With all the attention currently focused on the Gold Initiative and the upcoming vote on November 30th, it is a good time to pause and reflect on another non-banking monetary asset, one which shares key similarities with gold. But unlike gold which is recognized as one of the oldest forms of ‘money’, this one made its appearance only recently in the world financial market.
Advocates of free market policies have been calling for decentralization of money, the abolishment of monetary monopolies and legal tender laws, competing currencies in addition to the gold standard. These create the corner stones of a sound monetary system which is secured from inflation, debasement and irresponsible monetary policies. But now a supplementary solution is coming into play, which also promises to return the ‘power of money’ to the citizens themselves.
Gold acts as a decentralized currency as it cannot be artificially created by decree of neither bankers nor politicians, however gold alone cannot efficiently serve as a means of payment in the modern world. Physical gold cannot be electronically transferred and used for settlement in the digital age of the 21st century and paper gold can be easily manipulated. When dealing in physical gold, it mostly requires direct interaction and exchange of coins. Gold has no built-in means of transfer.
Thus gold settlements always rely on a trusted third party to store the gold in exchange for promissory notes or certificates which can then be electronically transferred. The question is, what would then guarantee a 100 % backing of such certificates? The origin of our current fiat currency system can be traced back to promissory notes based on gold, but which were eventually inflated by central authorities up to a point where our currencies were no longer backed by gold. In essence, trust extended to a central authority will eventually always be betrayed. What will prevent history from repeating itself, if the control of future currencies is again placed solely with a central authority?
The decades-long quest of monetary theoreticians was concerned with developing a fully decentralized, digital (and thus electronically transferrable) currency. A currency operating in a so-called ‘trustless fashion’, peer-to-peer, and demanding no trust or power to be delegated to any third party. There have been many electronic currencies or means of payment launched since the late 1970s, but all were reliant on a trusted third party.
The concept of a fully decentralized digital currency seemed impossible, because no one was able to conduct transactions and settlements, as well as manage issuance except for a central authority. But quite unexpectedly, an idea was suggested that now provides a solution to this conundrum, previously believed to be unsolvable! In a white paper, anonymously published in 2008 under the pseudonym of ‘Satoshi Nakamoto’ – the idea and concept of Bitcoin was thoroughly described by an unknown author. Within 12 months, the open source community of the internet implemented a working solution and Bitcoin was born.
What is Bitcoin?
Bitcoin is more than a currency and a payment facility, it is a technology and a protocol in which asymmetric cryptography, proof-of-work and a peer-to-peer distributed database work together to create something truly unique. It is a system for settlements and contracts, which can operate in a 100 % trustless environment, with no central authority and outside the realm of arbitrary control. However, it mathematically ensures to be both extremely safe and reliable. While there are unlimited possibilities to the future uses of Bitcoin, it is its monetary aspects which will be explored in this article.
Amongst its many attributes, Bitcoin also acts as a unit of account (currency) which exists within a public ledger (database). This is distributed amongst thousands and thousands of computers on the internet – the so-called ‘block chain’. Based on asymmetric cryptography (public/private key encryption), ownership of an individual Bitcoin (or bitcoin fractions) is signaled through their association with a public key and ownership is authenticated and control is exercised by holding the corresponding private key.
Unlike any currency and payment system, which was explored before, settlement and handling of transactions are not done through a third party, but by hundreds of thou- sands of individual actors, the so-called ‘miners’. These compete in solving mathematical riddles, which in turn give them the privilege of adding the next block of transactions to the ‘block chain’. By doing so, they make sure that the privilege of collecting and adding the transactions, rotation between all actors engaged in the mining process, and tampering with the transactions is ruled out. Should any violation be discovered, this actor would have his work invalidated by those actors who follow up on his malformed transaction block by winning the privilege of being the next to add the subsequent transaction blocks.
This process is called ‘Bitcoin mining’ – because on top of ensuring trustless settlement and transaction handling, it is also the means by which Bitcoin is ‘born’, distributed and put into circulation. Thus ‘miners’ who dedicate processing power to the network get rewarded with small amounts of a new Bitcoin along with transaction fees. This will lead to a predictable rate of decline in inflation, which will continue towards 2140 when the last Bitcoin is mined. It is mathematically calculated that no more than 21 million Bitcoins will ever exist, but being almost indefinitely divisible, a single Bitcoin could theoretically be enough for worldwide demand.
The Bitcoins themselves are stored in the ‘block chain’, a distributed database which can track each Bitcoin or fraction of a Bitcoin back to is very origin, through each and every transaction in which it was involved. This includes tracking current as well as all previous owners (or at least their publish key which has the so-called Bitcoin address). Since the database is distributed and shared between millions of actors, counterfeiting Bitcoin can also be ruled out completely. Bitcoin is thus a completely self-contained protocol, currency and payment system – all wrapped up in one.
How is Bitcoin different than our current currencies?
Bitcoin is not a currency per say. A currency per definition is backed by a sovereign state and supported by legal tender laws. Bitcoin is, however, the first and by far the most successful ‘crypto currency’. That is, a means of payment and unit of account based on the principles explained above.
Bitcoin differs radically from existing currencies in that it is fully decentralized! In the world of Bitcoin there is no central bank, no issuing authority, nor is there any need for a third party to facilitate settlements or handle transactions. By its very nature, Bitcoin transactions cannot be blocked, nor can Bitcoin be seized unless one can steal or force the owner to relinquish his private keys. Bitcoin transactions, whether large or small, operate with extremely small transaction fees. Transaction broadcasts are instant: any day of the week or any time of the day and can expected to be finalized and irreversible settled deep within the block chain within 30 minutes or less. Bitcoin transfers also cannot be reversed in any way. In many ways Bitcoin acts as a form of electronic cash or gold, with no possibility of payment cancellation. When a Bitcoin is sent, it is final. As the receiver you can thus trust that the transfer will create no future liabilities or compliance issues.
Getting access to the Bitcoin system only requires the gen- eration of a public/private key pair, which is a purely mathematical process and thus completely bypasses compliance procedures and the necessity to share private data with any third party. While one does need to be online in order to send Bitcoin, one does not need to ever have one’s private keys online, in order to simply receive Bitcoin. In fact, Bitcoin can be physically exchanged through the exchange of private keys, from person to person. Thus even physical Bitcoin products exist in the market place, thereby making Bitcoin accessible even to those who are not particularly aware of technology and the internet.
Through facilitating crowd funding and/or micro payments, Bitcoin enables business models which would otherwise be impossible, due to compliance concerns or transaction fees. With no potential compliance fallout and with extremely low transaction costs, Bitcoin is the one payment system which makes such business models practically possible.
No other currency of widespread use allows the user to have the same degree of anonymity when used electronically, and it is absolutely possible to pay with Bitcoin over the internet without revealing private data – such as credit card number, name, address etc.
Any device with internet access allows full and complete access to the Bitcoin network and thus opens up the global economy to billions of people without access to the banking system. With Bitcoin it is possible to send funds, also significant funds, within seconds to all jurisdictions. One can send payments to a recipient in Kenya, who owns nothing else but a first generation Smartphone, discarded as junk in Europe half a decade ago. Furthermore, this would be even easier than paying a local bill via e-banking, and also much faster. Bitcoin has the potential to be the ultimate money of the digital age, should worldwide adaption continue at the current pace and the global economy ensure more stability and greater liquidity. It is a com- pletely transparent solution provided by the free market to the free market.
Money laundry and fraud – and regulatory uncertainty
Bitcoin and crypto currencies do not have the best of reputations. Being a new asset class and having brought about a completely new market, a multitude of actors, many of which are not professionals rushed into the ‘Digital finance’ sector. In the most extreme case, the Bitcoin Exchange ‘Mt. Gox’ lost Bitcoin entrusted to them by clients worth hundreds of millions of dollars. This can be compared to the .Com age in the late 1990s in what could best be described as an industry wide ‘gold-rush’ sentiment. This phase saw the launch of countless businesses without carrying out proper due diligence. However, just as the IT-business has since matured and professionalized, so will digital finance and perhaps cause a radical change in the future of the finance world.
Bitcoin also has a reputation for being a great tool for money laundry. But while Bitcoin transactions can indeed be done pseudo anonymously, this is not the case when it comes to the exchange between fiat currencies and Bitcoin. Black market activity makes up a small percentage of the Bitcoin ecosystem and the Bitcoin market is far too small to facilitate the grey and black market economies of the world, in which the US Dollar and the participation of the traditional banking system significantly dwarf that of Bitcoin.
It also remains to be seen how sovereign states and regulatory authorities will react to the emergence of Bitcoin. Currently, most western nations treat Bitcoin as a foreign currency and try to fit Bitcoin into existing regulation, particularly anti-money-laundry and existing tax codes.
However, with Bitcoin being almost impossible to efficiently regulate in a classical sense and with regulatory authorities currently lacking the know-how with regards to crypto currency technology, the future will probably see many changes on this front. What is clear, however, is that Bitcoin and bitcoin technology has by now spread well beyond the point where it can simply be ordered or wished away by decree. Thus, even states and governments will have to come to terms with Bitcoin and adapt post-fact to a world, which has once again changed in unforeseen ways.
Bitcoin in Switzerland – and Bitcoin moving forwards
Switzerland, with its reputation as a geopolitically stable region, and with its business friendly environment where ample of highly qualified labor is available in areas of finance and technology, has attracted many crypto currency oriented businesses.
This is especially true in the business friendly Canton of Zug, where a number of Switzerland’s leading digital finance companies have established themselves and together formed the Digital Finance Compliance Association. This works together with the Swiss regulatory authorities in order to develop a framework for digital finance to thrive in Switzerland. Often referred to as ‘Crypto Valley’, these businesses create jobs and opportunities that did not exist before.
Switzerland has a proven history in regards to financial stability, friendly governance and even has existing examples of private currencies. In the long run, one can hope that digital finance and crypto currencies will usher in a revival of Switzerland’s status as the beating heart of central European finance and worldwide wealth management.
Swiss regulatory authorities have thus far been friendly to the developing Bitcoin economy in Switzerland, ruling the exchange of Bitcoin as a VAT free business and giving contracts in Bitcoin full protection of Swiss law. In all respects, Bitcoin and Bitcoin related business is fully legal in Switzerland as long as obligations towards AML are observed. However, strict Swiss banking regulations as well as hostility against Bitcoin from the Swiss banking sector continue to hold back the development of the industry.
Bitcoin adaption amongst merchants and private individuals is perhaps a bit behind in Switzerland compared to many other jurisdictions worldwide, where even large international companies and payment processors now accept Bitcoin. Nevertheless, intermediaries such as lieferservice.ch has during
2014 made it possible for anyone, anywhere in Switzerland to get take-away food delivered to the doorstep, fully paid in Bitcoin. Near the major population centers, one can find both café’s, restaurants and hotels accepting Bitcoins. Several major Swiss towns’ sport Bitcoin ATM’s where one can buy and sell Bitcoin against Swiss Franc and Euro. Switzerland certainly hosts more businesses developing solutions based on crypto currency technology than Bitcoin adaption warrants. However, as a currency and payment system, Bit- coin is also spreading rapidly.
As 2014 comes to a close, Bitcoin, as a free market alternative to existing currencies, seems more established than ever and the Bitcoin ecosystem is expected to grow significantly. The Bitcoin experiment must by all standards be regarded as a success and crypto currency as one of the most significant monetary developments in the new millennia.
Bitcoin will continue to develop and also strike the fear into those who believe in strong central control of the monetary system and of all financial transactions. However governments and banks should instead embrace this new technology and the opportunities it provides for creating new business, cost saving measures, wealth and a better future for all.
There will always be the need for banks and financial intermediaries – and this will not change with Bitcoin. But with a system of payment and a unit of account which works for no particular entity, money itself, through the Bitcoin technology, becomes completely apolitical and neutral. As a result, it operates efficiently in a trustless environment and cannot be artificially manipulated, devaluated or inflated. Money becomes a tool we can all rely on and this leaves everyone free to focus on core business and on creating value adding services. Bitcoin created an international system of payment and settlement, in which the whole world can participate without artificial barriers.
Undoubtedly – this sounds like a nightmare scenario for those who wish to control all aspects of human affairs, but to those who believe in freedom and free enterprise, Bitcoin promises a bright new future.
Niklas Nikolajsen, CEO of ‘Bitcoin Suisse AG’, a regulated Swiss financial intermediary, and Switzerland’s premiere Bitcoin broker and consultancy