Bitcoin and the Myth of Tech Utopia

The belief that every human problem can be solved with software forgets the human element inside all software.

The collapse of Mt. Gox, once the leading Bitcoin exchange, has been widely covered and documented already. It appears that only now have many people woken up and realized that Bitcoin rests entirely on software, with all that that entails.

Yes, most of the money that we have also depends on software. Your bank, for example, keeps track of the value of your account on a computer. But your money doesn't depend entirely on software. It's also backed by a trail of transaction information (backed up in multiple places), by the law, by the Federal Reserve, and by the U.S. government, which would not tolerate the sudden evaporation of every American's bank account.

The fact that Bitcoin is software all the way down is, in fact, the thing its boosters are so excited about. This is Marc Andreessen, just a month ago:

"Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate."
This all may be true in some theoretical sense. I don't know. I'm not a computer scientist. But all software design requires implementation. All implementation requires human beings. And human beings make mistakes.

In this case, Mt. Gox was an online exchange for Magic trading cards before it was an online exchange for bitcoins, and it would be surprising if it had been built by the kinds of programmers and security specialists you would want for the future currency of the world.

So now Andreesen and Co. are clinging to the idea that Mt. Gox was just a bad implementation, and the rest of the Bitcoin infrastructure is sound. That may be true. But there are two problems with this argument. First, the rest of the Bitcoin infrastructure was also built by, you know, people who make also mistakes and design imperfect code that can fail or be hacked by other people.

Second, how do you know it is sound? This is only a rough analogy, but in the banking world we rely on the FDIC and the U.S. government. If a bank has FDIC insurance, we assume the FDIC is guaranteeing it, up to $250,000. And we know that if the FDIC made a mistake and the insurance fund runs out of money, the government will step in to bail us all out. How are people supposed to verify the soundness of the Bitcoin infrastructure they are using without some trusted third party? Alan Greenspan would say that the market can police itself, but who wants to be the person to lose her life's savings so that everyone else knows to stay away from some bad operator? Andreesen himself said that Mt. Gox was to Bitcoin as MF Global is to dollars, but that's hardly comforting. What that implies is that Bitcoin needs regulators, statutory liability, and insurance funds, which is not what its advocates want.

Part of the underlying problem is an unwritten law of software competition: Security, performance, and reliability all cost money, but features are cheap and popular. So in the short term, it's a rational strategy to race ahead with feature development, skimp on security, and hope that you don't get caught with your pants down. This is why it's hard to expect high quality software when you're in the middle of a technological land grab, which is exactly what's going on with Bitcoin. This is especially true when the customers you're trying to attract are unsophisticated individuals sucked into the excitement of a speculative bubble. All the other Bitcoin exchanges may be safe as Ft. Knox—but that would be a surprise, given the incentives involved. Instead, we should expect shoddy development to be the norm.

More generally, there is no such thing as a technological utopia. No matter how perfect a technological concept is, when it enters the world of human beings, it becomes imperfect. Bitcoin is no exception. In addition to everything else, apparently Mt. Gox's problems are due in part to a Bitcoin vulnerability that has been around since 2011—but that humans didn't get around to fixing.

This is why we have laws, and regulators, and insurance, all of which would make Bitcoin more like ordinary money. Bitcoin may yet become a lasting part of our financial infrastructure, in part because it offers the promise of lower transaction costs. (As far as anonymity goes—well, look what the U.S. government is doing to Swiss banks.) But it will not usher in some kind of libertarian paradise.

The Winklevoss Twins Want You to Invest in Bitcoin—Don't!

Henry Ford brought cars to the masses. Mark Zuckerberg brought social networking. And the Winklevoss twins are trying to bring ... Bitcoins.

Remember Bitcoin? It's the virtual currency that isn't really a currency. It was developed back in 2009 by the pseudonymous hacker(s) "Satoshi Nakamoto." The idea was to create money that central banks couldn't print and governments couldn't tax. It would give people an anonymous way to buy and sell things over peer-to-peer networks without middlemen -- or inflation! -- taking a cut. Indeed, the supply of Bitcoins is tightly regulated: anyone can "mine" for them by running a computationally-taxing program, but there isn't that much digital gold in them thar computers. No matter how many people become virtual prospectors, the supply of Bitcoins will grow at a predetermined rate -- until 2040. After that, no more will be created.

In other words, Bitcoin has a massive deflationary bias that makes it semi-worthless as a currency. Because the supply of Bitcoins can't increase to meet increased demand, the price should go up. But if the price goes parabolic, nobody will want to part with their Bitcoins to, you know, actually buy things. (Except to buy illegal things). After all, why use your Bitcoins to buy things today when your Bitcoins will be worth more tomorrow? Now, this hoarding can set off a speculative bubble: People buy because the price is going up. And what if the price stops going up? Well, Bitcoin "investors" will try to take their profits off the table, which will push prices down even more, which will lead to even more selling, and so on. That's how Bitcoin went from $48 to $266 in a month -- and then to $105 in a day.

It's not clear why anybody would want Bitcoins. Normal people don't care about hiding what they buy from the government. They're happy with Paypal. And they definitely don't want to go through the hassle of actually getting Bitcoins, which, as Kevin Roose discovered, involves either giving a "currency dealer" your bank account info or sending cash to a Nigerian prince P.O. box.

Enter the Winklevii. America's most famous rowing-twins-who-love-pistachios-and-think-they-invented-Facebook want to make it easy for the little guy to gamble on crypto-currencies. On Monday, they filed paperwork with the SEC to launch an exchange-traded-fund (ETF) that would trade like a stock, and track the price of Bitcoin -- and only Bitcoin. Of course, as the prospectus for the delightfully-named Winklevoss Bitcoin Trust makes clear, there are plenty of risks speculating in a digital asset with no inherent value. Aside from the volatility of the Bitcoin market -- which is perfectly set up for manipulation -- there's the danger that the virtual coins in the Winklevii's virtual "vault" could get hacked, and vanish like that. And then there's the biggest risk of all: the government could outlaw Bitcoins at any moment. After all, why would the authorities put up with a currency people use to launder money, evade taxes, and buy narcotics?

But the Winklevoss twins are convinced virtual currencies are the hottest thing since virtual friends -- and this time Mark Zuckerberg won't steal their idea! They've already plowed some of their Facebook settlement money into scooping up 1 percent of all the outstanding Bitcoins, and now they want to give everyone else the chance to own part of THE FUTURE -- provided you pay them a fee. Here's how Tyler Winklevoss evangelized for this brave, new currency a few months ago:

We have elected to put our money and faith in a mathematical framework that is free of politics and human error.

He should try putting his faith in history. Inflexible currencies are nothing new, and have failed everywhere they've been tried. Bitcoin can only "work" as long as it's an alternative currency that only techno-utopians care about. And even then, it wouldn't really be a currency. It'd be the bubbliest dotocm stock of them all. That'd be a hard lesson investors would learn for themselves if the Winklevii's Bitcoin ETF somehow got approved (which it won't).

But the good news is if, against all odds, the Winklevoss twins' latest foray into business ends up getting turned into a movie, there's a ready-made title: The Muppet Network.

Why Bitcoin Can No Longer Work as a Virtual Currency, in 1 Paragraph

A single bitcoin no longer functions like a $20 bill.

On Tuesday, the Internal Revenue Service ruled that it would tax Bitcoin as a property, not a currency.

Some see the move as helping to bring the medium into the mainstream. Now that bitcoins can be taxed, they’re reportable, and the legal ramifications of buying and selling a coin are clear.

The IRS’s decision, though, may end one of the great dreams of Bitcoin. The U.S. government will now subject owners of individual bitcoins to capital gains taxes: What they gain on buying or selling a bitcoin, they must pay taxes on.

That’s a big deal, perhaps bigger than it seems, because—as a new blog post by Georgetown Law professor Adam J. Levitin explains—it means Bitcoin can no longer function as a digital currency.

To tax Bitcoin as property, he says, destroys its fungibility: One Bitcoin can no longer be exchanged for another.

This was one of the original intents behind the service. Bitcoin aimed to function as a kind of digital money, meaning it had to work as a unit of account, a medium of exchange, and a store of value. In reverse, that means:

As a store of value, Bitcoin’s price had to be predictably stable, such that you could neglect to spend a single bitcoin and know its value would not fluctuate wildly. In late 2013, many argued that Bitcoin’s quickly rising price kept it from functioning as a dependable store of value, but there were no technical or regulatory reasons it couldn’t function as such eventually.

As a medium of exchange, Bitcoin must be commonly desired. People must want to have Bitcoin; others must want to spend it. (Thus, it avoids the ‘coincidence of wants’ problem—in order to trade, both people don’t need to want something the other person has. Instead of trading rent for food, for example, you can rent living space from a landlord with money, and your landlord can use that money to buy food.)

Finally, as a unit of account, Bitcoin had to have a standard numerical value to be used to measure profits and settle debts. It had to be divisible (which it was, since smaller units of bitcoin could be traded); it had to be verifiable (which it was—this formed the basis of its cryptosecurity), and finally, it had to be fungible, meaning that every bitcoin was the same as every other bitcoin.

And that’s where it gets interesting.

Something like a $10 bill, for example, is fungible. The $10 bill you got from an ATM is the same as the $10 bill you got back as change at the ice cream parlor is the same as the $10 bill you (on a very lucky day) find on the street. It does not matter which $10 bill you spend.

So $10 bills, in other words, are interchangeable. This is why we don’t use horses, bananas, or hand-painted ceramic ashtrays as currency. (The hand-painted ceramic ashtray you got from an ATM is unlikely to be of the same quality as the one you found on the street. This is also why art doesn’t make a good currency.)

“So,” asks Levitin, “what does this have to do with Bitcoin?”

It still works as a speculative medium, Levitin writes. But one bitcoin, per Levitin, no longer equals one bitcoin no longer equals one bitcoin. Every bitcoin you own is a little different.

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Bitcoin Is the Segway of Currency

Can we get these half off if we pay with bitcoins? (Reuters)
We were promised jetpacks. We got Segways instead.

Well, we didn't get Segways. Nobody did. At least nobody other than mall cops, tour groups, and techies. Okay, and ironic polo players. But in any case, it's fair to say that Segway hasn't exactly been "to the car what the car was to the horse and buggy," like its founder Dean Kamen said it would. It hasn't even been to the moped what the moped was to the horse and buggy. Or what the bicycle was. It's just been a (sometimes morbid) punchline. And one that's almost too impossible to believe. Did you know that Kamen thought he'd need an around-the-clock factory churning out 10,000 Segways a week to meet initial demand? It's true. It's also true that he only needed to make 10 a week to do so.

This wasn't just self-delusion. It was mass delusion. Back in 2001, Steve Jobs thought Segway could be as big as personal computers. The venture capitalist behind Amazon thought it could be bigger than the internet. The entire internet. The only reasonable explanation for all this hype was that neither of them had actually seen someone ride a Segway. Because, as Y Combinator's Paul Graham puts it, you can't ride a Segway without looking like a "smug dork." And people generally try to avoid looking like that. They won't use something so inherently ridiculous, no matter how technically impressive it might be.

Like Bitcoin.

Now, for those of you who aren't techno-libertarians, Bitcoin is supposed to be a virtual currency you can use to buy things online. Except it's not really a currency, and you can't really buy that much with it. It's more like a dotcom stock—circa 1999. See, in just the last month, one bitcoin has gone from closing at a then-record $192 to reaching $788 on Monday. It then opened at $502 on Tuesday, before briefly rocketing up to $900, and ultimately falling to $646. Just your average 80 percent price swing. That's totally normal for currencies ... if you multiply their biggest swings by 80.

You can kind of see these absurd price moves in the chart below. But only kind of, because the vertical up-and-downs have come so fast that they've blurred into each other. It's almost as if Bitcoin doesn't have a single price at any one time, but rather a range of possible prices that depend on the observer. (Note: the red dots show each day's closing price, and the black lines show each day's high and low).

We can see this a little better if we zoom in on just the last two months. Bitcoin prices were pretty flat from the end of September through early October, but then (relatively at least) doubled slowly. Then they doubled quickly. And then even quicker—before falling fast. Not exactly a stable store of value.

So why has Bitcoin gone parabolic? And what does this have to do with Segway? Well, the short answer is we don't know why the virtual currency has exploded. Part of it might be demand from China (which you can see in this realtime chart of who's buying Bitcoins). Part of it might be the reduced supply after the FBI shut down and seized the drug website Silk Road's substantial Bitcoin holdings. And part of it might be pure mania. But all of these are just another way of saying that Bitcoin's design makes it prone to these boom-bust cycles.

Segway certainly knows something about design problems. Though in its case, its product worked fine, if zipping around on a glorified scooter was your kind of thing. The problem was you couldn't use the product without looking insufferably pretentious. Bitcoin, though, has deeper problems. Its product doesn't work, and its early adopters are still incredibly self-satisfied—because it's making them rich. But the product really doesn't work.

See, the idea behind Bitcoin is to create a decentralized currency that central banks can't inflate and governments can't tax. Basically, digital gold. And like actual gold, the only way to get new bitcoins is to "mine" for them. That involves running a computationally-taxing program on your computer that mostly generates gibberish, but maybe, just maybe, some bitcoins too. The key, though, is that mining for more of the virtual currency doesn't create more of it. That's because there's a predetermined number of bitcoins. Specifically, there are around 12 million today, and there will be 21 million in 2040—and no more after that. Of course, this limited supply means Bitcoin should tend to increase in value against the dollar. But only tend to. See, its deflationary bias means Bitcoin prices will go up and down quite violently. Think about it this way. The supply of bitcoins can't increase much to meet increased demand, so increased demand will make prices soar. And soaring prices will make early adopters try to cash out their winnings—which will send prices crashing back down.

Bigger Than PCs and the Internet Combined?

But techies say so what. That this misses the point. That what's revolutionary about Bitcoin isn't that it's a currency with no state-backing. What's revolutionary is that it's a payments system with no third-party, like a credit card company, standing in between buyers and sellers. See, any time you buy something, it's a minor leap of faith. You choose to believe that the seller will deliver as promised—and if they don't, you want your money back. That's where financial intermediaries like credit card companies and Paypal come in. They make sure buyers and sellers are both trustworthy, and handle any disputes.

Now, it's nice to be able to get your money back if things go wrong, but that's not free. The middlemen take their cut. Bitcoin, though, has no middlemen. It's just a decentralized peer-to-peer system. So you can't get your bitcoins back if things go wrong, but there won't be any transaction fees. The question is whether non-enthusiasts will think this trade-off is worth it.

Why Are So Few Black People Using Bitcoin?

The digital currency—popular among a mostly white, mostly libertarian contingent—might prove useful in communities where it's relatively difficult to secure a loan or transfer money.

Edwardo Jackson will gladly drop a Bitcoin primer on anyone who's curious. Beyond his outer enthusiasm for the digital currency—when he talks about Bitcoin, he speeds up as if discussing a newly-discovered oil reserve in his backyard—he loves trading it and tracking its movement in the markets.

In 2013, Jackson, a 39-year-old Las Vegas-based pro poker player and former writer for Upworthy, started spreading the gospel of the currency via his blog, Blacks in Bitcoin, where he claimed that he would “spontaneously combust” if he had no other outlet to voice his obsession with the digital barter.

“Can you imagine what it would have been like to own a piece of email technology in 1994?” asks Jackson, who believes the currency is still very much in its early adoption phase. “That’s what Bitcoin is like right now, and it’s only getting bigger.” While it's still being debated whether Bitcoin will ever gain a full foothold in the global financial ecosystem, there has been less discussion about the currency’s potential effects within communities that aren’t well served by traditional financial services. Bitcoin’s promise in the African American community has been especially overlooked—more time has been spent worrying that the currency would facilitate criminal activity.

Jackson doesn’t neatly fit the image many have of the typical Bitcoin user—the affluent, white, libertarian-leaning male. Jackson isn’t white, and he’s neither an Austrian School devotee nor a card-carrying member of the Seasteading Institute. (“I’m not what you would call an anarcho-capitalist,” he says. “I do believe that government can provide basic rules so that everybody can get along.”) As overall awareness of Bitcoin has grown, African Americans like Jackson might be able to serve as the currency's cultural ambassador to certain minority communities.

From the looks of things, that’s where the currency needs a higher profile. A study conducted in May 2014 by the Conference of State Bank Supervisors and the Massachusetts Division of Banks showed that African Americans are less likely than whites and Hispanics to have heard about virtual currencies in general. Another study, released in July 2014 by the digital media company Morning Consult, found that African Americans are less likely than white and Hispanics to know “a lot” about Bitcoin.

Bitcoin traders might interpret those findings to mean that there isn’t a market for the currency in the black community. Nicholas Colas, the chief market strategist of the brokerage firm ConvergEx Group, doesn’t believe that’s the case. Having written online commentaries and appeared on cable financial-news outlets, Colas is one of Bitcoin's earliest and most vocal evangelists. He believes the currency would be useful to a variety of demographics. “Bitcoin is a Rorschach test for anybody interested in banking, because different people see different things in what Bitcoin can offer different communities,” he says.