I feel we’re on the precipice of some delightfully weird and possibly very alarming developments at the intersection of code and money.  There is something deep in the rules that is getting rewritten, only we can’t quite see how yet. I’ve had this feeling before, as a self-described Cypherpunk in the 1990s. We knew or hoped that encrypted communication would change global politics, but we didn’t quite know how yet. And then Wikileaks happened. As Bruce Sterling wrote at the time,

At last — at long last — the homemade nitroglycerin in the old cypherpunks blast shack has gone off.

That was exactly how I felt when that first SIGACT dump hit the net, by then a newly hired editor at the Associated Press. Now I’m studying finance, and I can’t shake the feeling that cryptocurrencies — and their abstracted cousins, “smart contracts” and other computational financial instruments — are another explosion of weirdness waiting to happen.

I’m hardly alone in this. Lots of technologists think the “block chain” pioneered by bitcoin is going to be consequential. But I think they think this for the wrong reasons. Bitcoin itself is never going to replace our current system of money transfer and clearing; it’s much slower than existing payment systems, often more expensive, uses far too much energy, and don’t scale well. Rather, bitcoin is just a taste, a hint: it shows that we can mix computers and money in surprising and consequential ways. And there are more ominous portents, such as contracts that are actually code and the very first “distributed autonomous organizations.” But we’ll get to that.

What is clear is that we are turning capitalism into code — trading systems, economic policy, financial instruments, even money itself — and this is going to change a lot of things.

The question I always come to is this: what do we want our money to do? Code is also policy, because it constrains what people can and cannot do, and monetary code is economic policy. But code is not all powerful, which is where the bitcoin techno-libertarian ethos goes wrong. What I’ve learned since my Cypherpunk days is that we need to decide now what happens when the code fails, because eventually there will be a situation that will have to be resolved by law and politics. We should design for this rather than trying to avoid it. And this time around, there’s an even weirder twist: when we start describing financial contracts in code, we lose the ability to predict what they’ll do!

What does bitcoin get you anyway?

We’ve had electronic cash since well before I was born. We use it every day: bank balances, credit cards, and all the rest. Here are some things that these systems do:

• Transfer money without anything physical changing hands.
• Security. It’s not possible to take back spent money unilaterally, or spend the same money twice.
• Controlled money supply. You can’t mint your own.

These are the new features that bitcoin adds:

• Pseudo-anonymity. Parties to a transaction are identified only by a public key.
• A public ledger of all transactions that provides cryptographic proof of ownership. This is the “block chain.”
• Decentralization. The security of the system does not depend on the honesty of any single authority, but only honest action by the majority of nodes.

This is private secure global digital money without governments or banks, and you never need to trust in the honesty and competence of any one institution! It’s a really neat trick, exactly the sort of magic that first drew me to cryptography. You could learn how the trick is done places like here, but part of the trick is that it’s not just cryptography. It’s also clever alignment of incentives. It’s financial cryptography.

Here’s the core innovation: it is possible to use your computer to “mine” bitcoin — that is, create new money for yourself — and this mining operation simultaneously maintains the integrity of the global distributed ledger. This is a profound thing. It means that the distributed network operators (bitcoin “nodes”) get paid, and indeed bitcoin miners collectively made something like six billion dollars in the last year. It also means that control of the money supply is distributed, which makes it very unlike central bank money. This is the first place that the politics gets weird.

Control of the money supply

If you’re a government, you want to control your money. Traditionally, central banks do this to balance economic outcomes like unemployment and inflation. They’ve also created money for more drastic and often disreputable purposes like funding wars, inflating away debts or influencing the balance of trade. There’s a lot of destructive stuff you can do with the power to print money, which is one reason why states guard their monopoly closely. There are laws against counterfeiting.

But in the bitcoin scheme of things, money is created by anyone who can solve a specific type of computational puzzle. More specifically, you have to invert a hash function, a problem that can only really be solved by brute force guessing — a massive amount of guessing, something like 400 years on a standard PC. In other words, you pay for freshly minted bitcoins with computer time, an extremely capital and energy intensive process. This is in no way challenges the primacy of accumulated wealth; it’s a fundamentally conservative amendment to capitalism.

The whole point of this is to put an inviolate limit on how fast new coin can be created. You need a lot of resources to mine a little bitcoin — just like mining gold. In fact, the protocol automatically adjusts the difficulty of the hash problem so that new coins always get created at about the same rate, which means blocks are added to the chain at a constant rate, about ten minutes per block, no matter how many computers people throw at the problem, or how fast our computers get. And today, the bitcoin mining industry uses data centers full of custom chips that collectively dwarf the largest supercomputers. All doing essentially nothing except being expensive, which turns out to be a foolproof method of trust-less distributed control.

Sometimes a little trust gets you a lot, like a stable money supply without using as much electricity as a small country. Using trust as a design element is a hard concept for hard-core cryptographers, whose protocols are suspicious by design. But of course finance has always run on trust; there would be no credit without it, and there’s no credit in bitcoin either. No one ever has a negative balance, or even a balance at all, just ownership of tokens.

For the moment, mining is a profitable business and both the quantity of mining and the price of bitcoin are increasing. Which is good news for bitcoin users, because the work of mining is also the work of keeping the transaction processing network running; that’s why anyone bothers to process your bitcoin payments. That’s the sort of incentive engineering you get to do when money and code mix.

So the whole system is releasing new coins at a more or less constant rate, no one can speed it up no matter how much they spend, and it would be impossible to stop it without shutting computers down all over the world. Given bitcoin’s libertarian leanings, perhaps it’s not surprising that this is very much in line with Milton Friedman’s theory that a steady percentage increase in the money supply is the best policy. Then again, a constant coin mining rate also means a constant transaction processing rate, so perhaps this is merely a convenient choice for a payments system.

Either way, this arrangement is economic policy written in code. If the whole world ran on a bitcoin, there would be no way to manage recessions — for example to increse employment — by adjusting the money supply

The geopolitics of the block chain

All cryptograpy has politics, and bitcoin is no exception. It appeals particularly to a certain sort of techno-libertarian: why should the banks say what is money and when we can trade it? Why should they make all of our financial privacy decisions for us? And why should we have to trust any one person with our money?

But then again, these may not be particularly motivating problems for most people. Although a wide variety of merchants will now accept bitcoin for a wide variety of goods and services, like cash it’s well suited for shady deals — especially given its global and anonymous nature. It’s impossible to say for sure,  because that’s what anonymity is, but gray markets are likely the predominant use. But we do know that 70% of global trading volume and more than 50% of mining also occurs in China. This may be nothing more than peer-to-peer commerce, or it may indicate that bitcoin is at the center of a Renminbi-denominated halawa network of underground money transfers.

China, and other governments, have unsurprisingly taken steps to discourage bitcoin use, and bitcoin is now restricted or officially banned in many countries. There are potentially good reasons for this, such as the ability to prevent terrorist financing and money laundering, just as the international financial system has implemented progressively tighter controls. There are also potentially bad reasons to restrict bitcoin, depending on your politics: state mismanagement of the money supply, protections for incumbent banks, pernicious regulation of capital flows, or authoritarian surveillance of commerce.

But if you have an uncensored internet connection and the right software, no one can stop you from trading in bitcoin. Once again, the network proves to be a great equalizer between citizens and states. The Cypherpunks understood very early on that encrypted communication enabled uncensorable distributed coordination, and that this would challenge the power of states. But cryptographic money promises something even more revolutionary: state-free trade, economically significant transfers of cold hard currency. It’s a much bigger hammer.

What we didn’t think carefully enough about, back then, was who would be using these tools. Encrypted communication has supported the toppling of autocratic regimes, but it also supports terrorism. Bitcoin miners, too, might have diverse goals.

The cryptographic consensus algorithm currently in use by every bitcoin node dictates that the majority defines which transactions get added to the global ledger and hence validated. Which means that Chinese miners now effectively control bitcoin. In principle, all Chinese operators could collude to allow double spending of their coins. Or they could “hard fork” the protocol at any moment simply by adopting a new standard. Everyone else would have to go along, or their existing bitcoins would be worthless.

Thus the bitcoin protocol is already the subject of international diplomacy, as when American entrepreneurs visited China to lobby for capacity-enhancing changes (they failed). Running a specific version of the bitcoin software and maintaining a specific version of the ledger data is in effect a vote. However, this hasn’t prevented vigorous arguments and campaigns about how those votes should be cast.

Meanwhile the “bitcoin core” developers also have substantial but not absolute influence, as they maintain the standard open source implementation of the protocol. They can’t make anyone go along with changes, but it sure could be inconvenient if you didn’t want to. And what happens if they don’t all agree?

From cryptocurrency to crypto-contracts

The cryptographic innovations of bitcoin are public and easily copied, and profitable if you get in first on a successful new currency. So naturally there has been a dizzying array of “altcoin” implementations with varying degrees of adoption and stability. The most interesting altcoins add new features, such as extended capacity or new transaction types.

But there’s one altcoin that does something truly new and interesting: Ethereum allows software-defined transactions. That is: a transaction can contain code which executes to determine who gets paid what, or more generally to perform any computation and store the results in the public ledger (block chain). The Ethereum Foundation, a Swiss non-profit, says that Ethereum is a “decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third party interference.”

This is science-fiction stuff. First computational contracts, then AI lawyers, all executing on the open source Justice operating system… We’re not quite there yet, but Ethereum is the proof of concept. Like bitcoin, it extrapolates legitimately interesting technical innovation into a soaring anti-authoritarian dream. A “smart contract” is a financial contract defined by code. You cryptographically sign onto it, perhaps by making a payment, and then the contract then executes on the network, does its calculations, and ultimately makes payouts. As long as the majority of the Ethereum network is operating honestly, you get paid exactly what the code says you will get paid; neither the seller or anyone else can alter the terms after the fact. No courts are needed to enforce the terms, no intermediaries are involved, no trust is required.

If bitcoin is state-free money, smart contracts are state-free financial instruments that are fully transparent and make fraud impossible. Except no, of course not, just like encryption didn’t make anonymity easy, and for the same reason: there are systems outside the computer.

Cryptocurrencies are made of people

In one sense Ethereum’s libertarian promise is all true: just as bitcoin nodes validate transactions by consensus, all Ethereum nodes collectively enforce the code-as-contract guarantee. In another sense it’s completely bogus: the computers are still controlled by people, as a significant hack demonstrated.

The story goes like this: the Ethereum community crowd-funded an initial investment of $150 million dollars to seed a “distributed autonomous organization,” or DAO. This was one of the core visions that excited Ethereum proponents, and a DAO is probably the most cyberpunk entity of all time. As CoinDesk described it:

It’s likely best to think of The DAO — which is sometimes also referred to as The DAO Hub — as a tightly packed collection of smart contracts written on the Ethereum blockchain.

Taken collectively, the smart contracts amount to a series of by-laws and other founding documents that determine how its constituency — anyone around the world who has bought DAO tokens with ethers — votes on decisions, allocates resources and in theory, creates a wide-range of possible returns.

Unlike a traditional company that has a designated managerial structure, The DAO operates through collective voting, and is owned by everyone who’s purchased a DAO token. On top of that structure is a group of so-called Curators that can be elected or removed by DAO token holders.

Got that? It was a fund where the choice of investments, the election of officers, and other such matters were all done by submitting votes as transactions on the Ethereum block chain, to be interpreted by code previously placed there. And just to make it even more like a William Gibson novel,  nobody knew exactly who created this entity! Of course there was an Ethereum address attached to code that created the DAO, but Ethereum addresses are anonymous.

And then it was hacked. Maybe. Depending on your point of view. What actually happened is someone found and exploited a subtle bug in the DAO’s code and caused it to pay them the equivalent of $60 million to their Ethereum account.

Software is a subtle thing, and it’s extremely difficult to write bug-free code on the first go. It’s even harder to write code that will stand up against a malicious attacker who stands to make a life-altering amount of money if they break your system. In the event, the bug involved a problem with re-entrancy in the payout function, for which the proposed solution was to guard your disbursement code with mutexes. If you’re not a computer scientist, this is just technical detail. If you are a computer scientist, your skin is crawling. Long experience has shown that correct reasoning about these types of problems is nearly impossible for mere mortals. If smart contracts require super-human intelligence to prevent fraud, we’re in trouble.

What happened next is even more interesting. The human-language contract explaining the terms of buying into the DAO explicitly stated that the code was the final legal word. So perhaps the DAO code was buggy, but caveat emptor, the hacker played by the rules of the game and got paid. Maybe they weren’t even a hacker, but merely a savvy investor who understood a little-known clause in the contract. If the code is law, then whatever the code allows is legal by definition. Ultimately, the morality of this move is a question outside of the code itself. And that’s the problem.

The majority of people involved in Ethereum felt that investors should get their money back. But a sizable minority disagreed — they truly believed in this “code as law” model. And so both the community and the block chain split: there was a hard fork. To this day, there are two parallel Ethereum ledgers. In one world, the DAO hack was reversed. In the other universe, now called Ethereum Classic, the hacker got to keep their money.

Real financial contracts have lawyers and courts and precedents that provide a procedure for resolving disputes, and give investors reasonable safeguards. Discarding those institutional frameworks has a cost.

Turing’s Demons

Computer code can do arbitrarily subtle and weird things. This is a deep property of computation that we’ve known about even before the first electronic computers were actually built. Once a programming system reaches a minimal threshold of complexity, known as Turing completeness, there are a set of inter-related theorems that say, basically, you will never be able to tell what a program does without actually running it. It follows that it will always be possible to hide something malicious in financial code. If code is law, you’re going to get scammed. Legally.

One solution is to avoid general purpose code. There are strong parallels to recent computer security research that argues that all user inputs to system need be limited to very restricted, non-programmable languages. It’s just impossible to secure arbitrary code. And indeed, Wall Street already has purpose-specific languages for specifying financial contracts (such as derivatives) without invoking the disturbing power of general computation.

Turing completeness is a gateway to the dark powers. It freaks me out to imagine traders submitting contracts written in code to an exchange. It’s already tricky to untangle the web of counter-parties, derivatives, and legal triggers that can lead to cascading crashes in the financial system — just wait until we throw code in there.

But we’re not going to able to avoid all code. Even if traders aren’t allowed to use it to create new contracts, we need it for infrastructure. Every stock market, every financial exchange has code, and algorithmic trading is an entire industry. An increasing fraction of global transactions are handled by computers without any human review or intervention. This has led to weird behavior such as flash crashes — which are still unexplained, even in very simple, usually very stable markets like US Treasury securities. There isn’t even a single master audit record of every trade made, and there won’t be for years.

It gets even weirder when you add incentivized humans to the mix: financial players are going to exploit every edge case they can find. There’s a passage from Michael Lewis’ Flash Boys which describes the difficulty in setting up an exchange that can’t be gamed:

Creating a new stock exchange is a bit like creating a casino: Its creator needs to ensure that the casino cannot in some way be exploitable by the patrons. Or, at worst, he needs to know exactly how his system might be exploited, so that he might monitor the exploitation— as a casino monitors card counting at the blackjack tables. “You are designing a system,” said Puz, “and you don’t want the system to be gameable.” … From the point of view of the most sophisticated traders, the stock market wasn’t a mechanism for channeling capital to productive enterprise but a puzzle to be solved.

The designers of this new exchange, now known as IEX, spent months studying every type of order that could be submitted to other stock markets, and how these were exploited to rip off productive investors to the benefit of high-frequency traders (HFT). This is of course a moral judgement, and a judgment about what type of investor to privilege — and there are massive ongoing arguments about whether the current market structure that allows HFT is “fair.” But even if you know what you want your code to do, there’s no guarantee you’re going to get it. IEX found it incredibly difficult to avoid loopholes that could advantage high-frequency traders.

We are now, today, in our lifetimes, undertaking the process of turning capitalism into code. The code running our markets determines, literally, what is possible and who gets paid. Already, the cutting-edge of finance is basically nothing like “investing” as we usually think of it. It’s far more like hacking: find the properties of a complex system that get you the most money. Anything the exchange lets you do is legal, more or less. There are laws against market “manipulation” such as spoofing, but these terms are poorly defined ideas of fairness that don’t have simple technical definitions. Anyway, that’s only a problem if lawyers and regulators get involved. The code allows it.

I want our financial markets to be stable, transparent and fair. I want them to reward something other than the clever manipulation of an abstract system. And so I would argue for extreme simplicity in our electronic markets. Even very simple rules can spiral into complex consequences. Chess has more complex rules then Go, but it took computers 20 years longer to beat humans at Go. Recent game-theoretic work on algorithmic trading suggests that it’s going to be very hard to stabilize even very simple programs interacting with each other and with greedy humans.

Politics always wins in the end

Bitcoin and Ethereum are a kind of counter-power to established systems of money and finance. In the sense that many things are wrong with the current system and the powers-that-be are very hard to challenge, this is exciting. But the mistake is to think that code is enough. Wikileaks was premised on using cryptographic anonymization to protect their sources, but then Manning confessed to a freelance journalist. And all the encryption in the world could not protect Snowden from the NSA’s long reach; that required the cooperation of the Russian government.

The modern, automated stock market has already been gamed. In April 2016, an individual from Pakistan uploaded a fake document to the SEC’s EDGAR website, where public companies post their legally-required disclosures. Automated bots read the document and immediately traded on the false information, moving the stock price. The “hacker” made $425,000 in a matter of minutes, before anyone realized what was going on.

The Pakistan case was straightforward fraud, but it’s only going to get weirder. I have the Cypherpunk premonition again. Crypto-contracts shift the balance of power, and once again, a small group of people — this time, financial cryptographers — is playing with home-made nitroglycerine. Eventually it will blow up. Eventually, someone will do something with global consequences. Maybe they’ll make off with billions; maybe they’ll crash the economy of an entire country, or the world.

This will start a really big fight. And the lesson I’ve learned is that the code, while powerful, never has the last word. Eventually, there will have to be a legal and political settlement about what code the global financial markets should run on.  Ultimately, the code runs on people, not the other way around.

Yet code still has enormous influence. Financial technologists are now engaged in writing the code that will determine the future shape of the economy. Code is like architecture: it’s a built environment that determines where you can and cannot go. The code that the markets run on implicitly determines our economic policy. It sets the shape of financial hacking. It very literally decides who gets what.

So what economic policy do we want our code to embody? And given the complexity of computation, how can we be sure that this is what our code actually does? The answer is that we probably can’t, and the only solution is to get clear about our goals, and the legal and political mechanisms for resolving our arguments, before we inevitably discover that our software allows something we never intended.

I can do no better than to end with a quote from security researcher Eleanor Saitta:

Repeat after me: all technical problems of sufficient scope or impact are actually political problems first.