Bitcoin Politics, Community and Regulation – Crypto Academy Lecture 7


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welcome to lecture seven in this lecture
we’ll talk about all the ways that the
world of Bitcoin and the technology
touches the world of people will talk
about the community will talk about
politics within Bitcoin and the way that
Bitcoin interacts with politics and
we’ll talk about law enforcement and
regulation issues in lecture 7.1 will
talk about consensus in Bitcoin the way
that the operation of Bitcoin relies on
the formation of consensus among people
now there are really three kinds of
consensus that have to operate for
Bitcoin to be successful
the first kind is a consensus about the
rules this is a consensus about things
like what is it that makes a transaction
valid how can you tell a valid
transaction from an invalid one second
what makes a block in the blockchain
valid which block should be accepted in
which block should be rejected third how
the nodes in the p2p network should
behave how they should interact with
each other and what kind of protocol
they should use to discuss with each
other and more generally all the
protocols and data formats that are
involved in making Bitcoin work you need
to have a consensus about these things
so that all the different participants
in the system can talk to each other and
agree on what’s happening and so the
first form of consensus that goes into
Bitcoin is just a consensus about what
these rules should be in order for the
system to go forward the second form of
consensus in Bitcoin is consensus about
the history that is a consensus about
what’s in the blockchain and what’s not
in the blockchain and therefore a
consensus about which transactions have
occurred and once you have a consensus
about which transactions have occurred
what follows from that is of course a
consensus about which coins which
unspent outputs exist and who owns them
and so this consensus obviously flows
from the processes that we’ve talked
about in earlier lectures by which the
blockchain is built and by which a nodes
come to consensus the processes that we
hope push Bitcoin toward a consensus
about the contents of the blockchain so
that consensus about what’s in the
blockchain and therefore what the
history is is the second important form
of consensus that Bitcoin relies on the
third form of consensus that Bitcoin
relies on you
just the consensus that coins are
valuable that is the general agreement
that bitcoins are valuable that bitcoins
are a good thing to have and in
particular the consensus that if
somebody gives you a Bitcoin today the
tomorrow you’ll be able to redeem or
trade that for something that is of
value any currency needs this whether
it’s a fiat currency like the dollar or
a crypto currency like Bitcoin you need
a consensus that the thing has value
that is you need people to generally
accept that it’s exchangeable for
something of value now and in the future
and and it’s so that’s the third kind of
thing that Bitcoin needs now this this
form of consensus unlike the others can
be viewed as a little bit circular in
other words the my belief that the
bitcoins I’m receiving today are of
value depends on my expectation that
tomorrow other people will believe the
same thing it so consensus on value
relies on believing that consensus on
value will continue and this is
sometimes called the Tinkerbell effect
by analogy to Peter Pan where it said
that Tinkerbell exists because you
believe in her the same thing is kind of
true here that the consensus that
bitcoins have value exists because of
the consensus that bitcoins have value
so circular or not it’s a thing that
seems to exist and it’s important for
Bitcoin to operate now what’s important
about all three forms of consensus is
the way that they’re intertwined with
each other and this diagram shows a
little bit about what I mean when I say
that first of all the consensus about
the rules and the consensus about
history go together because it’s the
rules that determine which kinds of
transactions can go into a block and
which kinds of blocks can come into
existence if you agree on the rules that
is which blocks are valid then it’s
possible to build a consensus about the
blockchain in about history whereas
without a consensus about the rules then
people are going to disagree about
what’s in the history and you won’t be
able to come to consensus in that way so
consensus about rules and consensus
about history are tied together in a
similar way consensus about history and
a consensus that coins are valuable
is are also tied together consensus
about history means that we agree on who
owns which coins and agreeing on who
owns which coins is a necessary is a
necessary prerequisite for believing
that the coins have value because if if
there’s not a consensus that I own a
particular coin then I’m not going to
have any expectation that people will
accept that coin form from me in payment
in the future so consensus about history
is a prerequisite for consensus that
coins are valuable but in the same way
the consensus that coins are valuable is
needed to make the consensus about
history work and we heard about this in
the earlier lecture when we talked about
the incentive arguments the ways in
which the block reward that is built
into the mining process creates an
incentive for people to follow the the
expectations about lining so the
consensus that coins are valuable at
what is what creates the incentives that
allows us to get to a consensus about
history and so we have all three forms
of consensus here which are tied
together such that if any one of them
failed then the other ones would fall
apart as well and in a sense the genius
of Bitcoin the genius in bitcoins
original design was in recognizing that
it would be very difficult to get any
one of these forms of consensus by
itself consensus about the rules in a
worldwide decentralized environment
where there’s no strong notion of
identity that’s just not the kind of
thing that’s likely to happen consensus
about a history similarly that is a very
difficult distributed consensus data
structure problem which is not likely to
be solvable on its own and a consensus
that some kind of cryptocurrency has
value was also a very difficult thing to
put together what the designer of
Bitcoin and what the continued operation
of Bitcoin shows is that even if you
can’t build any one of these forms of
consensus by itself you can somehow
stand up all three of them together and
get them to operate in an interdependent
way and so when we talk about how things
operate within the Bitcoin community we
have to bear in mind that Bitcoin relies
on consensus it relies on agreement by
the participants and that that consensus
is a fragile and interdependent thing
in section 7.2 will talk about the
Bitcoin core software this is a piece of
open-source software which is a focal
point for discussion of and debate about
bitcoins rules the Bitcoin core software
is a body of open-source software it’s
licensed under the MIT license which is
a very permissive open-source license it
allows the software to be used for
almost any purpose as long as the source
is attributed in the license the MIT
license is not stripped out the Bitcoin
core software comprises the most widely
used Bitcoin software and even those who
don’t use it tend to look to it to
define what the rules are that is people
who are building alternate Bitcoin
software typically try to mimic the the
rule defining parts of the of the
Bitcoin core software that is they look
at the parts that check which
transactions are valid they look at the
parts that check which blocks are valid
and they try to behave in the same way
as the core software so this is the
focal point for talking about what the
rules are in fact the Bitcoin core
defines the de-facto rulebook of Bitcoin
if you want to know what’s valid in
Bitcoin if you want to know what the
rules are this is the place to look this
or explanations of it another related
piece of machinery is Bitcoin
improvement protocols or bits these are
formal proposals for a change for a
change to Bitcoin and typically an
improvement proposal will include a
technical specification for a proposed
change as well as a rationale for it so
if you have an idea about how to improve
Bitcoin by making some technical change
you’re encouraged to write up one of
these documents you’re encouraged to
publish it as part of the Bitcoin
improvement proposal series and that
will then kick off a discussion within
the community about what to do they’re
published in a numbered series each one
has a champion that is sort of an author
whose job it is to evangelize in favor
of it to coordinate discussion and to
try to build a consensus within the
community in favor of going forward with
or implementing
ocular proposal now what I’ve talked
about so far are proposals to change the
the technology there are also some VIPs
that are purely informational just to
tell people about things that they might
not otherwise know or that are
process-oriented that talk about how
things should be decided within the
Bitcoin community but nevertheless if
you have an idea about how to improve
Bitcoin typically you would make a
Bitcoin improvement proposal and that
would be the process for discussion
going forward of proposed rule changes
and so we have a rule book and we have a
process for proposing specifying and
talking about rule changes now the other
group we need to talk about with respect
to the Bitcoin core software are the
core developers we have these six people
maybe arguably five Satoshi Nakamoto who
I’ll talk about a little bit later is
not currently active but the other five
are currently involved as core
developers of the Bitcoin core software
so these are the people who are leading
the the effort to continue development
on the Bitcoin core and who are in
charge of which code gets pushed into
new versions of the Bitcoin core so how
powerful are these people well on the
one hand they’re very powerful in one
sense in another sense they’re not all
that powerful at all on the one hand you
could argue that they’re powerful
because the rule changes that is the
changes to the code that get shipped in
the Bitcoin core will be followed by
default these are the people who
actually hold the pen that writes that
can write things into the de facto
rulebook of Bitcoin on the other hand
because it’s open source software and
anybody can copy it and modify it
anybody can fork the software at any
time and so if the lead developers start
behaving in a way that the community
doesn’t like strongly rejects the
community can go a different direction
so one way of thinking about this is to
say that the lead developers are leading
the parade so they’re out in front of
the parade marching and the parade will
generally follow them when they turn a
corner but if but if but if they try to
lead the parade in the direction that’s
disastrous well then the parade ma’am
the marching behind them might decide to
go in a different direction they can
urge people on and as long as they seem
to be behaving reasonably the group will
probably follow them but they don’t have
formal power to force people to to
follow them if they take the system in a
technical direction that the community
doesn’t like so it’s worth in this
respect thinking about what you as a
user of a system can do if you don’t
like the way the rules are going or the
way it’s being run and to compare a
centralized currency like either a fiat
currency or a currency that’s issued by
a central entity against something like
Bitcoin so in a centralized currency if
you don’t like what’s going on you have
the right to exit you can leave the
currency which means that you can stop
using it you can sell any currency you
hold or try to sell it and then you can
just stop using it just like any
business that you do business with
almost any business you have the ability
to just stop dealing with them if you
don’t like what they’re doing on the
other hand if it’s a currency and you’ve
got a lot of business you’ve got a lot
of assets tied up in it it might be
expensive or difficult to actually exit
but with the centralized currency that’s
really your only option with Bitcoin
because it operates in an open-source
way you have the right to fork the rules
that means you and perhaps some of your
friends or colleagues can decide that
you’d rather live under a different rule
set and you can fork the rules and go a
different direction from where the lead
developers have gone the right to fork
like this is more empowering for users
than the right to exit you can exit if
you want but you have the right to fork
and that actually gives you more power
and therefore the community has more
power in a system like Bitcoin which is
open source than it would have with the
purely centralized system so although
the lead developers might look like a
centralized entity controlling
everything in fact they don’t have the
power that a purely centralized manager
or software owner would have let’s look
a little bit more at what happens if
there’s a fork in the rules and I’m
talking here in a previous lecture we
talked about the distinction between a
hard fork and a soft fork I’m talking
about a hard fork here so what happens
is the following so here we have the
blockchain which is coming along
bring up the history and at some point
there will be a fork in the blockchain
if there’s a disagreement about the
rules and you get two branches you get
one branch let’s say this one up here
which is valid under rule set a but
invalid under rule set B and conversely
you’ll have another branch down here
which is valid under rule set B and
invalid under rule set a if there’s if
there’s a hard fork as to what the rule
should be then there will be some
transactions that are valid on each side
and not the other and this will
eventually happen and once these
branches go apart they can’t come back
together because this branch is illegal
under the B rules this branch is illegal
under the AAA rules there permanently
separate so if if the currency that we
had over here on the left we can think
of as being Bitcoin the big happy
Bitcoin that everyone agreed on after
the fork it’s as if there are two new
currencies which you can think of as
being a coin corresponding to rule set a
and we’ll call this one down here beacon
corresponding to rule set B and it’s as
if at this moment where there was a fork
everyone who owned one Bitcoin at the
moment of the fork will receive one a
coin and one B coin at that time and
from that time on eight coins and B
coins will operate separately as if they
were separate currencies and and they
might operate independently the a group
and the B group might evolve their rules
different in different ways and
certainly their block chains will
continue to grow in ways that are
probably inconsistent across the two
coins so when this happens we might say
that the currency fork that it’s not
just the software the rules that forked
or the software implementing the rules
that forked it’s the currency itself
that forked and that’s an interesting
thing that can happen in a system like
Bitcoin that couldn’t happen in a
traditional currency where the option of
forking is not available to users okay
so what happens if a fork like this goes
on what act what do people actually do
how do they respond well after a hard
fork like this there are really two
cases the first case is where the fork
was really not intended as a
disagreement about the rules but the
fork was designed as a way of starting
an altcoin that is of starting a new
kind of cryptocurrency with different
rules and if some
just wanted to start their own currency
and they found it convenient to start
with a rule set that was very close to
bitcoins they found it convenient maybe
even to start with bitcoins blockchain
and to fork off as I as I Illustrated on
the previous slide then that’s not
really a problem the alt coin goes its
separate way the branches coexist
peacefully and some people prefer to use
bitcoins some prefer to use the alt coin
the interesting case is what happens if
the fork actually reflected a fight
between two groups about what the future
of bitcoins should be if that’s the case
then the two branches are rivals and the
branches will fight for market share we
after that after the fork there’s an a
coin and there’s a B coin and each
branch will try to get more merchants to
accept it each branch will try to get
more people to buy it the branches will
fight for market share though the
branches will fight to be seen to be
perceived as being the real Bitcoin
probably each branch says claims to be
the real Bitcoin and there’s a public
relations fight between them which goes
along with the fight for market share
each one wants to be seen as the real
thing and the other one to be seen as
the weird splinter group probably
eventually one branch will win and the
other one will melt away these sorts of
competitions tend to tip in one
direction once one of the two gets seen
as more legitimate gets seen as having a
bigger market share gets perceived more
broadly as being the real one the other
one becomes kind of a niche currency and
eventually will fall away so this is the
likely future if you had a fork that
reflected a fight over the future of
Bitcoin and what this amounts to is a
kind of rebellion within the Bitcoin
community where a subgroup decides to
break off and say we think we have a
better idea about how this should be run
and you have a competition between the
new and the old which eventually one of
them probably wins and become seen as
the de facto new rule set amid a facto
new governance structure
in section 7.3 we’ll talk about who are
the stakeholders in Bitcoin
really the question is who’s in charge
we’ve talked about how Bitcoin relies on
consensus and about how the rulebook of
Bitcoin is written in practice we’ve
talked about the possibility of a fork
or a fight about what the rules should
be so now I want to come to the question
of who actually has the power to
determine who might win a fight like
that okay so who is the power well
suppose there’s a negotiation about
rural setting there’s a discussion
within the community there’s a
disagreement about which rule set should
be used who actually controls the
outcome now if you think about it as
with any negotiation one of the most
important factors in in understanding
who has an advantage in the negotiation
is to look at what happens if the
negotiation fails and it comes down to a
fight and generally speaking whoever has
the best alternative to a negotiated
agreement is going to have the advantage
in in negotiation in other words whoever
is likely to win a fight is likely to
win the negotiation it’s the
long-standing rule that on the
playground the biggest strongest person
is likely to get their way even if no
blows are exchanged so let’s talk about
who actually has the power and who would
be able to win if there were a fight
involving a fork in the rules and a
struggle for power over what the future
of Bitcoin would be so we could make a
bunch of claims on behalf of a bunch of
different stakeholders the first claim
is that the Bitcoin core developers have
the power whoever it is that develops
the core software they have the power
they write the rulebook they literally
have their fingers on the keyboard and
have the ability to change the code that
gets shipped since they write the
rulebook since almost everybody does use
their code and does follow their rules
in practice you could argue that they
have the power because they can actually
put a change out there that other people
would at least by default accept so the
first stakeholder is the developers a
second claim though that we might make
is that it’s the miners who have the
power
why because miners are the ones who
write the his
three the miners are the ones who make
the blocks that record the transactions
that have happened and so if the miners
decide to follow a certain set of rules
then arguably everybody else has to
follow it we talked in previous lectures
about what happens if you have a
majority of miners certainly if there’s
a disagreement among the miners and
let’s say 80% of them want one rule set
20 percent want the other well the 80
percent group is going to be able to
build a bigger more impressive block
chain and so they have some ability to
push push the rules in a particular
direction now how much power they have
depends maybe on whether the fork is a
hard fork or a soft fork this can get a
little bit technical into the details of
the dynamics of Bitcoin but bottom line
is miners have some amount of power
because they get to write the history
and the history is going to be
consistent with whatever consensus rules
the miners end up following in the long
run
so the second claim is that the miners
have the power you might also claim
though that investors have the power
why because investors are the ones who
buy a lot in hold a lot of the bitcoins
and so it’s the investors who decide
whether Bitcoin has any value if the
miners control the consensus about the
history and the developers control the
consensus about the rules
it’s the investors who control the
consensus that Bitcoin will have value
or at least that’s the way the argument
goes so in the case of a hard fork the
investors if they all or mostly decide
to put their money on one branch on the
a coin or the B coin then that one will
have a lot of perceived legitimacy and
so the investors have a lot of power to
decide which way things go if there is a
fork on the other hand we could claim
that merchants and their customers are
the ones who have the power
why because merchants and customers are
the ones who generate the primary demand
for Bitcoin yes investors provide some
of the demand that supports the price of
the currency but the primary demand that
drives the price of the currency as we
saw in lecture 4 is is driven by a
desire to mediate transactions to use
Bitcoin as as a transaction technology
and because merchants and their
customers drive that demand they’re the
ones who drive the long term price of
Bitcoin or so this argument goes the
investors according to this argument are
just guessing where the primary
we’ll be in the future so investors are
guessing where the merchants and
customers will go in the future and
therefore it’s the merchants and their
customers who really have the power on
the other hand we could argue that no
it’s the payment services that have the
power they’re the ones that really
handle transactions a lot of merchants
don’t care which currency they follow
they simply want to use a payment
service which will give them dollars in
an ease of use and handle all of the
risk and so to the extent that merchants
and customers have power and that those
people rely on the payment services to
actually handle transactions well then
maybe it’s the payment services that
have the power because they drive
primary demand and Merchants customers
and investors will follow them okay now
I’ve argued for a bunch of different
parties all of whom I’ve argued should
have the power and there’s some merit to
all of those arguments but the fact is
all of those entities have some power in
order to succeed remember a coin needs
all these forms of consensus it needs a
stable rule book written by developers
it needs investment
it needs mining power and it needs
participation by merchants and customers
and the payment services that support
them so all of these parties have some
power in controlling the outcome of a
fight about the future of Bitcoin and
there’s no one that we can point to as
being the definite winner it’s a big
ugly messy consensus building exercise
there’s one more player that I want to
talk about when I talk about governance
of Bitcoin and that’s the Bitcoin
foundation the Bitcoin foundation was
founded in 2012 and it really does two
main things first of all it pays the
core developers or at least some of the
core developers it pays them a salary
out of the Foundation’s assets so that
they can work full-time on on continuing
to develop the software the other thing
that the Bitcoin foundation does is it
talks to government especially the US
government as the voice of Bitcoin
people in the Bitcoin community said
that we have a problem
that there’s no one to talk to
government on our behalf and so our case
is not being made our arguments are not
being heard in government we need to
have an entity
we’ll do that and the Bitcoin foundation
is one of the things that was set up to
do that and so that’s the other function
that the Bitcoin foundation was set up
to do now the Bitcoin foundation is not
in charge of Bitcoin any more than any
of these other parties are it has
membership from some members of the
community not from other members of the
community and its success ultimately
like everything else in this kind of
open source consensus based ecosystem
will be driven by how much support it
can attract and retain from the
community over time and it’s worth
discussing the points of controversy
that have happened with respect to the
Bitcoin foundation there have been
controversies over the membership in the
board where some members of the Bitcoin
foundation board have gotten into
trouble they’ve gotten into criminal
trouble or they’ve gotten into financial
trouble and and the foundation has had
to struggle with dealing with what to do
about members of the board that are
become become liabilities and have to be
replaced on short notice there’s been
some controversy from those people who
believe that Bitcoin should operate
outside of and apart from traditional
national governments that Bitcoin
shouldn’t be in the position of
negotiating with the government Bitcoin
should be what it is the independent of
government and simply operate across
borders not having to explain or justify
itself to government at all people who
believe in that point of view don’t like
the fact that there are people in suits
who hand out business cards saying
Bitcoin on them and talk to government
as the voice of Bitcoin and finally
there are people who there have been
controversies over the Bitcoin
foundation and the question of who put
these people in charge there are members
of the community who feel that the
foundation and the people who set up the
foundation aren’t really true
representatives of the community and
that they are anointing themselves as
leaders of something that they have no
right to put themselves in charge of so
although the Bitcoin foundation is
prominent there are still some questions
about what its role is going to be in
the long run I think it’s fair to
conclude that the Bitcoin foundation in
its dealings with government has done a
fair amount to smooth the road for
understanding of an acceptance of
Bitcoin at least within the
US government but still the foundation
continues to be a somewhat controversial
organization and one that’s going to be
the topic of debate going forward so
when we come down to the question of
who’s really in charge of Bitcoin who’s
in control the answer is in one way
nobody that there is no one entity no
one group that’s definitively in control
in another sense the answer is everybody
because it’s really the existence of
these consensus about how the system
will operate the three interlocking
forms of consensus on rules on history
and on value that really is what governs
Bitcoin and any group any rule set any
structure that can retain that consensus
will in a very real sense be in charge
of Bitcoin
in lecture 7.4 we’ll talk about the
roots of Bitcoin how it got started what
were the precursors to it and we’ll talk
about the mysterious founder of Bitcoin
there are really two precursors to
Bitcoin that that are worth talking
about first Bitcoin arose out of the
cyberpunk movement this was a movement
that brought together two trends or
arguments first was libertarianism and
particularly the idea that society would
be better off with either no government
or with a very minimal government with
government enforcing only the minimum
rule set necessary to allow people to
coexist at all so together with that
strong libertarian notion or perhaps
even anarchist notion we had the idea of
strong cryptography and public key
cryptography which started in the late
1970s these two ideas came together in
the cyberpunk movement and this was a
group of people who believed that with
strong online privacy and strong
cryptography you could re architect the
way that people interacted with each
other into a world in which people could
protect themselves and their interests
more effectively and could do so with
much less activity action or as they
would say interference from government
so that was the cyberpunk movement one
of the challenges on the cyberpunk
movement was how you were going to deal
with money in a future cyberpunk world
where people were interacting over the
net and interacting via strong technical
and cryptographic measures and so a
bunch of research came along led
especially by early digital cash work by
David Chama and others that that was
designed to create new forms of value
that functioned like money like cash in
the sense of being anonymous and easily
exchangeable but also provided stronger
notions of anonymity or or privacy and
so early work in that area and there’s a
whole interesting story about how that
developed and why it didn’t sweep the
world early work in that area came
together with the cyberpunk beliefs and
the desire to have a strong currency
that would be
decentralized online and relatively
private to create the world from which
bitcoin was born as well as the
philosophy that many of the early
supporters of Bitcoin and and even many
of the supporters today still follow
Bitcoin began in 2008 with the release
of this white paper called Bitcoin a
peer-to-peer electronic cash system that
was authored by Satoshi Nakamoto this
paper which you can still get online
easily is is the initial description of
what bitcoin is basically how it works
and what the philosophy behind its
design is and so this is still a good
thing to read if you want to get a quick
idea of the of how the technical design
of Bitcoin and how the initial
philosophy of its operation was
specified so this was this was the
beginning this was released along with
open source software to implement the
Bitcoin system back in 2008 and this is
where everything started now this was
written by this person Satoshi Nakamoto
and Satoshi is one of the central
mysteries of Bitcoin what do we know
about Satoshi
well Satoshi is the author of this white
paper in the original Bitcoin software
the name Satoshi Nakamoto was almost
certainly a pseudonym that is a fake
name that some person or people have
adopted for the purpose of doing doing
things related to Bitcoin the identity
of Satoshi is associated with certain
public keys with certain accounts in
certain systems so that there are
certain kinds of accounts or statements
or certain kinds of digital signatures
that would convince the community that
something was said by or issued by or
created by the real Satoshi so Satoshi
while being a pseudonym is also a person
who can speak and who has spoken
especially extensively in the early
history of Bitcoin what do we know about
Satoshi well we know that Satoshi writes
fairly well in English Satoshi uses
sometimes Americans sometimes British
Spelling’s there’s been a lot of
attempts to look at the text to look at
the code and to try to figure out what
is Satoshi she’s made of laying
where’s Satoshi from attempts to look at
the hours and times and what type of
machine does Satoshi used in all these
sorts of things try to figure out who is
this person or people and what are they
doing Satoshi was fairly active in
working on Bitcoin on writing about
Bitcoin and participating in online
forums until around 2010 and since that
time Satoshi has said almost nothing
there’s one notable exception that I’ll
mention in a minute Satoshi owns a lot
of bitcoins from early mining in the
beginning Satoshi was perhaps the only
miner are one of the only few people
mining bitcoins and those bitcoins that
were accumulated by Satoshi’s accounts
early on now are extremely valuable and
yet those accounts are not being cashed
out everybody can see which accounts
which Bitcoin addresses probably belong
to Satoshi and so if those coins were to
be cashed in if they were to be sold and
the proceeds transferred into any
particular bank account that would be a
very notable event and would be an
important clue to Satoshi’s identity and
so interestingly although Satoshi
created the the Bitcoin system and has
on paper made a lot of profit from it
Satoshi is unable to cash in that profit
without identifying him or herself
something that for whatever reasons that
Hoshi doesn’t want to do the real
identity of Satoshi still unknown the
question of who’s really Satoshi is a
favorite parlor game at Bitcoin oriented
conferences it’s also something that a
lot of reporters have tried to do people
have done all sorts of things they’ve
looked at text the text written by
Satoshi try to compare it to other
things they’ve tried to look at other
pieces of software to patent
applications they’ve looked at who is
writing papers about things that seemed
like technical precursors to Bitcoin
before Bitcoin came along etc etc in in
a well-known incident last year a
reporter from Newsweek found a guy whose
birth name was literally Satoshi
Nakamoto and fingered him as the as the
founder of Bitcoin as did the Bitcoin
Satoshi that was almost certainly
incorrect as we’ve since figured out in
fact one of the few
if any that Satoshi that the original
real Satoshi has spoken since 2010 was
to issue a short statement saying nope
I’m not that guy so as of today and
probably and probably or perhaps forever
we don’t really know who Satoshi is and
in some sense it doesn’t matter because
because of the notable feature of
Bitcoin that it is decentralized and
with nobody in charge Satoshi is not in
charge to some extent it doesn’t really
matter what Satoshi thinks anymore any
special influence that Satoshi has is
only because of respect that Satoshi
would have within the Bitcoin community
should Satoshi become active again so
it’s possible that we’ll never know who
Satoshi is so Bitcoin was started in
2008 by Satoshi whoever he she or they
are and has grown since then if we look
at a graph of the transaction volume the
number of transactions per day this
starts on the left at the beginning of
2009 and goes up to the summer of 2014
now what you see is something roughly
like an exponential growth and indeed
this is pretty much what you’d expect
from something that’s spread by word of
mouth like the internet like other
popular technologies Bitcoin has grown
in a roughly exponential way and when
there are jumps they typically
correspond to bursts of publicity
moments when Bitcoin became known in the
popular press for example or when there
were newsworthy events transaction
volume has gone up over time the total
value of Bitcoin also has gone up
perhaps in a similar way what you see is
this looks like zero but in fact it’s
just very low and you see a relative
arise starting here maybe beginning in
the middle of 2012 this is this looks
roughly like an exponential growth but
with two spikes superimposed on it one
here in roughly April of 2013 March or
April of 2013 it spiked up and then
relaxed back down to the underlying
exponential curve and then arguably here
around the beginning of 2014 it spiked
up to about this value and then relax
back down again
to something near the exponential growth
which has happened since then so
arguably Bitcoin has grown in a way that
is relatively organic and at a
relatively constant exponential rate
since it was born and those who believe
that Bitcoin has a bright future ahead
of it believe that this exponential
growth will continue
thus far in lecture seven we’ve talked
about the growth of Bitcoin we’ve talked
about how Bitcoin operates who’s in
charge of it I want to spend the rest of
lecture seven talking about government’s
government’s interaction with Bitcoin
and government attempts to regulate
Bitcoin and we’ll start simply with the
moment when governments noticed Bitcoin
when Bitcoin became big enough as a
phenomenon that governments started to
worry about the impact it might have and
governments started to talk about how to
react to it one reason why governments
would notice a digital currency like
Bitcoin is that an untraceable digital
cash if it exists can defeat capital
controls capital controls are rules or
laws that a country has in place that
are designed to prevent the flow of a
value of capital of wealth either in or
out of the country and by putting
controls on banks and investments and so
on a country can try to prevent these
flows bitcoin is a very easy way under
some circumstances to defeat capital
controls because someone can simply buy
bitcoins with capital inside the country
ship those bitcoins outside the country
by electronic means and then sell those
bitcoins for capital or wealth outside
the country by doing that they could
move capital or wealth from inside to
outside and similarly you could do the
same thing to move it from outside to
inside because wealth in this electronic
form can move so easily across borders
and can’t really be controlled a
government that wants to enforce capital
controls in a world with Bitcoin has to
try to disconnect the Bitcoin world from
the local fiat currency banking system
so that it’s not possible for someone to
turn large amounts of local currency
into Bitcoin or large amounts of Bitcoin
into local currency and so we see
countries that are trying to beef up or
protect their capital controls do that
in a notable example is China China has
has engaged in increasingly strong
measures to try to disconnect bitcoins
from the chinese fiat currency banking
system
another reason governments might worry
about untraceable digital cash is that
it makes certain kinds of crimes easier
in particular crimes like kidnapping
extortion that involved the payment of a
ransom or some kind of a payoff those
crimes become easier when payment can be
done at a distance and anonymously law
enforcement against kidnappers for
example often has relied upon exploiting
the handoff of money from the victim or
the victim’s family to the criminals
when that can be done by email and that
can be done in the distance in an
anonymous way it becomes much harder for
law enforcement to follow the money
similarly tax evasion becomes easier
when it’s easier for people to move
money around when it’s easier to engage
in transactions that are not easily tied
to a particular individual or identity
and finally the sale of illegal items
becomes potentially easier when the
transfer of funds can happen at a
distance and without needing to go
through a regulated institution a good
example of that is Silk Road Silk Road
was essentially the eBay for illegal
drugs you can see here a screenshot of
Silk Roads website when it was operating
it calls itself an anonymous marketplace
and you can see over on the left some
sorts of things that are for sale
illegal drugs were the primary thing for
sale on Silk Road you can see examples
of the sorts of things that were for
sale here Silk Road allowed sellers to –
to advertise goods for sale
they allowed buyers to buy those goods
the goods were delivered typically by
through the Mail’s or through through
shipment services and payment was made
in in bitcoins so Silk Road operated as
a tor hidden service something that was
discussed in an earlier lecture so by
operating as a tor hidden service Silk
Road the Silk Road servers could be
hidden from law enforcement so they were
difficult for law enforcement to reach
because Silk Road used Bitcoin for
payment it was also difficult for law
enforcement to follow the money and
figure out who the people participating
in the market were Silk Road was the
largest online market for illegal drugs
as I said it ran as a tor hidden service
and use payments in bitcoins the site
held the bitcoins in escrow
while the goods were shipped there was
an innovative escrow system which helped
to protect the buyers and sellers
against cheating by by other parties the
bitcoins would be released once the the
buyer a certified that the goods had
arrived Silk Road had an eBay like
reputation system that allowed spires
and sellers to get reputations for
following through on their deals and by
using that reputation system Silk Road
was able to give the participants in the
market an incentive to play by the rules
even though they would be very very
difficult to find otherwise
so Silk Road was innovative among
criminal markets in finding ways of
enforcing the rules of the criminal
market at a distance something that
criminal markets have in the past had
difficulty doing Silk Road was run by a
person who called himself Dread Pirate
Roberts and some of you may recognize
that reference obviously a pseudonym it
operated from February 2011 until
October 2013 Silk Road was shut down
after the arrests of this guy Ross
Ulbricht who was the alleged operator of
Silk Road he was arrested in October
2013 and he’s currently awaiting trial
the government says that he was the
operator of Silk Road and that he tried
to cover his tracks by operating using
various anonymous accounts by using tor
anonymous remailers and those sorts of
things but they said that they were able
to connect the dots and connect him to
Silk Road activity to connect him to the
servers and to connect him to the
bitcoins that belonged to the operator
of Silk Road they charged him with
various crimes relating to operating
Silk Road they also charged him with
attempted murder for hire it if the
allegations are true he more than once
tried to pay to have people killed
fortunately he was bad at it and nobody
actually got killed but nonetheless
there these are some pretty serious
charges the government in the course of
taking down Silk Road seized about a
hundred and seventy four thousand
bitcoins that’s quite a bit of value
they then auctioned those off to the
public as with the proceeds of any crime
under US law they could be seized by the
government and the government did
seize them so mr. Albrecht is awaiting
trial will eventually perhaps find out
the full evidence against him now there
are several lessons from Silk Road and
from the encounter between law
enforcement on the one hand and Dread
Pirate Roberts perhaps mr. Albrecht on
the other hand first of all one one
lesson is that it’s actually pretty hard
to keep the real world and the virtual
world separate the operator of Silk Road
believed that he could live his real
life living in society and at the same
time have a secret identity in which he
operated a fairly good-sized business
and technology infrastructure that
apparently is harder than you would
think it’s difficult to keep these
separate worlds completely apart and not
accidentally create some linkage between
them it’s hard to stay anonymous for a
long time it’s hard to be very active
and engage in a course of coordinated
conduct in which you’re working with
other people over time while remaining
anonymous the reason being that although
you can operate multiple identities if
there’s ever a connection between two of
those identities if you ever slip up and
use the name of one while wearing the
mask of another or if you ever slip up
and create a link between them that link
can never be destroyed and over time the
different anonymous or identities or
masks that someone is trying to use tend
to get connected and there’s a lesson
there as well the third lesson here is
that the feds that the law enforcement
can follow the money because even before
there was an arrest in the Silk Road
case the government knew that certain
Bitcoin addresses were operated by the
operator of Silk Road and they were
watching those addresses the result is
that the operator of silk road while
wealthy in according to the blockchain
was not actually able to benefit from
that wealth because any attempt to
transfer those assets over into the
dollar world would have resulted in a
traceable event and probably would have
would have resulted in rapid arrest and
so although mr. Albrecht was allegedly
the owner of 174 thousand bitcoins the
fact is he was not living like a king he
was living in a one-bedroom part
in San Francisco apparently unable to
get to the wealth that he allegedly
controlled the lessons here are that if
you intend to operate an underground
criminal enterprise and I hope you as
our students are not but if you are that
it’s a lot harder to do than you might
think that the technologies like Bitcoin
and Tor are not panacea is for people
who want to do these things and that law
enforcement actually has some pretty
significant tools that they can still
use and so although there might have
been some panic in the world of law
enforcement over the rise of Bitcoin law
enforcement is more and more realizing
that they can still follow the money up
to a point and that they still do have a
substantial ability to investigate
crimes and to make life difficult for
people who want to engage in coordinated
criminal action
in section 7.6 we’ll talk about anti
money laundering
what is money laundering and what are
the rules that governments have imposed
especially in the u.s. that effect
Bitcoin some Bitcoin related businesses
so the goal of anti-money laundering
policy is to prevent large flows of
money from crossing borders or moving
between the underground and legitimate
economy without being detected I talked
earlier about capital controls where
countries are just trying to prevent
money from crossing borders in some
cases countries are just fine with money
crossing borders but they want to know
who’s transferring what to whom and
where that money came from anti money
laundering is aimed at trying to make
certain kinds of crime more difficult
especially organized crime organized
crime groups often find themselves
getting a lot of money coming in in one
place and wanting to ship it to
somewhere else but not wanting to
explain where that money came from
hence the desire to get money across
borders or they find their self making a
lot of money in an underground economy
and wanting to get that money into the
above-ground legitimate economy so that
they can spend it on on sports cars and
big houses or whatever it is that the
the leaders of the group want to do anti
money laundering is designed to make
that more difficult to either try to
catch people trying to do those things
or else prevent them from doing it in
order to detect certain kinds of crimes
or make organized crime more difficult
one of the rules that goes with anti
money laundering is something called
know your customers sometimes called kyc
and the details of this can be a little
bit complicated depend on your locale
but the basic idea is this that know
your customer rules require certain
kinds of businesses that handle money –
first of all identify and authenticate
who their clients are – know who these
people are and to get some kind of
authentication that they really are who
they claim they are and that those
claimed identities correspond to some
kind of identity in the real world so a
person just can’t can’t just walk in and
say I’m John Smith from 1 to 3 Main
Street in any town USA they have to
actually give an identity and have that
be checked in order to engage in certain
kinds of business
second after identifying and
authenticating the clients the the
business may be required to evaluate how
risky it is what the risk is with
respect to a certain client engaging in
underground activities and this will be
based on how the client behaves how how
long-standing their business
relationship is with the company how
well-known they are in the community and
various other kinds of factors but know
your customer rules generally would
require some kind of risk analysis with
respect to individual clients and would
respect and would require a company
that’s covered by kyc to treat clients
whose activities seem riskier with more
attention and then finally third
typically there’s a requirement to watch
for anomalous behavior to watch for
behavior that seems to be indicative of
criminal activity or of money laundering
or of other sorts of things tying that
together with the with the risk
evaluation to understand what’s the
level of risk with respect to a
particular customer and how to what to
watch for with respect to a particular
customer kyc will often ask a company to
cut off business with a client who looks
too dodgy or who’s unable to
authenticate themselves or them their
activities sufficiently for the rule as
I said this gets complicated but this is
the basic outline there are mandatory
reporting requirements in the United
States that are worth talking about
for example companies in a broad range
of sectors have to report currency
transactions that are over ten thousand
dollars they have to file something
called a currency transaction report to
say what is the transaction who is the
who is the other party to the
transaction and there’s some requirement
to authenticate who they are this has to
be reported to the government and that
goes into databases and then might be
analyzed to look for patterns of
behavior that are indicative of money
laundering companies are also required
to watch for clients who are engaged in
what’s called structuring that is in
structuring transactions to avoid
reporting for example if someone engages
in a series of transactions that are
nine thousand dollars in value as a way
to get around the ten thousand dollar
transaction reporting rule that amounts
to structuring it looks like an attempt
to evade the reporting requirements
and a company that sees structuring is
required to report it and they’re
required to watch for it and so that
requires filing of a suspicious activity
report again filing that with with the
US government and that again goes into a
database might lead to investigation of
the client the requirements here differ
by country I am by no means trying to
give you legal advice about whether you
need this or what you have to do I just
want to give an idea of what kind of
requirements are imposed by but by anti
money laundering
rules but I do want everyone to note the
government the US government and other
governments take anti money laundering
rules very very seriously this is not
the kind of rule you can just blow off
and deal with it if you get a complaint
from the government later Bitcoin
businesses have been shut down they’ve
been shut down temporarily they’ve been
shut down permanently business people
have been arrested people have gone to
jail for not following these rules this
is one of those areas where government
will enforce the law vigorously and
where if you’re interested in going into
any kind of a business that is handling
certainly large transactions or for sure
currency or fiat currency value in in
quantity you had better be talking to a
lawyer who understands these rules this
is an area in which government
absolutely does regulate Bitcoin and has
ever since they noticed that Bitcoin was
large enough to to pose a risk of money
laundering
in section 7.7 I want to talk about the
r-word regulation now regulation often
gets a bad name and it especially has a
bad name among the kind of people who
tend to like Bitcoin regulation is some
bureaucrat who doesn’t know my business
or what I’m trying to do coming in and
messing things up it’s a burden it’s
stupid it’s pointless etc now those
arguments often are correct but I want
to talk in a little more detail in this
section about reasons why regulation
might sometimes be justified the
argument against regulation is pretty
common it’s pretty well understood I’m
not going to repeat it here and so
you’ll hear me talking mostly about what
reasons why regulation might be a good
idea because that argument is not as
well understood and I want to lay it out
here a little bit but just to be clear
the fact that I’m spending most of this
section talking about why regulation
might be good shouldn’t be read as a
endorsement that of widespread
regulation or is a feeling that
regulation is the greatest thing ever
it’s simply that I want to bring a
little bit more balance to the
discussion in a community where
regulation is often considered as always
bad or just stupid by nature all right
so the bottom line argument in favor of
regulation is just this that when
markets fail and produce outcomes that
are bad and often agreed to be bad by
pretty much everyone in the market then
regulation can step in and try to
address the failure so the argument for
regulation when there is an argument
starts with the idea that markets don’t
always give you the result that that
you’d like so let me give you an example
of a way in which the market can fail
and this is a classic example called the
lemons market which originated in a
discussion about used cars so well let’s
talk about a market in in concept a
market for widgets some kind of good
that we want to sell and let’s say that
widgets can be either low quality
widgets or high quality widgets a high
quality widget costs a little bit more
to manufacture than a low quality widget
but it’s much much better for the
consumer who buys it consumers like high
quality widgets much
much better now an efficient market a
market that’s operating well would
therefore deliver mostly high quality or
I’ll right at HQ widgets to consumers
why because the price of the high
quality widget will be just a little bit
higher but the widget will be so much
better that almost everyone will buy the
high quality widgets and so this is what
you would hope that a market would
provide and under certain assumptions a
market will provide that but let’s
suppose that customers for some reason
can’t tell a high quality widget apart
from a low quality widget what if they
really can’t tell which widgets are good
and which widgets are not think of a
used car from the classic example you’re
looking into used-car sitting on the lot
well gee it looks pretty good but you
can’t really tell if it’s going to break
down tomorrow or if it’s going to run
for a long time the dealer probably
knows if it’s a lemon but you as the
customer can’t tell the difference so
you can’t tell high quality from low
quality so if you think about what
happens where incentives drive people in
this kind of lemons market you can see
that as a consumer you’re not willing to
pay extra for a high-quality widget why
because you can’t tell the difference
and so if the used-car dealer says sure
this one is perfect it’s not a lemon at
all go ahead and buy it it’s only an
extra hundred dollars well it might be
that you’d happily pay a hundred dollars
for a higher quality car but you don’t
really know whether that car whether
that widget really is high quality so if
you really can’t tell which widgets are
high quality versus low quality then
you’re not willing to pay extra for for
the high quality one and if consumers
are not willing to pay extra for a high
quality one then producers can’t make
any extra money by selling a high
quality widget in fact they lose money
by selling a high quality widget because
they don’t get any price premium they’d
be better off buying the slightly
cheaper low-quality widget and selling
it and so the result is if consumers
really can’t tell with which widgets are
high quality in which are low quality
the market gets stuck in an equilibrium
where only low quality widgets are
produced and and consumers are
relatively unhappy with them now this
outcome is worse for everybody then a
properly functioning market would be
it’s worse for buyers because they have
to make do with low-quality widgets when
in a more efficient market they could
have bought a widget that was much much
better for only a little bit higher
price it’s also worse for producers
because because the widgets that are on
the market are all lousy consumers don’t
buy very many widgets the widget market
is relatively small and so there’s less
money to be made selling widgets than
there would be in a healthy market and
so both consumers and producers are
worse off you know in a world where
consumers can’t tell the difference
between high quality and low quality
widgets that’s a market failure it’s
called asymmetric information failure
and the result is a market that
sometimes called the lemons market ok so
how can we fix this well there are some
market-based approaches that try to fix
a lemons market the first market-based
approach relies on the sellers
reputation the idea is that if a seller
tells the truth to consumers about wist
which widgets are high quality in which
are low quality then the seller might
get a reputation for telling the truth
and once they have that reputation then
maybe they can sell high quality widgets
for a higher price because consumers
will believe them and therefore the
market can operate more efficiently the
problem with this is yes this sometimes
works but sometimes it doesn’t depending
on the precise assumptions you make
about the market but if you think about
it this is not going to work as well as
a market where consumers can really tell
the difference because for one thing it
takes a while for a producer to build up
a good reputation in order to build up a
good reputation they have to sell high
quality widgets at low prices for a
while until consumers learn that that
seller is telling the truth and that
makes it harder for an honest seller to
get into the market the other problem
that can occur is that that seller even
if they’ve been honest up to now if for
one reason or another their sales are
shrinking or they think they want to get
out of the market their incentive is to
massively cheat people all at once and
then leave the market rather than
continuing to be honest and then leave
the market and so in the beginning of a
sellers presence in the market and at
the end of a sellers presence in the
market reputation tends not to
this sort of reputation based approach
also tends not to work in businesses
where where consumers don’t do repeat
business with the same entity or where
the product category is very new and so
there hasn’t been enough time for
sellers to build up a reputation like
say in a high-tech market like say
Bitcoin exchanges the other market-based
approaches warranties that’s the idea
that a seller could provide a warranty
to a buyer that says that if this thing
turns out to be low quality if it
doesn’t work well for you I’ll give you
a new one I’ll pay you I’ll pay you back
or something like that and that can work
up to a point as well but there’s also a
problem there that this warranty is just
another kind of product which could also
come in high quality and low quality
versions a low quality warranty is one
where the seller doesn’t really come
through when you come back with a broken
product they don’t really replace it
they don’t really give you their your
money they make you jump through all
kinds of Hoops and so this is not a
panacea either so if you have a lemons
market which has developed and if these
market based approaches don’t work for
the particular market that you’re
dealing with then regulation might be
able to to help and there are three ways
in which regulation might be able to
help address a lemons market first
regulation could require disclosure they
could require say that all widgets be
labeled as high quality or low quality
and then have penalties on the firm’s
for lying that gives consumers the
information that they were missing a
second approach to regulation is to have
quality standards is to require that no
widget can be sold unless it meets some
standard of quality testing and have
that standard set so that only high
quality widgets can pass the test that
way you have a market that’s all one
kind of widget but at least its high
quality widgets assuming that the
regulation works as intended or you
could have required warranties so that
all sellers have to issue warranties and
then require then enforce the the
operation of those warranties so that
sellers are really held to the promises
that they make so all of these are forms
of regulation which obviously could fail
which might not work as intended which
might be Mis written or Mis
applied they might be burdensome on
sellers and so on but there’s at least
the possibility that regulation of this
type might help to address the market
failure due to a lemons market so this
is one example of how regulation can be
an efficient thing to do if it’s done
well when there’s a certain kind of
problem namely the ability the inability
of consumers to tell the difference
between a high quality and a low quality
product offering and so people who talk
about Bitcoin exchanges for example and
argue for regulation of them sometimes
point to them as an example of lemons
market another example of a market
failure or a place where the market
doesn’t operate the way that that you
would like it to in order to serve in
order to serve consumers is price fixing
price fixing simply is a case where
different people are selling a product
in a market and they just agree with
each other that we’re going to raise
prices or we’re not going to lower
prices related to price fixing is an
agreement not to compete where companies
that would otherwise go into competition
with each other agree not to compete
with each other for example if there
were two bakeries in town they might
agree that one of them will only sell
muffins and the other will only sell
bagels and that way there’s less
competition between them than there
would be if they both sold muffins and
bagels as a result of the reduced
competition presumably prices go up and
the merchants are able to to foil the
operation of the market because after
all the reason that the market protects
consumers well in its normal operation
is through the vehicle of competition
that sellers have to compete in order to
offer the best goods at the best price
to consumers and if they don’t compete
in that way then they won’t get business
so an agreement to fix prices or an
agreement not to compete circumvents
that competition and prevents
competition for operating in the market
so another way that the market can fail
is when people take steps that prevent
competition these these kinds of
agreements either an agreement to raise
prices or an agreement not to compete
these are illegal in most jurisdictions
this is part of antitrust law or
competition law in general antitrust or
competition law is aimed to prevent
cases where the market gets stuck
in in a situation where there isn’t
enough competition to protect consumers
or cases where somebody acts in a
deliberate way to try to prevent someone
from competing with them acting in a way
other than simply offering good products
at good prices antitrust law is very
complicated I’ve given you sort of a
sketch of it
but this is another instance where we
know that there are failures that can
occur and where the law will step in to
prevent in the easy cases things like
price-fixing or agreement not to compete
but in more difficult cases even some
attempts to reduce competition in the
market through say mergers or other
kinds of activities another example
where regulation might be helpful
in Section 7.8 I want to talk about New
York State’s bitlicense proposal I’ve
talked so far about regulation in
general I’ve talked about a few forms of
regulation I’ve talked in general about
why regulation might be justified in
some cases why it might make good
economic sense but now I want to talk
about a specific effort by a specific
state to introduce specific regulation
of Bitcoin well dig a little bit into
what the bitlicense proposal would do
this is an issue that is current as of
the filming of this lecture that’ll be
current as of the release of this
lecture and and it gives you a snapshot
of the kinds of things that regulators
are doing okay
so the bitlicense proposal was issued in
July of 2014 down at the bottom of the
slide here there’s a URL where you can
go and read it if you like here’s the
heading on it the New York State
Department of Financial Services that’s
the part of the state of New York that
regulates the financial industry and of
course the state of New York has the
world’s largest center of the financial
industry in it and so it’s a part of the
New York state government that is is
used to dealing with relatively large
institutions it’s a proposed set of
codes rules and regulations that has to
do with virtual currencies so this is a
new regulatory proposal from the state
of New York and this is there’s a lot of
text here but let’s walk through it it’s
worth talking about what the regulation
fundamentally says is that you would
need to get something called a bit
license from the New York Department of
Financial Services if you wanted to do
any of the things listed on this slide
if you wanted to engage in virtual
currency business activity that means
any one of the following things if
you’re dealing with New York or a New
York resident so if you’re doing any one
of these five things and any of your
customers are in New York and perhaps
consult your lawyer if you have business
partners or other aspects of your
business in New York relating to this
you need a bit license the first thing
is receiving virtual currency for
transmission or transmitting virtual
currency second securing storing holding
or maintaining custody or control of
virtual currency
behalf of others this might cover
something like wallet services or other
sorts of things
or perhaps exchanges buying and selling
virtual currency as a customer business
you can apparently buy and sell it for
yourself but doing it as a customer
business you need a bit licensed
performing retail conversion services
including conversion or exchange of fiat
currency or other value into virtual
currency conversion or exchange of
virtual currency into fiat currency or
the conversion or exchange of one form
of virtual currency into another form of
virtual currency so if you’re trading
virtual currency for fiat currency or
virtual currency for virtual currency
and finally controlling administering or
issuing a virtual currency if you’re
doing any one of those things in the
state of New York or or operating with
the New York State resident then you
need to get a bit license from the New
York Department of Financial Services
if this regulation goes into effect you
would have to apply for a license to
apply for a license there’s detailed
language in the proposed regulation
which you can read but roughly speaking
you have to provide information on the
ownership of your enterprise on your
finances and insurance on your business
plan generally to allow the Department
of Financial Services to know who you
are how well back – you are where your
money comes from and what you’re
planning to do you have to pay an
application fee you would have to pay a
licensee would have to do the following
things once you had a license
you’d have to provide updated
information to the Department of
Financial Services about the things I
talked about before
ownership finances insurance and so on
you have to provide periodic financial
statements so they can keep track of how
you’re doing financially you’d be
required to maintain a financial reserve
the amount of that would be set by the
division of Department of Financial
Services based on various factors about
your business what’s the nature of your
business how well financed it is who it
is how big it is et cetera etc the DFS
would be able to set rules about that
there are detailed rules about things
like how do you would keep custody of
consumer assets there anti-money
laundering rules which might or might
not go beyond what’s already required
there are rules related to cybersecurity
having a cybersecurity plan and
penetration testing and
so on there rules about disaster
recovery you have to have a disaster
recovery plan and that meets various
certain criteria there are rules about
record-keeping you have to keep records
and make them available to the DFS on
certain circumstances for some length of
time about certain kinds of activities
you’d have to designate a compliance
officer someone within your company your
organization who is in charge of
compliance and has responsibility and
authority to make compliance happen you
have to have written policies about
compliance and about certain kinds of
things that are satisfactory to the NY
DFS and there’s a requirement that you
disclose risks to consumers so that
consumers understand what are the risks
of doing business with you the exact
rules on that are not exactly clear at
this point but you might imagine
something like like these sort of
prospectus that comes along with a
mutual fund or with or with a publicly
traded stock perhaps that’s what the DFS
has in mind so these are fairly
substantial requirements for companies
that that have a bit license and anyone
with a bit license would be required to
do all this stuff the state of the
bitlicense proposal right now the
situation that it’s in as of this
filming which is August 2014 is it has
been proposed by the New York Department
of Financial Services it’s been formally
proposed you can go read the document
the the proposal at the URL that was on
the earlier slide the DFS has solicited
public comments they have asked members
of the public to write in and give them
comments about the proposal do you like
it do you not like it what’s good what’s
bad what do you propose changed and so
on and lots and lots of entities are
gearing up to send comments to the NY
DFS after all the comments are in in
accordance with the normal regulatory
process the NY DFS will decide what to
do they’ll decide whether to withdraw
the proposed regulation whether to issue
it in modified form whether to issue it
in exactly the original form and along
with that decision they’ll issue some
kind of a document that gives the
rationale for deciding what they decided
to do now various parties have asked the
NY DFS to grant an extension on the
original date for for
comments and NY DFS has signaled they
haven’t definitively stated but it seems
pretty clear at this point that they’re
going to grant an extension because of
that I don’t currently know the date I
can’t tell you the date by which you
have to comment but you can go and look
at the NY DFS website to get to get the
current status if you’re an interested
party by it by all means I would
encourage you to comment I would
encourage you to get together with
others and comment together and I would
advise you to make comments which are
thoughtful and constructive and give the
NY DFS reasoned arguments comments of
the sort of this is the coolest thing
ever or you guys are total idiots you
don’t know what you’re doing might make
you feel good but they’re not going to
affect what the NY DFS does my
prediction at the end of the day is that
some kind of bit license is likely to be
put in place by the NY DFS maybe maybe
it will be reduced from the scope or
changed from what was originally
proposed but some kind of bit license
that caught some kind of licensing
regime which calls itself bit license I
predict will be put in place by the New
York Department of Financial Services if
this happens or if New York doesn’t do
it and somebody else does something
similar the result will be that if you
want to do business in any of the
business sectors that we talked about in
the previous slide you would need a bit
license from the state of New York in
order to operate and if this goes into
effect this would really be an a major
step in the history of Bitcoin you would
have a situation where not only NY DFS
but perhaps other jurisdictions would
start to step in and regulate and you
start to see Bitcoin businesses get
closer to the model of regulated
financial institutions that traditional
financial institutions have been in this
would be a step that really is in some
ways contrary to some of the initial
cypherpunk or cyber libertarian ideas
about what bitcoin was supposed to be
and but in a very real sense I think
it’s inevitable that as soon as Bitcoin
became really valuable that Bitcoin
businesses became big businesses that
government got interested it was more or
less inevitable that regulation would
ensue because Bitcoin businesses touch
people because they they touch the fiat
currency economy because bitcoin is big
enough to matter government is paying
attention and bitcoin is getting
regulated this on the one hand
represents a retreat from what the
original advocates of Bitcoin had in
mind in another way it represents the
Bitcoin ecosystem growing up and
integrating into the into the the
regular economy which is much more
regulated regardless of whether you like
it or don’t like it this is a thing
that’s starting to happen and if you’re
interested in starting a business in
this area you need to be paying
attention to this trend will this be a
success will it be good or bad well I
think there’s one barometer we can look
to to understand whether a regulation
like the bitlicense
is actually successful from a public
policy standpoint at improving the
quality of Bitcoin businesses and that’s
this if something like bitlicense goes
into effect and if companies start
advertising to customers outside New
York that we have a bit license
therefore you can trust us and if that
argument that we’re regulated therefore
you can trust us is convincing to
consumers if consumers see regulation as
a positive in choosing a company then I
think the regulation will be working in
the way that its advocates wanted it to
do whether that will happen and how this
affects the future of Bitcoin is
something that we’ll have to wait and
see
you

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