Bitcoin

One of the criticisms leveled at Bitcoin by those people determined to hate it is that Bitcoin transactions are irreversible. If I buy goods from an anonymous counterparty online, what’s to stop them from taking my bitcoins and simply not sending me the goods? When I buy goods online using Visa or American Express, if the goods never arrive, or if they aren’t what was advertised, I can complain to the credit card company. The company will do a cursory investigation, and if they find that I was indeed likely ripped off, they will refund me my money. Credit card transactions are reversible, Bitcoin transactions are not. For this service (among others), credit card companies charge merchants a few percentage points on the transaction.

The problem with this account is that it’s not true: Baked into the Bitcoin protocol, there is support for what are known as “m-of-n” or “multisignature” transactions, transactions that require some number m out of some higher number n parties to sign off. Continue reading →

Yesterday at Forbes, William Pentland had an interesting piece on possible disintermediation in the electricity market.

In New York and New England, the price of electricity is a function of the cost of natural gas plus the cost of the poles and wires that carry electrons from remotely-sited power plants to end users. It is not unusual for customers to spend two dollars on poles and wires for every dollar they spend on electrons.

The poles and wires that once reduced the price of electricity for end users are now doing the opposite. To make matters worse, electricity supplied through the power grid is frequently less reliable than electricity generated onsite. In other words, rather than adding value in the form of enhanced reliability, the poles and wires diminish the reliability of electricity.

If two thirds of the cost of electricity is the distribution mechanism, then, as Pentland notes, there is a palpable opportunity to switch to at-home electricity generation. Some combination of solar power, batteries, and natural gas-fired backup generators could displace the grid entirely for some customers. And if I understand my electricity economics correctly, if a significant fraction of customers go off-grid, the fixed cost of maintaining the grid will be split over fewer remaining customers, making centrally-generated electricity even more expensive. The market for such electricity could quickly unravel. Continue reading →

“Selfie” was selected today as the word of the year by the Oxford English Dictionary’s editors, beating both “twerking” and “bitcoin.” Bitcoin’s company in that word list makes me appreciate the fact that others may be as sick of hearing about Bitcoin as I am about twerking. Nevertheless, it’s a pretty important week for Bitcoin, an I wanted to highlight some of the work I’ve been doing.

Yesterday the Senate Homeland Security and Governmental Affairs Committee held a hearing on the promises and challenges that virtual currencies hold for consumers and law enforcement respectively. I testified at that hearing and video of my testimony is below. You can also check out the written testimony, which is an updated version of the Bitcoin primer for policymakers I wrote with Andrea Castillo earlier this year. And ahead of the hearing I published an op-ed in The Guardian arguing that if the U.S. doesn’t foster a sane regulatory environment for Bitcoin, entrepreneurs will go to other jurisdictions that do.

All in all the hearing was hearteningly positive. The federal regulators and law enforcement representatives all agreed that Bitcoin is a lawful and legitimate payments system and that it holds great promise. They also agreed that plain old cash and centralized virtual currencies (contra Bitcoin’s decentralized design) are much greater magnets for money laundering, and that they needed no new laws or authority to deal with illegal uses of Bitcoin. I discuss the hearing and its implications on today’s Cato Daily Podcast with Caleb Brown.

Finally, I think there are lots of folks, especially in the wonkosphere, who think they know what Bitcoin is, but really don’t, and so the opinions they offer about its viability or significance are based on misunderstanding. For example, Neil Irwin at Wonkblog today wrote a 700-word post to suggest that what Bitcoin needs is a central bank. Now, if he’s trolling, kudos to him. But I really think he’s innocently ignorant of the fact that Bitcoin’s seminal design feature is that it is a decentralized payments system, and that the moment you add a central banker (which would in any case be impossible) you would no longer have Bitcoin, but Facebook Credits or Microsoft Points or airline miles.

So, if you think you have an inkling about what Bitcoin is, but you’re not too sure, or you don’t know why it’s so significant, please check out my cover story in the December issue of Reason, which was just made available online. Apart from explaining the basics, I go into detail about the little understood fact that Bitcoin is much more than just money. Value transmission is just the most obvious use case for Bitcoin, and thus the one that’s being built out first, but the Bitcoin platform is essentially a decentralized ledger, so it is also able to support property registrations, decentralized futures markets, and much more.

And truly finally, if you want to keep up with all the happenings in Bitcoin, including the Senate Banking Committee hearing later today, check out MostlyBitcoin.com, a site a built for myself but that I hope is useful to others that tracks Bitcoin stories in the mainstream media.

Deep Web Time CoverToday is a bit of a banner day for Bitcoin. It was five years ago today that Bitcoin was first described in a paper by Satoshi Nakamoto. And today the New York Times has finally run a profile of the cryptocurrency in its “paper of record” pages. In addition, TIME’s cover story this week is about the “deep web” and how Tor and Bitcoin facilitate it.

The fact is that Bitcoin is inching its way into the mainstream. Indeed, the NYT’s headline is “Bitcoin Pursues the Mainstream,” and this month’s issue of WIRED includes an article titled, “Bitcoin’s Radical Days Are Over. Here’s How to Take It Mainstream.

The radicals, however, are not taking this sitting down. Also today, Cody Wilson and Unsystem have launched a crowdfunding campaign to build an anonymizing wallet. In their explanatory video, they criticize the Bitcoin Foundation as “helping the United States” regulate Bitcon, presumably to hasten its mainstream adoption. “Their mission is a performance to both agree with, and maintain an independence from, regulatory power,” Wilson says. “But you can’t have it both ways.”

This is an internecine battle that I’ve observed in the Bitcoin community for years. That of the cypherpunks who see Bitcoin as an escape hatch from state control versus the entrepreneurs who are more interested in the network’s disruptive (and thus profitable) potential. While it might be a fool’s errand, I’d like to make the case that not only is the work of the two groups not in conflict, they actually benefit from each other.

I’ve been following Bitcoin since early 2011, and in April of that year I penned the first (yes) mainstream article about Bitcoin. It was in TIME.com, and it’s been credited with kicking off the first bubble. Since then my work has focused on the regulatory policy around Bitcoin and other crypto currencies, especially looking to educate policymakers about the workings and potential benefits of decentralized payments systems. Why am I so interested in this? My reasons are twofold and they track both the entrepreneurial and cypherpunk ideals, and yet I don’t think I’m bipolar.

Continue reading →

As you know doubt have heard, Silk Road has been shut down by the FBI and its alleged operator, Ross Ulbricht, has been arrested. I've been getting a lot of questions about this and what it means for Bitcoin. Here are some initial thoughts.

The price of Bitcoin is dropping. What does that mean? It means that speculators are speculating. That said, here's how I'm going to read it: If the main value of Bitcoin is that it can be used to buy drugs on Silk Road (as some contend), then we should see the value drop to zero is short order. If Bitcoin has other value, we should see it weather this jolt. One year ago a Bitcoin traded for about $14. As I type this, it's hovering at about $118 $127.

How did they catch the guy? Good question. I don't know the answer, but that won't stop me from speculating. I will point out two things. First is this from the criminal complaint against Ross Ulbricht:

During the course of this investigation, the FBI has located a number of computer servers, both in the United States and in multiple foreign countries, associated with the operation of Silk Road. In particular, the FBI has located in a certain foreign country the server used to host Silk Road's website (the "Silk Road Web Server"). Pursuant to a mutual Legal Assistance Treaty request, an image of the Silk Road Web Server was made on or about July 23, 2013, and produced thereafter to the FBI.

OK. So how did the FBI "locate" the servers that hosted the Silk Road Tor hidden service? The FBI has recently admitted that they have exploited vulnerabilities in Tor to identify users. Could it be that they exploited some vulnerability in this case? I look forward to finding out.

That said, here is another possibility. Also according to the criminal complaint (emphasis added),

On or about July 10, 2013, [Customs and Border Patrol] intercepted a package from the mail inbound from Canada as part of a routine border search. The package was found to contain nine counterfeit identity documents. Each of the counterfeit identification documents was in a different name yet all contained a photograph of the same person.

That person was Ulbricht and the package was addressed to him. Maybe it was from this lead that the FBI was able to begin the process of identifying the servers, once they had a suspect. If so, and if this indeed was a "routine" search, then the authorities got completely lucky!

Finally, I'll point out that Bitcoin was in no way involved in the identification of the suspect. In fact, in the criminal complaint the FBI argues that because the blockchain (Bitcoin's public ledger) is pseudonymous, that it is not useful in tracing transactions. I don't think that's quite right, but that's how the FBI sees it in this case. So, in this case at least, the privacy Bitcoin affords was not compromised in any way.

UPDATE: As I think about this some more, it's clear that the FBI was able to identify Ross Ulbricht because he posted his Gmail address to the Bitcoin Talk forum using the same username that first mentioned Silk Road ever. So, what are the chances that the CPB search that turned up the package of fake IDs bound for Ulbricht was routine? If it was routine, it was routine in the sense that packages to people on a watchlist might be routinely searched. I'm still not clear how the FBI got from identifying a possible suspect to locating the server for the Silk Road Tor hidden service.

How do you seize Bitcoins? I'm surprised by how many times I've been asked this question. It's amazing what it is that people seize upon in a story. < cough > I don't know how the authorities have carried out the seizure, but it's not to difficult to conceive how it could be done. Basically they would have to get the private keys to the suspect's Bitcoin addresses. (Think of it essentially like getting the password to an account.) They could either get that with his cooperation or if he had stored it somewhere now accessible to the authorities. Once they have the private keys, they would be able to transfer the bitcoins and I imagine that they would transfer them to a Bitcoin address that only they control.

UPDATE: So I got ahold of the seizure order and indeed I was correct that this is how the government will try to go about seizing the bitcoins. From the court order:

The United States is further authorized to seize any and all Bitcoins contained in wallet files residing on Silk Road servers, including those servers enumerate in the caption of this Complaint, pending the outcome of this civil proceeding, by transffering the full account balance in each Silk Road wallet to a public Bitcoin address controlled by the United States.

But to be clear, to seize bitcoins you do need to get the "password" that controls them. You can't just go to an intermediary and order that an account be frozen as you can do with traditional financial intermediaries like banks or PayPal.

I'll be tweeting and posting more as I learn more about what happened, but those are my initial thoughts. Shoot me any questions or thoughts you have. I'm at @jerrybrito on Twitter. And by the way, you can follow all the coverage of the Silk Road arrest and seizure on my site Mostly Bitcoin.

Last week, the Mercatus Center released “Bitcoin: A Primer for Policymakers” by yours truly and Andrea Castillo. In it we describe how the digital currency works and address many of the common misconceptions about it. We also analyze current laws and regulations that may already cover digital currencies and warn against preemptively placing regulatory restrictions on Bitcoin that could stifle the new technology before it has a chance to evolve. In addition, we give several recommendations about how to treat Bitcoin in future.

As I say in the video that accompanies the paper, Bitcoin is still very experimental and it might yet fail for any number of reasons. But, one of those reasons should not be that policymakers failed to understand it. Unfortunately, signs of misunderstanding abound, and that is why we wrote the primer.

Continue reading →

Timothy B. Lee, founder of The Washington Post’s blog The Switch discusses his approach to reporting at the intersection of technology and policy. He covers how to make tech concepts more accessible; the difference between blogs and the news; the importance of investigative journalism in the tech space; whether paywalls are here to stay; Jeff Bezos’ recent purchase of The Washington Post; and the future of print news.

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National Review today runs a pretty unfortunate article about Bitcoin in which the reporter, Betsy Woodruff, tries to live for a week using only bitcoins—a fun stunt already done by Kashmir Hill about two months ago. Aside from misrepresenting libertarianism, what's unfortunate about the article is how Bitcoin is presented to NR's readers, many of whom may be hearing about the virtual currency for the first time. Woodruff, who admits she doesn't completely understand how Bitcoin works, nevertheless writes,

From what I can tell, the main reason Bitcoin has any practical value is the existence of Silk Road, a website that lets users buy drugs and other illegal material online. …

A lot of Bitcoin aficionados will probably take issue with my next point here, but I’m pretty sure history will eventually be on my side. My theory is that Silk Road is the Fort Knox of Bitcoin. Bitcoin, from what I can tell, isn’t valuable because of idealistic Ron Paul supporters who feel it’s in their rational self-interest to invest in a monetary future unfettered by Washington; Bitcoin is valuable because you can use it to do something that you can’t use other forms of currency to do: buy drugs online. As long as Bitcoin is the best way to buy drugs online, and as long as there is a demand for Internet-acquired drugs, there will be a demand for Bitcoin.

Woodruff is right that folks who understand Bitcoin will take issue with her because she's demonstrably wrong. While it's true that illicit transactions probably did help bootstrap the Bitcoin economy early on, we are way past the point where such transactions account for any sizable portion of the economy. It's easy to put her "theory" to the test: Nicolas Cristin of Carnegie Mellon has estimated that Silk Road generates about $2 million in sales a month. The estimated total transaction volume for the whole bitcoin economy over the last 30 days is just over $770 million. So, Silk Road accounts for about 0.25% of bitcoin transactions—far from being the "Fort Knox of Bitcoin," as Woodruff says. And to put that in perspective, the UN estimates that the illicit drug trade accounts for 0.9% of world GDP.

The fact is that Bitcoin is not only a revolutionary new payments system that potentially disrupts traditional providers and can help serve the billions of unbanked around the world, but it also has the potential to be a distributed futures or securities market, or a distributed notary service. This is why Peter Thiel's Founders Fund and Fred Wilson's Union Square Ventures are investing millions of dollars in Bitcoin startups. Should we really think that these investors have overlooked what Woodruff posits—that the only value of bitcoins is to buy drugs? No, and I hope NR updates its story.

Today I had the great pleasure of moderating a panel discussion at a conference on the “Virtual Economy” hosted by Thomson Reuters and the International Center for Missing and Exploited Children. On my panel were representatives from the Bitcoin Foundation, the Tor Project, and the DOJ, and we had a lively discussion about how these technologies can potentially be used by criminals and what these open source communities might be able to do to mitigate that risk.

The bottom line message that came out of the panel (and indeed every panel) is that the Tor and Bitcoin communities do not like to see the technologies they develop put to evil uses, and that they are more than willing to work with policymakers and law enforcement to the extent that they can. On the flip side, the message to regulators was that they need to be more open, inclusive, and transparent in their decision making if they expect cooperation from these communities.

I was therefore interested in the keynote remarks delivered by Jennifer Shasky Calvery, the Director of the Treasury Department’s Financial Crimes Enforcement Network. In particular, she addressed the fact that since there have been several enforcement actions against virtual currency exchangers and providers, the traditional banking sector has been wary of doing business with companies in the virtual currency space. She said:

I do want to address the issue of virtual currency administrators and exchangers maintaining access to the banking system in light of the recent action against Liberty Reserve. Again, keep in mind the combined actions by the Department of Justice and FinCEN took down a $6 billion money laundering operation, the biggest in U.S. history.

We can understand the concerns that these actions may create a broad-brush, reaction from banks. Banks need to assess their risk tolerance and the risks any particular client might pose. That’s their obligation and that’s what we expect them to do.

And this goes back to my earlier points about corporate responsibility and why it is in the best interest of virtual currency administrators and exchangers to comply with their regulatory responsibilities. Banks are more likely to associate themselves with registered, compliant, transparent businesses. And our guidance should help virtual currency administrators and providers become compliant, well-established businesses that banks will regard as desirable and profitable customers.

While it’s true that FinCEN’s March guidance provides clarity for many actors in the Bitcoin space, it is nevertheless very ambiguous about other actors. For example, is a Bitcoin miner who sells for dollars the bitcoins he mines subject to regulation? If I buy those bitcoins, hold them for a time as an investment, and then resell them for dollars, am I subject to regulation? In neither case are bitcoins acquired to purchase goods or services (the only use-case clearly not regulated according to the guidance). And even if one is clearly subject to the regulations, say as an exchanger, it takes millions of dollars and potentially years of work to comply with state licensing and other requirements. My concern is that banks will not do business with Bitcoin start-ups not because they pose any real criminal risk, but because there is too much regulatory uncertainty.

My sincere hope is that banks do not interpret Ms. Shasky Calvery’s comments as validation of their risk-aversion. Banks and other financial institutions should be careful about who they do business with, and they certainly should not do business with criminals, but it would be a shame if they felt they couldn’t do business with an innovative new kind of start-up simply because that start-up has not been (and may never be) adequately defined by a regulator. Unfortunately, I fear banks may take the comments to suggest just that, putting start-ups in limbo.

Entrepreneurs may want to comply with regulation in order to get banking services, and they may do everything they think they have to in order to comply, but the banks may nevertheless not want to take the risk given that the FinCEN guidance is so ambiguous. I asked Ms. Shasky Calvery if there was a way entrepreneurs could seek clarification on the guidance, and she said they could call FinCEN’s toll-free regulatory helpline at (800) 949–2732. That may not be very satisfying to some, but it’s a start. And I hope that any clarification that emerges from conversations with FinCEN are made public by the agency so that others can learn from it.

All in all, I think today we saw the first tentative steps toward a deeper conversation between Bitcoin entrepreneurs and users on the one hand, and regulators and law enforcement on the other. That’s a good thing. But I hope regulators understand that it’s not just the regulations they promulgate that have consequences for regulated entities, it’s also the uncertainty they can create through inaction.

Ms. Shasky Calvery also said:

Some in the press speculated that our guidance was an attempt to clamp down on virtual currency providers. I will not deny that there are some troublesome providers out there. But, that is balanced by a recognition of the innovation these virtual currencies provide, and the financial inclusion that they might offer society. A whole host of emerging technologies in the financial sector have proven their capacity to empower customers, encourage the development of innovative financial products, and expand access to financial services. And we want these advances to continue.

That is a welcome sentiment, but those advances can only continue if there are clear rules made in consultation with regulated parties and the general public. Hopefully FinCEN will revisit its guidance now that the conversation has begun, and as other regulators consider new rules, they will hopefully engage the Bitcoin community early in order to avoid ambiguity and uncertainty.

Tim Lee is right. The Electronic Frontier Foundation post announcing its decision to accept Bitcoin is strange.

“While we are accepting Bitcoin donations,” the post says, “EFF is not endorsing Bitcoin.” (emphasis in original)

They’ve been using dollars over there without anyone inferring that they endorse dollars. They’ve been using various payment systems with no hint of endorsement. And they use all kinds of protocols without disclaiming endorsement—because they don’t need to.

Someone at EFF really doesn’t like Bitcoin. But, oh, how wealthy EFF would be as an institution if they had held on to the Bitcoin they were originally given. I argued at the time it refused Bitcoin that it was making a mistake, not because of the effect on its bottom line, but because it showed timidity in the face of threats to liberty.

Well, just in time for the Bitcoin 2013 conference in San Jose (CA) this weekend, EFF is getting on board. That’s good news, but it’s not as good as the news would have been if EFF had been a stalwart on Bitcoin the entire time. I have high expectations of EFF because it’s one of the great organizations working in the area of digital liberties.