Sean King

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Knoxville, Tennessee, United States

Monday, July 28, 2014

A Follow Up to My Official Comments on New York's and Lawsky's Proposed Bitlicense Regulations

I'm grateful for all the feedback on my official comments to New York's proposed bitlicense regulations. It has been mostly positive so far--they have been 92% upvoted since someone posted a link to them on Reddit shortly after I published them. I'm thrilled that some have found them to be valuable. All should feel free to use them however they see fit in publicly commenting on the Bitlicense regs or virtual currencies in general. 

For those who thought my comments were too long to read (TL;DR), the gist of them was as follows:

1) Blockchain technologies have a great many uses, and their non-financial and non-monetary uses far outnumber their uses in/for finance/money. Most anything that can be done on the Internet (running applications like Facebook or Dropbox, email, pornographic websites, message boards, etc.) can be done better and more securely by implementing blockchain technologies. In fact, it's possible to build a whole new version of the Internet (Internet 2.0) on blockchain tech. (Think MaidSafe).

2) Blockchains are protocols. Protocols are speech. In the US, speech can only be regulated within certain limits. Federal courts have repeatedly found, for example, that distribution of encryption software source code is protected free speech.

Additionally, the blockchains themselves encode free speech within them. Consider Satoshi's famous reference to the Times of London" article that is encoded in the first transaction.

3) In the US, individual states may generally only regulate within their borders. They have no authority to regulate activity that takes place wholly outside of their borders. Under the Commerce Clause of the US Constitution, only Congress is permitted to regulate "interstate commerce". Federal courts regularly enforce this limitation.

4) Federal courts have repeatedly placed severe limitations on the ability of individual states to regulate Internet activity. For instance, New York's prior attempts to regulate minors' access to Internet porn was struck down by Federal courts (American Library Association v. Pataki).

5) Blockchain tech is simply an extension of the Internet. Due to its ability to achieve "distributed consensus", blockchain tech will be the backbone of Internet 2.0--an even more distributed, secure, robust, and anti-fragile version of our current Internet.

6) New York's bitlicense regs thus implicate two very important constitutional limits on state power--free speech and the Commerce Clause. Furthermore, case law that has previously limited the ability of individual states' to regulate the Internet on these and other grounds is applicable precedent and should be considered by regulators in order to avoid unintended consequences and embarrassing court losses.

7) The New York regulators have failed to consider the impact of the bitlicense regulations on free speech and interstate commerce, and the subsequent unintended consequences that their regulations will create, because they view (thanks in no small part to the Bitcoin community itself) "virtual currencies" as "currencies" or "money", or something very much like them, and states have traditionally been permitted to regulate money transfer within their borders.

8) The bitlicense regulations go too far and are clearly unconstitutional because:

a) Virtual currencies are not money or currency but simply the means of achieving distributed consensus in a computer network (which, again, has very, very broad non-financial applications). Yes, virtual currencies have value, and yes they can be converted into real currency, but they are not inherently financial or monetary in nature. To claim that all virtual currency is money and regulate it as such (because some is used for that purpose) is somewhat like claiming that TCP/IP packets of information are money, and regulate them as such, because some are used to represent money on the Internet. TCP/IP packets can be used for far greater purposes than than money, and so can blockchains built upon "virtual currencies".

b) Since virtual currencies are not "just" or even primarily money, New York is wrong to think that its traditional ability to regulate money transfer businesses within the state, and require licenses for such, applies to all virtual currencies in each and every instance. Any regulations attempting to regulate the "money" or "financial" aspects of virtual currencies must include sufficient carve-outs to insure that their non-monetary uses (particularly for free speech and interstate commerce) are not unduly burdened. The current draft of the regulations does not do this. Implementing the regs "as is" will not only prove to be completely ineffective, it will likely lead to embarrassingly and perhaps politically costly court losses for New York.  In the meantime, they cost New York billions in lost opportunities.

Criticisms on Reddit forums of my prior comments (which I have summarized above) tended to fall into three main categories. Rather than trying to reply to those criticisms one-by-one there, I will spend a few minutes addressing the major points here.

First was the idea that the regulations only apply to uses of virtual currency as a "medium of exchange" or "store of value" and not for other non-financial reasons or purposes, and so my concern over a lack of carve-outs, and the resulting impact on free speech and interstate commerce, was unfounded. This criticism rests on a misreading of the regulations and a misunderstanding of the integrated "wholeness" of virtual currencies and blockchains.

Subject to certain specified limits, the regulations apply clearly to "any type of digital unit that is used as a medium of exchange or a form of digitally stored value or that is incorporated into payment system technology". Further, the regulations tell us that we are to interpret this applicability "broadly".

Notice that the regulations apply to the "digital unit" itself--at least, if it has ever been used (apparently anywhere in the world) as a medium of exchange or store of value or in a payment system technology.

Said another way, the regulations do not only apply when such a digital unit is used as medium of exchange or store of value in a given transaction or instance, but rather to any transaction involving any digital unit that was ever used as such, unless one of the limited exceptions noted in the regs applies.  In fact, since most any blockchain can be used as a "payment system technology" whether intended for that purpose or not, I don't see how any blockchain, regardless of its main use or purpose, escapes regulation under these rules.

Individual bitcoins are clearly used as a medium of exchange in commerce, they are definitely used as a store of value, and the Bitcoin blockchain is regularly used as a payment systems technology. Thus, subject to the stated exceptions in the regs, the regulations apply to any transaction involving bitcoins, not just when bitcoins are used as a medium of exchange or store of value in a given transaction.

But, as previously noted, the bitcoin blockchain is a general purpose ledger/register. It can be used to log or account for or record most anything--for instance, logging a political statement, storing the hash of some important document in the incorruptible blockchain, publicly registering ownership to a particular piece of property, creating a bridal registry, doing corporate accounting in an easily auditable way (so-called "triple-entry accounting"), reducing or eliminating spam, etc. This may be the single hardest thing for my detractors to get their minds around, but it is unquestionably and demonstrably true. The use cases for bitcoin and similar blockchains are nearly limitless.

Because, like paper, the blockchain can be used to record or account for almost anything, bitcoins are to Internet money or currency what paper is to physical money or currency. As one commentator on Reddit noted, to regulate all bitcoin as Internet money because some bitcoin is used as money is like regulating all paper as physical money because some paper is used as physical money.

Paper can be used to store thoughts in the form of a letter or journal, or an agreement in the form of a contract. Blockchains can be used to store hashes of the same or even to publish a letter or enter into a "smart contract". Paper can be used to memorialize and record ownership of property via "deeds", "titles" and "bills of sale". And, so can a given fraction of a bitcoin. Paper can be used for political commentary. So can a blockchain. In short, most anything that can be done with physical paper in the "real" world can be done better and more securely on the Internet with blockchain tech. Prior to the invention of blockchain tech, this was not the case. I'm shocked at how few of even bitcoin's most outspoken supporters understand this fact.

Part of the reason for the community's failure to "see the light" on this subject is a misconception that you can separate the coin from the chain. This fallacy crops up again and again, for instance when people say "bitcoins suck as a currency/investment, but the payment technology (the blockchain) might prove useful".

However, the "currency", the unit of account used on a given blockchain, is inseparable from the blockchain itself. Without one, the other does not exist.  The former is integral to the security and usefulness of the latter. If the "coin" on a given blockchain remains worthless for long, the whole blockchain becomes insecure and unusable. Without bitcoins of value, there is no secure blockchain and Bitcoin network. Without a market-valued unit of account on the blockchain, there is no sustainable "distributed consensus" and therefore no solution to the Byzantine Generals Problem. Without the "virtual currency" (I hate those words since they so limit one's paradigm!), there is no such thing as a secure and distributed/public ledger/register. Since there is no way to make an entry into the ledger/register/blockchain without transferring bitcoins, the chain and the coins are an inseparable whole.

Because you can't separate the coin from the chain without bringing down the whole edifice, the paper analogy used above is, in fact, appropriate. If you are going to regulate all bitcoins from the limited perspective of a financial services regulator, regardless of how a given bitcoin may be used in a particular case, there is simply no way to limit your regulation's impact on free speech and interstate commerce. If you regulate every coin, you de facto regulate every blockchain, and all of their varied uses. This is, once again, like regulating all paper as currency because some paper is currency.

"But bitcoins have value, which makes them different from paper and more like money", some of my detractors have pointed out, arguing that this justifies financial-services-style regulation. My response is that just because something has value doesn't make it subject to being regulated as a financial service. Nail polish has value, but it's not a financial service and shouldn't be regulated as such.

Additionally, and more importantly, bitcoins actually don't have that much value. With a single satoshi (currently the smallest subdivision of a bitcoin) I can theoretically make an entry in the Bitcoin blockchain. I could, for example, tag a satoshi to represent title to my car or the deed to my house, or most anything else for that matter, and I could transfer said title on the blockchain, instead of creating a "deed" or "bill of sale" on paper and transferring title that way. know what? The satoshi I would use for this purpose is actually worth far less than the sheet of paper I would need to use to create a deed or bill of sale in the alternative.

To conclude this section, no court would allow a state to use its traditional ability to regulate money transfers within its borders to justify regulations of all paper documents or transactions everywhere. Likewise, I'm convinced that no court. after gaining a proper understanding of blockchain technology, will permit New York to use its financial services regulations to control all transactions involving so-called "virtual currencies" on a blockchain.

The "way out" of this mess for New York, of course, is not to regulate "virtual currencies" in general, as the bitlicense regulations attempt to do, but rather to regulate very specific types of virtual currency transactions, where they are in fact used as "currency" or "money". As the Bitcoin Foundation of Canada recently noted in a report, existing laws are more than sufficient to accomplish this purpose. There is no need for new and comprehensive "bitlicense" regulations, just some sane regulations that extend existing currency regulations to cover certain virtual currency use cases.

The second set of criticisms came from Bitcoin supporters who, like me, share libertarian sympathies. They insist that time spent offering feedback to regulators is wasted. They believe that bitcoin is unstoppable and unregulatable, so why even bother to educate a regulator? Any collaboration with the state is collaboration with the enemy. The underlying fear here is that working with the state risks the establishment co-oping the blockchain revolution.

I'm not entirely unsympathetic to that viewpoint. In the long-run blockchain tech is unstoppable. Blockchains are are a superior version of the Internet itself, and with the exception of subjecting us to massive state surveillance, the Internet has proven robust against state regulation and censorship.

The only way for a state to stop the Internet is to adopt the ways of North Korea, completely isolating itself from the rest of the world. The Soviet Block could not withstand the Internet. China has been forced to "play nice" with the Internet (sure it censors, but routing around that censorship is trivial and regularly done in China). The Internet spawned the Orange Revolution, the Arab Spring, etc. The Internet lead to the collapse of Old Media (which is mostly bankrupt and being purchased by New Media companies). The Internet decimated the music industry, has severely impacted profits of the movie industry, put most bookstores out of business, gravely impacted the US Postal Service, and much, much more. In short, the "old" establishment had no success in keeping the Internet in a bottle.

The decentralized server-client model of the Internet has proven robust against state interference, but distributed peer-to-peer blockchain technology is actually even stronger. It is antifragile. Not only will it withstand stress, regulatory or otherwise, but it will find ways of routing around such stress and be all the stronger for it. Those who think the state can stop this technology simply don't understand the history of technological revolutions. And due to its peer-to-peer nature and ability to achieve distributed consensus, blockchain tech is a technology revolution like no other. There is no central point of failure. There is no central point of control. There is nobody to intimidate.

And...there is nothing to corrupt. For the same reasons blockchain tech can't be co-opted by the state in the long run, bitcoin technology can't be co-opted by the establishment in the long run. So, we shouldn't fear working with the state and the establishment to advance blockchain technology. Anything they do can only help. To the extent they attack, they make blockchains stronger and more antifragile. And to the extent they assist and are reasonably cooperative or responsive, they hasten the demise of their own significance and influence.

So, while I appreciate the disdain that some have for cooperation with state and the establishment, the fact is that we have little to lose and much to gain by engaging.

The third and final set of interesting criticisms came from those who are overly impressed and awed by state power and the special interests that control it. They insist that I waste my time in offering public comments on the regulations because, regardless of the soundness of my logic, the state will ignore me and use its monopoly on force to "kill this thing dead" (as we say in the South).

I have already addressed this criticism above. No state, save maybe North Korea, has successfully withstood or resisted the Internet, and blockchain tech is the Internet on steroids. If you really believe that the whole world is going to become like North Korea just to stop Bitcoin...well, let's just say I'm pretty sure you're wrong.

The above post was EDITED the evening of July 29 to fix typos and improve readability.

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