the avanti group
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Bitcoin itself is largely based on hashcash, a ‘proof of
work’ scheme proposed by Adam Back in the
1990′s as a way to stop spam. The idea behind hashcash was
to increase the cost of sending email to
the point that spam became uneconomic by requiring each sender
to perform a quantity of
computational make-work.
Before the rise of Bitcoin in 2009, the most successful
scheme of this kind was E-Gold, which operated
from 1996 until it was shut down by the Secret Service in
2007. E-Gold tapped into the libertarian
ideology of anonymous cash, but their technology fell far
short of the rhetoric. E-Gold wasn’t really
anonymous, and wasn’t even located outside US jurisdiction.
The company was registered in St. Nevis
and Kitts, the datacenter was located in Florida. The idea
that E-Gold somehow operated outside the
scope of US regulation was a spectacular example of
self-delusion by their management.
E-Gold wasn’t an anonymous currency as such, it was an
exchange that allowed customers to transfer
ownership of gold between them. Which was sufficient to
allow its use as a means of avoiding
government controls on money transfers. When the system was
shut down, some of the largest
complaints came from Iran, where citizens had been using it
to evade US sanctions, and were left
unable to access the money in their accounts.
The E-Gold episode had two curious aspects. One is that the
exchange was permitted to operate for so
long, when it was obvious that it was operating illegally.
In my work stopping Internet frauds, I would
meet Secret Service, FBI and Postal Inspectorate officers on
a regular basis, and the conversation would
almost always turn to the ongoing mystery of why the scheme
was allowed to keep running.,,The
authorities did not act until their hand was forced by the
collapse of ‘Solid Investment,’ a Ponzi scheme
that had made extensive use of E-Gold to conceal money
movements.
Another mystery is the sentences that the perpetrators
received. Instead of 10 years in jail and a
$500,000 fine, the CEO received 300 hours community service,
six months home detention and a $200 fine. It is difficult to imagine that one
of two things didn’t happen. Either the organizers of the
exchange coughed up some very valuable information as part
of their plea bargain, or the cooperation
with the authorities had begun long before the exchange was
finally shut down.
Many people in my field suspected that E-Gold was allowed to
operate because the Fed preferred to
have the money laundering activity happening in a flawed
exchange, than see the rise of a genuinely
anonymous electronic cash system. If so, the concern was
justified. The rise of Bitcoin came hard on
the heels of the collapse of E-Gold, and Bitcoin’s promise
of anonymity is backed by some real
cryptography.
If I had had the good sense to ignore the libertarian
ideology surrounding the launch of Bitcoin, I might
have bought a thousand bucks worth when the coins were
fetching $0.02 each. Such a stake would be
‘worth’ $6.25 million today. Who knows what Bitcoin might be
worth tomorrow? The answer could be
$250 or it could be $0.00. Nobody knows because Bitcoin is a
currency without any intrinsic value.
Unlike a government minted currency, you can’t use Bitcoin
to pay taxes or pay fees for government
services. Unlike bank issued scrip, there is no promise to
redeem Bitcoin in gold or specie.
This lack of intrinsic value had initially led me to dismiss
Bitcoin as broken. But I now understand that it
is the real genius of the scheme, as it allows the value of
Bitcoin to soar as long as there are more
punters eager to throw money into the expanding bubble. In
effect Bitcoin replaces both the E-Gold
system and the Solid Investment Ponzi scheme in one stroke.
The Bitcoin bubble is even better than a Ponzi scheme or a
mere stock bubble as there is no
expectation against which the performance of Bitcoin need to
be measured. The ‘value’ of Bitcoin will
increase for as long as there is more demand to buy than to
sell. As long as the value of Bitcoin
appears to be increasing in value (or at the least not
losing value), Bitcoin users are encouraged to
keep part of their funds in Bitcoin.
Another factor that encourages Bitcoiners to keep their
money in the system is the sheer difficulty of
transferring money in and out. This is largely due to US
government actions that have shut down many
of the ingress and egress portals in the Bitcoin ecology.
Barclays Bank in the UK and the Dwolla money
transfer service have already closed the accounts of Mt Gox,
the largest Bitcoin exchange. The lowest
cost means I could find of transferring $1,000 into MtGox
from the US would cost me at least $50,
possibly more (the sites are not exactly transparent about
fees). Allowing for another 5% overhead to
transfer money out, Bitcoin is an expensive way to move
money.
If Alice offers to pay $20,000 in BitCoin to Bob for his
crack cocaine, the actual value of the Bitcoins
themselves does not matter very much to either party as long
as Bob is reasonably confident that it
won’t drop too much before he can redeem his coins for cash.
Traditional money laundering techniques
such as buying and selling valuable goods can easily eat up
more than half of the amount transferred.
BitCoin does not need to be perfect to gain users, it just
needs to be a little more efficient than existing
options.
As far as the use of Bitcoin as an exchange medium is
concerned, the nominal price of the coin does
not matter except to the extent that the current price of
about $125 makes it impossible to use BitCoins
to buy a hamburger. But not to worry, the Bitcoiners insist,
we can make change! What they don’t
mention is that once change is added into the system, the
cryptographic proofs of anonymity that the
system purports to offer become faith based.
You can watch Bitcoin transactions in real time at
blockchain.info. Some of the transactions are quite
high value.
In the last hour (as of this writing) there were ten trades
over $50,000, one of which was for
$669,999.05. Just what is the economic activity that is
driving all these trades? Given the cost and
inconvenience of transferring money into and out of the
BitCoin system, one might be tempted to
presume that much if not most of the economic activity is
criminal.
Many of the customers left with money stranded in E-Gold
accounts lived in Iran. Last year the
administration ratcheted up sanctions against Iran to an
unprecedented level, attempting to sever
Iran’s connections to the international banking system.
These sanctions have limited effect on the
government, which can make alternative arrangements, but the
private sector is left to fend for itself.
Bitcoin provides the Iranian merchant class with an escape
mechanism.
As with E-Gold, the question is not whether US authorities
will act, but when, how and whether the
action will be effective.
The first blows have already been struck as the Department
of Homeland Security has begun legal
action against the Dwolla payment service, pressuring them
to stop Bitcoin transfers to Mt. Gox. US
currency reserves held by Mt. Gox were also seized for
failing to register with the Financial Crimes
Enforcement Network.
On Wednesday, DHS moved against the Costa Rica based ‘Liberty
Reserve’, another anonymous
payment transfer scheme, that also served as a means of
transferring money into and out of the
Bitcoin system. Arthur Budovsky, the founder of Liberty
Reserve was already on the run from a five year
prison sentence, reduced to probation, for his involvement
in an E-Gold like scheme called Gold Age.
The DHS began its action against the gold-based exchange
schemes from the bottom up, taking out the
small players like Gold Age before the raid on E-Gold. It
seems likely that enforcement action against
the Bitcoin system is following the same pattern.
Bitcoiners assure me that their system is government proof,
but I have heard the same arguments
about crypto-anarchy for years, and law enforcement has won
every single time the theories have been
tested.
Rolling up the Bitcoin system would be more difficult than
the action against E-Gold and Liberty
Reserve, but not impossible. If all else fails, DHS can ask
Congress for legislation. It is unlikely that any
member apart from Rand Paul would object. The raid on
Liberty Reserve provides DHS with an excellent
pretext for legislation, and that may well have been one of
the reasons for the timing.
If DHS does not act soon, Bitcoin might become too
widespread to be stoppable. Iran is holding its
presidential election on June 14th, and there are several
important national days before that. The end
for Bitcoin might be coming quite soon.
The Avanti Group
prcode81345782170 TAG
