Regulating The Bitcoin Ecosystem Master Thesis Rishabh Kapoor (4184009) Engineering and Policy Analysis Faculty of Technology Policy Management Delft University of Technology February, 2016 1 Title Regulating The Bitcoin Ecosystem Author Rishabh Kapoor Date February 1st, 2016 Email [email protected] University Delft University of Technology Faculty of Technology, Policy & Management Program Engineering and Policy Analysis Section Economics of Innovation Graduation Committee Chairman: Prof. Cees van Beers [Economics of Innovation] First Supervisor: Dr. Servaas Storm [Economics of Innovation] Second Supervisor: Dr. Filippo Santoni De Sio [Philosophy of Technology] 2 Acknowledgement This thesis is the final submission of my master studies which started in September 2011 as part of the Engineering and Policy Analysis program at Faculty of Technology, Policy & Management, TU Delft. My most sincere gratitude goes to my graduation committee. I'd like to thank Dr. Servaas Storm who guided and helped me during the whole graduation process and was kind enough to allow me the freedom to explore a new innovative theme. I really appreciate, that you helped me screen the papers which directly guided me to an in-depth research across disciplines. I gained a lot, from the efficient discussion each time as well. Also, Dr. Filippo Santoni De Sio, was very kind to give his valuable feedback in arranging the philosophy section better. Finally, Prof. Cees van Beers was helpful in his remarks for the practical applicability of the thesis. I also would like to thank Satoshi Nakomoto (Founder, Bitcoin) whoever he is for having the courage to give to the world this new financial model for us to think and rethink about society fundamentally and move towards balanced technology decentralization. Rishabh Kapoor February 2016, Delft 3 Abstract Bitcoin is a peer to peer decentralized virtual currency, released online through a research paper in 2008 by the unknown Satoshi Nakamoto . Around the world, many countries have cautiously taken minor initiatives to address the regulatory issues, due to its rising popularity. The regulation is not seen as complete, due to the nascent and novel outlook of bitcoins, requiring time for analysis and empirical evidence. The main research question that needs to be answered, is how can governance ideas be conceptualized to support technological decentralization while protecting against illegal activities? To answer this question a literature review is performed across academia, digital media and conferences/ independent authors. From this study, ideas for frameworks are consolidated, to effectively regulate bitcoins through coalitions, analyzed with game theory. This is complemented with a theoretical understanding of the technical, political, economical and ethical issues surrounding the bitcoin ecosystem. The thesis is broadly divided into seven chapters, where initially an introduction is presented which presents the structure of the thesis, along with the research problem and its motivation. This is followed by an exploration of bitcoin's current framework, which forms the most important theoretical part of the thesis. Here, its system design, strengths, challenges and solutions to regulatory issues are detailed. Also, how bitcoin is being perceived globally across twenty nations, is presented. Being an economic system, there has been reasonable skepticism, as to its validity as a money system. This is presented in the next chapter, where its economic structure is first explored, which is followed by an analysis of bitcoin, from the perspective of both Austrian economics and Keynesian economics. Further, to understand the overall validity of a new system, the ethical impacts must be considered. This has been analyzed through two frameworks in this thesis. Firstly, as a large social experiment and secondly through a standard ethical impact assessment. Also, bitcoin has always been portrayed in the popular press, as promoting decentralization. This is critically analyzed from classical ideas of noted humanitarian M.K Gandhi and British economist M.F Schumacher. As a follow up, a modern exponential technology framework presented by Singularity University, is offered as a comparison. Interestingly, it is observed that bitcoin excels in the material aspect of decentralization but struggles in the spiritual aspect, as detailed. The major regulatory solution offered in this thesis, is through coalitions among stakeholders. For clarity, seven crisis situations are highlighted with the different payoff's (relative power) among the different members assigned, with proper reasoning and a demo game explained. Finally, conclusions and favorable recommendations are drawn , along with sections on research limitations, future research and reflections. Also, an appendix section on the major digital media outlook, is presented for two years (Aug'13- Sep'15), to explain its popular portrayal and the opinion of the general audience. Overall, it can be said that it is still early days for bitcoin and there are major critics in every domain, countering its future existence. Consistent issues with taxation, anonymity tools like TOR promoting illegal activities, its inherent economic value and price volatility exist. The internet as an information medium, is probably the only suitable precedent for bitcoin, which has been far more successful than anticipated. The benefits of bitcoin from exponentially lower transaction fees, global banking outreach, framework for decentralized asset ownership transfer and its ability to impact the Monetary Policy of ruling governments have been appreciated. With over hundred competing digital currencies, the question is certainly not if, but when they would be competitive with fiat currencies. Keywords: Bitcoin, Cryptocurrency, Peer to Peer (P2P), Colored Coins, Game Theory Coalitions, Appropriate Technology, Technology Decentralization 4 Table of Contents Acknowledgement ........................................................................................................................................ 3 Abstract ......................................................................................................................................................... 4 Chapter 1: Introduction ................................................................................................................................. 7 1.1 Research Background ....................................................................................................................... 10 1.2 Research Problem ............................................................................................................................. 11 1.3 Research Question ............................................................................................................................ 13 1.4 Research Methods ............................................................................................................................. 13 1.5 Structure of Thesis ............................................................................................................................ 14 Chapter 2: Bitcoin's Current Framework ................................................................................................ 16 2.1 System Design .................................................................................................................................. 16 2.2 Strengths ........................................................................................................................................... 19 2.3 Challenges ......................................................................................................................................... 21 2.4 Global Positions on Bitcoin .............................................................................................................. 30 2.5 Solutions ........................................................................................................................................... 33 Chapter 3: Parallel's with Economic Theory ............................................................................................... 36 3.1 Economic Structure ........................................................................................................................... 36 3.2 Austrian Economics .......................................................................................................................... 39 3.3 Keynesian Economics ....................................................................................................................... 42 3.4 Addressing Issues .............................................................................................................................. 44 Chapter 4: Ethical Impact of Bitcoin .......................................................................................................... 47 4.1 The First Framework: Large Social Experiment ............................................................................... 47 4.2 The Second Framework: Ethical Impact Asessment ........................................................................ 48 4.3 Recommendations for the Impact Asessment ................................................................................... 50 Chapter 5: Technology Decentralization .................................................................................................... 53 5.1 Traditional Appropriate Technology ...............................................................................................