Bitcoin is certainly money, but it is not just money. And that’s what’s so exciting about it.
In his lead essay, Jim Harper masterfully explains why bitcoin is money and why it is in many ways superior to government fiat currencies. As Jim says, bitcoin is immune to the kind of hyperinflation that has plagued countries from Argentina to Zimbabwe. But what is more revolutionary is the greater bitcoin system itself, which not only allows there to be no central banker, but also makes many other innovations possible.
Bitcoin is essentially a decentralized ledger system. Until its invention, online digital payments had to rely on trusted third parties, like PayPal or Bank of America, to keep a ledger of accountholder balances. These are necessary to keep track of who owns what. If I send you $100 via PayPal, PayPal deducts the amount from my account and adds it to your account. Without such an intermediary, digital money could be spent twice. It’s not difficult to see how: Imagine that there are no intermediaries with ledgers and that digital cash is simply a computer file, just as digital documents are computer files. I could send you $100 by attaching a money file to a message. But just as with e-mail, sending you an attachment does not remove that file from my computer. I would retain a copy of the money file after I had sent it. I could then easily send the same $100 file to a second person. In computer science, this is known as the “double spending” problem, and until bitcoin it could only be solved by employing a ledger-keeping trusted third party.
Bitcoin’s invention is revolutionary because for the first time the double-spending problem can be solved without the need for a third party. Bitcoin does this by distributing the necessary ledger among all of the users of the system via a peer-to-peer network. Every transaction that occurs in the bitcoin economy is registered in a publicly distributed ledger, which is called the blockchain. New transactions are checked against the blockchain to ensure that the same bitcoins haven’t been previously spent, thus eliminating the double-spending problem. The global peer-to-peer network, composed of thousands of users, takes the place of an intermediary; you and I can transact without PayPal or any other central authority.
The fact that bitcoin is a distributed ledger makes it much more than just money. As Jim Harper hinted, it is also a payments system, which is something separate and apart from money. Seashells and cows can be money, but they can’t be payment systems on their own. And because it is a distributed and decentralized payments system, bitcoin is censorship-resistant.
In late 2010, after WikiLeaks began releasing its trove of State Department cables, many individuals sought to show solidarity with the group by making a donation to it. They found, however, that many payment processors, including Visa, MasterCard, and PayPal, would not remit money to WikiLeaks as a result of U.S. government pressure. PayPal even froze the group’s account so that it could not access funds it had already collected.
“Hey, Visa, Mastercard, Paypal: It’s MY money,” media critic Jeff Jarvis tweeted at the time. “How DARE you tell me where I can and can’t spend it?”
Yet as long as you rely on an intermediary to transact, it can indeed tell you how you can and can’t spend your money. This is why governments seeking to control online activity tend to regulate not end users, but intermediaries. For example, online gambling and sports betting is perfectly legal in countries like the UK, Ireland, and Australia, and residents of the U.S. will have no problem reaching the websites of gaming sites from those countries. Placing a bet is another matter, however, because the Unlawful Internet Gambling Enforcement Act of 2006 requires payments systems to block transactions to online gambling sites. And the rightfully defeated Stop Online Piracy Act would have worked in much the same way by requiring payment processors to block transactions to persons merely suspected of piracy.
By decentralizing the ledger, the bitcoin protocol leaves governments with no intermediary to regulate. Even if bitcoin fails as money, perhaps because it proves not to be a good store of value, it can still be a censorship-resistant payments system.
And it doesn’t end there. The fact that bitcoin is a distributed ledger means it is a protocol that allows for a vast number of other decentralized applications beyond payments. Bitcoin is not just one thing—not just money or a payments system—but a platform on top of which other layers of functionality can run, much like the Web or e-mail are applications that run on top of the Internet’s foundational TCP/IP protocol. It therefore has the potential to spawn any number of other services that are decentralized, and thus difficult to regulate or control.
For example, bitcoins are ultimately tokens (like cows or seashells) that are imbued with whatever value we agree they represent. To date, bitcoins have mostly tended to represent national currency values at a market rate, but there is no reason why particular bitcoins (or infinitesimal fractions thereof) could not represent a share of stock, a bond, an IOU, or a piece of real property. In this way, the bitcoin protocol, as a distributed ledger, could facilitate decentralized stock and bond exchanges, credit markets, or property registries.
As Robert Graham has pointed out, essentially anything that can be done with a ledger can be done on top of bitcoin, except without having to rely on intermediaries. He gives the example of bitcoin as a decentralized notary service that allows anyone to verify that a document existed at a certain point in time. Let’s say you have written a movie screenplay and before you shop it around in Hollywood you want to record that you had it first. To accomplish this, you can add the document’s cryptographic signature to the blockchain, bitcoin’s public ledger. If someone ever claims the screenplay as their own, you can point to the blockchain to prove you had it first.
Perhaps most interestingly, bitcoin could facilitate decentralized futures markets, whether for betting on stock or commodity prices, sports, elections, or anything else. One could publish to the decentralized ledger a prediction about the future and the amount one is willing to bet, and someone else could publish a message accepting the bet. At that point, both parties would be committed to the transaction, and when the event came to pass, the network would confirm who owns the wagered bitcoins, just as it confirms any other transaction. This could all be accomplished without relying on a betting site or any other easy-to-regulate intermediary.
The predictions market Intrade, a darling of academic economists and political scientists, recently ceased operations after it was sued by the Commodities Futures Trading Commission. And futures in motion picture box office receipts were prohibited by the Dodd-Frank financial reform legislation, shortly before Senator Chris Dodd decamped to become head of the Motion Picture Association of America. A predictions market built as a peer-to-peer network on top of bitcoin, however, could not be easily shut down or regulated, nor would there be an operator that could run away with user’s funds, as is also alleged of Intrade.
One could go on citing examples of imaginative potential uses of a decentralized ledger like bitcoin, including censorship-proof messaging and broadcasting, a decentralized domain name system, and much more. The bottom line, however, is that bitcoin has the potential to be much more than just digital money. It is a platform for financial and informational innovation that is open to anyone and everyone without needing to get permission to experiment.
The potential benefits to the economy and for liberty are profound, but such as system also threatens the authority of states. The few examples I’ve related touch on the regulatory jurisdictions of the Treasury Department, the Securities and Exchange Commission, the Commodities Futures Trading Commission, the Consumer Financial Protection Bureau, various state regulators, and probably also the Internal Revenue Service. These entities are beginning to assert their authority in the face of the challenge posed by decentralized currencies.
While it is true that bitcoin’s decentralized nature make it virtually impossible to shut down or regulate, it would be naive to think that governments could not substantially raise the costs of using it and slow down its development. As Jim Harper says, the choice is not whether to have digital currencies, it is whether we will have them the hard way or the easy way. The same goes for all of the decentralized applications a system like bitcoin enables. This is why it behooves us to begin to educate policymakers about what is coming so that we can avoid the hard way as much as we can, and begin to enjoy the benefits as soon as possible.