The promises of a decentralized currency: Think Locally and Buy Globally?

I once rented a part of a house that had been, well, not fully cleaned out from the previous occupants. It was a house full of hackers that had been variously occupied by friends and friends-of-friends for almost a decade as they passed through Austin on their way from or to new lives, which is to say, it had, well, "character".

One of the odder things left behind by the previous inhabitants was a literal pile of Final Fantasy boxes, completely intact save for the all-important registration codes. A bit of digging uncovered a fascinating tale of cross-border, tax- and fee-free value transfer. The former occupant, let's call him "Bob" was engaged in a business proposition with a colleague based in South Korea, let's call her "Alice." Whatever version of the RPG Final Fantasy had just been released in the States (only). This had proved very difficult to pirate, causing a huge untapped demand in Korea. Koreans, however, had been happily hacking away at another RPG game which was only just now catching on Stateside. So, Bob would tear off and destroy these registration codes, emailing the codes themselves to Alice in Korea. Alice, in exchange, would provide Bob powerful and rare in-game items for the newly-popular game - these were of less value to the Korean market, as it was saturated with players and therefore items, but there was no arbitrage market into the States -- before Alice and Bob, at least. Bob could then sell these on online grey markets for such items, effectively creating a way for both Alice and Bob to profit (rather lucratively, from my understanding) from local markets, and transfer value across borders without incurring bank costs, wire fees, or, for that matter, taxes. This setup lasted for as long as both were able to extract value from the arbitrage process, but obviously wasn't able to scale or even easily re-adapt to new opportunities.

With the rise and increasing stability of bitcoin as an actual contender for a digital currency, the global market suddenly starts looking a lot more local.

The Wealth of Local

In Cities and the Wealth of Nations, Jane Jacobs argued for the power of local production driving innovation and community resilience, and saw regional currencies as a way to create faster feedback loops for these micro-economies. There are many difficulties -- coordination, adoption, and inherently, scale -- in creating regional currencies. A number of informal, small/local business currencies have been tried, with Berkshares as a great example (http://www.berkshares.org/whatareberkshares.htm). The local currency concept has failed to really take hold, but continues to be successful as a hybrid alternate/social currency.

Jacobs also talked about the importance of self-sustaining local economies in the concept of import-replacement. This rubs a certain type of economist the wrong way - it's too close to import substitution industrialization (http://en.wikipedia.org/wiki/Import_substitution_industrialization), and it goes against the concept of comparative advantage and specialization. There's a long discussion to be had there, but if you're banging the Michael Pollan drum and eating local, that's import replacement. If you're still a hardened comparative advantage supporter, please read Ha-Joon Chang's discussion of interventionalist policies of modern "free trade" states (http://www.fpif.org/reports/kicking_away_the_ladder_the_real_history_of…), and let's move on.

This focus on local production was less about a fight about local-mom'n'pop-vs-big box, but more concerned with decentralization as a key towards resilient communities. Chain stores provide employment and cost-savings for buyers, but they respond to market forces outside of the scope of any one town. If the chain is facing external pressures, it may wantonly shut down local stores or disappear. As the chain has probably driven out any local competition, this leaves a town with no infrastructure. Whatever market forces that closed the chain store in the first place will similarly prevent other chains from filling the gap.

The Internet has provided a new local - one that is based around markets and themes instead of geographies. Your etsy purchase or kickstarter investment may not be going to your own community, but it is likely going to an entrepreneur who is building a small business in another community. It decentralizes even the concept of community resilience, allowing entrepreneurs to tap into larger markets, reviving their own local economies. For the buying communities, these create access to external (often niche) goods without resorting to centralized chain stores.

Even on the global scale, currency values have always seemed as much a game of chicken as anything else. Fiat currencies are all basically gambles in the economic health of the currency and the backing government. This was why when OPEC dabbled in switching its calculations from the dollar to the euro it was much more than math or politics, it was a bet against the health of the dollar, and an investment in the future of the euro.

Enter bitcoin.

For those of you following along at home, bitcoin is a new breed of currency - http://www.weusecoins.com is a great primer. After a series of failed internet-currency dotcoms in the 90s (Beenz anyone? Flooz?), bitcoin has seemingly solved one of the core problems - who controls the currency.

The earlier attempts all were centralized startups, each proposing a competing faux-currency to ease online transactions and slowly build a virtual currency of sorts, taking margins from the transactions or cost differentials, as well as reducing financial risk on the early commercial web. The early Internet currency attempts ran into regulatory problems (most countries frown upon private companies setting up alternate currencies, it turns out), and had to craft their offerings to avoid getting shut out.

Bitcoin provides ... well, something different. Instead of a currency that has evolved from being backed by precious metals into fiat currencies, bitcoin is backed by cryptographic algorithms. This provides an amazing openness for a currency - every transaction is part of a shared record log. However, the people behind those transactions are known only by their account numbers, in a world where you can create as many accounts as you like.

This is of course great for all sorts of things. As Ars Technica's Timothy Lee has noted, bitcoin is a threat to Western Union style money transfer agents (http://arstechnica.com/tech-policy/news/2011/12/bitcoins-comeback-shoul…) as a meta-currency that allows quick, fee-free transfers of value - requiring only someone who will exchange bitcoins for your preferred local currency. It's a boon to activists worldwide, providing a secure way for anyone to contribute effectively anonymously -- for all we know, the US attorney-general could be personally donating to wikileaks via bitcoins while his public job requires a somewhat aggressive stance.

Like any other good privacy technology, this cuts both ways. Bitcoins have also been used to purchase illegal drugs from a website only accessible through the privacy-protecting Tor network (http://gawker.com/5805928/the-underground-website-where-you-can-buy-any…), and you can imagine other nefarious uses that an untraceable currency could be used for. These were also problems for the more-traceable proto-currencies -- just under twenty percent of flooz.com's currency flow was fraudulent credit card charges before the service shut down.

While bitcoin doesn't rely on a central company to succeed, it has had a few close scrapes. Most recently, when that aforementioned drug clearinghouse was finally tracked down and busted, the FBI became the proud owners of well over $100 million worth of bitcoin (and boy, is that amusing). Whenever the FBI finally decides to trade these digital tokens in for good ol' greenbacks, they might still flood the market and crater the price.

In addition, bitcoin trading posts have been under increasing scrutiny - both by hackers and government regulators, which has caused more than a few speed bumps - from thefts of hundreds of thousands of dollars to market fluctuations reacting to government regulation. This underlines the fact that bitcoins are not just some crypto-geek fantasy currency being used by two people, but a vibrant currency that acts, well, increasingly like other global currencies, at least in a few key aspects.

Whether this is replacing one fetishized commodity (gold) for another (computing power) is unclear. In the global betting pool that is currency, though, I'd put some money on bitcoin for being a fascinating disruptive, decentralizing technology. And if you really want to blow your mind, look at namecoins (http://dot-bit.org/HowToGetNamecoins), which propose to use the bitcoin codebase to replace the Internet's naming system.

And if you're really interested in diving down the rabbit hole, there's always dogecoin.

Editor's note: I wrote this originally over a year ago, and, like an idiot, failed to press post. However, a decent amount of it was still relevant, so I did a few quick updates to reflect the fall of Silk Road and the dramatic increase in government regulation