Bitcoin invades mainstream banking system

Bitcoin 101Digital Currency Exchange, Bitcoin-Central, has been authorized by the French government to conduct bank style operations. In an announcement last month on, Paymium, the organization behind Bitcoin-Central said this:

We’re announcing today that is getting, through a partnership with Aqoba, allowed to operate like a bank, (or more precisely like a PSP [Payment Service Provider], which is basically the same as a bank, just without the debt-money issuing part).

If you’ve been following the crypto-currency story, you will realize that this is a huge step forward. For the first time a crypto-currency exchange has been brought into the mainstream banking circle, allowing believers in the idea of free choice in currency the opportunity to transact business through traditional channels. Bitcoin is, fundamentally, a currency; and, like any other currency, its purpose is to provide a means of exchanging good and services between individuals. Unlike government-sanctioned currency, however, the premise of Bitcoin is to remove the centralized, governing force from taking over the creation of the currency.

Bitcoin is a system of owning and voluntarily transferring amounts of so-called bitcoins, in a manner similar to an on-line banking, but pseudonymously and without reliance on a central authority to maintain account balances. If bitcoins are valuable, it is because they are useful and limited in supply.

Bitcoin is based on a concept known as crypto-currency that was originally described in 1998. Subsequently, Satoshi Nakamoto developed the first software to power Bitcoin, but no one knows exactly who Nakamoto is. He has remained an enigma even though his software is now used by millions of people to process millions of transactions representing millions of dollars in non-government controlled currency. Rather than deriving value because a central authority such as a government deems them valuable, as is the case with fiat currencies such as the euro, yuan, yen and dollar, Bitcoins have value because people know the supply is limited and unchangeable by planners. A April 2011 Forbes column describesthe system as simply as any:

As with shiny-metal-backed currencies, Bitcoins derive their value partly through their scarcity, which is defined not by how much can be dug up with shovels but by a cryptographic lottery. Anyone can get Bitcoins without paying cash for them by downloading and running Bitcoin’s “mining” program. The machines in Bitcoin’s mining network, now in the thousands, compute an encryption function called a “hash” on a set of random numbers, and coins are awarded every ten minutes to whichever miner happens to compute a number below a certain threshold.

That lottery tightly controls how many Bitcoins are created. There are currently close to 6 million in existence. By 2014 there will be about twice that number. Bitcoin’s distributed software is set to slow production over time so that there will never be more than 21 million in circulation. “No banker can control it. No evil dictator tyrant can print zillions and destroy the value,” says Bruce Wagner, organizer of New York’s Bitcoin developer’s meet-up.

With Bitcoin, the value of the currency is secured by limiting the total amount of coins that can be created. Unlike centrally controlled banking systems that allow an unlimited amount of currency to be created, causing the devaluation of that currency and robbing its holders of their wealth, Bitcoin has built-in controls that, when reached, prohibit the creating of additional currency. In other words, no fiat currency-style devaluation is possible. Of course in order to have value, Bitcoins must be accepted payment in exchange for something else of value. An alternative and surprisingly large and widespread economy has evolved around the currency, according to the 2011 Forbes report:

Of course, the other factor that determines the worth of a currency is whether anyone will accept it in exchange for goods and services. And for Bitcoin, a subculture of geek-friendly merchants is catching on. About $30,000 worth of Bitcoins change hands every day in electronic transactions, spent on Web-hosting, electronics, dog sweaters and alpaca socks.

The December announcement by Bitcoin-Centralis undoubtedly sending shock waves throughout the banking industry, not to mention central banks worldwide, because it represents Bitcoin’s mutational leap from its online alternate economy to the mainstream global economy.

The digital currency, still widely dismissed by many as Internet play money, gained an unprecedented foothold in the traditional banking world. In December, a Bitcoin currency exchange in France became the first to officially operate within the European financial system. Bitcoin-Central, and its parent company, Paymium, will offer their Bitcoin customers a legitimate French payment account through a partnership with the French financial firm Aqoba. Users will be able to buy euro-priced goods with a debit card attached to that account, and even have their salary paid into it. The account can then be used to buy Bitcoin-priced products online through Bitcoin-Central and, alternatively, trade in Bitcoins for euros.

Bitcoin represents such a paradigm shift in the concept of currency that, unlike some other forms of alternative currencies, it may be inherently resistant to government regulation, as Erik Voorhees, marketing and communications director for Bitinstant, wrotefrom a Rio de Janeiro North American Payments Association conference last fall. During the conference a senior attorney for the Federal Reserve presented on an obscure provision of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act that would tax any remittance payment company (RPC) making international payment transfers.

What the law means is that any company sending consumer money abroad, for any reason, must disclose an array of information that is actually quite difficult (and in some situations impossible) to disclose. It means that the cost of international payments – using the traditional money system – is inevitably going to increase by a non-trivial amount. Further, some RPC’s will just drop such service entirely for these onerous rules (this was confirmed by a banking official there, who conveyed how his bank was considering this very thing).

Except, Bitcoin, which would fall under the definition of a RPC,  “is not a company, but a decentralized computer network,” Voorhees writes.

Bitcoin itself clearly is the RPC, and will clearly fail to comply, so upon whom will the penalty be laid? Without vast overstretches of authority (which, I’m aware, are not out of the question), this provision on international payments is effectively rendered “unenforceable” by Bitcoin. The law becomes impotent. Of course, it was written by people who didn’t realize an RPC needn’t be a person nor company. Color me shocked that bureaucrats didn’t anticipate what the market might create.

I asked the presenter about this exact phenomenon—that this provision couldn’t be levied against Bitcoin as an RPC—and his reaction was amusing. After some back and forth explaining, he said “well, if the regulators don’t like what Bitcoin is doing, it’s very possible they could come after you,” to which I responded, “but that’s just it, there is no ‘you.’” He got that point, and then said, “well, then it’s likely the regulators will go after the infrastructure—they’ll go after the server farms.” To this, Charlie held up his laptop, and said, “but this is the farm!” Clearly the speaker didn’t yet comprehend the awesome power of Bitcoin. He didn’t realize there are no farms to seize, and this is one of the top legal counsels to The Federal Reserve.

Operating as they do under the thumb of central banks, traditional banks will have to decide if jumping into the crypto-currency market is a good decision. As we reported in MintChip Misses the Point of Digital Currencyattempts by Canada’s central bank to gain a foothold in digital currency has completely missed the most important tenet of digital currency—no central control.

However, digital currency is not simply about taking official money and making it useful for online and offline environments in a digitized form. The point of digital currency, and especially free-market digital currency, is to broaden the avenues for issuance and adoption of alternative nonpolitical monetary units. Most electronic cash systems already expand and revolve around the State-issued currencies, although they don’t have to.

If you’ve been following the Bitcoin story for any period of time, you have seen big government’s criticism that the system is nothing more than a gathering place for illegal businesses and even terrorist plots. Yes, Bitcoin promotes privacy and anonymity, but that is more the result of people’s natural desire for freedom of choice. See Free Competition in Currency Act [WOULD GIVE] Americans Freedom of Choice.

In truth, the creative spark that has generated so many forms of alternative currencies is nothing more sinister than the natural human impulse for self-preservation. But the U.S. government has a strong vested interest in preserving the legitimacy of and confidence in the dollar—after all, if you’re a fiat currency, completely unbacked by any tangible commodity, confidence is all you got.