Bitcoin and trust

Why is it that nearly all media reports miss what is most innovative about Bitcoin? Many people, like the economist that I cited in my last post, believe that in order for Bitcoin to be successful, people need to trust Bitcoin. As they see it, in the future there could be many different similar currencies. Bitcoin itself is open-source and therefore easily modified and copied. They imagine multiple competing currencies none of which would have a monopoly. The problem with multiple currencies, they tell us, is that they make it difficult for individuals to judge the trustworthiness of any single currency. This line of argument is faulty. People can only reason in this way if they have not done the research, if they have not read the technical paper on Bitcoin. Bitcoin was expressly created to eliminate the need for one form of trust.

In order to make this issue clear, we need to distinguish between two types of trust related to currencies. To accept a bank issued check, debit card, PayPal, or a credit card number in payment, the payee must trust the bank, PayPal, or the credit card agency to make good on the transfer of funds. Trust is not necessary, not in the same way, when a payee accepts cash. Yes, of course, on an abstract level to accept a US dollar bill in payment the payee must trust in the Federal Reserve. On a more practical level, though, the Federal Reserve has very little to do with it. We accept cash because we believe that we can turn around and directly use it to buy, save, or pay down debts. What most people are missing in the debate over Bitcoin is the difference between cash and non-cash forms such as deposits, stocks, and credit. The I-believe-the-central-institution-will-come-through-for-me trust necessary for non-cash transactions is fundamentally different from the I-will-be-able-to-directly-spend-it trust of cash transactions. It is in this sense that Bitcoin is the very first (correct me if I am wrong) form of electronically transmitted cash. Nobody needs to trust in any single institution in order to accept Bitcoins. They only care if they are going to hold their value, and if they can turn around and spend them.

People would argue that the use of Bitcoin is indeed founded on a trust in institutions. These are the exchanges, vendors, websites, and individuals that use them. However, if I go around the corner from my apartment to sell or buy some US dollars, assuming I know the exchange rate and am confident in my ability to spot counterfeit bills, do I need to trust the currency exchange office per se? Many people thought that Bitcoins would stop being used after the largest exchange, Mt. Gox, came crashing down a week ago. But would I stop believing in cash just because the currency exchange folded? The fact that Bitcoins retained their value even with the crash and fiasco at Mt. Gox demonstrates the extent to which trust in any single institution is not at stake here, not as it would be with non-cash type transactions. Of course, there is an issue of trust between individuals, but these are no different from the trust issues arising in cash exchanges. They amount to whether or not an individual is trusted to hand over the merchandise after being paid, or vice versa.

People will also argue that the use of Bitcoin is founded on a trust in the programmers that built and maintain the currency, and the individuals who review the code and tell everyone else that it is legitimate and will do as advertised. While there is some truth to this, it is practically irrelevant. The founder of Bitcoin uses a pseudonym and no longer appears to be particularly active in the project. Nobody seems to know who s/he is, yet people who use Bitcoin are not disquieted by this. If someone hands me a US dollar bill, how much do I really care about the Federal Reserve? In practice, I am only concerned with whether or not I can stash it away or use it when I want. If it turns out that Bitcoin is not as secure as people think it is, or that known security issues prove to be a greater hurdle than they are now, then confidence in the system may drop. This has little to do, however, with the trustworthiness and skill of Bitcoin coders and reviewers. If it turns out that dollar bills are being widely counterfeited, I would expect the Federal Reserve to step in and do something about it, but to what extent is trust in the institution really at play? Even more to the point, if my home is broken into repeatedly and my stash of cash stolen, or if I am often robbed on the way to work, is the Federal Reserve responsible?

A good way to conceptualize Bitcoin is to think of it as digital cash. Like cash, it is easily lost, stolen, and difficult to trace. As long as Bitcoins continue to hold value, people will devise and use methods of securing their holdings against theft and loss. Like cash, Bitcoin can be used between parties without a mediating entity. Like cash, Bitcoin transactions can be relatively anonymous. However, whereas cash is subject to unforeseeable central bank policies, Bitcoin is minted according to a transparent and fixed plan built into the code itself. And whereas cash is not usually sent by mail (transmitted over long distances), Bitcoins can be transmitted over the Internet to anyone around the world. Ultimately, though, to fully understand Bitcoin one will need to move beyond the cash metaphor. However, in as much as critics have seen the lack of a single trust-worthy institution as a weakness of Bitcoin, they have overlooked how even for cash a central institution is in practice irrelevant. A payee that accepts Bitcoins is concerned with Bitcoins holding their value and continuing to be accepted as payment. In the end Bitcoin may ultimately fail, but it will not be because people lose trust in any single company, website, institution, or programmer.

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6 responses to “Bitcoin and trust

  1. Ima Bitcoiner June 28, 2011 at 2:18 PM

    > Nobody seems to know who s/he is,
    or who they are …

  2. presentcynosure June 28, 2011 at 2:22 PM

    Yes, point well taken.

  3. Dmitri July 6, 2011 at 6:07 PM

    You are absolutely right.
    My hope is that bitcoin will keep rising in popularity, especially among retailers.
    And through that eventually make the currency stable enough so that month to month fluctuations in value will be minimal and predictable.

    I really hope people don’t give up on bitcoin, the mtgox aftermath shows that people recognize the value of this new currency.

  4. techthefuture July 7, 2011 at 5:41 PM

    I kind of disagree with you on the point that you don’t need to trust anyone when it comes to cash. Ultimately cash is backed by institutions like the federal reserve. It’s literally called a fiat currency. Saying it’s worth is not intrinsic but accredited it by the powers behind it (in this case US govt). When the fed decides to stunt with USD everybody using it is affected. So when they press more money, your cash becomes worth less. When they decide to let go of the gold standard -as they did in the seventies- everybody using the currency is affected. Trusting in cash ultimately means trusting that the powers behind it, will stay in place. And because it’s an interdependent system, continuing to put your trust in cash equals reenforcing the powers that sanction it.

    The true innovation of Bitcoin is that it depends on no institution at all. It depends solely on the proof of work of all nodes in the network. A truly distributed currency. In which the power is in the hands of none other than those participating.

  5. Edward Hall (Ted) July 7, 2011 at 9:35 PM

    Think that Bitcoin’s only real weaknesses are the following -

    Being “played” by existing financial bullies (basically becoming an extension of the current banking system)

    Or being shut down/smeared by centralized governments (just find some way of connecting Bitcoin to terrorism)….

    Bitcoin will be played just like all social debt based systems (it’s going to be much harder to play than others), and I’m sure terrorists will or are using Bitcoin… Just as they are using our stock market and cash systems… Don’t get duped by any smear campaigns that may come along. It’s all just a ruse to keep power centralized

  6. presentcynosure July 8, 2011 at 9:37 AM

    @Dimitri, I would love to see more in depth analysis of the fluctuations in value of Bitcoin on the exchanges. If you find something, be sure to pass it on.

    @techthefuture, of course you are right about the Federal Reserve. I recognize as much in my post. My point, though, is that when people use US dollars their trust in the Federal Reserve is abstract and does not impinge on their transactions in any direct way. If the Federal Reserve, through its monetary policies, effectively increased the amount of cash in circulation, then of course this will impact the use of cash as you point out. But the trust that people have in the Federal Reserve is not as relevant as the trust that they have in the economy at large. Imagine a situation in which the Federal Reserve ceases to exist but people still have faith in dollar bills because the US economy is so strong. Comparable situations have occurred with other types of cash.

    It is similar with Bitcoin. Bitcoin also has its Federal Reserve of sorts. It is the client and the block chain. Users of Bitcoin must have faith in the client and block chain on at least an abstract level. Practically, though, it is less relevant. What is more relevant is if someone accepts my Bitcoins and gives me what I want in exchange for them. In this sense Bitcoin is like cash. Accepting Visa, PayPal, and Treasury Bonds all require trust in a central institution. To use cash and Bitcoins, however, I only worry if someone will accept them. This type of trust is distributed or diffuse. It is trust in the economy, if you prefer. However, it is not only Bitcoin that is distributed in this way. Cash also depends on all of those participating in the cash economy. The difference, and here we will agree, is that whereas we do not know what the policies of the Federal Reserve will be in 5 years, we can be fairly certain about the rate of growth of the Bitcoin supply based on our knowledge of the Bitcoin client.

    @Edward Hall, I would love to know more about the intervention of the financial sector into Bitcoin exchanges. As far as the government, I have my doubts concerning the motives they have to smear or repress Bitcoin. If the financial sector is in fact investing in Bitcoin, couldn’t they be a powerful lobby for Bitcoin with the government? Also, it seems that people might have exaggerated, at least for the moment, the anonymity possible with Bitcoin transactions. It may prove that the government has but gained another tool of surveillance with Bitcoin. Instead of attempting to track the movements of cash (difficult), or the transfer of funds from multiple institutions (also relatively difficult), since all Bitcoin transactions are executed through and recorded on the Internet, the government only needs to harness some of its intelligence and computing power to link up those transactions to specific individuals.

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