Friday, January 27, 2012

paysafecard Could Be Huge

By Jon Matonis

Yes, that is my professional opinion for the potential of paysafecard. How do they become huge? All they have to do is adjust their 'Webshop' Terms and Conditions allowing online merchants to accept paysafecard for the sale of the bitcoin product. The global demand is certainly there. Sadly, paysafecard does not permit their product to be used for the purchase of bitcoin today because they do not view bitcoin as a valid consumer end-product -- but as a monetary intermediary. However, bitcoin is not defined in any jurisdiction as a monetary instrument, currency, or prepaid item and it is more of a fun 'cryptography product' than anything else.

The paysafecard group is an international company based in Vienna, Austria. They have more than ten years of experience in the area of prepaid online payment solutions and operate in 28 countries worldwide. paysafecard makes Internet payments as simple as using cash and ensures absolute protection against data abuse. No credit card or bank account is required and financial privacy remains fully guaranteed when making payments. The prepaid solution works like a prepaid calling card for mobile phones. The p2p transferable 16-digit code purchased at sales outlets is sufficient to carry out a payment transaction and the paid amounts are booked from the credit of the paysafecard, which may be accessed at any time online. Codes can be purchased in several denominations and then up to ten codes may be combined to make a single purchase not exceeding the equivalent of 1,000.00€ in most jurisdictions, well below the threshold for most anti-money laundering guidelines. With 350,000 sales outlets worldwide, including many in the United States, there are fourteen different currencies supported and a currency converter helps you pay in foreign currencies.

Now, a workaround does exist for purchasing bitcoin if you are willing to go through a virtual currency as a conduit. Currently, the virtual world exchange, VirWoX, accepts paysafecard for the purchase of Linden Dollars, the virtual currency of Second Life. In April 2011, VirWoX started accepting bitcoin and enabled two-way trading between bitcoin and Linden Dollars, which are in turn convertible to CHF, EUR, GBP, USD, and the other virtual currencies traded on VirWoX, the Open Metaverse Currency (OMC) and Avination's C$.

Astonished by these foreign exchange gymnastics, we decided to ask paysafecard about this apparent virtual currency exception which allows users to acquire bitcoin with paysafecard indirectly. Following is the official response received from paysafecard UK:
"Paysafecard is an anonymous payment option – there is no customer identification. By establishing a connection with another anonymous payment service as Bitcoins we would not only lose complete control over the flow of funds but also collide with local AML regulations. At this point we will not work with bitcoin exchanges."
"We allow paysafecard to be used on Virwox as Linden Dollars is a closed loop payment method, it can only be used for 2nd Life. The concern we have with working with a bitcoin exchange is we would enter into a payment cycle where we lose an element of control. If someone uses paysafecard to buy bitcoins we have not control how those bitcoins are used. They could be cashed out through another payment method or used on sites such as Silk Road, which goes completely against our merchant acquisition policy."
If the Mt. Gox floating-rate bitcoin exchange is any indication of market demand, the volume for paysafecard transactions could be substantial. In the last 30 days, the cumulative trading volume of $19.2 million at Mt. Gox alone would estimate a conservative $4.8 million per month for casual retail purchases of bitcoin, assuming a 25% small-denomination retail demand component. This amount does not even include the existing trading volume at other exchanges, such as TradeHill and Crypto X Change, and the volume that is sure to come from the newer category of fixed-rate exchanges, such as GetBitcoin and blizzcoin. At an extrapolated annual turnover of $57.6 million, paysafecard would do well to garner a piece of that up-for-grabs payment processing.

Sunday, January 22, 2012

Bitcoin: A Universal Complementary Currency?

By Pierre Noizat
ParisTech Review
Friday, January 20, 2012 

Bitcoin is a new payment application available on the internet since January 2009. In a way, by virtue of its open source publication, it is similar to the World Wide Web, the hugely successful internet application of the internet that now enables so many others. Much like the WWW has redefined the way mankind produces and shares knowledge, bitcoin transforms the social code underlying money supply to bring about a new degree of economic freedom. Can it be seen as a new monetary reform vehicle?

The relevance of complementary currencies is acutely underlined by the emergence of a global economy dominated by the rules of finance where state sponsored currencies are competing for growth and trade surplus. Until 2009, ideas for a monetary reform could revolve only around money supply mechanisms orchestrated by governments and the banking system. With the inception of a universal currency harnessing the transforming power of the web, new avenues may be explored for economic and social changes: here is why a universal currency like Bitcoin can help redefine money.

The Bitcoin Database of Transactions
The bitcoin protocol specifies how to build and maintain a distributed database of transactions on the internet. Transactions are published and signed electronically (using asymmetric cryptography and key pairs). The protocol enforces confirmation of every transaction by the network nodes.

Because all transactions in the database are linked together cryptographically, a property that explains why the bitcoin database is usually referred to as the bitcoin “chain”, any change in a past transaction would require computing an entirely new database from that point on.

Signatures by private keys ensure the title of property to any given amount of bitcoins: knowledge of the private key associated to the receiving address is required to send a part or the whole of any transaction output. The bitcoin transaction database holds all the necessary information for an address owner to receive and spend any amount of bitcoin: the database and the communication protocol together bring to life a new electronic currency.

Bitcoin Money Supply
Moreover, the bitcoin protocol specifies a money supply mechanism. Bitcoins are generated gradually by the network until a maximum quantity of 21 million bitcoins is reached. Bitcoins are created ex nihilo, pretty much in the same way as dollars are created when a commercial bank lends money to someone who is buying a house. The house existed before the loan. In fact, the seller is walking away with the dollars, de facto transferring the ownership of the house to the bank. The bank essentially created the money in its ledger out of thin air: it recorded the amount of the loan as a bank’s liability upon crediting with it the account of the borrower and that same amount was recorded as a bank’s asset, i.e. as a loan that must be paid back to the bank. Even top bankers and economists, including Nobel Prize winner Maurice Allais, call it magic.

Bitcoin builds on the recognition of the fact that the monopolistic aspect of the money supply mechanism in today’s banking system deserves at least to be revisited, if only because it has lasted for several hundred years. If only because of the continued effects of the financial crises, Bitcoin allows us to experiment with a new concept for money.

Bitcoin, as a new universal currency, is a true innovation, building on numerous prior attempts to create a sustainable currency and doing so independently of any state or centralized organization.

Towards the growth of a Bitcoin Economy?
Some bankers I spoke with shrug off Bitcoin on the somewhat circular logic that it cannot be backed by any assets in the real world. Well, thanks to merchants accepting bitcoins and to online exchanges trading bitcoins just like any other currency, a Bitcoin economy is emerging. If the economy of the euro or the dollar collapses, the expectation of a backing by the central banks is based on the assumption that a government has unlimited taxation power over said economy. The current financial crisis in Greece or, to a lesser extend in the US, demonstrates that actual use of this theoretical power is a stretch of economic reality. The truth of the matter is that 90% of the money today is created in the books of the banks and that price stability is the determining factor towards continuing public support of the central banks view.

There are over 140 state sponsored currencies in use across the world today. It is hard to prove that a new complementary currency will jeopardize the world’s economic outlook only because this new currency, unlike all the others, stems from a distributed monetary system without a central authority. The innovative feature of bitcoin that truly sets it apart from anything that existed before is simple: it is cash online without the necessity for a central organization or third party. As such, it is making other forms of cash transaction comparatively less convenient. Removing the necessity does not affect the usefulness of a third party in some cases. Transaction processing between merchants and their customers will always entail some kind of dispute resolution system, regardless of the currency that is being used for payments.

E-gold, as a tentatively universal currency backed by gold, was created in 1996 and failed mainly because it relied on a central organization to manage an inventory of gold. The quantity of gold needed was supposed to grow with the e-gold economy, which was impractical, dangerous and fundamentally useless in a digital age. (Another shortcoming of e-gold was the lack of a specific protocol: relying solely on a web browser to conduct irreversible transactions makes it difficult to secure them.)

Bitcoin money supply mechanism simulates the extraction of a rare metal with a mathematical model, using a clever recipe proven in electronic signature schemes and hashing algorithms that can be found today as ingredients in most banking systems.

One can think of bitcoin as a currency backed not by gold but by a metaphoric substitute of gold, since the quantity of bitcoins is limited by design: 21 million bitcoins.

Like gold, bitcoins can be seen as bonds that never mature but unlike gold, bitcoins bear virtually infinite divisibility and liquidity with no vaulting costs. According to 2010 year-end estimates by GMFS, total above ground stocks of gold are 166,600 tons worth US$6,500 Billion by 2010 average gold price, of which around US$2,400 Billion are held privately or by official reserves, in the form of coins and bars. The total stocks minus approximately 30,000 tons held in official reserves worldwide as of august 2011, gives us an estimated “market” size of US$1,230 Billion for gold as a private store of value. If we were to compute a fictitious exchange rate with the dollar based on these numbers, we would project an exchange rate of around US$600 for one BTC, if bitcoins were to capture only a 1% fraction of the private market for gold as a hedging instrument.

By the same token, if the bitcoin economy were to grow up to 5% of the US GDP, i.e. approximately US$750 Billion USD, and assuming the velocity of bitcoins to be the same as that of the dollars (around 50), then one bitcoin would represent the equivalent of US$700.

The numbers translate to a $15 Billion future valuation estimate for the bitcoin network. They are consistent with the market capitalization of Visa, Inc. ($55 Billion as of august 2011) or MasterCard ($39 Billion). Buying bitcoins today is like buying stocks of a new global electronic transaction network. At $10 as of august 2011, Bitcoins can be considered undervalued even if it is likely that other universal currencies might try to step in at some stage.

One would think at first that such a valuation would provide an investor with the rationale for purchasing the most powerful computer on earth (“K” in Japan as of June 2011) to take over the bitcoin network. However, doing so would drive away today’s “mining” participants and, at least temporarily would reduce the value of the bitcoins to zero. The supercomputer would stay idle, acting as a deterrent to any seller of bitcoin, waiting for the intruder to back away. In other words, to mitigate this risk, the new operator himself or herself would have had to acquire a large amount of bitcoins beforehand to keep the bitcoin economy running after the takeover, in the hope that more sellers would return after the more or less chaotic transition.

Additionally, by the time the attack is ready, it is unclear whether said supercomputer would be able to match the majority of the hashing power of the current nodes while this cumulative power is going up day after day. The uncertainty surrounding the outcome of this kind of hostile takeover makes it more likely that a rational investor would simply buy bitcoins much in the same way he or she would buy stocks in a start-up venture.

Another, more na├»ve attack would consist in buying “pools” of miners that are thriving these days on the bitcoin network. By joining a mining pool, a miner aims at gaining a share of the steady flow of bitcoin expected with a large amount of aggregate hashing power. The share is prorated according to the hashing power contributed by the miner. Conversely a solo miner can go for a long period before he/she earns the 50-bitcoin reward associated with the computation of a new block of transactions. Statistically, the expected rewards are the same though, only the income flow is steadier in a pool. Hence a miner would have no incentive to stay with a pool under the control of a hostile investor. He or she would simply switch to another pool or start mining solo.

This analysis remains true even after all the bitcoins have been minted. In fact, the incentive to “mine” transaction blocks will sustain the decline in the rewards by virtue of the increasing transaction fees combined with the increase in value of the bitcoins.

Electronic Money and Trust Management
Bitcoin is backed not only by this kind of projection but also by the trust of the “network nodes” that is materialized in the aggregate computing power of this group of people. Anyone with a personal computer and a graphic card (GPU) can join in and start participating in this giant transaction processing pool that defines the bitcoin network. It requires only downloading a piece of free software known as “mining” software in reference to the bitcoin money supply rules. Today, there are several tens of thousands of such “miners” around the world.

In contrast, Ripple, launched in 2004, attempted to create a universal currency by knitting together a web of Local Exchange Transaction Systems (LETS): IOUs issued in any LETS could be forwarded to any participant in the network, across a Web of Trust mechanism. However, a Web of Trust requires a central authority to manage trust certificates and to prevent fraud, raising lots of practical issues: the thorny problem of registering people to link them to a secure digital identity can lead a technological innovation to its demise even before it reaches any sizable roll out stage.

Bitcoin proof of work protocol avoids the need for a secure web of trust, relying instead on the assumption that a majority of the computing power is in the hands of honest participants: “honest” here simply means that they will cooperate to make the network confirm legitimate transactions. Legitimate transactions on the bitcoin network are those that can be linked cryptographically to the “genesis” transaction via the “longest” chain: the chain “length” refers to the depth of its proof-of-work, not to the number of transaction blocks. The “genesis” transaction is one that took place in January 2009 and got things started. This concept of cloud computing applied to the confirmation of transactions is very consequential: only two years after the launch of bitcoin, it takes already as much computing power as the “K” computer to take over the network. Taking over the network today with such a powerful machine would not prevent the network from operating but would disturb transaction confirmations until participants find a way to overcome the attack and regain control of the operations. Recovery strategies could be applied to resume operations normally thereafter. In other words, even assuming that a government or a large organization would be able to harness so much computing power to engage in such heavy-weight counter measure against the bitcoin network, its expected outcome is uncertain at best. This property makes bitcoin as resilient as a transaction network can be.

A universal currency like Bitcoin, which is using digital signatures and asymmetric cryptography, has the interesting additional property that it can go back and forth from digital to fiduciary status. The old boundaries between electronic transactions and cash transactions are blurred: the file containing the key pairs (public receiving address and secret key to sign the outgoing transfer of the amount received) can be printed. Let us say the public key is left apparent and the secret key is hidden underneath a cover: the cover can only be removed in a non-reversible manner. In doing so we have created a new e-note containing the bitcoins received on the public address that cannot be spent until the secret key is revealed. The e-note can be traded as long as it is not tampered with. The amount received on the public address can be printed also in a tamper-proof process: the amount received on the public address becomes the denomination of the e-note (7). When the cover of the secret key is removed, the e-note amount in bitcoins can be redeemed electronically for any payment using bitcoins. In further contrast with old notions of fiat money, e-notes without denomination are also possible: the amount received on any address can be checked by the recipient in the public bitcoin transaction database.

Decentralization and Deflation
By definition, a truly decentralized universal currency must start without a central authority regulating its money supply mechanism: this precludes establishing any form of correlation between the money supply and any set of economic parameters or measurements. Such systemic correlation would yield endless discussions between the users, hence requiring a governing body capable of moderating the discussion and enforcing the rules by some yet unknown universal democratic standards.

For the same reason, the new transaction software must be free software to escape the limitations and opacity of proprietary software. As Richard Stallman summed it up in his now famous statement: “The point of free software is either the users control the software or the software controls the users”.

To a large extend, state sponsored currencies like the euro or the dollar are created in a black box, with a lot of media attention focused on interest rates rather than money supply. A central organization promoting a currency system based on proprietary software would not be a game changer.

Therefore the money supply mechanism must be hard coded and published in the specifications from the outset, with little or no room for the currency to wiggle out of it to its possible demise. In the same logic, it is neither possible nor necessary to predict the rate of adoption and growth of the user base for the new currency: these numbers cannot be factored in with precision. The money supply model is therefore deflationary, defining a maximum quantity, unless the rules of generation are bound to the number of users by a user authentication protocol. This requirement is not compatible with an objective to design a decentralized currency since user authentication requires issuing identity certificates either in a web of trust or with a certification authority.

The Bitcoin specifications not only fulfill the requirement for a limited money supply but also make provisions for transaction fees to provide a sustainable incentive for miners to keep mining even after the rewards for the generation of new bitcoins have dwindled to zero.

Because Bitcoins are traded electronically, unlike gold, they are infinitely divisible and enjoy a high velocity, so a deflationary spiral can only reduce the scope of bitcoin to the function of a store of value, a more practical process than is used for gold. In fact, the deflationary spiral would have adverse economic consequences only if bitcoins were the exclusive currency in a given territory. That’s not the case: as a complementary currency, bitcoins are supposed to coexist with the local state sponsored currency not to replace it. Prices will most likely be expressed in local currencies. In an electronic online transaction, the price expressed in a universal currency can be easily adjusted in real time for exchange rate variations. Only for off line transactions, price stability is a strong requirement for a new universal currency.

In short, deflation will augment the attractiveness of bitcoins as a store of value and will only marginally affect its application as a trade currency.

Where do we go from here? In a global economy, the inception of one or more universal currencies is bound to happen as soon as technology permits it.

Bitcoin, as the first, is paving the way for new applications. In particular, bitcoin can greatly enhance the efficiency of money transfer where it is lacking, specifically development aid that was once famously characterized (by economist Peter Bauer) as “an excellent method for transferring money from poor people in rich countries to rich people in poor countries”. Bitcoin can leverage the generalization of mobile phones in developing countries to enable a money transfer directly to the recipient, bypassing all state bureaucracies and banking intermediaries. The institution or non-governmental organization responsible for the transfer could simply assign bitcoin addresses to recipients and their local merchants then fulfill the money transfers and payments in bitcoins.

The technology is enabling both a new kind of transaction network and a new universal currency.

By analogy, it is worth noticing that the World Wide Web does have a governing body, namely W3C, a non-profit organization made of more than 300 members among the largest companies in the high tech sector. Clearly, any leverage applied by a government to one of its constituents in W3C can be balanced out by the others if it does not fit the bill of the general interest. Because this principle holds successfully for the technology enabling new ways of producing and sharing as valuable an asset as knowledge, one is permitted to hope that a similar organization can also deal one day with the Bitcoin protocol specifications at a technical level to maintain its immunity from the hazards of macro-economic measurements.

Reprinted under Creative Commons.

For further reading:

Friday, January 20, 2012

A Virtual Fortune: Property Rights in Virtual Economies

Press Release
The Public Interest Advocacy Centre
Wednesday, January 11, 2012

The Public Interest Advocacy Centre (PIAC) today released a report entitled “A Virtual Fortune: Consumer Protection for Banking and Consumer Fraud in Virtual Worlds”. The report studies virtual worlds, which are sometimes described as “massively multiplayer online role-playing games” (MMORPGs) that provide an immersive virtual experience for many players that many players consider to be “real”. Many virtual worlds have developed virtual economies based on a virtual currency that may be exchanged for real-world currency. Players will play the role of consumer and entrepreneur within virtual worlds.

As virtual economies grow, there have been instances of fraud in these virtual worlds. PIAC’s report studies examples of economic fraud conducted in virtual worlds such as Second Life, Entropia Universe, EVE Online, and World of Warcraft. For example, there have been cases of bank runs, securities fraud, and theft of virtual property. These situations have resulted in a financial loss to consumers in virtual worlds. Notably, virtual world operators in most cases stated that these fraudulent schemes are “part of the game” while denying responsibility and liability and refusing to compensate players who have lost money to fraud in virtual worlds. Efforts to set up in-world justice systems have not been successful.

“Where a consumer falls victim to fraudulent activity within a virtual world, they are not likely to be successful in seeking redress or compensation for their losses,” said Janet Lo, Legal Counsel at the Public Interest Advocacy Centre and author of the report. “Virtual world consumers must be aware of potential risks to their in-world assets and property, such as in-world fraudulent schemes or unilateral actions by virtual world operators dealing with user accounts.”

Given that individuals view their virtual world avatar as an extension of themselves, the report explored whether real-world rights should extend to the avatar and whether traditional notions of property rights and consumer protection should apply to virtual avatars participating in virtual economies. The report noted the use of End-User License Agreements (EULA) or Terms of Service by virtual world operators to limit their liability and stipulate certain mandatory forms of dispute resolution. The enforceability of these terms in real world courts have been questioned but real world case law has not yet clarified the legal status and rights of virtual world users.

The report notes that real-world regulators around the world continue to examine virtual world economies and contemplate whether real-world regulation should be applied to financial transactions conducted in-world. For example, securities and payment regulations could be applied with a view to providing greater consumer protection to virtual world users.

“As virtual world experiences blend into social networking websites and other areas of commerce, regulators will need to consider how consumer protection will operate and whether the application of real-world regulations will be sufficient to protect consumers,” said Lo.

Wednesday, January 18, 2012

The Final Days of e-gold: Interview with Doug Jackson

Douglas Jackson Interview 2012 e-Gold

Doug Jackson and E-Gold were also the focus of a 2009 Wired magazine article.

Could Bitcoin be the Future of Internet Betting?

Hartley Henderson has published a prospicient article at Off Shore Gaming Association, "Could Virtual Currency be the Future of Internet Betting?". The author has identified a man known as R.C. who emphatically endorses bitcoin as a means of payment for online gambling and casinos across almost all jurisdictions. This supports our thesis that bitcoin is the digital equivalent of a physical casino chip. Henderson summarizes his discussion:
'If I had any say, all transactions at our book would be done in bitcoins,' the man said. 'They are untraceable and totally out of the control of any government. And most importantly they are an investment which someday I’m confident will rival silver prices.'
The author then asks R.C. specifically what makes bitcoins a better option than cash for online gambling:
"As you know, money transfer is vital to the sports betting, casino, and online poker industries. Bitcoin is an amazing solution. Through a combination of math and cryptography - it is a completely decentralized currency/commodity. That means no entity is in control, it is managed by all the nodes of the network, collectively. You can think about it like bitTorrent, if you are familiar with the file sharing protocol; purely peer to peer with no central management. 
Through this cryptography and decentralized design, each node on the network is a 'bookkeeper' of which bitcoin addresses own which coins. You cannot fake or forge a transaction or create coins outside of the system. Each node has a record and will not accept forgeries. So, even though there is a public record of all bitcoin transactions, the key is that nobody knows who owns a particular address and thus those bitcoins. So on the one hand it is completely transparent - all coins and transactions are public, but on the other hand nobody knows who owns those coins/bitcoin addresses. You can see how it could be useful to gamblers."
Peer-to-peer wagering, or social betting, is gaining quickly in popularity and Henderson makes the point that companies receiving a membership fee are distinctly different from companies that receive a commission on the winning bets:
"What R.C. didn’t mention is that in no country is peer to peer wagering illegal. There is nothing in the law that stops person A from wagering $20 with person B on the outcome of a game. What makes the transaction illegal in some countries is when an intermediary acts as the bookmaker. That is precisely why Betfair and Matchbook are seen as technically illegal by the U.S. government. Both are peer to peer wagering operations but they also take a commission on the winning bets. doesn’t do so. They simply have paid members."
Henderson also makes the bold case that bitcoin as a payment mechanism doesn't fall under the UIGEA because there is no money involved and there is no way the Department of Justice can effectively intrude. Our man R.C. perhaps explained it best:
"As far as UIGEA, there are no banks or processors involved. Moving bitcoins around is just like moving an image file or other data around. I would expect to see bitcoin-specific legislation before any attempt to apply the UIGEA. But even with legislation, I expect the future of bitcoin to be bright. There is no central authority to shut down. There are laws against file sharing copyrighted works, but due to the distributed nature of bitTorrent it cannot be effectively policed.
As far as pressure from the DOJ or other entity (it’s not a viable concern). Bitcoin can be classified as a commodity, or a currency, or nothing at all (it's just data). One can argue that it is like Facebook credits or World of Warcraft Gold. The government is not going after them. Also, the terms and conditions for states that the player is responsible for determining the legality of playing with bitcoins in his or her jurisdiction. Sign-ups are anonymous and the site does not know the origin of the players. No personal identification is requested; even an email address is optional. A player can sign up, send bitcoins, wager, and withdraw without the site ever knowing who he or she is. The properties of bitcoin allow this to happen. There can be no fraud, identity theft, or reversed transactions. All of those headaches are a massive cost to the industry - so you can see why bitcoin may be a significant factor in the future of online wagering."
Regarding the claims above, it remains to be seen if Facebook Credits will ever permit two-way exchange and, even if they did, that the U.S. regulatory authorities wouldn't move promptly to include them under the 'Prepaid Access Rule' for financial products. In the meantime, I agree that the resilient bitcoin is more suited to the monetary challenges ahead and it is another case of technology being ahead of the law.

For further reading:
"Leading Bitcoin Online Gambling Operator Opens Books", Bitcoin Money, January 18, 2012
"Could crypto-currency change how we pay?", Julian Bucknall, January 8, 2012
"Bitcoin and the Digital Currency Revolution", Dan Downs, January 5, 2012
"A Bitcoin Primer", Mike Koss, January 1, 2012

Thursday, January 12, 2012

Virtual Currency Poker Leaves Real Money on the Table

Tyler York of Betable presents some amazing numbers on how real money gaming would be supremely more profitable than virtual money gaming in "Virtual currency poker leaves money on the table".

Bitcoin, the digital version of a physical casino chip, is not discussed in the analysis. But since it currently falls into that legally unclassified area of 'not-real-money', it will undoubtedly start to appear in those gaming venues that inhabit the monetary space between real and virtual. Tyler York then asks, "given the tremendous revenue opportunity, why haven’t social game companies already offered real-money play?": 
"No, not because Facebook doesn’t allow gambling.

While this was true in the past, Facebook may soon allow real-money gambling on its platform. Even so, social games are on countless other platforms where gambling is already permitted in legal jurisdictions, including Android, iOS, and Google+. These companies didn’t pursue real-money social games for any of these platforms. 

No, not because gambling is illegal in the US.

While the Department of Justice opened the door for states to regulate online gambling within their jurisdictions, the fact that the US market was closed before wouldn’t have stopped major social game companies in foreign markets. The addressable ex-US worldwide gambling market contains millions of players that would give real-money social games the audience they needs to succeed. 

The reason game companies haven’t implemented real-money play is because gambling licenses are tremendously expensive and time consuming to acquire.

While theoretically possible, the process is so painful that the vast majority of game companies don’t even consider it. The time (≥18 months) and money (≥$1M including all associated costs) are an enormous barrier to entry for most game studios. Even if a studio could afford those costs, steps must be undertaken sequentially and spending more money doesn’t shorten the period of time it takes to get a license. There is also the added layer of complication arises from the necessary corporate structuring and off-shoring that must take place to comply with gambling regulations.

These time and money costs are simply too great for the vast majority of small-to-medium sized game studios, and the compliance issues become increasingly prohibitive as you look at large game companies. These huge pains have prevented Zynga and other game companies from offering real-money play to non-US players in spite of the massive potential revenue opportunity. Game companies have been better off investing their limited resources into virtual currency revenue streams because they will monetize immediately, although relatively poorly."

For further reading: 
"The Real 'New Frontier' of Gaming", Tyler York, December 19, 2011
"Real-Money vs Virtual Currency Gaming - Design Outside the Box", Jesse Schell, DICE 2010, May 12, 2011

Thursday, January 5, 2012

The EFF's Own Chilling Breeze

By Julian Noble
Wednesday, January 4, 2012

To stand up and fight to protect lawful online activity from legal threats isn’t for the faint of heart… it takes big ones.

The Electronic Frontier Foundation has a two decade history of taking on cases that set important precedents to protect rights in cyberspace. This is an organisation which has not been afraid to file lawsuits against the CIA, the US Department of Defence, the Department of Justice and other agencies, as well as major corporations like Apple and AT&T.

Recently, however, the EFF seems to be blowing some chilly air of its own and their source of gumption seems to have shrunk a little. They are no strangers to the pernicious effects of ‘self-censorship’; this is the ‘chilling effect’ where discussion, debate and activities are effectively destroyed before they even get started. It is the fear to speak freely or the fear to participate, because of vague legal threats or ill-defined laws. It is the uncertainty about where one’s rights begin and end, and the fear of crossing an invisible line. It is the providers closing or restricting customer accounts; not based on specific legal requests but based on some fuzzy margin even less well defined than the law itself.

Let’s see how the EFF explains its retreat from using one specific technology: Bitcoin, which is not inherently illegal and qualifies more than most as a frontier technology.

EFF and Bitcoin (June 20, 2011)

What then should we make of this statement from the EFF which reveals a primary motivator for avoiding a particular technology is legal uncertainty? At first glance this might make some sense, as ‘understanding the legal issues’ seems like a prudent first step, but you only need to step back into the EFF’s early history to see that their very birth was not just taking place in, but in a way inspired by an era of just this sort of uncertainty regarding electronic frontiers. Take this quote from ‘A Not Terribly Brief History of the EFF’.
"I realized in the course of this interview that I was seeing, in microcosm, the entire law enforcement structure of the United States.
Agent Baxter was hardly alone in his puzzlement about the legal, technical, and metaphorical nature of data crime."
This surely shows that the legal environment was not only uncertain – but positively muddy and misunderstood even by those tasked to investigate and enforce the law.

Arguably, law enforcement lags in their understanding of new technology just as much today. The ‘ambiguous nature of law in Cyberspace’ was almost a defining feature of the landscape, and back then, it didn’t stop the EFF from riding out into it; legal guns at the ready, if not blazing.

The EFF about-face regarding Bitcoin came shortly after a flurry of publicity regarding US Senators Schumer and Manchin raising their concerns about the use of bitcoins for illegal purchases on the silk road tor website. The senators mischaracterised bitcoin as “untraceable”. Senators seek crackdown on “Bitcoin” currency

In contrast to this sort of reaction, we have at around that time, a more measured opinion from Joseph Skocilich at US business and intellectual property law firm ‘Adler Vermillion & Skocilich LLP’
Innovation and Legal Panic—Bitcoin
"Boringly, the realistic legal issues facing Bitcoin are likely to be limited to those businesses that service the Bitcoin economy as a “money services business”, such as money transmitting, processing and foreign currency exchange. Laws which happen to be in great need of reform, as they are currently hindering innovation in the online payment industry. Simply using Bitcoin as payment for goods and services doesn’t create any legal issues beyond that of any other market exchange, where you and your business are free to accept payment in whatever form you choose."
Various organisations have been approached by the bitcoin community with offers of assistance as far as accepting bitcoin in their commercial operations, or as a low fee method of accepting donations. Some of their reactions are revealing:

A member of the SENS foundation website team cited the “possibility of BTC being made illegal in the US”. A statement from someone at (a technical person, not a legal rep) was particularly illustrative of the chilling effect:
"We talked to some fellow non-profits, and the lawyer from one particular organization gave us some strong reasons to not move forward. We then talked some with our lawyer, who cautioned against doing anything that could distract from Kiva’s core mission by bringing about controversy."
When the founders of Humble Bundle were approached they replied:
"Hey there, we have talked with the EFF and an attorney about this and it is very complicated to say the least. The stakes are very high and there are some extremely serious unknowns about using Bitcoins. While the concept is great, we are not prepared to be its first major test case, after listening to the advice we’ve been given."
How many such organisations have looked at the EFF’s stance on this and taken their self-censorship lead?

In some cases – there may be specific legal roadblocks with regards to adopting a new technology such as this. Charities in particular are highly regulated. Some government agencies such as the NGO Affairs Bureau in Bangladesh, require that each foreign donator fill out and sign a specific form giving authorisation for the donation, which obviously puts a damper on micropayment donations using a somewhat privacy-enhancing electronic payment system.

But the EFF’s published concerns are less specific than that.

If any of their fear is based on a perceived conflict of interest for having a financial interest – they should note that ‘holding bitcoin’ is not a prerequisite for using them as a payment mechanism. There are services which allow merchants or non-profits to receive their bitcoins in USD, avoiding any interim volatility or any position as a speculator.

Whether or not you see the value or likelihood of success for a technology such as bitcoin, it’s clear that one of the most pressing impediments to adoption is not violation of any particular law, but general legal ‘fear’. What does it say to the merchants and charities of the world, when even the EFF, the giant slayer, cites vague legal concerns in it’s refusal to even use a technology in a relatively passive manner?

For the bitcoin community, a sense of betrayal doesn’t seem entirely unreasonable here. It is not that the EFF should be expected to ‘endorse’ bitcoin – but that the EFF should be perfectly happy to use frontier technologies within the space where they are not specifically legally prohibited, and be willing to work with the community in helping users (or at least not discouraging them) as they move up close to the legal lines. Did the EFF need to eschew all encryption when defending our rights to use it?

It’s been 6 months since the EFF’s public statement of legal confusion. That’s a long time in the fast-moving technology world for a chill wind of self-censorship to swirl around. As a prominent non-profit organisation supposedly at the forefront of cyberlaw, EFF’s influence is substantial. Let us consider what it might look like if the EFF took this approach to certain other new technologies.

Press Release: EFF withdrawing from social networks.

For several years, EFF has been following the movement around social networking, a system of electronic communication which touts itself as providing “informal communities of peers”.

We’ve been a long time user of email and have been experimenting with social messaging technologies such as Twitter and Facebook, which are at the forefront of peer-to-peer and social systems.

However, we’ve recently removed all our Twitter and Facebook accounts, and we’ve decided not to have any social network friends or followers. We decided on this course of action for a few reasons:

1. We don’t fully understand the complex legal issues involved with social networks and electronic peer-to-peer communications.
Social networks raise untested legal concerns related to privacy, bullying and harassment, fueling of riots, impersonation and identity theft, among others. While EFF is often the defender of people ensnared in legal issues arising from new technologies, we try very hard to keep EFF from becoming the actual subject of those fights or issues. Since the legal implications surrounding the use of social networks and peer-to-peer systems in general are still very unclear, we worry that our participation in social networking may move us into the possible subject role.

2. We don’t want to mislead our ‘friends’. 
When people become a social network ‘friend’ or ‘follower’ of a nonprofit like EFF, they often expect us to be a genuine ‘friend’ or ‘follower’ in the more traditional sense. This can lead to legal misunderstandings as to the nature of our relationships with other participants in the social network. In 2011 Social media has been associated with the ‘Arab Spring’ uprisings as well as implicated in ‘fueling’ the Tottenham riots. This has led to renewed interest from governments in mapping the social network to identify collaborators, as well as mechanisms for shutting down certain social networks entirely in times of crisis. Because of this legal uncertainty, we are not comfortable with the number of ‘friends’ and ‘followers’ we have accumulated.

3. People were misconstruing our use of Twitter, Facebook and other social networking tools as an endorsement.
We were concerned that some people my have participated in these social networks specifically because EFF took part, and perhaps therefore believed the activity was safe and risk-free. While we’ve been following the social network movement with a great degree of interest, EFF has never endorsed Facebook or Twitter. In fact, we generally don’t endorse any type of product or service – and these are no exception. We appreciate the outpouring of support we have received from the social networking community, and we share that community’s commitment to privacy and innovation. We also appreciate their frustration with the privacy problems posed by existing on-line social networking systems. However, EFF will no longer be accepting or making friends. In upcoming meetings, we will also be reviewing and potentially withdrawing from the domain name system entirely – so that from the outside, we can better assist you in fighting #SOPA! To mitigate the risks inherent in electronic communications with the EFF, you can as always contact us via snail-mail at:

Electronic Frontier Foundation
454 Shotwell Street
San Francisco CA 94110-1914 USA

Donations using electronic methods such as credit card, bank wire or bitcoin are no longer accepted for similar reasons – we can best defend your use of these electronic systems if we are not seen to be ‘users’ ourselves. Cash in the form of notes is no longer accepted due to possible contamination with cocaine and the resulting legal risk that imposes. Gold bullion or cash in the form of coins can be delivered to the above address.

Reprinted with permission. This article first appeared at

Monday, January 2, 2012

Virtual Currency in Virtual Economies: Implications for Income Tax

"Virtual Currency in Virtual Economies: Income Characterization Issues for Social Media Companies" by Jim Carr, Jason Hoerner, and Carlos Kaplan of KPMG LLP was published in the November 21, 2011 (Vol. 64, Number 8) issue of Tax Notes International.

This article examines income characterization issues related to taxation of virtual currency. Some social media companies offer digital currency (so-called virtual currency) for online players to use in virtual words, online games, and other applications. Players can use virtual currency to purchase assets or services from other players within these online worlds. Players selling such items can convert the virtual currency to U.S. dollars or other currencies through online auction sites or the social media company that issued the virtual currency (Known as “real money trades”).

The authors discuss how the characterization of income derived in connection with an offering of virtual currency is pivotal to assessing the U.S. income tax consequences of that income from a cross-border perspective and how understanding the characterization may facilitate greater planning opportunities.

I highlight some of the more interesting findings below:

Page 3: "Because of the lack of U.S. guidance, social media companies engaging in cross-border transactions with consumers face uncertainty about U.S. federal income tax consequences."

Page 4: "Other social media companies' terms of service may permit virtual currency exchanges to be operated by third parties. Players may trade the virtual currency on these exchanges with other players for real currency, usually at their own risk without any guarantees from the social media company permitting the trade."

Page 9: "There is no comprehensive definition of currency under the IRC or Treasury regulations. For a CFC [Controlled Foreign Corporation], factors to consider in the typical transaction that may be relevant for this determination could include:

whether the player can purchase anything with the virtual currency outside the opportunity to play the MMOG;

the extent to which there are restrictions placed on what a player can buy and/or transfer to another player;

the right of the social media company to terminate a player's virtual currency at its sole discretion or if certain conditions occur; and

the ability of the player to exchange the virtual currency for true cash, whether through the MMOG or through third-party exchanges."

For further reading:
"Virtual currency: regulation and taxation issues", e-commerce law & policy, November 2008