Friday, November 2, 2012

The European Central Bank on Bitcoins

I have finally had a chance to read in full the unsigned report by the European Central Bank that I mentioned earlier this week. The report is quite impressive.

The report clearly states the advantages of Bitcoins versus current credit/debit cards:
Firstly, transactions are anonymous, as accounts are registered and Bitcoins are sent directly from one computer to another, Also, users have the possibility of generating multiple Bitcoin addresses to differentiate or isolate transactions. Secondly, transactions are carried out faster and more cheaply than with traditional means of payment, Transaction fees, if any, are very low and no bank account fee is charged.
The anonymity feature  of Bitcoin is the feature that I believe could be the driving feature behind the potential success of Bitcoin. As world governments attempt to get in the middle of more and more private transaction, more and more buyers and sellers will seek anonymity. (I discussed this during my interview with Trace Mayer).

The report mentions a virtual currency scheme that developed out of a limited telcom currency in China:
QQ is an instant messaging service [in China] provided by Tencent that allows virtual payments to be made with Q-coins. The currency can be purchased by credit cards or by using the remaining balance on a pre-paid telephone card. The exchange rate is fixed against the renminbi. Originally this currency was implemented only for the purchase of goods and services provided by Tencent. However, users started using it for person to person (P2P) payments and some merchants also started accepting Q-coins as a means of payment. In addition, several online games rewarded users with points that could be exchanged against Q-coins and ultimately against yuan in the black market. The virtual currency had evolved into an illegal money scheme. Chinese authorities saw the Q-coins traded reach several billion yuan in one year, after rising 20% anually. In June 2009, the Chinese authorities decided to ban this currency for trading in real goods in order to "limit its possible impact on the real financial system."
This provides a historical example of a virtual coin moving from a narrow base to a larger base.

It should be noted that Bitcoins, because of their structure, unlike Q-coins, could not be stopped by a government. The report also notes that this in a certain way is a two-edge sword of the Bitcoin system in that its complexity makes it difficult to fully understand:
The technical aspects of this system are complex and not easy to understand without a sound technical background. Therefore, a comprehensive explanation of the underlying technical mechanism is outside the scope of this report. 
Of note, the report sees Austrian economic theory as a driver of the development of virtual currencies:
The theoretical roots of Bitcoin can be found in the Austrian School of economics and its criticism of the current fiat system and the interventions undertaken by governments and other agencies, which, in their view, result in exacerbated business cycles and massive inflation. 
The report then goes on to cite the work of Austrian economists, Eugen von Bohm-Bawerk, Ludwig von Mises and Friedrich A. Hayek, with special emphasis on Hayek's Denationalisation of Money.

The full report is here.


  1. They cite the complexity of Bitcoin - but really, how many people understand our current fiat system? Initially most people are using bitcoin for low value transactions, and only a few true believers have taken the time to understand the protocol and are storing any amounts of value on a long term basis.

    If bitcoin succeeds, then those who adopted it early as a long term store of value will profit. They are the early investors in the system.

    But anyone can use it today with very little risk for normal small value transactions.

  2. The potential for Bitcoin to be the goto choice for transactions goes beyond just security. Namely, when you see all central banks printing in unison in a feeble attempt to solve sovereign debt issues, there will eventually be a "currency reckoning event" that will create demand for stability. Commodities will offer this, but for the internet economy, Bitcoin will be right there with a solution in place.

    I think the future will see decent Bitcoin economic transactional integration given its not something governments currently can manipulate, along with the security aspect.

    The bomb has already gone off. Just like the Austrian School was there to explain the housing bubble, I think Bitcoin will be there if and when the dollar as a reserve currency implodes.

  3. Wasn't it in an EPJ blog entry where some guy explained how Bitcoin wasn't as anonymous as is claimed?

    1. If I understand correctly, all transactions are public in the sense that the id of the wallet, and you can have many of these, involving the transaction can be seen. If you use the same wallet for many transactions, that can be determined. If somehow you could be connected to any one of those transactions, you could be connected to all of them. It is recommended that one use different wallets for different transactions, at least to some degree.

    2. With traditional banks, your identity is public (your name appears on paper checks and credit/debit cards), but the transaction history for your account is private. With Bitcoin this is reversed. The transaction history is public, but the identity of the account owner is private.

      Private is not the same as "impossible to find out". In both cases the private information can be found with a sufficiently motivated government effort. But for ordinary transactions, the initial privacy of Bitcoin reduces risk of identity theft.

  4. YES,bitcoin is not anonymous right "out of the box". Don't use it thinking as such.

    First, all transactions are logged in a public database. Yes, you only see the bitcoin address not a person's name, but to accept payments you obviously have to make your address public. And even if you don't, someone with a lot of resources (ie. The FBI, NSA) may be able to finger you with complex statistical techniques.

    The workaround for this is to use a "mixing" service that breaks the trail of transactions that leads back to you. Think money laundering. This costs money, however. Typically 1% of the transaction. It would be nice if the developers fixed this problem in the future.

    Second, it is possible for your IP address to be traced when you place a transaction. The workaround here is to anonymize your IP by using the TOR plugin for the bitcoin client.

    Bottom line, its not "out of the box" anonymous. It would be nice if they worked to upgrade it going forward, but for now don't make transactions under the impression its totally anonymous without protecting yourself. Basically, don't be a noob.

  5. Here's the info on Anonymity:

    Short Version: it can be as anonymous as you want it to be.

  6. Could the government prohibit Bitcoin transactions in the following ways?
    1) Withdraw use of the legal system for redress if Bitcoin or other non-approved money or barter is used
    2) Prosecute use of Bitcoin as some sort of tax fraud, even if Bitcoin transactions are reported to the IRS
    3) Prohibit conversion between Bitcoins and dollars, Those selling services for Bitcoins and buying food, shelter, etc with dollars (because those merchants are not yet accepting Bitcoins would be forced to open foreign dollar accounts, already difficult because of aggressive US policy in this area, or convert in person using dead presidents.

  7. Hey Bob did you catch the head of Pimco the other day stating the broken window fallacy? Little off topic, but the talking heads asked him about the gains for the economy bc of the rebuilding effort & he quoted it!! Maybe he reads EPJ!!

  8. Thoughts on Bitcoin Laundering:

  9. Chris P, for the noobs I created the to reduce the learning curve. In it I even provide tools to use with a computer that never connects to the Internet to (1) generate private keys for wallets and (2) generate transactions. This should provide extreme security and anonymity, if used correctly.

    Scott O, I suppose the US government could try to do stuff like that but it is really just a losing proposition like fighting things like BitTorrent. They will be fighting economics. Go ahead, pass a law to make Hurricane Sandy dissipate. We saw how well King Canute commanded the tides.

    First, keep in mind that Bitcoin is worldwide. There are about 450 users per million in the US while Mongolia has about 1,200 per million, Ukraine 1,900 per million, etc. The US is actually pretty slow on the adoption per capita.

    Second, there are already private law solutions with arbitration and mediation which operate under confidentiality and accept Bitcoin like Since there is a higher quality of equity and justice for a lower price these are pretty attractive value propositions.

    Third, it is going to be difficult to even assert there is an ownership interest in bitcoins; let alone deal with the plausible deniability the cryptography creates.

    Fourth, leverage on the exchanges is probably the weakest point. But the more leverage exerted on them the stronger the Bitcoin economy will get. For example, is starting to grow at increasingly exponential rates.

    In conclusion, the established fiat paper franchises and monopolies like USD, EUR, YEN (blood) and their payment systems like Visa, MC, Paypal, etc. (veins) have a new competitor that is BOTH the blood and the veins along with being CHEAPER in terms of time, money and privacy.

    With Bitcoin Pandora's Box has been opened. Sovereign wealth can be transferred anywhere to anyone at anytime. What the State is doing, the economy will perceive as damage and route around with this new invisible glue. The economics will cleave their own way.