Bitcoin vs. Big Government

Interest in Bitcoin has surged along with its valuation. Last
week saw its exchange rate soar past $100 for the first time ever,
landing the virtual currency on the front pages of The
Washington Post
and the Financial Times. Yet the
media frenzy, which has focused on the rapidly rising valuation and
its possible causes stemming from the bank crisis in Cyprus, is
overlooking Bitcoin’s true radical significance—that it can’t be
controlled by government.

In his new book,
This Machine Kills Secrets
, Andy Greenberg recounts
the history of the 1990s cypherpunk movement that paved the way for
WikiLeaks and Anonymous. The early Internet’s crypto-anarchists
foresaw a future world in which widely available cryptography
secured personal anonymity and privacy to such an extent that it
threatened the authority of the state. Their key insight, Greenberg
explains, is that anything that can be done cryptographically can
be done without government oversight.

Before eBay or WikiLeaks, cypherpunks like Tim May imagined
online markets for information in which buyers and sellers
transacted anonymously using untraceable digital cash. Anything
from state secrets to private credit reports would no doubt become
available for the right price. These ideas were notoriously taken
to the next level by the radical libertarian Jim Bell who proposed
a system  for anonymously crowdfunding the assassination of
corrupt government officials.

While almost all the technology necessary for such black markets
was available when the cypherpunks were writing, there was one
conspicuous exception: true digital cash.

Until Bitcoin, virtual currencies have in one way or another
relied on a third party intermediary, such as a bank or a credit
card company, to prevent “double
.” In the physical world, if I give you a $20 bill, I
will no longer have it. You can’t be as sure of that, however, when
the cash is a digital file that can be easily copied. The solution
has been to have a trusted intermediary keep a ledger of balances
and deduct a transaction’s amount from the payer’s account, and add
it to the payee’s.

Intermediaries, however, are the regulatory chokepoints at which
government can apply pressure. For example, after WikiLeaks
released its trove of State Department cables, payment processors
such as Visa and MasterCard succumbed to political pressure and
refused to transmit donations to the group. PayPal even froze its
account so that the group couldn’t access funds it had already
collected. As as a result, WikiLeaks has been driven to near

Today, online gambling is illegal under federal law and the
prohibition is enforced through payment processors, which are not
allowed to send money to offshore casinos. The infamous Stop Online
Piracy Act (SOPA) also targeted financial intermediaries and would
have banned payments to suspected pirate websites.

Bitcoin is revolutionary because it solves the double-spending
problem without employing an intermediary; there is only the payer
and the payee. The system accomplishes this by distributing the
ledger of transactions across a peer-to-peer network of users, much
like BitTorrent. This allows a record to be kept of all transfers
so that the same cash can’t be spent twice, but because it’s
distributed, there’s no one central authority keeping the ledger.
This makes bitcoins true digital cash. Like dollar bills or euro
coins, if you hand them over to a payee, you will no longer have
them. And because there is no third party running the ledger, there
is no one for the government to pressure or regulate.

(Article continues below video “Bitcoin the End of
State-Controlled Money.”)

Much of the discussion around bitcoin today centers on whether
it will work as money. Money has three
: it serves as a medium of exchange, a unit of
account, and a store of value. Because Bitcoin is distributed,
there is no central banker that can decide to inflate the money
supply. Some argue this makes it a good store of value, like gold
or Picassos, while others counter that Bitcoin’s historic
volatility make it a poor store of value and an unreliable unit of
account to boot. Given the public’s fear of currency devaluation in
Europe and the U.S., the question of whether you can stash your
wealth in bitcoin to avoid capitol controls and inflation is what
has been driving much of the media’s coverage of the currency.

Time will tell whether the gold bugs or the skeptics are right,
but what’s being overlooked is that it doesn’t matter whether
Bitcoin makes it as a store of value or a unit of account for it to
work as a medium of exchange. Even if the Bitcoin market remains
volatile and never pans out as a good store of value or unit of
account, one can imagine users converting their dollars or euros to
bitcoins for just long enough to make a transaction; perhaps just
minutes. And as long as it works as a medium of exchange, it is the
true digital cash that was missing from the cypherpunks’

With a little bit of effort, today you can purchase bitcoins anonymously with
physical cash
. You could then do all sorts of things the
government doesn’t want you to do. You could buy illegal drugs on
the notorious Silk
, an encrypted website that has been operating with
impunity for the past two years facilitating annual sales estimated
 at almost $15 million. You could gamble at various casinos or
prediction markets, buy contraband Cuban cigars, or even give money
to WikiLeaks. Dissidents in Iran or China can use Bitcoin to buy
premium blogging services from WordPress, which now accepts payment
in the currency. Perhaps more importantly, Bitcoin makes the
cypherpunks predictions of markets for stolen secret information
and even assassinations feasible.

Last month, the Treasury Department
issued guidance
on how it plans to regulate Bitcoin exchanges.
This is good news for the currency since it implies the government
is looking to regulate its use rather than prohibit it. Confronted
with Bitcoin’s potential, it’s not reasonable to expect that
Treasury’s money laundering cops would simply let it be. So it’s a
sensible approach for them to take because Bitcoin, much like
BitTorrent, can be used for both licit and illicit purposes and
would in any event be difficult to shut down.

Today physical cash is anonymous, which helps keep one’s
purchases private. Cash is also difficult to control: a $100 bill
never gets “declined.” As we move to an all-digital world, we
should ensure that we retain some type of digital cash that is not
tied to a financial intermediary that can spy on or control
transactions—even if, just like physical cash, it is put to
nefarious uses. The real question facing Bitcoin today, then, is
whether law enforcement and regulators will continue to show as
much restraint as they have so far.