Crypto Currency

So you think that money is the root of all evil? Have you ever asked what is the root of money? 

Ayn Rand

Yes, [we will not find a solution to political problems in cryptography,] but we can win a major battle in the arms race and gain a new territory of freedom for several years. Governments are good at cutting off the heads of a centrally controlled networks like Napster, but pure P2P networks like Gnutella and Tor seem to be holding their own. It's very attractive to the libertarian viewpoint if we can explain it properly. I'm better with code than with words though.

"Satoshi Nakamoto"

Computer software is an abstract concept for many. People generally have no idea how Facebook works, how emails get routed or how smartphones perform all their tricks. Developers do an exceptional job of abstracting away from all the low level details that underpin such software. What has software got to do with money though? Enterprising software developers have been at it again, creating a new money known as BitCoin (a dedicated wiki can be found here with further details). This article will not only attempt to explain this new concept that has the potential to revolutionise society, but along the way we will explore how the marketplace free of any Government interference, functions, and how this makes all of our lives better. Its an article of some length, so please ensure you have a large hot beverage at hand, take a breath; let us begin.

Let me start and re-hash what my previous articles have said; I am a firm believer in the fact that Governments should not be in the money business, such a task should be left to the free market. I've also discussed that consumers should select good money, be that commodity backed, in good faith or some clever new innovation that could only occur spontaneously from the free market. Individuals have attempted to challenge the State held monopoly of money by creating their own, a notable case is Bernard von NotHaus with his Liberty Dollar, however such activities have caused Governments to clamp down on challenges to their power. Governments don't like free money, shaking down individuals who challenge their 'wisdom'. Currencies issued from a central organisation will always be an easy target for the Government to shut down. 

Step forward a Cryptographic Currency known as Bitcoin, with the potential to revolutionise e-commerce and challenge the governments monopoly of money. It uses modern day Cryptography (Mathematics) to solve the conundrum of having a currency that is devoid of central control. The protocol functions in a peer-to-peer network. Rather than having a central third party checking the transactions to be correct, many users who are scattered all over the world perform such checks (known technically as miners). Think of it as the accounting ledger being public to all and distributed in such a way that everyone has access to it and works together to ensure its integrity. Integrity is also enforced by the difficulty of the Cryptographic problems. Anyone can then make anonymous transactions with the need for no financial intermediary, there is no third party. The buyer transfers the money direct to the seller. The coins themselves are cryptographic hash codes which are unique identifiers. With the use of public-private key pair technology these are then signed by the relevant parties. Miners then process transactions, validating that they are correct adding them to BlockChains (the accounting ledger). Each coin is unique and can not be double spent which is one of the key concepts that makes Bitcoin so unique. Up until that point digital currency systems were always susceptible to double spending and required a central third party to validate all transactions. Not with Bitcoin.

Want to know more. Here are some of the advantages:

Open Source Code
The code is open along with its theory, meaning it has been critiqued by a number of security experts around the world. It has no known flaws. It uses the same Cryptographic algorithms as your e-banking. The only flaws in e-banking are generally end users, or developers implementing the banking systems incorrectly. Therefore Bitcoin can be considered very secure.

Free from Inflation
Currently the currency grows at a predetermined mathematical rate, an algorithm that was purposely chosen to track the rate at which commodities, such as Gold, are mined. Eventually this will in all practicality stop with the supply never exceeding 21 million bitcoins. There is no corporation or political control over it therefore it can not be inflated. In this aspect it is even sounder than Gold. The Mathematics ensures it future scarcity.

People can now actually hold a currency that has the potential to not only retain its value but will appreciate over time. No need to worry about which is the best negative interest rate at your bank. Just keep your Bitcoins saved up and they will appreciate on their own, due to free markets increasing everyones purchasing power over time. I'm sure one day someone will create lending services, where users can lend their Bitcoins for a rate of return (legal property aspect would need to be explored) in a similar fashion to a Bank. Regular banks could take your Bitcoins, give you a rate of interest, lend this out to business for a slight profit. No doubt these areas will be gaps in the market that will be explored by the entrepreneurs as the money matures.

Peer to Peer Network
There is no central server for the network. Transactions are actually validated by the thousands of distributed servers, known as miners. This proof of work (the accounting ledger) is spread out among the miners who are rewarded with new coins created at a pre-determined mathematical rate. This proof of work, which is computationally expensive, makes it incredibly hard for someone to change the past or to double spend and corrupt the money. This distributed nature has great advantages. The Government can not physically shut it down (without shutting down the Internet). If they shut down one cluster of miners then others would join the network.

"No" (Low) Transaction Fees

Bitcoin cuts banks out all together. Its like dealing in cash but with all the benefits of electronic commerce. Banks no longer need hefty cuts for dealing with admin, bank managers, Government red tape and regulations. The third party is the mathematics. I'll cover the concept of low transaction fees later, suffice to say, its lower then any existing market offering.

No Double Spending
Coins can not be created out of thin air (excludes mining, which works on a pre-determined mathematical algorithm). Once a payment has been made it can not be reversed, nor can the coin or a wallet be copied and spent again. This keeps the system honest.

Cross Country E-Commerce
At present there can be boundaries from conducting trade between nations. As soon as you cross international boundaries fees can start to rise quite sharply. Bitcoin has no such limits, it doesn't matter if the person is half way round the world living in some totalitarian state. This is beneficial to nations who have been blocked from paypal or other credit card companies; the recent example of Wordpress now accepting Bitcoins shows how the currency can support free speech. No one on the network can tell you who not to pay, not even your Government. The currency itself is the ultimate liquid asset. Payment happens in seconds and becomes fully verified in minutes. I could pay someone in a country with strict capital controls or a nation that been blacklisted by paypal with no problem. Its just like Cash only with all the benefits of being digital.

Removes Political Censorship
Wikileaks is a recent example of where even Western Governments didn't like free speech and pressured payment companies to no longer process donations. Bitcoin allows free speech to prevail and Wikileaks now take Bitcoins as a form of donation. 

True Monetary Freedom
The most important feature of this new currency is the freedom is gives to people. Freedom to trade, free from inflation, free from currency or capital controls, inheritance tax (along with other forms of tax), free to manage your own assets completely free from a third party. Over time the money will no doubt be of wonderful value to society, however its the freedom of the currency that most appeals to me and is the most revolutionary concept it has created.

How it Began
The creator possessed the rare combination of being a Cryptography expert with Libertarian values. Known under the alias of Satoshi Nakamoto (a Japanese name, however people believe him to be British as he made references to the UK banking system) he built upon various ideas of others and created the first truly distributed free money. He created the protocol which others now maintain and the first thick client (a desktop application to create your own wallet containing coins). He did this because he wanted to. Not for money or fame, just because he believed it was the right thing to do. Individuals have other motives than money, despite what the left will tell you.

Since he gave his creation to the world he hasn't been seen since. However this is where others pick up and run with the system as it was all made open for other to contribute towards. 

So how do these Bitcoins work? How do I get hold of some? How can I store them? As detailed the coins themselves are in effect digital signatures that have been signed and verified by a network in a way that keeps everyone honest. These coins are stored in wallets. Wallets come in a number of forms and you can think of them just like your regular wallet that contains your cards and any cash you may be carrying. There are no limits to the number of wallets you can own, nor any limit on the size of your wallet (a wallet could contain an amount that is a fraction of a penny all the way up to millions of pounds). There are a number of options to store such coins.

Local Wallet
Local Wallets are created and stored on your local computer. This is how it started, the original client was written in such a manner (Bitcoin qt as it is known can be found here). Your wallet once it has some coins can be encrypted, meaning if someone does "steal" your wallet, they can't actually spend the coins without the password. This is the ultimate form of monetary freedom. You have complete control of your finances. If you want to spend money, it takes a matter of seconds to send to a seller. Likewise if you wish to receive funds then you can create an anonymous address and allow someone to credit your account.

However with great freedom comes great responsibility. If you forget your password, you can't access your coins, they are in effect lost. If your hard drive crashes and you didn't backup your wallet, tough, you've lost your coins. If your local machine becomes compromised by certain virus software, such as a key logger, and that person is able to log your password and ultimately have enough access to your system (and wallet), then again they could spend those coins (to their own account).

Then theres the problem of the client software, the original one for example took two days on my desktop to download the whole block chain (and when running in the background will considerably consume resources periodically as more transactions cross the network). Other clients are currently being released to solve such issues (Multibit is an example, I presume pruning the merkle tree) however then you find that Multibit doesn't support encryption yet (soon to be released I believe). Theres also the fact that you can't use these on Smartphones, or though a nice to use Web Interface. I can comprehend all the technicalities, so can others, but your average Joe will have a hard time. In order for the network to work, it needs to be made easier from a usability perspective (in fact this is just as important as the security, without usability the network will never gain mass appeal). This is where e-wallets step into the breach.

E-Wallet

Step forward the entrepreneurs amongst us. They could see all the issues above so set about solving them by taking away all the management involved, in effect assisting the end users in storing the coins securely and allowing non technical people to get started. E-Wallets have a number of advantages. You can access your money anywhere, anytime. You don't have to worry about backups, viruses or your personal computer being compromised. A third party will take care of such worries, for free. They generate their income based on either margins from buying and selling Bitcoins to their customers, advertising or some other source of income yet to be conceived. E-Wallets allow customers to access their coins on any computer system through an easy to use web interface, similar to your e-banking. They also supply applications for your Smartphone (due to its recent state predominately only for Android and iOS platforms). They take care of the all the intricate plumbing.

There is however a catch. E-Wallets were a first generation attempt to allow the majority of us to use bitcoins. Currently the bitcoin network has never had any weakness. Like I've said security weaknesses are the end users or the implementation of a system. There have been a number of notable cases where e-wallets have been hacked, the thief managed to gain access to the servers data which stored the wallet along with the private key and steal peoples coins. 

A Governments solution if they were aware of the Bitcoin platform, would be to condemn the service, stating more regulation was required in effect raising prices for consumers and stifling innovation. This is what always happens when Governments, Technocrats, Politicians and Commentators get involved. Thank God we have entrepreneurs, the people who do, as opposed to the people who talk. Enter the next solution.

Hybrid E-Wallet
One of the problems with e-wallets was that they stored all the data on the server, including the wallets private key (which could be used to gain access to someone's wallet - think of it like the key to your safe). If the central server was compromised then everyone's wallets were compromised. Another problem would be if the server went down, or even if someone attempted to shut it down, say the Government. All your coins would be tied up to that supplier with no way to get them back. New e-wallets, known as hybrids began to spring up. The concept was simple, try to solve the security issues of conventional e-wallets but maintain usability. Still not convinced?

A common attack was to gain access to the private keys in the central database. The solution therefore was to not store the private keys on the central server, instead run javascript on the client computer (your local machine) to generate the correct private key to open your wallet (hence the term "hybrid", you have in effect your wallet locally, but the server has all the APIs used to access your wallet). The server only stores the encrypted copy of your wallet, not the key to access it. Such third party systems in fact can not access your wallet, or your transactions and balance like a Bank or Government can. An overview can be found here. You own your wallet, all they do is provide a system that is far easier to use then a desktop client and store an encrypted version of your wallet. The disadvantage of course is if you forget your password, they can't help. In my view this isn't even a disadvantage. We all deal with passwords. If its important, write it down on paper and put it in a safe, share it with a loved one and so forth. I'm sure services will pop up that will store peoples passwords safely with ingenious security techniques that haven't been developed yet.

A popular hybrid e-wallet in the UK is BlockChain. The video below shows how ridiculously easy it is to create an account and pay someone. No paper work, proof of id, or admin - just trust in mathematics.

Before detailing the other superb security features of hybrid wallets I'd like to detail an example of why entrepreneurs are so important to economic development. BlockChain is a start-up conceived by someone called Ben Reeves. It is funded by the famous ycombinator start-up fund, that has made many a great company. He has done what many of us lack, realised the potential of a particular technology and begun to make this a usable for consumers. This is what Entrepreneurs do. They take future ideas, and turn them into accessible services. As great as Bitcoin is in theory, that's all it was a couple of years ago. You had to use desktop applications and manage all the security yourself, in that state no one was going to use it. It takes entrepreneurs (many others exist, similar to what Ben is doing with BlockChain) to take those services to the masses.

Steve Jobs was a great example of this in action. He was no engineer, but had an eye for value. He was the first to spot the value in Graphical User Interfaces and bring them to consumers, it was all stolen from Xerox. The iPod was just a copy of existing MP3 players that hadn't gained traction in the consumer market. Smartphones existed well before the iPhone, Bill Gates was trying to push tablets a decade before the iPad but Job's timing was impeccable. To achieve this Jobs stood on the shoulders of giants. OS-X which currently runs Apples computers exists because of Unix, a platform developed by engineers for engineers but not for consumers. No one can take away Steve Jobs brilliant talent for spotting value and making products accessible to consumers. That isn't to say he got everything right. He once famously remarked when Amazon brought out the Kindle that no one reads any more so they won't sell, and seven inch tablets would never sell - like all entrepreneurs its all trial and error. Bitcoin will be similar. All sorts of innovations created by entrepreneurs who spot gaps in the market will create new products to fill consumers needs. Lend/Borrow systems, Brain Wallets, send coins direct on Facebook further use of NFC swipe to pay with Bitcoins anywhere in the world seamlessly.

Back to the security, so what if it doesn't store the private key I still don't trust a third party with my money, you may say. BlockChain understands this. It doesn't want to lock you in. Young entrepreneurs are smart and realise the value they create is not in payment for their services, but for getting traffic to their servers, making money once they have the user base, similar to a Google business model. With a Hybrid wallet you can backup your wallet locally whenever you want. Alternatively you can send it to some other cloud storage solution, Dropbox, Google Drive your email account. You can have the backup copied automatically for every single transaction you perform, ensuring you always have the latest copy of your wallet (encrypted of course) at hand should the third party service disappear/go bankrupt.

The service also allows you to create a second password. This would then be requested whenever transactions are performed, ensuring in the unlikely case if someone gained access to your logon password and could look at your wallet they would not be able to transfer any coins. The coins are double encrypted with another private key a feature someone may wish to use with a savings account.

Two factor authentication is another security feature that is supported to further secure a wallet. When you login you would also be asked for a recent code that was sent to you. This can be either be through SMS, Email or Google Android Authenticator that runs on your mobile phone (meaning someone would need a physical device). It also supports Yubikey, similar to a physical key drive that provides a code to enter to your account. Again a physical device that is outside a hackers sphere. They only have access to data over cyber-space, not physical objects you possess. The service will only allow four password attempts if two factor authentication is enabled. If four failed attempts are made they will temporarily lock your account for a couple of hours and notify you that this has happened ensuring rough guess attacks are not attempted.

If you have a static IP address, you can lock your account to it (meaning a hacker would need to gain physical access to your actual computer).

You can create a physical paper wallet whereby your private key is printed as a QR code on a piece of paper. This means if your local computer is compromised with a virus or key logger software they couldn't see your password as your private key is stored at your house. You use your webcam to scan it in. Useful for long term savings accounts that you don't want to access or spend but wish to lock down. 

You can split your funds among multiple wallets, as there is no limit to the number of wallets you can own (I created around 3 to test - zero balances are fine). For small change you may wish to have little or no security, just a simple login password (similar to carrying cash) and for large savings wallets have many types of authentication detailed above - Bitcoin allows for many choices all down the consumer.

BlockChain also holds the majority of its code open source held in github meaning people can check for flaws and find bugs in it. All the code deployed to the servers is verified against known checksums to minimise malicious third parties changing the code. BlockChain provides local browser plugins that verify the local javascript that is run on your computer when generating your private key for login that I mentioned earlier.

In my opinion all Internet banking should be done on a secure system, preferably a non Windows device. I'd buy a Chromebook (if your tech savvy a recent Linux Distro will do). They run on Linux, a rock solid Operating System kernel that has been around for 20 years and is open source. Chromebooks give users minimal permissions meaning picking up malicious software is very hard. Verified bootup ensures any difference between boots are detected and a previous good copy of the Operating System is installed (the only way to hack this is to actually get physical access to the device and change the hardware - meaning its pretty safe). It runs the latest version of the Chrome Web browser, a very secure browser which is open source (constantly under the eyes of security experts with Google giving regular bounties to people who discover issues). Far more secure than closed source browsers such as Microsoft's Internet Explorer. The system is seamlessly kept up-to-date in the background. Why do a mention Chromebooks? Because consumer devices will continue getting thinner (not size, but in admin rights to the user). When people use computers, they don't want to update their OS, get anti-virus applications and check their firewall is up up-to-date. They want to turn on a machine and go. The Mozilla foundation have been working on a slimline smartphone OS, Firefox OS (based again on Linux), with the aim of making the phone a lightweight platform. No doubt Google will wish to eventually take Android (based again on Linux) in this direction, merging with Chrome OS, the operating system on Chromebooks.

All the above sounds complicated however Bitcoin is a platform and can be as complicated or simple as consumers want. Just as I have chronologically detailed how the platform for consumers has evolved within the short space of 3 years, in another several it will be even simpler and safer to use, the next generation of Bitcoin banks will emerge making payments effortless and efficient.

Bitcoin started with thick clients. Users had to keep this software up-to-date, download the complete BlockChain, ensure their computer was secure (Chromebooks were not around back then), deal with plaintext wallets, use third party software to encrypt them (in many cases use of a command line), back them up manually and so forth. You had to be a computer pro to do all this. As I have shown this state of affairs has now evolved into the fact you can login to a web interface, signup in a matter of seconds and you have a fairly secure wallet. As innovation improves so will usability along with security. 

Many have compared Bitcoin to the Internet when it first began and quite rightly for a number of reasons. Back when the Internet was in its infancy it was obscenely hard to use. No web browsers, graphical user interfaces, auto connect broadband wireless - it was just plain awful. However the basics were there a global interconnected network where people could share ideas and information. It took a decade later to gain mass public support and usability, now many rely on it as a service. The Internet was once dismissed as a toy for Geeks. Why do I need email, thats what the postal service is for? Why do I want to read something on a computer, thats what books are for? I think this quote best sums up how long it takes for new ideas to become mature enough for mass adoption,

"I predict that Bitcoin will reach usability sometime around 2019. I base that prediction on earlier disruption technologies, where blogging started appearing in 1994 and reached mainstream adoption in 2004; file sharing started in 1989 over the net and Napster hit in 1999. You had streaming video 1995, mainly porn sites streaming animated gifs, what was then tip of the spear technology; Youtube was founded 2005 and just swept the floor with everyone else just because they were usable. This is not something bad; it is just an observation that it takes ten years to get a disruptive technology from inception to becoming so easy to use that it reaches mainline adoption."
Rick Falkvinge

I'm sure there are other security options for e-wallets that I have missed but it gives you an idea as to the thought that has gone towards security. I bet many of you use internet banking, Paypal or whatever. How secure do you think your conventional banking is compared to all this detailed above (did I mention BlockChain also uses conventional TLS HTTP encryption on top of all the rest)? Sure, the Government protects your money but in the same breath they are secretly confiscating your funds through inflation and negative interest rates. You can make bitcoins as secure or in-secure as you wish. Some of the above may seem complicated to a non technical user however tutorials exist to show you how to do all this. Creating an online account takes seconds. To experiment with the above you don't even need to get any bitcoins, you can test by just continually logging in and out of the application, changing passwords levels etc. There will no doubt be many further security innovations to come.

Bitcoin is still in Beta. Many of the e-wallets are still very immature, its a high risk venture as non of this has been done before. All its users agree on one point, only put in what you can afford to loose. However many can still see the potential for the currency, how it could transfer the banking landscape forever. Due to its low user base it is still very much out of the public eye. Many users are either computer geeks (myself included), finance speculators who have spotted the potential, anarchists and libertarians. I'm sure mass use will come one day, but we are still in murky waters with a lot more to learn about the system.

Austrian view
Bitcoin aims to be a free, hard money. Mathematically its harder than Gold as it has a precise finite limit. Still many in the libertarian movement actually oppose such a system or have prematurely predicted its downfall. This would seem counter-intuitive. Investors who ascribe to the Austrian view, such as Peter Schiff and James Turk are also sceptical believing it to offer no advantages over Gold. I hold Gold. Gold has held value for thousands of years. Bitcoin can not compete with that historical record. However Bitcoin can compete in terms of technological superiority with its modern mathematics. I believe there is some vested interest within the libertarian community. Many make money from selling commodity based financial products. Bitcoin does away with the need for financial advice, fancy money managers. People can just hold the coins and take care of their own finances without the usual worry of inflation eating their life savings away. 

Bitcoin will be the spark that ignites the debate over regulation in finance - there is no bailout for a Bitcoin bank. In practice we will see the old banking system swamped under heavy regulation and a new finance sector, using true free market currencies to trade with. Governments will have a tough time trying to regulate such a decentralised system. Bitcoin won't be the last crypto currency, there will be others (there already are), weeding out the uncompetitive based on consumer demand.

It will also assist in debunking Socialist and Keynesian economic theory that is current conventional thinking, but as I and others have laboured, is plain wrong. 

Deflation
Bitcoin has appreciation built in. Inflation is not allowed. According to the State worshipers of all creeds without Inflation trade will ground to a halt. People will hoard their money, they won't buy food as an appreciating currency is far more important. Of course people will spend just as they had before. Genuine capital and savings will be able to form more naturally and spur economic growth to new levels. Prices adjust. People on the lowest incomes will benefit the most as all prices fall at a common rate. Inflation benefits the rich, not the majority. 

Credit Bubbles
There is no such concept in Bitcoin, but this is contary to the prevailing economic wisdom that of we need to fine tune this, or inject some "credit" here. Bitcoin will put that case to rest as bad businesses go bust, releasing scarce economic resources faster. Prices and production lines will not be distorted by massive credit bubbles engineered by central authorities. No more boom and bust on a nationwide (worldwide) scale. Liquidation of unprofitable lines will occur in small pockets in a continuous nature.

Central Planners and Regulation
We don't need them or their innovation stifling policies. Stop treating people like idiots and get out of the way. It will be a great challenge on the establishment.

With all of the above I'm still puzzled why many existing Austrian economic thinkers are still uneasy with Bitcoin. Busily reading their Mises or Rothbard texts for some clues, problem being that both economic giants had no idea how human imagination would create such an abstract currency.

People will be able to see all these concepts for themselves, not from some textbook. To see concepts can never be understated and is why a free market always wins out eventually. Actions speak louder than words. Socialism has a lot to say for itself but a miserable historical record for action. Socialists perversely usually manipulates the benefits that free markets have given to people, claiming such progress for its unjust causes. Markets need little words or political representation. It makes itself heard by its actions.

Counter Arguments
Bitcoin has been in the public domain for a few years now and therefore has been under widespread academic scrutiny. So far there have been no found compromises or issues with the protocol. That still hasn't meant there have been no concerns, many of which are popular myths.

Hard Limit on Money Supply
With a hard limit of 21 million coins many have said this will not be enough to expand to the needs of commerce and will not scale. The designers thought of this and ensured a bitcoin could have 8 decimal places to it. Meaning you can pay with 0.00000001 bitcoin. The whole currency has 2 Quadrillion units (a 2 with 15 zeros, compared with the World which has a population of 6 with 9 zeros), meaning it is more than sufficient to pass the divisibility test for years to come. Other currencies will no doubt come along if required.

Nothing Backs Bitcoin
The Dollar is backed by nothing but is still accepted as a medium of exchange. Gold is backed by nothing. The Software you are using now is backed by nothing, however it still has intrinsic value to us all. The internet is just a series of electrical pulses. Its the advanced Mathematics that backs bitcoin. It ensures it has a finite supply. It is backed by all the connected nodes who stay honest, its in their interests to do this as their income is derived by it being of value to the consumer. The very fact that it is not "backed" by a central authority is the very thing that gives it such value. Its no ones liability, only your own.

Its a Ponzi Scheme
In a Ponzi scheme you will always find someone at the base. In Bitcoin there is no central point, its decentralised. 

What if miner nodes are not Honest?
This is a published and known weakness. However it would cost millions of dollars to mount such an attack and as the network grows it would get more expensive, to the point that no single organisation could do this. If an attack was made the attacker would only be able undo what they have recently spent. They could not create money or steal from others. Compared with the millions of dollars it would take to mount the attack the gains would not add up, even if a collection of miners would form a cooperative. Currently miners get more financial gain from mining the network (transaction fees and bitcoins) then they would from bothering with an attack. Miners want it to remain honest as many hold and use Bitcoins themselves. The attack would also have to be run continuously as the network would resume normal operation as soon as the dishonest nodes stopped colluding.

Its a similar weakness to modern cryptographic algorithms which are considered secure but can still theoretically be broken. Brute force is always an attackers option. However in order to break a simple 8 digit alpha-numeric password using modern encryption may take 1000 years to do even with state of the art equipment, many of us won't care by then so we can live with that risk (in reality no one would attempt this as its a waste of resources and their lives). Its similar to the the honest node attack, theoretically its possible, in practice it won't be an issue.

Miners help keep the network secure and honest. To support the network during its first steps they were vital to ensure block chains (the accounting ledgers) were correct. To give incentives as gatekeepers of the network they were given Bitcoins. Anyone could participate, there were no rules or privilege. Money creation will slow over time, eventually to nothing so a question has to be asked why will people still mine and keep the network secure then? The plan is transaction fees will cover the costs. In its early years there is simply not the traffic to generate enough transaction fees to pay for the miners, hence the developers solved this by issuing money at a predetermined mathematical rate during the currencies growing pains. As the network grows and more people use it, more transactions will occur and fees will be a part of this. So why use this as opposed to Paypal? Because the fees should be so low as to be negligible. If the network gets really efficient then fractions of pennies will be all that is required. The incentive to pay fees for the users is their payments get processed quicker. If someone has a time preference for a quick payment, then they pay a larger fee. Many e-wallets set the optimal fee for a transaction so that it gets processed in a timely manner (when I say processed, I mean verified, it goes from wallet to wallet instantly).

The Biggest Risk is Government
This is what I perceive to be the biggest risk. Even if another crypto currency takes over from Bitcoin, the Government will fight tooth and nail to stop any monetary competition as whatever market money will exist it will be infinitely better than the Governments fiat. They will never be able to truly shutdown the network, but they will make it hard for the public to trade with it. No doubt we will see controls on trading houses on legimate companies providing services. They will use scare stories to bamboozle the public into their way of thinking, that can be assured its a common tactic. 

Governments will misinform people that it is for all our good to use our nations currency, with guilt trips a plenty. "Competitive Currencies damage the welfare system", "It will mean higher costs for goods and services", "it will be wasted effort when we already have a currency", "It encourages black markets and illegal activity". I can see it all already. 

The currency will however be the complete opposite. It will encourage the welfare state to shrink leading to more innovation, lower prices due to market competition and increased purchasing power for everyone. The Government will have to compete by not allowing arbitrary inflation as people will flock to other currencies.

Buying Bitcoins
If you live in the US you should have no problem buying Bitcoins. I think most places in the World it is fairly easy to buy. In the UK its a different matter and a real pain. It may be due to the heavy regulation or tight Government control but its not that simple. I had to follow this tutorial to exchange some money (as of writing there was a £10 limit per 7 days, previously this was £500. I suspect most people in the UK now have to use this service - its that bad!). It involves getting a smartphone app from Barclays called Pingit, a mobile payment platform (Pingit allows you to pay people if they have the application by just entering their mobile number). So you need either an Andoid or iPhone. Then once you have created an account follow the instructions. It worked fine for me and was simple enough, however its not for the average person. Bitcoin still has a lot of maturing to do.

I also setup a local wallet on my computer. Its just a case of downloading the software, waiting for the whole blockchain to download (took me around 2 days!), then creating a wallet and an address. This is what I used to transfer a penny from my e-wallet. Again, there is no way non-technical people are going to find the current thick clients very usable. E-wallets will be the way forward for mass adoption.

Fees are also an issue when converting domestic money into Bitcoins (not an issue in the US, but it is here in the UK). The fees using Pingit and BlockChain.info are around 6% - so for trading on a daily basis, its not worth it (in the US its around 1% for fees). The eventual ideal will be that your incomings and outgoings will be both denominated in Bitcoins, meaning no transfer fees. Governments will fight this.

A lot of people are speculating on Bitcoin and with good reason. If this is going to be a useful Global currency then if someone buys a Bitcoin now, imagine how much it will be worth in 10 or 20 years time? Current market valuation for the currency is around $120 million dollars. That is insignificant compared to global trade. As more people use it, then a Bitcoin will be worth more. Couple this with the fact its a deflationary currency and its value will go up over time. These two factors mean it potentially could be a very wise investment. Like all new concepts, just like a startup, you could loose it all due to its unproven model (although it has been going for a few years now). Its win or loose.

The Future

Bitcoin can exist alongside Gold and existing fiat money we use today. There is space for all. Whether Government fiat money can stand up to the competition remains to be seen, as history has shown with Government services against market services, they never do. Bitcoin was the creation of individuals who pursued their own goals under the influence of no central committee or planners. Their ideas happened spontaneously, the bottom up approach. We should all be thankful we live in such times to witness not just the creation of the greatest tool humankind has ever created, the Internet, but at a time when the Governments days are slowly numbered and there are genuine solutions to break the hypnotic grip it has held over the public. With revolutionary concepts such as Bitcoin there will be real examples of how markets make peoples lives better. You won't need to read a textbook or understand economic theory to see why money should not be controlled by the State. The actions of such products will speak louder than words. Bitcoin; if it fails or succeeds is not important. Its already made the playing field better for all of us.

The root problem with conventional currency is all the trust thats 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. Their massive overhead costs make micropayments impossible. A generation ago, multi-user time-sharing computer systems had a similar problem. Before strong encryption, users had to rely on password protection to secure their files, placing trust in the system administrator to keep their information private. Privacy could always be overridden by the admin based on his judgment call weighing the principle of privacy against other concerns, or at the behest of his superiors. Then strong encryption became available to the masses, and trust was no longer required. Data could be secured in a way that was physically impossible for others to access, no matter for what reason, no matter how good the excuse, no matter what. Its time we had the same thing for money. With e-currency based on cryptographic proof, without the need to trust a third party middleman, money can be secure and transactions effortless.
"Satoshi Nakamoto"

Freedom to Create and Prosper

The second part of our educational task - imaging how a market-run world would function - is much more difficult. Murray Rothbard once remarked that if the government were the only producer of shoes, most people would be unable to imagine how the market could possibly produce them. How could the market accommodate all sizes? Wouldn't it be wasteful to produce styles for every taste? What about fraudulent shoes and poor quality producers? And shoes are arguably too important a good to turn over to the vicissitudes of market anarchy.

Published in a recent Article by Llewellyn Rockwell

Most intellectuals claim they have all the answers to so called 'market failures'. Llewellyn Rockwell debunks this belief with a wonderfully written article (link above) which I recommend to read. Larry Page, one of Googles co-founders is quoted as saying, "Always have a healthy disregard for the impossible", which I think sums up human ingenuity throughout history and the spirit of the Entrepreneur. Government Officials meanwhile will promise you the world, but later declare its impossible to deliver on its prior commitments. Central planners and the selfish 'ethical' do-gooders will tell you because of 'market failures' they need to intervene in peoples lives, stealing societies resources. As always, they lack imagination and keep the public believing they can deliver what a free market can't.

The Technology sector is one of the few areas in the global economy with very little Government interference. The prime reason is its recent appearance. When Big Welfare was hatched, computers were the preserve of Governments and large companies; as a percentage of GDP the industry was insignificant. Yet in a short time-frame, technology is now embedded into all of our lives. Only 15 years ago I remember using slow dial up connections, paying for low storage email accounts with minimal content existing in the web.

Since then the range of services that are offered for free has been phenomenal. Ideas and concepts that were deemed 'impossible' back in the past are now a reality. No one could have envisaged the progress that has been made. Multi-language translation, navigation systems in phones, films and music on demand, self driving cars, global consumer marketplaces, computers for $25 (less than a pair of shoes) and many other innovations. The list is endless. One of the most important points I want to make is the cost. Its all either free (paid either through advertising or premium users) or next to nothing. This always benefits the poorest members of society. 

Its tragic that many other sectors are crowded out by Government control. I could pick a number. For sake of example the progress of healthcare has dramatically being curtailed by the socialisation of medicine. We can not speculate what innovations would have occurred if it was run by the free market, but like the technology sector the poorest members of society would have been the main beneficiaries, not the rich. The rich can always afford the best possible healthcare. Costs are so high because of Government intervention.

The great myth is that America has free market healthcare, the reality of course if not the case. Medicare and Medicaid are a form of socialised healthcare, similar to the NHS in Britain, regulations on insurance companies such as no age discrimination or the mandatory cover of doctor checkups, tax breaks for companies offering third party insurance as part of an employees employment contract, Medical organisations that prevent entry thus raising wages and prices; the list goes beyond this and is worthy of another post to do the topic justice. Its sufficient to say socialised medicine is falsely proclaimed by 'liberals' to help the poor, when in fact it is doing the complete opposite. Heathcare is rationed, sometimes available to a lucky few. Spending is out of control and can only be solved by the creativity of a free market, not Politicians.

I, like any other author, can not speculate on what the free market may have done more efficiently. However a common fallacy used to excuse escalating costs in healthcare is the equipment used has become increasingly sophisticated, thus one of the reasons behind rising costs. I pick this example as in contrast the technology sectors equipment has become increasingly sophisticated, yet the cost has at the same time come down dramatically, benefiting the poor. When I got a PC in the nineties very few people had them, due to cost. Now everyone who wants one has a personal computer. In free markets tools always get more sophisticated. In agriculture we use sophisticated machinery that costs tens of thousands of dollars (compared to a primitive plough) yet such nations live in massive calorie surpluses. Its the lack of Regulations, Interference, Selective Monopolisation that enable this to occur.

The fact the equipment has become more sophisticated means costs should have come down. X-rays, CT Scans; such equipment is not cheap but it provides rapid diagnosis, freeing up humans to perform other functions. There is no need for specialists to agonise over such medical issues, the machines do that for them in a matter of seconds. All they have to do is fix the issue. Costs go up in healthcare due to Government interference; a classic case of Socialism impoverishing us all, but in-particular the poor. By not allowing prices, freedom and consumer sovereignty to do their job, the poorest among society are the hardest hit.

There is no reason why we need a Government full stop. All goods can be provided efficiently when we allow people the freedom to run such services. Governments however don't want people to use their imaginations and want us to believe free markets can't provide services they have monopolised and interfered in for decades. The quotation above provides such an example that we need not use our imagination for, yet if provided by the Government many could not imagine how a free market could provide such goods. Free markets are smart and creative. Governments are not.

Short Selling - Another mistake of History Repeated

Well the FSA and American authorities have decided to ban short selling. Again if we look back to what occurred during the Great Depression and take a look at Murray Rothbards book:


"As early as mid-July, Hoover returned to a favorite theme: attacking short-selling, this time the wheat market. The short-selling speculators were denounced for depressing prices and destroying confidence; their unpatriotic “intent is to take a profit from the losses of other people” - a curious charge, since for every short seller there is necessarily a long buyer speculating on a rise. When the crisis came in the fall, the Stock Exchange authorities, undoubtedly influenced by Hoover’s long-standing campaign against such sales, restricted short selling. These restrictions helped drive stock prices lower than they would have been otherwise, since the short-seller’s profit-taking is one of the main supports for stock prices during a decline."

"Short-selling was - and usually is - the chief object of attack by demagogues who believed that short sales were somehow fundamentally responsible for falling stock prices, thereby forgetting that for every short seller there must necessarily be a buyer, and also that short-selling accelerates the necessary depression - adjustment in stock prices. Senator Smith Brookbart of Iowa had, as early as January, 1930, introduced a bill to prohibit all short selling."


Again Murray Rothbard is spot on, as short selling helps shake out unhealthy business models from the system at an earlier stage thus helping the bust. He also states that investment firms make money from short selling to cover their long losses. I think an explanation of short selling is required.

Short selling is the process where by an individual looks at a company and thinks it is overvalued, thus borrows the stock from someone who is holding the shares in a long position. They usually use leverage as this increases the amount of money they can make typically putting down say 10% of the total stocks value they have borrowed. They then sell the stock at the current prices and wait for the stock to fall. For simplicity say they buy £100 worth of stock at £10 each. They put down £10 to borrow them and they fall by 50% or are now worth £50 at which point the short seller decides to buy them back and give them back to the long position they borrowed them from. That would be £40 profit or in percentage terms 400% profit, which shows how much money can be made from this however, what happens if the stock goes up? Well this is where it can be very painful. If the stock goes up 50% you may get a margin call from your broker asking for a further £5 to ensure at least 10% down. If you can't cover that amount, and the stock keeps going up you are effectively in real trouble. If the stock never falls you have to buy those stocks back at the new price of £150 meaning a loss of 500% from the original amount (as the £10 is included in the £100 original total that was borrowed). A lot of Investors did this for Freddie and Fannie, Northern Rock and other financial firms during the end of 2006, the start of 2007, as they looked at the balance sheets and saw, well a train wreck in motion, and profited from it a lot. The reason I mention leverage is most people who do short selling are hedge funds, pension funds, investment banks etc, the very banks this new law is supposed to be protecting. Yesterday the finance stocks shot up 50% - 70% - however much I didn't really look at the specifics, but they shot up. Now the law said short positions had to be closed out, which means that those investment banks could have lost a lot of money yesterday as they would have had to buy the stocks back at a higher price in order to hand back to the long seller. This is one of the reasons the financial stocks rallied a huge amount. Of course some of the short positions could have been from months ago, even last year, however I imagine a lot of them would have been put on quite recently after the collapse of Lehman etc. So the law that was brought in for financial stability has in fact in all reality inflicted more damage on the banks balance sheets, all to give the stock market a boost and to have artificial stock prices. Its another government and regulatory blunder and in the long run will lead to more stock falls further down the line.

I also noticed the FTSE and Dow rallied by huge amounts, with the FTSE gaining 431 points. This happens in markets, Bear or Bull. Its goes down 600, goes up 400, down 400, up 250 etc. Of course if we get inflation over the coming years which I suspect the stock market may go up, but whats the point if inflation is just pushing the price up. Its like having a savings account giving interest of 2% while inflation is 4% - a net loss. If we wish to keep the comparison with the great depression have a look of how the Dow performed.

http://www.gold-eagle.com/editorials_01/seymour062001.html

As I said in my Next Great Depression post, the stock market fell but kept rallying. What point do you think we are at? Number 8 ... 16? However I would be surprised if the above was to be repeated as the Central Banks have already been priming the printing presses. It's going to get interesting that's for sure.

The Next Great Depression?

A great deal can be learnt through history. In a practical sense its completely useless, as it merely just documents past events, but past events can help explain current and possible future events. If you can never get to grips with a subject matter it is best to look at history to try and to identify possible similarities. I have taken some quotes from a historical book and I think a lot of the quotes below could be said of the current situation we find ourselves in.

"If the Federal Reserve had an inflationist attitude during the boom, it was just as ready to try to cure the depression by inflating further. It stepped in immediately to expand credit and bolster shaky financial positions. In an act unprecedented in its history, the Federal Reserve moved in during the week of the crash—the final week of October—and in that brief period added almost $300 million to the reserves of the nation’s banks. During that week, the Federal Reserve doubled its holdings of government securities, adding over $150 million to reserves, and it discounted about $200 million more for member banks. Instead of going through a healthy and rapid liquidation of unsound positions, the economy was fated to be continually bolstered by governmental measures that could only prolong its diseased state."

"The Federal Reserve also promptly and sharply lowered its rediscount rate, from 6 percent at the beginning of the crash to 4.5 percent by mid-November. Acceptance rates were also reduced considerably. This enormous expansion was generated to prevent liquidation on the stock market and to permit the New York City banks to take over the brokers’ loans that the “other,” non-bank, lenders were liquidating."

"Dr. Anderson records that, at the end of December, 1929, the leading Federal Reserve officials wanted to pursue a laissez-faire policy: “the disposition was to let the money market ‘sweat it out’ and reach monetary ease by the wholesome process of liquidation.” The Federal Reserve was prepared to let the money market find its own level, without providing artificial stimuli that could only prolong the crisis. But early in 1930, the government instituted a massive easy money program. Rediscount rates of the New York Fed fell from 4.5 percent in February to 2 percent by the end of the year."

"During 1930, the Federal Reserve had steadily lowered its rediscount rates: from 4.2 percent at the beginning of the year, to 2 percent at the end, and finally down to 1.2 percent in mid-1931."

"President Hoover was proud of his experiment in cheap money, and in his speech to the business conference on December 5, he hailed the nation’s good fortune in possessing the splendid Federal Reserve System, which had succeeded in saving shaky banks, had restored confidence, and had made capital more abundant by reducing interest rates. Hoover had done his part to spur the expansion by personally urging the banks to rediscount more extensively at the Federal Reserve Banks. Secretary Mellon issued one of his by now traditionally optimistic pronouncements that there was “plenty of credit available.” And William Green issued a series of optimistic statements, commending the Federal Reserve’s success in ending the depression. On November 22, Green said: All the factors which make for a quick and speedy industrial and economic recovery are present and evident. The Federal Reserve System is operating, serving as a barrier against financial demoralization. Within a few months industrial conditions will become normal, confidence and stabilization in industry and finance will be
restored."

"By early 1930, people were generally convinced that there was little to worry about. Hoover’s decisive actions on so many fronts—wages, construction, public works, farm supports, etc., indicated to the public that this time swift national planning would turn the tide quickly. Farm prices then seemed to be recovering, and unemployment had not yet reached catastrophic proportions, averaging less than 9 percent of the labor force in 1930."

"During the second half of 1930, production, prices, foreign trade, and employment continued to decline. On July 29, Hoover called for an investigation of bankruptcy laws in order to weaken them and prevent many bankruptcies—thus turning to the ancient device of attempting to revive confidence by injuring creditors and propping up unsound positions."

"As a consequence, while the immigration law had already reduced net immigration into the United States to about 200,000 per year, Hoover’s decree reduced net immigration to 35,000 in 1931, and in 1932 there was a net emigration of 77,000. In addition, Hoover’s Emergency Committee on Employment organized concerted propaganda to urge young people to return to school in the fall, and thus leave the labor market."

"He hailed the Federal Reserve System as the great instrument of promoting stability, and called for an “ample supply of credit at low rates of interest,” as well as public works, as the best methods of ending the depression."

"As 1931 drew to a close and another Congressional session drew near, the country and indeed the world were in the midst of an authentic crisis atmosphere—a crisis of policy and of ideology. The depression, so long in effect, was now rapidly growing worse, in America and throughout the world. The stage was set for the “Hoover New Deal” of 1932."

"During 1929, the Federal government had a huge surplus of $1.2 billion"

"From a modest surplus in 1930, the Federal government thus ran up a huge $2.2 billion deficit in 1931."

"One thing Hoover was not reticent about: launching a huge inflationist program. First, the administration cleared the path for the program by passing the Glass–Steagall Act in February, which (a) greatly broadened the assets eligible for rediscounts with the Fed, and (b) permitted the Federal Reserve to use government bonds as collateral for its notes, in addition to commercial paper"

"Thus, the Hoover administration pursued a giant inflationary policy from March through July 1932, raising controlled reserves by $1 billion through Fed purchase of government securities. If all other factors had remained constant, and banks fully loaned up, the money supply would have risen abruptly and wildly by over $10 billion during that period. Instead, and fortunately, the inflationary policy was reversed and turned into a rout. What defeated it? Foreigners who lost confidence in the dollar, partly as a result of the program, and drew out gold; American citizens who lost confidence in the banks and changed their deposits into Federal Reserve notes; and finally, bankers who refused to endanger themselves any further, and either used the increased resources to repay debt to the Federal Reserve or allowed them to pile up in the vaults. And so, fortunately, inflation by the government was turned into deflation by the policies of the public and the banks, and the money supply dropped by $3.5 billion."


Notice some parallels between the present and the period being described above? The things I find most striking are the fact the FED drastically cut rates from 6% to 1.2%, compared with today in which they cut from 5.25% to 2% at present. Also the fact that at the beginning of the bust the government were running huge budget surpluses, and within a couple of years were running huge deficits, compared with now where the US has persistently for years now been running up huge deficits which will get worse.

Of course the period being described was the Great Depression and the Quotes were taken from Murray Rothbards book, Americas Great Depression. Contrary to what people believe the great depression was not suddenly brought about after the infamous stock market crash in October 1929, it was brought about over a 3-4 year period of excessive monetary inflation in the previous years during the 1920's boom and increasing inflationary policies during the bust along with increased government interference, which made the Depression so great. In fact the stock market also rallied during this time and didn't bottom out till around 1933. Hoover was the creator of the New Deal, Roosevelt just merely carried on with it with even more enthusiasm contary to the myth that Hoover had a no hands approach to the economy. In the end this is where we now stand,


"But here, in the crisis of 1933, the banks could no longer continue as they were. Something had to be done. Essentially, there were two possible routes. One was the course taken by Roosevelt; the destruction of the property rights of bank depositors, the confiscation of gold, the taking away of the people’s monetary rights, and the placing of the Federal Government in control of a vast, managed, engine of inflation. The other route would have been to seize the opportunity to awaken the American people to the true nature of their banking system, and thereby return, at one swoop, to a truly hard and sound money."


We all know what happened in subsequent years. Nixon removed the US from the gold standard, and in effect all western currencies from gold as bretton woods was dissmantled. Now the dollar and world currencies are backed with nothing as we enter another dissasturous chapter in history of fiat currency.

If we wish to draw the parallels to today, roughly in 1928 real estate prices began to fall compared with 2006 in the US. 1929 and stock prices began to fall, compared with 2007 when the Dow was at its all time high. So what does that mean in the next few years if we are only at 1930. Well we have a lot further to go and the governments and Central Banks are doing exactly what history has taught us not to do.

However there are differences, which I believe position the US in a worse position. Back then the US had huge budget surpluses in previous years, exported goods throughout the world and had huge oil reserves (cheep energy reserves which can never be overstated). They also theoretically had the dollar backed by Gold which meant even though the FED tried to inflate they were constrained, where as now it is a complete fiat currency meaning there will be no limits to inflate this time. Ben Bernanke the current head of the FED is supposedly a student of the Great Depression but from what I've seen, he's repeating what was done 75 years ago, and he's doing a pretty good job of fooling everyone. Nationalising Fannie and Freddie Mac, that were created at the end of the Great Depression, is an absolute disaster as I have said before, and is exactly what President Hoover and the FED would have done during the last depression.

I will end on the following note from Murray Rothbard. Maybe we are facing another depression and crisis of the same magnitude? Or worse?

"What was the trouble? Economic theory demonstrates that only governmental inflation can generate a boom-and-bust cycle, and that the depression will be prolonged and aggravated by inflationist and other interventionary measures. In contrast to the myth of laissez-faire, we have shown in this book how government intervention generated the unsound boom of the 1920s, and how Hoover’s new departure aggravated the Great Depression by massive measures of interference. The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free-market economy, and placed where it properly belongs: at the doors of politicians, bureaucrats, and the mass of “enlightened” economists. And in any other depression, past or future, the story will be the same."