A Brief Case for Crypto: What Bitcoin is, is Not, and Why D.C. Should Proceed with Caution

In a June 2011 letter to Attorney General Eric Holder, Senators Chuck Schumer (D-NY) and Joe Manchin (D-WV) used these buzzwords to describe the Silk Road, an online marketplace for narcotics and other goods. In the letter, the senators asked that the Drug Enforcement Agency “take immediate action and shut down the Silk Road network.”

Fast-forward two years: the FBI arrests 29-year-old Ross William Ulbricht in San Francisco, charging him with founding and operating the network. Under an alias, Dread Pirate Roberts, Ulbricht allegedly raked in over $80 million in commissions and facilitated $1.2 billion in sales since the site’s inception in Feb. 2011.

After the arrest, the FBI has effectively shut down the Silk Road. However, the virtual currency that its users bought and sold their goods with, called Bitcoin, remains. But for how long?

Bitcoin is difficult to grasp and perhaps hard, if not impossible, to control. Many questions remain about its origins and future. Is it economically viable? Will it become mainstream? Who actually founded it?

Despite the uncertainty, one thing remains clear: misinformation regarding Bitcoin should not be the basis for government policy. It would be poor policy, if it is even possible, for Washington to shut down Bitcoin on false premises.

What is Bitcoin? Simplified.

Bitcoin, a decentralized virtual currency, allows users with an Internet connection to send money to other users pseudo-anonymously. Unlike centralized currencies, Bitcoin has no middleman or issuer, but instead relies on computing power to verify transactions and increase money supply through a process called “mining.”

While this may seem confusing, an imperfect but valuable analogy is that of gold. In a free market, no central authority regulates gold. It is difficult to track who trades gold with whom, the market relies on experts to verify that gold is real, and miners increase the supply of gold by pulling it out of the ground. Bitcoin is a completely digital, math-based gold.

Nobody really knows who founded the currency, but he/she/they went by the pseudonym Satoshi Nakamoto. Nakamoto is well versed in economics and cryptology, as she created an algorithmically sound, largely unhackable currency in Bitcoin. All the Bitcoin software is open-source and available online for anybody to download. Nobody controls Bitcoin, and some argue that Bitcoin cannot be controlled.

Why do people use Bitcoin? Who are they?

Bitcoin has myriad users, with a present total market value hovering around $2.13 billion or 180 USD to the Bitcoin.

Microtransactions, where small amounts of money are traded at high volumes, precipitated the rise of Bitcoin. The transaction costs that businesses like Paypal charge make sending small amounts of money internationally relatively costly.

In countries where inflationary pressures are a constant worry, like Zimbabwe, individuals have converted their money into Bitcoin as a store of value. Especially in Argentina where the government has attempted to strengthen the peso by restricting currency conversions, Bitcoin is viewed as a refuge for those without access to foreign dollars when they travel.

Many have invested in Bitcoin with the hopes that the currency’s value will rise. VC firms in the Silicon Valley have thrown money into the game, as have the Winklevoss twins who own roughly one percent of all Bitcoin in circulation. A growing number of consumers and businesses also own or accept Bitcoin, including vendors like Palo Alto’s Coupa Café.

Consumers of illegal products, as exemplified by the recently closed Silk Road marketplace, also transact in Bitcoin. Although the Silk Road is ostensibly gone, similar sites like “Black Market Reloaded” remain as outlets for illegal purchases. These sites are easily accessible via an anonymizing router like TOR.

Finally, small-time money launders and anti-financial establishment advocates also own Bitcoin, for practical and ideological purposes. Some view it as a haven from central government control of markets, others as a means of sending money away from government eyes—for better or worse.

Confronting common myths

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Myth: Bitcoin is the Silk Road.

Bitcoin is not the Silk Road. According to a U.S. court, Bitcoin is a form of money. There is no business running Bitcoin, no puppet master pulling the strings. Nobody owns Bitcoin just as nobody owns the dollar.

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Myth: Bitcoin is anonymous.

Bitcoin is pseudo-anonymous, which is not really anonymous. Although users’ identities are hidden, by tracking the public ledger where all Bitcoin transactions are posted, as well as through quantitative analyses of the transaction network, users’ identities can be stolen.

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Myth: Bitcoin has been hacked multiple times.

Although the companies and users that use Bitcoin have been hacked, the Bitcoin protocol itself—the currency—is cryptologically sound. Although it is theoretically possible that future quantum computing technology could overcome the system, Bitcoin is secure for the foreseeable future.

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Myth: The government can shut down Bitcoin overnight.

Bitcoin is not based in the U.S., but instead exists on the Internet. Although the government could target the businesses and users that use Bitcoin, defeating the currency would be a daunting task.

What, if anything, should be done?

As is, Bitcoin does not pose a major threat to national security. It lacks the overall liquidity for large-scale money laundering and is more traceable than the cash transfers criminals largely use to send money.

Surely, the rise of virtual currency warrants a robust, detailed debate as to whether Bitcoin is sound currency of positive economic benefit: some have argued that Bitcoin is a deflationary Ponzi scheme that will reward early investors to the detriment of latecomers (despite the publicly available code). However, we should confront fallacious arguments on both sides of the debate before calling for government action.

Senator Schumer characterized Bitcoin as “an online form of money laundering” back in 2011 when an estimated 4.5 to 9 percent of all Bitcoin transactions were on the Silk Road. Today, while some may launder money via Bitcoin, we should not let generalizations of criminal activity determine the fate of Bitcoin. By solely that standard, it would seem difficult to defend the use of paper money—we don’t know how much physical currency is used for criminal activity either.

While Bitcoin continues to grow, D.C. should not to scare away entrepreneurship and venture capital to Canada and Germany, but instead formulate clear, standardized policy to attract investment in U.S. money service businesses. 

The days of coin and cotton transactions are likely numbered. Whether Bitcoin succeeds or some other virtual cash mechanism prevails, our government—from the IRS to DHS—should be informed and prepared.

NOTE: The author does not own or plan to own any Bitcoin as of November, 2013.