Governments Must Co-Opt Bitcoin to Avert Disaster

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When the news spread that Archduke Franz Ferdinand of Austria was assassinated in Sarajevo, few, if any, had the foresight to envision the colossal consequences that topped all previous global conflicts. But this spark ignited the horrific chapter in world history known as World War I.

Ninety-nine years later, on an island not too far from Sarajevo, the European Union pulled off a money grab against bank depositors. And within a week an obscure term "Bitcoin" has nearly become a household name, rising in value by a large multiplier.  Digital money has made a grand entrance.

The events that will be unfolding from now on will relate to Cyprus much as the events of 1914 to 1918 and beyond stemmed from Sarajevo.

Bitcoin, and digital money in general, are made up of a bit-string that carries value and identity intrinsically – just via the sequence of the bits, independent of any media these bits are expressed in.

"Hackers will have a field day," worried bank depositors. "It is too risky to keep money as 'bits' on your phone," they argued. But when the Cypriot banks unilaterally declared that a big chunk of all deposits accounts would be snatched, the premise of deposit security came up for re-evaluation; and not only in Cyprus and in Europe, but also in the U.S. and elsewhere. 

The Federal Deposit Insurance Corp. insures American depositors, but banks can still limit withdrawals, replace money with IOUs – they hold the money!

The Sarajevo-like spark of Bitcoin is noteworthy because for the first time it occurred to a large number of people that bit-money (Bitcoin or otherwise) can be kept, stored, and safeguarded without handing it over to the banks. Unlike bricks of gold, or bundles of banknotes, bits are stored on tiny microchips, they flow through the air, and they swim smoothly in the new cross-continental ocean called the Internet.

And as for security – hello! Didn't the banks themselves tell us that modern encryption technology can keep hackers prying for hundreds of years before cracking the walls of modern crypto castles?  Cryptography works everywhere it is used:  In every bank, and in every phone. Its protection is not based on legions of sentries armed with guns, but on mathematical certainty, and on logical immutability.  Bits are what cryptography works on. Bit money can be backed up multiple times, it can be encrypted for free, it can be stored on the fly, and it can be paid – cut and dried.

Before our eyes, technology reforms the institutions that have evolved linearly since the Medici family used benches (the original "banks") to disburse loans in the 15th century.  Banks stand to lose their utility for security and convenience in favor of crypto-protected "bitted" money, and the only leg left for them to stand on is interest payment – which is how they started!

The technology is there. Bit money is ready to roll. The market has just opened: The meteoric rise in the exchange rate of Bitcoin (even after a sharp correction) is a shouting proof that people are eager for a means to store, guard and secure their financial wealth without using the banks as safe keepers.

Banks will need to adapt to having to offer threshold interest to attract depositors – sufficient interest to counter the perception of Cyprus-risk. In return, banks would need to lend money at higher rates. As money becomes more expensive, economic activity chokes... the ball is rolling, the Cyprus-Sarajevo spark is catching fire.

Bitcoin is bad news on many levels. The most obvious concern was proven after the Cyprus crisis erupted: stability. What if people start lending and borrowing bitcoins? If your debt is denominated in the digital currency, and then its price soars, your burden in dollars will be off the chart. How would the debtors ever pay back their debt if overnight it multiplies by a factor of three?

And let's remind ourselves that credit extension and repayment is the mechanism for societal growth.  Bitcoin is rogue. It offers no recourse to those whose accounts are hacked or who lose their shirts investing in the currency or simply misplace their passwords. There is no central authority to lay blame to, and its cryptography is too deep for most traders to follow. Thus most Bitcoin traders are not aware that its crypto foundation erodes at a pace which accelerates the greater the success of this currency.

Like all other mainstay ciphers and crypto products, Bitcoin relies on assumed "mathematical intractability" – the believed difficulty to solve a certain mathematical problem. There is no proof of such intractability, just an assumption that since academic cryptographers haven't easily cracked the code, nobody can. Remember the Enigma in World War II: the German cryptographers were sure that no one would be smart enough to crack it. But Alan Turing and his team eroded the crypto defense and shortened the war by about two years. The more valuable Bitcoin becomes, the richer a target it is for crypto hackers and the harder and longer they will work at it.

The powers that be have two options on the table: one is to try to roll back history, to uninvent digital currency, to scare people from what technology brings about, and re-fit the genie into the bottle. Good luck on that route.

The other option is to ride the tide. Bitcoin has flushed out the public readiness to deal with bits as carriers of tradable currency.

The policy conclusion is clear. Bitcoin should be disqualified as a functional tradable currency. However, a properly regulated, digitized option for the prevailing currency should be rushed to market. If not, Bitcoin will reign, suck in an enormous amount of wealth, and eventually implode, unleashing a financial tsunami of unimagined proportions.

Central banks and national treasuries should come forth with a requirements definition, or spec sheet, for a robust, trustworthy, durable and stable solution to digitize the national currency.

The benefits are enormous: for one, paying with a digital coin is much more secure than paying, like today, by exposing both the payer and the payee account. All payments today are account-based:  what flows between payer and payee is not money per se, but a software instruction that increases the figure representing the payee's money by the transacted amount while the figure that represents the payer's money is reduced by the same amount.  The two accounts are hacking targets, regardless of how small the transaction. With digital money, the most that can happen is that the transacted sum is stolen. No accounts are exposed for further hacking.

Digital money can be paid as an email attachment. It could be tethered to an intended purpose by means of "terms of payment" embedded in the bit string. So, for example, aid disbursed to developing countries need not end up in some corrupt bureaucrat's offshore bank account. And of course, digital money may be safeguarded with greater security than ever before.

Let commercial interests compete against one another, following the guidance set by central banks, and offer the public the advantage of digitized fiat currency to stave off the rogue alternatives.

Gideon Samid is the the chief technology officer for BitMint LLC, which is testing digitized U.S. dollars, and teaches computer science at Case Western Reserve University and the University of Maryland.

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