A Payment History of the United States

by Kaz Nejatian

  This move made it nearly impossible to reconcile how much bitcoin Mt. Gox owned against how much it was actually supposed to own.

  To understand this, it is important to know the difference between “cold storage” and “hot storage”. Recall from above that a person’s bitcoins are held in what is called a bitcoin wallet.

  A wallet with hot storage, or a “hot wallet”, is a bitcoin address that is connected to the internet that can spend bitcoin at anytime. A wallet with cold storage, or a “cold wallet”, is not connected to the internet. In fact, a cold wallet can be something as simple as a piece of paper that contains all the information needed to generate the private keys necessary to spend bitcoin.

  Unlike a hot wallet, a cold wallet cannot be easily hacked; but unlike a hot wallet, it is incredibly difficult to maintain a proper record of all bitcoin held by someone if it is all printed out on various pieces of paper. The move to maintain nearly all of its bitcoin in cold storage meant that Mt. Gox was no longer capable of adequately assessing whether it had all the reserves it needed in order to account for all its purchases and sales of bitcoin.

  As bitcoin prices kept rising, Karpeles became more and more wealthy. By late 2013, Mt. Gox was handling over 70% of the world’s bitcoin trade – and this is when big trouble greeted Mt. Gox.

  In mid-May 2013, Mt. Gox was sued by its biggest business partner Coinlab for $75 million. As if this wasn’t bad enough, days after the Coinlab suit was filed, the US Department of Homeland Security issued a warrant to seize nearly $5 million from Mr. Gox’s US payment processor Dwolla. The US government was alleging, among other things, that it was in violation of US Financial Crimes Enforcement Network laws and operating illegally in the United States.

  Around this time, Mt. Gox customers began complaining that they were experiencing delays withdrawing their funds from their Mt. Gox accounts.

  For the next few weeks, Mt. Gox avoided most press questions and attempted to allow customers to withdraw money in small batches. By late 2013, however, it became clear that Mt. Gox was in serious trouble and protestors began to protest the company’s offices in Tokyo.

  The trickle of complaints turned into a flood in February 2014 when on February 7, Mt. Gox halted all withdrawals complaining about a “bug in the bitcoin software”. Two weeks later, on February 28, Mt. Gox filed for bankruptcy in Japan claiming that hackers had stolen nearly 850,000 bitcoins, worth about $460 million at the time, form the company.

  The crash of Mt. Gox over the course of late 2013 to March 2014 caused the price of bitcoin to fall by nearly 50%. In late November 2013, while Mt. Gox was being sued but before its financial troubles, bitcoin was trading at $980. By late March 2014, bitcoin was trading at $450.

  While the Mt. Gox bankruptcy was a big shock to the bitcoin community, the network had suffered another devastating blow a few months earlier.

  On January 27, 2011, a few days after Jed McCalebt sold Mt. Gox to Mark Karpelès, an anonymous poster named “altoid” wrote a brief post on Shroomery.org, a website dedicated to, in its own words, spreading “accurate information about magic mushrooms so people can make informed decisions about what they put in their bodies.”

  Altoid, wrote that he had “come across this website called Silk Road” that would “allow you to buy and sell anything online anonymously.” Two days later, a user using the same name, posted a similar message on Bitcointalk.org, a website for bitcoin enthusiasts. Within weeks Silk Road, a website accessible only using special browsers so as to hide its tracks and anonymize its visitors, had become popular on both sites. A user on Shroomery.org posted, excitedly, “Yes, you can really buy drugs safely online.”

  By May 2011, Silk Road was so popular that hundreds of users were buying and selling drugs online – almost completely hidden from the US federal and state governments.

  If Silk Road had used credit cards or online payment providers like PayPal to process transactions, all its transactions would have been trackable by banks and the US government.

  Bitcoin, however, was readily available in early 2011 and it was different from every other method of payment.

  While bitcoin transactions can be tracked, they can also be made pseudo-anonymous. As described earlier, a bitcoin transaction is really a series of transactions and when a bitcoin is spent, the public ledger is adjusted to reference who spent and who received the currency. This information is publicly available, and thus bitcoin transactions are traceable. Unlike a bank account, however, a bitcoin address is not tied to identity of any user. So while it is perfectly obvious which user sent how much bitcoin to which other user, the names of the bitcoin users themselves can be easily hidden. For example, my bitcoin wallet address is 1BN1XUE3P2aSFb77sx8rhAEJ

  CREbgXcn7F. Without me telling you that right now, there is no way you could know who owns that wallet.

  Also, unlike credit card transactions, it is very difficult to trace which computer started a given bitcoin transaction. In today’s world, transactions are frequently traced using IP addresses. An IP address is a unique string of numbers that identifies each computer in a network. An IP address is to a computer what a home address is to a house. It is unique. So it can be used to track spending that started on a computer. Bitcoin, however, is designed such that transaction data be transmitted or forwarded to random computers on the network. So while it can be said which computers were involved in a bitcoin transaction, it is practically impossible to tell whether a computer stared, amended or simply forwarded the transaction information.

  This pseudo-anonymity means that users on Silk Road could buy and sell things with much more anonymity than they could have if they were using checks, credit cards or even ACH transactions. This feature led to increasing popularity of Silk Road.

  By early 2012, Silk Road was on track to do about $15 million in transactions annually. Estimates suggest that an overwhelming portion, perhaps as much as 75%, of this amount was illegal drugs. Although other items for purchase included tutorials on how to hack ATM machines, illegal pornography, and even a hitman to kill your business rival.

  As Silk Road grew in popularity, its founder, known as Altoid on Mushroomery.org and believed to be a user named Dread Pirate Roberts on Silk Road, began looking to hire engineers to help improve the website.

  In mid-October 2011, Altoid posted on Bitcointalk.org that he was looking for “an IT pro in the Bitcoin community”. The job posting asked interested applicants to send an e-mail to “rossulbricht at gmail dot com”. This job posting was likely the first time Altoid was related to an account with an actual name behind it – Ross Ulbricht.

  As was later proven in a criminal trial, Ross Ulbricht, the founder of Silk Road was a brilliant, libertarian ideologue. He had been a volunteer on and a donor to Ron Paul’s campaigns for President. He had written many essays promoting his political ideology.

  In one essay, he wrote that “Silk Road is about something much bigger than thumbing your nose at the man and getting your drugs anyway. It’s about taking back our liberty and our dignity and demanding justice.” And that “the drug war is an acute symptom of a deeper problem, and that problem is the state. If they legalize, regulate and tax it, it's just one more part of society under their thumb, another productive sector that they can leech off of.”

  In another essay, making an impassioned defense of non-state currencies like bitcoin, Ulbricht wrote that "the Federal Reserve system relies on the force of government to maintain its monopoly power on the issuance of money. This is how all central banks maintain their control. Without the state's involvement, people would be free to use whatever currency they like.”

  By mid-2011, with his libertarian message and a seemingly unlimited supply of illegal drugs for sale, Ulbricht (through his pseudonym Dead Pirate Roberts) had become a hero in some circles. It was also around this time that the US government began to take the threat of Silk Road seriously.

  On June 5, 2011, U.S. Senator Charles Schumer called a press confe
rence to declare that Silk Road had become a public menace.

  "[Silk Road] allows buyers and users to sell illegal drugs online, including heroin, cocaine, and meth, and users do sell by hiding their identities through a program that makes them virtually untraceable," said Senator Schumer "It's a certifiable one-stop shop for illegal drugs that represents the most brazen attempt to peddle drugs online that we have ever seen. It's more brazen than anything else by lightyears."

  This began a two-year investigation by the US Drug Enforcement Administration and the FBI which ended on October 2, 2013 in a San Francisco public library when Ulbricht was arrested and charged with drugs trafficking, money laundering and attempted murder (Ublricht had once allegedly attempted to hire a hitman to kill a business associate whom he believed was cooperating with the police).

  Two weeks after the arrest, FBI announced that it had seized nearly 144,000 bitcoins, valued at $28.5 million, from Ulbricht.

  The Silk Road saga was the most broadly reported coverage bitcoin had received and the currency’s affiliation with a criminal enterprise did great harm to bitcoin’s value.

  The day before Ulbricht’s arrest, bitcoin was trading at $145 on Mt. Gox. Immediately after the arrest was announced, its value plummeted to $109 – a fall of nearly 25% - thought the price slowly recovered.

  The combination of Mt. Gox and Silk Road along with a lack of general increase in bitcoin transactions caused enthusiasm for bitcoin to be muted for some months.

  The price of bitcoin had risen steadily throughout 2013, reaching a high of nearly $1,000 on November 25, 2013; but the price steadily decreased from that point reaching the low of nearly $200 by February 2015.

  The price of bitcoin alongside various use cases for the currency and attention from big banks recovered slowly throughout 2016 and crossed the $1,000 mark in early February 2017. As of this writing, in June 2017, the price for a bitcoin is just over $2,800 – an all-time high.

  While the price of bitcoin has increased dramatically and quite a few other digital currencies have found their footing, it is unclear whether bitcoin will ever become a mainstream currency.

  For those keeping track, it is important to remember that it took nearly 20 years before debit cards became mainstream in America. By that record, we should not judge bitcoin until nearly 2030.

  Conclusion

  Payments and money are an important part of everyone’s day to day life, but they are a part we rarely talk about.

  On any given day, the average person pays for what he or she eats, what he or she uses, how he or she gets places, and how he or she lives.

  We take our cards out to pay for breakfast, we use checks to pay rent, we use ACH to pay bills, and we use cash to pay the local coffee shop. It is difficult to imagine an average person in the United States going through his or her day without being touched by all forms of payment mentioned above. Even the most digital of us are touched by cash payments – frequently having to wait slightly longer behind someone counting out coins at a cashier. Even the most analog of us are touched by digital payments – frequently having to figure out how to pay for things online.

  And everyone is affected by the cost of payments.

  Cash, checks, ACH, credit and debit cards, and even digital currencies all have costs associated with them. These costs are eventually paid by the consumer. As an example, the Merchants Payment Coalition estimates that credit and debit card fees alone drive up the prices for everything costing the average family in the United States nearly $400 each year.

  That’s a $400 payment tax that very few people talk about. By comparison imagine how many newspaper columns would be written if the United States Congress passed a law increasing everyone’s property taxes by 20%. (The average American household pays about $2,000 in property taxes.)

  Similarly, imagine how many newspaper columns have been written about Amazon’s effect on US retail and the ever shrinking US retail margins. How many times have you heard a big retail chain shut its doors because it cannot turn a profit in today’s market? We often hear the reasons given as increased competition, higher wages, or increased rent. But for virtually every merchant in the United States payment costs are the second-highest operating expense after labor. How many stores could remain open if costs of payments were lower?

  We don’t know the answer to these questions because we don’t talk about payments that much. There are two reasons we don’t talk about payments that much.

  First, the technical aspects of payments are incredibly complicated.

  The average reader doesn’t really know how the internet works. How a computer talks magically with another computer. Same is true for payments. The underlying system is incredibly complicated, so we don’t’ talk about it that much. Even this book has avoided much of the technical discussion about payment systems. (For an incredibly detailed overview, please read Payment Systems in the US by Carol Coye Benson and Scott Loftesness.)

  Second, payment and banking in general seem boring at first glace. It is all about numbers, after all.

  Once we can get past the initial hesitance, however, the world of payments is fascinating. Payments has a history full of big characters and interesting events that mirror the building of any civilization. How many other issues have given rise to entire political movements? How many other aspects of our lives were hotly debated by America’s Founding Fathers and by King George? How many other issues would have gotten attention from titans such as JP Morgan and philosophers like Karl Marx and Adam Smith?

  The history of payments is incredibly fascinating. The goal of this book, as stated in the introduction, was to give a cursory review of it. I hope it has accomplished that.

  An Incomplete Bibliogrpahy

  This is not an academic work. Much of it has been written from memory. I’ve attempted to fact check all the facts and the stories – and they all have held true. To extent there are mistakes, as I am sure there are, I will update the digital copy of this book. However, there are certain works and writings without which the writing of this book would have been impossible. This is an incomplete list of such works, listed alphabetically by author’s last name.

  I will continue to update a bibliography and a reading list on my personal website www.nejatian.com.

  Aboucher, R. Bank Charge Cards in the 1970s, Banking 1969

  Adams, K. The Bank Card: Yesterday, Today, and Tomorrow, American Bankers Association 1974

  Baker, D. The Law of Electronic Fund Transfer Systems, Gorham & Lamont 1988

  Batiz-Lazo, B. A Brief History of the ATM, The Atlantic 2015

  Caskey, J. Is the Debit Card Revolution Finally Here?, Federal Reserve 1994

  Davies, G. A History of Money from Ancient Times to the Present Day, University of Wales 1994

  Durkin, T. Credit Cards: Use and Consumer Attitudes, 1970–2000, Federal Reserve 2000

  Evans, D. Economics of the Payment Card Industry, National Economic Research Association 1993

  Evans, D. Paying with Plastic: The Digital Revolution in Buying and Borrowing, MIT Press 1999

  Federal Reserve, Federal Reserve Payments Study 2016, 2016

  Ferguson, N. Ascent of Money, Penguin Books 2008

  Friedman, J. House of Cards: Inside the Troubled Empire of American Express, Kensington 1992

  Friedman, M. A Monetary History of the United States, Princeton 1963

  Griffith, K. A Quick History of Cryptocurrencies BBTC — Before Bitcoin, Bitcoin Magazine 2014

  Higgins, S. 3 Pre-Bitcoin Virtual Currencies That Bit the Dust, Coindesk 2014

  Holmes, T. Debit card statistics, CreditCards.com 2015

  Lord, L. He Led the ‘Charge It' Charge, U.S. News & World Report 1990

  Mandel, L. The Credit Card Industry: A History, G.K Hall & Co 1990

  Milletti, M. Banks Promoting A Mechanical Pal, New York Times 1977

  Nakamoto, S. Bitcoin: A Peer-to-Peer Electronic Cash System. Bitcoin.org

  Rodriguez McRobbie, L. The AT
M is Dead. Long Live the ATM!, Smithsonian 2015

  Rothbard, M. A History of Money and Banking in the United States, Ludwig von Mises Institute 2002

  Sienkiewicz, S. Credit Cards and Payment Efficiency, Federal Reserve 2001

  Szabo, N. Smart Contracts, 1994

  United States Government Accountability Office, Rising Interchange Fees, US Congress 2009

  Vanatta, S. Charge Account Banking: A Study of Financial Innovation in the 1950s, Princeton 2016

  acknowledgments

  I am an immigrant. My family moved from Iran to Canada when I was 12 years old. When they got to Toronto, my parents did what many other immigrants do. They opened up a corner store. I first became interested in payments working at my mother’s store. I was fascinated by how that little credit card machine worked. That I get to be the CEO of a payment company is a great joy. That I got to chance to write a short book about payments is an even a greater joy.

  I’d like to thank the amazingly talented team working every day at Kash to help change the world of payments. To make it faster. To make it more secure. To make it more fair.