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Economy

Despite Mt. Gox collapse, stateless bitcoin could still change the world

TOKYO -- The innovations behind bitcoin protocols have as many supporters as naysayers.

Charlotte Bowyer

     Skeptics see disasters such as the bankruptcy of Mt. Gox as reason for bearishness. Supporters point to the underlying fundamentals of the bitcoin system and claim it has the potential to positively disrupt the global economy.

     The Nikkei recently interviewed by email Charlotte Bowyer, research associate of the Adam Smith Institute, about the characteristics and potential of bitcoin.

Q: Why are liberal economists so fascinated by bitcoin? Can it change the way society is maintained? How realistic is that?

A: Bitcoin is a game-changing innovation, challenging existing commercial, financial, legal, political and economic structures. It is a societal experiment as much as an experiment in currency. It is an incredibly interesting phenomenon, and has the capacity and potential to be every bit as revolutionary as the Internet.

     In particular, bitcoin is fascinating because it embodies new ideas of what a currency is and how it operates.

     When the bitcoin project first began, it was largely the plaything of computer scientists and politically ideological individuals. A number of mainstream economists were initially dismissive of bitcoin, and a number still consider it doomed to fail, with rises in price evidence of an unsustainable bubble.

     However, economists and commentators are generally becoming less skeptical. For example David Andolfatto, vice president of the Federal Reserve Bank of St. Louis, recently declared bitcoin a "stroke of genius."

     Bitcoin has the potential to shape the world in a number of ways.

     It can challenge existing political and economic systems. For example, bitcoin can be used to circumvent a country's capital controls, and if enough economic activity took place using bitcoin instead of an official currency, it could undermine a nation's monetary or fiscal policies. It can also be used for political resistance, such as conducting illegal activities and accessing prohibited items.

Q: Computer scientists are excited because bitcoin is outside government control. Why is that so important?

A: Conventional currency is decreed legal tender by government law, and this is what gives it value. It is created by a central authority, and the money supply includes coins, notes and demand deposits. In contrast, bitcoins are essentially entries within a distributed ledger called the blockchain. All bitcoins exist as a record within this ledger, and buying, sending and receiving bitcoins result in movements across it.

     Whilst currencies are often specific to a country or geographical area, bitcoin is truly stateless.

     One of the most groundbreaking aspects of bitcoin is that no central authority is needed to approve or regulate transactions, nor is one needed to keep an accurate record of them. Instead, every computer connected to the bitcoin network downloads a copy of the blockchain. This is constantly verified, updated and synchronized with other computers, which reach consensus on the correct and longest version of the chain.

     Until the bitcoin protocol was developed, many computer scientists considered a distributed currency system to be impossible.

Q: How is this problem solved?

A: Bitcoin's use of P2P technology, public key cryptography and proof-of-work hashing combined with the incentive of seigniorage to maintain the integrity of the network is remarkable, and for the first time allows trust to be established among completely unrelated parties without the need for a central authority.

     The supply of a national currency is theoretically limitless, for governments can simply print more money to do things like pay down debts or stimulate demand. In contrast, both the supply of bitcoin and the rate at which it is created are algorithmically determined. Only 21 million bitcoins will ever be created, with the rate at which they're mined steadily decreasing until this is reached. Since this is written in its open-source code for everyone to see, it would be impossible for governments or any group to create more of them. This means that bitcoin is inflation-free, which makes the currency a theoretically good store of value.

     One-third of Americans and three-quarters of the world's poorest are "unbanked," with little or no access to traditional banking facilities and subject to very high financial fees. In contrast, creating a bitcoin wallet does not require a bank account, and so a bitcoin economy could thrive in the same areas an informal one does. Promoting bitcoin in such areas could create access to low-fee services and a range of goods to those previously denied them.

Q: Is the Mt. Gox scandal exceptional or could similar events happen in the future?

A: The Mt. Gox scandal was exceptional in the sense that its demise was due to internal issues and not because of an external problem with the bitcoin protocol itself. Whilst one of the biggest bitcoin exchanges, Mt. Gox was also known as one of the most vulnerable. Since its demise a number of experts have claimed that Mt. Gox's code was a mess and allowed exploitation, that the company lacked transparency and good governance, and that the exchange was ill-equipped to handle such high volumes of transactions.

     It must be remembered that bitcoin is still a new and experimental venture, and that programmers, entrepreneurs and developers probably have lots more to learn. It may well be that another company will run into difficulties. However, a process of discovery and failure is far from unique to bitcoin, and creative destruction occurs across all industries. The important thing to remember is that as of yet, nobody has discovered a catastrophic flaw within the bitcoin protocol itself.

Q: What can be done to prevent bitcoin use by criminals or terrorists?

A: To be honest, it is impossible to make sure that bitcoin will never be used for criminal ends. However, things can be done to minimize this type of use.

     The shutdown of Silk Road showed that it's possible to use existing law enforcement procedures to deal with criminal bitcoin activity. Laws regarding money laundering can and have been applied to bitcoin, although it's not yet clear how successful these will be in securing convictions (or, indeed, whether these were justifiable charges in the first place).

     Furthermore, as the bitcoin ecosystem matures and technologies become more advanced, businesses are likely to develop their own ways of detecting criminal activity and ill-meaning users. On top of this, the same cybersecurity considerations exist as for other online payment systems and online businesses.

     In contrast, attempts to over-regulate or shut down bitcoin completely simply drive users underground, where they're much more likely to come into contact with criminals and illegal activity.

     In fact, since a record of all bitcoin transactions is publicly viewable, criminal activity in bitcoin is actually easier to trace than it is in cash. Because there's no personal information involved in a bitcoin transaction, a lot of the problems associated with credit cards, such as fraud and identity theft, simply aren't an issue when using bitcoin.

     It is also important to note that one country's criminal or outlawed organisation may elsewhere in the world be considered legitimate. There may be times (such as when it's used to undermine a corrupt regime) where "illegal" bitcoin activity should be celebrated.

Interviewed by Nikkei deputy editor Hidemitsu Kibe

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