Solving the Bitcoin Puzzle: A Legal, Normative, and Game-Theoretic Analysis of Bitcoin and Other Cyber-Currencies

Abstract

What is the legal status of a “bitcoin,” a decentralized peer-to-peer digital currency? Is the use of bitcoins even legal? Should it be? The bitcoin cybercurrency thus poses a puzzle. Unlike centralized and publicly-created metallic or paper currencies, bitcoin is a privately-created, decentralized medium of exchange and thus is not backed by any national or transnational government or by any public or private bank. As such, the legal status of the bitcoin cybercurrency is murky and unclear at best. Despite this legal uncertainty, the demand for bitcoins on the Internet continues to grow. The authors will present a legal, normative, and game-theoretic analysis of the bitcoin cybercurrency. To provide a theoretical background to our legal and normative analysis, the first part of the paper will present an analytical model of the behavior of bitcoin users. In summary, the use of bitcoins can be modeled as a Prisoner’s Dilemma. That is, because of the limited supply of bitcoins and the rising demand of this cybercurrency, the temptation to defect by hoarding this currency -- rather than using bitcoins for the exchange of goods and services -- threatens the stability of the bitcoin cybercurrency as a whole. In the second part of the paper, the authors consider the legal status of bitcoins, discuss the policy and normative arguments for and against the legalization of bitcoins, and propose several possible legal frameworks for protecting the bitcoin cybercurrency and solving the bitcoin puzzle.