US authorities have begun to enforce regulation on Bitcoin businesses making some Bitcoin related services illegal or simply not feasible. Regulators have also expressed, and demonstrated, a willingness to prosecute off-shore financial businesses who do not adhere to their policies.
In this situation many Bitcoin businesses are faced with a choice, comply or go underground. But how can you run a business ‘underground’? How do you establish trust when there is no authority to give you a stamp of approval? How do you gain customers when your users know that you can simply disappear with their money?
The recent attention gained by anonymous stock broker service, TorBroker, has brought attention to these issues. Bitcoin Magazine has taken the time to look at the issues of Anonymous Finance and Trust.
In late March, the cryptic underworld of the Tor hidden service ecosystem added a new service to its midst: TorBroker, a gateway for Bitcoin users to the stock markets of the mainstream world. … TorBroker on the other hand is, as its name suggests, a fully-fledged broker, allowing users to buy and sell any of nearly a thousand different stocks and exchange traded funds at any time. It is also the first such service to accept customers anonymously, using Tor to protect their anonymity and not asking for any identifying information beyond a username and password.
The service has seen some usage in the months since then, but many people remain highly skeptical. There are two reasons behind this: legality and trust.
As a further legal safeguard for their service, TorBroker’s representatives have chosen to remain anonymous. Explaining their decision, TorBroker wrote to Bitcoin Magazine: “By going public we would attract the attention of local authorities who would be inclined to work on new regulation – or even just try to find some non-essential technicality that we’re unwittingly violating – to stop our service. By keeping our jurisdiction secret, we avoid attracting such attention.” Howevver, this strategy has its costs. Out of all the major anonymously operated services in the Bitcoin economy, many, including Bitscalper, TorWallet and Bitcoin Savings and Trust, have turned out to be scams, eventually suddenly disappearing with thousands (and in the latter case, over 1 million) of dollars of deposited customer funds. Other anonymous sites, on the other hand, have survived, and Silk Road in particular may well now be the single most trusted cryptographically anonymous entity in the world, so on the balance the question of whether or not one can ever trust an anonymous service remains hotly debated.
The general consensus view is that it depends on the precise nature of the service in question – specifically, the trust to profit ratio. On the Silk Road, an eBay-style marketplace for illegal drugs that, like TorBroker, uses Tor to help ensure both itself and its users anonymity, this ratio is fairly low, both with regard to Silk Road itself and even between buyer and seller. Each individual transaction brings a significant benefit to both the buyer and the seller (laying aside the argument that some users may be addicted and would benefit more from being forced to go cold-turkey; this is a purely conventional economic analysis), especially so because black markets tend to be very inefficient and so have high producer and consumer surplus per transaction, and Silk Road itself earns an average commisssion of about 6.3%. Thus, for both Silk Road and the anonymous merchant, profit is high. As for trust, the buyer only needs to trust the merchant to ship the goods each transaction, and needs to trust Silk Road to the same extent when depositing into their Silk Road account (or perhaps to a slightly greater extent, if the buyer also wants to have cash on hand in their Silk Road account to be able to buy a certain quantity of goods at will). Since profit is high and trust is low, the trust to profit ratio is very low, and so both Silk Road and the merchant have strong incentives to continue acting honestly – the value of the relationships is too high to justify running away at any particular point.
Now, consider Torwallet. Torwallet was essentially an anonymizing mixing service and a Bitcoin wallet all in one. Here, the wallet is usually free, although users can opt to have their coins mixed again at any time for a fee of 3%. Thus, profit is considerably lower than on Silk Road. As for trust, Torwallet is intended to be used as a wallet, encouraging users to deposit significant quantities of money into the wallet and, importantly, store them there for a long time. Thus, compared to Silk Road trust is very high. Thus, predictably, TorWallet eventually ran away. Bitscalper and Bitcoin Savings and Trust have even higher trust to profit ratios, as the service (in both cases, investment returns) requires the user to keep their money deposited for an extended period of time.
Unfortunately, TorBroker falls squarely on the “untrustworthy” side of this analysis. This is not their fault; it is simply a characteristic of the financial industry that trust to profit ratios are high, and this model, combined with an understanding of the more subtle, and legal, ways a business can probabilistically “run away”, even perfectly explains the recent global financial meltdown. However, there is one unique factor that does rest strongly in TorBroker’s favor. BitcoinStore’s Roger Ver made a post in TorBroker’s introductory thread on Bitcointalk, writing:
“I don’t know TorBroker or any of the people behind it, but about a month and a half ago they contacted me, and at least one other well known member of the Bitcoin community and asked us to publicly hold 1,000 BTC as a security bond that would be used to refund customers if TorBroker ever disappeared with their customers money.
While I fully support TorBroker’s efforts to bring additional economic freedom to traditional financial markets, legally it didn’t seem safe for me to be the front man for this.”
TorBroker has also tried to place this bond with many other prominent Bitcoin community members (who won’t be named to protect privacy), and, if trust proves to be too insurmountable an obstacle, is even willing to consider placing the bond with Silk Road’s own Dread Pirate Roberts. This would change the trust to profit calculus considerably; the extent to which TorBroker would benefit from running away would then be reduced by 1000 BTC, and, presumably, if TorBroker does run away the funds would then be proportionately distributed to depositors. For now, no security bond has been placed, but the fact that they are willing to voluntarily do so does suggest that they are attempting to build a viable and lasting business.
More recently, TorBroker has come up with several upgrades to their platform. In early June, they released a better securities list interface, an improved order system, performance and stability enhancements and reducing the minimum fee to $5 until July 11. They also released a promotional video explaining the benefits of their service:
The video begins by highlighting the three main disadvantages of traditional stock brokers: that they are “overregulated and complicated”, leading to bureaucratic inconvenience and a prolonged process in order to set up an account, they require minimum deposits that can be as high as $10,000, and “Big Brother is watching all your transfers.” TorBroker, of course, has none of these flaws. However, it does have weaknesses. Although it bypasses the inefficiencies of government regulation, its anonymous nature also sacrifices the main benefit that government can provide: trust. As discussed above, this is not an easily solvable issue, although there are many ways that TorBroker can mitigate it.
If it survives and continues to grow, it may well be an interesting experiment in the growing field of “crypto-economics”, and an example for more commercial hidden services to come.