BankThink The Hazards of Lending to Bitcoin Users January two 2014, 12:00pm EST Many businesses and consumers have taken an interest in emerging payment systems, such as Bitcoin. Such systems present overlooked legal issues for creditors, particularly with respect to perfection of security interests and recovery of collateral.
When Bitcoin Grows Up
It’s unlikely to discuss fresh developments in money without thinking for a moment about what money is. The best place to embark thinking about that is with money itself. Consider the UK’s most common paper money, the English five or ten or twenty quid note. On one side we have a famous dead person: Elizabeth Fry or Charles Darwin or Adam Smith, depending on whether it’s a five or ten or twenty. On the other we have a picture of the queen, and just above that the words ‘I promise to pay the bearer on request the sum of’, and then the value of the note, and the signature of the cashier of the Bank of England.
It’s worth thinking about that promise to ‘pay the bearer on request the sum of ten pounds’. When we parse it, it’s not clear what it means. Ten pounds of what? We’ve already got ten pounds. That’s exactly what we’re holding in our forearm. It doesn’t mean, pay the bearer on request ten pounds’ worth of gold: the link inbetween currency and gold was ended in 1971, and anyway, Gordon Brown sold off the Bank of England’s gold reserves in the 1990s.
The fact is, there’s no response to the question, ten pounds of what? The ten pound note is worth what it claims it is because the state, in the form of the Bank of England, says so, and we choose to believe it. This is what students of currency call ‘fiat’ money, money whose value has been willed into being by the state. The value of fiat money is an act of faith. There are quirks to this. In the case of the pound coin, if we ask how much it’s worth, the response is demonstrable: a pound is worth a pound. It shouldn’t be, tho’. According to the Royal Mint, which actually makes the stuff, three per cent of all pound coins in circulation are fake. Permitting for that, we should discount the price of our pound coin, and mathematically assign it a value of 97p.
In real life, there’s no need to do that, because the tremendous probability is that you won’t have any difficulty spending your fake pound for its utter nominal value. (That’s unless you’re caught out by a coin slot which rejects your money. Most people attribute the annoying frequency with which this happens to a problem with coin slots; mostly, tho’, it’s a problem with the currency. The other time you’ll have trouble with your fake coin is when you get one of the mutant squishy ones which look like partially chewed fruit pastilles and are so badly forged they edge on the endearing.) They’re worth what they claim because we choose to believe in them. Your mathematically determined 97p of coin is worth a quid because we believe it’s worth a quid. We trust it. That’s the very first main point about money. Its value rests on our belief in its value, underwritten by the authority of the state.
For the 2nd main point about the nature of money, we need to travel to the Pacific Ocean. In Micronesia, about one thousand eight hundred miles north of the eastern corner of Australia, there’s a group of islands called Yap. It has a population of 11,000 and is largely unvisited except by divers, but it’s a very popular place with economists talking about the nature of money, kicking off with a fascinating paper by Milton Friedman, ‘The Island of Stone Money’, published in 1991. There’s a particularly good retelling of the story by Felix Martin in his two thousand thirteen book Money: The Unauthorised Biography.
Yap has no metal. There’s nothing to make into coins. What the Yapese do instead is sail two hundred fifty miles to an island called Palau, where there’s a particular kind of limestone not available on their home island. They quarry the limestone, and then form it into circular wheel-like forms with a fuckhole in the middle, called fei. Some of these fei stones are absolutely thick, fully twelve feet across. Then they sail the fei back to Yap, where they’re used as money.
The excellent advantage of the fei being made from this particular stone is that they’re unlikely to counterfeit, because there’s none of the limestone on Yap. The fei are uncommon and difficult to get by definition, so they hold their value well. You can’t fake a fei. Just as you have to work to get money in a developed economy – so the money constitutes a record of labour – the fei are an unfakeable record of the labour that went into their creation. In addition, the big ones have the advantage that they’re unlikely to steal. By the same token, however, they’re unlikely to stir, so what happens is that if you want to spend some of the money, you just agree that somebody else now possesses the coin. A coin sitting outside somebody’s house can be transferred rearwards and forwards as part of a series of transactions, and all that actually happens is that people switch their minds about who now possesses it. Everyone agrees that the money has been transferred. The real money isn’t the fei, but the idea of who possesses the fei. The register of ownership, held in the community memory, is the money.
It has sometimes happened to the Yapese that their boats are hit by stormy weather on the way back from Palau, and to save their own lives, the guys have to chuck the big stones overboard. But when they get back to Palau they report what happened, and everyone accepts it, and the ownership of the stone is assigned to whoever quarried it, and the stone can still be used as a valid form of money because ownership can be exchanged even however the actual stone is five miles down at the bottom of the Pacific.
That example seems bizarre, because the details are so vivid and exotic, but our money functions in the same way. The register is the money. This is the 2nd main point about the nature of money. We think of money as being the stuff in our wallets and purses; but most money isn’t that. It’s not notes and coins. In 2006, for example, the total amount of money in the world in terms of value was $473 trillion. That’s a number so big it’s very difficult to get your head round: about £45,000 per head for all seven billion people on the planet. Of that $473 trillion, less than a tenth, about $46 trillion, was cash in the form of banknotes and coins. More than ninety per cent of money isn’t money in a physical sense. That number is even thicker in the UK, where only about four per cent of money is in the form of cash. What it is instead is entries on a ledger. It’s numbers on your bank balance, the electronic records of debits and credits that are created every time we spend money.
When we say we spend money, what we’re mainly doing is making entries on registers. Your work results in a weekly or monthly credit from your employer’s account to your account, maybe with another transfer of PAYE tax to the government, also your pension contribution if you make one, any forms of insurance, then a chunk automatically going off to your landlord or mortgage provider – all heading to different parts of the financial system, all of them nothing other than movement inbetween and among all these various ledgers and registers. This is what almost all of what we call money mainly is: numbers moving on registers. It’s the same system they have on 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 interwoven with the working of money. The very first of them, very likely the most significant lump of technology in human history, is writing. This embarks in ancient Sumer, about three thousand bc , with records of trade and inventory little by little evolving into other kinds of recorded script. The next big invention arrives in Renaissance Italy, with the popularisation of the balance sheet, and with that, of banks that become places where all the different transactions in a society, all the various credits and debits, are gathered together in a single register. The bank becomes the intermediary inbetween creditors who have spare money to lend and borrowers who have reasons for needing it. Instead of a near infinite multiplicity of transactions inbetween individuals, exchanging credits and debits rearwards and forwards as we exchange goods and services and IOUs, promises and debts and obligations, one to one, all the various transactions in all the various markets of a elaborate social environment are now held on the books of one institution: the bank. The society has one register, and that register is run by the bank. Arguably the very first indeed successful example, the very first to deploy the fresh technology of record-keeping effectively, was the Medici bank in Florence.
The final lump to this is the invention of the central bank, with the foundation of the Bank of England in 1694. In comeback for lending the sovereign a superb deal of gold, in the very first example 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’s at this point that banks, money and the modern state become fused together. The money system and the banks and the state are all in effect aspects of one another: a triple-headed monster, like Cerberus.
Brief historical digression: it took a while for this system to spread everywhere, especially in the United States, where arguments about the link inbetween the banks and the state and the money system have been a recurring theme. In How Would You Like to Pay, a lucid brief book on fresh money technologies, Bill Maurer points out that as recently as the 1860s the United States had eight thousand private currencies in circulation, issued by ‘banks, railroad companies, retail stores and other entities’. There is an interesting discussion of US money in Edward Castronova’s overview Wildcat Currency: he explains that states didn’t have the right to issue currency themselves, but they did have the right to regulate the issuance of money on their territory.[Two] This was a system prone to unintended consequences. Several states
permitted banks to issue money only in large denominations. This was done to force banks to retain adequate gold reserves. The theory was that holders of large denomination bills were more likely to comeback to the bank and exchange those bills for gold. As a result banks would have to keep more gold on forearm. A bank with more reserves is less likely to fail.
That was the theory. The practice: many of the fresh denomination notes were too big to use. As a result, there was a gigantic proliferation in private money, issued by everyone from farmers and merchants to hotels and restaurants and bars. An ordinary person’s wallet might contain a dozen different currencies, all worth different amounts in different places, since a bar’s money might trade at utter value in the bar itself, but would be worth significantly less the 2nd you stepped out the door – and less still as you moved further and further away. The government response, in 1851, was to create a three cent coin, the trime. It was only after 1864, when Congress banned the issuance of metal coinage for money, that private money began to be driven out of the economy.
In time, even the US joined the system of state-backed money dispensed through a central bank. This is the system we still have everywhere in the developed world today. The reason a lot of people are excited about bitcoin and its associated technologies is that for the very first time there is a genuine possibility of real switch in this area. Money has evolved in leaps, from the invention of writing to the invention of the balance sheet and the bank to the creation of the central bank, with all of these switches being variations on the theme of money as a register of credits and debits. And we’re now at a point when another leap is possible.
The simplest and fattest possibilities concern connectivity. We are more connected in more ways to more people than we ever have been at any point in human history. This is switching everything, and it would be deeply strange if it didn’t switch money too. There are many ways in which the influence could happen. For example, a thick part of the money system is about intermediaries. It goes back to the Medici, to that central register where the debits and credits are all gathered together in one place. The bank is the intermediary inbetween creditors and debtors. Demonstrable question: do we still need that intermediary? I have money I’m not using, you need more credit than you have, to buy a house or embark a business or buy a car or whatever. I lend you the money, and you pay me back. Easy-peasy. We have historically needed a bank to mediate that transaction, and to take a generous cut in the process. It’s not at all visible that we need it any more. We can find each other without the bank in the middle; thanks to the internet, we can locate each other without intermediaries. It seems very demonstrable to me that this area, that of P2P or peer-to-peer lending, is going to grow and grow. Why lend money to your bank for fuck-all interest when you can go to Zopa, the UK’s leading P2P site, and lend it directly to someone who needs it, for a comeback of five per cent? The reaction at the moment is very likely that the banks are old and have some deposit protection, whereas online lending is fresh and doesn’t. But that reaction is not writ in stone, and one lesson of the internet is that when customers’ behaviour switches, it can switch rapid. A lot of money is at stake here. The cut being taken when A sends money to B amounts to $1.7 trillion – that’s right, trillion – every year.
Connectivity has implications for other kinds of transfer too. Money is a way of transferring credit. Fresh forms of doing that directly are now possible. The superb trailblazers for this are in the developing world, especially 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 took off in popularity when violent chaos following the elections at the end of that year brought the regular banking system to a halt. That’s an example of the way chaos and uncertainty around traditional banking creates appetite for fresh services – not so different from 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 fresh form of money, making the kinds of facility you get from a bank account available to all sorts of people who don’t have one. Once you have a record of successful payments on your phone, merchants and institutions will take that as a sign you can be extended other forms of credit, and you can commence to stir from the informal economy where the poor are trapped – where there are no records of their credit, no records of what they own – to the broader economy. That’s thick.
The world’s population is seven billion. Two and a half billion adults don’t have a bank account. Paul Vigna and Michael Casey’s excellent book Cryptocurrency explains what that means:[Trio]
Somewhere in the order of five billion people belong to the households that are cut off from a financial system that the rest of us take for granted. They can’t begin savings accounts. They don’t have checking accounts. They can’t get credit cards. They live in places where banks don’t want to go, and because of this, they remain effectively walled off 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 flush toilet). So more than twice as many people have a mobile phone as have access to a bank account. If your phone can give you access to the things you would need from a bank, well, you’ve just disinvented the need for banks, and fundamentally switched the operation of the money system, across entire swathes of the developing and emerging world.
The reason phones can do this is because they embody a remarkably high level of trust. You can trust that the phone is the property of the person who wields it, because the combination of sim card technology and pin numbers is very strong. Behind the user-friendly façade of chip and pin are cryptographic mechanisms of industrial strength. Indeed, the pin number technology used in cashpoint machines primarily evolved as a question and response protocol to confirm nuclear weapon access codes. You can trust that this person who wields the phone is who they say they are: that basic act of trust is fundamental to the operation of all money systems.
What’s making this possible is cryptography. Cryptography is also central to one of the most interesting developments in the world of money, and that is bitcoin. I’m not sure whether bitcoin is likely to be the most consequential of all these developments: peer-to-peer lending, and non-bank payment systems of the M-Pesa type, seem to me at least as likely to switch lives, especially the lives of the poor. But there’s no denying that bitcoin is the best story.
Bitcoin is a fresh form of electronic money, launched in a paper published on thirty one October two thousand eight by a pseudonymous person or persons calling himself, herself or themselves Satoshi Nakamoto. Note the date: this was shortly after the collapse of Lehman Brothers on fifteen September, and the near death of the global financial system. Just as the Civil War was the prompt for the United States to end private money, and the crisis of Kenyan democracy led to the explosive growth of M-Pesa, the global financial crisis seems to have been a crucial spur, if not to the development of bitcoin, then certainly to the timing of its launch.
Bitcoin’s central and most arousing chunk of technology is something called the blockchain. This is a register of all the bitcoin transactions that have ever happened. Every time something is bought or sold using bitcoin – recall, that means every time something moves from one place in the register to somewhere else – the fresh transaction is added to the blockchain and authenticated by a network of computers. The mechanisms are cryptographic. It’s unlikely to fake a fresh addition to the chain, but it’s relatively effortless (by relatively effortless, I mean relatively effortless for a giant assembled array of computing power) to verify a legitimate transaction. So: unlikely to fake but plain to verify. The entities transferring the money are anonymous, and at the same time fully semi-transparent: anyone can see the bitcoin addresses involved, but nobody necessarily knows to whom they belong.
This combination of features has extreme power. It means that you can trust the blockchain, while knowing nothing about anyone else affixed to it. Bitcoin is in effect a register like the one kept in people’s memory on Yap, but it’s a register that anyone can see and to which everyone assents. For the very first time in human history, we have a register that does not need to be underwritten by some form of authority or state power, other than itself – and, as I’ve argued, that register isn’t some glossy add-on to the nature of money, it actually is how money works. A decentralised, anonymous, self-verifying and entirely reliable register of this sort is the largest potential switch to the money system since the Medici. It’s banking without banks, and money without money. The next several paragraphs give a brief technical explanation of how bitcoin works; if you aren’t interested, see you at the dropped letter.
The profoundest mystery about the physical universe is that it is so intertwined with mathematics. Gravity is inversely proportional to the square of the distance inbetween two objects. Why? Why does pi, essential in calculating the circumference of a circle, also prove essential to calculating the area of a circle: why is it an exact value, not just a rough guide or rule of thumb? Why does it also turn up in so many other places in mathematics? Why, for example, is the probability that two random numbers have no common factor equal to 6/π two ?
We don’t know why maths reaches so deeply into the texture of physical reality. One of the hardest things to understand about cryptography is that it rests on something that is inexplicable, and that is it works. As Julian Assange has said,
it just happens to be a fact about reality, such as that you can build atomic bombs, that there are math problems that you can create that even the strongest state cannot break … there is a property of the universe that is on the side of privacy, because some encryption algorithms are unlikely for any government to break, ever.
The effectiveness of cryptography in essence rests on a single truth about mathematics: that it is unlikely to factorise big numbers. For any number, there is no way of working out if a smaller number divides into it, brief of actually doing the calculation. This might sound like a petite point, but it means that when you have very long numbers – numbers that are hundreds or thousands of digits long – there is no way of cracking them down into factors other than by attempting every smaller number and eyeing if it fits. With very very big numbers, that process is, in practice, impossibly time-consuming. This makes very long numbers, and the prime numbers which are their factors, into miraculously effective cryptographical entities; the basis for all contemporary codes. This is in turn a hard fact for civilians to gulp, notwithstanding that it underlies more or less everything we do, in business terms, on the internet. (Note that having secure codes is not the same as having secure computers. Violating into people’s computers is a totally different story from cracking their codes – and once you’ve violated in, it often doesn’t matter what the host is doing cryptographically.) To take hold of bitcoin – or to believe in bitcoin – you do have to take this power on trust.
There are three main crypto-mathematical technics at work in bitcoin. The very first is the matching of a public address – that’s the bitcoin address of any given user – with a private key which provides access to that address. Albeit the cryptography involved in this process is fearsome, drawing on those aforementioned properties of prime numbers, it is so widely used – every time you use a credit card, every time you use a pin number – that we’ll just take it for granted here. When you spend some bitcoin, all you’re indeed doing is switching an entry on a digital register 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 into a ten-minute chunk of transactions, known as a ‘block’.
This is where the miners come in. (‘Mining’ is a bad metaphor for what these computers do: it’s more like clerking or verification. But mining is what it’s called.) Miners take this ten-minute block of transactions, each of which combines the two addresses of the parties to the transaction, the quantity of bitcoin moved and a time stamp, and run them through a ‘hash function’. These are cryptographical algorithms for encoding information: the one bitcoin uses is called SHA-256. The hash function takes a stream of information of any length and turns it into a unique set of letters and numbers, of a immobilized length. Here is ‘The cat sat on the mat’ run through SHA-256: 500532af74c472e39c7d685fddb727c3bf461ce41118f29f856bafe4024fc303. And here for purposes of comparison is ‘The cit sat on the mat’: a8727c0891cec28e10c03 aa09c759d92fd628e131435b502c04e60d 09ce4ef76.
As we can see, the output is sensitive to any switch in the input: alter so much as a single letter and the entire hash switches. Note that however long and complicated the input, the output is always sixty four characters long. Just to make the point, here is SHA-256 hash of the entire text of Ulysses: 6ff1c1a80b68b5414423a7e2e061d5f2f c09f7c4e86c4987e573bebc4e4991dd. Put all this together, and you have a system which makes it very effortless to check whether a given text has been hashed correctly: you just run it through the algorithm. At the same time it is unlikely to guess the input from the output. There are just too many possibilities: it is mathematically unlikely to land on the correct one. Anyone can check the hash function of Ulysses online in about ten seconds. Every computer in the world linked together could not switch roles the encryption, and work out that the input behind the hash is Joyce’s novel. This is just a peek of the magic power of encryption.
Miners take the transactions in the block, hash them, and add them to the hash of all the transactions that have ever happened in bitcoin. That’s right: the blockchain is a register of every transaction, however puny, which has ever happened in the currency. The miners then run the hash through a calculation, set up by Satoshi, which makes them come up with a solution that finds a immobilized number of zeros at the commence of the hash. That’s a trick to ensure that the calculation is reasonably difficult, for reasons I’ll get to in a moment. There’s no brief cut to this process, dependent as it is on sheer brute mathematical force. This is what is called a ‘proof of work’, to showcase that the miners have been through the necessary work involved in finding a solution. The proof of work is the third lump of mathematical/cryptographic wizardry involved in bitcoin. The miners throw numbers at the problem until one of them rams and a solution is found. (Hence the mining metaphor, the idea that they’re digging for the money.) This solution is then broadcast to the entire network.
At the point when the transaction is broadcast to the network, Satoshi did another clever thing. One of the problems faced by cryptocurrencies is the ‘double spend’ problem. A bitcoin is just a string of numbers: how can you tell that Joe, the customer in your coffee shop, hasn’t just cut and pasted the numbers he’s already used four times today? Bitcoin solves this by having the entire network check the entire register every time a fresh block is added. When the winning miner broadcasts the block, the computers on the network run through it to check that all the transactions on it are legit, and that no bitcoin has been double-spent. They in effect vote on the legitimacy of the transaction, and once the transaction is accepted, it is stamped with the number of the block and added to the blockchain. The miner who found the correct solution is compensated for their work in bitcoin: they are paid in the currency, for the work they do in validating transactions in the currency. This was another brilliant lump of design on the part of Satoshi, creating an incentive, inwards the network, for people to take part in making the network run.
The mathematical sophistication of bitcoin brings with it a duo of compromises. One is what’s known as the ‘51 per cent problem’. OK, so in principle nobody can double-spend, because the blockchain checks every transaction and votes on it. But what if the bad guys were to get control of fifty one per cent of the computing power on the network at any given moment? Then they could validate any transaction they desired. There would be no way of stopping them doing anything they felt like doing with fake and double-spent coins. There’s no real solution to the fifty one per cent problem, other than the sheer size of the network, which is unreassuring, as if a bank were to say that the only thing which stops criminals emptying your bank account is not some absolute principle of safety, but just that doing so would be too much effort. This is a difficulty, and one which stands out all the more given the sophistication with which Satoshi solved so many of the other conceptual problems of the fresh currency.
Another hard thing to disregard is the amount of energy used by miners. As bitcoin has got more popular – not civilian-popular, but nerd-popular and cutting-edge-capitalist-popular – the mining process has had more and more computer power thrown at it. The process is wasteful, since most of the mining, most of the time, is by definition unsuccessful, because only one miner wins the race. As Vigna and Casey point out in Cryptocurrency, by the middle of 2014, the bitcoin network, which
was then producing 88,000 trillion hashes every 2nd, had a computing power six thousand times the combined power of the world’s top five hundred supercomputers … And just two and a half months later, it had almost trebled to 252,000 trillion hashes. The world has seen nothing like this level of computational expansion. That’s why some doomsayers are predicting that if bitcoin proceeds on its present path, the planet faces an environmental catastrophe.
The amount of energy used by the computers linked to the network can’t be sustained. This is some way off, but there’s no denying that the process of mining is inherently wasteful. (Bitcoin miners have a preference for setting up in places where it’s cold, to cut down on their air-conditioning bills.)
There will only ever be twenty one million bitcoin: the finite nature of the currency was Satoshi’s way of making sure that, unlike the fiat currencies that governments are free to manhandle, nobody could ever ruin the value of bitcoin by arbitrarily determining to create more of it. The schedule is for these bitcoin to be created over the course of one hundred thirty years. As more computing power is added to the network, it becomes necessary to make the mathematical challenges stiffer, to slow down the miners’ progress. That’s where that string of zeros at the commence of the proof of work comes in handy: switching the number of zeros instantaneously affects the difficulty of the calculation, to slow down the mining of the coins. But this does mean that an awful lot of energy is going to waste. It’s an ugly side effect to a system of good intellectual elegance.
The result has been success for the currency, a much thicker success than most people who’ve never heard of it might suspect. The total value of all the bitcoin in circulation, as I write, is £4.24 billion. That number switches, often with disconcerting rapidity, since the price of bitcoin is sharply variable. This puts outsiders off, since one of the most basic functions of money is to store value; bitcoin is a lousy store of value, as many observers have pointed out. Bitcoin, however, already does an OK job with one of money’s other main functions, as a medium of exchange. You can buy plane tickets, book hotel rooms, buy computer equipment, food and pretty much anything else with bitcoin, which is now accepted by ems of thousands of businesses. Indeed, since you can buy bounty cards with bitcoin, and use the cards at Amazon and other e-commerce sites, you can in effect buy anything you want using the cryptocurrency. There are even bitcoin cashpoint machines. I went to look at one the other day, in a café in Bermondsey. The ‘SatoshiPoint’ was at the back of the premises, past the blackboard where a plane white was labelled a ‘Fat Wife’, past the cats’-cradle of outstretched hipster gams and MacBook Air charging cables, past the merchandise table of coffee mugs with the slogan ‘Underneath your tattoos you’re still a mainstream cunt.’ The SatoshiPoint was cracked. Tant pis, as Satoshi would say, if he/she/they were French, which he/she/they most likely aren’t. It doesn’t alter the fact that bitcoin has done very well for a form of money only seven years old, with no entity backing it other than lines of code running on a network of computers.
The growing utility of the currency has attracted attention. Citizens of countries such as Argentina, whose governments have a near ideal track record of debasing their own currency and demolishing the savings of their citizenry, have shown signs of preferring bitcoin to their own state’s money. One of the liveliest case studies in Nathaniel Popper’s brilliant Digital Gold concerns Wences Casares, a very sophisticated (and very successful) Argentine investor whose interest in bitcoin comes from his up-close-and-personal view of a cracked fiat currency.[Four] Casares is a big investor in and evangelist for bitcoin, not (or not only) because it will make him rich, but because it seems to him genuinely preferable to state-backed fiat money. He’s not the only one.
The mathematical sophistication and philosophical suggestiveness of bitcoin are not, however, the entire story. An effectively anonymous, untraceable way of moving money: gee, hmmn, I wonder who’d be interested in that? It’s no surprise that the very first big-business application of bitcoin came in the form of a criminal enterprise. Satoshi Nakamoto’s paper was published in October 2008. The detailed workings of the fresh currency, including the code which would operate it, were published on three January 2009. The very first ever transaction made with bitcoin was a deliberately experimental, avant-garde purchase of a pizza, for Ten,000 bitcoin, made on twenty two May 2010. (The community marks the anniversary of the very first transaction by celebrating Bitcoin Pizza Day. At current values, that pizza cost £2.77 million.) The very first large-scale criminal application for bitcoin began life months later, early in 2011.
Silk Road was an online drug market, set up by a charming, wonderful, 26-year-old Texan called Ross Ulbricht. Ulbricht, who has an undergraduate degree in physics and a master’s in materials science and engineering, was (is) a strange, very 21st century combination of driven and feckless. He was not the very first and will not be the last person to be led astray by a wish of the internet start-up route to billions. While doing his 2nd degree, Ulbricht contracted a bad case of Austrian School economics, and become wooed that government and taxation were essentially coercive systems. (This revelation occurred while he was attending Penn State, a publicly funded university.) So – to swift forward slightly – he set up an online exchange where buyers and sellers could meet to trade anything that did not involve doing harm to others: what that meant in practice was no to child pornography, but a big yes to fake IDs, guns and, especially, drugs. The exchange was accessible only via Tor, the very secure internet browser which hides the location of users so successfully that it is a good favourite of terrorists and paedos. (You may be wondering: who could possibly have created such an evil chunk of software? Reaction: the US navy. It invented and indeed maintains Tor as a means of communicating with spies and informants, and a instrument for dissidents in totalitarian regimes. The next time you hear a securocrat talking about the need to expand internet surveillance, you may find yourself wondering why our allies invented, distributed and proceed to support the single most effective web contraption for terrorists, criminals and paedos. The response is that the security classes think the usefulness of Tor outweighs the harm it causes. Except that perspective often seems to escape our leaders when they’re talking about the need to spy on us.)
Tor gives anonymity and geographical unlocatability to all its users; bitcoin gave an anonymous, non-locatable way of transferring payment. The result for Silk Road, which combined the two, was explosive growth. Within two years, Silk Road was one of the most successful internet enterprises in the world, and had attracted a buyer willing to suggest $1 billion. The man running it went by the pseudonym Fear Pirate Roberts, an attempt by Ulbricht to imply that the person behind the site had switched over time, since in The Princess Bride the identity of the DPR is passed down from one incumbent to the next. In two thousand thirteen Fear Pirate Roberts told a reporter in an encrypted internet talk that he now thought the site was worth ten or eleven figures. If his business had been legal, that estimate most likely would have been accurate.
Ulbricht had, however, made a mistake. Once, and only once, in the early days of Silk Road, he had used his real email address in a forum discussion which clearly showcased his involvement in running the site. He realised and quickly deleted the post, but it had already been archived, and so when the Feds came looking, they found the email address, providing them a prime suspect for DPR. By now Silk Road was a flagrant, brazen taunting of the US legal system. ‘Every single transaction is a victory,’ DPR announced, over the ‘thieving murderous’ state. DPR had a book club. It featured lots of Austrian School economics. He was in favour of a world in which ‘the human spirit flourishes, unbridled, wild and free!’ ‘Once you’ve seen what’s possible, how can you do otherwise? How can you ass-plug yourself into the tax eating, life sucking, violent, sadomasochistic, war mongering, oppressive machine ever again? How can you kneel when you’ve felt the power of your own gams?’ Elevated sentiments, but in reality Ulbricht was paranoid, appalled, and had even gone so far as to commission assassinations of potential informers. One of the would-be murderers was an FBI plant. The other commissioned killing had an unknown outcome, because nobody seems to have been murdered: the most likely explanation is that somebody or bods pretended to be hitmen in order to con Ulbricht out of money. (Neither case has come to trial.) Fear Pirate Roberts had downright lost his marbles.
That didn’t make him any lighter to catch. It’s not that Ulbricht almost got away with it: he didn’t. He was nonetheless hard 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 not just to catch him at it, but to grab the computer out of his arms while he was in the middle of criminal activity. Otherwise there would be no way to link him with the activities on Silk Road. ‘Put yourself in the boots of a prosecutor attempting to build a case against you,’ DPR said in an online talk. ‘Realistically the only way for them to prove anything would be for them to see you log in and do your work.’
Ulbricht had set up a system whereby simply closing his computer would permanently encrypt his hard drive. He could do the same just by hitting a duo of keys. They would have literally to snatch the machine out of his mitts before he could so much as touch the keyboard. The Feds would have one chance and one chance only to catch him, and they would have to grab him at his computer while he was logged in as DPR and running Silk Road. So that’s what they did. On one October two thousand thirteen Ulbricht was sitting in a public library in San Francisco, logged into Silk Road via the library’s wifi. He was in an online talk with an FBI agent whose job was to make sure Ulbricht was still online when his colleagues swooped. Ulbricht was at a desk across from a slight youthfull Asian woman when a duo of typical San Francisco street people began arguing loudly just behind him. He turned to look, and the youthfull woman grabbed his laptop: she was an FBI agent. So were the street people. Nice one, the Feds. Ulbricht was logged into Silk Road under the account ‘/Mastermind’. Game over for Fear Pirate Roberts. Ulbricht went on trial in 2015, was convicted, and is serving two life sentences without the possibility of parole.
There are several morals to this crazy, sad, fascinating story, brilliantly told in two long chunks of Wired reportage by Joshuah Bearman, and also in Digital Gold.[Five] From the bitcoin point of view, Silk Road was evidence for the largely but not entirely true maxim that there is no such thing as bad publicity. The very first thing many outsiders heard of bitcoin was the collapse of Silk Road. You might have thought that the connection inbetween the fresh kind of money and the fresh kind of criminal enterprise was off-putting, but it didn’t work like that, mainly, I think, because the scandal/disaster of Silk Road contained a nugget of public relations magic for bitcoin: it demonstrated that the currency has value. You could use bitcoin to buy and sell actual real world things that people want, stuff like cocaine and handguns and fake driving licences. If the money was good to buy those things, it would be good for other stuff too.
This speaks to the very first and loudest and most persistent doubt most civilians have about bitcoin: why on earth it has any value at all. The truthful response – which concerns the arbitrary basis of all monetary value – tends not to reassure sceptics. What Silk Road provided was a proof which went beyond argument: it showcased that it just does, OK? This point was all too coaxing for some of the officials involved. In a twist which would seem too rich in a work of fiction, two of the agents who hunted 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. Force got seventy eight months and Bridges 71. Even federal agents fell victim to the siren call of the anonymous currency.
In the process of arresting Ulbricht and shutting down Silk Road, the FBI became one of the world’s larger owners of bitcoin, because it seized the site’s considerable assets: 144,000 bitcoin, worth £43.9 million at today’s prices. It was a point of interest what it would do with them, and a point of danger, too, since it seemed possible that once the fresh currency had the attention of the authorities, they might conclude that this extra-governmental, anonymous, untraceable money was, in and of its own nature, illegal. Instead, what the FBI did, after thinking for a bit, was what it does to other confiscated assets: auction them off. The implicit point was not missed: the Feds say bitcoin is legal. It goes after that bitcoin has legitimate uses. That was a strong message. Bitcoin emerged from Silk Road in better form than ever.
The next big scandal to affect bitcoin could and arguably should have been more bruising. It worried 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-beloved trading card game Magic: The Gathering. It’s an acronym of Magic: The Gathering Online Exchange.) Mt Gox came into being as the reaction to the question, how can I get hold of some bitcoin, and/or how can I turn this bitcoin I have into real money? It was the place where you could buy bitcoin at the prevailing rate of exchange with whatever currency you held. It would store those bitcoin for you. As and when you chose to exchange them for cash, it would find a buyer. There were other places where you could do that, but Mt Gox was by far the thickest and best known: by 2013, it was treating seventy per cent of all bitcoin transactions.
Mt Gox was located in Japan, and was run by a Frenchman called Mark Karpelès. He had the background characteristic of many cutting-edge computing types, combining advanced mathematical abilities and a high degree of social isolation. The early bitcoin world was convivial, with many conferences and meet-ups, at which the community of early adopters, an evangelical crowd, would dangle out together and exchange ideas. Everybody knew everybody. Karpelès didn’t go to these gatherings. He had an unusually close relationship with his cat, Tibanne, whose health was not sturdy. Tibanne needed special injections which only Karpelès was able to give, and that made him incapable to travel to meet-ups.
Karpelès had a clear vision of how significant bitcoin could become: while running Mt Gox he was designing a point-of-sale machine, like a credit card reader, which would accept the currency; he was also working on a bitcoin café in Tokyo, which would be a showcase and proof of concept for the currency. But Karpelès, along with his abilities and his ideas, had something else, too, a trait apparent in many starlet players from the digital world. He had very little sense of what he could not do. He didn’t understand thresholds and practicalities. It is difficult to do ingenious fresh things with digital ones and zeros, and the people who have done so are correctly aware of how clever they are. But it is even more difficult to do clever things which are not digital. The digital starlets dislike and resent the intractability of the non-digital world, utter as it is of rivaling interests, resentful incumbents and human challenges. Mark Zuckerberg at Facebook tells his employees to ‘Move quick. Break things.’ Those maxims are much more useful when you’re dealing with digital bits than when you’re dealing with people. The generation of digital ‘disruptors’ and innovators have a collective tendency to imagine that they have significant insights into worlds they don’t in fact understand.
In the case of Mt Gox, the problem was basic: Karpelès couldn’t run a company. Mt Gox’s employees were on the 2nd and fourth floor of a Tokyo office building. Karpelès’s office was on the eighth floor. The employees often had no idea what their boss was doing, and since he kept a taut hold of the main functioning of the business, that meant nobody knew what the hell was going on. That mattered, because it became clear in 2013-14 that something was awry inwards the world’s main bitcoin exchange. Transactions were notoriously slow. Bitcoins being held on the exchange were worth $100 more than bitcoins elsewhere. That’s because if you had money at Mt Gox, it took so long to get hold of it that it was lighter to turn the money into bitcoin, and then transfer the bitcoin elsewhere: the mismatch inbetween supply and request drove up the price, as economics trains us it will. There had always been problems with the Japanese bank that treated Mt Gox’s transactions, but these difficulties seemed to go deeper. Nobody truly knew what was going on, apart from Karpelès, and he wasn’t telling.
On seven February 2014, Karpelès all of a sudden closed down all transactions on Mt Gox. He put out a statement blaming a flaw in the bitcoin protocol that permitted users to alter transaction codes in a manner that made it unlikely to tell if the transaction had gone through. That would enable them to spend money twice – which was exactly one of the technical problems Satoshi had supposedly eliminated with the creation of the blockchain. There was a gigantic backlash from the bitcoin community at Karpelès’s announcement, because it turned out this ‘quirk’ in the protocol was well known to developers, and all the other exchanges had developed ways of working around it. Hackers began using the freshly publicised flaw to attack bitcoin exchanges.
The flaw was a crimson herring. The real problem facing Mt Gox was, fairly simply and shockingly, that it had lost all its bitcoin. To understand how this can happen, you need to take hold of that when you own bitcoin, you don’t own anything physical: what you own is an entry on the register. Your ownership is merely access to that entry on the register. As for ‘you’, in this context all you are is an address on the register: that’s why bitcoin is anonymous. The address, which is nothing more than a string of numbers, could belong to anyone. To get access to it, you need its key: another string of numbers, cryptographically matched to that specific bitcoin address. So the address is one string of numbers, held publicly on the register; the key is another string, held privately by the bitcoin’s proprietor.
The analogy with a physical key, however, is not finish. Lose a house key and you can ask your neighbours for the spare you thoughtfully gave them, or call a locksmith, or break in through a side window. Lose a cryptographic key, and you have irrevocably lost access to your information. That string of numbers is unforgiving. The history of bitcoin has some blessed surprises, such as the story of the Norwegian electrical engineer who bought $26.60 worth of bitcoin in 2009, then left behind all about them until he eyed coverage about the cryptocurrency in 2013. He couldn’t at very first reminisce 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’d gone up a bit: to $886,000. He took a fifth of them and bought a vapid in a posh bit of Oslo. That’s a glad ending. But the unforgiving power of the public address/private key combination has also seen seven thousand five hundred bitcoin lost under a landfill outside Newport in Wales, when an IT worker chucked out an old hard drive on which he had stored the private keys from his two thousand nine bitcoin stash. Current value of loss: £2.1 million.
Satoshi’s idea had been for people to keep their bitcoin keys in a ‘wallet’, a private digital locker. You’d go online when you needed to spend something from the wallet, but otherwise it would be stored securely on your computer or mobile phone or whatever. The disconcerting power of the address/key combination, however, led people to want another solution to keep their keys safe – and that, ironically, led them towards places such as Mt Gox, or indeed Cryptsy, the harshly similar exchange which collapsed in January in very similar circumstances. By similar circumstances I mean: they lost a lot of bitcoin and don’t know how. The bitcoin were supposedly in ‘cold wallets’ – i.e. offline wallets – which ought to have meant they were safe. The proprietor of Cryptsy posted this message on the company blog:
A very interesting fact here, however, is that those bitcoins have not moved once since this happened. This gives rise to the possibility they can be recovered. In fact, I’m suggesting a bounty of one thousand BTC for information which leads to the recovery of the stolen coins.
If you happen to be the perpetrator of this crime, and want to send the coins back no questions asked, then you can simply send them to this address:
There’s something sweet about asking someone who has stolen lots of money – Ten,000 bitcoin, worth £2.8 million – to pretty please just give it back, and you promise not to be cross. But there’s something entirely idiotic about it too. From the same blog post: ‘Some may ask why we didn’t report this to the authorities when this occurred, and the response is that we just didn’t know what happened, didn’t want to cause scare, and were uncertain who exactly we should be contacting.’ The note of bafflement is embarrassing. It’s as if it had never occurred to the masterminds at Cryptsy that a deregulated currency, explicitly constructed to be outside state control and policing, might tempt thieves, and might also mean they’d have a problem getting help from the authorities. As for the precise particulars of what happened to Mt Gox’s bitcoin, we’ll most likely have to wait for Karpelès’s trial to find out: in August two thousand fifteen he was arrested by the 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 to the currency, the detail of how it works. They convincingly explain the trajectory of thinking most people go after when they hear about the currency, from Disdain through Scepticism, Curiosity, Crystallisation and Acceptance. Their book leaves you thinking there is a bright future to this cryptocurrency lark. Popper’s book is fascinating on bitcoin’s history, telling the stories of both the true believers and the early adopter-investors, but not sparing specifics on the many scandals and panics bitcoin has already gone through in its brief life. The effect of reading both books in succession is to hear very first the reasons bitcoin is utter of potential, and then the reasons it is total of risks. One of the most off-putting strands 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 certainly be more to come.
There was an example of the kind of risk involved in dealing with the currency in March 2014, when Satoshi’s real identity was erroneously ‘revealed’ by Newsweek. Their mistake, hilariously, was to pick a real Japanese-American man called Satoshi Nakamoto, who called the currency ‘bitcom’ and told reporters, accurately, ‘I got nothing to do with it.’ He then suggested an off the hook interview to the very first person who would buy him lunch. It became rapidly and irrevocably clear that Satoshi wasn’t, you know, Satoshi.
Before the mistake was exposed, however, many bitcoiners pointed out what a dangerous position the magazine might have put Satoshi in. If he were the cryptocurrency’s creator, he would also be the possessor of many early minted bitcoin. His holdings could, and likely would, be worth hundreds of millions of dollars. The key to those holdings would be kept somewhere – most likely at his house. All a thief or extortionist would need to get hold of harshly half a billion dollars was that string of numbers. Bad guys have been tempted to do bad things by much smaller incentives than that. This is one of those times when the people advocating for something end up being unwitting advocates for the other side of the argument. Wences Casares, the Argentine investor described by Popper, is an amazing advocate for bitcoin. And yet this detail stuck with me: he and his co-investors store their bitcoin keys in an offline laptop stored in a safe deposit box. No other form of computer storage is adequately secure. If those are the lengths you have to go to in order to defend yourself from crooks, what does that say about the safety of the cryptocurrency?
This history of criminality, fraud and disaster might well, you’d have thought, add up to a story of failure. It hasn’t. In parallel with the high-profile, front-pagey things that have gone wrong with bitcoin there has been a consistent trajectory of growth and enhancing interest. For all the things that have gone wrong, the currency itself has not collapsed, and has not been shown to be mathematically or conceptually flawed. The fact that the world is total of crooks, thieves, con guys and incompetents doesn’t invalidate the use of other types of money, so why should it invalidate bitcoin, just because it has so many criminal-friendly features? That seems to be the thinking. In any case, this currency, which is based on nothing more than mathematical calculations, is now worth billions of dollars, and has moved a long way from the early-adopting internet libertarian fringe of its early supporters. The irony is that success has brought the thickest dangers yet to the continuing existence of the cryptocurrency.
The very first of these threats comes in the form of what nerds call ‘forking’. The entire point of open source software, such as bitcoin, is that it is released into the wild, and users are permitted to amend and tweak it as they see fit. If a version is switched so that it becomes in some respects incompatible with other versions, that form of the software is said to be ‘forked’. The software which 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 favourite tech terms, a ‘forked Android’.) The open source nature of bitcoin has meant that the community can make switches to it, and that these switches are in effect voted on: bitcoiners either download and use the software, or they don’t. It’s a kind of ongoing plebiscite. When problems have arisen, they were adjudicated very first by Satoshi him/her/it/themselves, and then after he/she/it/they stopped being directly involved in running the cryptocurrency in 2011, by a puny group of five ‘core developers’ led by a computer scientist called Gavin Andresen.
What’s happened now is that there is a split in the bitcoin community, and also among the core developers. The issue is a recondite one concerning the block size – the amount of data in those ten-minute blocks of transactions. Satoshi set a block limit of one megabyte, evidently with the intention of having it rise over time as the size of the network, number of transactions and power of ordinary computers grew. One part of the community thinks that limit is about to become a crisis for the currency, which will grind to a halt as transactions have, in effect, to queue to be added to the blockchain. At that point, the currency becomes futile. So a group of developers, including Gavin Andresen, launched 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 think the switch will take bitcoin too far in a corporate-friendly direction, and would choose a smaller, slower, ideologically purer version of the cryptocurrency. The dispute has been acrimonious, and has seen a massive hacking attack launched against the XT network, and all mentions of XT censored from official bitcoin forums. So bitcoin is now forked. Mike Hearn, one of the people behind XT, abandon the bitcoin world in January as a result of the split, and now regards the currency as a failed experiment. ‘Despite knowing that bitcoin could fail all along, the now inescapable conclusion that it has failed still saddens me greatly,’ Hearn wrote in a strongly felt, strongly argued blog post. Bitcoin will either recover from this, or not.
It should 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 wide-ranging brief book about developments in the field, Identity Is the Fresh Money. His is the best book on general issues around fresh forms of money, and fresh possibilities generated by blockchain technology. You finish his book wooed that something is happening in which the register, and credit more generally, and money, and banking, and identity, are all commencing to blur together. That said, he’s not sure about bitcoin the currency. ‘I’m not persuaded that money or payments is the optimum [use] of the technology,’ Birch said, in response to this latest kerfuffle. It’s effortless to see the force of that, given that even in bitcoin’s pristine form, it takes ten minutes for a block of transactions to be compiled and sent to the network for verification and adding to the chain. There is something very unmoneylike about that inherent delay and inherent complication. Bitcoin may instead have most significance not as money but as a way of authenticating identities, exchanging contracts and executing transactions. In January, the UK government’s chief scientific adviser issued a report which said that ‘distributed ledger technologies have the potential to help governments to collect taxes, produce benefits, issue passports, record land registries, assure the supply chain of goods and generally ensure 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 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 Satoshi’s brilliant technology. It’s this potential that has attracted the attention of – cue music that indicates the arrival of bad guys – the banks.
Many people in the world of finance followed the bitcoin trajectory Vigna and Casey describe, from disdain through curiosity to acceptance. Their interest is mainly in blockchains. The banks have looked into the possibility of better, swifter, cheaper systems powered by blockchains, and have concluded that it’s possible for these to be a source of disruption and disintermediation of their business. Alternatively, they will be another profitable thing the banks own. They choose the 2nd option. A number of rivaling syndicates, funded and largely possessed by the banks, are rushing to develop and patent proprietary, finance-friendly versions of blockchain technology. A consortium called R3Cev is backed by forty two financial companies and seeks to develop what would in effect be a private blockchain; Goldman Sachs, one of the firms behind R3Cev, has also filed a patent for a private blockchain-backed currency called SETLCoin (one wag at the FT has dubbed it ‘the vampire’s quid’); Digital Assets Holdings, another blockchain company, is run by Blythe Masters, the English former J.P. Morgan executive who did more than anybody else to pioneer the credit default interchange, the dazzlingly ingenious fresh financial instrument which was a hefty success until it almost demolished the global financial system. This is just a lil’ sample, and there are many other bitcoin-related initiatives. One result is a fine deal of confusion. Bitcoin was evidently a major topic of conversation at Davos this year, where there was evidently much blurring inbetween bitcoin the currency, bitcoin the technology, cryptocurrency in general, the blockchain as in bitcoin, or the blockchain as in blockchains in general. The headline news is as goes after: in the world of finance, the blockchain is certainly going to be A Thing.
Irony klaxon. The very very first sentence of Satoshi’s original paper reads as goes after: ‘A purely peer-to-peer version of electronic cash would permit online payments to be sent directly from one party to another without going through a financial institution.’ It looks as if, on the contrary, those very same financial institutions are going to use this fresh technology to keep themselves right where they are: in the middle of every possible transaction network, extracting all the rent they can.
Bitcoin true believers are annoyed that pretty much every discussion of the cryptocurrency completes with a rhapsody about the potential of blockchains. Bitcoiners reject that idea: for them, the blockchain will never succeed apart from the currency. The trouble is, tho’, that in internet terms, bitcoin has already been around for fairly a while. January marked seven years since the launch of Satoshi’s original code. In seven years, Google, Facebook and Twitter had all become not just big companies, but fundamental parts of everyday life for hundreds of millions of people. They had become verbs. M-Pesa is about the same age as bitcoin, and treats half Kenya’s GDP. Bitcoin is nowhere near that. It’s time for the cryptocurrency to determine what it wants to be when it grows up. Blockchains could become merely a fresh mechanism to ensure the continuation of banking hegemony in its current form. That would be one of those final plot twists which leaves everybody thinking that albeit they loved most of the display, the ending was so disappointing they now wish they hadn’t bothered. Or, along with peer-to-peer lending and mobile payments, they could have an influence as good as the fresh kind of banking introduced in Renaissance Italy. That would be more joy.
 Duke, one hundred forty four pp., £14.99, October 2015, nine hundred seventy eight 0 eight thousand two hundred twenty three 5999 9.
[Two] Yale, two hundred eighty eight pp., £10.99, August 2015, nine hundred seventy eight 0 three hundred 21249 Five.