The fate of “E-gold” as a warning to cryptocurrencies

By
Pieter Cleppe
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Copyright: "bitcoin" by komersreal is licensed under CC BY 2.0

The large gains in the price of bitcoin over the last year have once again increased attention for this so-called “crypto currency”. Meanwhile, however, regulators are preparing a response.

While the ECB has published an opinion paper advising the EU Commission to enable it to require crypto currencies to obtain a license, India would now even be considering to criminalize possession, issuance, mining, trading and transferring of crypto-assets, something which was later contradicted by the Finance Minister, who stated that India would still “allow certain windows for people to do experiments on the blockchain, bitcoins or cryptocurrency.”

Belgian Bitcoin enthusiast Tuur Demeester belongs to bitcoin’s early adopters and is considered an eminent expert in the field. Before he was into bitcoin, he translated the magnum opus of one of the leading representatives of the Austrian school of economics, Spanish Professor Jesús Huerta de Soto. This book, called “Money, Bank Credit, and Economic Cycles”, is a fundamental critique of the contemporary banking system, which allows people to assume they are always and at any point able to collect 100% of their bank deposits, while in reality they can only dispose of a small fraction, if everyone would decide to exercise the right they assume to have at the same time. 

Like other libertarians, he gained an interest in bitcoin. In a 2012 interview with well-known bitcoin prophet Max Keiser, he explained that “when there is a link [between money] and the real world, the authorities can go there, confiscate, regulate, intimidate. This is what happened with E-gold”

E-gold: crucial to understand the whole point of Bitcoin 

“E-gold” was a digital payment system, created in 1996, in the early days of the internet, by an American oncologist, Douglas Jackson, and an attorney, Barry Downey. 

The idea was simple: develop a system which enables people to pay each other with gold, instead of with U.S. Dollars, whereby the transfer of the physical gold between clients of the website is facilitated through the use of internet technology, obviously with all kinds of safety precautions. The Gold that was owned by E-gold clients was stored by banks in Europe and Dubai. Without the internet, such a system could have never been as performant. In the 1990s, with the arrival of the internet, it really was an idea whose time had come. Technology made it possible for people to easily pay each other in gold, and avoid state money.

The E-gold system of facilitating payment in gold turned into a great success. E-gold, which was founded two years before PayPal, was described by the Financial Times in 1999 as “the only electronic currency that has achieved critical mass on the web”. By 2004, it counted two million users and by 2006, 3 billion of transactions had been happening through E-gold.

There were of course hacking attempts, while also criminals have used the system, but according to founder Douglas Jackson, a lot of criminals were also caught as a result of their use of the system.

How the government ended the party

The “Patriot Act”, American legislation passed in the wake of the attacks on September 11th, 2001, which violated civil liberties, according to its opponents, introduced new restrictions on transmitting money. The U.S. Treasury and Justice Departments came up with a stricter interpretation on what was legally allowed in 2006, on the basis of which E-Gold was been charged with several federal charges, including money laundering, conspiracy, and operating an unlicensed money transmitting business. This eventually led to the company’s demise. 

Despite founder Douglas Jackson denying that the tough treatment by U.S. authorities was inspired by fears E-Gold or similar initiatives could eventually emerge as a viable alternative to the U.S. Dollar, this was effectively something many in the so-called “crypto start-up community” believed. 

“The end of E-gold renewed interest in crypto currencies”

In an interview last year, Jackson pointed at an article on the history of crypto currencies, which recalled that the first crypto currency, called “E-Cash”, had been developed in 1991 and that no big developments had really taken place between the development of “S/Key Unix login” in 1994 and bitcoin in 2009. This, according to Jackson is because “E-gold exposed the disutility of crypto-based monetary schemes and as long as E-gold was active, none of them could get a foothold.”

The official launch of bitcoin in January 2009 noted that it was a “decentralised”digital currency, “without the need for a trusted third party”, according to the bitcoin white paper, a technical manifesto published by Satoshi Nakamoto, the pseudonym of the inventor of bitcoin.

Looking back on this in 2012, Jon Matonis, who then served as the Chair of the Bitcoin Foundation, wrote:

“The timing of Bitcoin’s appearance, and subsequent growth, is no accident either…An alternative money provider that was centralized would probably not survive long in any jurisdiction. The emergence of Bitcoin was baked into the cake already. We can see from the case against digital money provider e-gold that an efficient challenger to the provision of a stable monetary unit will not be permitted… really.”

E-gold founder Douglas Jackson refers to this quote to back up his case that E-Gold delivered for a while what bitcoin ultimately was created for. 

Bitcoin really aims to create some kind of digital gold, whereby no third party is needed to manage the system, precisely because of what happened to E-Gold, because of the risk that such a third party can be tackled by governments. 

Another concern is of course that a third party would be corrupted. To deal with this danger, bitcoin is “based on cryptographic proof instead of trust”, according to the Bitcoin white paper.

Did Bitcoin deliver? It cannot be denied that Bitcoin users do attribute value to it. The question however remains how scalable this system is, and in the first place how realistic it is that it would survive a full-on attack by governments. When it comes to gold and silver, for a few thousand years, governments have failed to stop these precious metals from playing a role as means of payment and means of saving, even if government restrictions have succeeded in preventing scaling here.

How scalable is Bitcoin?

Bitcoin’s recent price increase in fiat money terms seems to have made people forget that a lot of pessimism had emerged when it comes to Bitcoin’s potential.

According to so-called “Bitcoin maximalists“, Bitcoin is the most well-placed crypto currency to eventually emerge as the standard for digital money. Even they however concede that there remain a lot of problems preventing Bitcoin from succeeding, which were seen as the reason for the fact that Bitcoin’s price had been lagging really between the end of 2017 and the Summer of 2020.

Apart from the question how damaging Bitcoin’s price volatility is for its hopes to serve as a means of payment or saving method, and whether this is a temporary phenomenon or not, there is the so-called “Bitcoin scalability problem”, which basically means that the limited rate at which the bitcoin network can process transactions is experienced as too slow to really enable scaling.

Bitcoin transactions are being stored on a public distributed database, known as the “blockchain“. Giacomo Zucco, an Italian Bitcoin maximalist, and others consider this to be the cause of Bitcoin’s lack of scalability and support an alternative approach, the so-called “Bitcoin lightning” network, which enables much faster settlement of transactions and also involves the details of individual lightning network payments are not publicly recorded on the blockchain, which should guarantee privacy.

Still, it remains to be seen to what extent this can be a solution. In any case, this maintains the decentralised nature of Bitcoin. Bitcoin maximalists, like Zucco, have often accused alternative crypto currencies, like for example Ethereum, of having violated Bitcoin principles in order to cope with the scalability problem. Zucco has pointed out that “Bitcoin sacrifices efficiency in order to gain some government-resistance.” He now thinks that ” Should governments try to prohibit Bitcoin, it will probably only make it stronger.” 

Is Bitcoin able to withstand a full-on government attack? 

Even if Bitcoin would be sufficiently scalable in order to serve as a private digital global currency and even if it wouldn’t be possible to corrupt the system internally, the question remains whether it would be able to withstand a government attack.

This isn’t a mere detail, without which Bitcoin would be able to survive. It truly will determine the fate of Bitcoin.

Some argue that Bitcoin actually isn’t that decentralised, given how most of the big “mining pools” would be based in China. Then today, Bitcoin already does play a big role in the opposition against government, and not just because it serves as a means for the Chinese to circumvent the government’s capital controls. Russian opposition figure Alexei Navalny received $300,000 in Bitcoin this year alone.

Also in the West, a breakthrough of Bitcoin as money would have major consequences. Today, most Western welfare states are strongly dependent on low interest rates. In a paper, Claudi Borio, the chief economist of the Bank for International Settlements – the Central Bank of Central Banks, based in Switzerland – has made clear this is not a mere natural process but a consequence of deliberate policies, as he explained that “the decline in real interest rates over the last 30 years is not explained well by non-monetary factors but monetary policy seems to play a more significant role” 

When people no longer use state money, governments no longer have the option of “monetary financing”, whereby central banks maintain interest rates at an artificially low level, so governments won’t need to pay a high interest rate in order to refinance debt so to be able to afford rather exuberant spending patterns.

With monetary financing gone out of the window, governments will need to rely on either higher taxes or loans at a high interest rate, which in practice means they’ll be forced to cut spending.

Western governments are more than aware of this. 

Already in 2012, the European Central Bank warned for Bitcoin, arguing for supervision. In an opinion paper in February in response to European Commission plans for “a regulation on Markets in Crypto-assets”, the ECB went further, proposing that it should obtain powers to “refuse authorisation to an issuer of asset-referenced tokens, inter alia, where the issuer’s business model may pose a serious threat to financial stability, monetary policy transmission or monetary sovereignty”

It’s quite telling that the ECB openly admits Bitcoin and other crypto currencies may well threaten its “monetary sovereignty” – signifying the concern to no longer be able to engage in monetary financing. In sum, more EU regulatory action on crypto is highly likely.

Also the U.S. are likely to go further. U.S. Treasury Secretary Jannet Yellen has stated that “misuse” of crypto currencies constitutes “a growing problem” and that “we really need to examine ways in which we can curtail [cryptocurrencies’] use and make sure that money laundering doesn’t occur through those channels.”

Also the U.S. Dollar is being used by criminals, and on a much larger scale, so the real concern is of course something akin to the ECB fearing for its “monetary sovereignty” – as much as the U.S. Dollar’s position as the world reserve currency has been wrongly declared to be “under threat” many times before.

In any case, crypto currencies may prepare themselves for government action. How far will governments go?

In China, bitcoin is a frequently used means to circumvent capital controls. Every so often, Chinese authorities take action, but nevertheless, Chinese bitcoin and crypto users still manage to find loopholes in China’s regulatory framework, for example under the guise of making medical or other legitimate purchases.

Then, according to Michael Green, chief strategist and partner at investment advisory firm Logica Capital, China could shut down the Bitcoin network at a cost of only $7 billion per year, which is obviously pocket money, especially when compared with the threat Bitcoin may ultimately present for the ruling Chinese Communist Party, which is now trying to push a Chinese central bank-controlled digital currency onto users. It is designed to trace all movements of money, not exactly something akin to the spirit of crypto users, but that hasn’t stopped other central banks, like the ECB, to roll out plans for their own digital currencies, like the “digital euro”.

In February, Green argued that Bitcoin isn’t all that decentralized in the first place, as “the vast majority of the mining activity is occurring in regions like China, Russia and Iran, and if we incorporate the participation of mining pools, they control in excess of 90% of the hash rate. This is not a decentralized system.” He added he thinks it is only a matter of time until the U.S. government moves to ban BTC.

At the moment, bitcoin is only used by a very limited part of the population. Any challenge to governments’ monopoly on money is remote, so as of yet, there is no need for governments to make a big move. However, global depreciation of national currencies – a consequence of expansionary central bank policies, meant to finance both Covid spending and to maintain already high spending levels – may accelerate this.

Is it so inconceivable that governments would start prosecuting companies that facilitate the use of bitcoin?  

As mentioned, the Indian government announced this last month. Then, it has a history of raiding people’ houses to seize foreign currency and gold bars, so the real surprise would be if India were not to try to ban bitcoin.

Bitcoin proponents claim that it is harder to control or confiscate than physical gold, but this remains to be seen. Some have claimed that governments would need to suspend the internet in order to really ban bitcoin, but even that is perhaps not as inconceivable as it sounds. In 2019, during anti-government protests, the Iranian regime imposed a total shutdown of Internet for a whole week, forcing people to use the strictly government-controlled “National Information Network” instead. VPNs weren’t helpful here, but satellite filecasting technology could alleviate the situation for some. The episode costed at least $1 billion to the Iranian economy, but the Iranian regime, which had no qualms killing about 1500 people to stop the protests, considered this to be worth it.

To control the issuance of money is vital for dictatorships to survive, but it is equally vital for Western welfare states that have becoming ever more dependent on borrowing for their finances, and therefore on the ability of central banks to keep interest rate levels low, something that is no longer possible when money is not even controlled by the State anymore.

The fate of Montenegro is a recent case in point. For a few decades now, the beautiful Balkan country has used a foreign currency, first the D-Mark, then the Euro – originally because it had made aware that the central bank of Serbia, from which it seceded, would have the technical means to forge any national currency Montenegro would come up with. To build a highway, the country took a €1bn loan from China, which it is now struggling to pay back. In an ideal scenario, the country’s government should of course simply have opted not to burden citizens with all that debt, and it should have certainly avoided a loan with geopolitical strings attached. The episode makes clear how governments may easily run into trouble when they lose the ability to control money.

Therefore, even the greatest crypto optimists should realise that, due to the success of crypto money and due to the implications of that success, a hostile government response is a certainty. In India, the United States between 1933 and 1975 and elsewhere, governments have always largely failed to confiscate physical gold, which is seen as a store of value. Will they equally fail to curtail bitcoin and crypto currency? The jury is still very much out on that.

 

 

 

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