Bitcoin: a protocol for the distributed maintenance of a ledger?

When I finally found my way to Brian Micklethwait’s Pimlico pad on Friday evening I was in for a few surprises. The biggest visual surprise was Brian’s amazing collection of books and CD’s. The amount knowledge there, in one home, is staggering. I enjoyed running my eyes over the titles and trying to notice whole areas of expertise I might have missed out on. The real surprise was that I had arrived thinking I was to hear about a revolutionary communications protocol for the distribution of digital money. I was going to get a talk about the minutiae of digital accounting.

I was also pleasantly surprised to be joined by several of Brian’s Samizdata colleagues, who’s excellent work over many years got me, and no doubt countless others, into libertarianism and so it was an honour to meet them. Brian’s chief guest, Frank Braun was an IT security professional with an interest, and a small income stream, in Bitcoin and was there to explain how it worked and what the advantages were for freedom loving libertarians. Frank explained that he is a fan of “freedom technology” because rather than changing a culture to value and understand freedom, a difficult and uncertain process, building a new peice of technology is a smaller problem with a faster and more certain pay off. If you are reading this thinking you have found the software hacker you are looking for, move along, but Frank was merely an admirer of the work of pseodonymous Satoshi Nakamoto, the inventor of Bitcoin.

The following explaination is based on my notes and is therefore mostly pointless, I’m sure better explanations exist, but I am interested in sharing it as a snapshot of my understanding. If I’m seriously wrong, it would help if you left a comment. If I’m right then hopefully there is some value in the way I explain it.

The major feature of the Bitcoin protocol is to effect transfers of wealth, but it’s primary domain object – the primary noun of importance in the system – is not coins or vouchers but an accounting ledger. The maintenance of that shared public record is the primary task and the competitive challenge addressed by the participating nodes, the computer systems owned by users and service providers who take part. It’s like one big trackerless BitTorrent, a network with no centre and no boundaries, co-operating to store copies of some data to which new blocks are conststantly added. The content of these blocks, the ledger, is not something you would be familiar with. I understood it by analogy: if the Dollar were only handled by a single Federal bank, and there was no cash, then the Fed would need to record the transactions of every US citizen and every other user of the currency in perfect detail. As Frank put it, trying to do something illicit in such as system would be “dumb”. This perfect transparency was the opposite of what I had understood to be the point of digital money and of Bitcoin.

Of course, a degree of privacy is acheived by the use of pseudonymous cryptographic identities, and your privacy is dependant on how much personal data gets linked your digital fingerprint. Your public key is your bank account and your bank balance is merely the sum of the values of every transaction involving that public key. As you might have computed, your private key is your means of accessing your money.

In economic terms Bitcoin is non-State fiat money, and the unit for numeric values in the ledger. From the users perspective, the advantages were given as:

  • The system is able to clear transactions (store them in a ledger-block) within 20 to 30 minutes
  • Transactions are reliable, businesses do not suffer the expense or risk of payments being charged back by the credit card company.
  • It is not possible to have your account frozen.
  • Possible to work under a pseudonym.

The disadvantages, as I touched on above are:

  • No anonymity, flows of money can be traced and tracked.
  • (I got the impression later that in order to take part, you are forced to download enough data to calculate every participants bank balance, illustrating how little privacy there is)
  • Very few tax implications, that is, you should expect to be taxed.
  • Somewhat smaller risks for people who want to protect their earnings from tax enforcement, since there is no current enforcement.
  • Needing to hold state fiat money to pay state taxes mean you cannot trade soley in Bitcoin.

Despite the high degree of transparency the “eBay for drugs” known as Silk Road appears to be the killer app. Bitcoin reached notoriety when a US senator triggered the Streisland effect for Slik Road by talking to the media about shutting Silk Road down. Silk Road was an existing site for traders that lacked a payment system, and whcih adopted Bitcoin.

The combination of Silk Road and Bitcoin has already made drug users safer and more free. Allowing them to easily purchase drugs and have them shipped in the mail rather than visiting dark urban corners.

Braun spoke about how the Governemnt might choose to attack Bitcoin:

  • Attacking the exchanges affecting people’s ability to buy into and out of Bitcoin. This is important as the price of Bitcoins is very unstable and holding Bitcoins long term amounts to currency speculation.
  • Attacking the pricing, so that people loose faith in the currency, e.g. by conducting a pump and dump in which large volumes are bought until the exchange rates rise then are sold again forcing a sudden price drop.
  • Braun provided an anecdote regarding the analogous EGold system which had a central technical and legal point of failure. The EGold system was prosecuted and shut down.
  • Similarly, IceGold the eGold broker shut down when threats of prosecution were made against the founder, essentially extending “Process as punishment” to “Process as threat”.
  • Technical attacks could be addressed at the “Bootstrapping” phase or via deep packet inspection, though these were not covered in depth as the main threat is clearly to exchanges.

Frank identified some important lessons for the development of future freedom technologies:

  • People will be less obedient of Government when they have practical options available that flout authority.
  • The technology’s originator stayed anonymous which was a smart move for him and for the network. Counter example: Julian Assange.
  • Very few people were needed to affect change, in this case they created a $60m economy.

© IK

We went on to discuss market opportunities for Bitcoin in replacing Hawala and Western Union money transfer systems and whether Bitcoin might remain a “wholesale” form of money with retail users accessing it via human contact points. We also identified potential business opportunities for individuals setting themselves up as Bureau de Change in retail settings e.g. at the shop where you get phones unlocked.

I want to end with Bitcoin’s monetary policy. Large chunks of the libertarian community are motivated by one primary economic problem caused by the states domination of currency: inflation. Currently hovering around 5%, depending on your definition, inflation is the process of granting invented “fiat” money to banks and other major instutions and deliberately increasing the number of units in circulation and devaluing the currency. The effect on savers, which I don’t need to explain here, is that they are ripped off at a rate of 5% per year, and the effect over time is compounded year on year in a sick mockery of compound interest. That this deliberate policy is morally repugnant is an excercise in subtle understatement.

Bitcoin is a new system, and it is a type of fiat money whose value, like state fiat money, does not relate to anything real. It could collapse tomorrow. But it is a currency that directly protects people from inflation – in fact Bitcoin is limited by a resilient technical and democratic cap of just 21 million units – ever.

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