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Smart regulation of bitcoins?

Mt. Gox has suspended payments, at least until Monday, February 10. A suspension of payments means that it is not possible to withdraw funds from Mt. Gox. This is not a problem at a small outfit. Mt. Gox was the by far largest exchange for bitcoins at least until the last few months. Mt. Gox seems to have had difficulties redeeming accounts for some time. The problems started about the same time that the Financial Crimes Enforcement Network in the United States started treating Bitcoin firms as money transmitters and reportedly seized accounts in the United States related to Mt. Gox.

It is odd to read a spokesman for the Bitcoin Foundation — Jinyoung Lee Englund — say that the United States has a “smart regulation approach” at the same time this problem occurs.

But then again, maybe creating substantial difficulties for firms dealing in bitcoins is smarter than trying to ban them? The Russian government has announced that bitoins are banned in Russia.

Trying to ban bitcoins is not particularly bright. It shows a lack of knowledge, imagination or both. Bitcoins can be transferred around the world trivially by parties who completely trust each other. Anyone who has bitcoins in Russia can transfer funds abroad if they have someone they trust outside the country. It is equally easy to make the reverse transaction, bringing bitcoins into the country. Maybe bitcoins would be brought into Russia to sell? An institution such as Mt. Gox is not necessary.

 

 

Bitcoin and other digital currencies

Bitcoin has been much in the news lately. I have written a draft of a paper on “The Economics of Private Digital Currencies”. The paper uses Bitcoin to concretely summarize how private digital currencies work.

There are two major innovations associated with recent private digital currencies such as Bitcoin. The first is the settling of transactions by a peer-to-peer network. Instead of settling transactions on the books of a single institution such as the Federal Reserve in the United States, transactions are settled on a network in which no link inherently has more standing than any other link. More concretely, transactions are settled by agreement among participants in the network, for example Bitcoin’s network. The paper goes somewhat into the details without, I hope, becoming tedious for non-programmers.

The second innovation is the creation of exchanges in which buyers and sellers of Bitcoins are “end users” – people how hold bitcoins or want to buy bitcoins instead of agents such as brokers – and the trading is computerized without human intervention. This has resulted in 24/7 trading, which is quite different than trading on organized exchanges. It is more similar to Ebay than the New York Stock Exchange.

Whether Bitcoin or any other digital currency will exist in a couple of years is an open question. A close examination of Bitcoin reveals no inherent design flaws indicating that it will ultimately fail. The question is whether it will be useful. As with many other innovations, this is hard to tell.

The paper is available at http://www.jerrydwyer.com/pdf/digitalcurrency.pdf.