What’s Wrong With Bitcoin

What’s Wrong With Bitcoin

May 21, 2013 – Since it’s raining today and I cannot cut the grass, I figured it’s a good day to get this one off my chest.

By The Cerebral Aesthetic Vagabond

I don’t mean to pick on bitcoin specifically, and this essay pertains to all virtual currencies, including devcoin, litecoin, namecoin, ppcoin, terracoin and probably many more I’m not aware of. I’m definitely not an apologist for fiat currencies, nor am I a “gold bug.” I simply evaluate my surroundings dispassionately and logically. So here’s what I think about bitcoin.

Currency Competition

Fundamentally, I like the idea of competing currencies. Honest competition improves the health of any system, for it weeds out defects and enhances resiliency and stability. In fact, currency competition already exists because there are many sovereign currencies around the world that ostensibly compete against one another, despite increasing central bank policy collusion. The well known “dollar index” is a graphical depiction of this currency competition. Unfortunately, trading in multiple currencies is largely the domain of wealthy elites who straddle national borders.

I think part of the appeal of bitcoin is that it enables “ordinary” folks to trade in alternative currencies independently of national sovereignty, which is probably one reason why those same elites wish to target bitcoin, because they don’t control it and bitcoin gives the people too much freedom. Although I’ve come close to purchasing some bitcoins, if only as a token show of support for the concept, I harbor reservations that have prevented me from doing so.

As far as competing currencies go, I always thought Liberty Dollar was a good model, being essentially a privately issued currency based on precious metals. I consider it superior to bitcoin because it was based on something tangible, possessing secondary value as a precious metal. A recipient of a Liberty Dollar would receive a physical store of value that could be traded based on the value of its precious metal content alone. By contrast, you can’t pay your handyman with a bitcoin. Not surprisingly, Liberty Dollar was too great a threat to the centrally managed U.S. Dollar and so it was shut down for specious reasons. I fear bitcoin and its brethren will follow the same fate, which is one of the reasons I’ve been leery of purchasing any.

Theoretically Decentralized

Contrary to claims, bitcoin is centralized and easy to attack because of its centralized nature, and anonymously as well. The recent shutdown by the U.S. Government of a major bitcoin trader illustrates how bitcoin is more centralized than people realize. If bitcoin were truly as decentralized as its theory of operation suggests, then the shutdown of a bitcoin trader or even many such traders would not have been newsworthy. After all, the whole point of decentralization is that the loss of a portion of the system is insignificant to the rest of the system. So instead of a central bank acting as a gatekeeper for a sovereign currency, bitcoin has a handful of major companies playing a similar role, and they must comply with government edicts regarding the movement of money.

DIAGRAM

Whereas printed currencies and precious metal bars and coins are individual stores of value, bitcoin is like a single hoard of currency or precious metal in which each bitcoin owner owns a share of that hoard, not unlike a precious metal ETF. When one person sends bitcoins to another, nothing tangible is transferred; instead, an electronic package of data indicating the number of shares to be transferred is sent into the bitcoin system and migrates to the recipient. The bitcoins one “owns” are actually pieces of data typically stored on their own computer in an electronic “wallet.”

Because the bitcoins are stored as myriad bits of data and because the computing is performed on a distributed network of computers, it is claimed that bitcoin is therefore decentralized. However, individual bitcoins have no meaning; they only have meaning within the context of the bitcoin “cloud,” in which an individual bitcoin represents a share of the entire collection of bitcoins. In that sense the entire bitcoin network, software and data collectively behaves no differently from a huge centralized system. It’s not possible for an individual computer to utilize bitcoins in any way without the rest of the bitcoin cloud being available!

For example, if I want to send bitcoins to my coworker sitting at the desk beside me, I cannot do it peer-to-peer, from my computer to his, but only by sending the bitcoins through the entire bitcoin cloud, which doesn’t really strike me as a truly decentralized system. Ironically, the currency-based banking system that’s been around for a long time is less centralized than bitcoin, for if I want to transfer money from one account at a bank to another at the same bank, that transfer is recorded within that bank alone and it is not necessary to involve the entire banking network in order to effect such a transfer. Similarly, if I want to withdraw money from my bank, I can go to the physical branch and receive money directly from that branch, again without involving the entire banking network. A precious metal coin or bar is also less centralized than bitcoin, for an individual can trade that store of wealth for something without involving anyone else in the transaction.

Tempting Target

It does not matter whether any single hoard of stored value resides in a steel and concrete vault or in encrypted form in an internet “cloud.” Either way, the existence of any hoard of wealth in a single location – even a virtual one – makes it a tempting target for someone to attack, whereas millions of widely distributed individual stores of value would be too much trouble to attack, at least on a massive scale. Hackers, for example, don’t waste their time trying to crack the online passwords of individual bank accounts, but go after the bank’s central database where all the passwords are stored.

Bitcoin, because it’s in effect a single store of value – in the form of a distributed but highly interconnected database of encrypted virtual bitcoins – is a tempting target for malevolent forces. As far as I know such an attack has not yet occurred, but given enough time and ever more powerful computing resources, I think it’s only a matter of time until it does happen.

Relative Frailties

Although currency notes and precious metal bars and coins can be counterfeited (such as in the recently discovered instances of gold bars filled with tungsten), confidence in the currency or the precious metal is only undermined in proportion to the relative quantity of counterfeit items in circulation, and confidence can be improved by the removal of these counterfeit items, something which occurs on a continual basis.

Bitcoin, by contrast, is vulnerable to a systemic loss of confidence should an attacker successfully bypass bitcoin’s security mechanisms. Instead of destroying confidence in a few currency notes or precious metal bars, a successful attacker could destroy confidence in the entire bitcoin system in one fell swoop.

One of bitcoin’s greatest weaknesses is its dependence on a functioning electrical grid and a functioning internet, not to mention a large group of buyers and sellers willing to participate in the system. If the internet or the electrical system goes down, there is no way to extract the value from virtual bitcoins. By contrast, currency or precious metal coins or bars can be traded without the aid of computers or electricity, and were traded that way for thousands of years until a little more than a century ago. With peak oil and total economic collapse looming, not to mention already endemic criminality throughout our economic and political systems, I’m quite reluctant to park my meager wealth in a place from which I might not be able to get it back out.

Anonymity, one of bitcoin’s strengths, is also one of its weaknesses because it makes it possible for people to manipulate or undermine the asset anonymously. I can’t help but wonder if bitcoin’s exponential rise and subsequent crash a few weeks ago was engineered by governments seeking to protect the monopoly of their sovereign currencies. We may never know the answer because of the anonymous nature of bitcoin transactions.

Few, including me, completely understand how bitcoin works, meaning those who do understand how it works have an advantage over the rest, an advantage they may be tempted to exploit. Our incredibly complex financial system, for instance, gives people who understand how it works an advantage over the rest, an advantage they do exploit for profit. I imagine it’s only a matter of time before clever people apply the same nefarious skills in the virtual currency realm.

The complexity of bitcoin also gives those with superior computing power an advantage, which is why a cottage industry has emerged wherein people rig together networks of extremely powerful GPU processors for the purpose of “mining” new bitcoins. So if massive computing power can be used benignly to mine bitcoins, can massive computing power also be used maliciously to hack the bitcoin system or perhaps spy on it? Pondering the subject of immense computing power, a number of U.S. Government agencies with three-letter acronyms come to mind.

Bitcoin is so complex it raises a number of questions in my mind that I do not know the answers for:

* What happens if one’s computer crashes and the hard disk is wiped out? Does one lose the bitcoins in their electronic wallet? Can the bitcoins be recovered?

* What if one forgets their password? Can their bitcoins be recovered somehow?

* What if one’s computer containing their electronic wallet is stolen?

* What happens to bitcoins that are owned by someone who dies and takes their password with them to the grave?

* If bitcoins are “lost” can the be mined again or do they just vanish from the system?

Answers for all these questions are well established in the case of currencies and precious metals, but seem to be lacking in the case of bitcoin.

Conclusion

Contrary to popular belief, there is no such thing as intrinsic value. The value of everything is determined by human beings and is by no means permanent, although there do exist historical norms such as the value universally ascribed to precious metals. Thus, if humanity universally recognized bitcoins as valuable then my arguments above would be overshadowed by the reality of that mass recognition, but that is not yet the case, nor does it seem to me that bitcoin will ever become more than a faddish asset. For one thing, a lot of people who use currencies or recognize precious metals as valuable don’t even own a computer, the very thing that gives bitcoins any value at all. A lot more people would be leery of entrusting their wealth to a complex algorithm that resides in a nebulous “cloud” somewhere on the internet.

Any store of value has its own pitfalls: currencies can be counterfeited or intentionally debased, precious metals can be faked and bitcoins can be hacked, from within by unscrupulous individuals wielding powerful computing capabilities, and from without by tyrannical governments or others using anonymous market transactions. But bitcoin has a few more disadvantages as well: its dependence on a fully operational electrical and internet grid, the inability to physically hand somebody a bitcoin and bitcoin’s lack of tangible value. Granted, pure fiat currencies lack tangible value too but they are accepted everywhere as payment, and precious metals are universally recognized as valuable, neither of which claims can be made for bitcoin.

Finally, governments will never permit competing currencies to upstage their sovereign currencies. In just the last few months bitcoin suffered an exponential price rise followed by a brutal crash, which I suspect was engineered by governments. The U.S. Government has recently intimated its intention to “regulate” bitcoin as a commodity (as absurd as that sounds since it’s a purely virtual asset), the real intent being to prevent bitcoin from being anything other than a dollar proxy. And a few days ago the U.S. Government shut down a major bitcoin trader for specious reasons reminiscent of the shutdown of Liberty Dollar. The writing on the wall could not be any clearer.