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Bitcoin runs on paranoia, and that’s the beauty of it: Elaine Ou

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Bloomberg’s Elaine Ou explains how widespread paranoia and mistrust not only led to the creation of blockchain, the ‘trust network’, but sustains it.

By Bloomberg

Traditionally, the only sort of financial system that works at scale is one decided by courts and enforced by threat of violence. Even back in the days of primitive firepower, deposit and lending activities took place in temples consecrated to the ancient gods, to underscore the idea that dishonesty would be punished.

Widespread belief in the threat reduces the need for active enforcement. The IRS relies on a system of voluntary compliance, meaning that individuals are responsible for reporting and calculating their own tax obligations. The IRS doesn’t have time to check everyone’s work, and less than 1 percent of tax returns are audited. Given the odds, one might expect rampant tax fraud. But we don’t see that. Our tax system functions reasonably well — because Americans fear their government.

In fact, Americans are so inordinately obedient that Indian phone scammers have made hundreds of millions of dollars impersonating government officials. Last year, the New York Times profiled an IRS scammer from Mumbai, who gave this charming quote:

“I think they actually are really afraid of their government,” he said. “In India, people are not afraid of police. If anyone wants to come and arrest, they say, ‘Come and arrest.’ It is easy to get out of anything. But in America they are afraid. We just need to tell them, ‘You are messing with the federal government,’ and that is all.”

A system of deterrence works only as long as the threat is credible. The Holy Island of Lindisfarne held substantial unguarded wealth — or guarded only by God, one might say — until the heathen Vikings showed up and ransacked the place.

From the eighth-century English countryside to the modern global financial system, the only security has been the security of threatened violence. No longer.

Now there are public blockchains, designed to support a global financial system without the need for violence or threats. Rules aren’t enforced under duress, but by consensus between computers all over the world. There’s no way to add exceptions or conditions without the approval of every computer in the network.

While the humans behind the computers are still vulnerable to violence, any coercive threat would have to be applied to thousands of independent individuals, many of whom reside in sanctioned countries or ones without extradition treaties.

Oops! Some might consider this a flaw. When it comes to decentralized digital currencies, the U.S. can’t leverage its banking laws to advance foreign policy; participants in sanctioned countries are unlikely to enforce sanctions against themselves.

It’s also a feature. Decentralized jurisdiction has allowed Bitcoin to endure where previous attempts at privately issued digital money were quashed. Bitcoin’s value comes from its resistance to human arbitration.

That’s the theory, anyway. Decentralization is used to keep the network secure against collusion, but that security can be difficult to quantify until it is breached.

Bitcoin has the longest record of resisting intervention, and even its decentralization may be illusory. Last week, a critical software bug was quietly discovered and reported. The Bitcoin software maintainers quickly developed a patch and notified the largest businesses and miners before releasing the information to the public. Within 72 hours, over half the miners had applied the fix.

While it’s reassuring that a potential attack vector was repaired before exploitation, that sort of coordinated effort runs contrary to the idea that Bitcoin is made up of independent unyielding users. “Coordination” is just a socially acceptable form of collusion. And if collusion is possible, then is Bitcoin really immune to meddling?

Concentration of power has been a concern ever since the first Bitcoin mining chip was fabricated. Miners are responsible for arranging transactions into blocks, and majority control of mining power could selectively censor participants or rewrite portions of recent history.

Despite the potential for abuse, it hasn’t happened yet. No one wants to display outsize influence if a network is supposed to be decentralized. In 2014, one mining group became responsible for 51 percent of the total hashing power. Instead of taking advantage of the situation, the group backed off and promised to keep future power below 40 percent.

Confidence in a network’s decentralization is critical to a cryptocurrency’s value. Public blockchains remove the need for mutual trust between participants because everyone independently audits every transaction. In fact, sweeping distrust is necessary to motivate users to perform their own verification. A healthy paranoia is what keeps things running.