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.