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Ten Ways Governments Threaten Bitcoin

Published on March 13th, 2017 by John Light

Governments are strange beasts. Not quite market, not quite commons, governments occupy a unique space in the economy where societies permit (or tacitly tolerate) territorially-bound corporations that have fiat monopolies on important social functions and institutions. Governments use these exceptional permissions to create and enforce laws and regulations that inhibit the free flow of goods, services, and ideas within their jurisdictions, simultaneously creating and limiting opportunities for entrepreneurs, investors, and workers in the economy. All the while, governments engage in covert campaigns to undermine and neutralize foreign and domestic targets that are seen as threats to “national security” (read: government power and/or the profits of incumbent corporations), creating blowback and bad precedents that have come back to haunt governments and their citizens years later.

The Bitcoin network is a relatively young but growing part of the economy, spawning hundreds of businesses and nonprofit groups that support the fledgling technology, fueled by over $1 billion in venture capital and angel funding that has been invested since Bitcoin’s invention. While the Bitcoin network itself is decentralized, transcending government borders and legal jurisdictions, there is an uneven patchwork of government regulations bound by geography and international treaties that are creating centralizing forces and vulnerabilities in various parts of the Bitcoin economy. This is a cause for concern among members of the community that value resiliency and decentralization of power in the network. Unless there is a focused movement to eliminate the government interventions that threaten Bitcoin companies and distort the market to create these centralizing forces, we can expect this drama to continue to play out for years to come.

Note: This is not an exhaustive list of government threats to Bitcoin.

1. Bitlicenses and banking regulations

A “Bitlicense” is a specific license required to operate a business that serves as an exchange or brokerage firm for bitcoin and other “virtual currencies.” This kind of license prevents competition by limiting the number of companies that can legally do business within a jurisdiction, and puts customers at risk by requiring businesses to collect and store sensitive personal identity information.

First implemented by New York, some version of a Bitlicense has been proposed or implemented in states and countries around the world, including tech hubs such as California and growing financial hubs like the Isle of Man. In jurisdictions that have not adopted a Bitlicense, previously existing banking, money transmission, and money services business regulations have been used instead, producing the same cartelizing effects as a Bitlicense.

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2. Bitcoin bans

The alternative to licensing of Bitcoin exchanges has been the consideration or actual implementation of bans on Bitcoin exchanges, which further centralizes power in the remaining exchanges throughout the world and pushes people into underground market exchanges. While not an existential threat to Bitcoin, this concentration of power in regulated exchanges puts pressure on customers to comply with onerous KYC/AML requirements that put them at risk for identity theft and financial surveillance. This added friction slows down the adoption process, excludes people who are undocumented or security-conscious from the exchange market, and pushes people into slow, expensive, and risky gray or black market exchanges.

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3. Energy subsidies

The largely unregulated nature of Bitcoin mining makes it a nearly free market with nearly perfect competition. Miner profitability relies on many factors, including connectivity with the rest of the network, the cost of operating expenses, and hardware quality. The miners that survive these competitive conditions are the ones that are able to reduce their costs while increasing their hashrate and block propagation speeds as much as possible. Electricity is by far the largest operating expense of Bitcoin miners today, and so the miners that are most profitable today are the ones with the cheapest electricity costs – and the lowest cost is “free.”

Energy is highly controlled by governments in most parts of the developed world, either directly through government-run energy companies or indirectly through government-sanctioned energy cartels/ monopolies/ duopolies/ oligopolies. When energy companies have a surplus of electricity, governments will sometimes decide to give this electricity away for free. Governments also subsidize the production of energy by providing preferential tax treatment or direct cash subsidies to energy companies, artificially reducing the costs of certain kinds of energy.

Energy subsidies by governments create an uneven playing field in the energy markets, leading bitcoin mining to consolidate around areas with access to artificially cheap or free electricity. Given that there are only a relatively small number of places in the world with these kinds of subsidies, the hashpower responsible for Bitcoin network security is concentrating in just a handful of legal jurisdictions. This makes it easier for a government or coordinated group of governments to take control of the Bitcoin mining network through nationalization or de facto nationalization by regulation.

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4. Labor and immigration laws

Much of the Bitcoin industry relies on highly specialized knowledge in the fields of ASIC manufacturing, cryptography, computer science, finance, and economics. Labor and immigration laws restrict the movement of workers with this specialized knowledge, preventing a free market for labor from arising. Labor is artificially cheaper in some areas, or more expensive in others, because of government intervention that distorts the supply and demand curves of these markets. This creates concentrations of power in areas where these specialized skills and distorted labor markets exist: China for ASIC manufacturing, Europe and North America for cryptography and software development, London and New York for finance and economics, Silicon Valley for startup capital, etc.

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5. Research grants

Within the past couple of years, governments have become increasingly interested in Bitcoin. In 2015, the RAND Corporation published U.S. government-funded research about the ways that governments can disrupt “virtual currency networks” like Bitcoin. Governments have also become interested in blockchain data analytics, creating a cottage industry of companies devoted to tracing illicit flows of funds and other criminal uses of Bitcoin. In June 2016, the U.S. Department of Homeland Security announced that they had awarded research grants of approximately $100,000 each to Block Cypher and RAM Laboratories for “Blockchain Applications for Homeland Security Analytics.”

These kinds of government grants create incentives to do research that the market might not otherwise demand. They also create incentives for grant recipients to attempt to block certain changes to the core protocol that would impede such research e.g. automatic CoinJoin, Confidential Transactions, ZK-SNARKS, etc, in the case of analytics research. There is no evidence as of the time of this writing that the companies that have been awarded research grants for blockchain analytics are making any concerted efforts to block fungibility improvements in Bitcoin software. The general principle here is that core developers and full node operators will have to remain vigilant about spotting conflicts of interest by those that would seek to influence core protocol development.

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6. Legal tender laws

Legal tender laws are laws that give special privileges to bank-issued “fiat” currency above all other currencies. Fiat currencies issued in a legal tender regime (such as the U.S.) must be accepted for settlement of debts, public or private, such as a lawsuit settlement or payment of taxes. It’s like if McDonald’s was the only place you could legally eat in your area, and you had to pay for everything with a currency they issued called “McBucks.”

Since everyone who earns income is required to pay taxes, this means that everyone who earns income has an incentive to have at least enough fiat currency at the end of the year to pay their taxes. Since most businesses only accept their local fiat currency, consumers have an incentive to have much more than the minimum amount of fiat currency needed to cover their tax burden so that they can easily make purchases from local businesses without needing to exchange for fiat currency first.

The incentive structure created by legal tender laws privileges fiat currencies and hampers adoption of alternative currencies, even if the alternatives have more desirable characteristics. Such an uneven playing field is bad for bitcoin. The playing field must be leveled for bitcoin to truly compete with fiat currency on its own merits.

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7. Key disclosure laws

Key disclosure laws are laws that require suspects to turn over their decryption keys to police if a court order or warrant demands access to encrypted materials. Failure to comply with the order could result in contempt of court charges and lengthy prison sentences. Bitcoin uses private keys to sign and authorize transactions to transfer bitcoin. Encryption is used to encrypt private keys and messages containing transaction data, protecting this sensitive information from hackers. Courts may one day use key disclosure laws to force suspects i.e. people who have not yet been convicted of a crime to turn over the keys needed to decrypt such sensitive data. Courts may also force the disclosure of Bitcoin private keys so that the court can appropriate the bitcoins on behalf of the government or a plaintiff in a lawsuit.

Key disclosure laws put bitcoin owners at risk by creating a legal avenue by which they may be forced to disclose the private keys that control ownership of their assets and protect their transaction data, even if they are not convicted of a crime. This could open bitcoin owners up to theft by corrupt government agents or hackers who gain access to the private keys that have been involuntarily disclosed to the government.

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8. Intellectual property laws

Intellectual property (IP) laws turn ideas into private property. Such laws grant companies and individuals a government-granted monopoly over unique innovations, such as certain kinds of bitcoin wallets or mining chips. Once this monopoly is granted, the company that owns the IP via copyright, patent, or trademark can send government agents to attack anyone that copies the idea and compel the copier to either stop their IP infringement or pay rents for each copy.

This kind of monopoly on ideas slows down technological progress by making it a crime for people to copy or improve upon already existing ideas, blocking off certain avenues of innovation. While Bitcoin itself is free software, open for all to copy, remix, reuse, and redistribute, the same is not true for innovations built on top of Bitcoin. This has the potential to centralize control of important innovations in Bitcoin in the hands of a small group of people, who can then use this control to extract rents from the ecosystem or even take control of the network itself through e.g. mining centralization.

There is good work being done to counter-act the negative effects that intellectual property laws have on innovation in the technology industry. To fully protect creativity and innovation, intellectual property laws must be abolished so that people are once again free to copy, modify, and reuse ideas and information as has been done since the dawn of our species.

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9. Internet controls

As a peer-to-peer digital currency, Bitcoin is almost wholly dependent on the internet for its existence. In theory, Bitcoin can be used without the internet, but the inconvenience of “sneakernet” transactions makes the technology impractical to use and eliminates the majority of benefits offered by Bitcoin. The internet has become essential in other parts of modern life as well, from academia and business to entertainment and social services.

In recognition of the internet’s importance and power in society, governments have begun enacting various laws that impose controls on the kinds of content that people within their jurisdictions may publish and consume. In China, these controls on the internet are so pervasive and totalitarian that they have been given a nickname: the “Great Firewall of China,” a reference to the famous wall that once separated China from its northern neighbors.

Internet controls have the potential to negatively affect Bitcoin in several ways, including:

  • Privileging or harming miners by manipulating internet speeds in and out of the country.
     
  • Filtering out Bitcoin transactions passing through unencrypted connections.
     
  • Limiting the information that locals can find about Bitcoin, distorting their view of the technology in ways that may be good for the government but bad for Bitcoin.
     
  • Limiting the dissemination of dissenting viewpoints that would question government policies about Bitcoin, alternative currencies, the internet controls themselves, and other relevant issues.

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10. Corporate espionage

Allegations of corporate espionage by governments around the world are among the most troubling revelations to come out of the classified documents leaked by Edward Snowden. Governments have allegedly gone so far as to have their agents infiltrate private companies without the knowledge of those companies to spy on internal processes and interfere with the security of information technology products. In early 2015, it was revealed that spies working for the U.S. and U.K. governments allegedly hacked into the network of a German company called Gemalto, compromising private keys produced by the company for cellphone SIM cards and enabling the spies to decrypt the communications of potentially billions of cellphones without a warrant.

While the Bitcoin network is not yet large enough to warrant the kinds of expensive infiltration tactics seen in previous government operations, it’s possible that Bitcoin companies may become influential enough in the future to become serious targets for corporate espionage by governments around the world. Bitcoin hardware manufacturers, miners, wallet developers, exchanges, and other influential members of the Bitcoin industry could all be targeted, and will need to prepare accordingly.

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Free Bitcoin

Like all government regulations, these interventions are creating distortions in the Bitcoin economy that prevent the market and technology from growing naturally and organically, instead crippling Bitcoin in some areas and subsidizing growth in others. As Bitcoin’s influence grows, it will become increasingly important that Bitcoiners recognize government interventions that affect Bitcoin’s growth and then work with others in their area to put an end to these interventions so that Bitcoin can grow to its fullest potential without unfair help or hindrance.

Originally published on my personal blog at lightco.in.

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