Why Bitcoin Scares the Crap Out of Governments and Banks

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Depending on who you speak to, Bitcoin is either the most perfect example of a speculative bubble or it’s an attempt by software to eat the banking industry.

Unless you’ve been living under a rock, everyone is talking about it.  It has become a mainstay in the mainstream media outlets such as BBC News, Time, Wall St Journal and the Tech Press.

It’s also incredibly misunderstood.

What’s got the geeks so excited?

Sillicon Valley’s super VC Marc Andersen put it best

“I would not encourage your grandmother to put her life savings in [Bitcoin],” he said. “[But] every single smart computer science person I’ve had look into it has reached the same conclusion — it’s a fundamental breakthrough in technology

To understand why Bitcoin is such a breakthrough, it helps to understand why we have organised ourselves with Governments, Banks and Religion for the last several thousand years…

The Byzantine Generals Problem

So imagine you’re surrounding an enemy fort, you want to tell the other four Generals surrounding the fort that now is an opportune time to attack.  But beware! The Byzantine Messengers and Generals were known for treachery so any communication is risky without one very trusted source of information or a hierarchy of trust.

So we organised ourselves into hierarchies to keep order and control.  The bigger the bank or government the more stable it was, the safer your money was and the more you could trust it.

The Ivory Tower is Crumbling

Trust in Governments, Banks and any form of control is at an all time low because:

  • News breaks at the speed of a tweet
  • The financial crisis made “bigger” seem worse not better
  • Broadcast is being replaced by “Share”

The result?  Arab Spring, #Occupy and Bitcoin are just the opening salvo in a paradigm shift (in the truest sense).

But I don’t think it’s just the “nasty man in charge” that’s the problem.  The problem is systemic.

Scale is Becoming a Disadvantage.

A Global Corporation simply cannot address your concerns on the personal level because it’s driven to increase profits, lower cost and keep the machine moving.  Corporate’s are trying to adapt and humanise their business but over time the ones that survive will be much leaner, more automated and present a human face to the world .

Peak Jobs – Like Peak Oil but Worse?

In the relentless drive for scale, efficiency and automation “The middle class is steadily eroding.” According to a recent New York Times Article “Last year, the richest 10% received more than half of all income, the largest share since such record-keeping began in 1917.”

The reason some Governments and Banks are equally intrigued and terrified of Bitcoin is because it has the potential to reverse the trend.

To understand why Bitcoin is so disruptive, let’s explore how it works… 

Understanding Bitcoin: The Concept

To summarise this 10 page article (which blew my little mind) when Satoshi Nakamoto invented Bitcoin he intended to build three things, but actually only delivered two

  1. A new secure way to transact online, securely, anonymously and instantly – Half of Bitcoin
  2. A currency with real world value – Half of Bitcoin
  3. A scripting language to allow software engineers to write code to make Bitcoins do very clever things  - Not part of Bitcoin

This is important, we’ll come back to it

Understanding Bitcoin: A New Way to Transact

When I make a transaction today for say £50, it’s held in a bank’s ledger.  The ledger is essentially a big list of who’s paid who.  It’s very secure, and it’s only shared with other banks to protect it.

With Bitcoin, every single Bitcoin user has a copy of the ledger, which would be like everyone you’ve ever met having a history of every transaction you and everyone else ever made.  On the face of it sounds really dangerous, but in reality it’s incredibly powerful.

So because every transaction ever made in history is held by everyone on the network…

The network itself is the ledger.   The Bitcoin geeks call this is the “blockchain”.  The blockchain has every transaction ever made and it doesn’t require a central “Bank” or “Government” to prove a transaction happened.  It trusts the x Million people on the network more than one powerful organisation.  In this network, you can gain or lose new people daily, but because everyone has a copy nothing ever gets lost.  No more relying on the bank to keep things secure?

Understanding Bitcoin: A Currency with Real World Value

Bitcoins themselves have a value in real world currency, a Bitcoin is worth about $400 at the time of writing.  Unlike a paper currency there is no central bank printing money to deflate a currency but a computer algorithm.  The maths in the algorithm limits the network to producing one new Bitcoin every 10 minutes.

Bitcoins are discovered through a process called mining which will be familiar to any of you who ran SETI@Home back in the day.  Essentially a program on your computer does incredibly hard maths to “find” a Block (like finding a very long prime number) and this Block is added to the “blockchain” and will validate transactions (For example between Simon and his Dad for £100).  By adding a block to the block chain – everyone in the network now knows Simon paid his Dad £100 – and doesn’t need to check with a bank

There’s also a reward of finding a “block” which is 25BTC (which at the time of writing is just short of £5,000) Whilst money for “nothing” sounds good Miners are actually doing the community a service by providing “blocks” to validate transactions on the “blockchain”.

You can think of the reward as a way to incentivse people to leave their computers turned on all day to generate blocks.  The only problem is, as more people join the difficulty is artificially inflated to keep the block creation steady.

Herein lays Bitcoin’s flaw, so many people are trying to mine that adding to the blockchain is out of reach for most mere mortals, but it needn’t be if the currency hadn’t been intrinsically linked to the blockchain…

Understanding Bitcoin: Smarter Bitcoins and Scripting Languages

Ok, so Bitcoin doesn’t have a scripting language but if we take the first two concepts of a blockchain and real world value exchange and throw a script into the mix, things get quite interesting.

Initially this could be used to sign documents, store data securely, keep your money secure, buy property and much more (services like Mastercoin are doing this today).  All of this would happen without a central “agent”.  Imagine getting rid of the “estate agent” or insurance “broker”.  The sales job isn’t replaced, but the secure contract no longer needs a middle man…

Satoshi didn’t include a language in Bitcoin because you can really mess things up but as the guys at Ethereum point out, it could also do some amazing things if you got it right because of a concept called…

Distributed Autonomous Organisations

With a scripting language that can manage contracts you can write code that will replace an entire company, political party or even religion.  When your car is able to buy energy from the “gas” station using your Bitcoin wallet whilst you’re in the bathroom… that’s when software is able to communicate between blockchains in a secure distributed way.

There is opportunity here for the companies that get this right, but what are the odds the companies that do, are the big lumbering giants of today?

Are Hierarchies Truly a Dying Breed??

Probably not any time soon, but consider:

  • I believe we’ve reached the tipping point where scale is now a disadvantage for business because they cannot react to customers or change fast enough…
  • I believe the small, tech driven start-ups like Square, ZenPayroll, Transferwise and others could take advantage of the Blockchain concept very quickly…

Imagine if ZenPayroll added a feature to allow a small company to pay it’s employees in Bitcoins, directly into their Bitcoin wallet.  This future isn’t that far away or crazy.   You could soon be paid in Bitcoins, but not as we know them today.

That’s my crazy thought for the day… What do YOU think?