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they may be accepted by someone else. They are inherently fragile; government orders can be ignored or doubted, and a currency that has value only because of the belief that it will have value may have no value at all (for instance, if I believe that no one will accept it, I will not accept it either). The term “mining” may lead one to think that bitcoin is not fiduciary. It is true that real resources (computing hardware and energy) are expended in creating bitcoins. Since entry to min- ing is free, the value of these resources will be the market value of bitcoins pro- duced (whose number per day does not depend on the size of the network). But once created, the bitcoin has no value other than in exchange, contrary to a gold coin. Bitcoin’s viability as currency Can bitcoin truly rival or even replace existing currencies—particularly in the form of cash? A dollar bill in my hand cannot be anywhere else at the same time, my ownership of it is undoubted, and it can be exchanged immediately and finally. The many ingenious features of bitcoin try to emulate these properties of cash, but do so at some costs. One prominent cost is the loss of anonymity. Possession of the virtual currency must be linked to the unique identifier of the wallet. Admittedly, there is no limit on the number of wallets one can own and there are ways to make the wallet hard to trace back to its owner, but these require additional efforts. Another cost of using bitcoin is in the speed of the transaction. At a minimum, one must wait ten minutes for the proposed trans- action to be included in the block chain, and for large amounts it is customary to wait for six blocks, or one hour. These times are much slower than those to com- plete electronic retail transactions in most other currencies (e.g., a few seconds to charge a credit card either online or at a physical retail location), not to mention the times to make large financial trans- actions on standard networks. Why this delay to complete bitcoin trans- actions? It is rooted in the decentralized nature of the bitcoin network (and its reliance on a sort of majority voting), which is both its most ambitious feature and its main vulnerability. The confir- mation that the bitcoin is not being spent twice must await validation by the net- work, requiring at least ten minutes (al- though confirmation might be skipped for small transactions). Moreover, there have been a few instances of “forks,” mo- ments when part of the network accepted one new block as valid while another part rejected it and accepted a different block. These incidents happened for accidental reasons, but a fork could some- day be the result of malicious action. It is generally thought that it would be too expensive for a single malicious user (or group of malicious users) to take over more than half of the network; but if bitcoin were to grow significantly in value, this calculation could change. One well-known fork that emerged in March 2013 was due to nodes using two different versions of the bitcoin proto- col.4 This incident reminds us that the bitcoin protocol is based on open-source software. Bitcoin is what bitcoin users use. The general principles of bitcoin and its early versions are attributed to an otherwise unknown Satoshi Nakamoto;5 improvements, bug fixes, and repairs have since been carried out by the com- munity of bitcoin users, dominated by a small set of programmers. Although some of the enthusiasm for bitcoin is driven by a distrust of state-issued cur- rency, it is hard to imagine a world where the main currency is based on an ex- tremely complex code understood by only a few and controlled by even few- er, without accountability, arbitration, or recourse. The role of the state A fiduciary currency like bitcoin is use- ful only insofar as others accept it broadly. As a matter of theory, this broad accep- tance need not rely on the state, and history certainly offers several examples of currencies used without state support, oftentimes because the state-sponsored currency was proving deficient. But throughout most of Western history, the state has involved itself in money. At a minimum, the state has used money as a coordinating device, usually sup- porting its value by accepting it in the payment of taxes. The state has also concerned itself with money because one main function of money is to free a debtor from his or her obligations, tying money to an essential state func- tion, the administration of justice. That is why the U.S. Constitution gives Congress the power “to coin Money, reg- ulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.” Bitcoin is free of the power of the state, but it is also outside the protection of the state. How likely is bitcoin to remain so if it gains wide acceptance and the incentives to hijack it grow accordingly? Fraud concerns To the extent that the motivations of bitcoin’s founder, Satoshi Nakamoto, can be discerned from his original paper, they revolved around transaction costs, which he argued would arise mostly from the need to preclude fraud. His proposal was for a low-cost secure payment system that did not involve a central authority or “trusted third party.” The resulting invention of a state-independent unit of value is remarkable but perhaps co- incidental. Much of the interest in bit- coin is inspired by the ideas of Friedrich Hayek,6 that money should cease to be Charles L. Evans, President; Daniel G. Sullivan, Executive Vice President and Director of Research; Spencer Krane, Senior Vice President and Economic Advisor ; David Marshall, Senior Vice President, financial markets group; Daniel Aaronson, Vice President, microeconomic policy research; Jonas D. M. Fisher, Vice President, macroeconomic policy research; Richard Heckinger,Vice President, markets team; Anna L. Paulson, Vice President, finance team; William A. Testa, Vice President, regional programs, and Economics Editor ; Helen O’D. Koshy and Han Y. Choi, Editors; Rita Molloy and Julia Baker, Production Editors; Sheila A. Mangler, Editorial Assistant. Chicago Fed Letter is published by the Economic Research Department of the Federal Reserve Bank of Chicago. The views expressed are the authors’ and do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System. © 2013 Federal Reserve Bank of Chicago Chicago Fed Letter articles may be reproduced in whole or in part, provided the articles are not reproduced or distributed for commercial gain and provided the source is appropriately credited. Prior written permission must be obtained for any other reproduction, distribution, republica- tion, or creation of derivative works of Chicago Fed Letter articles. To request permission, please contact Helen Koshy, senior editor, at 312-322-5830 or email Helen.Koshy@chi.frb.org. Chicago Fed Letter and other Bank publications are available at www.chicagofed.org. ISSN 0895-0164PDF Image | Chicago Fed Letter Bitcoin: A primer
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