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The Fight For Bitcoin, Round Two

What really makes Bitcoin different? In The Fight for Bitcoin Round One: Water's Warm Maximalism, much was said about how and why to engage in good, truth-bearing faith with nocoiners, altcoiners, and Bitcoin skeptics alike. But not a lot was actually said about what makes Bitcoin truly special and what specifically puts it in a class of its own outside of the greater cryptocurrency, financial technology and economic market space. As mentioned in the previous article, predominantly as of late there is a whole lot of preaching from our permanent bullish culture leaders, which leads to wonderful and passionate zealotry, but perhaps many holes in fundamental understanding of Bitcoin's protocol and the direct effects of said mechanisms.

The apex predatory nature of Bitcoin is not without sound reason, but it is important to understand why the many high priests of Satoshi's church have such conviction in the hopeful success of such a unique and disruptive technological experiment. There is an ever-deeper cloud of knowledge billowing out of the thousands of nodes strewn across the planet, and just when it seems to coalesce into a complete and whole picture, another layer of incentives, another extrapolation of game theory, another form of legacy and incumbent systemic dematerialization presents itself to the now millions of eager, hungry students of Satoshi. “Fix the money, fix the world,” they say, but how can you fix the money without understanding the problems, and more importantly understanding the possible solutions to many of today's problems presented by Bitcoin in a succinct and pure manner?

Much has been written in Bitcoin Magazine about the issues with the petrodollar system, and how a centralized cartel of money changers can wreak havoc upon the working class with monetary supply expansion at a whim, but the focus of this piece is going to be the true demarcation and separation of Bitcoin from its asset class; the unfortunate peers of cryptocurrency and decentralized networks in name only. Like it or not, the altcoin casino of “all bark, no bite” initial coin offerings, jpeg money laundering schemes, and venture capitalist Cantillion yield-bearing smart contract platforms are most likely here to stay for the foreseeable future; there is simply too much economic incentive in charismatic leaders teaming up with marketing teams to sucker fresh meat into playing the role of unsuspecting exit liquidity for the ever-rotating carousel of pre-mines and ghost chains that is the cryptocurrency market at large. So rather than the beautiful blind dismissal that is more than likely more than deserved, let us instead equip ourselves with the knowledge to fight back on these predators with logic and logos.

For starters, the Howey Test, while perhaps being “an older law” in the grand scheme of financial technology, is relatively black and white. In the 1946 court case, the defendants, a Florida citrus company under the name Howey in the Hills Service, were selling large plots of their orange groves to mainly out-of-state investors under the premise and assurance that once the plots were planted and propagated, the profits would be guaranteed to break a certain margin. Only thirteen years prior was the establishment of the Securities Act of 1933, and the following year the Securities and Exchange Act of 1934, in which the Supreme Court gave the newly-formed Securities and Exchange Commission, now known colloquially as the SEC, the exclusive rights to regulate the newly-determined financial instrument of a security contract. This case was monumental in that it established precedent for what exactly determines a security contract versus a stock, a bond, a commodity, an asset or a currency. In this case, the Florida businessmen were offering a leaseback agreement, being as they were agriculture men, to non-growers, on their tracts of land with the future promise of harvesting, pooling and marketing the then non-existent citrus in exchange for a cut of the profits. The SEC sued the Florida men for not registering these transactions with them under the claim that these leases were clearly within the jurisdiction of the Securities and Exchange Commission. Under the now-known Howey Test, a transaction is an investment contract if:

  1. It is an investment of money
  2. There is an expectation of profits from the investment
  3. The investment of money is in a common enterprise
  4. Any profit comes from the efforts of a promoter or third party

When a potential security contract is being put up to the test, it is within the interest of the creator and marketer of the entity to NOT want to pass the test; passing the Howey test means your investment contract has been deemed a security and thus under the jurisdiction of the SEC, and thus punishable by fine or worse, if established without going through the proper channels of approval via the aforementioned regulatory bodies. In the case of Satoshi's open and fair launch of the Bitcoin network, there was of course no submission of approval via these channels, and thus the question remains if Satoshi was in violation of the Securities Act of 1933 and the SEC. One simply has to look at the first quadrant of the Howey Test to know that in zero ways was the establishment of the Bitcoin network in any sort of violation of the act; while participation in the network to mine bitcoin required the cost of the electricity running over the silicon in the CPUs at the time, this investment — available to any and all who downloaded the protocol — was not an investment of money. And perhaps if you did want to use an expanded definition of the term “money,” in which there is precedent as such as using broader terms of investment of “assets,” than one simply has to look at the second stipulation and see that nowhere within the white paper, nor any official supporting documentation, nor further yet in the code itself, is there any marketing material promising an expectation of profits from the investment of the energy used to mine the bitcoin. The SEC would have to prove that the investment of electricity was an investment of money, and that the open competition mining of bitcoin at launch was somehow a common enterprise between the miners, the exchanges and the core developers. Have people surrounding the project committed securities fraud?

Of course, but that is very different from the actual mechanism and anonymous entity responsible for the initial launch of the protocol promising as such. Bitcoin is simply not a security; it’s a commodity, an asset, or a currency perhaps, but not a security due to the “immaculate conception” of the project's launch. So where does that leave the other projects in the space? Does Ethererum skirt the same labeling as Bitcoin and find itself avoiding passing the Howey Test? In this humble contributor's opinion, as well as the opinion of the current and 33rd chair of the Security and Exchange Commission Gary Gensler, it does pass the Howey Test. Again, you do not want to pass the Howey Test. The initial “initial coin offering” that was the Ethereum ICO from July to August 2014 was organized and presented by Vitalik Buterin, mostly known at the time for being the founder of this very publication, with the concepts first described in a white paper in 2013. Right away we can see that it utilized an online public crowd sale, selling the not-yet-released tokens called ether for bitcoin. If we are giving Bitcoin's case the benefit of the doubt for passing unscathed by the first clause of the Howey Test, perhaps we can, too, be considerate, and for the sake of furthering the case, closely consider the investment of bitcoin as a money or an asset.

Of course, many of the readers of this publication would most likely object to that, as would the writer of this article, but it is important to understand the difference between using an electrical debt versus a traded, global digital currency with a per unit price around $564 and a market cap of nearly $8 billion. The case for Ethereum being a security is furthered when looking at the next clause, and in regards to the Ethereum Foundation's many public statements of further price increase and thus profits for all the initial investors. The marketing teams of the foundation have been quoted many times, as well as Vitalik himself, as perpetuating the assurance of market cap expansion via projects and common enterprise materialized by the Foundation and its promoters. Not only that, Joe Lubin, Ethereum cofounder and CEO of ConsenSys, was recorded talking about the ICO saying

“... a person can buy unlimited ether with pseudonyms. We may limit the size of a single purchase to make it easier to disguise … so that nobody is scared. If you are a whale, and plan to invest several million U.S. dollars’ worth, then you can do that in multiple identities. We will ask for a form of real world identity in the form of an email address just so we can make sure that everything works smoothly through the process, but we won’t be requiring it. So we can create a pseudonoymous email and identity and purchasing.”

While certainly shocking to see such brazen language, this is primary evidence of collusion and common enterprise between the token issuers and the investing parties. This is in clear violation of the four terms set by the Howey Test, and thus one could easily make a case that Ethereum, and the many, many similar initial coin offerings that utilize the rails of their system, are in fact securities and pass the Howey Test with flying colors.

But is that what the supposed free speech and free market defenders that make up the Bitcoin community want? Are we suddenly in favor of government overreach and a retail reckoning that will most likely hurt more working-class investors than it will the venture capitalist backers, such as J.P. Morgan, that have already made out handsomely in fiat and bitcoin terms when they helped kickstart this system? This is certainly a personal bias, but perhaps we can stay well within our lanes of free speech proponents to instead take a pragmatic approach to squashing the narratives of web3 and these smart contract social networks with technical facts to illuminate the eventual failures and shortcomings of these attempts without the need of the regulatory vengeance of Commissioner Gensler. Bitcoin had the fairest launch of any financial system in existence, nevermind the numerous actualizations of equity and fair chance described at length in the previous article; this simply cannot be said about predominantly pre-mined projects like Ethereum and certainly not for entirely pre-mined projects like Ripple's XRP, in which the entirety of the 100 billion tokenized supply was created and distributed in the genesis “block.” Currently, Ripple is under litigation by the SEC for violating the Securities Act of 1933 from a last-minute subpoena from the former head of the SEC Jay Clayton, last Christmas before he made his exit from the commission.

But what sets the consensus of a proof-of-stake system, or a Ripple consensus apart from the Nakamoto Consensus' proof-of-work is not such a simple violation of an 80-plus years-old law, but rather a computer science problem lovingly known as the Byzantine Generals’ Problem. The crux of the Byzantine Generals’ Problem, in a reductive sense, is how to distribute incorruptible and immutable truth via open and public channels. The Ripple consensus at its core relies on simply just trusting other validators in the gossip pool to not censor your transactions, and to order and sequence the transactions via utilization of a centralized clock. The proof-of-stake model that Ethereum is apparently transitioning to, is similarly relying on a trust system, but this time with a stake-based lottery mechanism that randomly distributes consensus control to validators algorithmically depending on how much equity one has in the system. Over time, the compounding yield will give further and further consensus weight to the stakeholders of the system, a problem further exacerbated by the over 70% pre-mine of tokens given to the Ethereum foundation at genesis for starting the protocol. This governing conflict of interest is clearly shown in the ever-changing monetary policy at the whim of Vitalik and his pre-mine enriched founders. The argument of whether or not this was in good or bad faith is simply irrelevant; no party will ever be able to catch up to governing weight of the foundation, nor do the mechanisms that secure the network allow for immutable economic transactional activity and history. Bitcoin did not quite solve the Byzantine Generals’ Problem per se via proof-of-work, as there are still statistical, albeit nearly impossible, scenarios of governance corruption with bad faith actors taking dominant control of hash rate. However, in a reality-based probabilistic manner, it does it as as well as any mechanism one could hope for; the universal, forgetful function of block discovery paired with the largest block height and highest hash rate makes it exceptionally, astronomically unlikely for any mining cartel to ever be incentivized to take a stab at controlling the Bitcoin network as opposed to acting in good faith.

If we all want Bitcoin to exist and its use be protected by free speech, we should find ways to distinguish it from its peers without the use of government regulation. And thus, it is on us to act like a decentralized consumer protection team that uses facts and reason to strike down the marketing teams and narratives of these “decentralized in name only” smart contract platforms. If these parties want the right to exist on the free market, then so do we want the right to talk fairly and freely upon the shortcomings of these products without minimization of lazy bucketing via such terms as “maximalists” or “toxic.” It should be to no surprise the term Bitcoin maximalism was defined and coined by the creator of a prominent alternative chain. Bitcoin solves a very real problem that humanity faces, while most of these platforms reinvent many of the financial solutions already solved by trusted third parties, while being nothing but a permissioned third-party platform themselves. Bitcoin truly is different, and it is more than okay to loudly and proudly think that; but best yet, is to know why.

This is a guest post by Mark Goodwin. Opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.