Sunday, March 31, 2013

BitPay, Reaching a $2M Milestone in March, Cuts Fees

By Jon Matonis
Monday, March 25, 2013

CEO Tony Gallippi
Bitcoin payment processor BitPay Inc. today announced its global processing volume for the month of March will exceed $2 million, a milestone for the company.

BitPay is also reducing its fees. The company will now process Bitcoin transactions and support settlement into 11 local currencies at a rate of 0.99% for all merchants. Previously, there were separate conversion fees on top of the 0.99% processing fee, so the company has essentially waived the currency conversion charges.

Bitcoin payments are designed to resemble cash transactions more than credit-card transactions. Bitcoin payments have no disallowed merchant category codes (MCCs), no selective payment embargoes, no chargebacks and near immediacy of final transaction confirmation.

Accepting the digital Bitcoin currency as a payment method allows merchants to reach customers in over 60 countries not supported by PayPal. It also allows merchants to reach various countries that are restricted by Visa and MasterCard for high fraud or lack of infrastructure. A consumer transacting in bitcoins needs only a mobile phone application or an Internet connection.

"We chose to celebrate this milestone by rewarding all merchants, large and small, with an across-the-board fee reduction, instead of offering tiered pricing which rewards only the largest merchants," says BitPay CEO Tony Gallippi, in a press release. "We want our merchants to use this fee reduction to offer discounts and incentives to their customers for paying with Bitcoin."

Settlements to local currencies are made with a guaranteed exchange rate locked in at the point of sale for no additional fee. This protects the merchant from potential volatility of the bitcoin exchange rate.

Supported currencies for settlement include the U.S. dollar, Canadian dollar, Australian dollar, New Zealand dollar, euro, Pound sterling, Danish krone, Mexican peso, Norwegian krone, Swedish krona and South African rand. Currently, BitPay provides one-day settlement for the U.S. and settlement in 2-3 days for other countries. Euro settlement is currently available in Belgium, Finland, France, Germany, Italy, Spain and the Netherlands.

BitPay has over 4,000 merchants on its payments platform and is acquiring new merchants at a rate of 1,000 per month, the company says. It also recently announced that it has integrated its payment platform with Amazon’s fulfillment services, enabling merchants to combine frictionless international payments with international shipping in a fully-automated system.

The Amazon deal alone is a massive win for BitPay as it fits perfectly with Amazon's expansion strategy and showcases the qualities of the bitcoin payment method. Gallippi said in an interview that "the Amazon partnership has the potential to catapult the company to an entirely new level."

Saturday, March 30, 2013

Cyprus Goes Cashless The Hard Way

By Jon Matonis
Sunday, March 24, 2013

The rolling crisis in Cyprus should reach a crescendo this week. If the parliament votes yes on some type of deposit confiscation, it would mean the people of Cyprus have elected to go “all in” on the euro and link their fate with the fate of the single currency.

When given a clear opportunity to leave the eurozone, Cypriots will probably decide to stay rather than rebuild their banking infrastructure from scratch.

With the latest maneuverings and after going full-circle with a range of alternatives, it appears that European bailout terms could be met by a 20-25% levy on deposits only in excess of the guaranteed 100,000 euros. Cypriot Finance Minister Michael Sarris said yesterday that a deposit levy was back on the table as a way to come up with the 5.8 billion euros needed by the new March 25th deadline for the larger rescue amount to be approved.

Writing for SkyNews, Ed Conway described the raid on bank deposits as “a step across the financial Rubicon.” Indeed, it has ramped up expectations as to what is now within the range of options for other EMU member states. Politely calling it a levy or deposit tax doesn’t alter the fact that it still amounts to brazen theft. Others have called it legalized bank robbery.

The Statist quote of the day goes to Naomi Fowler, Taxcast producer for Tax Justice Network, who said, “I think Cyprus is a cautionary tale to citizens that their government’s adventures in tax havenry will cost them dearly.” She advocates for global penalties against the provision of financial privacy which to this observer warps the very meaning of the word justice.

“Only put money in the banking system that you can afford to lose,” advises financial commentator Max Keiser. This is no more true than last weekend in Cyprus when bank depositors had electronic transfers blocked and were initially told to prepare for a confiscatory levy of up to 9.9% of their deposit balances across the board. The government then ordered banks to keep ATMs stocked since cash and credit cards were the only remaining methods of transacting. However, it is not clear how much longer the credit cards will be functioning in the country.

With banks in Cyprus now scheduled to re-open on March 26th after eight days of consecutive closure, this would make the Cypriot banking-system shutdown tied with the U.S. (March 6-13th, 1933) for longest number of shutdown days, following only first place Argentina (April 20-29th, 2002) at 10 days. Should the crisis extend beyond eight days and the European Central Bank pulls the liquidity it has been pumping into Cypriot banks, the ATMs may become cashless.

“The future of the euro zone has been put on the line for a few billion euros. Yet, the assumption of Cyprus not being a systemic risk rests on a single expectation: that it stays in the euro zone,” according to Stephen Fidler at The Wall Street Journal. “Should it exit, all bets are off.” However, other countries should be sufficiently discouraged from taking that route if they see live television images of a full-blown banking panic and an economic collapse within an EU member nation.

For now, the general attitude among the troika appears to be let’s experiment with Cyprus and if things go badly, it’s not such a long-term big deal because Cyprus is too small to matter. That could prove to be an optimistic fantasy.

With capital controls to prevent a mass exodus from Cyprus banks now fait accompli regardless of the bailout decision, Jeremy Warner at the Telegraph says that it is the end of the single currency in all but name:
Yet the point is that if capital controls are introduced, it basically makes Cypriot euros into a national currency, rather than part of wider monetary union. The capital controls will severely limit your ability to get your euros out of Cyprus, rending them essentially worthless in the wider eurozone. It would be a bit like telling Scots they can’t spend their UK pounds in England. Monetary union is many things, but above all it is about free movement of money and a uniform value wherever it is spent. When these functions are disabled, then you cease to be part of a single currency.
The era of free capital movement is behind us. Capital controls are about government keeping your money within easy reach should they ever want it. A decentralized and nonpolitical currency like Bitcoin starts to look attractive by providing a safer destination for wary depositors, allowing them to store their money securely in a digital account on their own computers, away from the big governments and politicians’ reach. It is possible to purchase bitcoins in Cyprus at

“Money flows to where confidence exists” says Alan Safahi, CEO of ZipZap, Inc., a global cash network with over 700,000 locations in the world. “As bitcoin gains more acceptance, consumer confidence increases and more money will flow to bitcoins, causing a continuous rise in price due to limited supply which then increases consumer confidence even more,” adds Safahi.

As this trend continues, ZipZap, which processes more purchases of bitcoin than any other cash network stands to benefit tremendously from this trend. “The growth opportunity is not limited to Europe. We are seeing a significant increase in volume in the past few days from consumers in the U.S.,” says Safahi.

The emerging trend towards bitcoin as a flight to safety seems to be accelerating despite the recent regulatory guidance from FinCEN (Financial Crimes Enforcement Network). As part of the Treasury Department, FinCEN’s guidance on enforcement would extend traditional money laundering rules to most types of virtual currencies, including bitcoin. Although bitcoin proponents emphasize that a test case has not emerged yet.

“It’s almost a badge of respect when the Treasury starts regulating you,” said James Rickards, author of Currency Wars. “You must be doing something right.”

“Gold is a great way to preserve wealth, but it is hard to move around,” added Rickards. “You do need some kind of alternative and Bitcoin fits the bill. I’m not surprised to see that happening.”

Friday, March 29, 2013

Bitcoin Foundation Reacts To FinCEN Guidance

By Patrick Murck
Bitcoin Foundation
Tuesday, March 19, 2013

FinCEN shook us all from our Monday afternoon stupor by dropping some provocative “guidance” for those involved in the business and use of digital currencies and, in particular those of us involved with the grand experiment that is Bitcoin.

You can and should read what FinCEN had to say for yourself here.

Upon an initial reading two things struck me:
  1. FinCEN firmly believes that virtual currency in general, and bitcoin in particular, does not fall under the prepaid access rules.
  2. FinCEN seems intent on recreating and expanding the prepaid access rules for virtual currency and bitcoin under the mantle of money transmission.
I was happy to see FinCEN issue some clarity around the overly-broad prepaid access rules and definitively state that they do not apply in the context of bitcoin. This is quite interesting because in my conversations with seasoned payments and digital currency lawyers, prepaid access seemed to be the most likely trigger for FinCEN regulation – closely followed, of course, by money transmission.

That’s about where my happiness ended as the clear guidance quickly devolved into something a little less comprehensible.

In particular, I’m a little disheartened that FinCEN appears to be creating an entirely new regulatory scheme under the guise of “guidance.” Of course, FinCEN cannot rely on this guidance in any enforcement action, as they must readily acknowledge. Simply put, under the Administrative Procedures Act (APA), FinCEN can’t promulgate new rules without going through a notice and comment proceeding whereby the public may have their voices heard. If FinCEN would like to expand its statutory authority over “money transmitters” to include brand new categories such as “administrators” and “exchangers” of digital currency it must do so through proper rule making proceedings and not by fiat. I welcome that conversation.

State Money Transmitter Issues

It should also be noted at the outset, in case there is any confusion, that FinCEN’s rule-making and interpretations have no practical effect on State money transmitter laws (although FinCEN or Congress may preempt such State laws in the future). State MTB laws and enforcement is something that should be discussed, and to some degree worried about, but it’s a separate issue.

FinCEN Overreaches

Read closely FinCEN’s guidance implies that every person who has ever had any virtual currency and has ever exchanged that virtual currency for real currency may now be considered a money transmitter under the Bank Secrecy Act. That is, of course, an untenable position.

FinCEN starts going off the tracks early on, as they carefully define a “User” (not subject to MSB registration) as “a person that obtains virtual currency to purchase goods or services” as opposed to an “Exchanger” who is “a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.” Left unsaid are any specifics around the facts and circumstances that would constitute “engaging as a business.”

What is crystal-clear is that once a person sells a single Satoshi for real currency that person is no longer a “User” and therefore not categorically exempted from MSB registration.

Later in the document as FinCEN turns its attention to discussing decentralized virtual currencies we get the money paragraph.

In a bizarre shot across the bow at miners, FinCEN states unequivocally that “a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter.”

And then, for good measure, FinCEN completely muddies the waters by stating: “In addition, a person is an exchanger and a money transmitter if the person accepts such decentralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.”

FinCEN’s position as it relates to bitcoin can be summed up as follows:
  1. A person may spend money to purchase bitcoin or mine bitcoin and then exchange the currency for goods and/or services without having to register with FinCEN as an MSB.
  2. If a person receives real money in exchange for their bitcoin they MAY have to register with FinCEN.
  3. If a miner exchanges their mined bitcoin for real money they MUST register with FinCEN.
  4. Anyone transacting bitcoin on someone else’s behalf MUST register with FinCEN.
This framework would wildly expand the reach of FinCEN and the BSA, and would be infeasible for many, if not most, members of the bitcoin community to comply with. An individual or micro-business cannot be expected to create a robust AML/KYC program anytime they sell 1 or 100 bitcoin on an exchange or in-person. The BSA was never intended to apply this broadly and reach this far into people’s everyday lives. Perhaps a little more guidance is needed.

Patrick Murck is general counsel at the Bitcoin Foundation. Reprinted with permission.

For further reading:
"The War On Bitcoin—and Anonymity", Eli Dourado, March 20, 2013
"FinCEN sounds death knell for US based Bitcoin businesses", Irdial, March 19, 2013

Wednesday, March 27, 2013

Is Institutional Money Coming Into Bitcoin?

By Jon Matonis
Bitcoin Foundation
Tuesday, March 26, 2013

This month saw two important developments on the road to a mature and robust bitcoin economy.

First, there was the joint CoinLab and Mt. Gox announcement involving Silicon Valley Bank that I wrote about here. While the North American accounts represent a huge amount of trading volume and a large percentage of Mt. Gox’s book, the more interesting aspect was CoinLab’s intention to provide investment channels for long-term bitcoin investors similar to the various gold and silver investment vehicles. Bitcoin is increasingly becoming a favorable asset class and structuring vehicles for institutional participation is a good thing, because it broadens bitcoin’s base and expands the network effect.

Also, on March 8th, the first bitcoin hedge fund formally launched, administered by Exante, Ltd. headquartered in Malta. With 80,000 BTC currently under management, their fund holds control to approximately .73% of all bitcoin in existence today. The fund has a sophisticated security strategy and the threat model addresses most of an institution’s concerns including data loss risk, hardware failure risk, jurisdictional risk, external hacker risk, dishonest employee risk, and employee death or disability risk. Using Shamir’s Secret Sharing algorithm, the container password is then split into three parts utilizing a 2-of-3 secret sharing model spread across multiple jurisdictions.

Individuals may ask why they need a professional fund with fees to manage what they can do on their own for free. And while this may be correct for knowledgeable and careful individuals, it is negligent for a company or an institution. Any institution investing on behalf of its customers has a fiduciary duty to protect those assets from theft, data loss, and jurisdictional risk. Additionally, a succession plan must be in place that anticipates reliance on multiple parties and the distribution of that reliance.

I would even say that it is negligent also for individuals not to have a shared secret and backup plan, because being a single-owner BTC holder is akin to burying gold bullion in the wilderness and not telling anyone. It may even be worse than that because someone from the future would at least have the random hope of finding the gold.

Professional funds for bitcoin investment can also provide an element of active management which would include the responsible use of leverage and risk control strategies that lock in gains through the use of proprietary derivatives and market timing. Also, the launch of a registered bitcoin ETF (Exchange-Traded Fund) in the United States is not that unrealistic.

These early stages of bitcoin in the ‘store of value’ role are precursors to a more advanced futures and options market. As more and more merchants decide to maintain and spend bitcoin balances rather than instantaneously converting out into national currencies, the derivatives and risk management tools will play a vital role. Just as commercial gold mining companies hedge their future production to protect against volatile price declines, bitcoin operators will be able to hedge bitcoins on their balance sheet without liquidating the underlying asset.

If bitcoin is digital gold, then gold is analog bitcoin. This is not just Wall Street titans getting involved and ruining Bitcoin as some have claimed. It is a necessary prerequisite for Bitcoin’s evolving role in global trade.

Tuesday, March 26, 2013

FinCEN Spying Plan Invites Privacy Workarounds

By Jon Matonis
American Banker
Thursday, March 21, 2013

The dangers to financial privacy are monumental. Consider an Obama administration plan to give spy agencies unfettered access to data on American citizens and others who bank in the U.S.

Suspicious Activity Reports, filed by financial institutions that operate in the U.S., are the primary documents that the Financial Crimes Enforcement Network intends to share. The reports cover all personal cash transactions exceeding $10,000, suspected incidents of money laundering, loan fraud, computer hacking and counterfeiting.

The Treasury Department proposal, revealed by Reuters last week, aims to consolidate financial data banks, criminal records and military intelligence. This initiative will put intelligence agencies, such as the Central Intelligence Agency and the National Security Agency, on the same footing as the Federal Bureau of Investigation, which currently does not have to make case-by-case informational requests to Fincen.

Also under the new proposal, Fincen's database would be linked to the Joint Worldwide Intelligence Communications System, which U.S. defense and law enforcement agencies use to share classified information.

Money was never meant to be a method of supranational identity tracking. Its use in that way could signal some level of law enforcement desperation. When all other enforcement tactics fail, surveil the finances.

More than 25,000 financial firms, including banks, securities dealers, casinos, and money transfer agencies, routinely file "suspicious activity reports" to Fincen, according to the Reuters article. Banks and other firms tend to over-report some financial details of ordinary citizens since the requirements for filing are so strict they don't want to be accused of failing to disclose activity that later proves questionable.

Increasing encroachment against financial privacy like this Fincen move "raises concerns as to whether people could find their information in a file as a potential terrorist suspect without having the appropriate predicate for that and find themselves potentially falsely accused," Sharon Bradford Franklin, senior counsel for the Rule of Law Program at the Constitution Project, told Reuters.

One protection from becoming scooped up in a fishing expedition and being falsely accused is the use of virtual or alternative currencies. But this week, Fincen issued guidance on virtual currencies and regulatory responsibilities.

Clarifying circumstances where the "money transmitter" definition applies under the law, Fincen classified de-centralized virtual currency as a convertible virtual currency that has no central repository and no single administrator, and that persons may obtain by their own computing or manufacturing effort. Although bitcoin was not singled out by name, the guidance appears directed at cryptocurrencies that operate in a peer-to-peer, distributed fashion such as Bitcoin.

The primary impact of the likely tighter compliance will be felt by the bitcoin-to-fiat exchanges operating in the U.S. and this will lead to jurisdictional competition, as seen in online casino gambling where the more entrepreneurial jurisdictions rose to dominance by embracing the technology early and not overregulating.

Almost serendipitously, discussions about adding privacy extensions to the Bitcoin cryptographic money protocol have been increasing lately.

Bitcoin is nonpolitical money and it falls outside the scope of reporting financial institutions. Since bitcoin does not provide user and transactional privacy by default, multiple bitcoin wallets and Tor, a client software and volunteer server network that enables online anonymity, can enhance privacy without modification to the core Bitcoin code. Nonetheless, code-modifying proposals for augmenting Bitcoin privacy have been introduced. One idea calls for automatic mixing techniques, which would periodically give all users the opportunity to shuffle coins among one another, making the money harder to trace without implicating individuals. Another concept is "coin control," a method for users to select which of their wallet’s multiple addresses to use as the "from address" (currently picked somewhat randomly by the client software).

Various proposals for improving bitcoin privacy include "Patching The Bitcoin Client" (2011), "Automatic Coin Mixing" (2012), "Coin Control" (2012), and "Yet Another Coin Control Release" (2013).

Also, a recent cryptographic bitcoin privacy extension submitted by researchers from The Johns Hopkins University was accepted for presentation to the IEEE Symposium on Security & Privacy in Oakland, Calif. The paper Zerocoin: Anonymous Distributed E-Cash from Bitcoin will be introduced on day two of the May conference.

Having received a preliminary copy of the academic paper, I interviewed Hopkins research professor Matthew Green about some of the details of Zerocoin.

Operating as a decentralized layer of anonymous cash on top of the existing Bitcoin network, "Zerocoin creates an 'escrow pool' of bitcoins, which users can contribute to and then later redeem from," Green explained. Users receive different coins than they put in (though the same amount) and there is no entity that can trace your transactions or steal your money. "Unlike previous e-cash schemes, this whole process requires no trusted party. As long as all the nodes in the network support the Zerocoin protocol, the system works in a fully distributed fashion," added Green.

Zerocoin developers are working on improved efficiency because implementation is impractical today given the space constraints of the “blocks” that make up the Bitcoin public ledger. "For one thing, the transactions are very large (40kb to spend a coin)," Green said. "While this isn't the end of the world – and bandwidth is always increasing – supporting these would put quite a strain on the block chain."

When I asked Green about the possibility of a "back door" for law enforcement that had been floated recently, he clarified, "The back door isn't part of Zerocoin. There's absolutely no need for it, and building one in would take significant additional effort. In fact, we only mentioned it as a brief note in the conclusion of our paper, mostly to motivate future research work."

If someone did try to build a back door for any reason, the open source Zerocoin would quickly become Zero-adoption.

Sunday, March 24, 2013

A Critique of Patrik Korda's 'Bitcoin Bubble 2.0'

By Peter Šurda
Economics of Bitcoin
Wednesday, March 6, 2013

Patrik Korda recently published a critique of Bitcoin: I get agitated when I disagree with others, so I wrote a rebuttal.

Competition under the network effect

Korda's first argument is that because it is easy to create a new cryptocurency, they will compete each other out of the market, kinda "race to the bottom", ending up with a hyperinflation and a collapse. However, he does not seem to understand the network effect, one of the most important aspects of money. The network effect both allows that money actually exists in the first place, as well as creates switching costs. As JP Koning said, "liquidity is sticky".

The problem with Korda's argument becomes more apparent because he himself shows a counterexample. He quotes Mises in explaining that silver has been replaced by gold and this demonetised silver. This explains how competition works under the presence of a strong network effect: the expected long term state is where a small number (maybe even one) media of exchange are the dominant ones, and other market players are far less liquid. For the same reason, a situation where there is a large number of competing cryptocurrencies without clear dominant players is not a stable state, rather a small number of dominant players will emerge.

The network effect is recognisable in particular with immaterial goods: there are a small dominant number of general purpose operating systems (Windows, iOS, Linux), a small dominant number of languages (Mandarin and English dominate, then Spanish and Hindi follow after a gap, and those four account for about half of the world population (I'm approximating, as people can speak more than one language)), there is only one dominant general purpose communication protocol (what we commonly call "the internet"), and so on. Surely, the composition of the dominant players can change, but it is a relatively slow process that does not magically happen overnight. Surely, there are a myriad of minor players, but there always tend to be a low number of dominant players.

If I said that everyone can create their own language, therefore without barriers to entry, everyone would end up with their own language and the ability to communicate would collapse, you'd surely think that I'm a moron.

Another important factor related to the network effect is path dependence. This means that the order in which choices are made influences the end result. This can mean, for example, the first mover advantage. Bitcoin is the first practically usable cryptocurrency, so it has a head start against others. And surely, JP Koning has a useful infographic showing that the market capitalisation of Bitcoin, the first mover, far outstrips the market capitalisation of others (by a factor of 100, at the time of making the graphic). This is also consistent with my claim from above that there typically is a small number of dominant players. Even though there is government interference in the choice of media of exchange (what we call fiat monies), international trade is affected significantly less than national, and we still have a small amount of major players (the USD and Euro).

I'm not arguing here that Bitcoin can't be replaced by something else, but that the scenario described by Korda makes no sense.


Korda makes the argument that Bitcoin is only usable with electricity and smart phone, but this is incorrect. Bitcoin is the first form-invariant medium of exchange, and can be used in almost any imaginable form, without having to rely on a middleman. Something like this never existed before in the history. People that criticise Bitcoin from this point of view tend to confuse implementation with the fundamentals.

Mises' Regression theorem

Korda, unfortunately, missed the core point of Graf's article. Even if there appears to be a wide disagreement on what the regression theorem actually says, we can be pretty sure about what it doesn't say. It doesn't say what happens to a medium of exchange after it becomes medium of exchange (and Robert Murphy concurs). It only talks about what happens before it becomes a medium of exchange. It does not say what happens between a medium of exchange becoming a medium of exchange and it becoming money, and it does not say what happens after it becomes money. It also does not talk about the scope of usage as a medium of exchange, how many people use it for something else than a medium of exchange, which media of exchange are sustainable, or any such invention that is frequently ascribed to it in particular by critics of Bitcoin. So unless Korda decides to mimick Smiling Dave and claim that Bitcoin is not a medium of exchange (and neither are gold, blue chip stocks or US bonds), the objection with respect to regression theorem is methodologically flawed.

Can Bitcoin become money?

Similarly as in the section about the regression theorem, Korda conflates medium of exchange (whatever is used in indirect exchange) and money (the most liquid good, and thus by implication, the most liquid medium of exchange). I consider the question of Bitcoin becoming money irrelevant for the near future. I have the same opinion as Vijay Boyapati, I think that if Bitcoin becomes money, that would be an unprecedented success. It would be the end of fiat money, and possibly also the state. But the implied criticism of Korda is a false dichotomy: either Bitcoin is money, or it's useless. I dub this fallacy money or nothing (and chicks for free). Contrary to this dichotomy, there is a wide range on the liquidity scale which is called "secondary media of exchange" (Mises) or "quasi monies" (Rothbard), that do provide, through liquidity, useful services. Bitcoin's further advantage is the decrease of transaction costs, which can be practically utilised as long as some level of liquidity persists. It already can be utilised now. There already are plenty of situations where the switch to Bitcoin improves utility. The criticism is like saying that unless everyone learns English, it makes no sense to learn it. Or even better, that it makes no sense to get an email address unless everyone uses email already.

Classification according to ToMC

As I wrote in my thesis, as Bitcoin is not money (yet), merely a medium of exchange, it is impossible to use the classification system of Mises to classify Bitcoin. If it becomes money, then we would have a classification problem. How to solve it I leave open in this post, as I consider it merely a theoretical question with no practical relevance. In my thesis I present options for solving it.

Now, Korda claims that Bitcoin is token money. However, going upwards from the bottom of the graphic in Mises' ToMC Appendix B, Bitcoins are not token money, because they are not fiduciary media, because they are not money substitutes. The Austrians use two definitions of money substitutes (I explain the difference between the two in my thesis):
  • absolutely secure and immediately payable claims to money (in the narrower sense)
  • things that act as full substitutes to money (in the narrower sense) from economic point of view
Irrespective of which of these definitions is correct, Bitcoins, clearly, are neither, as there is no underlying "money in the narrower sense". So the attempt of Korda to provide a classification of Bitcoin failed.


This is a complicated question, I just want to dissolve some unclarities. While some information about Bitcoin transactions is recorded in the blockchain, and publicly available, this information does not include any references to the identity of the parties involved in the transaction. While a vector analysis can reveal some relationships hidden upon first look, there are on the other hand many other things that can be done to obfuscate this. Examples are mixers (either explicit ones or ones that can do that function indirectly, e.g. Satoshi Dice), and some features that have not been fully implemented yet, e.g. transaction rewriting, or proposals for new opcodes.

From economic point of view, the "perfectness" of Bitcoin's anonymity is not the relevant question. The relevant question is whether this is significantly (from the point of view of users) better than the alternatives, and if it presents a significant cost increase for the attacker (e.g. the state). I'll leave this one open too, I'll just add that for transactions that do not involve a physical meeting of the trading parties, anything else than cryptocurrencies is highly unlikely to provide a comparative advantage over Bitcoin from the perspective of anonymity.


Korda seems to think that the question of the Bitcoin price being a bubble is important. I on the other hand consider it completely irrelevant. The relevant question is if Bitcoin decreases transaction costs, and the answer is that it does. Whether the price changes are a bubble or not does not change the answer to the question whether it has a comparative advantage against other media of exchange. The price is irrelevant (thanks for the slogan, Tony). Emphasising the bubble is kind of like saying that when the dot com bubble burst, this must mean that the internet is unsustainable and must collapse.

Almost all critiques of Bitcoin entirely ignore transaction costs. It's like arguing that there's no point in internet if we already have the library, the post office and the TV. According to the logic of these critiques, the businesses will decide to forego a highly profitable opportunity of providing services that increase the efficiency of social interaction and their potential customers are going to forego a reduction of costs of these interactions. Instead, the arbitrary judgement of these critics concludes that the target market is somewhere entirely elsewhere (in barter in a village, for example), and at the same time that arbitrary target market is not a good match for Bitcoin. It baffles me all the time. But I hear it all the time too. People have fixed ideas about what they think money should do, and when Bitcoin doesn't fit into that scope, they don't understand it. It is difficult to recognise a paradigm shift while it's happening, but it is always obvious after it already has taken place. I guess some people just have to endure having their brains in an ignorant state while the market structure changes around them and those with more foresight are able to increase the efficiency of their business operations (and increase their profit).

My recommendation for serious economic analysis of Bitcoin is to ignore the price as much as possible, as long as there is one (i.e. the price is higher than zero). It's simply not relevant.


Regrettably, Korda's criticism contains many flaws. Hopefully I manged to address them. My most important argument is that one should be careful to avoid mixing theoretical and empirical issues. To summarise my counterarguments:
  • Due to network effect, the market structure will move towards a small number of dominant cryptocurrencies, so there's no hyperinflation
  • Whether Bitcoin can become money is not important, as using it is already advantageous now, as a medium of exchange. If it ever becomes money, that would really rock though.
  • Non-economists do not understand the regression theorem and invent their own versions of it which are nonsensical
  • Bitcoin is not token money as it never was a money substitute
  • Bitcoin is pseudonymous, and has a comparative advantage against competitors from this point of view
  • The price of Bitcoin is irrelevant
Reprinted with permission.

Read part 2 of the critique: "The classification and the future of Bitcoin"
Read part 3 of the critique: "Is Bitcoin a money substitute?"
Read part 4 of the critique: "Response to Korda's article"

Friday, March 22, 2013

How Cryptocurrencies Could Upend Banks' Monetary Role

By Jon Matonis
American Banker
Friday, March 15, 2013

Peter Šurda
I recently had a fascinating chat with the economist Peter Šurda to discuss how nonpolitical cryptocurrencies like bitcoin could alter the future of fractional reserve banking.

Peter is also a software developer experienced in the online payments industry and will present at the Bitcoin 2013: The Future of Payments conference in San Jose in May. His 2012 master's thesis at Vienna University of Economics and Business was entitled Economics of Bitcoin: Is Bitcoin an Alternative to Fiat Currencies and Gold? He's an abstract thinker, but the implications of his work are tantalizing: that digital money like Bitcoin opens up possibilities for banking without central planners or a lender of last resort, where interest rates and reserve requirements are driven purely by the market.

The debate between the full reserve bankers and the fractional reserve bankers is an old one and it has been explored in depth by the Austrian school of economics. More recently, the debate has been broadened to include the dynamics of introducing the bitcoin cryptocurrency, which is the functional equivalent of digital gold, since its supply is predictable and fixed. (There are currently 10.9 million bitcoins in circulation with a total fixed supply of 21 million expected to be mined before 2140, 99% of them by the year 2032.) The Austrian school economist Michael Suede and the technologist Eli Gothill have speculated that fractional reserve banking can indeed appear within a bitcoin monetary environment. This is where we join up with Peter.

JON MATONIS: I enjoyed your blog post, "Market Forces and Fractional Reserve Banking." Do you consider fractional reserve banking to be compatible with Austrian economics?

PETER ŠURDA: First of all, I would like to separate fractional reserve banking and credit expansion. On one hand, there are ways of increasing the money supply, in the broader sense, which do not require fractional reserve banking or changes in the monetary base such as a system based on the principle of mutual credit like LETS [local exchange trading systems], or a fiat currency that uses bitcoin as reserves (i.e. they are not claims in the sense that Ludwig von Mises uses them, but they act as full substitutes). From the opposite direction, fractional reserve banking does not necessarily lead to credit expansion.

I agree with the full reservists that credit expansion has the effects described by the Austrian Business Cycle Theory. However, I agree with the free bankers that fractional reserve banking is not necessarily a violation of property rights and other ways of increasing the money supply also are not necessarily a violation of property rights.

So I think that the economic and legal analysis are two separate issues and need to be addressed separately. I avoided the legal analysis in my thesis and concentrated on Austrian Business Cycle Theory and policy issues, but in an earlier draft I have several pages about legal aspects too, and I discussed the topic with [the legal theorist] Stephan Kinsella.

JON MATONIS: How does a nonpolitical cryptocurrency like bitcoin alter the landscape in the "full reserve" versus "fractional reserve" banking debate?

PETER ŠURDA: Austrians have made arguments in the past that lead to the conclusion that fractional reserve banking does not necessarily lead to credit expansion, even though they never explicitly formulated it this way and might not have realized the connection. The reason is that if credit instruments do not decrease transaction costs over the monetary base, they are unlikely to act as a part of the money supply. Bitcoin shows that this is not only a hypothetical but empirically possible to implement. With Bitcoin, it is much less likely that credit expansion will occur.

In other words, we need to separate two things. Why do people want to hold fractional reserve banking instruments, which may include the interest payments as one of the reasons, and why do people want to use fractional reserve banking instruments as a medium of exchange which, I argue, requires that the fractional reserve banking instruments decrease transaction costs. That they historically manifested themselves through a common instrument is an empirical quirk and not an economic rule. The ability to loan money is beneficial. Contrary to many Austrians, I agree that maturity transformation can be beneficial, and if the loan ends up being a liquid instrument, it also can be beneficial. But if it is so liquid that it becomes a part of the money supply, that's when it has a detrimental effect on the economy.

For full reservists, Bitcoin shows that the question of fractional reserve banking is less important than they thought. Fractional reservists, on the other hand, need to think about the nature of the mechanisms equilibrating the money supply. I tried to explain the issue to [the economists] George Selgin and David Glasner in comments on their websites, but I wasn't successful in getting my point through.

JON MATONIS: If bitcoin is digital gold, does that portend a future where a bitcoin standard (akin to the gold standard) can emerge or partial bitcoin backing for other currencies?

PETER ŠURDA: They probably can emerge, but the more important question is whether they would be preferred to bitcoin. Only something that provides a significant improvement would be preferred. I only know two potential candidates for that: Ripple and OpenTransactions.

JON MATONIS: In a bitcoin world, is fractional reserve banking only possible with offline substitutes (such as physical coins or cards, which can be traded hand-to-hand, containing the private key to a bitcoin address) or an intentional "fork" in the block chain ledger?

PETER ŠURDA: Hypothetically, the reserves can be offline and the substitute can be a clearing system like Ripple, so there are other possibilities too. But if I understand your point correctly, offline "substitutes" might have a higher chance of actually becoming full substitutes because they might have more obvious advantages.

JON MATONIS: As the recent block chain fork episode demonstrates, there is a need for offline bitcoin transactions to continue. Is this demand sufficient for a money substitute to evolve, such as offline substitutes with full or partial bitcoin backing?

PETER ŠURDA: This is primarily an empirical question, so we can't be completely sure about that. I think the probability for this is significantly lower than with the currencies that we've known historically. The end result is also path-dependent; for instance, it depends on how quickly bitcoin matures and/or adapts to changes compared to the potential substitute.

Fractional reserve banking does not come into existence magically. It must follow economic rules. With gold and similar commodities, fractional reserve banking comes into existence for these reasons: On the demand side, there is a demand for money substitutes, because they provide something that money proper does not; and on the supply side, money substitutes carry maintenance costs for the issuer (e.g. storage of gold) and these need to be offset somehow. The issuer can charge on holding (e.g. demurrage of bank notes), transacting (e.g. check clearing), or, obviously, externalize the costs through fractional reserves. From the point of view of an individual user, fractional reserve banking appears to be the least costly alternative. So obviously fractional reserve banking wins.

Putting it together: If there is a general demand for money substitutes, this leads to fractional reserve banking. Unless it's illegal. Then it might not. Solution: Have money which does not lead to the creation of money substitutes. Bitcoin shows that at least hypothetically, this is possible. I might even go a bit further and make this statement: If on a free market money substitutes do not develop even though there is no legal or technical obstacle for them, it means that the choice of money is Pareto-optimal since no change in the monetary system leads to an increase in utility.

JON MATONIS: Does a demand for positive return on bitcoin balances lead to an environment of competitive bank lending with risk-adjusted interest rates? And will this lead to an environment of fractional reserve banking with depositors offered higher interest rates in exchange for the additional risk premium of running a fractional portfolio?

PETER ŠURDA: Yes, I would say it does, but until there are industry niches that primarily use bitcoin, it is probably not much different from gambling.

This might lead to negotiable credit instruments with maturity-mismatching or maturity transformation, depending on which economic school you use for terminology. However, I don't think this feature alone is sufficient for these instruments to be accepted as full substitutes whereas George Selgin appears to think it is. Now, whether to call such a situation "fractional reserve banking" even though no credit expansion occurs is unclear. I lean towards yes, but there could be other interpretations.

JON MATONIS: How do you see bitcoin changing interest rate structures and lending practices?

PETER ŠURDA: Using Bitcoin for loans only makes sense for those businesses that use bitcoin as a unit of account, unless, of course, you're just speculating on the market but don't actually sell any goods or services. I think this will only occur at much higher levels of liquidity or until we can be quite sure that it deserves the label "money." Until these higher levels of liquidity are reached, the price of bitcoin will probably be quite volatile, which reduces the likelihood that people use it as a unit of account.

However, there could be niche market segments that use bitcoin as a primary medium of exchange and [bitcoin] mining is the most obvious candidate. For these, the unit of account function would make sense even if the global market penetration is lower.

Assuming one of these thresholds is crossed and the money supply remains inelastic (i.e. no significant credit expansion), the interest rate of bitcoin should be a good reflection of the time preference of those market participants that use it as a unit of account. Bitcoin also makes it much easier for lending to occur in a decentralized manner, I think. Rather than a small number of "too big to fail" institutions, we should see smaller specialized teams that act as facilitators without owning the liabilities or being liable themselves.

JON MATONIS: Can a free market fractional reserve system (as opposed to a central banking fractional reserve system) coexist with full reserve banking? Or will one drive out the other?

PETER ŠURDA: I think that if money substitutes emerge, fractional reserve banking will out-compete 100% reserve banking in the market. I deal with this a bit in an earlier draft of the thesis. If they don't emerge, on the other hand, we'll have a money supply equivalent to the monetary base and debt will not cause changes in the money supply. It would be viewed as merely highly liquid credit. I don't think they can coexist for a long time assuming the same underlying money in the narrower sense, of course.

Tuesday, March 19, 2013

WinPoker Becomes First Major Gambling Operator To Adopt Bitcoin

By Jon Matonis
Wednesday, March 13, 2013

WinPoker in Curaçao announced that it will now begin accepting bitcoin as a deposit and withdrawal method to their WinPoker accounts which are on the iPoker network.

Consisting of over 30 different brands, including large European bookmakers like Paddy Power, Bet365, Betfair and William Hill, iPoker is the largest network of online poker rooms operating internationally. According to Pokerfuse, iPoker sits behind only the independent rooms PokerStars, Full Tilt Poker and PartyPoker in terms of cash game action.

The attraction of bitcoin to the online gaming community is obvious. Funds clearance is near immediate and the transactions are irreversible. Payment processing fees are a fraction of what they are compared to other payment methods.

James Lewis, Head of Poker Games for WinPoker, says, “We can take very small or very large deposits quickly, with little or no risk of fraud. As a result, players can access our games from areas of poor financial infrastructure, or can play exciting high stakes games quickly without waiting for a bank wire transfer to be processed.”

WinPoker has structured the process so that players choosing to utilize the bitcoin payment method do not also assume currency risk along with the inherent risk of casino gambling. Therefore, all bitcoin deposits convert into the user’s account currency (USD, EUR, or GBP) at the current market rate without currency conversion fees and then funds are credited to the player account within minutes. When processing a withdrawal, funds are converted back into bitcoin is credited to players’ bitcoin e‐wallets. No currency conversion fees are charged at any point in the process.

Although bitcoin has optional anonymity properties that would protect the identity and country of the player, those properties are not leveraged by WinPoker. As a licensed and regulated gaming operator, WinPoker must adhere to the regulations of the jurisdiction that they operate within. Lucas explains:
"Due to regulatory requirements, and to prevent fraud, collusion, money laundering, and ensure a safe and honest gaming environment for our players, we are required to adhere to strict KYC and AML policy. Players are required to produce documents to verify their identity, address, and source of funds where relevant, before they are able to withdraw any funds."
Of course player identification would be required when a real-money, licensed casino mingles bitcoin with other online payment methods that include legal tender.

The jurisdiction-less SealsWithClubs, which competes in the poker space as a bitcoin-only site, is not concerned about the news from WinPoker. “The bitcoin poker space will explode in 2013, so it’s something that is totally expected when I see other online poker rooms and casinos transitioning to bitcoin,” says Bryan Micon of SealsWithClubs.

Micon adds, “In this particular case, it doesn’t excite me all that much because first off no U.S. players are allowed and secondly WinPoker is only using bitcoin as a deposit option, not as a currency to gamble for.” When bitcoin is the currency of record and unit of account for gaming, it is less likely that funds could be frozen or confiscated through the actions of one of the casino operator’s bank accounts.

Another significant but less noticed advantage of using bitcoin ‘tokens’ directly as the gaming unit is that before a game can be declared gambling for regulatory purposes, there has to be real money involved. In the case of bitcoin, a strong case can be made that, even with secondary markets, certain virtual currencies lack the legal elements of material value and property.

When I asked Micon about future regulation of his play money bitcoin poker room, he said “I’m confident there will be other U.S.-facing, bitcoin-accepting poker sites in the near future and SealsWithClubs is growing extremely fast. As for licensing and regulation, it is something we are always exploring.”

Friday, March 15, 2013

First Bitcoin Hedge Fund Launches From Malta

By Jon Matonis
Friday, March 8, 2013

Ever since the bitcoin cryptocurrency first launched and achieved initial success, institutional investors and hedge fund managers have secretly sought a regulated investment vehicle for bitcoin placements. Malta-based Exante Ltd. has the solution with their new Bitcoin Fund.

"I hope our fund will be the first hedge fund to take advantage of using bitcoins," explains Managing Partner Anatoliy Knyazev. Exante actually announced the fund in October last year, but they did not make a serious effort to market it. Now, with more institutional interest emerging, they agreed to provide this update to Forbes.

Although any person or entity can acquire and store bitcoins on their own, institutional investors are typically restricted in the types of assets available within their investment charter. Similar to a mutual fund or hedge fund for alternative assets, Exante’s Bitcoin Fund permits institutions and high-net worth individuals to access the vibrant bitcoin market with a licensed product and this alone is an innovative development.

The fund shares are distributed exclusively through the Exante Hedge Fund Marketplace platform. Authorized and regulated by the Malta Financial Services Authority, Exante offers the Bitcoin Fund with an initial minimum subscription of $100,000 and a 0.5% upfront subscription fee.

However, U.S. persons and U.S. institutions will not be able to access the fund directly, because according to the Fund Disclaimer, “U.S. Persons may not subscribe either directly or indirectly for shares.”

Knyazev told Forbes that “the U.S. jurisdiction is tricky.” This is mostly due to the securities registration that the company is currently not prepared to complete and more recently the FATCA reporting implications for foreign financial institutions. “Typically, a feeder fund is established in the U.S. (commonly Delaware) to facilitate the investments. We are in the process of estimating our costs on creating one,” added Knyazev.

Founded in March 2011, the 60-person Exante team operates from offices in Malta, Singapore, and Russia. The Bitcoin sub-fund was incorporated as a Bermuda exempted company and is registered as a segregated account company receiving funds at Citibank London. From the Bitcoin Fund’s web site:
"We are the first fund that invests in core-level infrastructure of the new generation economy. We invest into Bitcoins. In 2011 internet transactions volume exceeded $500 billion. We believe that to win you have to be at the cutting edge. Bitcoin, based both on common and new technologies, is a perfect extension to traditional currency."
Current assets under management in the Bitcoin Fund are $3.2 million (2.5€ million) and there is no performance-based fee. However, the fund charges an annual management fee o.5% of Net Share Value payable monthly in order to provide the sophisticated security and wallet management that one would expect with such large amounts at stake.

The threat modelling approach addresses data loss risk, hardware failure risk, jurisdictional risk, external hacker risk, dishonest employee risk, and employee death or disability risk.

The private key itself is AES-256 encrypted. After exporting Bitcoin private keys from wallet.dat file, data is stored in a TrueCrypt container on three separate flash drives. Using Shamir’s Secret Sharing algorithm, the container password is then split into three parts utilizing a 2-of-3 secret sharing model. Incorporating physical security with electronic security, each flash drive from various manufacturers is duplicated several times and, together with a CD-ROM, those items are vaulted in a bank safety deposit box in three different legal jurisdictions. To leverage geographic distribution as well, each bank stores only part of a key, so if a single deposit box is compromised, no funds are lost.

As the fund does not employ leverage or derivatives for risk management, Exante intends to provide a two-way secondary market for the trading of fund shares. Similar to a contract for difference (CFD), this would allow existing Exante customers to trade in and out for Bitcoin Fund shares without going through the subscription or redemption process. It would also provide shorting opportunities without having to own the underlying asset. Customers will be vetted according to the regular Exante capitalization requirements and margin funds would be provided through institutional broker financing at a fixed % over LIBOR.

Thursday, March 14, 2013

A New Challenger in the Bitcoin Merchant Processing Race

By Jon Matonis
Friday, March 8, 2013

The large payment brands fiddle while Rome burns, seemingly unaware of the approaching bitcoin onslaught that is free of processing fees and political boundaries.

One of those barbarians at the gate, formerly known as WalletBit, has broadened its functionality and cut its pricing to expand directly into merchant processing. The company, based in Denmark, has rebranded itself Bitcoin Internet Payment System, or BIPS.

Best of all is that BIPS’ merchant tools and digital wallet services will be free unless, of course, conversion to national currencies is required, in which case it will charge 2.5% to convert out of bitcoin. Denmark and Canada have special reduced cash-out rates with same-day interbank transfers for Canadian accounts, says BIPS Director of Marketing Adam Harding. The strategy is to make it easy for merchants to get started and then aggregate their bitcoin balances with the company, which will make money over time providing foreign exchange conversion and premium services to the client.

This approach directly challenges the leading bitcoin merchant processor, BitPay, which just received yet another follow-on round of funding, and U.S.-only Coinbase, which appears to have a good future on the merchant side of the business.

Bitcoin's appeal to merchants is not only the lack of chargebacks and interchange fees but also the broadening of the customer base to include consumers from about 60 countries not served by PayPal. Also, traditional credit card products are typically not available in many countries either for political reasons, higher fraud rates, or lack of retail credit infrastructure.

The business model for bitcoin merchant processing was bound to mature and evolve, because an intermediary processor is not inherently required in this alternative payment system. In the world of Visa and MasterCard, it makes sense to have someone process transactions because authorization and settlement services are needed. But with bitcoin, the pure merchant processors are an interim step at best since third-party authorizations and chargebacks are not part of the architecture due to the distributed nature of transaction confirmation on the bitcoin block chain.

What's important to merchants is the coin management with various mobile apps and shopping cart plug-ins as well as the optional foreign exchange conversion. This is where the industry is headed and BIPS realizes that.
Merchant plug-ins are becoming commoditized and foreign exchange options are driven by strong partnerships with domestic and international financial institutions. This leaves the wallet technology as the wedge for innovative differences, such as management reporting capabilities and online secure access. All of the current so-called merchant processors offer online wallets that are under the control of the operator, meaning that bitcoin private keys are stored and protected by the operating company.

Smartly deploying two-factor authentication for wallet account access with a one-time passcode technique, BIPS (the former WalletBit) uses Secure Card and Google Authenticator, BitPay uses Google Authenticator, and Coinbase uses Authy.

I believe that online wallets, or eWallets, that do not store the client’s private key, such as BlockChain's My Wallet and StrongCoin, have an advantage in the long term because this setup removes the need to trust and audit the company's procedures. Although performing the cryptographic operations in the browser has its own challenges, the risks are reduced substantially compared to a localized breach since the threats to non-private-key-holding wallets are limited to a man-in-the-middle attack or a court order demanding “rogue” javascript delivery (the browser equivalent of a wiretap).

As bitcoin wallet functionality becomes more mature and robust, merchants will simply elect to partner with the best standalone client wallets and the best eWallets. If and when those accumulated bitcoin balances need to be exchanged for national currencies, then the wallet providers with the most attractive conversion options and limits will be the leaders.

BIPS has an advantage here because it supports 42 different currencies for converting out of bitcoin at 2.5%, whereas BitPay supports 11 different currencies at 2% fee, and Coinbase offers cash-out only in U.S. dollars at 1% with strict limits. Additionally, the cost of conversion has to be looked at in conjunction with the merchant processing fees. On that score BIPS and Coinbase are free while BitPay charges 0.99%. So, for merchants choosing to store bitcoin with the processor rather than convert it to government currency, BIPS and Coinbase are zero charge. (For a merchant that takes in 10% or less of its monthly sales in bitcoin, storing it with the processor can be an inexpensive way to acquire the currency and have a market position.)

Looking towards the future, barriers to entry are very low for the bitcoin merchant processing business. The differentiators for success will be online wallet security configurations, foreign exchange conversion options, and merchant software tools – in that order. With the market spread regionally now, it's still a jump ball.

Friday, March 8, 2013

Bitcoin Exchange Deal Repatriates Assets To U.S.

By Jon Matonis
Saturday, March 2, 2013

Although the deal for Mt. Gox bitcoin exchange and CoinLab to partner on U.S. customer business was brokered by Seattle-based CoinLab, it would not have been possible without a solid and willing financial institution in the United States.

Innovative Silicon Valley Bank stepped up to the plate and agreed to facilitate the U.S. dollar financial flows for individuals and businesses managing trading accounts on bitcoin's largest floating-rate exchange. For better or worse, this launches the exchange directly into the world of the Department of the Treasury's Financial Crimes Enforcement Network (FinCEN) as SVB already adheres to those strict reporting requirements. "Like any new business we are looking at it very carefully and we are willing to entertain the idea while monitoring the industry closely," says Carrie Merritt, director of public relations at SVB.

Japan-based Mt. Gox sees about 80 percent of their traffic originating from North America. The new deal should vastly improve the speed of Mt. Gox account setup and funds clearing which improves overall liquidity. Additionally, with a bank in the U.S. providing smooth transfer of funds, it paves the way for hedge funds and other institutional investors to enter the market because investment charters can sometimes limit new placements to U.S. entities only.

Speaking to Forbes, CoinLab CEO Peter Vessenes explained that the exclusive 10-year deal will bring "a specialized user interface to the Mt. Gox platform and facilitate larger transaction sizes for better liquidity, maybe even adding forex trading APIs and FIX protocol support." Structurally, with CoinLab providing back-end clearing services and local customer support, Mt. Gox eliminates the need to open a U.S. subsidiary on their own which would have involved a significant investment in administrative overhead.

Despite the fact that foreign dollar deposits are already held at correspondent money center banks in New York, the centralized and unfettered enforcement access to customer data becomes the single greatest aspect of this new deal. The move to domicile in the U.S. may prove counterproductive if bitcoin trading volume is driven to smaller, less regulated offshore exchanges.

As nonpolitical cryptographic money, bitcoin is not recognized as legal tender in any jurisdiction so exchanges are technically not considered to be 'foreign currency dealers' nor is bitcoin officially recognized as a 'prepaid access' device. Nonetheless, CoinLab took the step last week of registering with FinCEN to become a Money Services Business (MSB) and their entity and registration number are available here. Since they are a self-declared seller of prepaid access (MSB code 413), they now must comply with a litany of Bank Secrecy Act requirements, including Suspicious Activity Reporting.

According to Vessenes, the arrangement involved several high-level discussions with Silicon Valley Bank on the legalities and merits of entering the bitcoin business. Asked if the federally-chartered, FDIC-insured banking partnership would mean fewer compliance responsibilities for CoinLab, Vessenes replied, "I wish. We will be increasing both compliance and customer support staff in the coming weeks." He added that, "CoinLab's new Anti-Money Laundering (AML) program and Know Your Customer (KYC) controls will be reviewed periodically by Silicon Valley Bank and certain employees will have to complete regular AML training."

Mt. Gox grew to its current size before the strict regulatory framework advanced around them and they genuinely seem like a reluctant participant in the strenuous and exhausting labyrinth of compliance measures. Although a more free market approach would have been to establish banking relationships in a variety of jurisdictions and challenge the perceived status of bitcoin trading as "currency trading," I don't get the sense that they intend to use the issue of regulation and a licensed U.S. bank as a tool for competitive advantage.

It's more likely that Mt. Gox's local banking partners did not want to be involved with such a large U.S. customer base requiring adherence to the U.S.-led  Foreign Account Tax Compliance Act (FATCA) monitoring and reporting regime. Japan has agreed to become FATCA compliant by 2014.

For the U.S. citizens that make up the majority of the exchange's customer base, FATCA ensures that it doesn't really matter where they maintain customer fund accounts, so for those customers the deal primarily improves transfer fees and clearing time for U.S. dollar funds. Mt. Gox's non-U.S. customers (except Canadians) are not affected by the change and they continue with procedures as before the announcement.

The transition of customer business from Mt. Gox to CoinLab involves three phases and yes it will include Canadian customers too.  Phase one is alpha with about 100 customers starting in a few days, phase two is beta with 5,000 customers on March 15th, and phase three is all accounts going live on March 29th. Account transitions are voluntary for customers, otherwise affected accounts will be closed. All trade matching will still occur on Mt. Gox systems.

Mark Karpeles is Managing Director at Mt. Gox, part of Tibanne Co. Ltd. (Japan), which is self-funded without venture capital. Peter Vessenes as CEO of CoinLab, Inc. previously took $500,000 in start-up funds to leverage bitcoin mining opportunities for gamers. Greg Becker is President and CEO at Silicon Valley Bank.

Monday, March 4, 2013

Tabletop Bitcoin ATM Is Huge for Payment Privacy

By Jon Matonis
American Banker
Wednesday, February 27, 2013

It looks like a high school science project, but this countertop machine may be a bulwark of financial privacy in the age of digital money.

Last weekend at the Free State Project's annual Liberty Forum in New Hampshire, entrepreneurs Zach Harvey and Matt Whitlock advanced the anonymous purchasing of bitcoin with their new Bitcoin ATM. The little machine, about 24"H x 12"W x 12"D, exchanged and dispensed over $5,500 worth of bitcoin in one weekend.

Similar to the way a vending machine operates, the orange prototype accepts cash bills and reads a QR code containing the depositor's Bitcoin address. After subtracting a 1% transaction fee, it delivers bitcoin to the address in about five seconds. The Bitcoin Machine can accommodate paper note denominations up to $100.

Previously, individuals who wanted to purchase bitcoin privately without revealing personal details had to arrange face-to-face meetings through; make use of bitcoin-otc, an online marketplace where participants take counterparty risk and rely on user reputations measured by an e-Bay-like ratings system; or make a cash deposit at a bank or retail location, under the watchful eye of security cameras.

Now, with a device that directly converts paper cash to bitcoin anonymously, the interaction is between human and machine. The value of that subtle difference should not be underestimated. No longer does the buyer of bitcoins have to show his or her face, or trust counterparties to make good on their end of a deal. Depending on how many bills each bitcoin ATM can hold and how much bitcoin it can digitally store, users can now enter the bitcoin blockchain in a very significant and private way.

The New Hampshire-based startup, Lamassu Bitcoin Ventures, hopes to commercialize the technology and get the countertop ATMs placed in restaurants, bars and other retail businesses. Harvey told CNET's Declan McCullagh. "If we made these machines somewhere around $1,000 to $1,500 each, depending on the commission, they could be able to buy [the machine] and make it back within a reasonable period of time."

This could prove to be very profitable for the establishments hosting the machines if their bitcoin inventory gains dollar value prior to sale. Additionally, Lamassu Bitcoin Ventures could be the exclusive provider of bitcoin for the ATMs or partner with an existing exchange to provide greater risk management.

Even people who have been in the Bitcoin world for a while and have used every type of exchange are blown away by the simplicity of this machine," Harvey said. "I'm just putting in a dollar. Before they really know what's going on, their phone tells them, 'You have Bitcoin.'"

Despite media reports claiming this to be the world's first Bitcoin ATM, that notable distinction belongs to Todd Bethall of, which dispenses plastic BitBills and sends bitcoin to a Bitcoin address.

Launched in 2011, Bethall's beta ATM comes equipped with a Genmega GK1000 Kiosk running Windows XP Pro with ActiveX drivers for the bill acceptor, printer and card reader. The California corporation that owns the original Bitcoin ATM was recently put up for for sale at the price of 1,500 bitcoin, but that was before bitcoin's recent price appreciation. At the current exchange levels, the asking price now works out to about $45,000.

Sunday, March 3, 2013

Expect Blowback if KYC Rules Are Expanded

By Jon Matonis
American Banker
Tuesday, February 26, 2013

The uncovering of an alleged $200 million credit card fraud scheme has triggered calls to expand know-your-customer rules. Those who prescribe ever-greater surveillance should be careful what they wish for.

In what was described as a sprawling criminal enterprise stretching across dozens of states and numerous countries, fabricated identities were used to obtain credit cards and doctor credit reports to borrow large amounts of money. At the heart of the alleged scheme were the merchant processor accounts used to accept and process the cards with stolen identities, authorities announced on Feb. 5. ATM withdrawals involve video surveillance and direct purchasing of merchandise doesn't yield cash. So the fraud ring allegedly used merchant accounts, mostly those of jewelry stores, since it is easier to obtain cash in a bank account using a fictitious sales transaction.

In some instances, sham companies were created and then those businesses established the direct relationship with the merchant processor and purchased the credit card terminals, the FBI said. Involving 25,000 fraudulent credit cards, 7,000 fake identities, and 1,800 "drop addresses," the conspirators allegedly wired millions overseas to Pakistan, India, the United Arab Emirates, Canada, Romania, China, and Japan.

For the duration of the probe, account information was known about the senders of international wire transfers, but not much was known about the recipients.

That is why experts are now pointing to this alleged scheme as justification for the expansion of Bank Secrecy Act and anti-money laundering regulations to include the identification and scrutiny of the recipients of funds associated with high-risk transactions.

Micah Willbrand, director of AML and compliance for LexisNexis' North American Financial Services Markets, told a trade publication, "Laws and regulations today only require that the bank have KYC [know your customer] in place for the sender, not the receiver of money."

"But card fraud schemes demonstrate why it's imperative to have KYC controls in place for both senders and recipients," he adds. As a result of the Foreign Account Tax Compliance Act, "all countries are realizing we need to know more about who's receiving the money. We need to be more transparent about how money is moving around the world, and that is something everyone is coming around to."

That is a very optimistic assumption, especially since considerable resistance already exists regarding global standardization of information-sharing. Ultimately, compliance would require a lot more legwork and due diligence on the part of banks, and financial institutions have been reluctant to move in this direction. If banks were required to replicate the current KYC controls for recipients as well as senders, the jurisdictional challenges would be complicated and expensive.

Willbrand justifies the investment cost in a subtle advertorial “article”: "The implementation of FATCA will guide financial institutions … globally by providing them with a reference on what verification is required of their customers and the level of due diligence required from them based on their asset transfers. FATCA will, therefore, enable FIs everywhere to create a standardised customer onboarding process that will clearly define risk tolerances and accepted practices for engaging with customers."

Expanding KYC guidelines to include the recipient of funds would require a massive uniform international process that is continually monitored and updated. Additionally, the cross-border sharing of customer information could realistically lead to equally determined calls for reciprocity on the part of U.S. financial institutions. U.S. banks that act on behalf of the recipients of international funds could find themselves swarmed with overseas requests for KYC information prior to any funds transfer.

For Willbrand, it's a Big Data problem of not enough domestic and international information available to detect anomalies and potential risks earlier. Automated third-party systems are more efficient than the manual review systems in place at some banks today. Willbrand says, "Data about identities is not combined internationally. The only way to get an accurate profile is by cross-checking public records with utility bills and bank accounts around the world."

Willbrand's call for expansion of money transfer surveillance powers represents an overreach that merely attacks the symptom of the problem. Privacy and data security rules vary, and sometimes conflict, in the many jurisdictions around the world. Big Data might be the answer, but it should be Big Data at the front end, during the credit card account opening process and the determination of spending limits – not Big Data that extends privacy violations worldwide.

Friday, March 1, 2013

The Cashless Utopia Mirage

By Jon Matonis
Sunday, February 24, 2013

David Wolman's article The Anonymity Fantasy gets off on the wrong foot by claiming to know what we all "deserve" or "what we all want." As a reader, this is aggravating on multiple levels, but the pretentious fun doesn't stop there as we later learn that anonymous cash does not equal freedom and that "clinging to cash" is misguided.

I could be cynical here, but I really don't think it's about perfidiously advancing a thesis to promote his new book. I think David actually believes all of this despite what history teaches us.

Let's not kid ourselves, because the end of money, as we know it, really means the beginning of the transactional surveillance State, which makes this a serious debate about the boundaries of State power and the dignity of an individual.

Unfortunately, the real world extends beyond Wolman's polite corner of Oregon.

There are activists and dissidents in hostile regions paying for Internet blogs, food supplies, and safe harbor. There are payments being made to border guards on a daily basis to flee a murderous government somewhere. There are women selling baskets and blankets at street markets to feed their hungry families. There are cancer patients buying weed from a friend if their state doesn't accommodate medical marijuana. And even before and after the Third Reich, persecuted peoples have always needed a way to protect and transfer what little remained of their wealth.

The persistent war on cash has more to do with moralistic society than it does with civil society as Wolman claims. With ultimate tracking capabilities, how does Wolman decide when a government's "right" becomes a wrong? Does he defend the victimless crime laws against online gambling and consensual sex for money between adults? Does he defend confiscation of private sector wealth when a socialistic regime runs out of funds? Does he defend an orchestrated payments blockade against whistleblower site Wikileaks? Does he defend brutal government law enforcement measures in Syria and Gaddafi's Libya?

Anonymity and civil society do mix --- it is omnipotent violent government and civil society that do not mix.
Wolman is thinking like a technologist when he promotes the cashless utopia and, as a technologist, he's probably correct because paper cash is inefficient, problematic, and dirty. But it's mostly inefficient and problematic for the overzealous regulators and tax collecting apparatus.

Efficiency happens to be a very short-sighted and unintellectual argument. Selective breeding for certain 'preferred' traits is a vastly more efficient method and so is the training-from-birth selection criteria employed by totalitarian states that place athletes in the modern Olympics. I doubt Wolman would want to live in those efficient societies --- cashless or not.

Also, it's a good thing that Wolman partially credits consultant David Birch with his un-semantic argument about the differences between anonymity and privacy, because that way he doesn't have to shoulder the sole blame for such an untenable supposition.

Privacy, especially user-defined privacy, sits on a sliding scale that is defined by the individual. One person's idea of privacy may be anonymity from all and another person's idea of sufficient privacy may be privacy from aggressive marketing companies and governments but perhaps not from banks. The point being that it is the prerogative of the individual, not book authors or digital money consultants, to determine where one sits on that personal sliding scale.

Cash is not the enemy of the poor. Nor are the poor hurt by anonymity --- they are the ones who desire it the most. If that were not the case, we would see the informal, unlicensed economy shrinking rather than expanding. It's only the global repressionists who cannot accept human nature without moralizing that promote the end of anonymous cash.

As Web anthropologist Stowe Boyd proclaims, anonymous cash equals freedom and we should rejoice in that.