Why Bitcoin’s Bad Reputation is in the Eye of the Beholder

Marcus Swanepoel is the CEO of BitX, a Singapore-based bitcoin services company focused on digital currency in developing markets.

In this opinion piece, Swanepoel tackles the issue of bitcoin's bad reputation, arguing this perception is more based on misinformation than fact.

As an industry insider, it is sometimes very hard to admit that bitcoin suffers from serious negative perception issues: that in the minds of many people bitcoin is still automatically linked to thoughts of drugs, terrorist financing and money laundering.

Needless to say, this has massive implications for all potential stakeholders: It slows down consumer adoption, it has regulators set the bar unreasonably high for bitcoin companies to operate and many banks still refuse to provide bitcoin companies with simple operating accounts.

All of this results in the stifling of innovation, the creation of an unfair competitive environment, and ultimately, a negative connotation for the consumer who is meant to reap the benefits of this new and useful technology.

We’ve spent enough time with all these stakeholders to reasonably assert that most of these concerns are driven by perception and emotion, rather than facts and data. Are there risks around bitcoin? Yes, of course – they exist in all financial systems.

The more important questions are to ask what the nature and extent of these risks are, and if and how well they can be mitigated, relative to the benefits this new technology brings to society.

So let’s try and put a few things in perspective:

Before we dive in, it’s important to consider how we got here in the first place. It’s been a long and windy road for bitcoin, but at the root of it all sits our industry’s own modern day twin peaks: Silk Road and Mt Gox.

Most people first learned about Bitcoin from the collapse of Mt Gox (with a strong message that "bitcoin is a scam" or "bitcoin is not secure") and the rise and fall of Silk Road ("bitcoin is only used by drug dealers"). Without going into a whole psychology lesson, let’s just say that first impressions, whether rightly or wrongly so, matter – and worse, often can persist – even if information to the contrary is subsequently received.

So as a starting point, we need to realize we’re formulating all our arguments on very shaky ground. Given this, all we can really do is to appeal to people’s sense of logic and fairness to consider the facts before making sweeping judgments on some very important and complex topics.

A couple of 'real-life' metaphors are also helpful to put these events in perspective: just like the Lehman Brothers bankruptcy that didn’t signal that 'USD is a scam, or USD is insecure', or that a recent $1bn drug bust in San Diego didn’t mean 'USD is only used by drug dealers', it’s important to realize that Silk Road and Mt Gox were also outlier events, and predominantly a function of the people involved rather than the ‘currency’ being used.

Let’s also just take a step back and take a look at how big the bitcoin economy really is. This is important, because with all the media attention on bitcoin it often distorts views, resulting in commentators extrapolating minor bitcoin issues to much larger imaginary market sizes.

The bitcoin economy is really, really small.

When measured by market cap, it is currently worth roughly around $6bn. By some estimates up to 30% of that is not usable, so in reality, it’s even smaller. Let’s call that the Bitcoin Free Float (BFF) for now. Using this handy visualization from Visualcapitalist (yes, it’s a bit of a moving target but it’s accurate enough to get the right perspective), we can see that the personal wealth of Bill Gates is around 20 times the BFF, and Apple’s market cap is around 150 times the BFF.

Yes that’s right, one company in the US is around 150 times larger than the entire usable bitcoin economy. We don’t even need to look at respective industry growth rates or other much larger data points like the value of gold, the value of global payments systems or broader definitions of money – whichever way you look at it, the size of the bitcoin economy is really insignificant right now.

Getting reliable data on bitcoin use is very difficult, but we have to start somewhere.

In another post, we spoke about the power of disaggregation, so instead of going with the typical "bitcoin is sometimes used for drugs and by terrorists and that kind of thing" narrative, let’s get a bit more specific:

Terrorist financing

While we don’t have exact data on the extent of this within the bitcoin economy, we do know a few things. Firstly, that most law enforcement officials we’ve dealt with saw an article about ISIS supposedly using bitcoin to fund their operations (and for the sake of the argument, let’s temporarily ignore that this was published by Fox News, which has been accused by many of having various biases in their news coverage).

Quite disturbingly, very few of these same officials had any knowledge that the EU law enforcement agency Europol subsequently published a report citing there was no evidence to link ISIS to bitcoin. In fact, from a terrorist financing perspective, the big culprit in the recent Paris attacks was prepaid cards, an industry that was projected by Mastercard to be over $820bn in 2017 (more than 200 times BFF), if not larger.

Terrorists also use many other, much larger regulated and unregulated financial systems like Hawala to achieve their objectives.

This is also not the first time there have been accusations of journalists inaccurately trying to combine the highly controversial topics of ISIS and bitcoin to drive more traffic to their websites. While the media has (inadvertently) done a relatively good job of raising awareness about this new technology, they have also done a tremendous amount of damage through highly selective or sometimes even gross misreporting.

Let’s look at some other useful data points: A recent Emerging Terrorist Finance Risks report by the leading global body on the topic, FATF, also suggests that while there is a risk of virtual currencies being used for terrorist financing, it represents a great opportunity for financial innovation and that traditional financing methods still continue to present the most significant terrorist financing risks.

In a separate report, FATF also published guidance for a risk-based approach to virtual currencies — nowhere is the alarm raised that bitcoin is somehow more of a risk than other terrorist financing methods. A February 2016 statement by the European Commission dealing with terrorist financing also specifically states that "virtual currencies entail certain risks but do not at this point in time pose a threat to financial stability due to their still limited size…".

Given Bitcoin’s market size, transparency and lack of market depth, we’d also argue it’s probably the worst way of all to finance terrorism or move money for illicit use in general.

Money laundering

Once again, this one is tricky in terms of obtaining actual data, but a very useful and credible source of information is a recent publication by the UK Treasury that indicates bitcoin to be a low, if not the lowest risk for money-laundering compared to other methods.

Anecdotally, we’ve also spoken to many other government officials who further substantiate this: that money launderers prefer to use places that are not transparent, with high liquidity, typically large opaque markets etc, everything that bitcoin isn’t. Some money launderers might have started using it a long time ago before having a real understanding of how bitcoin works, but as their knowledge has grown with the rest of the world, many of them have realized it’s not exactly the best way to go about their business.

As this American Banker interview shows, there are top money-laundering experts that agree with this, despite them not believing in the technology itself.

Illegal substances

Addiction comes in many forms, and one of the worst cases we’ve ever seen is people’s addiction to reading stories about bitcoin and drugs.

Yes, we’re also guilty. And just like real drug markets, the largest beneficiaries in this are the ‘producers’ and the ‘pushers’: the journalists and media companies that headline these stories to drive traffic, clicks and revenues.

The bitcoin and drugs narrative triggers a lot of public interest, and while some of it originates from fact, it’s certainly not representative of the broader bitcoin economy. Let’s look at some examples:

While traditionally difficult to detect, there is a whole suite of new tools available to get more accurate data on the scale of illegal activity in the bitcoin economy, in particular the purchase of illegal substances. A good example is the use of Chainalysis’s tool that was used to give an overview of bitcoin movements in 2015.

Here you can clearly see that that transactions directed to illegal substance sites (shown in red) are very much in the minority. Further analysis also shows they predominantly come from two sites: BTC-e and LocalBitcoins, both who do not require proof of identification or have implemented anti-money Laundering (AML) processes (and arguably, would like to keep it that way).

This is important to know, because it also helps legitimate bitcoin players flag users that might have been transacting on these sites as higher risk, or ban them altogether. It should also be an indicator to law enforcement as to where they can focus their energy to make the biggest impact in terms of combatting this specific risk.

Once again it’s also helpful to note the relative size of the problem. The size of the global drug market is huge, and by some estimates it’s already bigger than the global auto industry and soon to exceed the $3.7tn global oil and gas market. This completely dwarfs anything drug-related that’s ever been done or arguably ever will be done in the bitcoin world.

We recently did a presentation to law enforcement where there were a lot of concerns about people being able to buy drugs with bitcoin. During one of the breaks one of the officials pointed out that there was likely more drugs being bought or sold for fiat currency in a downtown road close to the conference venue than in the entire bitcoin economy on that particular day.

Given the size of the global drugs market, that statement probably wasn’t too far off. If you’re in law enforcement and want to genuinely rid the word of drugs and terrorism, trying to track those doing it with bitcoin is probably not the optimal use of your time.

So, do people buy drugs with bitcoin? Yes. Do they do so more than with other payment methods, both on an absolute or relative basis? Evidence suggests this is not the case, not even close. In fact, as more people start to realize that bitcoin isn’t really anonymous and how traceable bitcoin transactions really are (especially when even the industry ‘pros’, like the founder of Silk Road, very publicly gets caught and sentenced), the more they are likely to avoid using this as a payment channel for these types of transactions.

Will this risk ever go away? No. Can it be successfully mitigated? Without a doubt, yes.

Ransomware

Here’s another one that sticks its head out every now and again: companies that have their IT systems seized by hackers who demand payment in bitcoin to unlock it, commonly through what is known as ‘ransomware’.

The first important thing to note here is that this practice has nothing exclusively to do with bitcoin — it's been going on from long before bitcoin was invented (in fact, since 1989), although it’s picked up in recent years as the internet economy has grown. The second important thing to realize is that just like all other 'financial transactions', bitcoin is typically just one type of payment method used by these extortionists: depending on the group or scheme, it could also be one or all of wire transfers, premium text messages, online vouchers or prepaid cards.

There are even some people who would argue that ransomware is a good thing: that it helps identify potential vulnerabilities in IT systems, and that it is to the benefit of the users or customers of those systems that there are incentives out there to make sure these issues get discovered and fixed.

As Peter Van Valkenburgh at Coin Center points out, if we’re looking to stop this we’d be better off fixing the weaknesses in our IT systems rather than trying to block the tools that can identify and capitalize on these weaknesses.

Ponzi schemes

While most Ponzi schemes are designed to live in the grey zone and are therefore technically not illegal until officially declared ‘Ponzi’ (typically as they start blowing up), this is unfortunately also bitcoin’s next ticking time bomb that we might as well cover now.

I will bet all my bitcoin that within the next 12 months a headline like "bitcoin Ponzi scheme collapses" will be all over the news, making it appear as if bitcoin itself was a Ponzi scheme that has collapsed. Now thankfully most people, including the chief economist at the World Bank, have realized that bitcoin is not a Ponzi scheme. But the fact that some Ponzi schemes like MMM use bitcoin as one of the many methods to collect their member funds is going to create a lot of confusion in the market when it eventually does blows up.

And once again a lot of the media attention will be diverted to bitcoin instead of the Ponzi scheme itself, similar to what happened with Mt Gox and Silk Road.

More generally speaking, in terms of getting better visibility on industry data, let’s keep this in mind: The bitcoin industry is still very new, and will likely take many decades to fully mature.

That said, for a ‘financial system’ that is so new and small, it has made surprisingly big strides in terms of building tools to get the right data and to help the industry self-regulate.

Two to three years ago we had very little visibility on what was going on in the bitcoin ecosystem — today we have a whole myriad of tools that are all evolving rapidly to give us access to better data and provide new ways to mitigate risk.

These include the likes of Chainalysis, Elliptic, Coinalytics, Blockseer, Scorechain, SABR and more. So when we think about what is possible in terms of gathering data and mitigating the risks around bitcoin, let’s not get too stuck in the present, especially given the size of the bitcoin market.

Let’s look at the long-term trend and realize that we’re on a fast trajectory that is not only positive, but one that is likely to take us to a place where we’d be able to identify and manage risk better than with any other financial system that has ever existed.

We noticed something quite peculiar when working with some financial institutions and regulators. The fact that we could use the public blockchain to show when a specific person, for example, used bitcoin to buy drugs online got them extremely worried: "We don’t want to expose ourselves to these kind of customers and risks…".

But where do you think that same customer banks in the ‘normal’ banking system? Yes, most likely with your bank. If that same customer can’t buy his drugs with bitcoin, is he just going to stop buying drugs altogether? Nope.

And when they buy drugs with cash today, where do you think they get that cash from? Your ATM!

The fact that bitcoin companies can have such amazing visibility on these things is a huge benefit to law enforcement and society at large, but strangely, these same bitcoin companies are being penalized for actually being able to detect it so well. Bank customers are already doing the same bad things at a much grander scale, the banks just can’t make such a direct link between them and their customers most of the time. So they kid themselves into thinking that the problem doesn’t exist for them in the first place.

Many of the decision-makers in the banks also seem to mistakenly believe that bitcoin has some inherent characteristic that makes it more prone for illegal use versus other ‘more innovative’ decentralized digital currencies. This is not the case.

The only reason why bitcoin sometimes appears worse is because it was the first one used, and still is the most popular. Any similar mechanism will run into the exact same problems in the future, just calling it by a different name doesn’t make that problem go away.

At the heart of it, bitcoin is there to benefit society: it is a new financial paradigm that ultimately makes it easier, cheaper and safer for people and institutions to transmit and store value. Like the internet, it doesn’t discriminate based on who you are or where you’re from, allowing for equal and universal financial access.

It’s worth expanding on this parallel with the Internet particularly in the context of all the ‘bad stuff’ that people associate bitcoin with. Is the internet all good? Definitely not.

Terrorists, money launderers and drug smugglers use Facebook, Twitter and Whatsapp to communicate and co-ordinate every single day. Some people might feel uneasy about the fact that at least 5–30% of visible online traffic comes from pornography. And here we’re not even considering the deep and dark web, where there are all kinds of really bad things going on that we’re not going to even mention here.

But despite all these issues, does society make a concerted effort to try and ban the internet? No. And it’s not so much because it’s hard to do, it’s more because the positives to society grossly outweigh the negatives.

For these same reasons, we should all be very careful how we think about bitcoin, because most evidence suggests bitcoin to have the same net positive effect, if not more, than the internet. Both the internet and bitcoin are tools that can be used by the ‘bad guys’ or the ‘good guys’, and thankfully most of the world are in the latter category.

So let’s all start looking at the glass half-full rather than half-empty. Let's consider the facts when assessing the industry, continue to be transparent about both the good and the bad, and make a concerted effort to report and communicate responsibly. Yes, there will always be risks, but just like with all the other financial and communication systems of the world, we should put our energy into trying to mitigate these risks, not eliminate them.

Bitcoin isn’t going away, so we all might as well start dealing with it constructively.

This article was first published on the BitX blog and has been republished here with the author's permission.

Bad boy image via Shutterstock