BitCoin: Technology & Morality

CS 463 Lecture, Dr. Lawlor

Technology of BitCoin

It's actually pretty simple:

A "transaction" is moving some money between one address and another.
An "address" is an ECDSA public key. The corresponding private key, which you keep secret, is used to authorize transactions by digitally signing them. The public key acts as the address's public name. There is no connection between an address and a legal identity; one person could have any number of addresses, and it's not possible to look at a transaction and be able to tell the difference between somebody rearranging their own accounts, and a major transaction between two people. An address never has negative balance--transactions that move out more money than are in the address ("double spend") are not valid.
A "wallet" is just a list of addresses and their corresponding private keys. A wallet file contains 100 spare keys for future use in the "key pool", so you can back up the wallet, make some transactions, and still manage to recover.
A "block" is a list of recent valid transactions, collected in a peer-to-peer fashion. The "blockchain" is a hash-linked list of all the blocks so far. If you receive money, you have an incentive to make sure everybody knows about the transaction, by getting it included in the blockchain.
"Mining" is collecting and verifying the blockchain, which is key to keeping the entire ecosystem running. About every 10 minutes, somebody finds a block + nonce that has a SHA-256 hash with "enough" leading zeros, where "enough" keeps getting adjusted so they get found every 10 minutes. Currently you need about 50 leading binary zeros, which takes thousands of trillions of tries to find. The incentive to do this is you're allowed to add a transaction moving 25 bitcoins into your wallet at the end of the verified block!

The surprising things about it are:

There is no central bank, and no central trusted authority. Anyone can 'mine' to verify transactions--they'll even pay you coins to do this. This means counterfeiting is not really possible--you need to say where the money in your wallet came from for the transaction to be valid. In particular, officially sanctioned inflation like the 1933 Gold Executive Order, or today's quantitative easing, is theoretically impossible. (Granted, the government could just ban BitCoin and require people to use GovCoin, possibly at some exchange rate.)

By design, BitCoin's overall behavior is similar to the gold standard. Whether this is a bug or a feature depends on your point of view.

The total value of the BitCoins issued, times the current BitCoin/dollar rate, is about a billion dollars. This makes it big enough to be interesting to investment banks like Goldman Sachs. The total value of the US dollar is something like $10T, so BitCoin is a fairly minor currency.

Morality of BitCoin

One problem with BitCoin is nobody knows what the value should be--is a pizza 10,000 BTC or 0.0001 BTC? Value stability can be a problem with any currency, where there are two macroeconomic error conditions:

Inflation: value of the currency drops. Slight inflation is usually considered beneficial, since it acts like a tax on currency doing nothing (not invested in productive activity). Extreme inflation, "hyperinflation", first destroys savings and then destroys commerce, and is basically always caused by the supply side, where the government keeps printing money, usually to inflate away government debt.
Deflation: value of the currency rises. Deflation is easy for the government to fight if they can just print more money. If they can't, such as due to the gold standard, there's a serious problem with debt--deflation makes it harder for borrowers to repay with the more valuable currency. If borrowers can't repay, lenders won't lend and the economy siezes up.

The other huge problem with alternative payment services is they tend to get used for thing you can't do on legitimate services--for example, illegal transactions like money laundering or drug transactions. This means what looks like a technical issue, preserving anonymity in transactions, turns into a very controversial social and very thorny moral issue.

For example, the $1m/month online illegal drug marketplace Silk Road uses BitCoin as its payment service, despite denominating prices in US dollars. Dealers and buyers still get busted, but it's during delivery, or because they didn't hide their IP address sufficiently, not via the payment service.

Morality of Drug Laws

In 2010 a doctor of neuropsychopharmacology in the UK led a workshop of experts to quantify the harms from a set of drugs, resulting in this surprising chart:

Nutt et al study of drug harms, chart by type of harm

The first author of the study, David Nutt, was fired from his position on a UK government research council due to disagreements about this approach.

I personally am not sure what the lack of correlation between harm and legality implies--should we ban the manufacture, possession, and distribution of alcohol too? Legalize everything to the right of some trade-off point? Reboot our approach to drug addiction entirely? How? Unfortunately, there are no easy answers, only complex and historically dependent trade-offs.

One lesson here is you can't ignore the second-order and third-order effects of your choices. The designer of BitCoin chose to make transactions anonymous, which has fairly straightforward implications for a very touchy subject that could result in BitCoin being demonized and banned.