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Episode 753: Blockchain Gang

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Episode 753: Blockchain Gang

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Episode 753: Blockchain Gang

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KEITH ROMER, HOST:

At first, Charlie Shrem's life was like a dream for a young entrepreneur. By the time he was 22 years old, the company he had started in his parents' basement in Brooklyn had hit the big time. He hired dozens of new employees. His company got a real office in Manhattan, cool, high-tech name - BitInstant. Somebody even wrote them a jingle to use in their ads.

Do you remember the BitInstant theme song?

CHARLIE SHREM: It's - yeah, of course. I could sing it word for word.

ROMER: I would - would you?

SHREM: Yeah it's (singing) it's your money, why wait? BitInstant's got lowest rates. It's your money, why wait? Get bitcoin the fastest way. And then he's like (singing) so I hopped online to place my order quick. I don't know, all those - all those words.

ROMER: As you might have guessed from the lyrics, BitInstant's mission was to help people buy bitcoin. This is back in 2012, and digital currencies like bitcoin were just starting to get hot.

ROBERT SMITH, HOST:

It used to be to buy bitcoin you would have to arrange with somebody somewhere who knew somebody who was willing to sell you some. Or you'd have to wire money to a big exchange in Japan and wonder if you'd actually get the bitcoin. BitInstant made it as easy as getting a money order. You could walk into a Wal-Mart or a pharmacy like Duane Reade, give them cash and walk out with bitcoins in your digital wallet. They even did bitcoin transactions online.

ROMER: Charlie says there was a lot of demand for his service.

SHREM: We were processing over a million dollars a day.

ROMER: One of the things that people liked about digital currencies like bitcoin was that unlike bank transfers or personal checks, bitcoin let you buy things anonymously, which was really attractive to a certain kind of person.

SMITH: Drug dealers.

SHREM: Also drug buyers.

SMITH: (Laughter) Drug buyers, too.

ROMER: There was a website called Silk Road where people could buy and sell marijuana, cocaine, ketamine...

SMITH: Horse tranquilizers...

ROMER: Sure, but I don't want to be...

SMITH: ...Hit men.

ROMER: One time hit men.

SMITH: OK, one hit man. All those people using Silk Road, they drove up the demand for bitcoin, which, Charlie says, makes sense when you think about it.

SHREM: It's always going to be the people that need to use something the most are going to be the first ones to use it.

ROMER: One of the people who needed to use bitcoin was a man who went by the screen name BTC King, bitcoin King. On Silk Road, BTC King served as a money changer for all the drug buyers and sellers who wanted to trade dollars for bitcoin.

SMITH: And BTC King, he got his bitcoins from Charlie Shrem's company, BitInstant.

ROMER: It seems to me that you knew roughly what this guy was up to.

SHREM: Yes.

ROMER: And yet you were sort of like, let's go ahead and do this. And I'm just sort of curious, like, what your thinking was in terms of, like, back in that moment.

SHREM: I wasn't thinking. That was the whole point.

SMITH: And for a couple of years, not thinking worked out just fine for Charlie. In fact, it was really, really profitable. Twenty-two-year-old Charlie Shrem was a millionaire.

ROMER: Is there a moment that you remember when you were kind of like, oh, no, I've gone way too far down this road?

SHREM: Yeah, I do. And that was the moment they were placing the handcuffs on my hands.

(SOUNDBITE OF SONG, "WHY WAIT")

ZHOU TONGED: (Singing) It's your money. Why wait? Instant transfers, no delay. It's your money. Why wait? Time is money, don't be late. It's your money. Why wait?

SMITH: Hello, and welcome to PLANET MONEY. I'm Robert Smith.

ROMER: And I'm Keith Romer. Today on the show the story of Charlie Shrem - how this kid from Brooklyn went from living in his parents' basement to living the life of a bitcoin millionaire to, well, federal prison.

SMITH: Charlie Shrem's odyssey into prison and back out again is a kind of parable for everything that has happened with bitcoin in the last five years. Charlie and bitcoin have gone from being idealists to outlaws to trying to make it as respectable citizens.

(SOUNDBITE OF SONG, "WHY WAIT")

ZHOU TONGED: (Singing) Time is money, don't be late. It's your money. Why wait?

ROMER: To understand just how and why Charlie Shrem ended up in handcuffs, it helps to get your head around the culture that surrounded a lot of the early enthusiasm for bitcoin.

SMITH: You know that guy in high school who picks up Ayn Rand for the first time, reads "The Fountainhead" and then cannot stop talking about this new libertarian world and what it means, man? That was the young Charlie Shrem.

ROMER: Only instead of "The Fountainhead," for Charlie it was bitcoin. Bitcoin was going to be the key to unlocking the libertarian utopia of the future.

SMITH: Because think about it - bitcoin is sort of the exact opposite of something like a credit card. Credit card leaves a whole paper trail that can be tracked by banks or the government if they want to get up into your business.

ROMER: Charlie says bitcoin takes that power back from the banks and the government and gives it to individuals.

SHREM: At the end of the day, like, I have a dollar bill, I hand it to you, there's no one in between the transaction. There's no law that prevents me from handing you a dollar bill. Bitcoin is the same way. So that same way that I could hand you a dollar and the room - no one could be in the room, no one can see it, no one could hear it - I could send a dollar to someone in China the same exact way.

SMITH: If everyone used bitcoin, Charlie evangelized at the time, governments wouldn't be able to control how and where people spent their money. Big banks wouldn't be able to get rich charging people for moving their own property from one place to another.

ROMER: Charlie didn't just kind of think these things. Remember, he was 22, and he was one of those 22-year-olds who is so sure he's figured everything out.

SHREM: I believed that I was completely right about everything all the time.

SMITH: Including, you know, that it was OK for his company to help drug dealers buy bitcoin.

ROMER: You know who didn't think it was OK for his company to do that? The federal government. Charlie was just coming back from a bitcoin conference in Europe when he was arrested at JFK.

SHREM: I did a perp walk into waiting vans and then brought to Metropolitan Correctional Center. I wouldn't wish it on my worst enemy.

ROMER: In the end, Charlie was convicted of aiding and abetting the operation of an unlicensed money transmitting business. He was sentenced to two years in federal prison in Pennsylvania.

SHREM: You get to prison and you say goodbye to your family.

ROMER: You strip down naked. The guards take away your clothes.

SHREM: They do a full body search - cavity search check.

ROMER: A doctor looks you over. You get your prison uniform, your bunk assignment.

SHREM: And you're on your way.

SMITH: Prison was hard for Charlie at first.

SHREM: You ever have that feeling that you want to cry, but you hold yourself back. And you just want to start bawling, and the only place to cry is in the shower.

ROMER: How long did that feeling last?

SHREM: A few weeks.

ROMER: That sounds like a terrible few weeks.

SHREM: It was.

ROMER: Charlie is 5-foot-4. He's not a big guy.

SMITH: And there he is in federal prison. He's scared. I mean, he's scared of what's going to happen to him.

ROMER: One night early in his sentence, he's reading in the prison dorm, and one of the other inmates comes up to him.

SHREM: In the middle of the night, some, like, huge guy walked up to me, and I thought he was going to beat me up because I had my light on. And he said, hey, man, you got to turn your light off, but if you want to read, here - borrow my book light. I was like, oh, wow, he's like - he's like lending me his book light.

ROMER: It does feel like that's a good outcome to that - to that.

SHREM: Yeah, he was really - we ended up - he would make me gyros, like, once a week. He was a really nice guy.

SMITH: Gyros - like, heroes - like, Greek food.

ROMER: Yeah, yeah, yeah. I mean, like, cooked on a radiator or whatever, but still.

SMITH: Now, most of the time in prison, Charlie didn't just get things for free because in prison, just like the outside world, you have to pay for most things.

ROMER: But you can't just reach into your pocket and pull out a $5 bill, right? In prison, there is no paper money. For a while, they used cigarettes, but then federal prisons outlawed cigarettes. So now there's a bunch of different ways you can pay for things in prison.

SHREM: The guy who fixes headphones only accepts protein bars. The guy who cuts your hair wants jars of peanut butter. But I would say the overwhelming majority of people would except mackerel just because everyone else would accept it. So if the guy - if I only had mackerel, I don't want to...

SMITH: Like, mackerel the fish.

SHREM: Yeah, there was, like - there were, like, packets of mackerel in soybean oil, and they cost about a dollar-50.

SMITH: These vacuum-packed things of mackerel were basically a currency in prison. And remember, Charlie has a lot of thoughts about currency...

ROMER: ...And the problems that come up with currencies. How safe was a packet of mackerel in soybean oil as a currency? Someone could steal your life savings from underneath your bunk, or the mackerel itself could go bad. Those packets of mackerel had a shelf life of, like, three years. And if that happens, it's not so easy to get your hands on more mackerel.

SHREM: There is a finite amount of money that people can send you from outside, and that you could spend at the prison commissary. And even that - there's a finite amount that you can actually spend every week.

SMITH: Each week, one inmate was allowed to buy a maximum of 14 packets of mackerel.

ROMER: But Charlie says, at one point, the guards seized this one guy's entire supply of mackerel and just left it out in a common area for anyone to take.

SMITH: It's like free money.

ROMER: Yeah. And you know what happens when you give out free money? Inflation. Physical mackerel comes with all of these built-in problems as a currency. So lying in his bed at night, Charlie starts to think - what if prison mackerel could be more like bitcoin?

SHREM: And instead of people trading, like, individual mackerels between each other, they'd be able to trade digitized mackerel.

SMITH: Charlie clearly has plenty of time to lie on his cot or whatever he sleeps on and do this thought experiment.

ROMER: He's in prison - nothing but time.

SMITH: So - OK - so obviously there are a lot of problems with setting up a new digital currency in prison. I mean, maybe the most obvious one is...

ROMER: You're in prison.

SMITH: They don't have computer (laughter).

ROMER: And this is where Charlie has an insight. What's important about bitcoin - what's most revolutionary about bitcoin - is not bitcoin itself. It's how the bitcoin system keeps track of where the money is.

SMITH: Yeah. With bitcoin, the computers in the network keep a record of all the transactions that people are making. The system even has its own catchy name. They call it the blockchain.

ROMER: A list of the latest transactions - that's a block. You link that block of transactions to the block that came before it and the block that came before that - that's a blockchain.

SMITH: But without computers, Charlie has to think of a different way to do the mackerel blockchain. So he thinks, you know, what if we just had inmates write down all the transactions in physical notebooks which they can get from the commissary. In blockchain lingo, these inmates would be nodes.

ROMER: I want to pay you two mackerel to give me a haircut.

SHREM: Yep. Instead of trading me actual mackerel, we'd go to one of these nodes - one of these people - and say, hey, I have this money in my account. Can you transfer it to his account?

SMITH: That way, no physical mackerel would have to change hands.

ROMER: It's all going to be in Tommy Knuckles' notebooks.

SMITH: Tommy Knuckles.

ROMER: I made - I made that up, by the way. To the best of our knowledge, Charlie was not in prison with anyone named Tommy Knuckles.

SMITH: OK. So he solved the first problem - how do you record transactions? That's done. But there's a second problem Charlie's got to solve. All of the people he wants to use his mackerel currency with - they're criminals - every single one. That's why they're in prison - even Tommy Knuckles.

ROMER: So trust is an issue.

SMITH: Trust is a huge issue. Now, Charlie and all the other inmates could just go to the warden, like a third party, and say, hey, I'm not sure Tommy Knuckles is always writing down the right thing in his notebook. Would you mind being in charge of the notebook?

ROMER: But maybe they don't want the warden to have all that information. Or maybe they don't trust the warden to do a good job, either.

SHREM: The question was - how do you do it without a trusted third party? How do you do it without a centralized authority?

SMITH: So if you don't want the warden to be in charge and you don't want one guy, Tommy Knuckles, to be in charge, what do you do? You make it so that no one is in charge.

ROMER: Instead of just Tommy Knuckles with his notebook, you get lots of different inmates in different parts of the prison, all with their own notebooks, writing down all the digital mackerel transactions happening in their part of the prison.

SMITH: This just kills me. And then every hour or so, out in the yard, these inmate nodes sit down with each other and copy the new transactions into their own notebooks.

SHREM: So they update each other's. Now you have two nodes that have it.

SMITH: Each of these guys meet with other guys who also have notebooks. Notebooks beget notebooks. And all of a sudden, everyone has the same record of transactions. It is a distributed ledger, as they like to say in the bitcoin world - distributed ledger.

ROMER: Charley did not actually set up the whole digital currency in prison. For one thing - completely against prison rules, and Charlie had learned his lesson about breaking the rules. He was in prison altogether for a year and a half. And in that time, he did try to keep up with what was going on in the outside world with blockchain and bitcoin and all the rest of it. But prison is not a great place to keep track of what all the bitcoin kids are talking about on websites like Reddit.

SHREM: People would print out, like, the front page of Reddit and present it to me.

ROMER: But you couldn't click on any of the links.

SHREM: I know. That's why it was funny. It was so stupid. They'd print out the front page of Reddit and mail it to me, but I couldn't click the links.

ROMER: What Charlie would've learned if he'd been able to click on the links was that thinking about bitcoin was undergoing this huge change while he was locked up.

SMITH: Instead of the focus being on what bitcoin could do to revolutionize the world, now everyone has time to look at what the technology underlying bitcoin - the block chain, distributed ledger - what that could do on its own.

ROMER: And that people starting to get interested in block chain and distributed ledger stuff were not just libertarian 22 year-olds anymore. Now you've got, like, the shouty financial journalists at Fortune magazine.

(SOUNDBITE OF ARCHIVED RECORDING)

ANDREW: A new report says the blockchain, the technology that underpins the digital currency bitcoin, will become central to the global financial system. Bob, do you buy this?

BOB: I buy it hook, line and sinker, Andrew.

SMITH: All right. The journalists were in. Giant global banks - they wanted a piece of the action, too.

(SOUNDBITE OF ARCHIVED RECORDING)

UNIDENTIFIED MAN: Welcome, and thank you for you interest in blockchain. We are going to discuss this topic today with two experts from Deutsche Bank.

ROMER: OK. The banks were in.

SMITH: And then as proof that these radical underground ideas of Bitcoin had become completely mainstream...

(SOUNDBITE OF VIDEO, "HOW THE BLOCKCHAIN IS CHANGING MONEY AND BUSINESS"

SMITH: ...Ladies and gentlemen, a TED Talk.

(SOUNDBITE OF VIDEO, "HOW THE BLOCKCHAIN IS CHANGING MONEY AND BUSINESS"

DON TAPSCOTT: The technology likely to have the greatest impact on the next few decades has arrived. And you'll be surprised to learn that it's the underlying technology of digital currencies like bitcoin. It's called the blockchain - blockchain.

SMITH: Blockchain.

ROMER: So one of the reasons that everybody in the financial industry is so excited about the blockchain is that there's this trust problem.

SMITH: It's essentially the mackerel problem all over again, except instead of convicted criminals...

ROMER: ...It's unconvicted criminals.

(LAUGHTER)

SMITH: It's unconvicted criminals.

ROMER: It's unconvicted criminals.

(LAUGHTER)

SMITH: It's bankers. We're sorry, bankers. But - OK, OK. So, for instance, there are two sides to every trade - two banks. One bank might think, oh, I just sold a hundred shares. The other one might think, well, wait - I thought I just bought a thousand shares. And it could be an honest mistake, could be not a not-so-honest mistake, but for whatever reason, they disagree. And this is expensive to sort out. With a distributed ledger, there's a record that both of you made together at the time in the first place, so no disagreements.

ROMER: And the thing is these days, for a lot of transactions, it's not just two banks. It's three or five or 20. And every time you add an additional bank, you add all this complexity and all this paperwork...

SMITH: ...And lawyers and sometimes there are even faxes, still, in 2017.

ROMER: You put all of that on the distributed ledger, though. You get rid of the fax machines. You cut way down on the lawyers having to review every little accounting mistake. It's all automated, efficient. It's cheap. The banks love the idea.

SMITH: In July of 2016, Charlie Shrem gets out of prison into this new world. His girlfriend's waiting for him.

SHREM: I came out in my prison clothes, and I had a box of stuff with me. And we got rid of my prison clothes. I changed in the car, and we left.

ROMER: What is that - what does that feel like to be on the outside?

SHREM: You ever see that statue of Atlas with the world on his shoulders? Imagine having that, and imagine it being lifted within seconds. You feel a physical weight being lifted off of you. You - it's like - it's as if that whole year, you were slumping, and, all of a sudden, you could stand up straight.

SMITH: The first thing Charlie does when he's on the outside is to get a cup of coffee. The second thing is to finally click on those links on the Reddit page. Everything has changed.

SHREM: Before I went to prison, there were no really many blockchain products. There was only bitcoin. There were a few other, like, fledgling ones, but it was mostly bitcoin. When I got out, that year was the year of the blockchain. That's when a lot of things happened.

SMITH: Twenty-two-year-old Charlie would have hated these things. Back then, he called himself a bitcoin maximalist, meaning he wanted the entire financial system to be replaced by bitcoin. The point was to take power away from the banks, not give them one more tool to control us.

ROMER: But older, wiser, 27-year-old Charlie - he's fine with it.

SHREM: Well, I'm definitely not a bitcoin maximalist anymore. I believe that. And there's not, like, one chain to rule them all. Bitcoin does some things really amazing, but there are other projects that can do some things even better.

ROMER: Charlie's not only OK with all the changes, he's kind of excited about it. He starts thinking about what the best way is for him to get back in the game.

SMITH: In the end, he comes up with his own clever twist on this whole blockchain stuff. He thinks - what if blockchain could be used to do an end-run around the way companies go public, the way stocks are created and traded?

ROMER: Charlie creates a new company, Intellisys Capital. Intellisys is going to run an investment fund that will buy up privately owned companies in the U.S. Shares in the fund will be sold not through a broker on some stock exchange somewhere, but - wait for it - on the blockchain. Instead of a paper stock certificate, you'll get a digital one on the distributed ledger.

SHREM: It creates the ability for people to take their own companies public or their own assets public and sell shares to those people anywhere in the world.

SMITH: And, you know, whereas bitcoin relies on this collective agreement that bitcoin is, in fact, worth something, Charlie's new project will be based on real assets - physical, tangible companies that make money, that do things.

ROMER: In this case, a really physical, really tangible company.

SHREM: The first company - sanitary waste, septic tank pumping and porta-potty cleaning.

ROMER: You are selling a made-up currency that's supposed to represent shares in a business that moves human excrement from place to place.

SHREM: Yes.

ROMER: My - like my dad would say, do not invest in that company.

SHREM: Your dad, you know, would be very smart to tell you that - never to invest in something that you don't know everything about - so your dad's a smart guy.

ROMER: My dad is a smart guy.

SMITH: (Laughter) Charlie is not really counting on the Keith Romers of this world and their dads to invest, though. The fund is closed to most American investors. In fact, to avoid violating U.S. securities law, he's registered his new company in the Cayman Islands.

ROMER: Why is it in the Cayman Islands?

SHREM: That's just what the lawyers decided.

ROMER: And that more than anything is how you know when a technology has really matured. Everyone starts listening to their lawyers.

(SOUNDBITE OF MUSIC)

SMITH: We are always interested in stories about how old technologies find a new life. You can email us - planetmoney@npr.org - or you can find us on Facebook or Twitter.

ROMER: Our show today was produced by Sally Helm. Thanks, Sally. Our editor is Bryant Urstadt. Special thanks today, also, to Wall and Broadcast. That's the podcast where we first heard about Charlie Shrem's story. Also, thanks to Charley Cooper at R3 and Nathaniel Popper of The New York Times. Nathaniel's book, "Digital Gold," is a great history of the early days of bitcoin.

SMITH: I'm Robert Smith.

ROMER: And I'm Keith Romer. Thanks for listening. One more thing - if you're looking for something else to listen to, check out another great show from NPR.

LINDA HOLMES, BYLINE: I'm Linda Holmes from NPR's Pop Culture Happy Hour podcast. What has pointy ears, a cape, a huge ego and knees that don't bend? That's right - Lego Batman. To get the skinny on his new movie and lots of other good stuff to watch and read, find Pop Culture Happy Hour on the NPR One app or at npr.org/podcasts.

(SOUNDBITE OF MUSIC)

ROMER: Hey, it's Keith again with one last note. In an earlier version of this podcast, we misstated the crime that Charlie was convicted of. It was not money laundering. It was, in fact, aiding and abetting the operation of an unlicensed money transmitting business.

(SOUNDBITE OF SONG, "WHY WAIT?")

ZHOU TONGED: (Singing) It's your money. Why wait? Instant transfers - no delays - no delays. It's your money. Why wait? Time is money. Don't be late. Time is money. Don't wait. It's your money. Why wait? BitInstant's got lowest rates. It's your money. Why wait? Yeah, bitcoin's the fastest way - fastest way. It's your money. Why wait? Hey. It's your money. Why wait? It's your money. Why wait? It's your money. Why wait? It's your money. Why wait? It's your money. Why wait? It's your money. Why wait?

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