Date: November 7th, 2012
Filed in: Frontpage, Opinion
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Necessary conditions for the long-term success of Bitcoin

In this article I present my answer to the the question: What does Bitcoin need to succeed in the long-run? Before we consider the question, let’s put Bitcoin into the wider context of the counter-economy.

The Counter-Economy

The counter-economy (a.k.a. the informal economy) in general is all economic activity which is not fully regulated, taxed, or controlled by the state. In its simplest form it is a Lemonade stand which operates without a license, it partly includes a mom-and-pop store which optimizes its taxes by running some of its business off the books, and in the dark corners of it you can find completely separate market places like Silk Road.

The counter-economy is not a small feat, if you combine all black markets of the world together you’ll get a 10 trillion US$ economy, second only to the United States of America. In many developing countries it already comprises large parts of the economy and it is growing faster then the officially recognized gross domestic product (GDP) [The Shadow Superpower, Foreign Policy, October 28, 2011].

The term counter-economy in a more specialized meaning is also used in Crypto-Anarchy and Agorism. Agorism is revolutionary market anarchism.  In a market anarchist society, law and security would be provided by market actors instead of political institutions. Agorists recognize that situation can not develop through political reform. Instead, it will arise as a result of market processes [agorism.info].  A good introduction to Crypto-Anarchy is the following quote from the Crypto Anarchist Manifesto published by Timothy C. May in 1992:

Computer technology is on the verge of providing the ability for individuals and groups to communicate and interact with each other in a totally anonymous manner. [...] These developments will alter completely the nature of government regulation, the ability to tax and control economic interactions, the ability to keep information secret, and will even alter the nature of trust and
reputation.

One has to note that Crypto-Anarchy is not a philosophical utopia, but the attempt to shape life and society in the presence of disruptive technologies. The corresponding technologies have already arrived and we are facing a great divide: we will either live in the total surveillance state or in a Crypto-Anarchist libertopia.

So what role does Bitcoin play in this context? A free society needs a free market and a free market needs sound money. Bitcoin is money with good properties: it is pseudonymous, there are no frozen accounts in the Bitcoin system, it doesn’t allow charge-backs (a big problem for merchants accepting credit cards), and it is very cheap and fast to transfer Bitcoin. As such, the use of Bitcoin is a huge advantage compared to a barter or cash-only economy, because developed economies need money transfer, at the very least for B2B transactions.

Three hypotheses for the long-term success of Bitcoin

So what does Bitcoin need to succeed in the long-run? In short, it needs no state, no banks, and OTC. The three hypotheses in more detail:

  1. The Bitcoin community should not try to get legality for Bitcoin, we should not ask the state to resolve conflicts in the community.
  2. The Bitcoin community should not focus on interoperability with the traditional banking system.
  3. Widespread availability of over-the-counter (OTC) Bitcoin exchangers is crucial for Bitcoin to succeed in the long-run and give us more freedom.

Let me explain the reasoning behind this hypotheses. Public choice theory in general and plain common sense states that people will do what is in their self-interest. This includes politicians, bankers, and cops. It is very important to fully grasp this simple truth: People do what is in their interest and you cannot assume that your interests equal their interests. They are usually not the same.

There is no such thing as people working for the common good. Even people who are supposedly helping others selflessly are actually helping them in order to live in accordance with their own value system.

No state

The state is a regional monopoly of force which extracts resources (usually money) from its citizens to (a.) mainly finance itself, its wars and its surveillance apparatus and (b.) use the rest to provide so-called services which could be provided better and cheaper by the free market. These services are usually used as a justification of the existence of the state, but the real reason of its existence is the easy money the state money recievers can get. The money is taken away from the productive citizens via taxation and the monopoly of the money supply (via inflation your money becomes worth less). Thereby, the latter strategy is better, because it is harder to notice by the ignorant
masses.

If you combine the institution of the state and its inherent interests with the conclusions from public choice theory and the Bitcoin system you are looking at the potential for a lot of trouble. Bitcoin prevents inflation (there is no inflation in Bitcoin once all coins have been mined) and helps tax evasion (it is hard to regulate and control). It is potentially life-threatening to the state, because it strikes at the root of state financing. Therefore it follows that the state will fight Bitcoin heavily once it realizes that. In my opinion it is absolutely ludicrous to think that the state will embrace Bitcoin.

The most likely scenario is that the state will try to close down Bitcoin altogether. If that is not possible the state will try to change Bitcoin in a way that allows to implement know your customer (KYC) regulations more easily in the system.

Just wait and see what kind of discussions we will get in the Bitcoin community once the state is cracking down more on Bitcoin exchangers and businesses and actors like the Bitcoin Foundation will try to remedy the situation by working together with state agencies to make Bitcoin more regulatory compliant.

In my opinion, this shows why the Bitcoin community should not try to get legality for Bitcoin and should not ask the state to resolve conflicts in the community. All this will do is drive more unwanted attention to the Bitcoin ecosystem. The self-interests of the state prevents legality and regulatory acceptance of Bitcoin in its current form.

History lesson: e-gold

E-gold provides an important history lesson of the Those who cannot remember the past are condemned to repeat it (George Santayana) category. E-gold was a digital gold currency which existed between 1996 and 2009 and allowed the instant transfer of gold ownership. In 2008 the company reported more than 5 million accounts. A flourishing ecosystem existed around e-gold. In the end, exchangers were attacked and closed down due to regulatory problems. E-gold itself was indicted for money laundering and the operation of an unlicensed money transmitting business. The indictment happend although e-gold itself tried to get the corresponding license earlier and was told that is was not necessary. Sounds similar to the situation with Bitcoin right now? The game is rigged, folks! You cannot win if your are playing by the rules.

No banks

Banks are major beneficiaries of fractional-reserve banking and can borrow cheaply from the central banks. They operate in one of the most heavily regulated industries which results in huge barriers to entry and not much competition. This leads to large profits, for example from transaction and credit card fees. Financial service providers like PayPal, Western Union and Money Gram also have very large fees, because the regulatory hurdles reduce the amount of competition and result in large costs. Since small income foreign workers who send money home are the largest customer base for such services the high fees are actually a tax on the poor. Bitcoin threatens this profits and poses a regulatory risk. Therefore, Bitcoin exchangers will be attacked by competing financial institutions (remember TradeHill as such an example).

A widely successful Bitcoin system is against the self-interests of the established financial industry and it makes no sense for them to deal with the corresponding regulatory challenges in the long-run.

If the Bitcoin economy depends on the traditional banking system it is doomed to fail. Just imagine what would happen to the Bitcoin economy if Mt.Gox, which currently is responsible for about 80% of all Bitcoin exchanges, suddenly would have to close down.

In my opinion, this shows the second hypothesis: The Bitcoin community should not focus on interoperability with the traditional banking system.

The case for OTC

We now have established that from a self-interest standpoint the state and the traditional financial industry is naturally opposed to Bitcoin. To ensure the long-term stability and success of the Bitcoin economy we need a completely separate system of exchange, a network of over-the-counter (OTC) exchangers. An OTC exchange happens when two people meet face-to-face trading Bitcoin for cash (or gold/silver). OTC is not the sending of cash in the mail or wire transfer. Such a widespread network of OTC exchangers is the system most resilient against state attacks, because it is heavily distributed and the banking system is skipped entirely.

This reasoning supports the third hypothesis: Widespread availability of OTC Bitcoin exchangers is crucial for Bitcoin to succeed in the long-run and give us more freedom.

The how-to Secure and professional Bitcoin OTC exchanges gives practical advice on OTC. The content of this article was presented at the 2012 Bitcoin conference in London [slides].

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