Saturday, September 26, 2015

Jon Matonis: "Banking cartels could use private blockchains as blockades"

By Ian Allison
International Business Times
Monday, September 21, 2015

Bitcoin has boldly blazed a trail for a seamless global financial system, open to anyone on the planet. But this is not a proposition that banks are naturally disposed to.

Some people may say Bitcoin has solved a particular value transfer problem and this should not be conflated with what banks are planning to do with blockchain technology.

However, it could be argued that the highly regulated and exclusive nature of banking has allowed this industry (for the time being) the luxury of analysing its own disruption and formulating ways to manage this, in a manner not afforded to taxi drivers or hotels and B&Bs.

The economist Jon Matonis, the former executive director of the Bitcoin Foundation, believes banking cartels obsessing about private blockchains must answer a fundamental question: "Are these private blockchains going to be able to be used against smaller financial institutions or weaker nations to institute a blockade, just as SWIFT and CHAPS are able to do today?"

As the only global payments settlement network, Swift has blocked Iran from participating; Russia was threatened with being blocked; and Israel was also threatened with a block.

"If countries can be blocked out of the payments system because they are in a politically incorrect part of the world, then they would also be able to be blocked out of something that's a permissioned blockchain.

"We haven't really changed anything then if it's not open access, if all they have done is recreated the cartel.

"They cannot answer that a permissioned blockchain won't be used against smaller financial institutions for purposes of a blockade. The primary Bitcoin blockchain would route around that."
Matonis pointed out that this has prompted both Russia and China to construct their own Asian version of Swift over the past three years. Apparently, the China International Payment System (CIPS) is slated for roll out in 2016.

"They recognise the power that Swift holds. Led by Russia and China, they are building their own consortia to rival Swift, so that they will have a parallel alternative in case Swift decides to block access."

Disruption management

"The banking industry, the financial institutions, they have the luxury of sitting around today and actually analysing their own disruption," noted Matonis.

"This is what this Bitcoin/blockchain stuff is – 'look, we are analysing our own disruption. Now how do we want to be disrupted? Bring it in-house?

"Disruption doesn't work that way. It comes from the outside not the inside. If you look at Airbnb and Uber - Airbnb is the largest lodging company in the world and they don't own a single property. Uber is the largest taxi service in the world and they don't own a single car.

"Uber came up with the underlying technology to attack from another vector and it's the same thing that is going to happen with the banking industry, the banks just haven't accepted it yet.

"They will be disrupted in the same way by an outside technology and they are not going to be able to usurp the underlying technology and disrupt themselves from within because it will completely change what they are.

"In the future, the largest financial network may not be bank-owned at all and the most circulated currency may not be government issued."

Blockchain made the mainstream financial press last week with the announcement that the R3 initiative had nine big banks onside to create common standards for distributed ledger build out.
Matonis said: "Evolving towards a bank-wide standard for blockchain appears to be a replication of how Swift came into being; Visa did the same thing on the retail payments and was originally a bank-owned network.

He said: "If they are going to experiment on this stuff it makes sense for each one of the banks to pay one ninth of the cost instead of the full cost. That's where the true cost savings are?"

Some critics take an extreme view that all private blockchains are creating is another MySQL or shared database.

"Many fintech executives mistakenly view private blockchains as off-the-shelf products whereas they are rather 'byproducts' of a highly-valued native token with massive network effect - bitcoin. Bitcoin is not created to get more chain. The blockchain is created to get more coin."

However, Matonis does see value in the experimentation: "I think that they can achieve some cost savings. And actually I think that there is some benefit for banks doing these blockchain experiments because it prepares them for the future.

"They will already be orientated towards blockchains, they will be able then to eventually leverage what is the strongest most secure decentralised network - that of Bitcoin, where they could actually have value reside on it, and we end up in a world where there is a hybrid approach of private blockchains and the public global Bitcoin Blockchain."

Matonis favours a future state in which Bitcoin works as a settlement network at a higher level, implying that the primary blockchain would not handle every small transaction.

Digital gold

In this respect Bitcoin could be treated more as a reserve asset the way that gold is treated among nations today. Gold eliminates counterparty risk and as such is the ultimate settlement. A lot of countries, such as Germany for example, are repatriating their gold because they don't want it all to be in New York, Matonis pointed out.

"Bitcoin would take on a reserve asset role similar to gold. It would be a reserve currency asset class that countries would have on their balance sheets. It's digital gold; gold is analogue Bitcoin because gold can't be stuffed through a wire."

He said smaller transactions can be handled by a system like the Lightning Network. "Coinbase is already settling transactions between members, so every single thing doesn't have to be on the primary Bitcoin blockchain, because it's not always going to be free.

"The people who want these bigger blocks like the XT people, they want to extend the subsidy for free transactions longer by putting many, many micro-transactions on there even like for pennies.
"All that is a subsidy - it's not actually free. It's just that it's being subsidised by the larger blocks which are paid for ultimately by the transaction validators in the form of increased capacity, increased storage, increased bandwidth."

Matonis said people see the need to extend this "subsidy" for free transactions because Bitcoin has not reached critical mass.

"They look at it as a PayPal, Facebook thing where the end result is to get every single person in the world using it for their daily transactions.

"But it could be behind the scenes at a large scale settlement level. Individual people may not even need to know that they're using it but ultimately it's been settled that way."

Returning to the question of permissioned blockchain hype, Matonis concluded: "The cynical side of me would say that we should call private blockchains what they really are - wealth transfer mechanisms from banks to fintech consultants."

Saturday, August 1, 2015

Bitcoin is Not Campatible With the State

By Oleg Andreev
Monday, August 4, 2014

Bitcoin and State do not go together at all. Neither logically, nor economically.

Logically, if you think that the state is a useful and viable institution and Bitcoin is a useful and viable technology, you are lying to yourself. State is a hierarchical construction of “trusted third parties” (TTPs). In theory, some social interactions may involve a conflict that may be resolved by a trusted third party (arbiter). In a nation state it is ultimately some government agency (e.g. a cop). In case there’s a conflict between a citizen and a government agency, there is another government agency to watch over it. Thus, a cop is watched by his chief, a chief is watched by a court, court is watched by a parliament or a president, and those are being overthrown by an angry mob from time to time. The theory goes that every single conflict can be justly resolved by the state if parties cannot resolve it by themselves.

Bitcoin is an attempt to remove some trusted third parties from equation. That is all sorts of financial institutions including government regulators. From the Bitcoin perspective, it is a moral hazard to enable control over money supply and monetary flows to a hierarchy of trusted third parties. History is full of examples when private banks and government agencies could manipulate and destroy entire economies by being able to produce money without limits or censor its use. Bitcoin is strange and a bit complicated way to protect all users of money. Users can transact without need for any third party to record and acknowledge their transactions, and what’s more, no one can even become a third party by hijacking the system and imposing controls and rules on its usage. The former is not possible without the latter.

Wednesday, July 15, 2015

Bitcoin Is Sedition

By Justus Ranvier
Wednesday, June 11, 2014

The Reaction

Ever since the venture capital scene started talking about Bitcoin back in 2013, one of the most frequently cited comments from them is that Bitcoin is interesting for the technology, not the currency. In fact, this  mantra has become so common that it almost sounds… scripted.

The Problem

What’s going on here?

Apparently millions of Bitcoin users around the globe never got the word that Bitcoin isn’t interesting as a currency.   If Bitcoin wasn’t interesting as a currency, then why would the banking system need to go to such lengths to slow down the capital flight from the Dollar to Bitcoin by enacting restrictive Choke Point restrictions on both regular businesses and P2P trading?

The answer lies with the fate of the US Dollar. All government currencies have a finite life cycle, with an average lifespan of 27 years.  The USD has lasted longer than most, but it will not be an exception. However, whether you’re talking about the Weimar Germany, or Argentina, or the USSR, or the USA, the death of a currency follows an known script. The most important part of this script is that the connected elites get out first and leave the rest of the population to be the bagholders.

The problem with Bitcoin is that goes off-script. The hoi polloi got into Bitcoin before the elites got into it, and Bitcoin contains none of the mechanisms via which they normally arbitrarily inflate the currency to enrich themselves. This is a problem if you’re part of the modern financial aristocracy. Something Must Be Done.

Thursday, March 19, 2015

Bitcoin and iGaming: Disruption Comes From Your Blind Spot

By Jon Matonis
Saturday, March 14, 2015

It has often been said that bitcoin is the ideal digital casino chip. But what does that really mean?

For starters, it means that online gaming, more than anything else, is all about the customer experience.

Whether it's a land-based casino or an online casino, gamblers want a seamless experience with immediacy and privacy, and operators want an irreversible payment method. Bitcoin provides all three.

I recently made the prediction that within five years, half of the top 10 iGaming operators will be bitcoin-only.

Of course, the mainstream online casino operators don't see it that way and I wouldn't expect them to. They have a profitable and expanding business model with national fiat currencies. Why would they want to disrupt that revenue stream?

Funny thing about disruption though is that it rarely comes from within. Disruption comes from your blind spot.

While major iGaming and industry gambling conferences in the west have paid lip service to bitcoin and cryptocurrencies as alternative payment methods, they have simultaneously relegated it to a niche solution where presentations are neatly tucked away in a side corner. Kodak did the same thing after surprisingly inventing the first digital camera in 1975.

Reshaping the iGaming market

The grand opportunity with bitcoin is not with the major operators, which is exactly why I predict that half of the top 10 iGaming operators will soon be bitcoin-only.

New bitcoin gambling operations will evolve in that way organically – they will not be the major operators of today shedding their national fiat currency businesses. It will occur more along the lines of how Sony and Canon exploited Kodak's weak spot.

The major differences between bitcoin-only operators and the majors are a stark reminder of how complacency for something unusual and new can threaten an entire business model. The differences are revolutionizing the playing field.

For instance, bitcoin operators do not need to maintain a bank account anywhere in the world. If structured carefully, operating expenses can be covered entirely in bitcoin, including salaries and even real-time payouts to the all-important affiliates.

Provably fair cryptographic techniques for casinos, like those deployed at SatoshiDice, eliminate the need for eCOGRA-type bodies to provide legitimacy and credibility.

And probably most important, solving the payment dilemma in parts of the world under-served by banks or restricted by traditional payment networks opens up the world's vast unregulated gambling markets.

While some licensed and national currency gambling sites attempt to push funding compliance to bitcoin wallet providers, other gambling sites are moving forward now by accepting bitcoin directly from customers. Indeed, bitcoin's strengths and speed-to-market play very well in this fertile and untapped ground.

These startling innovations will likely reshape the market for iGaming around the world, creating a new set of skills required for the industry, but that is not yet realized by today's mainstream market leaders.

The management team decisions that bitcoin operators need to be focused on include:
  • In-house vs outsourced payment processing
  • Hot wallet/cold wallet ratios to balance customer service and ultimate security
  • Providing direct or indirect methods for customers to acquire bitcoin
  • The percentage of operational assets held in bitcoin vs national currency
  • Hedging and float yield strategies for bitcoin company assets

Blockchain tech is the cutting edge

With the bitcoin network just a little over six years old, the current statistics related specifically to bitcoin and gaming are impressive.

One hundred percent of the world's countries can be reached via the bitcoin payment option and no other payment method can make that claim. It has been estimated by Coinometrics and others that approximately 40% of bitcoin network transaction volume is related to payments for online gaming. Bitcoin-only casino operators lead the field for the bitcoin-related web advertising market. And, there are over 150 bitcoin-only casinos and gambling sites operating today.

AnoniBet claims to be the "first bitcoin sportsbook and casino" operating since 2011 and the original SatoshiDice pioneered the field of blockchain betting.

Since the field is moving so rapidly, bitcoin gambling directories and lists have sprung up, with sites like my favorite Bitcoin Gambling Sites and the more objective Bitcoin Gambling Wiki. Some bitcoin gambling sites are simply too new to be listed, such as BurnTurn poker and the promising Augur project for a decentralized prediction market.

If you want to see where the innovation in gaming occurs today, the bitcoin and blockchain sector is the place to look.

Taking the lead

My advice to bitcoin gaming businesses? Ignore the regulators.

By that I mean the gaming commission regulators at least while the industry is in a grey area. They don't know what they are doing with respect to bitcoin and, out of apathy, they frequently push the opportunity to the financial regulators who end up delaying implementation.

Bitcoin suffers from an outright usage ban or threatened ban in only three countries: Bolivia, Ecuador and Russia, which is still considering the final ban legislation, but blocks access to bitcoin-related websites in the meantime.

Regulators are not leaders, they are followers. Don't count on them to be insightful and innovative. Their primary job is to slow you down.

Do what you do best and build lasting and profitable businesses. Maybe even launch a skunkworks business within your organization. Failing that, perhaps acquire one of many bitcoin-only gambling operators from the industry lists above. Ultimately, it may assist in the upcoming drive to remain relevant.

Jon Matonis recently presented at a bitcoin seminar and a cryptocurrency regulatory compliance panel both for ICE. He is scheduled to make a presentation called "State of the Market for Bitcoin in Gambling" at his first iGaming conference in Asia on 19th March 2015.

Wednesday, March 18, 2015

The Finanser Interviews Jon Matonis

By Chris Skinner
The Finanser
Wednesday, March 18, 2015

Bitcoin still stirs up a huge debate about where it will go in the future; will it become institutionalised; what is the blockchain going to do to banking; and more.  In order to clarify the debate, we interviewed Jon Matonis, a renowned expert on bitcoin and cryptocurrencies, to find out what is the truth.

Tell me about yourself and your background Jon.  

I was involved with the Bitcoin Foundation since its inception, starting in 2012, as one of the founding board directors. At the end of last year I decided to retire from the Foundation board and give other people the opportunity to step forward and work on the board.

It was never meant to be a lifetime gig for any person.  Prior I was working in the payment space at Visa and VeriSign, working on the public key cryptography for online banking, and prior to that I was an FX and Derivatives trader for commercial banks. I have been blending all these skills into this new brand amazing field of financial cryptography.

What’s the future of the Bitcoin Foundation?

In terms of the Bitcoin Foundation going forward, it still is an excellent institution. People should be encouraged to join it, as it does pay for some of the core developers’ compensation. It doesn’t pay for all the compensation, as no one entity controls Bitcoin development.  It is an open source project so it’s not a centralized power struggle, but does provide some compensation. The main focus of the Foundation today, which is slightly different from when it first founded, is to develop a standards body for Bitcoin Core, along the same type of protocol standards as the IETF. It is premature to just automatically throw that over the fence with the IETF standards process, as it would be lost. It has to mature, has to have more participation, more advocates to allow it to thrive in an IEFT structure. That is what the Foundation is preparing the protocol for, so that eventually it will go into a larger more rigorous standards body process.

You mentioned you’ve been a trader and involved with the payments industry so why did you get interested in bitcoin?

I had always been studying and focusing a lot of my research work on digital currencies and alternative monies. Even prior to Bitcoin going back to Digitcash and E-Gold days. In late 2009, I got introduced to Bitcoin by a random email from Satoshi Nakamoto.  I didn’t give it much thought at the time and then 3-4 months later I started to focus upon it. It seemed to solve a lot of problems encountered by the first generation digital currencies, primarily around the centralization issue for preventing double spends. That’s the real breakthrough and is what got me excited both as a trader and as a digital currency monetary theorist. Bitcoin came up with the way to solve the double spend problem, without having to go back to a centralized mint for reissuance or confirmation that the units weren’t double spent. The cryptographic principles for Bitcoin have been around prior to the launch of Bitcoin. There was nothing uniquely new about any of the individual components but it was unique in how it was assembled as a peer-to-peer distributed environment. That was the real breakthrough.

You say it’s decentralized, which often raises the question: is this money without government.

Well the decentralized and peer to peer computing capabilities are the wave of the future. So that is definitely going to last. I see that growing in fact rather than going in the other direction.

In respect to the ‘money without government’ phrase, we actually have always had money without government going back to the evolution of money, even gold and pre- gold barter days. Gold was the form of money without government before the kings and monarchs started stamping their image on them. So I don’t see concept of money without government as being something impossible to achieve.  Instead, we are regaining something that was lost.

But regulators and government officials, when it comes to a value exchange that is unregulated, worry about drug runners and terrorists. Do you see that as a threat? 

I don’t see it as threat. It’s not specific to Bitcoin and other crypto currencies.  Any type of value exchange medium for small or medium transactions are subject to abuse.  The tradeoffs are that you have to severely clamp down on the benefits of having digital money in an absolute way, to prevent something happening on the negative side in an absolute way.  What I mean by that is that the so called drug and criminal communities that you’re labeling, dwarfs what’s happening in Bitcoin. You don’t blame the monetary unit for the actions of the criminals.

I agree with, although another problem of an unregulated value exchange system is that you get lots of hacking and issues like MtGox and Bitstamp failures.  These things give Bitcoin a bad name. Do you see a structure to give consumers more assurance that it is safe to use?

Let’s talk about MtGox and the episode of Bitstamp. Regulation cannot be a panacea for ‘caveat emptor’ (buyer beware). Regulation cannot be a panacea for everything. It rarely works in a way that a government intends it to anyway. Look at episodes in the United States where Lehman Brothers and MF Global were both regulated entities and meant to be safe.  They weren’t. So in terms of protecting consumers, that is just what the government regulators put forward for the justification of massive regulation in the Bitcoin arena. We are now seeing major areas of Bitcoin being involved with best practice though.  If you look at the recent BitStamp episode, that actually resulted in adoption of new multisig technologies for Bitcoin and cryptocurrency exchanges. So the solution with BitStamp generated a more robust and stronger exchange system, which happened outside the action of any government regulation.

Alongside that you are seeing firms like BitGo, which was the multisig company, and companies like Xapo, CoinBase and more adopting their own private insurance to provide customer security and peace of mind for any funds that they choose to leave there. So the market is stepping up, through best practices and through providing these solutions. The main take away from MtGox, which happened over a year ago, is that it demonstrated the exact opposite of too big to fail capitalism. It’s always curious to me that some the critics of MtGox would prefer a world where the tax payers always steps in and bail everybody out. That’s not the world we need to be moving towards, so that MtGox was allowed to fail on its own accord should be taken as a positive sign that the system is working.

It’s interesting that traditional value stores have started to pick up on Bitcoin since failed. A lot of institutions that have got licenses and government regulation are starting to try to incorporate cryptocurrency and blockchain technology in what they do.  That feels like a movement towards the institutionalisation of cryptocurrency. Do you think that will happen or would that be the opposite of the wishes of the community that created this capability? 

Well the wishes of the community don’t really matter here and the institutionalisation of Bitcoin will be jurisdiction by jurisdiction.  Going back to your other point though, the exchange environment has matured significantly over the 12 months since MtGox and that’s a beneficial sign.  Not only are they aware of this, but the service providers are a lot more robust.  Some of them are taking steps on their own in anticipation of future regulation but to present a more mature offering. Users of these services have also worked out that it’s not right to use firms like MtGox as a bank vault, which they should have never been using as such in the first place.  So Bitcoin gives you a way to control your own assets and not required to leave everything on balance.  It’s down to your own guidelines and comes back to what I said, caveat emptor, whether its regulated or unregulated.

On the institutionalisation of Bitcoin, you will start to see that happen. I don’t think this is a negative and, as mentioned it will be jurisdiction by jurisdiction. Trading liquidity, increasing volume and depth of the market will lead to institutionalisation.  It is unavoidable that we will get to a phase where we see Bitcoin derivatives type instruments, which we are already starting to see evolve in certain markets.  It will be just like any other commodity that goes through stages and develops.  We are just seeing that on a faster time horizon with Bitcoin, which seems like it is moving a lot more quickly. We will get there.

I can see it happening. That’s why you see innovators like Fidor Bank and Circle creating cryptocurrency consumer guarantees and assurances, similar to traditional regulated banking licenses, but in the new model world rather than the old model world.  Is this the correct view?

It is a correct view. We are also starting to see it on an international level. You will have the small local regional players, but you will start to see the ones that are large have a global footprint, which will end up only being beneficial because a global footprint for a cryptocurrency type operation really sets the stage for entry into the remittance market. When you have a global player that covers multiple countries you’ve pretty much displaced the functionality of someone like Western Union.

That’s where things get very interesting. For example, Ripple is working with Wells Fargo and other banks to have their technology capabilities incorporated but using other cryptocurrencies than bitcoin.  Will we see a different cryptocurrency arrive?  Is bitcoin the one?

Well there are already over 300 crypto currencies that come and go. Bitcoin has the majority share at almost 99% share. Bitcoin is the dominant player. Ripple is making a lot of progress with financial institutions, as they are making this area their main focus of attention. I don’t see systems like Ripple as being truly decentralized however. They have distributed deployment, but the currency unit itself is entirely pre-mined by the founders of the currency.  That means it is not decentralised, as there are people who work out where to deploy that initial currency unit. The Ripple currency XRP is what they use as a glue to hold everything together and the test as to whether something is truly decentralised is: who will be the financial winner with Ripple’s success? Ripple has lots of venture capitalists participating in it, and investors in XRP. Those people will be the winners. Because of that Ripple doesn’t take them away from a single point of failure. Their implementation with lots of financial institutions, and what they are trying to do with various asset webs and connections, is very appealing to banks as it makes it subject to oversight and regulation.  At some point, when you traverse everything in that world however, there is still a single point of failure. Regulators like to have that single point at the end of the day, because then they can regulate it. Bitcoin doesn’t give them any type of single point to focus on.  That’s why it’s democratized value.

So if Ripple is not the solution, how will banks manage cryptocurrencies into their operations?

This is actually a very interesting area.  I am starting to focus on it a lot more in my work as, in some ways, it’s the flip side of Ripple and alternative cryptocurrencies that want to do their own independent blockchains. What we are starting to see evolve are banks beginning to leverage the existing Bitcoin blockchains.  The blockchain that already exists, rather than trying to recreate something that will be a second or third tier chain. The reason this is interesting is that it's already there to be exploited.  The fact is that banks just have to figure out a way to connect to the Bitcoin network, which gives them the same type of liquidity and ability to do the large amount transactions they currently have on SWIFT.

An interesting company that illustrates this development well, came out of the SWIFT innotribe challenge last year coincidentally.  This is a company called Epiphyte based in London, and with offices in New York.  They created an interface for commercial banks on both sides to be able to leverage and utilise the Bitcoin network, in lieu of using Fedwire or CHAPS or SWIFT, who are liquidity providers.  The banks never end up touching the cryptocurrency. This solves the challenges of correspondent banking for large global banks, who have to tie up a lot of capital in counterparty cover.  Equally, there are other parts of the world where banks do not want to leave a lot of money with their correspondent banks, due to the counterparty risk.  If they can leverage something like the Bitcoin blockchain then this will have significant impact on the future of correspondent banking worldwide.

That's one of the reasons I believe bitcoin as a cryptocurrency has more relevancy at the wholesale level, replacing both Hawala and correspondent banking structures at the same time.

So if I summarise what we have covered so far, you believe we will have a jurisdiction-based system that regulates usage at a national level but, because it’s incorporated by banks into wholesale bank structures, it massively reduces costs. Is that how this plays out?

Yes.   It’s important to look at jurisdictions, as jurisdictions do have the ability to regulate the in-and-out functionality of their own currencies into cryptocurrencies.  When you talk about a country having Bitcoin regulation, what they are really regulating is their own currencies exchanged into and out of another cryptocurrency. That’s what you’re seeing at bitcoin exchanges and banks, and will be one primary level of regulation.

Beyond that, you will have a whole parallel world which will exist person-to-person.  In some ways that world is more interesting than person-to-business use of cryptocurrencies as in a person-to-person environment, similar to using Skype or using encrypted email, you find new ways of doing things.  In this case, you have an independent financial messaging system which has allowed us to create a large global value exchange network. That secondary level of exchanges, person-to-person or otherwise, with a cryptocurrency like bitcoin is outside the control of regulators. That’s not even an area where the regulators have a remit, and is why they will have to focus upon when cryptocurrencies are converted into and out of their own national currency.

So that person-to-person exchange, what will be the protection mechanism that will take place in that the system? Will free agents manage the system?

Well ultimately this will rely on the Bitcoin blockchain, which is secured by the power of the overall mining participants. This represents the largest distributed and secure computing project in the world. In aggregate it exceeds the top 500 or 600 super computers combined.

And here, I want to make a point about the price of bitcoin, as this comes up a lot. I don’t think watching the price is that important. It’s more important to look at the number of projects and developers working on building user friendly solutions. It is more important to focus upon the installed base of bitcoin wallets.

At the end of the day, the bitcoin price should reflect a price level that is sufficient to protect the aggregate value of transactions that are arriving over the blockchain. If you extrapolate that forward and say that a lot more economic activity is occurring on Bitcoin blockchain, then the security reaches a level that is consummate with the value riding across that decentralized value transfer network. As a result of this, that will tend to slowly increase the natural price of Bitcoin. That’s the only way to guarantee that the transactions riding across the network will be secure.  Then people will be willing to pay for that additional security in increased transaction fees.

It’s a feedback loop, as you won’t have those transactions occurring if the miners aren’t rewarded through a higher price of bitcoin. You won’t have the higher price of bitcoin if the transactions aren’t occurring in the first place. So it’s very much a feedback loop in a two-way structure.  That’s why I don’t put a lot of effort or thinking into the alternative cryptocurrencies, as they tend to be distraction for building the strongest leading network that we need for migrating economic activity and commerce.

Final question Jon.  If you were a betting man and you were betting on what will happen in the future, where would you put your money… or don’t you use money anymore?

I do have to still use money in some cases and also credit cards but, if I look at it from a Bitcoin investment point of view, I would bet on investing in the actually currency and using that as a proxy for the sector, rather than choosing individual companies. I think it’s unique and rare that we have an opportunity in the investment world to choose a currency as a way to invest into an entire sector. It is a proxy for the sector.  If there was a way to invest into healthcare through a healthcare currency, you have that now for investing in bitcoin as a cryptocurrency for the digital value exchange sector.

In terms of your portfolio, I look at this in the same way as gold.  If people are comfortable in having 10-15% of their overall net worth in something like gold and precious metals, then equally they should be comfortable in having 10-15% in bitcoin. It’s investing in assets and commodities on a portfolio percentage basis.  I think this whole transition that you describe as the ValueWeb  will be complete when we start calling gold an analogue version of bitcoin.

Monday, February 2, 2015

Volatility, Deflation and Manipulation: A Response to Bitcoin's Critics

By Jon Matonis
Monday, January 26, 2015

Bitcoin has its share of critics and skeptics, and opposition to the emerging technology – especially among the intelligentsia – shows no sign of abating.

Notable commentators on the topic range from author Jeffrey Robinson to finance blogger Karl Denninger, Boston University professor Mark Williams, rabid Keynesian Paul Krugman, Austrian economist Gary North and FT Alphaville's Izabella Kaminska.

Generously, I'm assuming that the pundits listed above have a thorough and accurate understanding of the bitcoin protocol that facilitates its native token's dual role of currency and commodity.

Typically, the arguments put forth by an elite group of critics like this could be easily attributed to a lack of economic credentials or real-world experience in sophisticated financial markets. But that is simply not the case here – which makes it all the more puzzling to comprehend. Since the various critiques fall short on any convincing economic analysis, I suppose one could put it down to mere philosophical differences on the origin and nature of money.

With the resilience of distributed peer-to-peer networks amplified by powerful public key cryptography, we are all in new territory now; the world stands on the precipice of a fundamental realignment in the transfer of value. At its root, bitcoin is a value transfer protocol. We may voluntarily choose to utilize it or not. Most importantly, there is no coercion imposed through legal tender laws.

Value is subjective

Perhaps most disturbing to the bitcoin critics is the fundamental myth that bitcoin exposes – the myth that the State confers value on money and that we need 'kings' to coin our money.

We are constantly reminded by the critics that money can only be a legal creature of the State and that it is the "civil society system which puts the value into currency". Expounding on the thesis advanced by German economist Georg Friedrich Knapp in The State Theory of Money (1924), an exposé advocating the Chartalist approach to monetary theory claiming that money must have no intrinsic value and strictly be used as tokens issued by the government, these modern-day chartalists promote the notion that only governments and sovereign issuers have the ability to confer legitimacy to money.

A belief in central banking is also a belief in the central planning of an economy. Additionally, it represents central planning of the highest order, because it interferes with the market's price discovery process for money – the rate of interest.

As the antithesis of central planning in money, bitcoin gradually achieves more and more market-based legitimacy. Institutional and government legitimacy are not required for bitcoin to serve as store of value, medium of exchange and unit of account.

Kaminska's first piece on bitcoin in early 2013 highlighted a fairly good interaction between Chris Cook and an Austrian economist on the intrinsic value debate. Here's more on subjective and intrinsic value with Willem Buiter, chief economist at Citi.

Volatility is a red herring

But wait, isn't all this volatility damaging bitcoin and its reliability as a store of value and medium of exchange?

As bitcoin grows and matures, multi-jurisdictional exchanges will emerge which also include specialized derivatives products for hedging risk and this will have the effect of increasing market capitalization and smoothing out price volatility. Bitcoin swaps are already being conducted over swap execution facilities.

Although important, the speculative volatility is actually a sideshow to the main event of bitcoin establishing a footing in the financial world. Even at a mere six years old, bitcoin exhibits no more volatility than the luminary Swiss franc or North Sea Brent crude oil, with the latter losing more than 50% of its value in about six months.

Fear not deflation

But what about the hoarding of bitcoin? Isn't that bad for its use as money?

I prefer to call it savings and maybe it's time to unlearn all those lessons taught in school. Savings and deflation are not bad for an economy. As Jörg Guido Hülsmann once said: "We should not be afraid of deflation. We should love it as much as our liberties."

Contrary to the central banking and political class insistence that deflation must be prevented at all costs, an economy with a monetary unit that increases in value over time provides significant economic benefits such as near-zero interest rates and increasing demand through lower prices.

Ultimately, the market will reach an equilibrium between investment and savings because in the absence of an equilibrium the benefits of a savings-only strategy would evaporate. Proper economic growth through sound investments will lead to a productivity-driven deflation.

Ironically, it's the store of value function for bitcoin which enables and reinforces its use as a medium of exchange. According to Daniel Krawisz of the Satoshi Nakamoto Institute, hoarders give bitcoin value and he states that "the initial price of bitcoin was caused by people who wanted to hold it, not people who wanted to spend it. Furthermore, each subsequent step in bitcoin’s advance must begin with more holders, not more spenders."

No naked shorts, so far

I am continually amazed by those who shout "market manipulation" yet fail to see the very blatant manipulation they abhor present in the naked short selling of precious metals and in the Plunge Protection Team. We all know the world's most important trading desk sits on the 9th floor of 33 Liberty Street.

Kaminska writes: "Bitcoin markets are a hotbed for unscrupulous market practices. Everything from HFT, front-running, rebating, preferential order flow, poor margining, naked shorting, and now the truly popular one – active 'collusion' by big players. It’s all there."

In reading this, you would be forgiven in thinking that Kaminska might also be referring to highly-regulated markets populated by the likes of MF Global and the interest rate rigging cartel of RBS, Citigroup and JP Morgan. She is not. Certainly Kaminska doesn't condone that type of market activity, but that's not really the point.

The point is that we have a brand new marketplace, for a digital bearer instrument no less, germinating in parallel to the entrenched incumbents and along the way battling the retail and wholesale payments oligarchy as well as the vested interests of legal tender threatening bans. Of course, the bitcoin exchange markets experience illiquidity, lack of market depth, and a few bad actors willing to exploit such conditions. They are in the vanguard of cryptographic security architecture for dynamically-connected bearer wallets.

Fraud on any level, whether State-sponsored or from malicious principals, has no excuse and should not be tolerated. The solution is not to ensconce the new exchanges in the straight-jacket of the perceived level playing field with too-big-to-fail benefits and socialized losses, but to encourage multiple competitive exchanges across multiple jurisdictions. We wouldn't have the COMEX tail wagging the spot market dog if we had robust precious metals derivatives markets on every continent.

With bitcoin and exchanges, it's all about jurisdictional arbitrage.

Should we really believe that the two young founders of Bitstamp match the antics of Jon Corzine? After all, episodes like Bitstamp are not due to an orchestrated crisis of liquidity.

But who will protect the people?

The European Banking Authority published their report on virtual currencies complete with a risk drivers chart of 70 bitcoin risks, which was promptly hailed by the FT Bitcoinmania crowd.

For a sane and thoughtful response, we turn to Ken Tindell, who believes that the "EBA’s considered opinion is that European financial institutions should shun bitcoin like a dead skunk and go nowhere near it until the 'scheme operators' are persuaded to change bitcoin to be managed by a wise and omniscient regulator." He concludes that the EBA doesn't really understand bitcoin and they exaggerate the risks to support a mandate which deters financial innovation unless it fits into their limited construct.

In the United States, the Consumer Financial Protection Bureau did the same thing with the publishing of its advisory warning to consumers about the risks of virtual currencies.

To better assist consumers, I described some of bitcoin's superior attributes in the area of financial protection, because when the words 'financial protection' are in your agency's official name, it appears disingenuous to omit features from what may be one of the world's most protective financial instruments ever designed.

In no particular order, bitcoin provides protection from counterfeit bank notes, protection from financial surveillance, protection from identity theft, protection from physical loss of assets, protection from cross-border restrictions and excessive fees, protection from payments blockades, protection from government-sponsored inflation, and protection from confiscation. Can your currency do all that?

Furthermore, without a central bank and without taxpayer-funded deposit insurance, it is somewhat comforting to know that bitcoin's lender of last resort is the same as the lender of last resort for gold – those silly believers of subjective value.

In the province of financial journalism, bitcoin unmasks the Statists.

Friday, December 12, 2014

Financial Services Club in Oslo

On December 10th, 2014, I spoke on the topic of "Cryptocurrencies and Bitcoin" at the Financial Services Club Nordic Region event. It was held at the lovely Ekeberg Restaurant in Oslo, Norway.