The True Value of Bitcoin

I’m often asked what a bitcoin is worth right now, referring to the price in fiat currency a unit is valued at, and I usually respond that I don’t know and I don’t care. The true value of bitcoin as a system, and therefore of a single bitcoin or fraction thereof, is currently immeasurable. This is generally met with skepticism, as if I’m playing a semantic game. And perhaps I am to some degree. But it’s really not quite so simple as saying “$91.92 USD.” The true value of bitcoin is not what a single bitcoin can be purchased for today but the combined future value of two intangibles: the composition of the bitcoin community and bitcoin’s useful purpose.

The first part is easy to understand. Bitcoin is the accumulation of the talent, hard work and dedication of the people who develop and maintain the protocol, build industries around the protocol, the merchants and consumers who use the bitcoin protocol in their daily lives, and those who promote and protect the protocol. As more people become a part of the bitcoin community, the value of the system increases.

The second part requires a deeper dive into what bitcoin actually is (hint: it’s not virtual currency).

Bitcoin is Distributed Finance

Bitcoin is not just money. Bitcoin is a protocol for fixing, storing, and transferring value. This includes the recursive use of Bitcoin to fix, store, and transfer bitcoin itself as a thing of value. Money presupposes such an underlying transparent and accountable system for fixing and transferring property. While some may treat bitcoin like money, in reality it is a new class of digital asset. As a digital asset, the first widely adopted use of bitcoin was as a safe and secure store and transfer mechanism for fiat currency value. This is how most people think of and use Bitcoin today, as a substitute for money, but it is an inadequate classification. Perhaps the best way to think of bitcoin is as a method for Value over IP (sadly, VoIP is taken as an acronym).

When I first encountered bitcoin, the first thing that struck me was the way in which bitcoin replaces the traditional chain of title in property law. The bitcoin protocol secures a party’s interest in an asset in an identifiable and secure manner, and provides a transparent set of rules and enforcement mechanisms so that all parties are held equally accountable. It does all this without any reliance on financial, regulatory, or judicial authorities. Truly, bitcoin is code as law.

Perhaps bitcoin can best be understood as a response to failing institutions. Private financial institutions have failed to address a systemic inequity with regard to who has access to the global financial system. Public institutions spend more resources keeping people out of the global financial system than in building infrastructure to allow the world’s disenfranchised to access global finance.

Indeed, while some have wrung their hands and complained about the challenges traditional financial institutions have in serving disenfranchised populations, others have stepped up and created consumer-friendly solutions. As it happens, Kenyans using the Kipochi wallet have access to a global financial system using bitcoin and, as they want, can convert bitcoin into m-pesa for local transactions and purchases.

Where the government and private sector have failed, open-source development may have found the answer in bitcoin.

The Value of Bitcoin as A Distributed Financial System

The way to assess bitcoin’s true value is by quality of the community and how that community utilizes the bitcoin protocol to address market needs. If bitcoin becomes the digital asset ledger for System D assets and transactions it would address a $10 trillion market that is completely unaddressed by either public or private financial institutions. This is why most investors in the industry feel that the current $1 billion market cap is low given bitcoin’s potential to reconceive how society’s value and property are conceptualized, stored and managed in an Internet-enabled world.

This is all very exciting, but bitcoin only has value as a system to the extent individual participation and inclusion are respected. In order for any system to be useful to System D and disenfranchised populations it must be private, decentralized (and thus extra-governmental) and transactions within the system must be irreversible (and thus secure and respected). It is the combination of these three elements that makes bitcoin anti-fragile. And it is this combination of elements that allows for securitization of digital assets, perfect fungibility of those assets and thereby the unearthing of new and previously inaccessible sources of capital.

A compromise on any of these core principles devalues bitcoin as a whole. That is why the community will aggressively challenge any threats to these principles.

Privacy Is Intrinsic to the Value of Bitcoin

Unlike chain of title in property law, the bitcoin protocol does not rely on proof of identity for an individual to assert proof of ownership to a digital asset stored within the blockchain (the distributed public ledger that records assets in the bitcoin protocol). All that is required to assert ownership is possession or knowledge of a bitcoin private key (sort of like a password for your bitcoin address).

Privacy is an essential component of bitcoin because the protocol authenticates ownership and transactions via a distributed ledger system. Without privacy Bitcoin becomes far more nefarious than anything the NSA could dream up. It would be a full, public transaction log detailing, in an identifiable way, every value transfer you and every other bitcoin user has ever made.

In many instances, bitcoin’s private method of recording property rights is far superior to identity-based systems. For dissidents, journalists, political activists and other stigmatized classes of people privacy is essential to their livelihood and, in some parts of the world, even their survival. This method is also superior to legacy systems where uncertainty over ownership  has stifled innovation. Gone would be the days of trying to decode the identity of an owner of a copyright because of poor identifying information relating to the artist, uncertain contractual rights, or simple failure to assert a claim of ownership in a timely manner. The blockchain would make ownership of copyrighted material transparent, secure, and simple to assert and prove. Contractual rights, royalties, and even droit moral could be incorporated into the blockchain. Royalty and license payments could be automated and fully auditable in real-time.

Going a step further, the blockchain could also prove an elegant solution to applying copyright law’s first sale doctrine to digital goods. A content producer could create a unique digital asset in the blockchain for each instance of a digital good. This asset would embody a unique and transferable ownership right to a consumer, and the consumer could freely transfer this right via the blockchain. Because a unique instance on the blockchain is required to unlock the content, the seller would lose access and the buyer would gain access in a manner not unlike how a physical book or cd is transacted. Of course, these transactions would be fully transparent and auditable.

Privacy on the network begets transparency. You can’t expect participants to allow full financial transparency at the institutional level if the participants can’t choose to guarantee the privacy of their individual transactions. The trade-off here is clear, privacy for individuals leads to transparency in formerly opaque business. This is why we saw the first provably fair gaming service developed on the bitcoin protocol and now sold for close to $12 million.

But it’s easy to see how things could quickly go awry if privacy, and indeed anonymity, isn’t respected on the network. A single data breach at a bitcoin exchange service maintaining all or part of an identifying database could lead to the exposure of a user’s entire online financial life (I imagine the Federal Trade Commission would have something to say about that). While some types of exchanges will have to verify and record customer identities in relation to fiat currency to bitcoin exchanges, this is ultimately a consumer choice issue. It is the consumer’s choice to use an exchange that requires identity verification or to find another means of obtaining bitcoin.

As a result, bitcoin firmly puts financial privacy back in the hands of consumers for the first time in at least a generation.

A Sane Regulatory Environment

The most immediate threat to bitcoin quickly fulfilling its highest purpose as a useful system is overbroad and defensive reactions from the regulatory and law enforcement community. Over time, it’s possible and maybe even likely that any overbroad or defensive regulatory response may be rendered moot by the technology. But in the short term it would dramatically impact the speed with which bitcoin can be deployed to solve pressing market needs and global inequity—and thus suppress the value of bitcoin itself.

It is the modern way that arguing to restrict or condition access to any system is to argue on the wrong side of history. Technology and networked society has driven a wave of openness, collaboration, participation, and individual responsibility. Those institutions willing to go with the tide and ride the wave will be carried along, while those who resist too strenuously will be swamped.

One notable way forward is for the industry to show a willingness to regulate itself, in particular when it comes to interactions with traditional financial institutions and regulatory authorities. But such organizations have to know their limits and keep in mind what is feasible and value accretive for the community as a whole. As Jon Matonis, the Bitcoin Foundation’s Executive Director, has said: “As self-regulatory organizations are excellent non-governmental solutions for industry best practices, they need to be vigilant about maintaining the integrity of the original mission. In the case of bitcoin as a negotiable digital asset class, the protection of core fundamental attributes includes perfect fungibility, payment irreversibility, and user-defined privacy.”

Resisting inclusion and openness by creating lists of “tainted” bitcoins or restricting transactions to bitcoin addresses that attain a sufficient identity score (for knowing your counterparty) may seem to be a clear and certain path to easing the regulatory concerns, but such systems would dramatically impact the fungibility and participatory nature of the overall system and thereby devalue the entire bitcoin project. Any customer identification that goes beyond the transition from traditional finance to bitcoin is a line in the sand that cannot be crossed no matter how expediently it eases the regulatory burden for some businesses in the space.

Thinking that the most regulated businesses in the most regulated jurisdictions will dictate the core values of the bitcoin community is folly. Entrepreneurs may choose to create highly regulated businesses that utilize the bitcoin protocol, but those regulations must be their burden to bear.

Before we start discussing what concessions the bitcoin community should make, we should first decide which stakeholders should be appeased and why. Why, for example is law enforcement driving this conversation instead of consumer or merchant advocates? Is it in anyone’s best interest to have law enforcement making policy decisions that directly affect consumer choice, financial privacy, and market dynamics?

Indeed, we need to have a frank discussion not only about law enforcement’s “seat at the table” but of the broader tradeoffs implicit in the aggressive enforcement of financial crime, preferably before we criminalize entire nascent industries.

Some clear and notable effects of increased enforcement efforts are:

  • A chilling effect on banking for innovative non-financial institutions like virtual currency and distributed financial firms. Some national banks have instituted blanket policies that they will not take on the regulatory risk of banking any business associated with bitcoin without regard to a particular company’s compliance measures or risk profile.
  • Growth in the number of underbanked and unbanked people as fewer people are able or willing to clear the compliance hurdles necessary to effectively “know your customer” or “know your counterparty.”
  • Exclusion of “high-risk” groups of people (often poor, marginalized, and ethnic minorities) from the global financial system, often with grave humanitarian consequences. Global remittance is the lifeblood for many communities. Companies facilitating these transfers are routinely shut down by banks unwilling to take the risk of banking “high-risk” populations.
  • For the few companies that can still operate in the global remittance space, compliance costs and uncertainty have resulted in less competition and astronomical fees on populations that are least able to bear the burden of these costs: a pure tax on the poor and disenfranchised for being poor and disenfranchised.

This leads one to seriously question whether law enforcement concerns, which are at times unproven and theoretical, should be dictating these public policy outcomes. Or, if perhaps we should be discussing whether law enforcement efforts are costing us, as a society, more than we benefit from them.

Here are a couple of modest proposals to bring some sanity back to the US regulatory environment for the emerging payments industry broadly and as stop-gap measures for bitcoin as it evolves beyond traditional finance:

  • Create uniformity and clarity out of kafkaesque state-by-state money transmitter regulations either through preemption and integration into a federal agency or through home-rule and reciprocity agreements.

U.S. rules and procedures related to money transmission are arguably the most opaque, anti-competitive, and parochial regulations that companies in the United States have to face, and they are offensive to an open and participatory system.

Perhaps the root cause for the failing multi-state regulation of money transmission is that each individual state is not required to respect the judgment of another state. Instead, each state wants to assert jurisdiction over any business that touches one of their consumers, leading to a regulatory patchwork that is unworkable in an Internet-enabled world where customers could be anywhere at any given time. The Internet doesn’t respect borders and jurisdiction.

And so now we have arrived at a point of sheer absurdity, where state regulators don’t understand the applicability of their own rules to a particular industry, but at the same time the industry will still be held to account for failing to abide by the incomprehensible rules—that is, once the regulators get around to figuring them out at some point in the future. To be clear, the industry (which at times could be a two-person technology startup) should in principle be able to understand the rules regarding money transmission and how they apply to their business. This violates our most basic sense of fairness. No one should have their lives ruined and face jail time for violating rules that no one can understand.

In fact, it is the duty of law enforcement and regulators to explain the rules in a clear and comprehensible fashion before applying them to and enforcing them within a new industry. It is also the duty of regulators in a free society to make these decisions in the open, transparently, and with participation from the public.

  • Safe harbor protection under the BSA for banks and financial institutions exercising reasonable diligence and good-faith efforts to mitigate financial crime.

Bank Secrecy Act compliance is rooted in a results-based methodology. Firms that fall under FinCEN’s administration of the BSA are required to put in place policies and procedures to ensure proper and accurate reporting of customer transactions and to proactively prevent financial crime from occurring within their systems, even from one bad actor. The outcome of this results-based approach is that firms suffer from great uncertainty as to where that elusive “one bad actor” could be in their system and how they will be treated by regulators if, despite best efforts, some financial crime is detected. In practice this leads to a culture of risk-aversion and an ever shrinking circle of “safe bet” firms that are allowed to participate in the global financial system and reap the benefits therefrom.

Firms should be rewarded for their good faith efforts to root out financial crime, for adopting industry best practices, and for taking seriously their responsibility as upstanding members of the global financial system. Allowing for statutory, and thereby certain, safe harbor protection for those firms, if it so happens that a bad actor slips through their net, would allow firms to take more risk onboarding customers and increase participation in the global financial system.

As it is, the regulatory process is much like a sausage factory: every animal looks different going in, and they all look like sausage coming out. It seems that to satisfy some of the voices in the regulatory and law enforcement community, bitcoin must grow to resemble a low-cost version of PayPal or Western Union. It must be less disruptive to traditional finance, not more disruptive, and it must put less power in the hands of consumers and merchants and more power in the hands of the state and intermediary institutions. It may be that for bitcoin to be palatable to some stakeholders it will have to look like the sausage Washington, DC is used to eating. But it just so happens that sausage is less valuable than steak.

The Future of Distributed Finance

The point of the bitcoin project isn’t to reform the traditional financial system. It isn’t to integrate into the traditional financial system. The point is to obviate the traditional financial system.

Unlike traditional public and private institutions, the bitcoin community is open, transparent, and participatory. Anyone, from a law enforcement official in Washington, DC to a Haitian street merchant, can have a say in how bitcoin develops and participate in the project. It is the responsibility of existing stakeholders in the global financial system to find common ground and participate on equal footing.

The right of an individual to make sovereign financial decisions and participate freely and without undue burden in the global economy is a cornerstone of human dignity and empowerment. Since the end of the colonial era, traditional financial institutions have failed to develop systems to include disenfranchised and developing world populations. Unsurprisingly, the result of this failure is that others have taken the matter out of their hands. For better or worse, distributed and participatory finance is here, it’s valuable, and it’s worth fighting for.

Satoshi lit the fuse. We are the dynamite.

Also from this issue

Lead Essay

  • Jim Harper reviews the traits that make a given class of items either useful as money or not. These are the traits that, for example, made gold and silver historically such widespread monetary standards. He finds that bitcoin possesses many of them to a very high degree, but that it very importantly fails on some. Bitcoin’s future is unclear in another respect as well: Established government and financial industry interests will do whatever they can to preserve what they view as their own turf. Still, the greatly increased use of digital currency seems inevitable to him in some form or another, and that form could well be private.

Response Essays

  • Dan Kaminsky argues that bitcoin’s success so far stems from the success of the Internet itself, and also from the failures of plain old money. Traditional payment methods all face serious challenges in our digitally connected world, and transaction costs to maintain our financial network make plain old money less and less attractive in contrast to its digital counterpart. But bitcoin isn’t perfect either, and the threat of large conglomerates abusing their power isn’t limited to plain old money. It can happen in the bitcoin network too.

  • Jerry Brito argues that bitcoin is far more than just money. It’s also a distributed-ledger payment system, which means it’s a lot like Visa, MasterCard, or PayPal, but with one key difference: There is no central authority managing the payments. As a result, bitcoin is open to becoming a lot more than “just” money. It can also be used as a token to represent claims on other items. As such, very small fractional bitcoins can function as bonds, stock certificates, property deeds, IOUs, or even decentralized futures markets. The full scope of these possibilities is vast, and we are only beginning to grasp the implications of bitcoin.

  • Chuck Moulton argues that bitcoin is a sound form of money. Its quantity is known, it expands at a known rate, and it will eventually stop expanding. As a result, fluctuations in the value of bitcoin are almost entirely a function of demand. Moulton suggests fractional reserve banking as a way of stabilizing bitcoin’s value. He goes on to suggest that nations might consider dollarizing to bitcoin as a way of preventing inflation, with the very significant caveat that “a second or third generation cryptocurrency may be the one to finally take hold.”

  • We are pleased to publish this contribution from Patrick Murck, Bitcoin Foundation General Counsel, who argues digital currency will disrupt traditional finance. This disruption is both very much intentional and likely to empower consumers who have not been able to take advantage of traditional financial services. Older financial system players are likely to resist, of course: They have a stake in the status quo.