I am thrilled to announce that Professor Carolyn Shapiro is joining the firm as Of Counsel. As the former Solicitor General of Illinois, a constitutional law scholar, and a former Supreme Court clerk, she shares her tremendous appellate experience and acumen. Moreover, I deeply admire Carolyn’s long-standing commitment to public interest work and all she’s done to stand up for the rule of law in recent years — and consider myself very fortunate to be able to collaborate with her in this new capacity. You can find her full biography here, select publications on SSRN, and her Tweets @cshaplaw.
The Bank of Canada recently published a study on “cryptoassets” that contains a subtle but significant error. In this post I explain what went wrong and why the Bank, which has previously released high-quality scholarship on this topic, should prioritize a more nuanced understanding of the roles that digital money like bitcoin can play in the banking system.
The authors pose the question, “How much electricity would be needed to have all Canadian payments settled on a proof-of-work blockchain?” In the appendix, they calculate that settling every Canadian retail transaction on a bitcoin-like blockchain would entail astronomical energy costs, and conclude: “changes to the bitcoin technology and usage need to be substantial before it could be used as a retail payment method.”
This approach is based on a faulty premise about bitcoin and its blockchain that is emblematic of a broader misconception.
At its essence, the appendix conflates payment with settlement, and then determines that every retail transaction would be settled on the bitcoin blockchain, despite no such requirement at a technological or conceptual level.
Even putting aside the appendix’s use of widely–debunked energy estimates or its dismissal of bitcoin-integrated payment technologies, central banks should be conceptualizing of bitcoin as a money and the bitcoin blockchain as a high-security form of settlement. The bitcoin blockchain is not and was not designed to be a method of payment for every retail transaction in the world.
To analogize this distinction, imagine a payment between parties on an app like Venmo. If Alice keeps $100 in her Venmo account and sends $30 to Bob, the payment is merely numbers moved internally on Venmo servers. Only when either party decides to “cash out” — withdrawing funds from Venmo to their bank account, for dollars — might the transaction be considered settled:
Like Canadian Dollars or Euros or USD, bitcoin-based payments can be made available via Venmo/Cash App, credit cards, checks, ACH, Paypal, and other layered payment systems. In other words, retail payments could retain existing payment infrastructure and still be denominated in bitcoin, and not necessitate settlement to a bitcoin-like blockchain.
We do not even need to address major recent developments in bitcoin payments technology, such as the Lightning Network and other “Layer 2” development,” to understand that no changes to bitcoin’s technology need to take place before it can be used in Canada’s payment landscape. Bitcoin is not VISA or Venmo — it’s closer to money those companies move around.
To be charitable, perhaps the authors intended only to demonstrate what we discuss here: the futility of broadcasting all retail payments on bitcoin’s energy-intensive blockchain. If so, on this we agree. We do not mean to advocate that all Canadian retail payments should be conducted with or denominated in bitcoin. For many reasons, including familiarity, security, and price stability, Canadian customers and retailers may prefer to transact in CAD. Still, the conclusion that “changes to the bitcoin technology” are required is simply not true.
Moreover, the bitcoin blockchain’s proof-of-work electricity consumption is not an accidental byproduct: it is the means by which transactions are made all-but-irreversible a short time after they are added to the ledger and repeatedly confirmed by network consensus. In other words, the electricity and consensus confirmations offer a level of final settlement better-suited for high-value transfers (e.g., between banks) than for retail payments. If the intent here was to highlight the absurdity of using the bitcoin blockchain for retail payments, without acknowledging the utility of its blockchain for high-value settlement between institutions like central banks, then the authors should make that clear. As Hal Finney, the first person to ever receive a bitcoin transaction, predicted in 2010:
“I believe this will be the ultimate fate of Bitcoin, to be the ‘high-powered money’ that serves as a reserve currency for banks that issue their own digital cash. Most Bitcoin transactions will occur between banks, to settle net transfers.”
Bitcoin has a variety of pros and cons, uses and misuses. What it does not have is a centralized research department to create these sorts of reports, nor a communications department to publicize and distill its applications and policy implications for lawmakers and central bankers. Such are the consequences of decentralization.
Still, it would be a shame if policymakers do not realize that the questions here go beyond retail payments, and carry global, potentially historic implications. For example: when nations with their own currencies trade with each other, which money should they use for settlement? Former Federal Reserve Chairman Paul Volcker recently lamented the lack of a “common numeraire” in our international trade system. A numeraire, he describes, would act as the monetary unit in international settlement, and free central banks from reliance on the unpredictable supply of a third nation’s currency, most recently the U.S. dollar.
It is worth considering whether a digital money like bitcoin — with predictable and verifiable supply, as well as Internet-native design tailor-fit for digital banking — could fulfill the role of “numeraire” and establish a “metric unit” for international exchange. If that possibility seems outlandish, fair enough. So too at one point was the possibility of agreement on the mass of the kilogram or the length of the meter, but the measurements enabled trust and coordination, and rapidly became integral for global advancement in science and trade.
The Bank of Canada’s study shows that it is still all too easy to misunderstand what bitcoin is. This is especially true when communications from bankers and bitcoiners alike present strawman caricatures of each other. But this also means that if we are to get serious about the complex and overlapping realms of central banking, retail payments, and digital money, we all ought to be a bit more rigorous and critical. Especially when we read third party research, like this study here, that narrow and misconstrue the discussion of what bitcoin is, and could be.
One of Satoshi Nakamoto’s last known public posts, in 2010, was a warning: “Wikileaks has kicked the hornet’s nest, and the swarm is headed towards us.” At the time, PC World had just published an article describing how bitcoin (then trading for a whopping $0.20) could be used for permissionless donations to Wikileaks, despite any bans by local authorities or payment processors. It is impossible to know Nakamoto’s exact concern, but one thing was clear: how people chose to use the bitcoin protocol he released — including how they would spend the bitcoin “currency” it issued — was out of his hands, even if it meant others could use it to potentially break social norms, business monopolies, and local laws. And if bitcoin payments to Wikileaks (or poker sites) were forbidden, could Nakamoto or bitcoin’s other developers be held personally liable for enabling unlawful activity?
Today, nearly a decade after Nakamoto’s warning, regulators continue to wrestle with waves of permissionless innovation emerging from open-source projects like bitcoin, and to a greater extent, from the Internet itself. A fundamental question remains: should programmers of open-source software — where anyone can build upon, re-release and re-deploy the code — be held responsible if users take the code and violate their local laws or regulations, and if so, where should we draw those lines?
One possible answer comes from a Commissioner of the Commodity Futures Trading Commission (CFTC), Brian Quintenz, who recently published his thoughts on when, in his estimation, the CFTC should (and should not) bring action against open-source developers whose code is used to violate CFTC regulations. As Quintenz put it, “Absent proof that developers intended that the code facilitate conduct that is illegal, the CFTC should not bring a case against them.” He proceeded to list several relevant questions to consider in determining a “developer’s intent,” including whether the developers were promoting, profiting from, or modifying code in order to enhance unlawful activity.
For developers who, like Nakamoto, are designing, building, and launching code, these questions of liability are not merely musings: they affect the likelihood of attracting investment, users, and developer talent.Absent more specific statutes or binding authority from regulators, sometimes public speeches and statements are the best sources of legal guidance available.
With Commissioner Quintenz’s commentary in mind, we wanted to highlight a question we expect to surface in the near future: to what extent should open-source developers of bots or algorithms expect to have some legal responsibility for actions that bots take on behalf of their users? Take, for example, a “trading bot” that enabled a user to plug into a trading platform and buy or sell products or digital tokens based on user-provided parameters (e.g., if it rises to XX, sell it — if it falls to YY, buy it). Could a trading bot developer be held liable if a user in a Treasury-sanctioned country downloaded open-source trading software and, via a VPN, surreptitiously deployed on a US-based exchange to sell bitcoin, violating U.S. sanctions? The short answer is likely no, and here’s why:
Guidelines for Code Design
In his speech, Commissioner Quintenz weighed a related question about software that is “specifically programmed” to violate laws, in this case, “to purposely distort the final settlement price” of a futures contract. His approach is worth highlighting here: “The more a code is narrowly tailored to achieve a particular end, the more it appears as if it was intentionally designed to achieve that end.” In other words, if the bot were knowinglydesigned and intended to manipulate a futures contract (also known as “banging the close”), it would “look a lot like aiding and abetting” of a legal violation — but if it merely allowed a user to make trades at whatever time they wanted, and it is only the user who deploys the software to manipulate a price during a particular interval, the developer should not expect to be held liable.
Additional questions emerge for developers of software that users could operate in ways that transgress Securities and Exchange Commission (SEC) rules, but for those developers, similar principles should apply. For example, if a a developer releases software knowingly and purposefully to enable users in the United States to manipulate trading markets, then the developer might be held liable for contributing to the forbidden action. Recent charges against a software developer involved in designing custom software that enabled sophisticated spoofing of futures markets confirms as much. If, on the other hand, the developer merely releases an open-source trading software — essentially exchange-agnostic, asset-agnostic, leaving the decision entirely up to the user as to which assets to trade, consistent with the laws of the users’ own jurisdiction — then the developer has a compelling case that they should not be held responsible for actions taken (or modifications made) by end-users of their own volition.
Users, Use Care
For users themselves, similar guidelines should apply. On the one hand, if users deploy software to knowingly engage in unlawful activity, they should expect to be held responsible. On the other hand, the risk associated with other types of software use is less clear. For example, imagine a group of card-game enthusiasts who utilize an algorithm to help them trade Magic: The Gathering cards online, an activity that (as far as they know) is legal within their jurisdictions. If their regulators in the future clarify that online trading of Magic cards is somehow outlawed, the group members might expect that any future trades of these cards will incur legal risk, but are less likely to be held liable for previous trades of these cards, since they did not then knowingly engage in impermissible activity. As a best practice, users should take care to check the requirements of their local jurisdiction and adjust their activities accordingly, regardless of the actual functionality of the open-source software before them. As a matter of policy, the onus here should fall on the users, not on open-source developers, since developers would be hard-pressed to monitor, limit, and/or tailor access to their code to meet the evolving jurisdiction-specific needs of each user.
For the time being, Quintenz’s recent focus on a software developer’s intent is a sensible rule of thumb for open source projects of all stripes, including in the context of bots and digital assets. Put differently, developers of OpenOffice should not be held liable if someone uses it to draft a ransom note; on the other hand, a developer clearly designing for illicit use, like releasing a tool called “OpenPassportForger,” would have a comparatively harder time arguing he or she did not intend it to be used to break the law. Even with these broad principles in mind, other market- and jurisdiction-specific rules can still apply in certain circumstances. For example, SEC regulations regarding algorithmic trading strategies conceivably apply to algorithms that trade securities (like stock in eBay and Amazon), while not applying to algorithms that help sellers arbitrage prices between eBay and Amazon platforms, since the products are not securities subject to SEC jurisdiction.
And until the day comes that bots are sentient enough to consult their own lawyers, developers and users of sophisticated automated software should — when in doubt — consult attorneys* of their own.
[*] Disclaimer: Consistent with the terms and conditions of this site and blog, this post is not and should not be treated as legal advice.
This season’s steep decline in the price of bitcoin and other digital assets has rekindled a fierce debate about their role in the global economy: opponents lambast them as a Ponzi scheme about-to-collapse and proponents promise they will replace government currencies entirely. The reality is that, at least in the short term, both extremes are highly unlikely, and policymakers, especially central bankers, are charting a course in between that recognizes that some form of digital money is here to stay. Notably absent from many of these discussions, however, is the biggest Central Bank in the world: the Federal Reserve.
After a year when bitcoin’s price dropped over 75%, this might seem to be a counterintuitive moment for these conversations — but they are already subtly starting. Just the other day, the Governor of the Bank of England, Mark Carney, expressed a remarkable openness towards digital money. “It is still early days for cryptoassets,” Carney explained, and despite their present shortcomings, they are “throwing down the gauntlet to the existing payment systems” to improve services. Last month too, the Managing Director of the International Monetary Fund, Christine Lagarde, made the case for central banks to explore, adopt, and issue digital currencies, because a “new wind is blowing” “and we are all in the process of adapting.”
Carney and Lagarde’s middle-ground approach stands in stark contrast with caustic criticism from some of their colleagues: two days after her speech, a member of the European Central Bank vilified bitcoin as “evil spawn of the financial crisis” and previously, an official at the Bank for International Settlements deplored it as “a combination of a bubble, a Ponzi scheme and an environmental disaster.”
Such categorical dismissals are belied by the growing recognition that digital money like bitcoin may offer a variety of advantages, including in terms of security, transferability, transparency, and inflation resistance. As Lagarde suggested, central banks could choose to issue their own digital currencies that compete with bitcoin in terms of monetary policy, payment privacy, or other features.
Although it may appear premature to imagine central banks managing a digital money alongside traditional reserve assets, the possibility is real enough for central banks to take it seriously, and several are. A major survey released last week reported that some 70% of central banks are engaged in work around digital currencies, and half have moved onto “hands on” proof-of-concept activities and other research. The Bank of Canada also quietly published a research paper examining how central banks might operate under a “bitcoin standard” similar to the gold standard of the late 19th century. The paper explained that a bitcoin standard would not mean the end of government money or central banks — but that backing national currencies with bitcoin reserves could offer several major benefits over current international monetary standards, due to the stability presented by bitcoin’s algorithmically-fixed inflation rate. The European Central Bank, Bank of Japan, and Reserve Bank of India are closely studying digital money as well.
Similarly, the U.S. Federal Reserve should formally explore the potential impact of digital money on U.S. economic interests. Although the current and prior Fed Chairs have been publicly tepid on the subject area thus far, Fed branches are engaging more straightforwardly. The other week, the Federal Reserve’s St. Louis branch suggested that a cryptocurrency might “eliminate” the core tension for the the U.S. dollar: being asked to function both as a stable global reserve currency while also meeting domestic needs (known as the Triffin dilemma). As a New York Times op-ed recently noted, the U.S. dollar’s position as the world’s reserve currency gives the United States a unique opportunity to lead — or stand to lose if other countries leave it behind.
The bottom line is that categorically dismissing bitcoin and other digital assets as irrelevant or “evil” for central banking purposes is increasingly out of step with the trends and tools at hand, not to mention widespread appetite for a potentially faster, fairer financial system. (Why does sending a check take 4 business days to clear, again?). The U.S. Federal Reserve should join its counterparts and start preparing its financial infrastructure for a fast-approaching new reality: where nation-backed moneys compete and co-exist alongside digital moneys settled with distributed ledgers, electricity, and math-driven consensus.
Here is where we will be periodically sharing articles and links, mostly about frontier technologies, new and emerging areas of law, and the Supreme Court. Feel free to let us know what you think in the comments or on Twitter (@jpscasteras; @MishaGuttentag). Please forgive our lawyerly disclaimers — the gist is that the content in this blog is just commentary and does not constitute legal advice nor create an attorney-client relationship.