John Lanchester · When Bitcoin Grows Up: What is Money? · LRB 20 April 2016
It is impossible to discuss new developments in money without thinking for a moment about what money is. the best place to start thinking about that is with money itself. Consider the UK’s most common paper currency, the English five, ten or twenty pound note. on the one hand we have a famous dead person: elizabeth fry or charles darwin or adam smith, depending on whether it is a five, a ten or a twenty. on the other we have a picture of the queen, and just above that the words “i promise to pay the bearer on demand the sum of”, and then the value of the note and the signature of the bank of england teller. .
It is worth thinking about that promise to ‘pay the bearer at sight the sum of ten pounds’. when we analyze it, it is not clear what it means. ten pounds of what? we already have ten pounds. that is exactly what we have in hand. It doesn’t mean paying the bearer at sight ten pounds in gold: the link between currency and gold ended in 1971, and Gordon Brown sold the Bank of England’s gold reserves in the 1990s anyway.
Reading: What is money when bitcoin grows up
The fact is that there is no answer to the question, ten pounds of what? the ten pound note is worth what it says it is because the state, in the form of the bank of england, says so, and we choose to believe it. this is what currency scholars call “fiat” money, money whose value has been willed by the state. the value of fiat money is a leap of faith. there are peculiarities in this. In the case of the pound coin, if we ask how much it is worth, the answer is obvious: one pound is worth one pound. although it shouldn’t be. According to the Royal Mint, which actually makes the material, 3 percent of all pound coins in circulation are fake. Taking that into account, we should discount the price of our pound coin and mathematically assign it a value of 97 pence.
In real life, there’s no need to do that, because chances are good that you won’t have any difficulty spending your fake pound at full face value. (That is unless you get caught in a coin slot that rejects your money. Most people attribute the annoying frequency with which this happens to a problem with the coin slots; however, it’s mainly a problem with the coin The next time you’ll have trouble with your counterfeit currency when you get one of the squishy mutants that look like partially chewed fruit pastilles and are so badly forged they border on endearing). they are worth what they say because we choose to believe in them. . your mathematically determined 97p coin is worth a pound because we think it is worth a pound. we trust it. that is the first main point about money. its value is based on our belief in its value, backed by the authority of the state.
for the second main point about the nature of money, we need to travel to the pacific ocean. In Micronesia, about 1,800 miles north of the eastern corner of Australia, there is a group of islands called Yap. It has a population of 11,000 and is largely unvisited except by divers, but it is a very popular place for economists to talk about the nature of money, beginning with a fascinating article by Milton Friedman, ‘The Island of Stone Money. ‘, published in 1991. There is a particularly good retelling of the Felix Martin story in his 2013 book Money: The Unauthorized Biography.
yap has no metal. there is nothing to convert into coins. What the Yapese do is sail 250 miles to an island called Palau, where there is a particular type of limestone that is not available on their home island. they quarry the limestone and then shape it into a circular wheel shape with a hole in the middle, called fei. some of these fei stones are absolutely huge, 12 feet across. they then sail on the fei back to yap, where they are used as money.
The great advantage of fei being made from this particular stone is that they are impossible to counterfeit, because there is no limestone in yap. fei are rare and hard to come by by definition, so they hold their value well. you can’t fake a fei. Just as you have to work for money in a developed economy, so money constitutes a record of work, EIFs are an unfalsifiable record of the work that went into their creation. In addition, the big ones have the advantage that they are impossible to steal. however, likewise, they are impossible to move, so what happens is that if you want to spend some of the money, you just accept that someone else now owns the coin. a coin found outside someone’s home can be transferred back and forth as part of a series of transactions, and all that really happens is that people change their minds about who owns it now. everyone agrees that the money has been transferred. the real money is not the fei, but the idea of who owns the fei. the property register, which is kept in the memory of the community, is money.
Sometimes it has happened to Yapense that their boats are hit by a storm on the way back from Palau, and to save their own lives, the men have to throw the big stones overboard. but when they return to palau they report what happened, and everyone accepts it, and ownership of the stone is assigned to whoever mined it, and the stone can still be used as a valid form of money because ownership can be traded even though the stone real is five miles at the bottom of the pacific.
That example seems strange, because the details are so vivid and exotic, but our money works the same way. the record is the money. This is the second main point about the nature of money. we think of money as the things in our wallets and purses; but most money is not that. They are not bills and coins. In 2006, for example, the total amount of money in the world in value terms was $473 trillion. that’s such a large number that it’s very hard to wrap your head around: around £45,000 per person for the seven billion people on the planet. Of that $473 trillion, less than a tenth, about $46 trillion, was cash in the form of bills and coins. more than 90 percent of money is not money in a physical sense. That number is even higher in the UK, where only about 4 percent of money is in cash. what it is, instead, are entries in a ledger. they are numbers in your bank balance, the electronic records of debits and credits that are created every time we spend money.
when we say that we spend money, what we mainly do is make entries in the logs. your work results in a weekly or monthly credit from your employer account to your account, maybe with another transfer of taxes paid to the government, also your pension contribution if you make one, any form of insurance, then some of it goes automatically to your landlord or mortgage provider – they all go to different parts of the financial system, all of them nothing more than the movement between all these ledgers and records. this is what almost everything we call money mainly is: numbers that move in registers. it’s the same system they have in yap.
The third point is that money, as it has evolved, has a crucial relationship with technology. there are a number of technologies that are inexorably intertwined with the workings of money. The first of these, probably the most important piece of technology in human history, is writing. This begins in ancient Sumer, around three thousand BC. c., with trade and inventory registers gradually evolving into other types of registered writing. the next great invention arrives in renaissance italy, with the popularization of the balance sheet, and with it, of banks that become places where all the different transactions of a society, all the various credits and debits, come together in a single Registration. the bank becomes the intermediary between creditors who have extra money to lend and borrowers who have reason to need it. instead of an almost infinite multiplicity of transactions between individuals, exchanging credits and debits back and forth as we exchange goods and services and taxes, promises, debts and obligations, one by one, all the various transactions in all the various markets of a social complex. environment are now held on the books of a single institution: the bank. the company has a registry, and that registry is in charge of the bank. Arguably the first truly successful example, the first to implement new record-keeping technology effectively, was the Medici Bank in Florence.
The final piece of this is the invention of the central bank, with the founding of the Bank of England in 1694. In exchange for lending the sovereign a large amount of gold, in the first instance to build a navy to fight the French, The Bank of England acquired the right to print paper money. that paper money could then be used by ordinary people to pay their taxes. it is at this point that banks, money and the modern state merge. the monetary system, the banks and the state are, in effect, aspects of each other: a three-headed monster, like cerberus.
Brief historical digression: It took a while for this system to spread far and wide, especially in the United States, where arguments about the link between banks and the state and the monetary system have been a recurring theme. In How You’d Like to Pay, a lucid short book on new monetary technologies, Bill Maurer notes that as recently as the 1860s, the United States had 8,000 private coins in circulation, issued by “banks, railroads, retail stores, and other entities’.1 There is an interesting discussion of American money in Edward Castronova’s Wild Currency Overview: He explains that states had no right to issue currency themselves, but they did have the right to regulate the issuance of money in its territory.2 this was a system prone to unintended consequences.several states
allowed banks to issue money only in large denominations. this was done to force banks to hold adequate gold reserves. the theory was that holders of large-denomination bills were more likely to go back to the bank and exchange those bills for gold. as a result, banks would have to have more gold on hand. a bank with more reserves is less likely to fail.
That was the theory. practice: many of the new denomination bills were too large for use. As a result, there was a huge proliferation of private money, issued by everyone from farmers and merchants to hotels, restaurants and bars. a common person’s wallet might contain a dozen different coins, all with a different value in different places, since the money in a bar might trade at its full value on the bar itself, but would be worth significantly less at the time you walked out the door, and even less as you walked further and further away. the government’s response, in 1851, was to create a three-cent coin, the trime. It was only after 1864, when Congress banned the issuance of metal coins in exchange for money, that private money began to be squeezed out of the economy.
Over time, even the United States joined the system of state-backed money that is distributed through a central bank. this is the system we still have everywhere in the developed world today. the reason so many people are excited about bitcoin and its associated technologies is that for the first time there is a genuine possibility of real change in this area. money has evolved leaps and bounds, from the invention of writing to the invention of the balance sheet and the bank to the creation of the central bank, all of these changes being variations on the theme of money as a record of credits and debits. and now we are at a point where another jump is possible.
The simplest and greatest possibilities concern connectivity. we are more connected in more ways to more people than we have ever been at any point in human history. this is changing everything, and it would be profoundly strange if money did not change as well. there are many ways the impact could occur. for example, a large part of the monetary system is dealing with intermediaries. It dates back to the Medici, to that central register where debits and credits are brought together in one place. The bank is the intermediary between creditors and debtors. obvious question: do we still need that intermediary? I have money that I’m not using, you need more credit than you have, to buy a house or start a business or buy a car or whatever. I lend you the money and you return it to me. easy peasy. historically, we have needed a bank to mediate that transaction and to take a generous part in the process. it is not at all obvious that we need it more. we can meet without the bank involved; thanks to the internet we can locate ourselves without intermediaries. It seems very obvious to me that this area, that of p2p or peer-to-peer loans, is going to grow and grow. why lend money to your bank for shitty interest when you can go to zopa, the uk’s leading p2p site, and lend it directly to someone in need, for a 5 percent return? The answer right now is probably that banks are old and have some deposit protection, while online loans are new and don’t. But that answer isn’t set in stone, and one lesson from the internet is that when customer behavior changes, it can change quickly. a lot of money is at stake here. the part taken when a sends money to b amounts to $1.7 trillion, that’s right, trillion, every year.
connectivity also has implications for other types of transfer. money is a way of transferring credit. new ways of doing it directly are now possible. The great pioneers of this are in the developing world, especially in Kenya, which has adopted a form of direct transfer called m-pesa. this involves the transfer of credits not from bank account to bank account, but from one mobile phone to another. m-pesa was introduced in 2007 and gained popularity when the violent chaos following elections later that year paralyzed the regular banking system. That’s an example of the way the chaos and uncertainty surrounding traditional banking creates an appetite for new services, not unlike the United States, where the civil war made private money ultimately unviable. a few years after its adoption, m-pesa is the conduit for half of kenya’s gdp. credit goes from phone to phone, and that credit is a new form of money, making the kind of ease you get from a bank account available to all kinds of people who don’t have one. once you have a record of successful payments on your phone, merchants and institutions will take it as a sign that you can get other forms of credit and you can start to get out of the informal economy where the poor are trapped, where there are no records of their credit, not records of what they own, to the economy in general. that’s huge.
The world population is seven billion. two and a half billion adults do not have a bank account. Paul Vigna and Michael Casey’s excellent book Cryptocurrency explains what that means:3
Somewhere in the order of five billion people belong to households that are insulated from a financial system that the rest of us take for granted. they cannot open savings accounts. They don’t have checking accounts. they can’t get credit cards. they live in places that banks don’t want to go, and because of this, they remain effectively isolated from the global economy.
but there are at least seven billion mobile phone subscriptions in the world (four and a half billion people have access to a toilet). therefore, more than twice as many people have a mobile phone than have access to a bank account. if your phone can give you access to the things you’d need from a bank, well, you’ve just disinvented the need for banks and fundamentally changed the operation of the monetary system, across entire swathes of the developing and emerging world.
The reason phones can do this is because they represent a remarkably high level of trust. You can trust that the phone is owned by the person who owns it, because the combination of SIM card technology and PIN numbers is so strong. Behind the user-friendly façade of chip and pin are industrial-strength cryptographic techniques. in fact, the pin number technology used in ATMs initially evolved as a question-and-answer protocol to confirm nuclear weapon access codes. you can trust that this person who owns the phone is who they say they are: that basic act of trust is fundamental to the operation of all monetary systems.
What makes this possible is cryptography. Cryptography is also central to one of the most exciting developments in the world of money, and that is bitcoin. I’m not sure if bitcoin is likely to be the most important of all these developments: Peer-to-peer lending and non-bank payment systems of the type m-pesa seem to me at least as likely to change lives. especially the lives of the poor. but there is no denying that bitcoin is the best story.
bitcoin is a new form of electronic money, launched in an article published on October 31, 2008 by a pseudonymous person or persons calling themselves satoshi nakamoto. Note the date: This was shortly after the collapse of Lehman Brothers on September 15 and the near death of the global financial system. just as the civil war was the impetus for the us to wipe out private money, and the crisis of kenyan democracy led to the explosive growth of m-pesa, the global financial crisis appears to have been a crucial spur, if not to development . of bitcoin, then certainly at the time of its launch.
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The core and most exciting technology of bitcoin is something called blockchain. this is a record of all bitcoin transactions that have ever occurred. every time something is bought or sold with bitcoin (remember, that means every time something is moved from one place in the ledger to another place), the new transaction is added to the blockchain and authenticated by a network of computers. the techniques are cryptographic. it’s impossible to fake a new addition to the chain, but it’s relatively easy (by relatively easy, I mean relatively easy for a large variety of assembled computing power) to verify a legitimate transaction. so: impossible to fake but simple to verify. the entities that transfer the money are anonymous and, at the same time, completely transparent: anyone can see the bitcoin addresses involved, but no one necessarily knows who they belong to.
this combination of features has extraordinary power. it means that you can trust the blockchain, without knowing about anyone else connected to it. bitcoin is indeed a record like the one stored in the memory of people on yap, but it is a record that anyone can see and everyone agrees with. for the first time in human history, we have a registry that does not need to be backed by some form of authority or state power, other than itself, and, as I have argued, that registry is not a brilliant complement to the nature of money. It’s actually how money works. Such a decentralized, anonymous, self-verifying, completely trustworthy registry is the biggest potential change to the monetary system since the Medici. It is banking without banks and money without money. The following paragraphs give a brief technical explanation of how bitcoin works; if you’re not interested, see you on the drop card.
The deepest mystery about the physical universe is that it is so intertwined with mathematics. gravity is inversely proportional to the square of the distance between two objects. why? Why is pi, essential for calculating the circumference of a circle, also essential for calculating the area of a circle? why is this an exact value, not just a rough guide or rule of thumb? why does it appear in so many other places in mathematics as well? why, for example, is the probability that two random numbers do not have a common factor equal to 6/π2?
We don’t know why mathematics reaches so deeply into the texture of physical reality. One of the most difficult things to understand about cryptography is that it is based on something that is inexplicable, and that is that it works. as julian assange has said,
It just so happens that it’s a fact about reality, like that you can build atomic bombs, that there are mathematical problems that you can create that even the strongest state can’t break… there’s a property of the universe that is in the privacy side, because some encryption algorithms are impossible for any government to break, ever.
In essence, the effectiveness of cryptography is based on a single truth about mathematics: that it is impossible to factor large numbers. for any number, there is no way to tell if a smaller number divides into it, unless you do the math. this may sound like a small dot, but it means that when you have very large numbers (numbers that have hundreds or thousands of digits) there is no way to factor them out other than to try each smaller number and see if it fits. with very, very large numbers, that process is, in practice, incredibly slow. this turns very large numbers, and the prime numbers that are their factors, into miraculously effective cryptographic entities; the basis of all contemporary codes. this, in turn, is a hard fact for civilians to digest, even though it underlies more or less everything we do, commercially speaking, on the internet. (Note that having secure codes is not the same as having secure computers. Breaking into people’s computers is a whole different story than breaking their codes, and once you’ve broken in, it often doesn’t matter what the user is doing. host cryptographically. ) to capture bitcoin, or to believe in bitcoin, you have to rely on this power.
There are three main cryptomathematical techniques at work in bitcoin. The first is matching a public address, which is any user’s bitcoin address, with a private key that provides access to that address. Although the cryptography involved in this process is scary, as it relies on the aforementioned properties of prime numbers, it’s so widely used (every time you use a credit card, every time you use a pin number) that we’ll take it for granted. seated. here. when you spend some bitcoin, all you’re really doing is changing an entry in a digital ledger from address a to address b: at that point, your transaction is broadcast to the network, where it takes its turn with other transactions waiting to be compiled in a ten-minute chunk of transactions, known as a “block”.
This is where miners come in. (‘mining’ is a bad metaphor for what these computers do: it’s more like clerk or check. but it’s called mining.) miners take this ten-minute block of transactions, each combining the two addresses of the transaction parties, the amount of bitcoin moved, and a timestamp, and run them through a ‘hash function’. these are cryptographic algorithms to encode information: the one used by bitcoin is called sha-256. the hash function takes an information stream of any length and converts it into a single set of letters and numbers, of a fixed length. here is ‘the cat sitting on the mat’ run via sha-256: 500532af74c472e39c7d685fddb727c3bf461ce41118f29f856bafe4024fc303. and here for comparison purposes is ‘the cit sat on the mat’: a8727c0891cec28e10c03 aa09c759d92fd628e131435b502c04e60d 09ce4ef76.
as we can see, the output is sensitive to any change in the input: as much as a single letter is modified and the whole hash changes. Note that no matter how long and complicated the input is, the output is always 64 characters long. just to make the point, here is the sha-256 hash of the full text of ulysses: 6ff1c1a80b68b5414423a7e2e061d5f2f c09f7c4e86c4987e573bebc4e4991dd. put all this together and you have a system that makes it very easy to check if a given text has been encrypted correctly: you just run it through the algorithm. at the same time, it is impossible to guess the input from the output. there are simply too many possibilities: it’s mathematically impossible to land on the right one. anyone can verify ulysses hash function online in about ten seconds. all the computers in the world connected to each other could not reverse the encryption and determine that the input behind the hash is joyce’s novel. this is just a glimpse of the magical power of encryption.
miners take the transactions in the block, process them, and add them to the hash of all the transactions that have ever occurred in bitcoin. That’s right: the blockchain is a record of every transaction, no matter how small, that has ever occurred in the currency. The miners then run the hash through a calculation, set by satoshi, which makes them come up with a solution that finds a fixed number of zeros at the beginning of the hash. that’s a trick to ensure that the calculation is hard enough, for reasons I’ll get to in a moment. There are no shortcuts to this process as it relies on sheer mathematical brute force. this is what is called a “proof of work”, to show that the miners have done the necessary work to find a solution. proof of work is the third piece of mathematical/cryptographic magic involved in bitcoin. miners throw numbers at the problem until one of them hits and a solution is found. (hence the mining metaphor, the idea that they are looking for money). this solution is then broadcast to the entire network.
the moment the transaction is transmitted to the network, satoshi did another clever thing. One of the problems that cryptocurrencies face is the “double spending” problem. a bitcoin is just a string of numbers: how can he know that joe, his coffee shop customer, didn’t just cut and paste the numbers he already used four times today? bitcoin solves this by having the entire network check the entire record every time a new block is added. when the winning miner transmits the block, computers on the network check it to verify that all transactions on it are legitimate and that no bitcoin has been double-spent. in effect, they vote on the legitimacy of the transaction, and once the transaction is accepted, it is stamped with the block number and added to the blockchain. the miner who found the correct solution is compensated for their work in bitcoin: they are paid in the coin, for the work they do in validating transactions in the coin. this was another brilliant piece of design on satoshi’s part, creating an incentive, within the network, for people to participate in making the network work.
The mathematical sophistication of bitcoin brings with it a couple of trade-offs. one is what is known as the “51 percent problem.” okay, in principle, no one can spend twice, because the blockchain verifies each transaction and votes on it. But what if the bad guys gained control of 51 percent of the network’s computing power at any given time? then they could validate any transaction they wanted. there would be no way to stop them from doing whatever they wanted with counterfeit, double-spent coins. there is no real solution to the 51 percent problem apart from the size of the network, which is disturbing, as if a bank said that the only thing that prevents criminals from emptying your bank account is not an absolute principle of security, but only that doing so would be too much effort. this is a difficulty, and one that stands out even more given the sophistication with which satoshi solved many of the new currency’s other conceptual problems.
Another hard thing to ignore is the amount of energy used by the miners. As bitcoin has become more popular, not among civilians, but among nerds and cutting-edge capitalists, the mining process has had more and more computer power. the process is wasteful, as most mining, most of the time, is by definition unsuccessful, because only one miner wins the race. as vigna and casey point out in cryptocurrency, in mid-2014, the bitcoin network, which
It was then producing 88 trillion hashes per second, had computing power six thousand times greater than the combined power of the world’s top five hundred supercomputers… and just two and a half months later, it had almost tripled to 252 000 trillion hashes. the world has seen nothing like this level of computational expansion. This is why some doomsayers predict that if bitcoin continues on its current path, the planet faces an environmental catastrophe.
The amount of power used by computers connected to the network cannot be sustained. this is a bit of a stretch, but there’s no denying that the mining process is inherently wasteful. (Bitcoin miners prefer to settle in places where it is cold, to reduce their air conditioning bills).
there will only be 21 million bitcoins – the finite nature of the currency was satoshi’s way of ensuring that, unlike fiat currencies that governments can abuse, no one could destroy the value of bitcoin by arbitrarily deciding create more of it. the timeline is that these bitcoins are created over the course of 130 years. As more computing power is added to the network, it becomes necessary to make the math challenges harder to slow down the miners’ progress. that’s where that string of zeros at the beginning of the proof of work comes in handy: changing the number of zeros immediately affects the difficulty of the calculation, to slow down the mining of the coins. but this means that a lot of energy will be wasted. it’s an ugly side effect for a system of great intellectual elegance.
The result has been the success of the currency, a success far greater than most people who have never heard of it might suspect. the total value of all bitcoins in circulation, as I write, is £4.24 billion. that number changes, often with disconcerting rapidity, since the price of bitcoin is highly variable. this discourages outsiders, as one of money’s most basic functions is to store value; bitcoin is a lousy store of value, as many observers have pointed out. bitcoin, however, already does a good job of one of money’s other main functions, as a medium of exchange. You can buy plane tickets, reserve hotel rooms, buy computer equipment, food, and just about anything else with bitcoin, which is now accepted by tens of thousands of businesses. In fact, since you can buy gift cards with bitcoin and use the cards on amazon and other e-commerce sites, you can buy anything you want with the cryptocurrency. there are even bitcoin ATMs. i went to see one the other day, in a cafe in bermondsey. the ‘satoshipoint’ was at the back of the premises, past the blackboard where a flat target was labeled ‘fat wife’, past the cradle of sprawling cats and macbook air charging cables, past the merchandise table of coffee cups with the slogan ‘beneath your tattoos you’re still a conventional asshole’, the satoshipoint was broken. tant pis, as satoshi would say, if he/she/they were french, which they probably aren’t. It doesn’t alter the fact that bitcoin has functioned very well as a form of money for only seven years, with no entity behind it other than lines of code running on a network of computers.
the increasing usefulness of the currency has drawn attention. Citizens of countries like Argentina, whose governments have a near-perfect record of devaluing their own currency and destroying their citizens’ savings, have shown signs of preferring bitcoin to their own state money. One of the liveliest case studies in Nathaniel Popper’s glittering digital gold concerns Wences Casares, a highly sophisticated (and very successful) Argentine investor whose interest in Bitcoin stems from his up close and personal view of a broken fiat currency.4 Casares is a huge bitcoin investor and evangelist, not (or not only) because it will make him rich, but because he finds it genuinely preferable to state-backed fiat money. he is not the only one.
However, the mathematical sophistication and philosophical appeal of bitcoin is not the whole story. an effectively anonymous and untraceable way of moving money – gosh, hmmm, I wonder who would be interested in that? Not surprisingly, the first application of bitcoin for large companies came in the form of a criminal enterprise. satoshi nakamoto’s article was published in october 2008. the detailed workings of the new currency, including the code that would operate it, was published on january 3, 2009. the first transaction made with bitcoin was an avant-garde and deliberately experimental purchase of a pizza, for 10,000 bitcoins, made on May 22, 2010. (the community celebrates the anniversary of the first transaction by celebrating bitcoin pizza day. at current values, that pizza cost £2.77 million). began the first large-scale criminal application of bitcoin vida months later, in early 2011.
Silk Road was an online drug market created by a charming and handsome 26-year-old Texan named Ross Ulbricht. Ulbricht, who has a bachelor’s degree in physics and a master’s degree in materials science and engineering, was (is) an odd, very 21st-century combination of impulsive and irresponsible. he was not the first and will not be the last person to be led astray by the dream of launching the internet to billions. While in his second grade, Ulbricht picked up a serious case of Austrian school economics and became convinced that government and taxation were essentially coercive systems. (This revelation occurred while he was attending Penn State, a publicly funded university.) So, to go a little further, he created an online exchange where buyers and sellers could get together to trade anything that didn’t involve harming others: which in practice meant no to child pornography, but a big yes to fake IDs, guns, and especially drugs. The exchange was only accessible via Tor, the highly secure internet browser that hides users’ locations so successfully that it’s a huge favorite of terrorists and paedos. (you may be wondering: who could have created such an evil piece of software? answer: the us navy invented and, in fact, maintains tor as a means of communicating with spies and informants, and a tool for dissidents in totalitarian regimes the next time you hear a securocrat talk about the need to expand internet surveillance, you may wonder why our allies invented, distributed, and continue to support the most effective web tool for terrorists, criminals, and paedos. The answer is that security classes I think the usefulness of tor outweighs the harm it causes, except that perspective often seems to escape our leaders when they talk about the need to spy on us.)
tor grants anonymity and geographic unreachability to all its users; bitcoin provided an anonymous and non-traceable way of transferring payment. the result of the silk road, which combined the two, was explosive growth. Within two years, Silk Road was one of the most successful internet companies in the world and had attracted a buyer willing to offer $1 billion. the man who ran it used the pseudonym dread pirate roberts, an attempt by ulbricht to imply that the person behind the site had changed over time, as in princess bride the identity of the dpr is passed from one owner to another . In 2013, Dread Pirate Roberts told a reporter in an encrypted internet chat that he now thought the site was worth ten or eleven figures. if his business had been legal, that estimate would probably have been accurate.
Ulbricht, however, had made a mistake. Once, and only once, in the early days of Silk Road, he had used his real email address in a discussion forum that clearly showed his involvement in the running of the site. he noticed and quickly deleted the post, but it had already been archived, so when the feds searched, they found the email address, giving them a prime dpr suspect. now silk road was a blatant and blatant mockery of the american legal system. “every transaction is a victory”, announced the dpr, over the “robber killer” state. dpr had a book club. featured a lot of Austrian school economics. he was in favor of a world in which “the human spirit flourishes, unrestrained, wild and free!” “Once you’ve seen what’s possible, how can you do anything else? how can you reconnect to the oppressive, violent, sadistic, warrior and oppressive machine that eats taxes, sucks lives and never again? how can you kneel when you have felt the power of your own legs?’ It heightened feelings, but in reality Ulbricht was paranoid, terrified, and had even gone so far as to commission assassinations of potential informants. one of the possible killers was an fbi plant. The other hit-and-run had an unknown outcome, because no one seems to have been killed: the most likely explanation is that someone or bodies pretended to be hit men to con Ulbricht for money. (None of the cases have gone to trial). the fearsome pirate roberts had completely lost his marbles.
that didn’t make it any easier to catch. Not that Ulbricht almost got away with it: she didn’t. however, it was difficult to pin down because, even once the feds knew who he was and what he was doing, that combination of tor and bitcoin was still powerful. to convict him, they would have to not only catch him, but also take the computer out of his hands while he was in the middle of criminal activity. otherwise there would be no way to link it to activities on the silk road. “Put yourself in the shoes of a prosecutor who is trying to make a case against you,” the dpr said in an online chat. “Realistically, the only way they can test anything would be to watch him log in and do his work.”
ulbricht had set up a system whereby simply shutting down your computer would permanently encrypt your hard drive. he could do the same thing just by pressing a couple of keys. they would literally have to snatch the machine out of his hands before he could even touch the keyboard. the feds would have one chance and one chance only to catch him, and they would have to catch him on his computer while he was logged in as dpr and running the silk road. so that’s what they did. On October 1, 2013, Ulbricht was sitting in a public library in San Francisco, connected to the Silk Road through the library’s Wi-Fi. He was in an online chat with an FBI agent whose job it was to make sure Ulbricht was still online when his colleagues pounced. Ulbricht was at a desk across from a slim young Asian woman when a couple of typical San Francisco street people started arguing loudly right behind him. he turned to look, and the young woman grabbed her laptop: she was an fbi agent. also the people on the street. well, the feds. ulbricht logged into silk road with the account ‘/mastermind’. Game over for fearsome pirate Roberts. Ulbricht went to trial in 2015, was convicted and is serving two life sentences without the possibility of parole.
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There are several morals to this crazy, sad and fascinating story, brilliantly told in two lengthy cable reports by joshuah bearman, and also in digital gold.5 From bitcoin’s point of view, the silk road was evidence of the great but not entirely true maxim that there is no such thing as bad publicity. the first thing many strangers heard about bitcoin was the collapse of the silk road. I might have thought the connection between the new kind of money and the new kind of criminal enterprise was nasty, but it didn’t work out that way, mainly, I think, because the Silk Road scandal/disaster contained a nugget of PR magic. for bitcoin: proved that the currency has value. you could use bitcoin to buy and sell real world stuff that people want, things like cocaine, guns, and fake driver’s licenses. if money was good for those things, it would be good for other things too.
this speaks to the first and strongest and most persistent doubt that most civilians have about bitcoin: why the heck does it have any value. the truthful answer – which refers to the arbitrary basis of all monetary value – tends not to reassure skeptics. what silk road provided was a proof that went beyond discussion: it proved that it just works, okay? this point was too compelling for some of the officials involved. In a twist that would seem all too rich in a work of fiction, two of the agents who hunted down DPR, Secret Service Agent Shaun Bridges and Dea Man Carl Force (!) turned out to have stolen Bitcoin from DPR. they pleaded guilty to charges of money laundering and obstruction of justice. the force got 78 months and the bridges 71. even federal agents fell victim to the siren song of anonymous currency.
in the process of arresting ulbricht and shutting down the silk road, the fbi became one of the world’s largest bitcoin owners, seizing the site’s considerable assets: 144,000 bitcoins, worth £43.9 million at current prices. it was a point of interest what he would do with them, and also a point of danger, as it seemed possible that once the new currency had the attention of the authorities, they might conclude that this anonymous, untraceable, extra-governmental money was, in and by its very nature, illegal. Instead, what the FBI did, after some thought, was what it does with other seized assets: auction them off. the implicit point was not missed: the feds say bitcoin is legal. it follows that bitcoin has legitimate uses. that was a strong message. bitcoin came off the silk road in better shape than ever.
the next big scandal to hit bitcoin could and arguably should have been more damaging. it was an online exchange, based in japan, called mt gox. (The name comes from the site’s previous existence as a trading forum for the nerd-loved trading card game Magic: The Gathering. It’s an acronym for Magic: The Gathering Online Exchange.) mt gox was born as the answer to the question, how can I get some bitcoin and/or how can I convert this bitcoin that I have into real money? it was the place where you could buy bitcoins at the prevailing exchange rate with whatever currency you had. would store those bitcoins for you. as he decided to exchange them for cash, he would find a buyer. there were other places you could do that, but mt gox was by far the biggest and most well-known: in 2013, it handled 70% of all bitcoin transactions.
mt gox was located in japan and was run by a frenchman named mark karpelès. it had the background characteristic of many kinds of cutting-edge computing, combining advanced mathematical skills and a high degree of social isolation. The early world of bitcoin was nice, with lots of conferences and meetups, where the early adopter community, an evangelical crowd, got together and exchanged ideas. everyone knew everyone. Karpelès did not go to these meetings. He had an unusually close relationship with his cat, Tibanne, whose health was not robust. tibanne needed special injections that only karpelès could give, and that prevented her from traveling to meetings.
Karpelès had a clear vision of how important bitcoin could become: while running mt gox, he was designing a point-of-sale machine, like a credit card reader, that would accept the currency; he was also working on a bitcoin cafe in tokyo, which would be a showcase and proof of concept for the currency. but karpelès, along with his skills and his ideas, also had something else, a trait evident in many stars of the digital world. he had very little sense of what he couldn’t do. he did not understand the limits and practicalities. it’s hard to do new and clever things with digital ones and zeros, and the people who have done it are rightly aware of how smart they are. but it’s even harder to do smart things that aren’t digital. digital stars dislike and resent the intractability of the non-digital world, filled as it is with competing interests, resentful headlines, and human challenges. mark zuckerberg on facebook tells his employees to move fast. he breaks things.” those maxims are much more useful when it comes to digital bits than when it comes to people. The generation of digital “disruptors” and innovators have a shared tendency to imagine they have important insights into worlds they don’t really understand.
in the case of mt gox, the problem was basic: karpelès could not run a company. mt gox employees were on the second and fourth floors of an office building in tokyo. Karpelès’s office was on the eighth floor. employees often had no idea what their boss was doing, and since he kept tight control of the core running of the business, that meant no one knew what the hell was going on. that mattered, because it became clear in 2013-14 that something was amiss within the world’s leading bitcoin exchange. transactions were notoriously slow. bitcoins held on the exchange were worth $100 more than bitcoins elsewhere. that’s because if you had money in mt gox it took so long to get it that it was easier to convert the money to bitcoin and then transfer the bitcoin elsewhere – the mismatch between supply and demand drove the price up, as an economy we show that it will. There had always been problems with the Japanese bank that handled mt gox transactions, but these difficulties seemed to run deeper. no one really knew what was going on apart from karpelès, and he didn’t say so.
on february 7, 2014, karpelès suddenly closed all transactions on mt gox. he released a statement in which he blamed a flaw in the bitcoin protocol that allowed users to alter transaction codes in a way that made it impossible to tell if the transaction had gone through. that would allow them to spend money twice, which was exactly one of the technical problems that satoshi had supposedly eliminated with the creation of the blockchain. There was a huge reaction from the bitcoin community to Karpelès’s announcement, because it turned out that this “quirk” in the protocol was well known to developers, and all other exchanges had developed ways to work around it. hackers began using the newly publicized flaw to attack bitcoin exchanges.
the defect was a red herring. the real problem facing mt gox was, quite simply and surprisingly, that he had lost all of his bitcoin. To understand how this can happen, you need to understand that when he owns bitcoin, he doesn’t own anything physical: what he owns is an entry in the registry. ownership of it is simply access to that entry in the registry. as for ‘you’, in this context all you are is an address on record: that’s why bitcoin is anonymous. the address, which is nothing more than a string of numbers, could belong to anyone. to access it, you need its key: another string of numbers, cryptographically matching that specific bitcoin address. then the address is a string of numbers, kept publicly on record; the key is another string, held privately by the owner of bitcoin.
However, the analogy with a physical key is not complete. You lose a house key and you can carefully ask your neighbors for the spare key you gave them, or call a locksmith, or break in through a side window. you lose a cryptographic key and you have irrevocably lost access to your information. that string of numbers is unforgiving. the bitcoin story has some happy surprises, like the story of the norwegian electrical engineer who bought $26.60 worth of bitcoin in 2009, then forgot about it until he saw coverage about the cryptocurrency in 2013. at first he couldn’t remember the password he had used to encrypt his private key (that must have been a sweaty few moments), but then he did and the coins were still there. they had gone up a bit: to $886,000. he took a fifth of them and bought a flat in a posh neighborhood of oslo. that’s a happy ending. but the unrelenting power of the public address/private key combination has also led to the loss of 7,500 bitcoins in a landfill outside newport, wales, when an it worker tossed away an old hard drive on which he had stored the private keys of your 2009 bitcoin holdings. Current value of loss: £2.1 million.
Satoshi’s idea had been for people to store their bitcoin keys in a “wallet,” a private digital locker. you went online when you needed to spend something from the wallet, but otherwise it would be safely stored on your computer or mobile phone or whatever. however, the bewildering power of the address/key combination led people to look for another solution to keep their keys safe, and that, ironically, led them to places like mt gox or, indeed, cryptsy, the exchange more or less similar that collapsed in January. under very similar circumstances. By similar circumstances I mean: they lost a lot of bitcoins and they don’t know how. supposedly, the bitcoins were in “cold wallets”, i.e. offline wallets, which should have meant they were safe. the owner of cryptsy posted this message on the company blog:
One very interesting fact here, though, is that those bitcoins haven’t moved once since this happened. this gives rise to the possibility that they may be recovered. in fact i am offering a 1000 btc reward for information leading to the recovery of the stolen coins.
If you are the perpetrator of this crime and want to return the coins no questions asked, you can simply send them to this address:
There’s something nice about asking someone who’s stolen a lot of money (10,000 bitcoins, worth £2.8 million) to please return it, and you promise not to get mad. but there’s also something completely idiotic about that. from the same blog post: ‘some may ask why we didn’t report this to the authorities when it happened, and the answer is that we just didn’t know what happened, didn’t want to cause a panic and weren’t sure who exactly we should be contacting’, the note of bewilderment is embarrassing. it’s as if it never occurred to the cryptsy masterminds that an unregulated currency, built explicitly to be outside of state control and surveillance, could tempt thieves and could also mean they’d have trouble getting help from the authorities . As for the precise details of what happened to mt gox’s bitcoin, we’ll probably have to wait for Karpelès’ trial to find out: in August 2015 he was arrested by Japanese police and in October he was charged with embezzlement.
The two best books on bitcoin itself are Vigna and Casey’s Cryptocurrency and Popper’s Digital Gold. vigna and casey are excellent on the technical background of the coin, the details of how it works. they convincingly explain the path of thought that most people follow when they hear about currency, from disdain to skepticism, curiosity, crystallization and acceptance. his book leaves you thinking that there is a bright future for this crypto joke. Popper’s book is a fascinating one on the history of bitcoin, telling the stories of both true believers and early adopter-investors, but he spares no detail on the many scandals and panics bitcoin has already been through in its short life. . The effect of reading both books in succession is to first hear the reasons why bitcoin is full of potential and then the reasons why it is full of risk. One of the nastiest threads in Popper’s book concerns the all-too-present threats of hacking, extortion, and theft. the mt gox scandal has been the worst of these so far, but there will surely be more to come.
There was an example of the kind of risk involved in currency management in March 2014, when satoshi’s true identity was mistakenly “revealed” by newsweek. His mistake, hilariously, was choosing a real Japanese-American man named Satoshi Nakamoto, who called the currency ‘bitcom’ and told reporters, accurately, ‘I have nothing to do with it.’ he then offered an exclusive interview to the former. person who would buy him lunch. it became quickly and irrevocably clear that satoshi was not, you know, satoshi.
however, before the error was exposed, many bitcoiners pointed out the dangerous position in which the magazine could have put satoshi. if he were the creator of the cryptocurrency, he would also be the owner of many of the first minted bitcoins. his possessions could, and probably would, be worth hundreds of millions of dollars. the key to those possessions would be kept somewhere, probably in his house. all a thief or extortionist would need to make off with roughly $500 million was that string of numbers. bad men have been tempted to do bad things by incentives much smaller than that. this is one of those times when people who advocate for something end up being unwitting advocates for the other side of the argument. Wences Casares, the Argentinian investor described by Popper, is an impressive proponent of Bitcoin. And yet, this detail stuck with me: He and his co-investors store their bitcoin keys on an offline laptop stored in a safe deposit box. no other form of computer storage is secure enough. If those are the lengths you have to go to defend yourself against criminals, what does that say about the security of cryptocurrency?
this story of crime, fraud and disaster might well, you would have thought, add up to a story of failure. It hasn’t paralleled the high profile and front page things that have gone wrong with bitcoin, there has been a steady trajectory of growth and increased interest. despite all the things that have gone wrong, the coin itself has not collapsed and has not been shown to have mathematical or conceptual flaws. The fact that the world is full of swindlers, thieves, swindlers and incompetents does not invalidate the use of other types of money, so why should you invalidate bitcoin, just because it has so many criminal-friendly features? that seems to be the thought. In any case, this currency, which is based on nothing more than mathematical calculations, is now worth billions of dollars and has strayed far from the early-adopting internet libertarian fringe of its early followers. the irony is that success has brought the greatest dangers yet to cryptocurrency’s continued existence.
The first of these threats comes in the form of what nerds call a “fork”. The point of open source software, like bitcoin, is that it is set free and users can tweak and modify it as they see fit. if a version is changed so that it becomes incompatible in some respects with other versions, that form of the software is said to be “forked”. The software that runs Amazon’s Kindle e-reader, for example, is a forked version of Google’s open-source Android operating system. (it is, to use one of my favorite tech terms, a ‘forked android’). The open source nature of bitcoin has meant that the community can make changes to it, and that these changes are voted into effect: bitcoiners download and use the software, or they don’t. it is a kind of ongoing plebiscite. when problems arose, they were adjudicated first by the satoshi himself, and then, after he/she/they ceased to be directly involved in the operation of the cryptocurrency in 2011, by a small group of five ‘core developers’ led by a computer scientist named gavin andresen.
what happened now is that there is a division in the bitcoin community, and also among the main developers. the problem is hidden in relation to the size of the block: the amount of data in those blocks of transactions of ten minutes. Satoshi set a one-megabyte block limit, apparently intending it to increase over time as the size of the network, the number of transactions, and the power of ordinary computers increased. a part of the community thinks that the limit is about to become a crisis for the currency, which will stop as transactions, in effect, have to queue to be added to the blockchain. at that point, the coin becomes worthless. So a group of developers, including Gavin Andresen, released Bitcoin XT in August 2015, which is Bitcoin as we know and love it, but with a larger block size. another group of developers disagrees: they believe the change will take bitcoin too far in a business-friendly direction, preferring a smaller, slower, and more ideologically pure version of the cryptocurrency. The dispute has been acrimonious and has seen a major hacking attack launched against the xt network, and all mention of xt censored from the official bitcoin forums. so bitcoin is now forked. Mike Hearn, one of the people behind XT, left the Bitcoin world in January as a result of the split and now regards the coin as a failed experiment. “despite knowing that bitcoin could fail all the time, the now inescapable conclusion that it has failed still makes me very sad,” hearn wrote in a strongly argued and heartfelt blog post. will bitcoin recover from this or not.
It must also be said that some bitcoiners believe more in the technology than in its use as money. david birch is the author of a fresh, original, and fascinatingly comprehensive short book on developments in the field, identity is the new money.6 his is the best book on general topics related to new forms of money and new possibilities generated by blockchain technology. you finish his book convinced that something is going on where the registry, and credit in general, and money, banking and identity, are starting to get confused. That said, you are not sure about bitcoin, the currency. “I’m not convinced that money or payments are the optimal [use] of technology,” Birch said, responding to this latest uproar. It’s easy to see the strength of that, given that even in bitcoin’s pristine form, it takes ten minutes to compile a block of transactions and send it to the network for verification and addition to the chain. there is something very unmonetary about that inherent delay and inherent complication. bitcoin, on the other hand, may have more importance not as money but as a way to authenticate identities, exchange contracts and execute transactions. In January, the UK government’s chief science adviser issued a report saying that “distributed ledger technologies have the potential to help governments collect taxes, deliver benefits, issue passports, register land records, secure the chain of supplying goods and, in general, ensuring the integrity of government records and services’, the possibility is that the blockchain could be adapted to do this with lower levels of friction, lower levels of cost and higher levels of security. security than any existing system. this may not be the blockchain in its original bitcoin form, but some other blockchain or blockchains, using subtly different versions of brilliant satoshi technology. it is this potential that has attracted the attention of the banks, the reference music that signals the arrival of the bad guys.
many people in the world of finance followed the path of bitcoin described by vigna and casey, from disdain to curiosity to acceptance. his interest is mainly in blockchains. Banks have looked into the possibility of better, faster and cheaper blockchain-powered systems, and have concluded that these may be a source of disruption and disintermediation of their business. alternatively, they will be something else profitable from the banks. they prefer the second option. a number of competing syndicates, funded and largely owned by banks, are racing to develop and patent proprietary, finance-friendly versions of blockchain technology. a consortium called r3cev is backed by 42 financial companies and seeks to develop what would in effect be a private blockchain; Goldman Sachs, one of the firms behind r3cev, also filed a patent for a private blockchain-backed currency called setlcoin (one joker in the foot has called it “vampire quid”); Digital Assets Holdings, another blockchain company, is run by Blythe Masters, the former J.P. morgan executive who did more than anyone else to pioneer the credit default swap, the dazzlingly ingenious new financial instrument that was a huge success until it almost destroyed the global financial system.7 this is just a small sampling, and there are many other bitcoin – related initiatives. one of the results is great confusion. bitcoin was apparently a major topic of conversation at davos this year, where there was obviously a lot of confusion between bitcoin the currency, bitcoin the technology, cryptocurrency in general, the blockchain as in bitcoin or the blockchain as in blockchains in general. the news headline is this: in the world of finance, blockchain is definitely going to be a thing.
irony horn. The first sentence of Satoshi’s original article reads as follows: “A purely peer-to-peer version of electronic money would allow online payments to be sent directly from one party to another without going through a financial institution.” instead, those same financial institutions are going to use this new technology to stay where they are: in the midst of all possible transaction networks, extracting as much rent as they can.
True bitcoin believers are upset that nearly every discussion of cryptocurrency ends with a rhapsody about the potential of blockchain. bitcoiners reject that idea: for them, the blockchain will never succeed apart from the currency. however, the problem is that, in terms of the internet, bitcoin has been around for quite some time. January marked seven years since the release of the original satoshi code. In seven years, Google, Facebook and Twitter had become not only large companies, but also essential parts of the daily lives of hundreds of millions of people. they had become verbs. m-pesa is about the same age as bitcoin and handles half of kenya’s gdp. bitcoin is nowhere near that. it’s time for cryptocurrency to decide what it wants to be when it grows up. Blockchains could simply become a new technique to ensure the continuation of banking hegemony in its current form. that would be one of those final plot twists that leaves everyone thinking that while they enjoyed most of the show, the ending was so underwhelming that they now wish they hadn’t bothered. Or, along with peer-to-peer lending and mobile payments, they could have as big an impact as the new kind of banking introduced in Renaissance Italy. that would be more fun.
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