Wednesday, June 27, 2012

The Bitcoin Richest: Accumulating Large Balances

By Jon Matonis
Friday, June 22, 2012

Everyone is familiar with Forbes 400 as the definitive list to wealth in America. But few people know about the world's up-and-coming bitcoin richest and what motivates them to accumulate and maintain large balances.

The Bitcoin Richest ranks the top worldwide holders of bitcoin wealth on the blockchain. The caveats are that we cannot identify the affluent person or business (but you know who you are) and the same entity may hold the private keys to multiple bitcoin addresses. At the current exchange rate of $6.50 per BTC, the top address on the list holds control to an astonishing $2.85 million in total value (as of 6/20/12). Top ten balances are clickable to show dates with transaction history and my analysis follows:

BTC Balance                Bitcoin Address (Hash 160-bit format)

438824.90216295 8bf24a18a58ab500d30c73bf21dbf4703d31ad2c
105555.0000000 582431b9e63d2394c8b224d1bc45d07ae95d2379
79956.00100000   a0b0d60e5991578ed37cbda2b17d8b2ce23ab295
59258.88000000   89a37004da17f792487bcc26f853c7722c56fd91
53000.00000000   3d9e561f21d312f9b8b46e74169263e2452d5591
50129.66980000   2004f419e735115cb2a42cbc76f5b0a20c9698f8
50000.00000000   863ec44fbf7c9ed0819b52f275006b22ba781794
50000.00000000   f1c87a5e8ff7d14e74b858089bf771c94b1b6db4
47457.46000000   6fbe1851f5d1de5477d147e93b3da5c0c98f4e8e
45000.00000000   f68212be6db427d4b30f01113920db0e9e457c8d

Source: Bitcoin richest addresses created on June 19, 2012 by znort987 via blockparser.


What can we learn from this list? First, it demonstrates that a broad group of people are comfortable enough with the bitcoin crypto to exit the traditional banking system and leave significant value on the blockchain for extended periods. I can only guess that they must have a rigorous onsite and offsite backup process for retrieving the private key or perhaps they rely on Brainwallet for the utmost in mobility.

Also with the exception of the top three addresses, the wealth is evenly distributed as 8,000 BTC is the cut-off to make the top 100 list. Incidentally, this has remained consistent with a similar list computed in December 2011 in which the cut-off to make the list was 6,925 BTC.

But why leave your wealth in a distributed proof-of-work system instead of a traditional bank? In a broad sense, bitcoin wealth offers protection from unpredictable political risk such as sovereign confiscation, excessive taxation, and capital controls at the border. In addition to preservation of value when compared to national fiat currencies, bitcoin wealth eliminates bank solvency risk and the risk of exogenous shocks to the uber-leveraged financial pyramid. Remember, a pyramid was not a monument but a tomb.

One of the challenges confronting bitcoin consultants in certain industries is how to transfer bitcoin value in amounts of $10 million or more for purposes of trade settlement and for the mitigation of jurisdictional bank risk. With the total bitcoin market capitalization at approximately $60 million and the largest single address holding merely $2.85 million, you can begin to see the obstacles. The bitcoin market is still too nascent and small for robust use in global trade settlement. Liquidity and depth would have to increase significantly to accommodate requests without severe price disruption.

Thanks to the excellent work of, we can get an idea of current trade and settlement usage by looking at the 100 largest bitcoin transactions culled from the most recent 50,000 transactions. Bitcoin Days Destroyed also provides an indication of transaction volume that attempts to strip out transfers to oneself and account reorganizations.

For further reading:
"The death of banks – and the future of money", Detlev Schlichter, June 20, 2012
"Underground Remittances - From Hawala to Bitcoin", Mondato, June 20, 2012

Sunday, June 24, 2012

TORwallet Sparks Trust Without Jurisdiction Debate

By Jon Matonis
Tuesday, June 19, 2012

In the world of the Internet, entities can provide online services without any consideration for a legal jurisdiction. But, in the world of Tor or Onionland, entities can do so anonymously.

Intended to protect users' personal freedom, privacy, and ability to conduct confidential business, Tor (The onion router) is a system that improves online anonymity by routing Internet traffic through a worldwide volunteer network of layering and encrypting servers which impedes network surveillance or traffic analysis.

TORwallet has just announced an online bitcoin wallet run as a TOR hidden service (to access the service users must run the onion proxy software on their computer). They do not log any information except the current account balance and the bitcoins from many TORwallets can be mixed instantly to a single address in a single transaction to make them extremely difficult to trace. The same anonymity and untraceability of that crumpled paper money in your pocket is now available in electronic form.

Obviously, the cashless society people do not want this because full transaction traceability is the unstated motivation behind eliminating cash. Don't fall into this complacent attitude of a 'cashless society represents the future' because if we lose the monetary privacy features that we already have, it is a grim future indeed! Game over.

With Tor, the trade-off then becomes near total anonymity versus the ability to have legal recourse in a national jurisdiction. In relinquishing the option for legal recourse and for identifying the site operators, users must be content with the ongoing trustworthiness of the service. How do users become content and satisfied? Is anonymous reputation even possible? Trust will always be relative so is that enough?

eBay pioneered large-scale reputation credentials with its buying and selling platform that rewarded excellent service and punished repeat offenders. Long-standing positive reputations became very valuable in the competitive online marketplace, but users still had limited legal recourse against eBay and even though they may not know the other party to a transaction at least eBay did. The digital marketplace Silk Road currently operates a platform with a participant reputation system. However, in a two-party online Tor wallet service, you only have the earned trust of the non-jurisdictional site operator and that is comprised mainly of longevity and customer service. Only time will tell.

Essentially, the principle behind all mixing services is the ability to remove or obscure any linkage to a real-world identity because the bitcoin blockchain maintains a public transaction log of all transactions. Since the method used to obtain or purchase bitcoin may have revealed certain financial or personal links, it becomes necessary to render the blockchain useless for traffic analysis. Properly mixing bitcoin with other users' bitcoin will cause a chain of custody to break down and thereby provide plausible deniability for any transactions.

The privacy advantages of Tor-based mixing services are numerous. For instance, compared to proxy servers or VPNs, there are usually no IP logs kept which would be vulnerable to a court order or a server raid even if you paid for the VPN anonymously. A court order can also force a VPN to commence logging at any time.  According to TORwallet, "Any service not on Tor probably keeps logs of your IP address and could be coerced into giving up your information. Anyone wanting to force us to talk would have to find us first." They also claim that moving clean coins around from several large disconnected pools decreases the risk of matching inputs and outputs to trace client coins. Additionally, "being a Tor relay mixes your traffic in with other people's traffic, making it more difficult to do timing and correlation attacks." And from the user's perspective, the use of multiple wallets and mixers distributes risk.

Another Tor-based mixing service is Bitcoin Fog which charges between 1%-3% (randomized for obscurity). Perhaps the earliest and original bitcoin mixing service is Bitcoin Laundry which acquired the BitLaundry service running on Google App Engine in 2011. 

Disclaimer: bitcoin is not a recognized currency or monetary instrument in any jurisdiction.

For further reading:
"Review: TORwallet", Vitalik Buterin, Bitcoin Magazine, June 19, 2012
"Tips for Running an Exit Node with Minimal Harassment", Mike Perry, June 30, 2010
"Plaintext over Tor is still plaintext", phobos, June 1, 2010
"Anonymity and the Tor Network", Bruce Schneier, September 20, 2007

Monday, June 18, 2012

Why Apple Is Afraid Of Bitcoin

By Jon Matonis
Wednesday, June 13, 2012

When you finally grasp the magnitude of Apple’s play in the payments business, it becomes clear that potential competitors will be shunned from the platform. As Daniel Terdiman suggests in CNET, "New Apple features may leave fresh app roadkill in their wake as Apple is likely to undercut several existing third-party applications." With the introduction of Passbook, Apple has launched mobile payments on iOS and competing virtual payment systems, including bitcoin, must be terminated.

Roadkill in payment apps has already occurred and they were never given the chance to be made irrelevant. The decentralized digital currency bitcoin has had two functioning payment applications on the Apple App Store -- Blockchain Wallet and BitPak, both of which have since been unceremoniously evicted. Several other bitcoin-related apps currently appear in the store but they don't seem to be restricted by Apple since they don't enable send/receive transaction capability as the wallets do.

In April, I covered the extraordinary Blockchain Wallet product in Forbes only to see the app abruptly removed from the store in less than two weeks. The explanation given by Apple was that "apps must comply with all legal requirements in any location where they are made available to users." Apple further stated, "it is the developer's obligation to understand and conform to all local laws" and the developer was referred to the legal department for an exact explanation of which law it violates. Clearly, they will not be able to cite a law as no laws prohibiting bitcoin currently exist in any jurisdiction. Fortunately, the wallet app is still available here at the Cydia Repository for jailbroken iPhones.

At about the same time, BitPak received an electronic notification that the first bitcoin wallet for iOS had also been removed from the Apple App Store again citing similar legal reasons. Sadly, BitPak's developer says that he would have continued BitPak development had the app stayed in the store and that he had been working on a revision which would have put the blockchain in the cloud for greater efficiency.

Basically, it boils down to this. Apple realizes that, with their current installed base of 400 million active credit card details, the mobile payments war at the point of sale is largely theirs to lose. Why complicate the strategy by offering competing currencies and competing systems on the iPhone platform? If Apple can facilitate proprietary mobile payments successfully, it can undoubtedly spur demand for more Apple products.

Even though bitcoin payment apps could boost sales of Apple mobile hardware, bitcoin poses a more specific threat because, as its own independent, nonpolitical currency, the third-party legacy players (i.e., VISA, Mastercard, banks) can be bypassed which would disrupt Apple’s partnerships with dongle players like Square and iZettle. Bitcoin payment apps have already demonstrated the effectiveness of QR codes and scanning at the point of sale which is obviously Apple’s bridge strategy prior to full Near Field Communication (NFC) deployment.

According to Caribou Honig, a partner with QED Investors:
"The pending battle for these revenue streams will be the stuff of legends. Never have so many corporate giants been lined up for their piece of the pie. Let’s start with Apple. My thesis is that they are the only company capable of catalyzing adoption of tap-to-pay on smartphones. But which prize do they seek?
I predict they will take no interchange revenue and no fees. They will avoid such barriers to adoption. Advertising revenue will be negligible. Apple’s prize is simply to boost sales of high margin iPhones. The mobile wallet will be a key selling feature and create yet another means to lock people into the iOS platform."
Bitcoin is not the only virtual currency target. The founders of micro-payment service Flattr say that they are the victims of an 'app dictatorship' after Apple rejected the podcatcher Instacast based on its integration with Flattr. Apple cited App Store Review Guidelines 21.2 which states that "the collection of donations must be done via a web site in Safari or an SMS." A Bitcoin Forum member then surmised: "Have the app create the script and route that out through using SMS. I wonder what the difference is though between an app that uses Flattr and an app that uses PayPal, as far as being used to transfer funds from one person to another."

PayPal is a unique and interesting exception. Having been in the App Store since the very beginning, PayPal has the volume and clout to the point of where rejecting it would harm Apple more than PayPal. Also, PayPal holds consumer accounts and processes only national currencies so they are more like a bank and card company combined. However, Apple still hugely regulates what can be done via PayPal. While consumers can send payments to each other and link PayPal to fund their iTunes account, developers selling in the App Store are forbidden in accepting PayPal directly due to Apple’s 30% cut.

Bitcoin might be stymied by Apple for now, but I predict that even the well known PayPal app will join the growing list of roadkill if Apple decides to enter person-to-person payments.

For further reading:
"Does Apple’s Passbook App Make Cents?", Tricia Duryee, June 16, 2012
"Passbook Is the Beginning of Mobile Payments On iOS", Brent Rose, Gizmodo, June 11, 2012
"Understanding Bitcoin", Nicolas Mendoza, Al Jazeera, June 9, 2012
"Apple’s mobile payment plans and its vision for retail", The MultiChannel Retailer, June 2012
"A wealth of wallets", The Economist, May 19, 2012

Thursday, June 14, 2012’s Plan to Build the Future of Legal Systems

By Zachary Caceres
Radical Social Entrepreneurs

Peter-Jan Celis
All around the world, people struggle with expensive legal fees and backlogged courts. Judges are sometimes biased or corrupt. Political agendas tilt the scales of justice. In many places in the developing world, courts are used almost exclusively by elites.

But if 26-year old Peter-Jan Celis has his way, this is all bound to change. Celis founded – a private, online small claims court based in Santiago as part of Start-up Chile.

While building, he has come to see a paradigm shift in law and legal services as the only realistic way to fix the problems of today’s legal systems. Taking arbitration online and making it cheap and user-friendly is the first step towards a much deeper vision.

Celis is an outspoken advocate of polycentric law, a clunky phrase for a network of parallel legal systems, where jurisdictions and legal firms compete with each other to ensure high-quality and low price.

At its debut, lay dormant for months. But recently, Celis suddenly found himself trending on sites like HackerNews and Reddit, and his website has roared to life.

Radical Social Entrepreneurs chatted with Celis about, and his bold vision for the future of legal systems.

RSE: So, what’s

Celis: is a small claims court for the internet. We offer fast and convenient online arbitration that is legally binding in 146 countries at just $299 total fixed price ($149.50 per party).

RSE: That’s surprisingly cheap. Some courts can charge that much just in paperwork fees. At RSE, we’re always interested to hear people’s stories and how they arrived upon their radical social entrepreneurship project. What’s yours? How does a twenty-something end up in ‘start-up law’?

Celis: The divorce of my parents has been going on for 7 years and still running. It became very obvious to me the court system was failing around the same time I got interested in private law as a “last frontier” for innovation.

In essence, any legal system is an attempt to manage negative externalities, although incentives in centralized legal systems unfortunately also go beyond that.

[Negative externalities are effects of private activity which spill over onto others. For instance, pollution or loud noise. –Ed.]

Imagining how private law might work as an alternative to today’s monopoly legal systems was the last “hard nut to crack” for me. Trying to find a pragmatic way in the current legal system was an even harder exercise, but after studying arbitration at a CIArb course (Chartered Institute of Arbitrators) I came up with the system.

What I am most proud of is that I found a way to offer immediate enforcement value to my customers leveraging current international arbitration laws while hoping to build a more reputation based enforcement mechanism as soon as possible. (Read: user profiles.)

RSE: seems to have two main components. The first is the arbitration service, which is why people pay you. The second is your contract clause. With one click, people can literally copy and paste a clause from your website into their contracts — making any disputes that arise cases. This could be used by all sorts of people. How have both components been received? What’s the caseload like? What does the market look like?

Celis: The service has been very well received. There is, however, a lag between clause usage and dispute filing. As a result, the number of disputes arbitrated can still be counted on one hand.  Also, I can’t track how many contracts use my clause yet.

When I launched my service on January 17th, I started with business-to-consumer marketing, assuming case load would take off organically. However, looking at my stats now, I see maybe 1 case filing per 500 unique visitors and most of those don’t even end up in arbitration hearings because either the filing is fake or the responder refuses to agree to arbitration.

Post-dispute agreement on arbitration is indeed very unlikely as often one of the parties knows they are likely to lose. Hence it is really important for me to push my customers to add my arbitration clause to all their contracts pre-dispute.

So looking at where I am now, I received a lot of media attention, good and increasing traffic and great applications from arbitrators, rails developers, and business developers. The only thing lagging is a steady case load, which is why I decided to start focusing on business-to-business partnerships with market places and escrow companies.

If they send the disputes between their users to me for arbitration, it lowers their support costs and users can settle in a low cost and binding way.

I am not giving up on targeting consumers though. The great response I get when I talk openly about the vision for has convinced me I should take a page from the 37Signals handbook and out-educate any existing arbitration provider.

RSE: So how can other startups or individuals use your service?

Celis: can be used for any type of commercial and private dispute. Disputes that are not arbitrable include crimes and all issues involving identity. To give you an idea, the disputes that have been settled using arbitration so far included the parents of a quickly divorced couple disputing who has to pay what share of the wedding, a freelance management consultant and his client disputing project delivery and payment, and a dispute between a student and a private tutor.

So in practice, I advise everybody to put the arbitration clause in all their contracts, to avoid costly and time consuming court litigation. Businesses are well advised to put the clause in their terms and conditions.

If anyone reading this interview runs or works for a market place or escrow service, I’d like him or her to contact support on my website so we can talk about a partnership.

RSE: Great. Let’s get back to your bigger vision.
How scalable are the services provides? Having affordable arbitration in the developing world, where so many people face such terrible courts, would be a major achievement for humanity. But does rely so heavily on the effectiveness of state-provided courts that it’s constrained to the developed world? If I live in a country with ineffective courts, how binding is the judgment?

Celis: In its current version indeed relies on the existing framework for international arbitration and as a result on the local courts for enforcement. Please note, however, that even when doing business with less reputable jurisdictions, it is the location of assets of the other party that matters for enforcement. In other words, even if you do business with someone from the Central African Republic you can always go after his assets in other countries if possible.

Overall though, I agree that will only be able to revolutionize the rule of law in corrupt developing countries if a) we are able to provide arbitration cheaper than $299 – e.g. evolve to 2% of claim value if the depth of our arbitrator market increases – and b) becomes so well known as a brand that the reputation on your future profile becomes so important that being called out if you don’t pay up is enough for people to comply.

RSE: We keep calling a start-up. Are you in the ‘market for law‘? What do you say to someone who says that law is necessarily the duty of nation-states and their sub-units? Centralized provision of law seems to work decently – though certainly not perfectly – in some places, and extremely poorly in others, such as in the developing world. What are the virtues of your ‘start up law’, polycentric approach?

Celis: I do consider to be in the market for law. Currently we are simply a service that applies equity principles/contract law, but the next step is building a market place of arbitrators with reputations and case law history. Eventually I want to allow 3rd party providers to plug-in to my system as well, so becomes the platform for polycentric law.

As far as those who doubt, I’d rather just create the future and people will use it if it benefits them. If you surveyed people 20 years ago whether some TV broadcasting time should be randomly distributed to everybody who wanted it, people would most likely have demanded special checks to make sure criminals or those with extreme views could not participate.

Today there is YouTube and everybody thinks it is the most common-sense thing in the world that everybody can upload a video.

Polycentric law, if universally adopted, would eliminate all the incentive problems in politics that public choice theory describes so well. Being principled as a politician would pay off.

Last but not least until we get to this polycentric ideal, having a few extra private alternatives to government courts can only benefit consumers.

RSE: Wow. So what is the future of law given changing technology and start-ups like Are we ever going to be able to challenge monopolies in the market for law?

Celis: The monopoly on law is basically a claim by the government that they are best at managing negative externalities and as a result, the reputation of individuals in the legal system. As reputation becomes more important on the internet, and more advanced dispute resolution systems arise to track reputation online, this claim will become increasingly unsustainable.

In the future, I see law and as a result politics moving online, with “being a famous politician” meaning, among other things like YouTube views and Facebook followers, “having a lot of arbitrators in my group with a lot of users liking us.”

Another catalyst for this change will be major governments going into bankruptcy and major currencies going into hyperinflation or extreme currency controls. There will be a void for “government” services such as justice, social security and education, and the free market will have to fill it.

RSE: Fascinating. Thanks a lot, Peter-Jan.

Tuesday, June 12, 2012

Detaining Developer At US Border Increases Cryptocat Popularity

By Jon Matonis
Thursday, June 7, 2012

The developer of a leading open source application for encrypted online chat, Nadim Kobeissi, claims to have been detained and interrogated at the US-Canadian border yesterday. "Out of my 4 DHS interrogations in the past 3 weeks, it's the first time I'm asked about Cryptocat crypto and my passport is confiscated," tweets Kobeissi. The US interrogator also asked about which encryption algorithms Cryptocat deployed and they were curious about its level of censorship resistance.

Cryptocat establishes a secure, encrypted chat session that is allegedly not subject to commercial or government surveillance. It uses client-side JavaScript to implement 256-bit Advanced Encryption Standard for message encryption and Elliptic curve Diffie-Hellman for key agreement. Similar to the Off-the-record Messaging (OTR) cryptographic protocol available via plugin, Cryptocat generates new key pairs for every chat implementing a form of perfect forward secrecy and deniable encryption. However, the web-based Cryptocat can also accommodate multiple parties to an encrypted chat session.

Kobeissi recently tweeted, "it's important that my interrogation doesn't blow confidence in Cryptocat out of proportion. It's still an experiment that needs work." Of course, JavaScript crypto does have its limitations (and critics) since it would still be susceptible to a server-side code poisoning attack.

But, the implications for privacy and freedom are truly astounding. An application like this can save lives, because during the tense moments of the Arab Spring the sources of certain instant messages and other online communications were tracked down and killed for their political views and organizational skills. Indeed, in journalism sourcing also, the privacy of an off-the-record source can be a matter of life and death.

Unlike other cryptography products that can later be used as a verifiable record of the communication event and the identities of the participants, perfect forward secrecy leaves no such trail. Kobeissi readily admits that this feature can be used for bad as well as good but it's worth the risk: "It's like if someone says 'Hamburgers: they can be used to feed the good and they can be used to feed the Taliban. I guess that means we should get rid of hamburgers then.' It bothers me that we're so afraid that our freedom will be used against us that we're willing to just give it up."

On television, RT America has even gone so far as to refer to Cryptocat as CISPA's kryptonite because it's a service that denies third-party access to private conversations online thereby making the Cyber Intelligence Sharing Protection Act largely irrelevant.

Encryption programs like Cryptocat that safeguard our private conversations and correspondence may not be the only government target. Just last year, a bitcoin developer coming from China was denied entry and questioned for hours by US Customs agents about how Bitcoin worked, where he got them, and how he traded Bitcoin for legal tender.

According to the ACLU, the border interrogation about Kobeissi's encryption program raises troubling questions about the government's claimed powers at the border. The "SSSS" designation stands for Secondary Security Screening Selection and if selected you become subject to extensive searches and interrogations -- for any reason whatsoever. Ironically, since overall awareness about the existence of the Cryptocat program has increased, perhaps this unfortunate detention at the US border has done some good after all.

For further reading:
"Anti-surveillance App Developer Targeted at Border by Department of Homeland Security", Brandon Turbeville, Activist Post, June 9, 2012

Wednesday, June 6, 2012

The Case for Monetary Freedom

By Jon Matonis
Thursday, May 31, 2012

The Cato Institute has just come out with their Spring/Summer 2012 edition on Monetary Reform in the Wake of Crisis. It is the published version of their 29th Annual Monetary Conference which addressed the fundamental issue of how to prevent another global financial crisis without merely tinkering on the edges of the government fiat money regime.
"The first step is to rethink the role of government and central banks in the existing system, and then consider alternatives — such as the gold standard — that would substitute rules for discretion, increase choice in currency, and allow markets to determine the optimal quantity of money. After nearly a century of U.S. central banking, it's time to reconsider whether the Federal Reserve's monopoly status, discretion, and growing regulatory powers are more a source of crisis than a cure."
Always relevant and informative, this issue has two particular noteworthy addresses -- the first by Dr. Ron Paul and the second by James Grant of Grant's Interest Rate Observer.

Ron Paul is the Chairman of the House Financial Services Subcommittee on Domestic Monetary Policy and in 2009 he introduced the Free Competition in Currency Act. This article is based on his Keynote Address at the Cato Institute’s 29th Annual Monetary Conference, November 16, 2011, in Washington, D.C. In stark contrast to the Paul Krugman, Bill Still, and Ellen Brown inflationistas, Paul's keynote address, "Why Monetary Freedom Matters," passionately makes the case for denationalizing money and repealing legal tender laws as the only remedy to restore a functioning and free market monetary system:
"I took the position that I wouldn’t close the Federal Reserve down in one day. The Fed will close itself down eventually when it destroys the value of the dollar. But I don’t want that to happen, either closing it down in one day or waiting for a collapse of the whole system. My idea is similar to what F. A. Hayek (1976, 1978) had talked about. Why don’t we denationalize money, legalize competition, allow free markets to work, and allow free-market banking to work? I think we should legalize competition in currencies, which means that first we recognize the Constitution and repeal the legal tender laws.
I have a bill that actually legalizes competition. We also would have to address the subject of fractional reserve banking—I think what we have put up with in fractional reserve banking and the pyramiding of debt is atrocious, but there is a disagreement in libertarian circles about exactly what you do with fractional reserve banking in a free market—but that is a small argument compared to whether or not we should have competition in currencies and allow something else to circulate."
Then, in "Banking Dysfunction," James Grant systematically exposes both the fallacy and folly of capital adequacy reserves and examines the misdirected regulatory thrust:
"Let us be clear: on Wall Street, there was never a capitalist Eden. There was, however, an era of capitalist clarity in which the owners of the banks and investment banks not only reaped the profits but also bore the losses. Insolvency, in the case of a nationally chartered bank, meant a capital call for the stockholders, the proceeds earmarked for the depositors and other senior creditors. It was, after all, the investors’ bank, not the taxpayers’.
What’s truly and importantly new in banking is the definition of cash. When cash was gold, or notes convertible into gold, the basis of credit was gold. There could be only so much credit because there was only so much gold. Today, cash is paper, and paper is the basis of credit. There can be a titanic volume of credit because of paper there is no end."
In a separate Cato paper this month on "Competition in Currency: The Potential for Private Money," Thomas Hogan writes that, "the lack of participants in the private banknote market appears to be due to the uncertain legal status of private note issue and the rigorous prosecution of currency-related crimes."

Saturday, June 2, 2012

Lex Mercatoria: The Emergence of a Self-Regulated Bitcoin

By Jon Matonis
Monday, May 28, 2012

As the Bitcoinica brokerage saga metastasizes yet again with the shocking revelation that no recent database backups exist, earlier security warnings to the company's founder are being reviewed.  One observer suggested that "as the potential payoff of a hacker approaches $1 million, the likelihood of being hacked approaches 90%."
Over eight months ago, another reviewer posted:
"I've worked on financial systems before. As others have stated, if you're dealing with real money, then you have a big bulls-eye painted on your forehead, and you need to make sure that your system is hardened. Make sure you understand attack vectors and protect against them -- XSS, SQL Injection, man-in-the-middle, etc. Make sure your passwords are salted and hashed. Auditing. Can't emphasize this enough. Things will go wrong, and when they do, you need to be able to tell when, where, and why. In our case, we had shadow tables in our database where we logged changes, and then consolidated and exported that data into an auditing system. We could confirm that a user made X change at Y time from Z IP address."
Large financial system websites are some of the most lucrative online targets and bitcoin has the added dimension of a target-rich environment that rarely results in prosecution. Not only is it difficult to prosecute the individual or individuals responsible for the hack, it is difficult to prosecute the financial site itself for negligence due to the many disclaimers inherent in voluntary and unregulated service providers or due to complicated offshore circumstances (although New Zealand does offer a dispute resolution scheme for Bitcoinica retail clients). Additionally, there is always the possibility of an artificial hack staged by an insider. Therefore, self-regulation is the order of the day and in the sometimes jurisdiction-less environment of the Internet, bitcoin entities and their customers currently operate under their own brand of lex mercatoria to enforce accountability.

Lex mercatoria wine merchants

Lex mercatoria is Latin for "merchant law" and it is the body of commercial law used by merchants throughout Europe during the medieval period emphasizing contractual freedom and alienability of property. Like an air guitar, bitcoin is arguably the ultimate form of intangible alienable property. The difference being, of course, that air guitar transactions are not publicly recorded on a distributed and enforced ledger.

Merchants relied on this legal system developed and administered by them while shunning legal technicalities and deciding cases ex aequo et bono. We are actually in the midst of such a case right now as the leading Bitcoinica parties attempt to sort out the claims process to the best of their abilities with limited account records. There is no court. There is no judge. Bitcoin is not defined as legal property. Deliberation is currently focused on the most fair and just method of separating the legitimate claims from the fake claims. But this is new ground for a bitcoin-related settlement and undoubtedly it will set an early benchmark for future cases. The prior hack involving Linode servers was settled in full via Bitcoinica customer reimbursements.

As for the attacking hacker, it will most likely go unprosecuted since fungible bitcoins possess many of the characteristics of physical cash and even if the attacker had been sloppy, the amount involved does not really justify expensive network traffic analysis that would potentially link an IP or bitcoin address to a real-world identity.

The investment adviser for the transfer of Bitcoinica LP, Tihan Seale, posted that "Bitcoin Consultancy was first retained to perform a comprehensive security audit on March 27th and they became owners and operators of Bitcoinica LP on April 24th." This latest security breach at Bitcoinica occurred on May 11th. In a separate email, Seale reiterated, "I'm responsible for deal selection and due diligence for the fund that invested in Bitcoinica. I expect the Bitcoin Consultancy members will continue to operate the business going forward. They have expressed their commitment to seeing things through, and they have my respect for this."

Whatever becomes of the Bitcoinica margin trading entity in the future, it is clear that a sort of 'digital' lex mercatoria is emerging -- one that recognizes the complete voluntarist nature of the bitcoin protocol in commerce. We don't have to imagine The Enterprise of Law: Justice Without the State because we are living through it now.

Self-regulation may be the only available option as authorities are in a quandry. Specifically regulating bitcoin imbues it with legally-recognized value and that is something that the State will resist for as long as possible. So, happily we continue to trade our air guitars.

To the bitcoin detractors, these various security breaches are not a fault of the peer-reviewed bitcoin cryptographic protocol but a lapse of security experience and poor judgment by the respective administering companies. The beatings will continue until security improves. Trust in the overall connected infrastructure may have been fractured temporarily, but just as the guild structure flourished the improved lex mercatoria that evolves as a result will strengthen bitcoin in the end.

For further reading:
"Bitcoin: The Cryptoanarchists’ Answer to Cash", Morgen Peck, IEEE Spectrum, June 2012
"Taking the law online:’s plan to build the future of legal systems", Zachary Caceres, May 29, 2012
"Interview with Zhou Tong", Coinabul, May 29, 2012