-cost, but more conventional alternatives. The fact is that in the long-run most honest people don’t want to use a weakly-regulated peer-to-peer “crypto” currency which offers less security, stability and legal verifiability than conventional currencies. Also, since Bitcoin will never achieve its dream of becoming an all-purpose medium of exchange that people are willing to hold and save, and not just used for spot exchanges on an as-needed basis, there will remain transaction costs at both ends of Bitcoin transactions as its users convert out of and then back into the conventional currencies that they really want to hold. Finally, the lack of formal, institutionalized accounting in the small Bitcoin economy based on the transactors’ names and other legal identifiers – a feature the enthusiasts see as Bitcoin’s greatest virtue – is ultimately going to add another layer of reporting costs and potential legal liabilities for users, since governments are clearly not going to allow a massive tax evasion and money laundering system to flourish unencumbered by verifiable record-keeping and reporting. Once governments fully catch up to the technology, and all of those required regulatory features are built into the more mature version of the Bitcoin economy, it is hard to see what benefits will remain.

The surge of interest in these cryptographic platforms should have a beneficial competitive effect in driving down some of the costs of international transactions and spurring the evolution of more efficient correspondent bank relationships. Perhaps some societies and governments will even be spurred to explore public banking alternatives. That ongoing evolutionary process might move somewhat more rapidly now than would otherwise have been the case. So we can thank the Bitcoiners for that. But once that process is complete, most of the utility of the crypto-currencies that spurred the innovation will evaporate, since using those currencies comes with added risks and costs that the conventional currencies don’t possess in the same degree. The crypto-currencies might survive as a minor semi-legal sideline for the purchase of pornography, drugs and other unsavory items. But I’m inclined to think the dreams of the investors in both the currencies themselves and in the ancillary infrastructure around them will largely prove to be misguided.

I have been told by some of the Bitcoin fans that one cannot simply assimilate the features of Bitcoin into existing payment networks, since Bitcoin is really very different from the bottom-up, technologically speaking.  That might well be true, but my claim is that in the long run the cost savings from Bitcoin transactions will prove so small, and the added costs, risks and inconveniences so great, that conventional third party payment systems will have no problem out-competing Bitcoin, not by assimilating Bitcoin technology but by running more conventional payment technology in a cheaper and more efficiently networked way.

Another Bitcoin fan told me, “you can exchange your bitcoins into dollars about six times back and forth and a transaction is still cheaper than with a credit card.” But the relevant comparison is with a check card used for immediate payment with one-time transaction fees, not credit cards used for deferred, interest-bearing payments. Conventional digital payment platforms continue to evolve, and will eventually be able to accomplish all that Bitcoin achieves, but without the risks that come from using a clandestine payment system that can’t be easily and directly regulated and in which contracts can’t be legally upheld and disputes legally resolved without a lot of time-consuming and cost-adding investigative headaches. The very existence of a system of market exchange based on private property rights presupposes and depends on a legal system that can efficiently assign and uphold those rights. A market system and a legal system are two faces of one and the same animal.

Bitcoin fans in the programming community are very impressed by the purely mathematical and technological achievement of Bitcoin in creating a “trustless” payment system that permits anonymity without double-spending and obvious fraud. But the feature of conventional monetary and payment systems that Bitcoin enthusiasts seem to regard as the source of original sin – transparency to governmental and legal authorities, and a retrievable and enforceable public record of transactions – is in fact one of the very cornerstones of the conventional  systems’ well-established utility. Building a trustless and partly clandestine system is primarily of value to black marketeers, money launderers, gamesters and tax cheats. The fact that programmers have cleverly solved a technical problem that allows them to exchange virtual gold in a virtual kingdom without knowing the identity of the troll or dragon princess on the end of the transaction really isn’t all that awesome a source of value for non-virtual, real-world economies, or for the grownup people who live in those economies.

Cross-posted from Rugged Egalitarianism

Follow @DanMKervick

27 Responses to Bitcoin’s Evolution toward Self-Destruction

  1. Viorel Teodorescu

    Bitcoin is not a currency. Bitcoin is a commodity.

    With all the good or bad traits that flow from there…

  2. Woah, what’s with the Victorian morality?

    […] purchase of pornography, drugs and other unsavory items.

    There’s a strong ethical argument that can be made against pornography, which is however not included in a term such as “unsavory”. And when it comes to drugs: given that the current distinction betweenwhich can be bought legally and which can’t is a bit arbitrary, should we really denounce the illegal ones as immoral?

    • I think the term “unsavory” applies well to many purveyors of pornography and drugs. Part of that is due merely to the fact of illegality, but part stems from other factors as well.

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  4. Red,

    I dont think Dan uses the word ‘immoral’ here… I take Dan’s larger point wrt ‘unsavory’ to mean the typical goods and services that people who would like to keep the details of such electronic purchases clandestine, would be transacting in, and would perhaps therefore still use the crypto-currencies…. for instance those in conduct of an illegal conspiracy (drugs, gun purchases, explosives, prostitution, receiving stolen property, terrorist support, etc..) would like to keep the details or even preferably the very existence of such transactions clandestine… so these “crypto-currencies” work nicely for these people ie it keeps the transaction clandestine… otherwise why use them? rsp,

    • Right. Some of those activities are illegal; some are just activities many would like to hide.

      • I think I understood what the grouping was supposed to mean but I have a big problem with “unsavory” in this context since it carries a connotation of morally wrong.

        Language matters: calling “unemployment support” “unemployment benefits” implies that being unemployed is desirable under current conditions, calling “speculators” “investors” implies that speculation is good for a society’s productive capacity, calling “illegal” “immoral” condemns more harshly.

        Also: could someone remove my truncated first comment?

  5. Users of US dollars engage in many criminal activities. Up to 90% of US currency contains cocaine. Should we ban it?

    • I didn’t argue that we should ban Bitcoin, but only argued that its utility is going to turn out to be very limited.

      • OpenThePodBayDoorsHAL

        A guy sells a Bitcoin to a guy who sells a Bitcoin to a drug dealer, and guy #1 gets immediately arrested. Under that standard every operator of a bank ATM should be in handcuffs. HSBC Bank launders *hundreds of billions over more than a decade* and gets a wrist-slap fine and NO arrests are made. “Clandestine” (your favorite word to describe Bitcoin) transactions totaling > $1 Trillion per year (according to the UN) in the lovely USD, and tiny tiny Bitcoin gets singled out.
        My point is that everyone wants to apply a different set of standards to tiny little Bitcoin because they can’t continue to fill their utterly corrupt and criminal coffers if it takes off. Sure, continue to follow the “pull” payments model, where I hand a waiter or valet parking guy my secret number and he can do what he likes (fraud much? Yes). I’ll pursue the “push” model where just the exact amount is pushed in a one-time, one-way fashion, through an open network with transparent accounting. Ah if we only had transparent accounting with MF Global, but at least Jon Corzine is doing a long prison term…oh wait.

        • Again, I said nothing about arresting anyone. I said that in the long run, Bitcoin’s only utility will be for carrying out transactions people are trying to keep secret.

          • People have the right to privacy though. Bitcoin also confers the benefit because you can move bitcoins around the world without suffering transaction costs by ripoff artists. Im not saying bitcoin is all good but it has its benefits.

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  7. I’m not sure that credit agencies could not form for bitcoins. Presumably credit was available before the advent of fiat currency. Credit cards that authorize the deduction of bitcoins from the banks account via loan/credit mechanism is possible. Therefore I do not see the point of some of the objections.
    Note that I don’t believe that bitcoin was designed well (deflationary and rentier prone).

    I wonder whether anyone would care to speculate: Why do nations in dominant positions use one currency and not two or three? I understand small nations being willing to accept dollars or Euros in place of their own currency to pay off taxes owed, but is there really a disadvantage to bigger nations if there are two currencies? I’m motivated to bring this after speculating what would happen if deflationary currency with little governing control were also accepted to pay taxes. That is, citizens would have the right to be paid in either currency, and pay taxes in either currency. One form of money would be more stable in value and take the place of bonds, while the other would have growth potential.

    • It is probably less a government thing and more likely that the more stable a nation’s currency is, the less likely people want to deal with more than one currency.

      But, I have wondered what would happen if one of the mechanisms Greece used to get out of trouble was to accept Greek Bonds at face value for all government taxes and fees. And, also accepted/accounted/converted the bonds at very small denominations. Essentially, converting Greek sovereign debt to Greek currency with an exchange rate with the Euro equal to the market price of the bond. I expect they would want to set up the central bank and other banks to smoothly convert between the two. Then, they come up with a way for merchants to accept either as electronic payment according to the exchange rate. Maybe give people two debit cards, a bond card and a euro card. Bond card purchases will be in Euro according to the exchange rate (not face value) unless the transaction is with the government in which case the payment to the government is at face value.

      On the flip side, the government could pay for domestic services with bonds at the exchange rate or Euros or even some combination.

  8. Good article – your thinking on bitcoin mirrors my own. I wish I’d been an early adopter and subsequently cashed in like a tulip bulb magnate circa January, 1637.

    Other than that, most folks don’t need a crypto-currency. Our money already is mostly digital and we aren’t moving shipments of drugs, porn, or buying assassinations. Thus bitcoin is merely a sideshow curiosity, likely to fade away over time or be hammered into oblivion by the state, notwithstanding the dire protests of its drowning fanbois.

    • It’s no longer clear to me how many of the apparent fanboys are actual fans, or are just talking their book to drive up Bitcoin prices before cashing out. A lot of Bitcoin rhetoric has that “please don’t break the chain” feeling to it.

  9. Can’t say I cared enough about bitcoin to look much into it, but wasn’t this just largely (not entirely but largely) a way for illegal activities to go down, like all this “hidden” websites were you could openly sell drugs, and a craze that true government haters clung onto, or were simply speculated on to raise prices?
    hmmm…surprised Goldman and bros didn’t start funneling $ into bitcoin!

    • Corey Bordes

      No, this is a way for six billion or so people who don’t have access to our financial system to participate in the world economy. The majority of Africans and Indians now have cell phones or at least access to SMS, which means they can use cryptocurrency. One of the biggest problems in developing nations is the inconsistency of their cash flow and their subsequent reliance on loans from one another as well as microfinance institutions. In these parts of the world getting to a bank or delivering funds to a debtor can be a logistical challenge and sometimes families don’t get the funds they need when they need them. Cryptocurrency can mean the difference between eating and going hungry at times for a lot of people in the world.

      The fact that Goldman Sachs has produced a 25 page report about this is telling. So is the fact that I can buy bed sheets on Overstock.com using technology released five years ago. I made a purchase on Amazon earlier today using Bitcoin and the Zinc Save browser extension for Chrome. My $41 order was about $2 cheaper than what I would have paid using USD. Pretty cool.

      In the end bitcoin the currency isn’t that important. It probably won’t last, but the groundwork for an update to the global financial system has been laid and that can’t be changed or taken away. You can’t uninvent something. Mark my words, if you are alive and living in a developed nation you will use 20 years from now you will be technology which descended from this recent cryptocurrency boom in your daily financial activities. If you can find a reputable escrow (I assume you won’t yet accept a smart contract built on the Bitcoin protocol) I’ll happily bet on it.

      • We already had digital currency systems before Bitcoin was ever dreamed of, and those systems will continue to evolve and expand their technological and institutional reach, and cost efficiency. I have little doubt that currency-based exchange will virtually 100% digital in the future. But when people trace the ancestry of those digital systems, my bet is they will trace them to the state-backed digital currency systems.

      • Since one bitcoin is around a few hundred dollars right now, how is the bitcoin divided so that you could pay 41 bucks?

  10. Wayne Turner

    The ending text at the ArsTechnica article also makes the point that the entry of organized traders into crypto-currency exchange will defeat the stated purpose of Bitcoin:

    “Wouldn’t you place your bitcoins at a place where the transactions are more likely to be honored?” Ivo Welch, a finance professor at the University of California, Los Angeles, wrote to Ars. “There is an irony here. Bitcoins exist to avoid institutions, and now we will have institutions.”

    • Reading that article it occurred to me that the HFT organizations that can do bitcoin trading transactions faster than anyone else would also have the horsepower to solve the bitcoin mining equations faster than anyone else, and reap virtually all the mined bitcoins for their own accounts. It’s probably that, not simply providing a secure trading platform, that they have set their sights on.

  11. mikeriddell62

    Dan an excellent portrayal of the issues facing Bitcoin.
    The whole hullabaloo has put the alternative/complementary currency idea on the radar of investors in search of the next big thing.
    That is likely to involve a platform that can transform communities using the power of business. What is likely to connect the two will be a currency underpinned by the scarce resource of time, that is earned into existence for activities that produce sustained behaviour change.
    In design terms, Bitcoin is flawed but it has provided hope to the developers of community currencies the world over that the need for an alternative to cash has the potential for funding.

  12. There is another issue with the bitcoin private exchanges. Bitcoin exchanges take in bitcoins and make payment in fiat currencies. The exchanges also receive fiat currencies for bitcoins. If the exchange sells coins at a low prices and buys at a high price, the exchange runs out of fiat currency. The tendency of using bitcoins as an investment, can cause depletion of the fiat currency at the exchanges. Mt. Gox is known to have adopted a policy of “fractional reserves”.