Bitcoin
Alan L Tyree

On 31 October, 2008 Satoshi Nakamoto posted a message on the Cryptography Mailing List announcing the availability of a research paper entitled "Bitcoin: a Peer-to-Peer Electronic Cash System".¹

According to Nakamoto, the essential characteristics of the new system are:

• Double spending is prevented using a peer-to-peer network;
• there is no 'mint' or other trusted parties;
• participants may be anonymous;
• new coins are 'mined' through a cryptographic process; and
• the same cryptographic process is used to prevent double spending.

Nakamoto was active on the Cryptography Mailing List and in developing software to implement the ideas explained in his paper. The software and Bitcoin itself went public on 3 January, 2009. The software is open source and is available for all major computer operating systems.

Nakamoto disappeared in April 2011 after sending a note to one of the Bitcoin developers saying that he had 'moved on to other things'. His or her identity is still unknown, although an article in the New Yorker suggested several possibilities: see (Davis 2011).

Bitcoin claims to solve a number of 'problems' associated with making payments at a distance.²

Transferring money through conventional channels is costly, particularly when it is an international transfer. For example, sending $500 to the Solomon Islands costs a minimum of 10% if the transfer is done through a bank, and can be as high as 20%. These fees may be reduced to about 8% if a transfer agency is used instead.³ Even using specialised services may be expensive when the exchange rate is taken into consideration. There may be additional charges at the receiving end.

Transfers are not always very speedy. Transfers can seldom be made in less than an hour, and 'standard' transfers though main stream banks may take 2-5 business days.⁴

An account may be required at the sending location or the receiving location or both. Bitcoin enthusiasts dislike accounts, probably more than the traditional reader of this Journal. Accounts mean loss of anonymity and vulnerability to freezing or seizure. While these are seen as favourable traits by regulators, they are also traits that make Bitcoin attractive to certain persons. As with the desire for privacy, it is not necessarily because these people are engaged in nefarious activities.

Finally, something that angered a large section of the community and infuriate Bitcoin enthusiasts was the organised denial of service for making payments to Wikileaks. Bitcoin enthusiasts saw this as an arbitrary exercise of private power to please governments, often foreign governments. PayPal, Visa and Mastercard refused to process donations to Wikileaks in spite of no charges being brought or any illegal activity identified.

Bitcoin could solve all these 'problems':

• it is and will remain cheap to transfer value;
• it is virtually instantaneous;
• it requires no accounts; indeed, it is impossible to know who 'owns' Bitcoins;⁵ and
• it is free from the arbitrary exercise of government or private power.

In addition, the algorithm which allows Bitcoins to be 'mined' also controls the rate at which the currency expands. The number of Bitcoins will expand in an orderly, gradually decelerating, fashion until there are a total of 21 million Bitcoins, a level which will be reached somewhere around 2140. There is no such thing as 'quantitative easing' in the Bitcoin universe.

'Digital cash' is a catchy name for a simple concept. A 'coin' is an encrypted computer file. The coin contains certain information, most notably a serial number that identifies the coin uniquely.

If P wishes to purchase goods or services from a seller S, then P transfers the coin to S using special software. S verifies that P is the owner of the particular coin and then takes steps to be recognised as the new owner.⁶

Since digital cash, including Bitcoin, is merely an electronic file which is encoded with certain information, some method must be found to combat 'double spending'. Until Bitcoin, the solution was a central ledger where spending could be recorded. The ledger was, in effect, a register of who 'owned' the digital coin.

Because the register was a centralised system, it had to be operated by a trustworthy entity. In practical terms, this meant that digital cash was operated by banks. From the perspective of Bitcoin enthusiasts, it also meant that digital cash was subject to all of the problems discussed above.

In the traditional digital cash system, the seller S verifies that P is the owner of the coin by contacting the register. In effect, the ownership of the coin is then transferred by the register from P to S.

Although digital cash appeared to be a radical concept, it could be explained by traditional banking law concepts. Digital cash was nothing more or less than a bank account operated in a particular fashion: see (Tyree 1999). The 'coin' represented a debt owed by the bank to the 'holder' of the coin. By contacting the register and altering it, the coin could be transferred to the new owner.

Bitcoin is different. In effect, the cryptographic verification process anonymises and distributes the ledger. Sender and receiver are identified only by untraceable cryptographic keys, but there is a public record of every coin's movement in the network. Everyone can see that a particular bitcoin has moved from P to S and this allows the code to prevent double spending.⁷

When S wishes to accept a Bitcoin from P, there is a network wide process which verifies a cryptographic puzzle. The solution is published to all participants of the network and there is verification that the Bitcoin which originally belonged to P now belongs to S. There is no central register involved, and transactions are identified only by cryptographic keys.

Bitcoins are traded against other currencies. Their value has fluctuated wildly in the time since trading was initiated.

Early Bitcoins had almost no value at all. Trading started in April 2010 at around US 14 cents, but gradually increased as enthusiasm for the 'currency' grew. It achieved US dollar parity in February of 2011, and speculators began to buy and sell Bitcoins.

A story in Forbes Magazine⁸ caused a rush on Bitcoins and by June of 2011 Bitcoins traded for over US$27. Bitcoins became so valuable that people installed special computers to 'mine' Bitcoins. According to an article in Wired, one miner had an electric bill so high that police raided his house, suspecting a hydroponic drug garden.⁹

As with so many financial bubbles, disaster was not far behind. In mid June, Mt Gox, the largest Bitcoin exchange admitted that its database had been hacked. MyBitcoin, a 'wallet storage' service, designed to be a safe location to store Bitcoins was hacked, losing about half of its stored value.

At the present time, Bitcoins are trading at just under US$5: see Bitcoin Charts mentioned above in footnote 1.

It is clear that Bitcoin cannot be analysed in terms of traditional banking law concepts. There is no debt owed by an `issuer' since there is no issuer in any meaningful sense. Bitcoin is not `backed' by any institution, and is not tied to any other currency.

A Bitcoin is not a bill of exchange or a promissory note since there is no promise to do anything at all. It would not seem to violate s44 of the Reserve Bank Act 1959 which prohibits the issue of a bill or note for the payment of money payable to bearer on demand and intended for circulation.

Section 22 of the Currency Act 1965 provides:

A person shall not make or issue a piece of gold, silver, copper, nickel, bronze or of any other material, whether metal or otherwise, of any value, other than a coin made or issued under the repealed Acts or under this Act or a British coin as defined by the repealed Acts, as a token for money or as purporting that the holder is entitled to demand any value denoted on it.

Bitcoin, being intangible, probably does not fall within the notion of `token' for money. In any case, the is no suggestion that the holder is entitled to demand any value denoted to it. And to whom would such a demand be made?

So it is probably `legal' to use Bitcoin as a mechanism for making payment for goods and services. The seller is, of course, not obliged to accept tender of Bitcoin, but may do so.

Bitcoin is one of the most interesting `digital cash' concepts to come along in many years. If it survives the vagaries of Internet commerce, it may be necessary to consider questions of regulation. By it's very nature, Bitcoin would be very difficult for any single government to regulate.