Sunday, December 29, 2013

Bitcoin Analysts Contribute to a Post-Legal Tender Age

By Jon Matonis
Monday, December 23, 2013 

The year 2013 saw at least three bitcoin analyst reports from financial investment firms, an astonishing achievement for a young five-year-old digital currency. In some economic circles, bitcoin has slowly entered the ‘reserve currency’ lexicon.

Are we entering a post-legal tender era, where the provision of money is determined by the market and not by central bankers? Why do we see mainstream analysts reporting on price and economic impact for bitcoin when we never really saw that with other digital currencies?

The reason is simple – previous digital currencies were not decentralized with an independent floating exchange rate and they did not operate beyond confiscation.

Examples such as Digicash and e-Gold were brilliant proofs of concept, but their centralized nature also offered a single point of failure. Governments are not going to accept a challenge to their monetary authority if they don’t have to.

In a paper entitled “Regulating Digital Currencies: Bringing Bitcoin Within the Reach of the IMF,” Nicholas A. Plassaras suggests that the International Monetary Fund is ill-equipped to handle the widespread use of bitcoins into the foreign exchange market, highlighting the inability of the Fund to intervene in the event of a speculative attack on a country’s currency by bitcoin users.

He also hints at some of the tools that the IMF may consider deploying in the face of the global bitcoin challenge.
That academic study was followed by three analyst reports from the institutional investment industry. Together, all four studies solidify bitcoin’s maturity into a new and unique asset class with broad implications for both fiscal and monetary policy.

On 31st July, BBVA Research released “Bitcoin: A Chapter in Digital Currency Evolution” which concludes that bitcoin is here to stay and that the regulators and financial institutions embracing bitcoin early will likely become the leaders of the future digital monetary system.

On 1st December, Wedbush Securities released “Bitcoin: Intrinsic Value as Conduit for Disruptive Payment Network Technology” by Gil Luria and Aaron Turner.
The report observes three key sources of demand for bitcoin:
(a) as a disruptive payment network technology,
(b) an alternative uncorrelated asset class, and
(c) a safe haven currency.
Additionally, the report states that bitcoin represents another potential low-cost funding method for PayPal, leading Wedbush to predict “that with more regulatory clarity PayPal would likely embrace bitcoin.”

On 5th December, BofA Merrill Lynch Global Research published “Bitcoin: A First Assessment” by David Woo, head of global FX and rates strategy. Since Woo is considered to be one of the leading currency minds on Wall Street, his 14-page report represents a massive endorsement for bitcoin.
Woo states:
“We believe bitcoin can become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money transfer providers. As a medium of exchange, bitcoin has clear potential for growth, in our view.”
Placing a $1,300 price target on bitcoin, he also identifies the three things that need to happen in order to justify the current bitcoin valuation – it will need to account for at least 10% of all global e-commerce B2C transactions, become one of the top three players in the money transfer industry, and acquire a store of value reputation close to silver.

As a contra indicator, the Bank of America Woo report can probably claim responsibility for diffusing the most recent bitcoin rally that took the cryptocurrency to an intraday high of $1,156.00 on the CoinDesk BPI.

As we gradually enter a post-legal tender era, it behooves us to examine the possible implications for fiscal and monetary policy within a bitcoin economic environment. This article focuses on fiscal policy while a future piece will focus on monetary policy.

Aside from the beneficial wave of new job creation and economic opportunity, bitcoin as a competitive and successful monetary unit influences some pretty substantial adjustments forthcoming to fiscal policy.

High on the list, of course, is the effect on true income determination and the resulting taxation policy. A growing army of bitcoin independent contractors and informal merchants selling labor and goods will operate off-the-grid, adhering to the same honor system that exists for paper cash today.

To fill State coffers, it is likely that the bulk of tax revenue from individuals will shift from taxing income to taxing consumption (or spending).

Good riddance. A progressive income tax is one of the fundamental tenets of Marxism and it holds back incentives for innovation and achievement.

Far more likely in a bitcoin environment would be heavy taxes on consumption, which are regressive in nature but also more equitable than progressive taxes. The ease of bitcoin merchant identification and point-of-sale audits makes consumption taxes nearly inevitable for a worried nation-state with diminishing revenue.

Other fiscal policy impacts revolve around how the spending beast will be starved by a lack of sufficient revenue to pursue global military adventurism and other unpopular spending programs made possible only by the ability to print prosperity.

The arrogance of control maintained through the unlimited issuance model of the world’s reserve currency will be dealt a mighty blow.

For the first time in modern history, a government will actually be forced to justify why they want to increase direct taxation and to demonstrate why that particular activity should be funded. Consequently, everyday people will become more empowered in the government actions executed under their name.

However, many in society will be left behind by this monumental shift of real wealth leaking out of national fiat currencies, because people have largely underestimated the widespread, latent demand for a non-political currency.

Joerg Platzer, founder of Crypto Economics Consulting Group, encourages individuals to start preparing for this day in advance to ensure economic survival. He also emphasizes the need for governments to be honest and to anticipate the vast swath of society that will simply be impoverished after the great wealth transfer to a cryptocurrency society.

Further economic thoughts on the cryptocurrency and free banking space will undoubtedly be filled out by other bitcoin economic thinkers, such as Peter Šurda, Konrad Graf, JP Koning, and George Selgin.

Thursday, December 26, 2013

Bitcoin Ideology and the Tale of Casascius Coins

By Jon Matonis
Tuesday, December 17, 2013

A weekend article in The New York Times examined the ideological underpinnings of the bitcoin cryptocurrency. While the article got most of it correct, it missed some additional principles that are core to the adopters of bitcoin.

First of all, a vote for bitcoin is essentially a vote against the established monetary order with its centralized authority, legacy infrastructure, and diminishing financial privacy. Moreover, it is also a vote for an individual’s choice in currency and freedom of transaction without payment blockades and surveillance. To both the technical and non-technical, bitcoin represents fungibility, irreversibility, and user-defined privacy.

As The New York Times pointed out, additional facets that bitcoin adopters find attractive include how bitcoin demonstrates the absurdity of a central bank’s unlimited issuance model and the irrelevancy of self-serving capital controls.

A decentralized cryptocurrency separates a functioning medium of exchange from state control.

Nothing illustrates this more starkly than a physical bitcoin on a coin-shaped metal disc, which could be considered a negotiable monetary instrument in some jurisdictions. Lately, bitcoin has appreciated so much that the older 10 BTC and 25 BTC Casascius coins must now be declared to US Customs when entering or exiting the US.

FinCEN’s involvement

On November 27th, Casascius founder Mike Caldwell received a letter from FinCEN, the US Treasury bureau responsible for safeguarding the financial system from illicit use and combating money laundering. The letter implied that his three-year-old business of selling coin-shaped pieces of metal could be defined as a money services business requiring registration with FinCEN and possibly registration with the money transmitter regulators in each individual state.

The FinCEN claim rested largely on the premise that Caldwell had no way of verifying that the coins were being shipped to the same person, or persons, that purchased the items with bitcoin. Caldwell believes that the coins should be viewed as collectibles.

Subsequently, Caldwell suspended operations of his coin-shaped metal business and ceased taking orders for purchases of new product. He also engaged legal counsel to ascertain if his business was indeed acting as a money transmitter under the law.

In telephone conversations with Caldwell, he reiterated to me that the ongoing operation of his business was secondary to establishing the important freedom-to-contract principles and choice in currency principles.

According to Caldwell, he took the drastic step to suspend as a precaution, however he does not believe that he is in violation of any existing laws as he is only sending empty private keys in the mail.

Business model

Under the current business model, Casascius receives an order and the payment received does not involve any US currency or any other countries’ currency. He accepts bitcoin for the sale of a round metal disc with a private key attached under a hologram. The strong reputation of Casascius and its process is paramount to the success of a physical bitcoin, because it involves trusting the integrity of a third party.

During shipment, the coin-shaped piece of metal is valueless and corresponds to a bitcoin address containing zero bitcoin. When the recipient receives the coin-shaped piece of metal, an appropriate amount of bitcoin is transferred to the corresponding public key, or bitcoin address.

In an alternate approach, Casascius could send the coin-shaped metal and allow the recipient to initiate the transfer of bitcoin to the corresponding bitcoin address, thereby removing Caldwell from handling the bitcoins at all. In that scenario, Caldwell would not be handling US dollars or bitcoin so it would be difficult to see how any possible money transmission was occurring.

Recalescence Coins, LLC in Port Orchard, WA has already moved to the model of selling blank coins as a result of the FinCEN letter received by Casascius.

Caldwell and his attorney plan on responding to the FinCEN letter, describing their process and outlining a satisfactory business model.

Casascius uses brass tokens in the shape of a coin. Another business based in the UK sells similar coins. Other companies could just as easily use rectangular plastic or special paper to store a hidden private key. They could even be divided, sent separately, and re-joined later to form a complete private key. However, the requirement to separate a private key would mean sending empty private keys in the mail somehow represents a form of money transmission which it does not.

Form factors

Also, form factors matter legally, or they should. Phil Zimmermann faced a somewhat similar situation when he could not export his email encryption program, Pretty Good Privacy (PGP), due to US restrictions on the exporting of encryption with “munitions-level” strength. A group of volunteers then transcribed the computer code line-by-line into a book format to export PGP as a book to be re-transcribed and compiled on the other side.

Money is the speech of commerce and “we need freedom of speech in our financial commerce,” says Mike Gogulski, a stateless ex-American living in Bratislava, Slovakia.

The Liberty Dollar case exemplified how far a government will go when alternatives to the compulsory unit of account begin to emerge. The Liberty silver coins containing real silver were embarrassing to the government that was issuing the fake silver coins, so the public had to be protected from thinking that the real silver coins were actually money. Huh? Government prosecutors in the case laughingly described Bernard von NotHaus as representing a “unique form of domestic terrorism“.

All money is an illusion at some level, because like language and religion, its proliferation and success depends on growing adoption from an increasingly larger pool of adherents.

The creator of the Bitcoin protocol gave the world a method to conjure up its own monetary illusion. The reason this is a gift is because, prior to bitcoin, other monetary illusions depended either on legal tender laws for their illusory value or physical objects like gold and diamonds which are easily confiscated.

Bitcoin put the power of “survivable” money directly in the hands of the masses. It is a testament to bitcoin’s survivability that it still exists today.

Bitcoin is not permitted to exist because various governments are bitcoin-friendly or pledge to support innovation. Bitcoin exists today precisely because it is distributed and decentralized, designed to outlast political institutions.

And, it is beyond confiscation because it is digital. If it could be eradicated, it would have been eradicated as soon as it broke out of its niche market with a few pizza deals back in early 2010.

I understand from sources that approximately twelve such letters were issued by FinCEN in the last 30 days. If so, the purpose hopefully is to better understand these bitcoin business models and not just to use impressive letterhead in persuading voluntary business suspensions. In the case of Casascius, I fear the latter.

Monday, December 9, 2013

Why Bitcoin Fungibility is Essential

By Jon Matonis
Sunday, December 1, 2013

What is the essence of bitcoin fungibility and why is it so important?

Fungibility refers to the concept that every unit or subunit remains equivalent and identical to any other unit or subunit. It is the property of a good or commodity whose individual units are capable of mutual substitution.

For instance, one bitcoin is considered the same as any other bitcoin when it comes to price and acceptance. Gold bullion has fungibility with identical degrees of fineness or purity. Government paper cash has fungibility provided that the bills have not been marked or serial numbers have not been ‘blacklisted.’ In other words, you cannot be held responsible for the historical path of that banknote prior to its acceptance by you.

Herein lies the controversy. Should you care where your money came from and how does a monetary system cope with the resultant risk placed upon the bearer?


Recently, it has become fashionable in some bitcoin circles to suggest that blacklisting, or the more palatable term of redlisting, can be implemented to discourage the large-scale stealing of bitcoin wallets or even the ransom demands of petty criminals like CryptoLocker. Either way, it boils down to some form of coin validation with the more insidious side effect being government collusion with the coin validators for purposes of linking individuals to all of their transactions.

A related Scottish monetary case from the 1700s suggests that coin validation is a misguided premise. Fortunately, the judges in that case upheld the principle of unrestricted fungibility. Altering the monetary framework through blacklisting, redlisting, whitelisting, or any variant of subjective taint measuring would have catastrophic implications for the integrity of the financial system, thus detrimentally impacting economic prosperity for the whole.

Although opt-in efforts at sanitizing bitcoin or ensuring proper clean coins will inevitably emerge in a free market, that does not mean they are necessarily beneficial for the larger bitcoin economy and the principles of a non-politicized monetary unit.

Technical solutions

Fortunately, the political and market-based efforts to disrupt the integrity of a digital currency will be met with high-powered technical solutions, effectively rendering coin validation techniques useless in a sea of powerful circumvention.

Anonymizing and mixing solutions such as Zerocoin, CoinJoin, and SendShared will proliferate and encompass a larger and larger portion of overall bitcoin transactions despite the politics.

Bitcoin core developer Gregory Maxwell commented on the recent coin validation efforts:
“To stop this nonsense we have to make it impractical to pull off by changing the default behavior in the bitcoin ecosystem. We consider the lack of a central authority to be an essential virtue, which means that we can’t be protected by one either. We must protect ourselves. This means things like avoiding address reuse, avoiding centralized infrastructure, adopting— and funding!— privacy enhancing technology.”
Distributing mining and Hashcash creator, Adam Back, was simply astonished, exclaiming: “Their technical representatives of Coin Validation should be ashamed. How can someone who doesn’t understand a concept as basic as fungibility and its relation to transaction costs, and the difference between identity and coins hope to exist in this ecosystem.”

Harming bitcoin growth

Private sector attempts at promoting coin validation to seek favor with regulators are doomed to failure, because Bitcoin operates as a worldwide network with a border-less monetary unit. At the jurisdictional level, economies that embrace coin validation knowingly erect barriers to the free flow of digital capital and restrict the beneficial properties of bitcoin-induced growth in that particular region. It would be similar to “blacklisting” that entire jurisdiction from the world economy.

With the Unites States at an embarrassing 2% of all worldwide exchange volume for bitcoin trading, I cannot imagine that government authorities would want to take any steps which make the jurisdiction even less appealing.

Quite the opposite would be the economically sound position for US regulators to take.
If Director J. Shasky Calvery at FinCEN were sincere about attracting bitcoin-related companies to the US and not inhibiting innovation, she would have FinCEN make a public pronouncement that banks in compliance with existing AML laws and KYC guidelines have nothing to fear from engaging in business with bitcoin companies.

Additionally, FinCEN should state explicitly that it rejects coin validation and any other attacks on unrestricted fungibility for bitcoin, because this would undoubtedly taint the jurisdiction.

This type of leadership action would accomplish two objectives. First, it would serve to establish the longer-term principle that bitcoin trading does not require regulation as a government-issued financial instrument (as other jurisdictions have done).

Secondly, it would lift the cloud of the chilling effect emanating from one of the country’s leading law enforcement agencies, which we all know is an obtuse method to control and gain preemptive compliance in an extrajudicial manner.

User reaction

At the economic level for bitcoin businesses, any exchange or merchant that attempted to launch or participate in a coin validation scheme would find themselves largely shunned by the user community. Given such massive disapproval from the bitcoin user community, organized boycotts against certain companies could become a reality.

Conversely, any exchange or merchant that rejected coin validation schemes or redlisting would experience a dramatic increase in business volume. This fact alone should produce a stabilizing effect due to the incentives aligned against the validation trolls.

Protecting the core Bitcoin protocol, including unrestricted fungibility as it relates to bitcoin transactions, mining, and acceptance, requires vigorous defense of bitcoin transactions that are free from third-party validation because such validation jeopardizes overall fungibility and creates transactional friction.

Proactively, I call upon the Bitcoin user community and Bitcoin infrastructure companies to oppose any initiatives that attempt to undermine bitcoin fungibility and to support solutions that promote the broad adoption of privacy enhancing technologies for bitcoin.

However, do not worry, for bitcoin fungibility is inherently protected by design. If all else fails, there is always the ultimate solution to “fork off” the debilitating, validation-seeking Govcoin chain and become free again.

Sunday, December 8, 2013

Exante’s Bitcoin Fund Reports YTD Performance of 4,847%

By Jon Matonis
Monday, November 25, 2013

Although technically launched in late 2012, Malta-based brokerage Exante released their 2013 year-to-date (YTD) performance statistics for The Bitcoin Fund last week. Listed in Bloomberg’s Comparative Fund Analysis section, The Bitcoin Fund came in with a 4,847% return, leading its peer group by a wide margin.

The closest funds in the comparative analysis registered a year-to-date performance of 33.7% and 25.4% respectively. The Bitcoin Fund gives institutions and high-net worth individuals easy, secure and rapid access to the vibrant bitcoin market with a unique licensed product.

The company also offers a reliable secondary market for the trading of fund shares on both a long and short position basis. Recognising that speculative bitcoin trades exceeded transactions for goods and services by 20 to 25 times in the latest quarter, Exante co-founder Vladimir Maslyakov told Bloomberg that:
“The real economy is not growing as fast as the price, speculators are usually much faster.”
It is impossible to know with certainty the motives behind a trade (or if liquidity-enhancing speculation is even detrimental), but this new chart from attempts to measure the ratio of trade volume to transaction volume, as explained by David Perry.

However, this imbalance is expected to adjust as Bitcoin has now surpassed PayPal and Discover to become the world’s fifth largest payment network by daily transaction volume, as measured by Coinometrics.

Lately, increasing demand for bitcoin has been driven by China which recently eclipsed the US in active bitcoin nodes on the network. This rapid price appreciation tends to put pressure on bitcoin-related startups because entrepreneurs must increasingly justify how a placement into their company will yield a higher rate of return than simply investing straight into the digital currency. Building out the ecosystem benefits everyone.

Arguably, bitcoin represents a binary investment: either ultimate success as a world reserve currency, or capitulation to a zero price point.

The key challenge for venture capitalists and startup investors will be to leverage any investment into a scalable infrastructure company for dual participation by maintaining asset balances denominated in bitcoin. It would be counter-productive to financially support a bitcoin ecosystem company without also supporting the underlying base currency.

Union Square Ventures’ Fred Wilson seems to miss this point when he declares that his primary interest in Bitcoin is its ability to become the “financial and transactional protocol” for the global Internet, and that he and his firm own very little bitcoin. Wilson makes this statement as if Bitcoin can achieve the lofty protocol role without any impact on the monetary value of the underlying base currency unit.

It is almost as if he believes that USV’s portfolio company Coinbase will be better off by converting bitcoin-operational proceeds into US dollars and keeping balance sheet assets in US dollars. Unfortunately, I suspect this is the case at Coinbase.

Meanwhile, the Exante Bitcoin Fund’s assets under management currently total over $35m and the fund does not charge a performance-based fee because there is no discretionary management or use of leverage. However, there is an annual management fee of 1.75% as well as a 0.5% transaction fee.

Exante is regulated by the Malta Financial Authority and, as of 18th November, the value per unit of the Bitcoin Fund was $658 where one unit equals one bitcoin. Exante is not alone in the bitcoin fund business, since SecondMarket launched the private, open-ended Bitcoin Investment Trust (BIT) in September 2013.

The private investment vehicle is based in the US and open to institutional and accredited individual investors. SecondMarket also intends to facilitate two-way trading of the trust shares on its proprietary platform to enable both long and short positions. Barry Silbert, CEO, said:
 ”US investors, including wealthy families, are allocating more of their investments into Bitcoins in order to diversify portfolios.”
Silbert also confirmed that he’s working with Pensco Trust Co, Entrust Group Inc and Equity Trust Co to offer investors the ability to purchase bitcoin for individual retirement accounts. In a little under two months, SecondMarket’s Bitcoin Investment Trust has already attracted $46.8m under management.

Thursday, December 5, 2013

Financial Services Club in Vienna

On December 3rd, 2013, I participated in my first Financial Services Club meeting. The event was held at the stately Residence of the British Ambassador to Austria in Vienna.

The panel discussion was “Virtual Currencies” – a phenomena, a trend or future money? moderated by Thomas Labenbacher, Chairman of the Financial Services Club CEE.

This will be a Panel Discussion Thomas Labenbacher - Chairman of the Financial Services Club CEE will moderate the panel - See more at: