Can Bitcoin Be Trustless?

11.04.2016

Individualist societies lack solidarity relations insuring from ambiguity. An individual’s life in this kind of society mostly depends on his or her ability to purchase necessary items on markets. For that reasons, individuals look for a thing, or a commodity, that would enable them to purchase any commodity in future. Any individual looks for a commodity connecting him or her with the society, thus providing insurance against future’s ambiguity. This commodity is money.

Money isn’t heaven-sent: people choose some commodity to act as money. The mechanism of selection is variable. Importantly, no commodity turns into money for eternity, and it has always been a source of risks and ambiguity. Today, individuals believe in an possibility of exchanging one commodity for another; this belief may weaken or wither tomorrow. For that reason, individual’s trust in a commodity acting as money has to be maintained continuously.

Authorities of any country, except for those nations where USD is official currency in their national currency’s stead, care for building trust in their national currency. Developing economies struggle to inject their currencies into international monetary turnover; developed economies have their currencies dollarizing weak economies.

Money’s dependence on trust in volatile exchange rate era is way higher than back in days of gold standard. Any currency trader knows that words impact quotations as effectively as macroeconomic factors.

Anatomy of Trust

Functioning of money relies upon several forms of trust. First, it’s belief that an item is exchangeable for any commodity, which is based on relevant experience. Recurring exchange of the item for commodities by a multitude of individuals reinforces their confidence that this unspoken rule will carry on.

However, unspoken rules are breakable for the sake of profits. For that reason, secondly, trust in money relies upon trust in the state or any other authority capable of legal forcing. If a market player starts falsifying money or otherwise break the rules of exchange, the authorities will force them to comply with the rules.

For instance, in 18th century England, nearly 65% of those accused of counterfeiting money have been executed. This reaction is explainable with seriousness of the issue of trust in money. Fake money causes troubles not only to those receiving it as a payment. Counterfeiting not only undermines trust of individuals to this sort of money; it undermines the market’s confidence in rules of exchange and counterparties thereto, as well as in authorities that are supposed to maintain the rules.

Therefore, the third and the most fundamental form of trust is market players’ trust in social system behind the money. It is the trust in the very design of the society offered by authorities. If authorities violate basic values of the society, the trust in money fades.

Capitalism of free competition era considered gold standard a norm, while fiat money could be introduced only as a temporary and extreme measure. Contemporary state monopoly capitalism considers fiat money a norm. The policy of wealth redistribution via money supply manipulation is also a norm, as the policy is aimed at such socially important issues as economic growth and countering unemployment.

This form of trust is especially vivid during civil wars. The foes may issue their own money, mostly to fund the warfare. It happened during Russian civil war. Turnover of such money and extent of their acceptance on market reflect not only the forcing capability of the issuer, but also signify social support for the issuer.

Still, does bitcoin need those forms of trust?

Bitcoin and three forms of trust

First form. Money holder believes in possibility of exchanging it for goods. Bitcoin holder believes in possibility of exchanging it for money. Regular owners, miners, payments services, traders – they all believe in it. Even those who not just pretend to accept bitcoins by using services of payments processors, but actually sell goods for bitcoins, believe in that, too.

This confidence is developed thanks to market-makers who buy and sell vast amounts of cryptocurrency at exchanges. They maintain the cryptocurrency’s liquidity, and daily reinforce the ecosystem’s trust in retention of the system.

Second form. Bitcoin is not a legal tender in any jurisdiction. Nobody is obliged to accept bitcoins as payments or as means of repayment. On the one hand, lack of governmental forcing, which legal tender status is associated with, complies with anarchic ideology. On the other hand, legitimization of money reinforces individual’s confidence in future. Money is in fact a weapon pointed at ambiguity.

Customers of banks trust them not only because it’s not the first day of banking. If a bank violates exchange rules, authorities will imply their forcing functions. Activities of crypto-industry players, however, is still mostly based on the first form of trust.

Primordial bitcoin did not imply any third parties for transactions. Its current form implies key players, absence of which would have made normal operation impossible. It’s mining pools, wallet providers, exchanges, and payment operators. Regular bitcoin users just have to trust those intermediaries.

If those intermediaries suddenly decide to do something profitable to them and impairing regular users, no authority could force them to comply with rules that, by the way, are not provided by any contract. Even though bitcoin itself has received official legal interpretation in several currencies, no regulations for crypto-exchanges have been developed yet.

The only example of such regulatory framework known today is New York’s BitLicense. Some crypto-exchanges abandoned the state of New York after the framework had been enacted. Decentralized wallets and exchanges, just like smart contracts, are here to reduce the risk of failure to meet obligations via their automation instead of criminal punishment risk. However, those projects in their current form cannot resolve the matters now.

Third form. Social design, which bitcoin has been initially associated with, is cryptoanarchy. There is no government or any kind of authorities by definition. However, there is a Creator of bitcoin, there is a Bitcoin Jesus, Bitcoin evangelists, and regular believers. The farther they go from cryptoanarchy, the less trust regular believers will have in bitcoin.

This certainly does not mean that bitcoin cannot be ideologically redesigned. If someone associates it with a less radical social design, a larger and more moderate community may support it.

Justification of Trustless Money

Ripple stresses that XRP, just as bitcoin, is not an amortizable balance, so it does not imply any trust in a third party, and has no counterparty risks. Certainly, as nobody undertakes to amortize bitcoins or even accept them as payment, there is no risk that someone fails to comply with the obligations in questions. Does it mean bitcoin needs less trust than other forms of money?

There is no trustless money; however, trust related to different kinds of money has its own specificity. In some sense, even gold coins are based on trust, however, credit money require more trust, while fiat money require even more. Therefore, bitcoin, being fiat money without any obligations of the issuer, require even more trust. Bitcoin is by no means trustless money.

Private cryptocurrencies require even more trust than national. This could be the reason for their volatility, and trust in them is extremely fragile. Math is better at a stable supply of money than the state, however, neither math nor state may maintain stable demand.

Obviously, state regulation of bitcoin is contrary to its ideology that had inspired its creator, and that continues inspiring lots of enthusiasts. However, it is just as obvious that news on ban of bitcoin push its exchange rate downwards. Similarly, news on government acceptance reinforce trust in math-based currency Bitcoin, thus increasing demand and pushing the exchange rate upwards.

Is there anything more inspiring and trustworthy than increasing exchange rate?

by Dmitri Bondar

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Tags: Bitcoin