In the late 90’s and early 2000’s, e-gold was the industry leader.  As one of the world’s first successful online payment systems e-gold was a pioneer using many now standard practices such as SSL connections and API’s.  Brought down by a run in with regulators in 2008 the e-gold story is required reading for anyone involved in the digital currency world.

Sent in by Wikipedia editor Cadwallader, below is a thoroug review of the e-gold story.

e-gold (deliberately spelled with a lower-case ‘e’) was a digital gold currency operated by Gold & Silver Reserve Inc. under e-gold Ltd. that allowed users to open an account on their web site denominated in grams of gold (or other precious metals) and the ability to make instant transfers of value to other e-gold accounts. The company was founded in 1996 and had grown to five million users by 2009, when transfers were suspended due to legal issues. At its peak in 2008 e-gold was processing more than USD 2 billion worth of precious metals transactions per year ^[1], on a monetary base of only USD 20 million worth of gold (~2.54 metric tonnes) ^[2], indicating an extremely high monetary turnover (velocity) of about 100 times per year (similar to M-PESA). e-gold Ltd. was incorporated in Nevis, Saint Kitts and Nevis with operations conducted out of Florida, USA.

Beginnings

e-gold was founded by oncologist Douglass Jackson and attorney Barry Downey in 1996. The pair originally backed the services accounts with gold coins stored in a bank safety deposit box in Melbourne, Florida.

The company, which was launched two years before PayPal and had obtained over one million user accounts by 2002, and was the first successful digital currency system to gain a widespread user base and merchant adoption. It was also the first website or payment service to offer an Application Program Interface (API) enabling other services and e-commerce transactions to be built on top of it. ^[3] e-gold was used by both individuals and merchants for services ranging from metals trading, online auctions, to online casinos, and a donation platform. By 2001 several dozen companies and individuals began offering third party exchange services between national currencies and e-gold, allowing e-gold to become a company with an international user base.

e-gold, which allowed transactions as small as one ten-thousandth of a gram of gold, was also the world’s only successful micro-payment system. The company’s payment statistics were published live and showed hundreds of thousands of micro-transactions were being made daily by computer programs using the API.

Governance

e-gold was unique at the time in that they created the “e-gold Special Purpose Trust” which held title to the physical bullion on behalf of the users. ^[4] They also created a real-time statistical reports page ^[5] that showed the total holdings of each metal in the trust account, list of gold bars with serial numbers, the total number of accounts, as well as the total number and value of transactions in the previous 24 hours. This transparency enhanced e-gold’s reputation and popularity with their users, and also enabled many observations to be made about how e-gold was being used.

Imitators

e-gold’s market success by 2001 spawned a wave of imitators. These included Goldmoney.com, e-Bullion.com, CrowneGold.com, Pecunix.com, INTgold.com, and several others including a multi-million dollar Ponzi Scheme with no gold at all called OSgold.com. ^[6]

Crime Wave

e-gold’s early success also proved to be the cause of its demise. e-gold’s store of value and large user base made it an early target of financial malware and phishing scams by increasingly organized criminal syndicates in Eastern Europe. The first known phishing attack against a financial institution was made against members of the e-gold mailing list in June 2001. ^[7] The technique was refined with attacks against the digital gold systems like e-gold and later used to attack other financial institutions starting in 2003.

The Rise of the Romanian Hackers

With no effective means of verifying the identity of account holders, e-gold began to suffer from an increasing rate of criminal activity mainly perpetrated by Eastern European hackers against its users. In addition to phishing, the attackers made widespread use of flaws in the Microsoft operating systems and Internet Explorer web browser to collect account details from millions of computers to compromise e-gold accounts. ^[8]

Jackson’s theory was that e-gold is a book-entry system with account histories, making it simple to conduct an investigation to track down misappropriated funds after the fact. ^[9] However, the public perception, similar to that of Bitcoin today, was that e-gold accounts were anonymous. (That perception was erroneous, as is the similar belief that Bitcoin is anonymous.) e-gold accounts were “pseudonymous”, ^[10] allowing the creator of the account to use any name or label he wished to use. However, the account history was permanent, and e-gold could in most cases correlate a person’s real identity to an e-gold account when they funded or liquidated an account with G&SR, e-gold primary exchanger to US Dollars.

Unfortunately, e-gold users did not enjoy the same ability to determine the real identity of the owner of an e-gold account, and this is what facilitated the explosion in auction fraud and other types of identity fraud using e-gold accounts.

Fourteen Flavors of Fraud

Various fraud artists from Western countries were also able to take advantage of the e-gold system as a means of funding their schemes, enabling for the first time in history, international ponzi schemes, calling themselves “High Yield Investment Programs” or HYIPs. ^[11] DGC Magazine Editor Mark Herpel identified the probable source of e-gold’s mysterious micropayments as automated interest payments made by ponzi schemes to their tens of thousands of members. ^[12]

Perpetrators of auction fraud on e-bay who were based in Eastern Europe and would sell fake or non-existent items on the site. These criminal syndicates preferred their victims to pay in e-gold because it was the fastest and easiest way for them to move the funds overseas. ^[13]

The wave of online crime that engulfed e-gold led to a steady stream of complaints to government authorities by defrauded account holders, who often did not understand the difference between e-gold and the fraudulent person or company that encouraged them to open an e-gold account and wire money to fund it. ^[14]

The Systemic Problem

As an online transactions system with exchange agents worldwide, e-gold enabled criminals and hackers in Eastern Europe the ability to quickly and easily move money from victims in America back to the country from which the attacks were originating. Several of the cyber crime gangs that plagued and used e-gold were based in Râmnicu Vâlcea, Romania. ^[15]

e-gold was unknowingly part of a larger systemic problem with the banking system. The banking and credit system in the United states were not designed for a digital environment, and are therefore fundamentally insecure and highly vulnerable to identity theft and check fraud, as well as trust based attacks such as phishing. The willingness of credit card companies to allow people to apply for a card without being identified in person enabled the massive growth of identity theft. ^[16] (Ironically, not verifying the identities of account holders would be one of the main criticisms raised against e-gold.)

The Internet made it possible for organized crime networks outside the United States to used strategically placed members in financial institutions in the United States to perpetrate billions of dollars worth of financial crimes, primarily through identity theft. ^[17] The money from these crimes then needed to be laundered and transferred back to the headquarters of the perpetrators in Eastern Europe. This is normally done through bank wires from big american banks, such as Bank of America, ^[18] and traditional money transmitters like Western Union. ^[19] However, e-gold and other digital gold systems, with their low cost instant clearing payments and international network of exchange agents, provided a much faster and cheaper conduit for getting the already laundered money back home. Therefore, certain crime gangs started using the digital golds as the return conduit for part of their operations.

The Public Relations Problem

In 2001 Goldmoney.com was founded by James Turk and became a competitor to e-gold. Turk, who had filed patents on a digital gold payment system in 1993 but launched his system five years behind e-gold, took a two-pronged strategy to outmaneuver e-gold. First, he sued e-gold for patent infringement. ^[20] Though this action failed in court, Turk had successfully positioned himself in the market as the “inventor of digital gold” even though Jackson was the one who had taught himself how to program and written the first version of e-gold himself. (Turk sat on his patents for several years, and eventually hired a software company to build his “invention” because he is not a computer programmer.)

Second, Turk recognized the e-gold crime problem and began positioning Goldmoney as the “white glove” gold system that required identity verification to open accounts, versus e-gold as the irresponsible “wild west” operator riddled with crime. ^[21] This marketing strategy worked very effectively for Goldmoney as it drove e-gold founder Jackson to entrench himself in defense of his libertarian principle that the user is responsible for his behavior and the courts are the way for disputes involving allegations of fraud to be resolved. Ten years later, e-gold would be out of business, shut down by the US government, but Goldmoney would be sitting on USD 1 billion worth of gold and millions of users. ^{[22] [23]}

While Goldmoney succeeded in becoming the world’s largest gold storage system, and held four patents for a gold payment system, ^[24] they were never able to replicate e-gold’s success as a payment system, because they were so fearful of replicating e-gold’s success as a magnet for criminal activity. Goldmoney prohibited the development of independent exchange agents, which greatly limited their global reach. In January 2012 Goldmoney turned off the ability to make payments from one account to another citing “insignificant” demand for P2P metal transactions as not justifying the high cost of regulatory compliance. ^[25] It was e-gold’s usefulness and ease for payments combined with their international network of exchange agents that made it a magnet for crime.

There were early reports where e-gold had actively helped to catch and collar cyber criminals, such as the one who stole Cisco Systems’ firewall code and offered it for sale to be paid in e-gold. ^[26] And Jackson claimed to have “aided 300 investigations and reported 3,000 suspected kiddie porn buyers to the National Center for Missing and Exploited Children.” ^[27] However, Turk’s PR strategy was highly successful, as first Goldmoney, and then federal law enforcement agencies began to characterize e-gold as the payment system of choice for criminals, terrorists and child pornographers. ^[28] (In reality, the US Dollar is by far the most popular transaction medium for criminals of all types. ^[29] US Banks are the most popular institutions for money laundering, on the order of USD 500 Billion per year, dwarfing e-gold’s transaction volume by two orders of magnitude. ^[30] )

Criminal Prosecution

The Changing Definition of a Money Transmitter

The USA Patriot Act, passed in the wake of the 9/11 terrorist hijackings more than five years after e-gold had been launched, made it a federal crime to operate a money transmitter business without a state money transmitter license in any state that required such a license. At the time a “money transmitter” was in most states defined as a business that cashed checks or accepted cash remittances to send from one person to another person across international borders, such as Western Union or MoneyGram. For example, prior to 2010, California regulated money transmitters under the “Transmission of Money Abroad Law”. ^[31] One of e-gold’s competitors, the e-Bullion company, applied for a money transmitter license from the State of California in 2002, but was informed by the State of California that their business which dealt in gold accounts did not fall under the state’s definition of a money transmitter.

In 2004 G&SR (the parent company of e-gold) requested that the US Treasury Department conduct a compliance examination in order to clarify what regulations, if any, e-gold fell under. ^[32] The Treasury issued a report on January 11, 2006 confirming that e-gold accounts were excluded from the definition of “currency” under the USC and CFR definitions. The Treasury did not want e-gold to be acknowledged as money, which made it impossible to obtain a money transmitter license.

However, in its actions from 2006-2008 the U.S. Treasury Department in conjunction with the DOJ stretched the definition of money transmitter in the USA Patriot Act to include any system that allows transfer of any kind of value from one person to another, not merely national currency or cash. Using this new interpretation they then proceeded to prosecute the USA-based gold systems, e-gold (and later e-Bullion) under the USA Patriot Act for not having money transmitter licenses, even though these companies had previously been cooperating with regulatory authorities and told they did not fall under the definition of money transmitter. (Although the charge of not having a money transmitter license was eventually dropped against e-bullion.) Several years later FINCEN further expanded this definition to apply to foreign companies allowing US persons to open accounts, which forced Jersey based Goldmoney.com to suspend the ability to transfer value from one holder to another in December 2011. ^[33]

e-gold The Black Sheep

e-gold was in many ways the philosophical predecessor of Bitcoin. Unlike PayPal, which ran on top the USA banking system and therefore posed no competitive threat to the banking system, e-gold was a maverick outsider with no allies in the banking establishment, whose founders self-consciously viewed themselves as offering an alternative to the banking system. While banks suffer from the same problems with criminal activity, phishing, ponzi schemes and money laundering on a much larger scale ^[34], and some of the biggest banks have even knowingly participated in money laundering with apparent impunity ^[35], e-gold’s iconic status as a controversial alternative currency system loved by cypherpunks and libertarians made it an attractive target for US law enforcement agencies, with a big pile of assets to seize and few political allies.

While e-gold had begun implementing much stronger controls against abuse by users of the system by 2005, and was actively combating the use of its system for child pornography as a founding member of The Financial Coalition Against Child Pornography ^[36], the Justice Department had apparently made a high level policy decision to blame e-gold themselves for the malignant activities of a small minority of their users. ^[37] In 2007 the proprietors of the e-gold service were indicted by the United States Department of Justice on four counts of violating money laundering regulations and knowingly allowing a transaction to purchase child pornography. ^[38]

The government also claimed that e-gold was a ponzi scheme that did not have the gold to back the accounts. However, that claim was later shown to be false when judge rejected any charges of fraud regarding the e-gold user agreement and confirmed the veracity of the company’s gold reserve audit – showing that e-gold was fully reserved.

Resolution

The case against e-gold was brought under Title 18 USC section 1960 in UNITED STATES OF AMERICA v. E-GOLD, LTD, District of Columbia court. e-gold filed a motion to dismiss the case on the grounds that they did not fit the definition of a money transmitter. The court ruled against e-gold, stating that “a business can clearly engage in money transmitting without limiting its transactions to cash or currency and would commit a crime if it did so without being licensed.”^[39] This ruling enshrined in case law the Treasury Department’s expansion of the definition of a money transmitter to include any system by which stored value of any kind may be transferred from one person to another, even if the stored value is not cash, or national currency.

After vigorously contesting the charges for a year, in July 2008 the company and its three directors accepted a bargain with the prosecutors and plead guilty to one count of “conspiracy to engage in money laundering” and one count of the “operation of an unlicensed money transmitting business”, in exchange for the other charges against them (allowing a transaction to pay for child pornography) being dropped. ^[40] The company was ordered to pay fines of $3.7 million.

In November Gold & Silver Reserve CEO Douglas Jackson was sentenced to 300 hours of community service, a $200 fine, and three years of supervision, including six months of electronically monitored home detention.^[41] He had faced a maximum sentence of 20 years in prison and a $500,000 fine. Judge Rosemary Collyer said the men deserved lenient sentences because they did not intend to engage in illegal activity. Jackson’s lawyer claimed Jackson was spared the heavier fine because he is deeply in debt – the Judge said “Dr. Jackson has suffered, will continue to suffer, and may never be successful with E-Gold”. Reid Jackson, Douglas Jackson’s brother, and E-Gold director Barry Downey were each sentenced to three years of probation, 300 hours of community service, and ordered to pay a $2,500 fine and a $100 assessment.

Gold Seizure

Initially the US Attorney’s Office of the District of Columbia entered a motion to seize and liquidate the entire gold reserve of e-gold under asset forfeiture law. This would have allowed the law enforcement agency to add the proceeds of the sale to their operating budget. At the time e-gold held more gold in its vaults than the bottom third of the countries on the IMF list of central bank gold reserves, which would have made it one of the largest asset seizures in history, comparable to invading a small country and seizing its gold reserves. However, the federal judge in the case denied the motion and ordered the reserves to be held and liquidated for the e-gold account holders who could prove the origin of their funds.

e-gold was placed into receivership and the gold reserve was liquidated for USD 90 million. The court ordered “Rust Consulting”, a private company in Maryland, to organize refunds to account holders who could prove legitimate sources for the funds. The balance of unclaimed funds will be claimed by the US Attorney’s Office for the District of Columbia under the asset forfeiture law. A three month window has been set from June 3rd, 2013 to October 1, 2013 for e-gold account holders to submit a claim on their funds. ^[42]

Aftermath

After the e-gold and e-Bullion cases, California (2010) ^[43] and several other states amended their regulations to follow the federal precedent to define all digital value transfer systems as money transmitters. However, California’s new law is so broadly worded as to define a very wide range of Internet startup companies, such as the room booking service AirBnB, as “money transmitters”. ^[44] If the law were consistently applied many more Internet start-ups might be subjected to the same kind of prosecution that e-gold experienced.

After the resolution of the criminal case, the directors of e-gold Ltd vowed to continue operations following the new Federal KYC guidelines. They applied for a money transmitter license for the company, but it was denied because the directors are now convicted felons. Jackson and Downey have continued trying to find a way to sell the company to persons eligible for a money transmitter license in order to recoup some value from their once wildly successful internet payment system.

Conclusions

e-gold was one of the first, if not the very first pioneer of Internet payments. While e-gold received a lot of bad press due to the criminal case against them, it is important to recognize e-gold’s place in Internet history as the world’s first successful online payment system which pioneered many of the systems and techniques that e-commerce users now take for granted, including making payments over an SSL encrypted connection, and offering an API to enable other websites to build services using e-gold’s transaction system.

e-gold presaged Bitcoin as an alternative internet transaction system that operated completely outside of and independent of the legacy banking system. This proved that alternate financial systems were possible and that a significant number of people would enthusiastically use such a system.

Though e-gold was ultimately shut down by the US government, the federal judge on the case ruled that the founders of e-gold “had no intent to commit illegal activity.”

Founder Douglas Jackson failed to foresee the ways in which criminals and hackers could exploit an internet payment system by manipulating the appearance of identity (identity theft and fraud). Their payment model failed to include a web of trust that would enable users to have some degree of confidence of whom they were dealing with, and to eliminate bad actors. In retrospect e-gold’s tardiness in addressing the identity issues allowed the criminal syndicate to grow so large that the resulting crime wave ruined the company.

e-gold’s failure was ultimately due to the inability of their business model to provide a system of reliable user identification and the failure to provide a workable dispute resolution system to identify and cut off illegal and abusive activity in their user community. Other transaction systems such as Webmoney.ru ^[45] and Goldmoney.com ^[46] learned from e-gold’s mistakes and were able to successfully field similar systems with low rates of abuse by addressing these deficiencies. While PayPal has done a better job of addressing abuse than e-gold did, they now suffer from ^[47] and battle against the same crime wave that took down e-gold. ^[48] Financial cryptographer, Ian Grigg, has observed that Bitcoin has repeated the same fundamental errors that e-gold made and that despite its decentralized nature the cyber crime-wave may bring Bitcoin to a similar ending.^{[49] [50]}

]]> http://www.dgcmagazine.com/the-e-gold-story/feed/ 0 http://www.dgcmagazine.com/bitcoin-selling-out/ http://www.dgcmagazine.com/bitcoin-selling-out/#comments Tue, 21 May 2013 23:15:47 +0000 Julia Dixon http://www.dgcmagazine.com/?p=1454 Continue reading →]]> The 2013 San Jose Bitcoin Conference has proven to be rather controversial. While it is considered to have been a success, being well attended and attracting high profile speakers, it has brought up a very divisive topic in the Bitcoin community…regulation.

In his presentation at the conference Peter Vessenes, the executive director of the Bitcoin Foundation, announced that the Foundation will be hiring a lobbyist saying “It’s time to engage with regulators and have a good, productive conversation.”

High profile investors Cameron and Tyler Winklevoss declared that “Cooperation [with regulators] is really the way forward.” And expressed that recent moves towards Bitcoin regulation are a good thing saying “FinCEN acknowledges virtual currencies. They’ve given guidance, which is a big step.”

There are many in the Bitcoin community who worry that close co-operation with regulators will destroy what Bitcoin is meant to be, free from political control and anonymous. Lifetime Member of the Foundation, Mike Gogulski, has even called for the disbandment of the Foundation.

Late last year Jon Matonis, also on the board of the Bitcoin Foundation, published an article entitled Bitcoins Greatness not Realized by Succumbing to Regulation.  In the piece he express concern that compliance with AML & KYC rules will link names to transactions and has the possibility of “cumulatively degrading the privacy of all bitcoin transactions.” Adding that …

Bitcoin’s great promise lies in its potential ability for both income and consumption anonymity. It is this feature alone that allows users to maintain the same financial privacy as physical cash today and it is this feature that will also lead to liberating advancements such as a thriving and interconnected System D, unhampered and undiluted freedom of speech, and superior asset management that can truly be said to be off-the-grid.

I tend to agree with Matonis. The idea that embracing regulation will actually work out for the Bitcoin community is a bit of a fairly tail. As he reminds us…

Those who support the antithetical overlay of  bitcoin on the current financial system ensure us that it will only be temporary and that we must build bridges. That would be nice but it’s a fairy tale. It reminds me of the Marxist theory of historical materialism and the Marx-Engels ideology that if we only tolerate the bourgeois state during the transitional advancement to a higher phase, we will see the complete “withering away of the state.”

I don’t see this as a political debate, or smart business management, or selling out, I see this through the lenses of power. Those who have it don’t like to lose it. Bitcoin and commercial banking/monetary policy are incompatible. Crypto-currencies threaten the government/banking cozzie power sharing deal and if you think they will give up power voluntarily you’ve got to stop dreaming about sailing the Caribbean in your new yacht and wake up.

As c-net reminds us co-operating with regulator didn’t work for e-gold.

that didn’t stop the E-Gold online payment system from being shut down after a federal indictment on charges of money laundering. Not only did E-Gold chairman Douglas Jackson interact with regulators, he even testified before the U.S. Congress a year before the indictment took place.

I can’t imagine that US regulators will stand by and let Bitcoin succeed. This isn’t crazy conspiracy stuff; this is basic theory on incentives and human behaviour.  All those regulators have mortgages to pay and friends to impress…they don’t want to be rendered irrelevant.

In this part we examine the Voucher-Safe economy, trust, security and software.

The Voucher-Safe Economy

“One of the things that occurred to us as being necessary in order to have a robust economy, is that the people who are operating the servers need to get paid for doing that.”

All of the players in the Voucher-Safe economy, the Publisher, DHT (Distributed Hash Table) server, OFS gateway, SDS (permanent database) server, etc. are in the business of earning tokens. As Kevin explains it, “you can think of tokens kind of like micro Vouchers, which are backed by Vouchers which are in a special Voucher safe.”

Tokens are created by the Publisher, from backing Vouchers, and are sold to Voucher-Safe users. “What is silently going on here in the middle of all these payments, pickups, storing receipts and so on, is that all these charge some number of tokens. For example, it costs a token to store a receipt, and it also costs tokens to make payments or to pick them up.”

Once the players in this system, for example the OFS gateway, accumulate a certain amount of tokens they can redeem them for Vouchers. The OFS gateway operators would initiate an exchange with the Voucher Publisher and say ‘ok, I’d like to cash in my tokens.’ Those tokens are then taken out of circulation and the Publishers Voucher safe, where the users who have been buying the tokens have been placing Vouchers, is debited to create a new Voucher. This new Voucher is then paid to a special safe which is owned by the operator of the OFS server.

This method encourages the OFS gateway, and other server operators, to be very careful about which Issuers and Publishers they do business with. Kevin explains that this is an intentional incentive. “Basically what this boils down to is that the publisher and all of the other servers are getting paid in the same issuer’s currency. You wouldn’t want to accept any Issuer that you didn’t have confidence in because this is how you are making your money as well.”

It is also important to note that “the number of tokens is fixed by the publisher but the value of a token is fixed by the Issuer.” For example, an Issuer may set the of value of a token at .005 grams of gold, about 2 ½ cents.

“And that means that although it gets divvied up in different ways, the total cost of a payment is about 47 & ½ cents. About 2/3 of that is paid by the payer and the other by the receiver. 50 cents or less to make a payment and that’s regardless of the amount of the payment. As the same amount of work has to be done and the same operations have to take place whether your payment is for 5 clams or 5 million clams.”

How does a user obtain, exchange and ‘redeem’ Vouchers?

There are many ways to obtain Vouchers, an obvious method is to purchase some from a Voucher Issuer.

Voucher-Safe was designed to be an AML compliant, and yet anonymous, digital cash system. The Issuers are charged with maintaining AML compliance.  To purchase a Voucher from an Issuer a user would (dependent upon the policies of the Issuer) likely have to provide ID in accordance with Know-Your-Customer rules. Similarly, if a user wanted to redeem their Vouchers, they would likely have to have an account with the Issuer and provide ID and bank account information.
While most Issuers will likely require ID as they will have to interface with the fiat banking system, Voucher-Safe’s creators do envision Issuers that may not require ID. “It is conceivable that one could have an Issuer which only traded its asset base in exchange for other types of vouchers or anonymous digital cash.  For example, suppose an Issuer existed for a metal-backed voucher currency which only bought or sold the metal using Bitcoin. That Issuer could likely get away with not requiring ID from its customers.”

“But the idea here is that many users wouldn’t need to be ID’d, just as many people can have physical cash in their wallets and purses without needing a bank account. One could imagine ‘Voucher-cashing’ services just like there are check-cashing services.  Also decentralized exchanging operations, along these lines:”

Purchasing a Voucher from an exchange would be like purchasing Bitcoins on an exchange, and it would come with many of the same issues. Kevin notes that “the exchanger issue is a problem for any digital currency. There’s just no way to fix it that I can see other than going to this decentralized model … about dealing in cash and dealing with other people who use the currency. … And it gets around single points of failure such as large exchangers that are doing millions of dollars a day in through put. And I think that kind of thing is ultimately where we are going not just with Bitcoin but with Voucher-Safe and pretty much everything else.”

Plans for the voucher-Safe system include an ‘auto exchanger’ or escrow service.  This service would allow people to exchange between different Voucher-Safe currencies or Vouchers from different Issuers “as anonymous digital cash without ever having to go through an exchanger.”

Another interesting feature of Vouchers that is important to note, is that they expire.

“We didn’t want this to be a money storage facility. We want this to be a transactional system. … The idea is that it is very, very important to make sure that you don’t end up with value that is permanently in limbo. If Vouchers are somehow lost, you can’t just leave that value out there forever. You have to have some way to take it out of circulation.”

What happens to the backing of an expired Voucher will be determined by the Issuers policy. But there are safe guards in place to prevent Vouchers expiring. “Whenever you’re doing a voucher transaction, your client will automatically use the oldest vouchers possible first.”

It is also possible to simply log into your Voucher-Safe every few months and revalidate any expiring Vouchers. This will however cost you a few tokens.

Trust

When dealing with the digital exchange of physical assets, trust is an unavoidable factor. Users of Voucher-Safe, or any currency with a physical backing, have to trust the Issuer.

Voucher-Safe is designed to be as decentralized and require as little trust as possible. But there is no escaping it, you must trust the Issuer.

Issuers will be discussed in detail in Part III, but one of the first Voucher-Safe Issuers will be PXGold.

Reputation is a huge factor in Issuer trust. Sidd, the creator of PXGold and monetary architect of the Voucher-Safe system, is also a co-founder of Pecunix, a well-respected gold custodian. “Pecunix has a good reputation. But at the same time the bottom line is when you bring me the Voucher, can I give you the gold? So far, we’ve been going for 12 years and there’s never been a problem.“

An important difference between Pecunix and PXGold is that PXGold will not make the location of it’s gold vaults public. While this may cause some trust concerns, it is done to protect customers gold from confiscation. “PXGold is based on an entirely different premise.”

Sidd explains the reasoning behind this decision. “With Pecunix, we held audits, we said ‘this is how much gold we’ve got, this is where we keep it, these are the checks and balances, this is how much gold is in the account, etc.’ But we have now got evidence of the danger of that because of what happened with e-gold. Because all of e-gold’s information was out in the open, the government came along and confiscated the gold. They literally took that gold even though it didn’t belong to e-gold, it belonged to the customers.”

“So, when it comes to PXGold, that information won’t be made public. There will be people who know and people who can verify, but it won’t be public.”

Trust in the Issuer is necessary, but very little trust in the Publisher, and other Voucher-Safe players, is needed.

Kevin explains that it “would be very hard for the Publisher to run off with much of anything. The Publisher has zero ability to do anything with Vouchers outside of those presented by a user for a specific transaction.  It cannot determine anyone’s ‘balance.’  It cannot tamper with the values of vouchers, despite being the party who signs them, because Vouchers with incorrect amounts would be rejected at the Issuer.”

“The same can be said about the DHT and SDS operators.  Yes they maintain ‘databases’ but all the records are encrypted using keys to which the server operators have no access.  The worst thing they could do would be malicious deletion, which profits them in no way.  And there are mirrors and backups in place to allow for this possibility.”

Security

PXGold’s security systems are impressive and are an improvement upon Pecunix’s well-known security. “Everything in Pecunix is encrypted, a lot of it is double encrypted. The entire database is encrypted. If our server got stolen by the authorities they wouldn’t be able to make a dent in it.”

Sidd is very seriouse about the security of PXGold “What we’ve done with PXGold, is that every single account is encrypted to its own key and the key for that account is actually that persons login details.” If authorities were looking for information on an individual from PXGold’s database, “they would actually have to come to us with the persons account details before we would even be able to find them in the database otherwise they’re not even searchable.“

“Nobody builds systems like that; I think I’m the only one. I’m a bit pedantic about that.”

Software

The software that makes up the Voucher-Safe system will be published. “Voucher-Safe has published source clients (3 of them). This is not quite the same thing as ‘open source’ because open source technically means that anyone can check in changes.  For obvious security reasons, we wouldn’t want that.  However by publishing the client source, we invite others to create competing client versions white labelled for particular Issuers or even ground up rewrites.  It would be great if someone made one for Android phones, for example.”

“The network source code (for the server side) is not published at this time.  However, every line of code which runs on a user’s computer has source code available, either from us or from the authors of the particular library component.”

The decision to delay the publishing of this code was done for several reasons. Sidd believes it is important to ‘vet’ Issuers and Publishers for the first few years to prevent any shady server operators from destroying trust in the system.  “As it stands now, we will run the only Publisher (vouchi.com) and we will vet every Issuer to make sure that that Issuer is trust worthy. And that way we can, to a certain extent, protect our investment in the software.”

Kevin adds that “ultimately the software for the VP/OFS/SDS/DHT/PKS should be published also, or at least licensed and franchised out to others who will make wise and profitable use of it.”

“In the end it’s about enabling free market money, which is not the purview of a single Publisher, Issuer, or network, any more than it should be the purview of a central bank.”

The final part of the Voucher-Safe special will discuss Voucher-Safe’s interaction with Bitcoin, Issuers and Onion Pay, a Voucher-Safe merchant checkout.

Well over the past year, that’s exactly what I’ve worked on, and I’ve certainly discovered a few things along the way.

How did we get here?

We’re at a point in history where governments around the world have accumulated record levels of debt on their balance sheets.  There are significant risks of a sovereign debt crisis that threatens the global economy and challenges the solvency of many nations.  When interest rates rise, governments may be forced to deal with the consequences of escalating federal debt; I anticipate that the banking system may suffer from falling asset prices (such as long-term government bonds and mortgages on their balance sheets) which they won’t be able to further finance due to substantially higher interest payments.  In these types of circumstances, bond holders are at risk since the two most likely courses of action are to either default or to expand the money supply.  Both of these outcomes result in the erosion of fiat currency, leading to greater inflation and a depleted purchasing power.

As a result of my views on the current economic environment, I was quite taken with the idea of an alternative currency – one that isn’t controlled by governments & central bankers, and that doesn’t rely on the full faith and credit of a country.  Bitcoin, a relatively new digital currency that’s based on faith in an algorithm and network, remains speculative.  And although it’s certainly picking up traction, plenty of questions still remain regarding its regulatory hurdles and trust concerns.

So what was it that compelled me to pursue this digital gold path and why did I retreat from working on such an ambitious idea?

Well, it dates back to my days at Apple, where I worked on the foreign exchange team.  We hedged currency risk and had chief economists come in and talk to us about secular trends in the macro-economy and its effects on Apple’s business.  One particular economist, a former central banking chairman from a European bank, struck a chord with me as he was discussing the inflationary risks associated with sovereign debt levels – something I had learned about while studying Austrian economics and following experts such as Ron Paul & Peter Schiff.  After this chairman finished his presentation, I asked him a few questions regarding the state of gold and his general outlook for precious metals. Paraphrasing his response: “Well, I definitely understand why precious metals have been performing so well – they’re a clear hedge against inflation.  But I just don’t understand the intrinsic use – it’s not like people can spend their gold… they have to use dollars to make purchases.”

And then it clicked – why couldn’t people spend a hard asset?  After all, the world has operated on a gold standard for thousands of years.  We’ve only been off of it (officially) for the past ~4 decades.  So why is it that people trust some piece of paper, that’s probably a bit unhygienic and can even be printed at will, to transact for goods and services?  Precious metals are natural resources that derive their value from their scarcity.  Wouldn’t it make more sense to be transacting in digital gold, especially given advancements in technology?

Following that discussion, this idea was baking in my mind – I felt compelled to pursue it and make something out of it.  It solves a major problem in a large space: money.  And money is a part of everyone’s life, so it’s in a market that holds no bounds.

It was then that I decided to start Vaurum.  I jumped into the deep end and didn’t look back.  I knew I had a lot of work ahead – I had to recruit a co-founder, illustrate a working business model, build a secure prototype and form strategic partnerships.  Little did I know, those priorities, while important, certainly weren’t the hard part.  Raising investment wasn’t even the hard part.  So what was the hard part?  It was the part where I realized just how high we’d have to jump to get over the regulatory hurdles, not to mention that even if we did build some major traction, I’d still have to figure out a way not get shut down.

I remember reading about E-Gold and the Liberty Dollar, and then talking to industry insiders that half-jokingly warned me not to end up in an ankle bracelet.  It really makes you take pause to do some due diligence.

In contrast to most startups in Silicon Valley where entrepreneurs can use approaches like the lean startup methodology to quickly build & test a prototype while collecting customer feedback, creating an alternative currency had a whole new set of risks associated with it.  The top question (by far) that I received from potential investors and engineers interested in the project was something along the lines of: “this is very, very interesting – what’s the regulatory climate like?”  Basically, even if you build a viable business that gets traction and can scale, what’s the risk of it being shut down due to factors out of your own control?  The reality is that you just don’t know.  Startups are hard enough as it is – you already have to be somewhat delusional to win; you have to believe in yourself and your company when no one else does.  Now don’t get me wrong – it’s not that entrepreneurs are completely irrational – it’s that entrepreneurship is a completely irrational sport.  So to play the game, you have to learn how to do things that are completely irrational.  You have to learn not only how to collect facts and make good decisions, but also how to filter some information and completely ignore some facts.  But when you involve regulatory hurdles and throw in challenges by federal governments, it adds significantly more friction for every single party that’s involved: the founders, the investors, the employees, the customers, and the strategic partners.  Those are things that you can’t ignore.

There were times when I would come across investors that bought into our vision to create a universally used gold-backed currency but remained completely blind when it came to the regulatory risks associated with actually building it and testing it in a live market.  One particular investor even encouraged us to go public with our product without worrying about regulatory risks and told us to simply discard any licenses that we need to get it off of the ground legally, as if there would be no consequences for it whatsoever.  Another potential strategic partner that we were in talks with mentioned that there’s plenty of demand for gold currency, but that they wanted us to build it instead of building it themselves.  We learned that the reason for these events was that people didn’t want to face the risks associated with creating a competing currency, but wanted the benefits of having one around just in case it worked.  It’s the founders that are put in the position of having to take these risks in their entirety.

So we’ve decided to make a some changes over the past few weeks that are based on a three core realizations that I’ve had:

1)      Companies that try to pick a fight with the government most likely will lose 10 times out of 10.  And then what?  You’re out of business and the impact that you intended to have never reaches its full potential.  Great companies build bridges, not walls – work with governments, not against them.

2)      We’ll often ask the following question: “what will change over the next 10 years?”  While it’s good practice to create a vision and work to realize that vision over time, this isn’t the right question to be focused on.  We should be asking ourselves the opposite: “what won’t change over the next 10 years?”  It’s the things that won’t change that you can build a viable business model around.

3)      And finally, for entrepreneurs – produce things and get them out into the world as much as you possibly can.  It’s through this process that you learn from your experiential knowledge.  If I hadn’t gone through this journey, I wouldn’t have discovered many of the great truths that I’ve faced over the past year – lessons that will last a lifetime.  I also wouldn’t have grown as an entrepreneur, and I certainly wouldn’t have been able to apply my experiences to our next big aspiration, which is what we’re currently pursuing with the new model for Vaurum.

In all that I’ve learned in our adventures in trying to create our own currency, it’s the application of these lessons that excites me the most about what’s next.  It has allowed us to get a big stronger, a bit wiser, and a lot more determined to make a positive impact in the world.

But as DGC’s were starting to take off and be recognized for their many benefits, the rug was pulled out from under the industry with the prosecution of e-gold. The old DGC business model is centralized and vulnerable to seizure, censorship and prohibitive regulation.

The Voucher-Safe system allows for a more decentralized, Anti-Money Laundering compliant way to anonymously exchange value. It’s DGC 2.0, a more flexible and resilient system where anything can be money. “The idea behind voucher-safe is that it isn’t about making just one thing money. Money  can be gold, it can be existing national fiat currencies, it can be bitcoins, it can be silver, it can be anything of value that people want to exchange.”

I recently had some very in-depth discussions with Sidd, Voucher-Safe’s founder (also co-founder of Pecuinx) and Kevin, the principal developer. Voucher-Safe is software and a network that allows for the anonymous and very affordable exchange of the encrypted representation of value. DGC readers will be familiar with Voucher-Safe from the 2011 Industry Overview Issue.

Sidd and Kevin began designing the system when they ‘saw the writing on the wall’ soon after the demise of e-gold.  As Kevin put it, they began discussing how it would be possible to “operate one of these businesses without getting an ankle bracelet like Doug Jackson’s.”

The problem with the old DGC model is that they are account based and centralized.  Kevin recalls “seeing footage of Doug Jackson testifying before congress and actually boasting about how he was able, because it was all in one database, to track every little flake of gold from the first time it was put in the system to every account it had ever been in and so on.“ With an account based system the operator has a record of all transactions and can be held liable for their clients’ illicit transactions. E-gold’s ability to track all transaction through the system was used against them. Having records of all transactions is “absolutely a sucker’s game, particularly if you’re talking about an alternative currency that’s not going to be in good standing to start with simply because it is alternative. You have to separate the payment system from the store of value”

The Voucher-Safe system is designed to do exactly that. The Issuer, who hold the assets, is separated from the rest of the system and has no knowledge of the transactions taking place with the ‘cash’ that it has issued.

The system is modelled after gold backed “claim checks” or receipts. A good analogy would be a gold backed paper currency where you have gold sitting in a vault somewhere and the “claim checks” on this gold then circulate as cash. In this situation, those looking after the gold in the vault have no idea whose wallet that claim check is sitting in. Their only concern is the safe keeping of and accounting for the assets that back those claim checks.  “And that situation has been recreated technologically with Voucher-Safe where the vouchers are a circulating bill and you have digital wallets where different kinds of vouchers representing different assets can circulate.”

It is a complicated process to replicate this situation in the digital world. To understand how Voucher-Safe works you need to understand who the players are. There are three primary players in this system, the Issuer, the Publisher and of course, the users.

The Issuers are the entities holding, maintaining and accounting for the assets that back a particular issue of vouchers. The Issuer is AML compliant. Anyone wishing to purchase assets from the Issuer will need to provide identification and information in accordance with Know-Your-Customer rules. The Issuer is responsible for maintaining those assets and assuring that the amount of vouchers issued is always less than or equal to the assets that they hold. However, the issuer has no knowledge of what their customers may or may not do with those vouchers once they have been issued to them.

The Publisher works with one or more Issuers, facilitating transactions and is an essential part in the payment system. Publishers join the Voucher-Safe network to earn tokens which are in essence mini-vouchers. (This arrangement will be discussed in the next part of the series.)

The users are anyone who is using the Voucher-Safe software to exchange value with other users.

The Publishers and the exchange process are the heart of the Voucher-Safe network. To achieve the goals for the system, it was necessary to find a way for transactions to take place without centralized receipt signing, accounts or transaction records, all while maintaining anonymity. Not an easy task.

Because this process is so important to the functioning of the system, I’ll list the steps in the process. But, for those who don’t want to get bogged down in the technical details, here is an analogy that will hopefully be helpful in understanding the process.

Issuer A is a respected bullion vault and you would like to own an ounce of gold stored in their vaults. You go to Publisher A, who works with Issuer A, you give them $1,700 and you receive a receipt for one ounce of gold. (You can think of the Issuer and Publisher as a private Mint and Treasury.)

You owe Joe some money for some services he has provided and the two of you decide to settle your bill by passing the receipt for one ounce of gold stored in Issuers A’s vault on to Joe.

Joe gives you a lock for which only he has the key.

You then take this lock to Publisher A’s office and ask them to please place your receipt for one ounce of gold in a safety deposit box and give them Joe’s lock to put on the box.

Joe then stops by Publisher A’s office and notices his lock on one of the boxes.

Joe is able to open the box with his key and retrieves the receipt.

You and Joe then give each other receipts for the transaction.

Note: Neither one of you have an ‘account’ with the Publisher. The Publisher never asks you for ID and has no idea who you are. The only thing Issuer A knows is that you purchased one ounce of gold stored in their vault and that they issued you a receipt for the gold. They have no idea that you exchanged this receipt with Joe

In the digital world, this process is much faster, but involves a few more steps.

It is very important to note that the single most important feature of the Voucher-Safe system is the limited information that each player in the process has. This is particularly true of the Issuer who has no knowledge of anything besides vouchers. It knows which vouchers are on the circulation list and it knows about voucher serial numbers and nothing else. It is a “need to know” system.

This limiting of information is done through encryption, so that each player only has access to the information they need, and through anonymous communication via the OFS Gateway. You can think of the OFS as a proxy that hides IP addresses. All user login and payment-related communications happen via the OFS and, of course, the OFS cannot read the contents of any of the messages traveling through its system.

Below is a step by step of the transaction process in the Voucher-Safe system.

• The Payer logs in and all the vouchers in his safe are decrypted
• When the Payer initiates the transaction the client software automatically selects a voucher for payment, starting with the oldest first
• To send a payment, the Payer will need to have the Voucher-Safe ID of the Payee. (This  looks like an email address, but is similar to a Bitcoin payment address)
• The Payer enters the Payee Voucher-Safe ID of the safe that they want payment to go to
• The software creates a message that includes the voucher(s) to be transferred and Payee safe ID and any payment details (a memo field, or baggage fields)
• If there are any payment details associated with the payment, (information in the message that is only for the Payee) then these are encrypted using the Payee’s public key.
• The whole payment message is encrypted with the Publisher’s  public key and signed with the Payer’s private key
• The message is securely transmitted to the Publisher via the OFS
• The Publisher decrypts the payment message and checks the signature from the Payer
• The Publisher looks up the Payee’s safe ID and retrieves his public key
• The Publisher verifies its own signature on the vouchers to be certain that they are unaltered and valid
• The Publisher sends a message detailing the amounts, serial number, and amounts required (if splitting or combining vouchers) to the Issuer via an encrypted communication.
• The Issuer checks that the vouchers are still on the active circulation list (this prevents double spending)
• If there are no problems, the Issuer assigns new serial numbers for the output amounts and sends this information to the Publisher
• The Publisher acknowledges the Issuer and makes the new signed vouchers using the new serial number, while the Issuer retires the old serial numbers and adds the new serial number and amount to its active circulation list
• The Publisher includes the new voucher and the original payment details in a new message which it signs and encrypts to the payee
• Publisher places the encrypted voucher & message on the DHT (Distributed Hash Table) which acts like a safe deposit box in the cloud
• The Publisher places the change voucher (should there be one) back in the Payer’s safe and returns a successful status reply to the Payer
• The message is stored on the DHT with a unique encrypted address that the Payee can find
• When the Payee logs in to his Voucher-Safe (or clicks “refresh”)the software automatically checks the Distributed Hash Table and finds the encrypted message
• The Payment message is collected and decrypted
• Payee now has the voucher, but he needs it to be stored permanently in his safe by having it revalidated and replaced with a new voucher of identical value
• The Payee creates a message that includes the voucher and the Payer’s ID
• The Payee then signs this message  with its private key
• The whole message is encrypted with the  Publisher’s public key
• The message is securely transmitted to the Publisher via the OFS
• Once again the Publisher facilitates the issuance of a new voucher and destruction of the one sent by the Payee.
• The Publisher signs this voucher with its private key and then encrypts it with the Payee’s public key
• The Publisher stores the new encrypted voucher in the Payee’s safe and sends a successful status reply
• After the successful pickup by the Payee, the transaction becomes irrevocable
• If the Payee fails to pick up the payment within the time set by the Payer, then the Payer becomes able to pick up the payment voucher himself (i.e. retrieve it)
• The Payee’s Voucher-Safe software generates a receipt for the Payer, signs the receipt with its private key and places the receipt on the Distributed Hash Table for the Payer to find
• If there were any private payment details, those are included in the receipt data signed by the Payee, along with any optional return memo text

Even this is simply an overview of the process. There is quite a lot happening under the hood, but thankfully the Voucher-Safe software makes the user experience much simpler. You can watch demo videos, or try it out for yourself at Voucher-Safe.com.

For those who are interested in the technical specifics of the Voucher-Safe system, they can be found by creating an account at Voucher-Safe.org. The client source code and API documentation for all components can be downloaded from the site as well.

Voucher-Safe is a secure cloud based system.  Unlike Bitcoin, “there is nothing actually on your phone or on your computer. If your phone should get lost or stolen or arrested by authorities, there is nothing for them to find.” All of the information in the system is encrypted, sometimes twice. “What that means is that no one, including the voucher Publisher, can see what value somebody has. They might see that there are so many rows in the table at this hash for that particular safe, but there is no way to know what those rows represent, or whether they are simply payment receipts.”

Voucher-Safe’s carefully thought out design and payment system make it vastly more flexible and resilient than previous digital currency business models. “We’ve been through generation one of digital currencies now and it’s time for generation two.“

The next parts of the Voucher-Safe special will cover Issuers and assets, the economic incentives of the system, trust in the system, the extensive security procedures, supporting apps and payment software and more.

Part II examines the Voucher-Safe economy, trust, security and software.

Part III looks at Voucher-Safe’s interaction with Bitcoin, Issuers and OnionPay.

The authors believe that three conditions are necessary, no state, no banks and an “over-the-counter” market.

Prior to explaining these reason they consider it important to first “put Bitcoin into the wider context of the counter-economy” noting that the ‘counter-economy’ is large and growing. “if you combine all black markets of the world together you’ll get a 10 trillion US$ economy, second only to the United States of America. In many developing countries it already comprises large parts of the economy and it is growing faster then the officially recognized gross domestic product (GDP)”

Three hypotheses for the long-term success of Bitcoin

So what does Bitcoin need to succeed in the long-run? In short, it needs no state, no banks, and OTC. The three hypotheses in more detail:

1. The Bitcoin community should not try to get legality for Bitcoin, we should not ask the state to resolve conflicts in the community.
2. The Bitcoin community should not focus on interoperability with the traditional banking system.
3. Widespread availability of over-the-counter (OTC) Bitcoin exchangers is crucial for Bitcoin to succeed in the long-run and give us more freedom.

Let me explain the reasoning behind this hypotheses. Public choice theory in general and plain common sense states that people will do what is in their self-interest. This includes politicians, bankers, and cops. It is very important to fully grasp this simple truth: People do what is in their interest and you cannot assume that your interests equal their interests. They are usually not the same.

There is no such thing as people working for the common good. Even people who are supposedly helping others selflessly are actually helping them in order to live in accordance with their own value system.

No state

The state is a regional monopoly of force which extracts resources (usually money) from its citizens to (a.) mainly finance itself, its wars and its surveillance apparatus and (b.) use the rest to provide so-called services which could be provided better and cheaper by the free market. These services are usually used as a justification of the existence of the state, but the real reason of its existence is the easy money the state money recievers can get. The money is taken away from the productive citizens via taxation and the monopoly of the money supply (via inflation your money becomes worth less). Thereby, the latter strategy is better, because it is harder to notice by the ignorant
masses.

If you combine the institution of the state and its inherent interests with the conclusions from public choice theory and the Bitcoin system you are looking at the potential for a lot of trouble. Bitcoin prevents inflation (there is no inflation in Bitcoin once all coins have been mined) and helps tax evasion (it is hard to regulate and control). It is potentially life-threatening to the state, because it strikes at the root of state financing. Therefore it follows that the state will fight Bitcoin heavily once it realizes that. In my opinion it is absolutely ludicrous to think that the state will embrace Bitcoin.

The most likely scenario is that the state will try to close down Bitcoin altogether. If that is not possible the state will try to change Bitcoin in a way that allows to implement know your customer (KYC) regulations more easily in the system.

Just wait and see what kind of discussions we will get in the Bitcoin community once the state is cracking down more on Bitcoin exchangers and businesses and actors like the Bitcoin Foundation will try to remedy the situation by working together with state agencies to make Bitcoin more regulatory compliant.

In my opinion, this shows why the Bitcoin community should not try to get legality for Bitcoin and should not ask the state to resolve conflicts in the community. All this will do is drive more unwanted attention to the Bitcoin ecosystem. The self-interests of the state prevents legality and regulatory acceptance of Bitcoin in its current form.

History lesson: e-gold

E-gold provides an important history lesson of the Those who cannot remember the past are condemned to repeat it (George Santayana) category. E-gold was a digital gold currency which existed between 1996 and 2009 and allowed the instant transfer of gold ownership. In 2008 the company reported more than 5 million accounts. A flourishing ecosystem existed around e-gold. In the end, exchangers were attacked and closed down due to regulatory problems. E-gold itself was indicted for money laundering and the operation of an unlicensed money transmitting business. The indictment happend although e-gold itself tried to get the corresponding license earlier and was told that is was not necessary. Sounds similar to the situation with Bitcoin right now? The game is rigged, folks! You cannot win if your are playing by the rules.

No banks

Banks are major beneficiaries of fractional-reserve banking and can borrow cheaply from the central banks. They operate in one of the most heavily regulated industries which results in huge barriers to entry and not much competition. This leads to large profits, for example from transaction and credit card fees. Financial service providers like PayPal, Western Union and Money Gram also have very large fees, because the regulatory hurdles reduce the amount of competition and result in large costs. Since small income foreign workers who send money home are the largest customer base for such services the high fees are actually a tax on the poor. Bitcoin threatens this profits and poses a regulatory risk. Therefore, Bitcoin exchangers will be attacked by competing financial institutions (remember TradeHill as such an example).

A widely successful Bitcoin system is against the self-interests of the established financial industry and it makes no sense for them to deal with the corresponding regulatory challenges in the long-run.

If the Bitcoin economy depends on the traditional banking system it is doomed to fail. Just imagine what would happen to the Bitcoin economy if Mt.Gox, which currently is responsible for about 80% of all Bitcoin exchanges, suddenly would have to close down.

In my opinion, this shows the second hypothesis: The Bitcoin community should not focus on interoperability with the traditional banking system.

The case for OTC

We now have established that from a self-interest standpoint the state and the traditional financial industry is naturally opposed to Bitcoin. To ensure the long-term stability and success of the Bitcoin economy we need a completely separate system of exchange, a network of over-the-counter (OTC) exchangers. An OTC exchange happens when two people meet face-to-face trading Bitcoin for cash (or gold/silver). OTC is not the sending of cash in the mail or wire transfer. Such a widespread network of OTC exchangers is the system most resilient against state attacks, because it is heavily distributed and the banking system is skipped entirely.

This reasoning supports the third hypothesis: Widespread availability of OTC Bitcoin exchangers is crucial for Bitcoin to succeed in the long-run and give us more freedom.

The how-to Secure and professional Bitcoin OTC exchanges gives practical advice on OTC. The content of this article was presented at the 2012 Bitcoin conference in London [slides].

The post can be read in it’s entirety here.

Monetary tyranny can take many ugly forms. It can be deliberate inflation, persecutory capital controls, prearranged defaults within the banking cartel, or even worse, blatant sovereign confiscation. Sadly, those threats are a potential in almost any jurisdiction in the world today. The United States does not have a monopoly on monetary repression and monetary tyranny.

Once the State is removed from the monetary sphere and loses the ability to define legal tender, its power becomes relegated to direct legislative and enforcement measures that do not immorally manipulate a currency. Taxes for wars and domestic misadventures will have to be raised the old-fashioned way — that is to say government money cannot be raised by simply debasing the currency.

Just as the Second Amendment in the United States, at its core, remains the final right of a free people to prevent their ultimate political repression, a powerful instrument is needed to prevent a corresponding repression — State monetary supremacy. That task has fallen to an unlikely open source project that is based on cryptography protocols and peer-to-peer distributed computing. As the mechanism for a decentralized, nonpolitical unit of account, the Bitcoin project uniquely facilitates this protection.

The timing of Bitcoin’s appearance, and subsequent growth, is no accident either. If one follows the relevant sentiments and trends, it’s evident that society was approaching a breaking point. Essentially, bitcoin is a reaction to three separate and ongoing developments: centralized monetary authority, diminishing financial privacy, and the entrenched legacy financial infrastructure. An alternative money provider that was centralized would probably not survive long in any jurisdiction. The emergence of Bitcoin was baked into the cake already.

We can see from the case against digital money provider e-gold that an efficient challenger to the provision of a stable monetary unit will not be permitted… really. In 1996, a humble oncologist named Doug Jackson bravely built an auditable and verifiable system of transferring ownership rights to gold and silver bullion in an online digital environment. Wired’s Kim Zetter described it this way:

E-gold is a privately issued digital currency backed by real gold and silver stored in banks in Europe and Dubai. Jackson says about 1,000 new e-gold accounts are opened daily, and the system processes between 50,000 and 100,000 transactions a day.

With a value independent of any national legal tender, the electronic cash has cultivated a libertarian image over the years, while drawing the ire of law enforcement agencies who frequently condemn it publicly as an anonymous, untraceable criminal haven, inaccessible to police scrutiny.

Where have we heard that before? Then in December 2005, the U.S. Federal Bureau of Investigation and Secret Service raided e-gold’s Florida offices. Jackson tells Wired, “They basically raped our computers and also took us offline for 36 hours, took all the paper out of our office.” Jackson says that the government also froze parent company Gold and Silver Reserve’s U.S. bank account but the company survived, “only because its euro, pound and yen accounts are maintained outside the United States.” The physical bullion assets were subsequently seized as well.

With the prosecution resting on a civil complaint charging Gold and Silver Reserve, Inc. with operating as an unlicensed money-transmitting business, Jackson finally acquiesced in July 2008 and plead guilty to conspiracy to commit money laundering (a victimless crime) and operation of an unlicensed money transmitting business rather than the alternative threat of 20 years in jail and a half million dollar fine.

Wired magazine, in June 2009, published this excellent account of the e-gold business in the wake of the federal investigation entitled “Bullion and Bandits: The Improbable Rise and Fall of E-Gold”. Also included in the article is probably the most telling photo of all — Doug Jackson sitting on the floor surrounded by file boxes labeled U.S. Secret Service.

Zetter writes, “At e-gold’s peak, the currency would be backed by 3.8 metric tons of gold, valued at more than $85 million.” E-gold founder Doug Jackson wanted to solve the world’s economic woes, “but instead got an electronic ankle bracelet for his trouble.”

Recently, in 2009, Bernard von NotHaus was indicted on counterfeiting charges for manufacturing a private metallic coin that actually contained some precious metals. After 23 years of research and development plus 11 years of operating in the marketplace, Liberty Dollar suspended operations. Following the conviction and for the appeal, the prominent Gold Anti-Trust Action Committee filed an amicus curiae brief in support of acquittal and revolving around the question of whether anyone but the government has the right to issue money. Afterwards, many commentators pointed out the absurdity of penalizing honest money to strengthen the facade of manipulated money.

Further contributing to the disturbing trend against monetary freedom and financial privacy are initiatives like the Foreign Account Tax Compliance Act (FACTA), which has been written about many times on these pages and also in The New York Times. Other countries around the world would not even contemplate such a brazen endeavor that imposes a costly withholding and disclosure regime on sovereign foreign entities and financial assets. Furthermore, they see it as American arrogance and American hegemony run amok.

However, society will not be ready to fully embrace the promises of decentralized nonpolitical currency until it can come to terms with the fact that money in a free society should not be used for the purposes of identity and asset tracking. Banks and governments may be concerned with that goal, but it is not the role of our money.

http://www.forbes.com/sites/jonmatonis/2012/10/04/bitcoin-prevents-monetary-tyranny/