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Tuesday
May172011

L020: Is Bitcoin the Wikileaks of Monetary Policy?

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Calacanis primer on bitcoin


By Robert Tercek

Cynics make the argument that complaints about the loss of privacy in the digital domain are pointless.  "If you use a credit card or an ATM machine, you're already living in the fishbowl," the wags say.   

Fair point. Financial institutions monitor where and when you withdraw cash and how you use your credit or debit card.   The transition to e-commerce has intensified their grip on your consumption pattern.   And the migration to the cloud will reinforce the power of financial institutions and the government to keep track of you and your data.

But it doesn't have to be this way.


Centralization Versus Diffusion

The struggle over the Internet's future can be summarized as a battle of centralized control versus radical decentralization.  This struggle has already played out across a dozen different industries, from content publishing to retail, from brokerage to software publishing.    

In each case, powerful incumbents fought hard to maintain control over their proprietary information asset.  They faced an existential challenge:  information asymmetry was their raison d'etre. That's how they controlled an entire marketplace.   

Without the advantage of inside information, their traditional businesses made no sense.  Members of each reigning oligopoly had not evolved to compete on a level playing field with hungry rivals who had equal access to the same information.   In the end, in industry after industry, the incumbents were undone by their overreliance upon centralized information.   

Truly disruptive Internet companies begin by destroying the information asymmetry that favors old-school incumbents.  After the middlemen and brokers have been elbowed aside, the profit margin that was previously skimmed off each transaction has been returned to the consumer in the form of a discounted price.  

You experience this every day on the Web.  When you shop for a house or car online, when you use a price comparison engine for e-commerce, when you book an airline ticket or hotel room online, when you download an MP3, or when you read a newspaper article for free on a web site, you are enjoying the benefit of the Web's ability to explode proprietary information silos.

As soon as an industry's data silo is breached on the open Internet, centralized power is diffused.  Immediately it rushes to the edges of the marketplace.   Brokers who seek to control transactions get destroyed, but switchboards who facilitate faster transactions often prosper.  Sometimes the mere possibility of an alternative is sufficient to break the grip of the oligopoly, because buyers immediately hedge their bets and seek out alternatives, forcing the incumbents to play by new rules they did not create.

And so we've seen music labels, bookstores, travel agencies, retailers and software giants undone by the ability of consumers to use new tools to browse information by themselves and find better-priced alternatives.   


What Bitcoin Disrupts
 
Now Bitcoin and other P2P payment systems have opened a new front in this battle, bringing decentralization to money supply.   

Bitcoin presents an unambiguous challenge to the government monopoly on the power to print money.  In concept, Bitcoin raises serious questions about the legitimacy of national monetary policy in a globalized digital economy.  In practice, Bitcoin could undermine it completely.

Symbolic paper currency requires all participants in the economy to maintain a fiction:  that thin sheets of paper represent real value even though they lack the intrinsic value of precious metal.  And symbolic paper currency is a dwindling percentage of the total money supply.  Increasingly, money exists purely as digital information:  no one uses trucks to move hundreds of millions of dollars when they complete a transaction.   As long as we all agree that those numbers on a glowing screen represent real value, the system works.

Since you have no alternative, you have to play along.  But the system doesn't necessarily serve you.

Complete control over the monetary system enables governments to set the price of money.   And they manipulate the market continually.   In case you hadn't noticed, for three years governments all over the world have been flooding the market with money in the form of bailouts and fiscal stimulus.  The result is an inflationary debasement of currency.   National treasuries are printing their way out of the crisis.   Your salary and savings bear the price.  It's a hidden form of taxation.

In the past, you as a citizen were powerless to stop this type of government behavior until the next election cycle.  Governments freely manipulate their currency to favor some players and to disadvantage others.

Bitcoin promises to change the way we think about two important aspects of money in the digital domain:

1. It gives participants the option to opt out of their government's monetary policy. Bitcoin is immune to government manipulation.   
2. It restores anonymity to transactions. Bitcoins cannot be tracked. There is no central server to take down.

The link between money and identity enables the government to monitor your behavior and enforce a range of laws including compliance with tax codes, gambling statutes, drug laws, money laundering laws and more. Bitcoin presents the option to avoid these regulations.

Big financial clearinghouses like Visa, Mastercard, and American Express serve as the government's minions, happy to enforce government policy while raking in the profit off of every transaction.  Even PayPal dances to the government tune.  These companies won't play nicely with Bitcoin.  In fact, PayPal has already shut down the accounts of individuals trying to "exchange" bitcoins for real money [ see http://coinpal.ndrix.com/ ].

When the government decides it doesn't like what you are doing, its financial minions act swiftly to enforce the rules. In December, PayPal, Mastercard and Visa shut down donations to Wikileaks, strangling the project's finances.

Last year it was Wikileaks.  This year, who knows what company or web site will fall afoul of a sprawling government bureaucracy hooked on secrecy?  

This type of centralized control is antithetical to the decentralization inherent in the Internet.  From the web's vantage point, money supply looks like just another marketplace rigged by a small number of market makers.  

We've seen this movie before and we have a pretty good idea of how it will end.  Napster upended the music industry, but the central directory of user names presented a juicy target for RIAA and the record labels that wanted to retaliate by suing their former customers.   So the next generation of P2P file sharing programs survived by adapting:  Napster's progeny eliminated the need for centralization, making it much more difficult to track down and prosecute users.   

Wikileaks suffered from a similar flaw:  a rigid centralized structure that, perversely, mirrored the governments its founder sought to demolish. And that centralization proved to be a fatal weakness. Shortly after the U.S. government began to systematically shut down Wikileaks, a new generation of leaking sites has emerged, each promising to improve on the original design by enhancing diffusion:  Greenleaks, OpenLeaks and even Anonleaks.ru.

The same process is bound to repeat itself with digital cash. The opposite of centralization isn't more centralization. It's diffusion, anonymity and the lack of a digital trail.

Of course, the incumbents won't give up without a fight.  They've already introduced legislation that will stifle innovation in online payments. As Aaron Greenspan, the founder of FaceCash, pointed out in his Quora post, California Assembly Bill 2789, which passed in September 2010 and became law as of January 2011, effectively protects the incumbent players from competition by outlawing innovation. According to Greenspan, even investors could face jail time.

That threat, combined with similar legislation in 42 other U.S. states, may be scary enough to stifle innovation here.  

But that won't spell the end of innovation in digital cash. It just means that innovation will migrate to other places where it the local government welcomes it. Like money, innovation flows where it is treated best.

-----------------

LAUNCH Coda
#29: Power corrupts those who never should have had it.

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