Time to eat some crow.
Nearly five years ago, I wrote a BankThink post about bitcoin that emphasized the network’s then-low costs and near-real-time settlement. Bitcoin was an obscure phenomenon at the time, and what I missed was that as the currency’s popularity grew, the peer-to-peer system’s limited throughput would undermine those two particular benefits.
Today, average transaction fees exceed $2.50, and transfers sometimes take hours to confirm. A long-running debate about how best to scale the network has created a rift in the bitcoin community, culminating in a game of chicken between the factions that could split the currency into two competing versions.
I stand by my old headline: “Lightning fast, dirt cheap: bitcoin shows what banking could be.” (Emphasis added here.) Whether bitcoin could sustain the low latency and low fees of the early days was beside the point. Surely centralized systems — which don’t require computers distributed across the globe to reach consensus on the state of a ledger — should allow real-time, low-cost payments in the 21st century. And perhaps bitcoin helped push that toward reality. Five years ago, such a goal was scarcely on the horizon in the U.S. This was years before Zelle or the Federal Reserve’s Faster Payments Task Force. The automated clearing house didn’t even provide ubiquitous same-day settlement between bank accounts then.
Nevertheless, it’s fair to say that like a blindfolded person feeling the trunk of an elephant and thinking it’s a snake, I didn’t quite have the big picture in 2012. The most important thing about bitcoin, the characteristic the gives the lie to the oft-repeated claim that it’s “a solution in search of a problem,” is not the speed or the cost of transactions. Nor is it the pseudonymous nature of bitcoin addresses, a privacy feature that voyeurs, gossips and stalking exes (as well as law enforcement) can circumvent by analyzing the flow of funds on the public blockchain. It’s certainly not the exchange rate with the dollar, which has had a bumpy ride but recently hit another all-time high of $3,000. (By the way, if you’re a consumer and this is the first thing you’ve ever read about bitcoin, FOR THE LOVE OF GOD DO NOT INVEST MORE THAN YOU CAN AFFORD TO LOSE.)
No, the key thing about bitcoin is its censorship-resistance — something that I only obliquely touched on in my original post, when I mentioned that the currency could be used to purchase drugs on the dark web or send donations to WikiLeaks, which was then operating under a blockade by the major payment networks.
Censorship-resistance solves a real problem, and not just for drug dealers or ransomware attackers. Centralization may offer certain efficiencies, but it also creates single points of failure that are vulnerable to political or social pressure. As I wrote a year later, in 2013:
Set aside whatever you may think about WikiLeaks or Julian Assange. Just take a step back and consider this: Lawmakers strong-armed financial institutions into cutting off payments to a publisher that embarrassed the government.
If WikiLeaks can be censored this way, it can happen to another publication or media organization someone in a position of power doesn't like — be it Playboy or High Times or Guns & Ammo or Fox News or MSNBC or your trusty American Banker.
But WikiLeaks continued to accept donations via Bitcoin. That's the benefit of having a decentralized system, where payments are validated by "mining" computers scattered around the globe. There's no company with nervous shareholders for the demagogues to bully. … For someone who values freedom of speech, it's nice to know something like that exists.
WikiLeaks was an edge case, you say? Nobody cares about the edge cases, until they become one. Constitutions, due process, the presumption of innocence, reasonable doubt and cryptocurrency all provide valuable protections for edge cases.
Permission to pay
As the world goes digital and physical cash transactions continue to decline — egged on by payments companies aiming to expand market share and by governments seeking to maximize tax revenues — there will likely be a lot more attempts to turn trusted third parties into choke points. The writer Brett Scott warned about this last year:
“Cashless society” is a euphemism for the "ask-your-banks-for-permission-to-pay society." Rather than an exchange occurring directly between the hotel and me, it takes the form of a "have your people talk to my people" affair.
It would be facile to claim that censorship-resistance is “more important than ever in the age of Trump.” Where were all these people clutching their pearls about the current administration’s authoritarian tendencies in 2011, when the FDIC published a since-retracted “hit list” lumping in pornography and “racist materials” (both forms of speech) and other legal businesses with Ponzi schemes as examples of “high-risk” industries?
The truth is that the Comstocks of e-commerce span the ideological spectrum, and governments aren’t their only weapon. Two years ago, following a racially motivated shooting in South Carolina, activists pressured eBay, Amazon and other companies to stop selling merchandise with the Confederate flag on it — even toy cars from “The Dukes of Hazzard.” Again, set aside your feelings about the shooting, or what the flag may symbolize. Just think: if one noisy group can browbeat eBay to block the sale of (nonlethal) materials you find offensive, another might come along and try to censor something you hold dear. And yes, I understand that this “ban” was not a First Amendment violation; people have the right to boycott or protest whatever they want, and private businesses have the right to discontinue selling a product for any reason they want. But in a world where all payments are subject to veto by virtue-signaling middlemen, today’s politically correct social norms could become tomorrow’s dangerous control state.
Red finance, blue finance
For a taste of what’s to come, witness the recent kerfuffles over USAA’s on-and-off sponsorship of Fox News host Sean Hannity, and Bank of America’s canceled funding of a Trump-esque interpretation of Shakespeare’s “Julius Caesar.”
Now, when I hear a blowhard spouting conspiracy theories on TV, I laugh and change the channel, and I avoid going to see plays that try way too hard to be topical and edgy. Others with more time on their hands seek to cleanse the world of bad thoughts, however they define them, and they’re gung-ho to conscript corporate America in their crusades.
Financial institutions will be a favorite target for enlistment, since they sit in the middle of so many transactions. Again, this is not far-fetched. It has already happened with “sin” industries and payday lenders.
Trot out the ol’ nebulous “reputation risk” if you like. But in a large, culturally heterogeneous and increasingly polarized nation, severing a business relationship just to save face with the kale-eaters in Brooklyn might harm a company’s reputation with red state customers, and vice versa.
If an undocumented migrant worker in California wants to send bitcoin to his aunt in Mexico, President Trump cannot stop the transaction (though he could make it harder to exchange dollars for bitcoin on this side of the border). If a lonely man in a wheelchair wants to pay a consenting adult in another city bitcoin to take her clothes off in front of a webcam, the combined forces of the religious right and the carceral left cannot stop the transaction. If you want to use bitcoin to buy a vintage Lynyrd Skynyrd LP with “problematic” imagery on the cover, all the social justice warriors from every college campus in America cannot stop the transaction.
The downside of censorship resistance is that genuinely dangerous people like ISIS might take advantage of it too. According to a recent article by Rand Corp. researchers “the use of digital currencies among terrorists is not widespread—yet,” but that could change. I don’t have a really great answer on this that doesn’t take us back into politics. Suffice to say that long-term solutions to terrorism might fall outside the scope of financial services policy.
Politics is hard to get away from. And unfortunately, politics may break bitcoin.
The price of scaling
The bitcoin scaling debate is fascinating, complicated and highly technical, and I can’t do it justice here. An oversimplified version goes like this:
For a few years, one camp has wanted to move quickly to increase the network’s capacity by increasing the maximum size of transaction blocks, currently one megabyte, that are added to the blockchain every 10 minutes. Bigger blocks would shorten confirmation times, allow more transactions to be processed per second, and hold fees down. (Users who want their transactions processed quickly have to pay higher fees to coax bitcoin miners, who record transactions on the ledger, into prioritizing them.) It’s urgent, the big blockers say, given the bottlenecks and rising costs to send money over the network, which make bitcoin less appealing as an alternative to Visa or Western Union.
Another camp has wanted to proceed more cautiously. Larger blocks, they point out, would require more powerful computers, reducing the number of nodes that can store a copy of the entire blockchain and double-check the work of miners. Mining itself is already too centralized, with much of the processing power located in China. The blockchain conservatives tend to prefer “second-layer” solutions, such as the Lightning Network, which would separately track small, frequent payments between individuals for cups of coffee and the like, reserving the bitcoin blockchain for final settlement.
Various compromises have been floated, but the debate has grown increasingly acrimonious and the camps distrustful of each other. It will all come to a head on Aug. 1, when a “fork,” or secession, could begin, leaving bitcoin holders with the equivalent of a stock split but creating risks such as brand confusion. (Which of the two coins would be the real bitcoin?) Ethereum, the second-biggest cryptocurrency network, weathered a similar split last year, and both Ethereum and so-called Ethereum Classic have their devotees.
There are hundreds of other cryptocurrencies. Most of them seem half-baked or dodgy (there’s a ruder term for these; it rhymes with “bitcoins”). A few are interesting, such as Monero and Zcash, each designed to be more anonymous than bitcoin. None of these coins have yet achieved the network effect of bitcoin.
We’ll see if bitcoin can have its cake and eat it too. The world needs faster and cheaper international payments, but above all it needs censorship-resistant ways to transact. Banks ought to be able to provide the former, maybe using some of the technologies bitcoin has spawned; aside from physical cash, bitcoin remains our best hope for the latter.
The views expressed here are those of the author, so don’t blame his staff. He has a small holding of bitcoin, and if he had a lick of sense he’d be holding a lot more today.
To learn about what banks such as JPMorgan and Citi are doing with the technology bitcoin inspired, come to American Banker’s Blockchains + Digital Currencies conference in New York on Tuesday. On-site registration will be available.