I sincerely believe that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity under the name of funding is but swindling futurity on a large scale.
THE FIRST BITCOIN WAS mined, but getting a brand new currency into the hands of users without a government forcing them to adopt it is no mean feat. For Bitcoin, the rate of adoption has been slowly increasing since 2009 until it began reaching a tipping point at the end of 2017.
There is a catch-22 in the adoption of any new information network. Consider a service like Facebook, for example: if none of your friends are on it you won’t have much use for it, but your friends won’t come to Facebook unless you’re there. Yes, you are that special.
The ‘network effect’ in economics explains how goods and services increase in value the more and more people use them. As the number of your friends on Facebook increases, so does the value of Facebook to you, making you more tolerant of horrible adverts for things you don’t need and growing the potential advertising revenue for the business that controls the network.
These network effects take on different forms for various types of networks but all rely on the principle that a network becomes more valuable as more people use it.
One way of quantifying this value is called Metcalfe’s Law, which states that the value of a telecommunications network is proportional to the square of the number of connected users of the system.
This law is named after Robert Metcalfe who co-invented the Ethernet technologies that make the internet possible. In the eighties Metcalfe founded the company 3Com that used to sell network adapters that could be added to personal computers so that they could communicate with each other.
Metcalfe and his colleagues realised that when you just connected two computers together to share files and printers the value of doing so was limited, but increased exponentially when you added a third computer to the network. Each new computer added did not just slightly increase the overall value, but rather did so dramatically.
Metcalfe’s Law is often disputed and is sometimes applied to networks where the calculation of value isn’t quite comparable to computers sharing resources with each other, but the exponential increase in value of a network proportionate to the amount of new nodes added to it is obvious in everything from political uprisings to social networks.
As an increasing number of people flock to the Bitcoin network, so the value of Bitcoin similarly rises.
While network effects are often used to describe the positive impact that more users have on the value of something, they can also describe negative externalities – for example, if too many people use something too quickly it could cause congestion or overload the system.
Facebook currently has just over one billion users and has pulled off the seemingly impossible in creating infrastructure that can handle this load. If all one billion users had tried to join the network in its first month of operation they would have swamped the company’s servers and Facebook probably would’ve been wiped out as a result.
Too much too soon can be fatal. Steady growth over time allows the system to scale and gradually accommodate larger numbers of users, even as the value of the network to those users increases exponentially.
To get more people using Bitcoin there have to be more things they can use it for. If there is nowhere that you can spend Bitcoin, why would you want it in the first place? And if no one wanted it, who would choose to start accepting it as payment?
The upside of slow and steady growth is that by the time Bitcoin is big enough for powerful companies or authorities to want to try and stop it, it will be too big for them to do anything about. At its current size, the only way to stop Bitcoin practically would be to make it worthless by spreading information suggesting reasons for it to be, or to turn off the internet itself. Any attempts at the former have so far failed miserably, while the latter isn’t plausible unless you destroyed our planet – in which case we would have better things to worry about than how we pay for sandwiches.
On that note, it’s worth mentioning that in 2017 the Blockstream company launched the first satellites into space running the Bitcoin node software. These satellites can be accessed from just about anywhere on earth using cheap components that can be ordered online for the equivalent price of a fancy lunch.
This makes it possible for Bitcoin to carry on even without the internet, and if the planet is destroyed one day perhaps an alien civilisation will stumble upon the immutable record of all our Bitcoin transactions floating around in space.
It also means that if the internet was miraculously turned off we would still be able to independently run the Bitcoin network.
Another tactic you may employ in attacking Bitcoin is to control the majority of computing power on the network. If you controlled a sufficient majority of Bitcoin mining hardware, for example, you could introduce fundamental changes to the software, interfere with the record of transactions or prevent any new transactions from being made.
Referred to as a ‘51 percent attack’, this would also be practically impossible given the current size of the Bitcoin network. You would essentially need more resources than the countries of China and the USA combined to even begin, and then you would need to cover billions of dollars per day in running costs. Even then you would likely fail as the proof of work algorithm adjusts to the new mining power and laws of supply and demand are brought to bear on the market for mining equipment.
Attempts at technically defeating Bitcoin would be an exercise in futility, although it would be fun to watch someone try.
We saw the limits of control of decentralised systems in the early days of content piracy when new services like Napster made it possible for people to illegally share copies of songs online. Unlike previous services for music sharing, Napster connected users directly to each other in a peer-to-peer network.
A swift reaction by regulators made it outright illegal for you to share or acquire music in this way, but that didn’t stop many people from using Napster to download their favourite Fatboy Slim, Nirvana, and other nineties tunes. To stop Napster authorities had to go after its founders and force them to take systems offline.
More germane to the discussion of Bitcoin and cryptocurrency is the BitTorrent software that is also used to download music, movies and other data. Unlike Napster, BitTorrent has no single point of failure. The network is created by millions of people running the BitTorrent software and sharing bits of files with each other.
While BitTorrent is used by some to share content illegally, it is also used to share open source software, Creative Commons-licensed content and other information that may be legally shared without compensation. Some software companies use BitTorrent technology to deploy security patches and updates for their software in an efficient and perfectly legal way.
Banning people from using BitTorrent because it is also used to share content illegally would make about as much sense as banning bread knives because some people may use them to stab others. This is aside from the obvious fact that it would be practically impossible to police BitTorrent.
In the chapter Making Chains of Blocks we discussed why distributed networks are so powerful, because they interpret any attempt at limiting access as breakage and route around it. Trying to control such a system is like cupping water – the more you grab at it, the more it finds ways around your fingers.
Like BitTorrent, Bitcoin is beyond the direct control of any authority. Governments could choose to make it illegal, but this wouldn’t stop people from using it, just like banning the unauthorised sharing of music and movies hardly stopped anyone from doing so.
Content piracy has been reduced over time, however, as companies like Apple and Netflix have identified the market demand that was represented by people sharing files online. It wasn’t that people necessarily wanted music and movies for free, but rather they wanted to get hold of it over the internet and the only good way to do so was using services like Napster and BitTorrent.
Apple under the leadership of Steve Jobs introduced the iTunes Store where people could legally buy digital copies of songs, and proved that convenient beats free.
As it turns out, most people are honest and willing to pay for things if they are enabled to do so.
The network effects of Bitcoin began with it being a good store of value and are now entering a new phase as Bitcoin also becomes a very good medium of exchange. As the network grows in value it adds new users and those new users substantially increase the value of the network. As with a snowball rolling down a hill, Bitcoin picks up weight and momentum through this virtuous circle.
If society en masse decides that we want Bitcoin and billions of people are using it around the globe without harming anyone as a direct result of doing so, then it’s not only irresponsible but just plain stupid for authorities to try and stop them.
Instead, it makes sense to look at what Bitcoin and cryptocurrency represent as needs people are expressing and try to work with it instead of against it.
There is also no societal requirement to ban Bitcoin.
The point has been made that cryptocurrency is used by drug dealers and cyber criminals, but so are banks and the US dollar. It’s not like terrorists and gangsters had a problem with old school money.
Pablo Escobar quite happily plastered millions of dollars into the walls of his houses and he had no problem spending or transporting cash, if the TV show Narcos is anything to go by.
In another example, one of the best things to happen to Mexican drug cartels was HSBC opening up in their country. Billions of dollars flowed over the US border into Mexico for drugs sold, and was then deposited into HSBC bank accounts in one of the worst examples of how the traditional banking system facilitated crime.
HSBC didn’t even attempt to hide this fact from US authorities who fined it a paltry £1.2 billion in 2012 and handed it a suspended threat of prosecution that was dropped in 2017.
Buying drugs on the street in the USA can get you a stiff prison sentence, whereas not a single individual working at HSBC has been punished for facilitating billions of laundered dollars by organisations that literally cut off people’s heads.
Unlike traditional banks who keep their accounts private, an indelible and transparent record of transactions is maintained by the Bitcoin blockchain for anyone to see. It can be tricky to link Bitcoin addresses to the people who own them but is certainly not impossible.
Bitcoin does not provide the magical gift of anonymity to criminals that many people believe it might. This might change as new technologies such as Dandelion could be introduced in the future to make Bitcoin more anonymous.
As things currently stand the entire record of all Bitcoin ever spent is transparent and publicly available, unlike physical cash transactions. Anyone can query a transaction, or use a blockchain browser such as Blockchain.info to look up details. This will tell you the value of Bitcoin transferred and which addresses sent and received it. If you can link those addresses to people you can begin to plot out precise transactional records.
Quite the opposite of being a gift to criminals, Bitcoin may actually be a useful tool for regulators and tax authorities with a public record of all stored and spent Bitcoin, provided they can link addresses to other identity data. It would require just the right amount of effort by authorities so that it wouldn’t allow for whimsical snooping, but would be justified in the case of extreme criminal activity.
The cryptocurrency community is split between those who favour regulators having access to an immutable and transparent ledger of transactions, and those who believe that all transactions should be private and untraceable.
Some alternative cryptocurrencies such as Zcash and PIVX are designed for this purpose, using complex cryptography and relaying to confirm transactions without leaving a trace.
The most popular anonymous cryptocurrency at time of writing is Monero, led by South African computer scientist Riccardo Spagni.
While not designed specifically for anonymity, Monero has become the cryptocurrency of choice for people wishing to cover their tracks when sending value over the internet. If a private currency like Monero did ever replace Bitcoin as the predominant cryptocurrency, or if Bitcoin adopted technology such as Dandelion to become similarly private, it would create a potential headache for any authority attempting to track transactions. The degree of smirk with which you greet that statement will align with your position on the spectrum of crypto-anarchy.
While privacy features in cryptocurrency are a challenge for traditional authorities, there are opportunities for the technology to be harnessed by governments and central banks. Sovereign blockchains could be built that replaced incumbent banking infrastructure.
Venezuela was the first country to launch its own formal cryptocurrency in the form of the Petro that is linked to the price of a barrel of oil; Venezuela’s chief export product.
Australia, Senegal, Tanzania, the US Federal Government and many others are already developing or seriously considering their own blockchain technology and vendors like IBM are offering packaged products that target public sector customers. Theoretically.
But blockchain giveth and blockchain taketh away.
Simply retooling fiat currency systems with blockchain technology wouldn’t change much from a central banking perspective. Sure, it would give governments a better database for transactions, a higher degree of transparency depending on how they specify the technology, and would improve the way old money works. But it would still be old money.
This is another reason why the mechanics of blockchain technology are less interesting than the new system of trust offered by Bitcoin. Blockchain is a technological marvel, just like a Ferrari engine is a feat of engineering – but you need the rest of it, the story of Bitcoin or the brand promise of a luxury Italian sports car, to make it cool. For some people.
What’s more likely is that mass adoption of Bitcoin and other cryptocurrencies would force a transformation in government services and taxation.
Bitcoin is simply a better set of rules for how money works. A better story.
It’s not plausible that governments would or even could ban the use of Bitcoin. Nor should they seek to. At best they can attempt to control the flow of fiat currencies into the cryptocurrency ecosystem while building better services that would compel the tax payers of the future to part with some of their earnings.
If you manage to get hold of Bitcoin without using fiat currency to buy it then it’s practically impossible for authorities in the existing system to even know you have it. It might be stored using a brain wallet and there wouldn’t even have to be material evidence of your Bitcoin stash. Even with software wallets it would be difficult to trace, especially when a tax authority would have to do so for potentially millions of citizens.
At that point you get to decide when, how and if to pay your taxes. Governments will no longer be able to force tax payments with threats of penalties or prosecution but will have to encourage them by offering better services and management of infrastructure.
If cryptocurrency is successful at displacing a significant portion of global monetary supply then it will bring free market forces to bear on government services, for better or worse. Or both.
***
Imagine that you and I are playing chess and I suddenly declare that I am going to start moving my pawns in the same way as my queen. This would probably ruin our game unless you agreed to the new rules and started moving your pawns in the same way. More likely is that you’d lose your temper with me and rage-quit the game, possibly by flipping the board.
Bitcoin has suggested new rules for the global game of money and the people who are really good at playing by the old rules don’t like it. That doesn’t matter so long as there are enough people who agree to play by the new rules.
The game of fractional reserves in the old world of money, and its resulting reliance on debt, is decried by many in the cryptocurrency community. It’s a system that has failed us repeatedly and Bitcoin introduced a way for us to make dramatic improvements. I’m certainly not going to defend the old set of rules, but the truth is always more complicated than extremists would have you believe.
Simply put, fractional reserves mean that banks only have to have a certain percentage of the funds that represent deposits and loans made to them. They don’t actually have to keep all of the money that you have in your account, just enough so that they can settle average obligations on any given day.
Banks also don’t have to have money in order to lend it out.
If banks stored nuts, say, and a total of 100 nuts had been deposited by customers squirrelling away their savings, the bank could keep a fractional reserve of 20 nuts because it knows that it never has to disburse more than that amount in a week. So long as the bank always has 20 nuts available it can carry on running, even though it owes 100 nuts to their respective owners.
This is why a bank failure is so devastating. When an event causes a run on the bank, which means many people trying to get their money out at the same time, the system implodes because the bank doesn’t actually have all the money represented in its customer accounts.
In most countries banks are insured up to a certain degree of failure, regulated by a central bank with governments providing fall-back as what is known as a ‘lender of last resort’. It has been uncommon in modern times for banks to fail.
That is, until we encounter economic situations that weren’t anticipated, such as the dotcom bubble collapse of 2000 or the subprime lending crisis of 2008. Lehman Brothers in the USA, ING in Holland and Saambou in South Africa are just some of the banks that have failed in the last half-century. When this happens customers literally lose money they will never get back.
In most countries any money that is deposited into a bank is no longer the legal property of the customer making the deposit. It’s owned by the bank to do with what it pleases, with an agreement to return the balance to the customer when it is asked for, and assuming that the bank is able to do so.
Commercial banks may also lend money to customers, which is then added to the supply of legal tender in that country. This expands the amount of money in an economic system and also provides regulators with interest rates as a tool to be used in macroeconomic governance.
You can think of the current banking system as something that emerged organically by trial and error. Banks discovered that they only had to keep a small percentage of the wealth they were storing long before there were central banks and other authorities to hold them accountable.
Macroeconomic theory doesn’t provide falsifiable predictions, unlike science, and while many business schools may teach macroeconomic principles as law, reality is that it’s mostly trial and error with a dose of bullshit.
At time of writing this book the global sum of debt had reached about $230 trillion, while the total monetary supply in the financial system is estimated to be about $95 trillion. The world owes more than double the amount of money in existence and there are some countries that will simply never be able to settle their dues – including the world’s biggest economy of the USA.
While central banks are supposed to protect us from economic instability by governing commercial banks, the reality is that commercial banks hold all the cards. We saw this play out with the subprime lending crisis of 2008 and the bail out of banks in 2009. Governments could either allow commercial banks to fail, have millions of people become bankrupt, or they could temporarily solve the problem by bailing out banks using tax-payer money, and then print more money in an attempt to fill the massive gaps left in the wake of the crisis.
The quantitative easing process of printing money to prop up the financial system is a sign of desperation. It means that there are no solutions except to make more money out of thin air and pump it into economies via banks, where a vast majority of it will end up in the hands of a very few individuals.
On the one hand modern economics has created an environment in which humanity has thrived. In 1870 the richest person alive did not have a working toilet in their home, nor electrical lights. Now you can have both those things and still be considered poor. Infant mortality rates are lower than they have ever been and the average life expectancy is higher.
The progress made in the last one hundred years thanks to capitalism and the share distribution of public companies is remarkable, and the improvement it has made to the lives of billions of people is undeniable, but it’s not a perfect system and is far from fair when one considers the vast inequalities that still exist.
The bankers who directly caused the 2009 crisis were not punished, and most did not even lose their jobs. Some were even awarded for the crisis because they saw it coming and shorted the market so that they could cash in on the disaster of their own making. Like HSBC laundering money for drug cartels, the great banks of Wall Street directly caused billions of dollars in losses for the global economy and received little more than a rap on the knuckles from authorities for doing so.
It’s delusional to think that this set of economic rules is the best we can come up with for humanity. Our trust has been betrayed time and again. Now we’re taking it back.
If we allow the status quo to continue the unsustainable level of debt in the global financial system is so high that it threatens to melt down our economies, to say nothing of hyperinflation and other threats that directly affect the poorest of the poor while wealthy individuals are shielded from disaster.
It’s not too late to turn things around, but it requires us to start playing by a new set of rules.