April 5, 2016

Bitcoin Without the Bite: Can Digital Currencies Help Governance?

Bitcoins

Bitcoin is a decentralized digital currency. It allows individuals to digitally generate currency through ‘mining’ — a process that leverages the individual’s computational power to solve algorithms (a short video summarizing ‘mining’ can be viewed here). ‘Miners’ are rewarded for their solutions with coins that can be used in a secure and anonymous manner to conduct transactions. Given the possibilities, it is understandable why Satoshi Nakamoto’s initial white paper on Bitcoin served as a clarion call for libertarians. Here at last, was an idea that freed netizens from the tyranny of currency generation — a long-lasting bastion of state monopolies.

Such a dramatic interpretation of Bitcoin’s birth is only appropriate, given the currency’s flair for drama (at times providing enough material for popular television shows!). The 2015 year began with the arrest of Ross Ulbricht, the man behind Silk Road — an online marketplace that allowed users to purchase illegal goods and services using Bitcoins. Silk Road’s high-profile case brought public attention to the darker possibilities of an unregulated currency. And, yet, by the end of 2015, Bitcoin rebounded to become the best performing currency of the year. Similarly, 2016 began with a public fallout amongst Bitcoin’s core developers. Despite this, some observers believe this is the year Bitcoin will finally stabilize as a currency.

Given this storied history, Bitcoin may seem an unusual topic of choice for a blog post on governance innovation. If a volatile, decentralized currency can support illicit activities, shouldn’t we just regulate it? How can such currencies support governance innovation? While considering these questions, I believe it is more important to consider the larger idea Bitcoin represents, rather than assess the currently available product. More specifically, there is a need to separately unpack the key words I used to describe Bitcoin — ‘decentralized’ and ‘digital.’

Many of the governance challenges posed by Bitcoin stem from decentralization. Decentralized currency generation means a sovereign nation’s central bank can no longer actively control the money supply. This is not as unusual as it sounds — think of the EU member countries handing over this power to the Euro Central Bank. But, the problems posed by Bitcoin’s model for decentralization do not end at macro policy — it has surprising implications for social equity. ‘Decentralized’ generation doesn’t mean everyone in the world has an equal opportunity to mine coins.

Mining has increasingly become an energy and resource intensive activity, restricted to people with access to technological knowledge and hardware. One could make an argument that mining merely reduces currency printing to an economic activity — a service with a value and a price. However, if mining were ever to be taken over by organized cartels, the decentralized nature of Bitcoin would ensure their anonymity. Within the Bitcoin community, conspiracy theories of mining cartels abound. In any scenario, if Bitcoin were to be scaled as a mainstream currency, the point that it may further entrench the digital divide between the rich and the poor is not a trivial one.

Despite these drawbacks, from a governance perspective, much of the promise of Bitcoin is held in the word ‘digital’. To understand this, let us summarize the problems with physical cash. First, physical cash can be spent anywhere without any information trail — this leads to the problems of corruption and black money. Second, cash needs to be transported physically — a challenge in developing countries that do not have strong enough banking networks. And, third, holding and withdrawing cash necessitates the involvement of third parties. Banks have been performing this function for centuries. Digital currencies can enable software to efficiently scale alternatives to traditional transaction services.

Digital currencies can resolve many such challenges. Bitcoin, in particular, offers the greatest asset a digital currency could possess in this regard. The underlying technology behind Bitcoin is the blockchain protocol, which ensures no successful transaction can ever be erased. Theoretically, this means no transaction can be completed off the books, limiting the possibilities for paying bribes, creating black money, or evading taxes. Digital currency can also be used as a tool for financial inclusion, by progressively reducing the developing world’s dependence on banking agent networks for last-mile cash distribution. With rapidly growing access to mobile Internet, one can imagine a future where digital currency can be mainstreamed.

Tunisia’s e-Dinar marks the first attempt by a government to create a digital currency based on Bitcoin’s blockchain technology. The currency is still generated by the country’s central bank — underlining the fact that digital currency need not be synonymous with decentralized currency. Bitcoin is a harbinger for a future that no longer relies on physical currencies. While the final chapter on Bitcoin is far from written, focusing only on the product rather than the possibilities it represents may be a case of missing the trees for the woods. Bitcoin powerfully reimagines what it means to be a currency. From the perspective of policymakers, it represents an opportunity to resolve age-old problems with cash transactions.

The views expressed in the Government Innovators Network blog are those of the individual author(s) and do not necessarily reflect those of the Ash Center for Democratic Governance and Innovation, the John F. Kennedy School of Government, or of Harvard University.

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