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Bitcoin seeks to be an electronic cash (currency) system that doesn't rely on trust. Paradoxically, Bitcoin requires a trust-based ecosystem.

Bitcoin seeks to be an electronic cash (currency) system that doesn't rely on trust. Paradoxically, Bitcoin requires a trust-based ecosystem.

As a brief summary: The Bitcoin system was developed as an electronic currency by Satoshi Nakamoto (apparently, a pseudonym). Bitcoins exist only in the online world (they have no physical form). Each Bitcoin is uniquely identified, and is part of a limited edition (only a pre-set number will be issued). And, if properly executed, Bitcoin transactions are anonymous and non-reversible. For a more detailed explanation of Bitcoin's architecture, see Benjamin Wallace (Wired) or The Economist.

Bitcoin is intended to be digital cash/currency, based on cryptography and peer-to-peer networks, rather than trust. As Nakamoto explains:

The root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.
Nakomoto cites as conventional currency's root problem: "all the trust that's required to make it work." But Bitcoin requires us to replace trust in legal systems, institutions and procedures, with a system where we must:

1. Trust the willingness of counterparties to accept Bitcoin as currency for payment -- a huge leap of faith. Purchasing Bitcoins means participation in a 100 percent trust-based system, without any legal mechanism to compel their acceptance. Conventional currencies rely not just on trust, but also on the force of law. For example, in America the "Legal Tender Statute" (31 USC Sec. 5103) specifies that: "United States coins and currency ... are legal tender for all debts, public charges, taxes, and dues." No country issues Bitcoins, and no government legally compels anyone to accept them as payment.

2. Trust unregulated institutions with your personal bank information just to purchase Bitcoins. As described in Mother Jones:

... if you ... have qualms about handing over all of your bank information to an anonymous internet stranger, then you might want to just give up now. The major Bitcoin exchanges don't accept credit cards ...
3. Trust a cryptographic, peer-to-peer network computer technology most Bitcoin users don't understand.

4. Trust that Bitcoin (really, a beta) won't be replaced by a superior digital currency system, rendering original Bitcoins obsolete and worthless.

5. Trust that the Bitcoin Foundation/other participants won't create additional Bitcoin series, thereby diluting the value of the original Bitcoins.

6. Trust that governments won't intervene to render Bitcoins worthless (e.g., if Bitcoins facilitate too much drug-dealing or money laundering, the U.S. government could make their possession illegal).

7. Trust an anonymous creator (Nakamoto) who's mysteriously "moved on to other projects" and disappeared.

8. Trust that Bitcoin markets will be available to provide prices in real currencies -- as recent events demonstrate, also a leap of faith.

9. Trust that your Bitcoins are stored in a secure location. Precisely because Bitcoin transactions are anonymous and non-reversible, they're highly vulnerable to theft. If your Bitcoins are stolen, they're pretty much untraceable. For a non-exhaustive list of major Bitcoin theft incidents, click here.

Rather than as currency, perhaps we should evaluate Bitcoin as the first example of Dadaist Digital art. An art work exists as part of some limited edition and has no intrinsic use. If you purchase art (for financial reasons), you must believe/trust that members of the art ecosystem will value/be willing to purchase that work at a future time.

Dadaism was:

an ... international movement ... repudiating and mocking artistic and social conventions and emphasizing the illogical and absurd.
One of Dadaism's first major works was Duchamp's Fountain (created under the pseudonym R. Mutt). As shown below, Fountain is an off-the-shelf, mass-produced urinal.
Source: Wikipedia; Marcel Duchamp, Fountain 1917. Photograph by Alfred Stieglitz

The urinal designated as Fountain, however, had considerable value. Replicas, authorized by Duchamp, have sold for over $1 million each.

Duchamp made an important artistic statement with Fountain; but on another level, he created an intellectual joke about the nature of art.

Nakamoto, in "Bitcoin: A Peer-to-Peer Electronic Cash System" and other writings, makes important observations about cryptography, currency and the nature of trust.

Bitcoin's design is highly significant and will likely influence payment systems for years to come. However, Bitcoin's implementation feels like an elaborate intellectual joke. Under the guise of eliminating the need for trust, Nakamoto demonstrates that trust is an inescapable part of payment systems.

Is Satoshi Nakamoto the Duchamp of our Digital generation? Bitcoin's inventor seems sophisticated enough to understand that, as currency, Bitcoin's long term value might be zero. But analogous to Duchamp's Fountain, Bitcoin might be intellectually priceless -- for the issues it highlights (or as the first example of Dadaistic Digital Art).

Steven Strauss is an adjunct lecturer in public policy at Harvard's Kennedy School of Government. Immediately prior to Harvard, he was founding Managing Director of the Center for Economic Transformation at the New York City Economic Development Corporation. Steven was one of the NYC leads for Applied Sciences NYC (Mayor Bloomberg's plan to build a new engineering and innovation center in NYC), NYC BigApps and many other initiatives to foster job growth, innovation and entrepreneurship. In 2010, Steven was selected as a member of the Silicon Alley 100 in NYC. He has a Ph.D. in Management from Yale University, and over 20 years' private sector work experience. Geographically, Steven has worked in the US, Asia, Europe and the Middle East. You can follow him on Twitter at: @Steven_Strauss

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This is cross posted from my blog, and originally published on April 14th, 2013 as Nine Trust-Based Problems With Bitcoin

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Comment Preferences

  •  Interesting (0+ / 0-)

    In brief, modern economies function on trust, and Bitcoin cannot be integrated with them without also incorporating trust.

    Who will enforce a contract denominated in Bitcoins? It will be difficult for them to be anything but a novelty until they have support of government.

    I'm on a mission! Testing the new site rules.

    by blue aardvark on Tue Jan 07, 2014 at 10:41:45 AM PST

    •  IANAL, but contracts are enforced (1+ / 0-)
      Recommended by:
      johnny wurster

      by the parties themselves in civil court. Seems to me that liquidated damages could be dollar-denominated and judgments enforced (or not) as in any other case, regardless of whether Bitcoins were involved in the original terms.

      We're not generating enough angry white guys to stay in business for the long term. --Sen. Lindsey Graham (R-SC)

      by uffdalib on Tue Jan 07, 2014 at 10:51:21 AM PST

      [ Parent ]

  •  Interesting take. (0+ / 0-)

    But Bitcoin is so five-years-ago. People new to the idea of cryptocurrencies should check out the other 50+ examples now extant:

    Cryptocurrencies list

    We're not generating enough angry white guys to stay in business for the long term. --Sen. Lindsey Graham (R-SC)

    by uffdalib on Tue Jan 07, 2014 at 10:44:39 AM PST

    •  Thus diarist's point #4 n/t (0+ / 0-)

      “Texas is a so-called red state, but you’ve got 10 million Democrats here in Texas. And …, there are a whole lot of people here in Texas who need us, and who need us to fight for them.” President Obama

      by Catte Nappe on Tue Jan 07, 2014 at 11:32:44 AM PST

      [ Parent ]

  •  libertarianism doesn't work & trust a big part (0+ / 0-)

    Trust and law are pretty much opposites: laws and police powers exist because in large, complex, diverse, and unequal societies/markets where there are few or no common interests and significant imbalances in money, power, and access to information, they're the only thing that keeps the peace that allows people to invest their time and resources in productive activities rather than jealously guarding what they have.  Otherwise you end up with revolution from the bottom in response to naked predation from the top ... while most people just walk away and care only for their own needs.

    In the absence of trust, a strict, impartial, and aggressively enforced code of law is essential to prevent the kind of anti-competitive and anti-social behaviors that would discredit and destroy the system if left unchecked.  Bitcoin provides neither: no "trust" but also no rules to replace them because what animates Bitcoin - like all other libertarian "alternatives" - is a naive and absolutist notion of "freedom" as the ultimate good and "power" as the ultimate evil, with one invariably inversely proportional to the other.  A totally unregulated system is held to be paradoxically more secure precisely because it allegedly offers no points of leverage for unscrupulous parties to manipulate the system as a whole.

    Libertarians believe that laws and police powers are bad because they infringe upon "freedom", but at the same time libertarianism privileges an essentially mercenary ethos: money is the measure of all things, and whoever has the most simply must be a better person on the inside who deserves the right to do what they want because they're superior. In other words, libertarians and those they hold up as the ideal citizen and human being are the very last people that rational actors would want to grant increased freedom to.

    Domestic politics is the continuation of civil war by other means.

    by Visceral on Tue Jan 07, 2014 at 11:43:49 AM PST

  •  You dilute your argument by overselling it. (0+ / 0-)

    Points 1 and 8 are sufficient.  The rest of that, I'm not sure that I agree, but I don't want to get bogged down in it because points 1 and 8 are key.  And they're actually the same point.

    If bitcoins stop being accepted by ENOUGH people -- not all people, just ENOUGH, and that can easily happen -- then the supply of bitcoins will self-inflate.  Too many coins, not enough stuff to buy with it, not enough vendors willing to take it.  We can safely assume there will always be currency traders ready to convert bitcoins to some other regular institutional currency, but there's no reason to assume that the trading for bitcoins couldn't plummet as a result of swings in the reach of its purchasing power.

    What is there to stop such a thing happening?  Well, that's the uncool part of not having a government or federal reserve.  If the US dollar starts to plummet, the treasury can start buying back T-bonds and negotiating with other governments to have them stabilize currency rates by buying dollars.  Bitcoin can't do that.  There's nobody running the asylum.  By design.

    So I think Bitcoins are safe as long as they remain small.  If they ever did become successful, though, they would be vulnerable.  

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