Donovan Griffin. Information Today. Volume 31, Issue 4, May 2014.
Ever since the media caught wind of bitcoin, coverage of the electronic payment system has tended to focus on the scandalous aspects of its use, including its role in facilitating transactions for the deep web marketplace Silk Road, the collapse of and theft from the once-dominant exchange site Mt. Gox, and the bungled scoop outing bitcoin’s pseudonymous creator Satoshi Nakamoto by Newsweek, which misidentified California engineer Dorian Satoshi Nakamoto. Descriptions of the concept of bitcoin are usually relegated to a few introductory sentences or sidelined as an infographic in order to get to the more titillating aspects of the story.
In truth, skipping over comprehensive descriptions of bitcoin isn’t always a cynical move on the part of reporters. Fully explaining how the currency works took Nakamoto the majority of his nine-page introductory paper, “Bitcoin: A Peer-to-Peer Electronic Cash System,” and it involves no small amount of mathematics and code. Really explaining how bitcoin transactions—let alone theft—work is beyond the scope of most news articles on the subject.
Unfortunately, this glosses over why many proponents of bitcoin lobby so stridently for its acceptance and feel so dejected when it’s derided by traditional media outlets. Beyond the money invested and the potential fortunes mined in bitcoin, many techie proponents are deeply involved for a relatively simple reason: They find the underlying structure of bitcoin fascinating.
A Trustless Currency
Bitcoin is most often described today as a cryptocurrency, but Nakamoto’s original paper mainly refers to the concept as electronic cash or an electronic payment system. One of the most important aspects of this electronic payment system, unlike prior digital currencies, is its total lack of trust.
In justifying the need for a new electronic payment system, Nakamoto notes the “inherent weaknesses of the trust based model” of commerce on the internet, in which third-party financial institutions are trusted to process electronic payments. Because these third-party financial institutions need to mediate when disputes arise, Nakamoto argues that the entire concept of trust-based systems acts to increase the costs of a transaction, meaning merchants may take more information from customers than they strictly need in order to protect themselves from fraud.
Instead of trust, Nakamoto’s proposed system is based on a foundation of peer-to-peer (P2P) cryptographic proof, which means that many people are working together to computationally validate all the payments made using bitcoin. “[W]hen you want to make a payment from one person to another, that transaction gets submitted to this network of miners, and what they do is they timestamp it to make sure nobody’s done that before,” says James Angel, visiting associate professor at the University of Pennsylvania’s Wharton School.
Bitcoin miners are people who earn small pieces of bitcoin over time in exchange for their work validating payments as a part of bitcoin’s public ledger, which is called the blockchain. All these transactions are publicly available for view, although some anonymity is preserved with bitcoin addresses. Similar to email, bitcoin addresses are how bitcoins are sent. They are composed of a series of random numbers and letters that do not identify the owner and are generally used only once.
Bitcoins are stored in digital wallets, where users can check their balance or transfer bitcoins. Bitcoin wallets have a private key, which is used to sign off on transactions that have come from the wallet’s owner. A request to transfer goes to the blockchain, where miners confirm transactions in chronological order, which takes several minutes. Much of Nakamoto’s original paper focuses on preventing this system from being abused and preventing a user from double-spending his bitcoins.
Follow the Money
So how does the U.S. dollar fit in? Bitcoins can be traded for local currencies over exchanges, with extremely variable rates; bitcoin.org reminds new users that “[t]he price of a bitcoin can unpredictably increase or decrease over a short period of time due to its young economy, novel nature, and sometimes illiquid markets.” Although exchanges and measuring websites calculate a bitcoin’s price differently, a general idea of the currency’s value can be ascertained at any given time.
Bitcoin to U.S. dollar exchange rates remained less than a dollar until early 2011 and then gradually rose over the course of 2012 before shooting up to more than $100 per bitcoin for several months in 2013. In November 2013, the exchange rate broke $1,000 per bitcoin. Rates at the time of publication are seeing bitcoins trade at around $449.
Although it wasn’t always so during its short history, the currency can now be used to purchase goods and services from thousands of small internet businesses as well as from several larger, more established companies. They can be used to donate to a host of nonprofits and charities.
The Playing Field
If the bitcoin process seems complicated and volatile compared to cash transactions in local currencies, it is. So why use bitcoin when there are plenty of other functioning currencies already out there, which are backed by governments?
There are several motivations among the types of people who use bitcoin at the moment, according to Angel. Techies tend to gravitate toward the system for its technical ingenuity and brilliance, he says, and this accounts for a great deal of the population of bitcoin users today.
The second wave of bitcoin enthusiasts are what Angel refers to as cyber-libertarians: “These are the folks who have a fundamental mistrust of institutions, whether it is government officials, the Fed, whatever,” he says. “[T]he idea of having a currency that is not controlled by a central government … is their ultimate libertarian fantasy of freedom.”
Similar to the cyber-libertarians, Angel notes that there are online cryptocurrency supporters who see bitcoin as a hedge against doomsday scenarios, appreciating its limited supply of coins and its mathematic basis and holding the perhaps short-sighted view that the currency cannot be regulated.
And then there are the people who see bitcoin as a get-rich-quick scheme. “You definitely have a gold rush in there of people who think they’re going to make money off of it,” says Angel. He notes that there are those who feel this way among the community, and especially among the host of businesses that have sprung up around bitcoin (which has recently attracted more than a few venture capital firms), including BitPay, mining, and investment companies.
Certainly, there are overlapping motivations among the current supporters (and detractors) of bitcoin. But unless a killer app appears that makes bitcoin payment something preferred by the average person and his merchant, Angel predicts the currency will fade away.
Who Is Satoshi Nakamoto?
It’s widely believed in the community that Nakamoto is a pseudonym representing one person or several people who created bitcoin. Communication from Nakamoto is largely composed of the original paper he (or she, or they) created as well as a series of emails and forum posts that seemed to die down around 2010, with one exception.
On March 7, 2014, the account linked to Satoshi Nakamoto on p2p foundation.ning.com posted a denial: “I am not Dorian Nakamoto.” Nakamoto made the post not long after a Newsweek journalist claimed to have found the creator, who turned out to be Dorian Satoshi Nakamoto, who has denied all connection to bitcoin.
Libertarians see something of their own in the fabric of bitcoin and its creator. Although the language of Nakamoto’s paper describing bitcoin is relatively reserved in its condemnation of third-party financial institutions, his subsequent emails and forum posts illuminate what he hopes bitcoin can accomplish—and what he knows it cannot.
One such email attributed to Nakamoto on a cryptography mailing list finds the anonymous creator replying to a doubter, who claims that solutions for political problems cannot come through cryptography. ‘Yes, but we can win a major battle in the arms race and gain a new territory of freedom for several years,” Nakamoto writes. “Governments are good at cutting off the heads of a [sic] centrally controlled networks like Napster, but pure P2P networks like Gnutella and Tor seem to be holding their own.”
Later in the same mailing list, Nakamoto openly acknowledges the political stance evoked by his electronic payment system. “It’s very attractive to the libertarian viewpoint if we can explain it properly. I’m better with code than with words though,” he writes.
Brainstorming the language used in the bitcoin proposal submission to tech news website Slashdot with other forum users, Nakamoto is quick to quell the more hard-line positioning of other early bitcoin adopters: ‘”The developers expect that this will result in a stable-with-respect-to-energy currency outside the reach of any government.’—I am definitely not making [any] such taunt or assertion,” he writes.
Mr. Nakamoto Goes to Washington
Wary as bitcoin’s creator was to tangle with government, the modern-day disciples of the currency are eager to gain mainstream acceptance, even from the U.S. government.
Robocoin, a company that produces bitcoin ATMs, set up an event on Capitol Hill in April aimed at increasing legislative awareness of the currency. The language of Robocoin’s congressional invitation shaped bitcoin’s progress to be completely in line with lawmaker goals: “Welcome to the future of anti-fraud, anti-identi[t]y theft and anti-money laundering—this is customer protection built for the 21st century.”
Recent congressional reaction to bitcoin has been mixed. In February, Sen. Joe Manchin, D-W.Va., sent a letter to federal regulators expressing a desire to ban bitcoin entirely after the collapse of Mt. Gox. In reply, new Federal Reserve Board of Governors chair Janet Yellen said that since bitcoin has no tie with any banks the Federal Reserve can regulate, the agency has no authority over the currency.
Rep. Jared Polis, D-Colo., came out on the side of bitcoin, lightheartedly calling for a ban on the U.S. dollar since it can be used in the commission of crime, echoing Manchin’s claims about bitcoin. During Robocoin’s congressional information session, where it demonstrated its bitcoin ATM, Polis gave a brief talk.
The IRS recently made a statement classifying bitcoin as a property rather than a currency for tax purposes. While this is valuable information for those who’ve made money with bitcoin in knowing how to correctly file their taxes, Angel says, the ruling is “almost a worst of all possible worlds for bitcoin enthusiasts, because what it means is when you mine, you recognized taxable income on the receipt of the bitcoins. It also means that whenever you spend bitcoins, you have a taxable gain or loss depending on the value on when you got them or when you spent them.
“So that’s just going to make tax accounting really messy for any legitimate person for using it from any everyday transactions,” he says.
Ethical Currency
Some of Nakamoto’s early posts focus on the ways bitcoin can be strengthened, specifically so that as the peer-to-peer blockchain process grew, it could be protected from bad guys. In his estimation, a single miner or a group of miners could double-spend their coins if they controlled more than 50% of the computing power on bitcoin’s network. Other posts indicate that Nakamoto is concerned with the ethical nature of bitcoin, particularly as a practical matter.
The notion of bitcoin ethics is also the focus of Angel’s work. He recently published a paper with Douglas McCabe called “The Ethics of Payments: Paper, Plastic, or Bitcoin?” Angel describes an ethical use of a currency to be the relative cost to both parties in an exchange. “In general, something is considered to be exploitative when you’re using your power relationship to impose a large cost on your counterparty at very small gain to yourself,” he says.
In the paper, he concludes that while there may be ethical uses for both cash and credit in certain situations, there is no such easily explainable ethical use for bitcoin—where exchange of bitcoin would be preferred by both parties and forcing them to accept another form of payment would be exploitative. Angel points out in the paper that no monetary system, including bitcoin, is evil by itself. But the only ethical advantages he can imagine it would have are of the apocalyptic variety, where the existence of an evil regime forces legitimate people to use an untraceable currency. “That’s kind of a stretch,” he says.