Governments do not want (for the moment) to shut Bitcoin and other public blockchains down

At the beginning of 2017, the People's Bank of China made announcements it was investigating bitcoin and met with several exchanges (marketplaces where traders can buy and sell digital currencies, such as bitcoin, using fiat currencies like dollars) to warn them they would be closed if they violated anti-money laundering regulations.

Almost simultaneously, Japan issued a new law accepting bitcoin as a legal currency. The move also required exchanges in the country to comply with regulatory requirements.

Following China and Japan, Australia is now attempting to crackdown on money laundering and terrorism financing with plans to regulate bitcoin exchanges.

At a first glance, governments trying to discipline digital currencies markets might be seen as interfering with the proliferation of this new technology. However, as a more careful analysis suggests, it might instead signify a growing recognition of bitcoin and other cryptocurrencies as influential value transfer protocols by authorities.

Such a fact has great implications for the long-term survival (and quotation value) of cryptos based on public blockchains (a public blockchain network is completely open and anyone can join and participate in the network; the network typically has an incentivizing mechanism to encourage more participants to join the network - bitcoin is the largest public blockchain networks in production today).

Let us try to be more precise about this. In order to do so, we focus on bitcoin and its ecosystem.

The security of bitcoin relies on the distributed consensus achieved by the mining game. It was initially expected this mining activity being carried by competitive miners. However, increasing sunk costs have forced mining to be organized into pools of coordinating actors to share both rewards and efforts.

At this point a natural question comes to mind: What could a cartel of miners do in case it controlled 51%+ of CPU power of the entire bitcoin’s blockchain? It is often asserted that a cartel can double-spend bitcoins in a so called 51% attack. Nevertheless, as underlined by Nakamoto (2008), incentives in the bitcoin environment encourage nodes to stay honest. If a greedy attacker is able to assemble more CPU power than all the honest nodes (and it is actually very costly), he could defraud people by stealing back his payments. As soon as people in the system perceive bitcoin unsecure though, the coin value would immediately drop towards zero and so the value of the stolen payments. It follows that a 51% cartel attack is unlikely to generate enough reward within the bitcoin economy to be worthwhile to the attacker.

However, according to Kroll et al. (2013) this does not rule out the possibility of a 51% attack that aims to destroy the bitcoin economy in order to achieve utility outside the bitcoin economy. Authors call this threat the Goldfinger attack.

For example, a government might want to block bitcoin transactions, to enforce the law, deter money laundering, or achieve some other institutional goal (similarly to Japanese, Chinese and Australian authorities above). Authors show how game theoretically this government can trigger a “death spiral" scenario: The currency is killed by generating uncertainty about the possibility of an attack to shut the crypto system down. As long as the threat is sufficiently credible, the bitcoin community cannot justify trying to save the currency. This in turn suggests that the government can profit by bluffing: If the government is able to make strong claims about an imminent attack, it may be able to scare off rational players and start a death spiral without the need to mount a real (and expensive) Goldfinger attack.

As the discussion so far makes clear, Japanese, Chinese and Australian governments interested in fighting frauds with bitcoins could potentially launch a Goldfinger attack and seriously put the crypto’s ecosystem in danger (about this, most of the bitcoin mining pools are in China and their localization is known; Chinese authorities are not very democratic and gentle when it comes to put an end to something).

They instead decided at this stage to regulate exchanges, thus legitimating even more bitcoin and other cryptocurrencies alike. In our opinion this is good news for those believing in (public) blockchain technology, as well as for investors: Cryptocurrencies are not going to be banned (at least for the moment).

References

https://www.cnbc.com/2017/08/17/bitcoin-faces-regulations-crackdown-by-asia-pacific-country.html

Nakamoto (2008) – Bitcoin: a peer-to-peer electronic cash system

Kroll et al. (20013) – The economics of bitcoin mining or, bitcoin in the presence of adversaries

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