Posted 17 Jan 2011
Financial privacy is a fundamental right which the law does little to protect. In fact, the laws of any country with a central bank and strong bank regulations make financial privacy a very difficult right to exercise.
Dissatisfaction with central banks has grown in recent years, as evidenced by the large number of co-sponsors to Dr. Paul's bill to audit the Fed. Even if the Fed is subjected to an audit, it is only the first of many steps needed to secure more economic freedom and the best financial privacy.
That road to financial freedom and financial privacy is a long one. Since the law cannot adequately protect financial privacy, we must find alternative peaceful methods to protect our rights. No matter how dissatisfied we are with central banks, there are few viable legal alternatives.
The most popular alternative has been to buy gold or to buy silver. The reality of using gold or silver has really only been to move savings and investments to gold and silver.
Every-day transactions are still conducted in national currencies. I suspect this is due, in part, to the fact that very few merchants or service providers will accept direct payment of gold or silver coins. The premium for coining gold and silver money may also prevent widespread adoption of using gold or silver as common currency.
Another alternative has been the use of digital currency. Since the 1990's, many digital currencies have been created, separate from the national currencies of the world. Some of them were responding to the market need for easier online payment systems, many of them hoped to achieve what regulation and statutory law has not been able to achieve: true financial privacy.
Most of those currencies have either vanished like e-gold, subjected themselves to regulation like GoldMoney, or have become a huge part of the system itself like PayPal.
Even those digital currencies that continue to exist without regulation or prosecution, such as Pecunix or WebMoney, are at risk of the fates of their brothers because they all share a common attribute which prevents them from becoming a viable alternative to national currencies for transactions large and small.
However, Bitcoin is different because it is censorship-resistant.
But many claim that digital currencies will eventually provide a viable alternative to national currencies.
The fundamental flaw that all prior digital currencies have suffered is centralization. Either all transactions must be verified by a central authority, like WebMoney, or when they are backed by a tangible asset such as GoldMoney, there is a physical location where the assets must be stored.
Centralization creates an identifiable target for bureaucrats to attempt to prosecute, subpoena, regulate, impose political pressure, or bring a host of other attacks. Physical storage exposes those stored assets to many of these same risks, plus a risk of regime change, war, natural disaster, or some other threat to the physical location which can lead to reporting, regulation, or confiscation.
E-gold and Liberty Dollar faced prosecution and GoldMoney submitted to regulation. The fate of UBS bank account holders demonstrates the risk of relying on friendly governments for financial privacy and financial freedom. UBS defied hundreds of years of established constitutional law and revealed the names of account holders because of political pressure.
Thus, systems like WebMoney and Pecunix, established entirely outside of the US, are not immune to the problems of centralization. Centralization is not only a risk for digital currencies. Napster was shut down because it relied on a centralized database. Wikileaks was temporarily shut down because its website was hosted on a single server.
A digital currency backed 100% by gold, like GoldMoney, may ultimately be the best model. But no digital currency has yet become widely accepted enough for the average person to use it to buy groceries, gas, a movie ticket, or a cup of coffee.
It will take another kind of model to bridge the gap between the current worldwide monetary dictatorship to a world of financial freedom and privacy.
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One of the latest developments in digital currencies, Bitcoin, has solved the centralization problem. It is a very new development, but it has been gaining ground and may be sufficient to make central banks irrelevant to every day life and thus free mankind from the economic bondage that most of the world has been under for at least the last century.
This solving of the double-spend problem using a decentralized network is the great breakthrough. This makes Bitcoin the first digital censorship-resistant currency.
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Bitcoin offers a verifiable store of value while maintaining a decentralized structure. It operates peer to peer, meaning there is no centralized authority to issue or verify Bitcoins.
Free, open source software allows users to anonymously and securely generate their own Bitcoins and transfer any amount of Bitcoins anonymously and securely. The software specifically limits inflation and, because it is open source, anyone can audit it.
Rather than discuss the details of how Bitcoin works, I would rather focus on something that hasn't been fully developed elsewhere. There are several economic and legal benefits and risks to any person who decides to use Bitcoin. I think, ultimately, the benefits far outweigh the risks. If Bitcoin is not the answer, hopefully a similar successor will eventually succeed in securing our financial privacy and thus our financial freedom.
The biggest risk is the point at which Bitcoin users enter or exit the central bank economy from the Bitcoin economy. This is a risk because this is the point at which regulation by government is most likely to be created, most likely to be enforced, and most likely to have some effect.
This would probably have the largest effect because many people are deterred from an activity if they would be breaking a law. If enough people were deterred, Bitcoin would be spread to fewer users. Without a sufficient user base, the success of Bitcoin is limited.
Another reason why regulation at the point of entry or exit from the national currency economy might be effective is due to the enhanced visibility of transactions at that point. Once transactions are conducted within the Bitcoin economy, they are very difficult to detect, audit, subpoena, and control.
So far there have been no real efforts to regulate Bitcoin. People can already exchange Dollars, and other national currencies for Bitcoins. The risk is currently very low that anyone who engages in the business of exchanging national currencies for Bitcoins within jurisdiction of US federal law will be subject to regulation as a Money Service Business. There are many other alternate currencies that circulate regularly throughout the US with no such regulation.
Disney is not listed as a registered Money Service Business for selling Disney Dollars. Washington D.C. area businesses trade in a local currency called Potomacs to support local businesses, but nobody is registered as an MSB to exchange those. Even virtual currencies like those used in World of Warcraft or Second Life, which regularly are exchanged for national currencies, have never given rise to registration requirements. But, none of those currencies ever posed a threat to the power of the money printing press that central banks now enjoy.
Even if at some future time, government decides to force Bitcoin exchangers to register, there will likely be many legal ways to avoid having to register as a Money Service Business when exchanging Bitcoins for a national currency.
Here are some of the major benefits of Bitcoin that make it capable of replacing national currencies in many transactions and providing true financial privacy.
Open Source - This means that anyone can look at the source code and see what the program is doing to make sure that it is doing what the creators say it is doing. This is like Dr. Paul’s bill to audit the Fed on steroids.
Strong Encryption - Bitcoin uses stronger encryption than the world wide banking system so it is much safer from identity thieves, hackers, and other kinds of fraud or physical theft than banks.
It uses SHE-256 and Elliptical Curve Digital Signature Algorithm (ECDSA) which is among the best practices encryption used by banks, financial institutions and the US Department of Defense.
Free - Anyone can get a Bitcoin account, or as many Bitcoin accounts as they want, absolutely free. Plus, transactions are absolutely free. This is a huge advantage over PayPal, credit cards, bank transfers and even most other digital currencies like GoldMoney, Pecunix and WebMoney.
Easy - It is an extremely easy system to use. If you can use email, you can use Bitcoin.
P2P - Each transaction is made directly with the other person. There is no third party like a bank that you must rely on for the transaction or that even knows about the transaction. Third parties like Paypal and banks will interfere with transactions between two consenting parties because of banking regulation.
Easily Exchanged For National Currencies - There are already many people around the world that will exchange cash for Bitcoins. Many will exchange in person, through the mail or in many other ways. You can even get an anonymous credit card and load it with cash using Bitcoin payments.
Some Already Accepting Bitcoins - There are many merchants and service providers around the world already accepting Bitcoins. Simple solutions already exist for merchants to integrate Bitcoin into daily transactions so it is likely that many more will do so.
HowToVanish.com accepts them and I accept them in exchange for legal services. WordPress accepts bitcoins to promote the freedom of speech. To protect your Internet privacy we highly recommend using a VPN and the VPN Private Internet Access accepts bitcoins which adds an additional layer of privacy. In fact, we think you should never trust a VPN unless it accepts bitcoins. And Ice Servers, located in Iceland with extremely protective freedom of speech laws, accepts bitcoins for web hosting services.
Unlikely To Be Regulated - Bitcoins might be treated as an imaginary currency, more like a novelty currency like Disney Dollars, Chuck E. Cheese Tokens, Linden Dollars, Monopoly money or Potomacs. Bitcoins don’t resemble any US minted currency so they aren’t likely to violate laws like Liberty Dollars. Alan Greenspan is also quoted as cautioning against regulating private digital currencies in the September 8, 1997 edition of Forbes Magazine.
Impossible For Authoritarian Governments To Control - Because Bitcoin is a simple, open-source program, capable of being encrypted, and accessible through proxy servers, it will exist anywhere the internet can exist.
If an authoritarian government like Cuba or China made it illegal for citizens to access or use, the account of every citizen would still exist unharmed and be accessible outside of that country. It would also be practically impossible to enforce such a ban because, like music file sharing, it would be almost impossible to detect and prosecute.
Impossible To Audit - Much like cash, you will still need to pay taxes on all income, etc. earned in Bitcoins, but there will be no way for anyone to verify what you have claimed because accounts and transactions can be completely anonymous.
Privacy – Encryption, anonymization, and world wide access means that Bitcoin does what the law does not do: protect financial privacy.
Capable Of Off-Line Payment – If a transaction needs to occur off-line, an account for the amount to be transferred can be set up and the entire account number and password can be given to the person rather than an electronic transfer.
Micro Transactions – Because each transaction is free and extremely easy, it will be a vehicle for transactions in very small amounts and micropayments worth fractions of a cent.
Convenient Apps - Smartphone apps could make use of Bitcoins in every day transactions extremely easy. Bitcoins could be sent by text message, email, or through a smartphone app that will generate a barcode and read a barcode. The cost to a major corporation like Starbucks to implement is almost zero. The cost to a Girl Scout to use when selling cookies is almost zero.
Almost No Inflation Risk - Bitcoin is a fiat currency. Unlike the Federal Reserve, the limit of Bitcoins is hard coded into the software at 21 million. If any programmer were to try to increase that number and inflate the supply, she would have to convince a majority of other users to accept that inflated supply before it became effective.
Diffuse Inflation Risk - Even though inflation is extremely unlikely, assuming for the sake of argument that it happened, the benefits would be spread out equally among the entire network of Bitcoin generators. And, anyone with a computer can generate Bitcoins so theft by inflation would be greatly diminished.
Instantaneous Transactions - Bitcoin transactions take place instantaneously. There is no need to wait for the next non-holiday business day, no need to deal with the bank hours across multiple time zones, no need to wait a few days for a check to clear.
Generate Your Own Bitcoins - If you want to, you can let the Bitcoin program run in the background on your own computer and be compensated in Bitcoins for providing computing power to the network.
No Central Organization - Decentralization is what makes Bitcoin different from all digital currency predecessors. It is this main difference that makes it capable of competing with national currencies and capable of ending the Fed. Bitcoin has no organization, no central server, and nothing to attack.
You can shut down thousands of individual computers where the program is installed but it will still continue. If someone has their computer, or even their account compromised, they can download it again for free, and access any other accounts that they have that weren't compromised.
Even though a centralized Napster was shut down, its decentralized peer to peer file sharing successors have been more successful because of their decentralized natures. They have had a multi-billion dollar effect. Bitcoin is comparable to the successors to Napster and will have a similar effect.
World Class Cryptography - This is the second element that makes Bitcoin such an important revolution in money. The program to create, authenticate, prevent double spending, prevent counterfeiting and protect the Bitcoin network is being developed in an open source format by many of the world’s top cryptographers.
Legally Conduct Hawala Transactions - The Bitcoin network is a worldwide hawala network and anyone who has an account will have access to it. There are now fewer cultural or geographic boundaries to hawala transactions.
Money Supply Mimics Gold - The creation of the supply of Bitcoins mimics the discovery and supply of gold as money throughout history.
No Chargebacks - Credit cards and Paypal often charge back purchases, taking money from your account without notice or explanation. This cannot happen with Bitcoin.
Free Market Solutions - Many of the risks that arise from using Bitcoin are likely to be solved by a world wide free market of users. For example, there is some risk that when you pay someone for goods or services, they will take the money, claim that they weren't paid, and run away into oblivion.
This kind of fraud is easily prevented by using a trusted escrow that will undoubtedly arise in the marketplace. A free market in escrow companies will likely charge less than the monopolistic rates of 2-3% or more that PayPal or a credit card will charge. The benefits of segregating transaction verification from the authorization to use the monetary unit should be apparent.
Here are a few of the risks to consider.
New - Bitcoin is still very new. There may be bugs that are discovered in the software or something else that goes horribly wrong. It is probably very risky to store much value in Bitcoins for the near future. At the same time, like most high risk investments, if Bitcoin takes off, value stored in terms of Bitcoins could radically appreciate in value.
Not Widely Adopted - Even if there are no bugs and if Bitcoin continues to exist for a long time, if Bitcoin is not widely adopted it will not be very liquid. This will limit its use for buying groceries, buying gas, paying bills, paying rent, or any other everyday transaction. The less accepted the currency is, the more you will have to rely on the central bank controlled monetary system. GoldMoney and many other digital currencies have similarly failed to gain a sufficient user base to replace national currencies for most every-day transactions.
It May Become Illegal For Someone To Use It - Prior digital currencies and applications like Napster were doomed to be regulated as soon as they became wide spread. If Bitcoin becomes widely adopted, there is a chance that legislators or law enforcement will target users.
Regulators may attempt to require registration of people exchanging Bitcoins for national currency or even force Bitcoin users to track and report their transactions. An outright ban on its use may even be possible.
Even though possible, I think attempts to regulate and prosecute people under these laws will be as effective as the copyright prosecution of people who shared music. Grandmothers and grade-schoolers will be prosecuted while there will be almost no deterring effect on the public.
Fiat Currency - Bitcoins are created from work, offering computer power, but they are still a fiat currency. It is fiat not because some government has declared that it has value, but because a Bitcoin does not have any intrinsic value and its value is unrelated to the value of any physical quantity. The price of a Bitcoin is still based on faith that someone else will accept it as payment and so could become worthless.
Transactions Are Final - If a mistake is made in a transaction, if you accidentally send too much money, if you mis-type a decimal place, there are no ways to stop, cancel or refund the money without a separate transaction. Users bear that risk.
Trust - Since there is no third-party audit trail, users will have to trust that the other party will recognize a transaction. It will be almost impossible to get money back from unscrupulous fraudsters that will receive funds, not perform their obligations under the contract, and claim that they never received any funds.
Subject To All US Taxes – There is no income tax benefit to earning income in Bitcoins, rather than US dollars. Since there is an active market trading them for US dollars, there will probably be income tax liability generated for Bitcoin income, and other taxes.
Banking Industry Enemies – The banking industry was able to siphon off billions of dollars from tax payers without much of a peep from the public. This same behemoth is one of the principal competitors of Bitcoin. This competitor has deep pockets and a lot of the public influence. I do not underestimate their ability to crush good ideas in the short term.
Could Be Regulated – Bitcoins, transactions in Bitcoins, or simply entering or exiting the Bitcoin economy is likely to be officially regulated in some way. This has been the principal weapon that the banking industry has used to decimate competitors. I expect there to be some attempt to regulate or control Bitcoins, against the advice of Alan Greenspan, if they become widely used.
Inflation/Deflation – Bitcoins are still in an inflationary state, but once they reach their maximum of 21 million they will be in deflation. Although Bitcoins are easily divisible to a very small fraction, it is unclear whether the ability to make small payments will continue without major changes.
Very Small Bitcoin Economy – The entire Bitcoin economy is currently slightly more that $1 million. That is extremely tiny and so it may be subject to severe manipulation by deep pockets.
Stigma - Many people with dictatorial tendencies will repeat the epithet that only criminals would need the privacy of Bitcoin. Many honest people might even be fooled by the rhetoric. If enough people are fooled, the public disfavor could prevent its wide spread use and prevent the effectiveness of Bitcoin.
Financial privacy as a fundamental freedom is impossible when a central bank dictates the value of the money in your pocket and forces you to disclose information whenever you transact in the economy. Bitcoin is in its infancy, but offers the first real chance of providing financial privacy and freedom to a large group of people.
Investing in Bitcoin is a risky financial endeavor, but it will become less risky if more people sign up for a free Bitcoin account, start accepting Bitcoins in exchange for their own labor, services, merchandise and other things.
Some may even offer a discount for payment in Bitcoins. Asking to pay with Bitcoins may also help stimulate Bitcoin growth.
The signers of the Declaration of Independence risked their entire fortunes and their lives to favor freedom over authoritarianism, I am willing to risk a few dollars. We even created the Free Bitcoin Guide to help you learn how to safely and quickly begin using bitcoins.
Feel free to share your thoughts or experiences using Bitcoins in the comments.
