UCLA's John Villasenor takes you inside the world of cryptocurrencies (think bitcoin)

John Villasenor

John Villasenor is a professor of electrical engineering and public policy at UCLA and a Brookings Institution fellow. (Bill Kisliuk / UCLA / July 8, 2014)

You can donate to a PAC, buy a Tesla or order a Domino's pizza using bitcoin. California just repealed a ban on such cryptocurrencies, so the question is not only "Now what?" but "What?," period. Any currency that's not tied to something like gold is essentially faith-based, but faith may be harder to come by for something like bitcoin, which took a PR hit in the Mt. Gox failure in February and has no physical existence anyway. You may want to try it out just because it's neat, says John Villasenor, a UCLA professor of electrical engineering and public policy and a Brookings Institution fellow, but it's the "decentralized trust" that underpins bitcoin transactions that is the real innovation.

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FOR THE RECORD:
Bitcoin: In the "Patt Morrison Asks" column on Wednesday, the name of a Treasury Department bureau was incorrect. It is the Financial Crimes Enforcement Network, not the Financial Crime Enforcement Network. John Villasenor's transcribed reference to "stock charges" should have been "stock charts." —

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Bitcoin is the biggest of the cryptocurrencies. What makes cryptocurrency different?

I'm not one of those who believes bitcoin is going to replace the U.S. dollar. But think about some strange things we take for granted that, if you take a step back, don't make sense.

When you buy something with a credit card, you provide all the information to defraud you. That doesn't make a lot of sense. If I hand you $10 cash, unless you're going to whack me over the head, you can't get me to give you any more. With a credit card, I authorize you to charge $10 and you could charge $50 and, in the immediate term, there's no way for me to stop it. Every few weeks we find out millions of credit cards have been compromised. What we have is not really fine.

Enter bitcoin. On the security side, in a bitcoin transaction, you are never providing any other party with information that could be used to defraud you. When you send bitcoin to somebody, even if they're not trustworthy, they cannot use the information you provided to extract more money than you want to give.

Second, efficiency. In a bitcoin-like system, money can move essentially instantaneously, and the fees can be much smaller than with traditional transactions.

What is so hard for most people to grasp about it?

The hardest thing — not unreasonably — is that bitcoin is completely decentralized currency. There's nobody in charge, no company, no government, no consortium — collectively everybody acts to run it. Most of us grew up in a world where government has oversight over currency like the dollar.

Is there an actual bitcoin coin?

Strictly speaking, no. People have made little things with a capital B on them. But you can send a half-bitcoin, or .003 bitcoin. I can't send you less than a cent, but I can send you the equivalent of less than a cent in bitcoin.

How is the value of bitcoin determined?

By the market. You might say, how do we know the value of Tesla stock? There's no government body that says Tesla stock is worth X. The value is whatever willing buyers and willing sellers are willing to exchange Tesla shares for. How many dollars it costs to buy one bitcoin flows up and down, a lot like stock charges or foreign exchange charts.

What's the impact of California repealing the old law that banned alternate currencies?

I don't think it fundamentally changes the larger regulatory landscape, but it is important because it represents a more open-minded approach to bitcoin from the government of California. One big complication is that [bitcoin's] issues are both federal and state.

And that could mean regulation.

The government has money reporting laws. If you go to a traditional bank for a wire transfer for $60,000 as a down payment on a condo, that gets reported [because of] "anti-money laundering/combating the financing of terrorism" [rules]. If you send $70,000 in the bitcoin network, there's no reporting at all. The Financial Crime Enforcement Network, part of the Treasury Department, can't mail a letter and say you need to keep us in the loop. They have oversight more easily over people who change dollars into bitcoin and vice versa, but [otherwise] there's no reporting. The parties transacting in bitcoin aren't readily identifiable. They're identifiable simply by strings of numbers and letters. That does raise some regulatory questions.

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