Government And Bitcoin: Their Mutual Discomfort

There are no limits. There are only plateaus. And you must not stay there. You must go around them.

— Bruce Lee

The topic is the adaptation of Bitcoin (Pending:COIN), the original implementation of blockchain technology, to existing requirements of standing governments, along with the promise of the blockchain technology to improve the lot of the global population through modifications of government enabled by Bitcoin. It is to be expected that existing governments will react positively to the former; negatively, to the latter. But this article considers a surprise exception that may become the rule.

Blockchain’s near-term (about one year) investor significance. My usual focus on implementation of blockchain tech, and the focus of others interested in the technology, as measured by funds invested, has been blockchain’s potential use in transactions and financial record-keeping. In particular, this is the primary locus of the application of the “permissioned” blockchains. Existing, pre-blockchain, transactions technologies, managed by financial institutions and exchanges and clearers through consortiums such as R3-CIV, have invested heavily in this permissioned blockchain tech. This investment is expected to bear fruit in the ever-receding “soon.” For the purposes of the investors that follow Seeking Alpha, this near-term aspect of blockchain tech will doubtless dominate investment implications for the major US and global financial institutions, such as Bank of America, whose current blockchain strategy is detailed here; and CME Group, whose strategy appears here.

But as I argued in my most recent discussion of blockchain technology, here, there is no reason not to proceed along both threads of the technology simultaneously. Like the internet, blockchain will benefit by not predefining its role, perhaps giving rise to a multitude of unanticipated applications, as did the internet.

Bitcoin’s potential as a model for a change in global government. There are, of course, no citizens of Bitcoin. So it is not a government, but a governance model.

But in a two recent articles by Tom W. Bell, here, and here, he suggests a broader characterization of Bitcoin’s function – extending beyond the two standard characterizations – a store of value and a means of exchange. Bitcoin’s own governance replaces authority with …. nothing. As such, it becomes a model for a new form of national government, as well as new discretion by citizens in choosing how they will be governed within a single national boundary.

Elsewhere, Ariel Deschapell, in consideration of the strengths and weaknesses of governance of public blockchains such as Bitcoin and Ethereum, argues that efforts by factions within the Bitcoin user community to change Bitcoin governance to meet the faction’s particular needs, are to be resisted in the interest of the long run success of the cryptocurrency. He argues that changes in Bitcoin that work in favor of its long run viability and success happen organically through growth of “teams,” or what might be called “spheres of influence,” that achieve their objectives at first through attachments to the existing network such as apps or “sidechains,” accessing some existing Bitcoin characteristics, while modifying others within the sidechain only – without needing to exert power over other Bitcoin users, through artifices such as “consensus,” or worse, the methods employed in Ethereum’s DAO crisis – to subsequently accept the modifications of a subgroup involuntarily. If the sidechain succeeds on a commercial basis it will grow within the unchanged broad structure of Blockchain, allowing completion ultimately leading to the success of the sidechain’s modification. This essentially Libertarian system of Bitcoin governance deserves pride of place as the sixth of the fundamental characteristics of Bitcoin.

The implications of Bitcoin’s form of governance. This approach to governance, combined with the Bitcoin property of locationlessness, raises the intriguing possibility of removing the limitations on choice of alternative government and law from their current physical borders, providing individual communities with a choice of legal systems and forms of governance. Bitcoin permits extending such changes to including local choice of alternative national currencies, even alternative monetary and fiscal policies.

The effects of a single community’s ability to choose another nation’s set of commercial regulations creates positive implications that extend beyond the community’s borders to the rest of the globe. If a large community outside the United States, for example, were to choose US bank regulations, it would open that community to US commercial banks with little or no associated red tape. There are now examples of nation-states willing to permit individual communities within their borders to make such choices.

How would Bitcoin affect such pockets of multi-government locations? How would such a system exploit and change Bitcoin?

What are the key characteristics of Bitcoin that support borderless government? The usual list of Bitcoin’s innovations follows below:

  1. Trustlessness. Use of Bitcoin depends fundamentally on the notion of trustlessness. The principal: Although anyone can access Bitcoin, no individual or group may alter it in any fundamental way without universal agreement. This property is essential to the future of Bitcoin. Yet it seems fragile.
  2. Permissionlessness. The promise of trustlessness. Permission is not a factor in the use of Bitcoin. Anyone can use it. Further, anyone can participate in the process of verifying Bitcoin transactions.
  3. Immutability. Once a transaction is verified, it cannot be reversed.
  4. Transparency. All transactions are “visible” to any user. Transactions other than your own, however – while visible – are gibberish.

I add fifth and sixth characteristics, important to the subject at hand:

  1. Locationlessness. Transactions in the Bitcoin network are without location. As with the other properties of Bitcoin, if makes the currency different from standard transactions systems, creating both potential problems in application of Bitcoin to familiar transactions and opportunities to capture new constituencies.
  2. Leaderlessness. Domains or “spheres of influence” with defined modifications to the basically changeless (outside of the important ability to modify code for the better and to fix bugs) permit flexibility within the fundamental principle of Bitcoin governance: leaderlessness.

The near term. In the near term, government reaction to perceived threats to their prerogatives poses a threat to the future of public blockchains like Bitcoin. Because the forces that provide the fuel for Bitcoin’s key characteristics are economic and thus anathema to the those who wield non-economic forces.

How does economics drive the functionality of Bitcoin? The activity that drives the functioning of Bitcoin is called mining. Mining is fundamentally an economic activity. A miner incurs a cost – primarily the energy consumed in operating the computers that verify Bitcoin transactions – and seeks a profit – a payment in bitcoins that results from winning a race with other miners to be first to verify a “block” of transactions.

The critical economic theory that creates the six essential characteristic of the Blockchain network is game theoretic – a “Nash equilibrium” results from miner behavior. A Nash equilibrium is produced by the economic bending of the incentive to hack networks attached to the internet, driving hackers to protect the network instead.

By placing miners in an environment where the tradeoff between anticipated profits and known costs of mining greatly exceeds the tradeoff between the anticipated profits and enormous costs of hacking the Bitcoin network, each miner individually has greater incentive to mine than to hack Bitcoin. Moreover, the result of each miner’s decision to mine – not to hack – further increases the cost of hacking.

What could go wrong? The first, most dangerous, vulnerability of Bitcoin is that human action is not solely driven by economic forces. Geopolitical forces are also important. Two adjustments to Bitcoin would meet the minimum survival requirement of rendering Bitcoin consistent with this fact.

  1. Bitcoin must not interfere with the unfettered exercise of governmental prerogatives with a government’s defined borders.
  2. Bitcoin must configure itself so that Bitcoin’s own function is independent of government’s influence. This seems the more difficult of the two.

The internet and its uncontrolled broadcast of personal information have taught us all the importance of geopolitical forces in an economics-driven environment. Hackers are no longer simple criminals. They more often are either protected and encouraged by nation-states, or are themselves nation-states.

And the nation-states in question are not limited to renegades such as North Korea. Every major nation hacks the web for personal information, including hacking the information of its own citizens. It may be fairly said that the conflict between the internet’s idea of its prerogatives and those of nation-states remains unresolved. This continuing conflict suggests that the seemingly internet-beneficial “partnership” between the governance of the internet and that of the United States, while it greatly accelerated internet development, may ultimately be regretted.

In this vein, I noted with mixed emotions the recent non-binding resolution of Congress, calling for national support of blockchain tech. It might be more accurately described as national interference in blockchain tech.

This desire of nations to know information its citizens would like to protect creates a personal motive that will drive interest in Bitcoin’s independence from government domination. And simultaneously it drives nation-states’ desire to hack Bitcoin. This is the paradox at the heart of Bitcoin politics. Bitcoin offers the promise of protecting individual rights to privacy that nation-states no longer provide. But who will protect Bitcoin from the nation-states, acting individually or in concert?

Nodes in Space. This vulnerability has apparently not escaped the attention of Bitcoin leadership. A partnership to launch satellites broadcasting the bitcoin blockchain from space has been announced by bitcoin core developer Jeff Garzik. Garzik plans to build satellites called ‘BitSats’ as part of a bitcoin orbital system, providing redundancy to the network. In his words, “We want to keep bitcoin healthy and free by finding alternative ways to distribute block chain data.” Alternative, presumably, to land-based nodes that are vulnerable to government seizure.

A Space Node.

The second threat to Bitcoin is the politics within the governance of Bitcoin, such as it is, and the remote possibility of collusion among miners to attack the Bitcoin network. Looking at this most immediate concern, one’s attention is drawn to the dominance among the Bitcoin user community of Chinese citizens, and among the miner community of Chinese companies.

The interest among Chinese users seems to be focused on two applications. First viewed in its tenuous role as a store of value, it fuels the Chinese weakness for “get rich quick” schemes. Second, in its potentially more lasting role as a transaction mechanism, it permits relatively easy movement of Chinese wealth out of China, bypassing the Chinese government’s capital controls. The production-side dominance of China-based miners, coupled with the consumption-side use of Bitcoin to bypass Chinese law, makes the vulnerability of Bitcoin to action from the Chinese nation-state apparent.

Should the Chinese nation-state perceive its interest to be attacking the network by, for example, usurping control of more than 50% of total mining power, the cost to China of this snatch-and-grab would be negligible as the Bitcoin network is presently structured; the effect on Bitcoin, terminal. “Nodes in space” seems adequate to protect the first of Bitcoin’s points of vulnerability, the seizure of nodes. The second source of vulnerability, the protection of the miner’s computers and their energy resource requirements, is more daunting.

Indeed, a sign of Chinese governmental fear of the growing dangers to its sovereignty appeared on September 29 th, as The Shenzhen Stock Exchange blocked a deal that would have seen Chinese manufacturer Shandong Luyitong purchase bitcoin mining hardware firm Canaan. The report of this decision suggested it was due to apprehension of officials at the Shenzhen Stock Exchange concerning “uncertainty surrounding Bitcoin as a technology.”

What are the possibilities? The essential possibility presented by Bitcoin is the ability to remove the physical dimension from fundamental aspects of governance and financial regulation through its locationlessness property. A locality, with the permission of its nation-state, could choose its own financial system, including currency; its own judicial system; even aspects of governance, such as taxation. This governance alternative is being implemented now in Honduras. The national government has amended its constitution to create zones that go by their Spanish acronym, ZEDE. Why would Honduras forfeit its own sovereignty? Of course, it wouldn’t. But it might incorporate individual sub-components of foreign law, regulation of policy, on a localized basis, if it were viewed to be both practical and a reinforcement of popular support for the national government through direct economic and social benefits to its citizens.

Honduras’ sentiments are not difficult to understand. This device is a means of short-circuiting the otherwise impossibly complex task of changing each of Honduras’ laws and regulations individually and irrevocably to emulate another system. In one step, Honduran law-makers provide its citizens with the option of adopting the Anglo-Saxon legal system in a selected area, for example. The law goes so far as to permit an area to submit legal disputes for settlement in a different jurisdiction. You can read about this in Bell’s articles.

How does a cryptocurrency facilitate this kind of individual choice? By the Balkanization of Bitcoin that its government-less structure facilitates. A Bitcoin sidechain might alter the compensation of miners from bitcoins to electronic dollars, which could then be incorporated into a dollar-denominated peer-to-peer transactions system in one of Honduras’ ZEDEs. This would permit the availability of a stable currency, permit same-day settlement, and avoid the loss of seigniorage that results in countries, such as Ecuador, that have simply adopted the dollar. In other words, the locality gets a new and improved dollar transactions system.

If access to the zone by global firms on terms defined in US regulation were part of the arrangement, the prospect for increased trade and new foreign operations locating in these zones would be created. Since economic growth is Honduras’ fundamental goal, this would seem likely. The success of this Honduran initiative would potentially spur its adoption elsewhere, leading to a major opportunity for expansion of the more established, mature regulatory and governance structures on the globe, without compromising the sovereignty of smaller nations.

The effect on Bitcoin would also be positive, both providing a new source of value to network participants and motivation for the global community of governments to accept it.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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