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Bitcoin virtual currency may be worst of both worlds

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After being celebrated by some as the future of money in a digital age, the virtual “peer-to-peer crypto currency” known as Bitcoin has taken some serious hits in the past week or so. Among other things, it has been criticized as a scam — based on economic assumptions that are described as “laughable” — and has come under fire from the U.S. Senate for the ease with which drug dealers and other subversive elements can make use of it. And if all that wasn’t bad enough, a user now says he has lost the equivalent of almost half a million dollars in a Bitcoin theft. The virtual currency could be the worst of both worlds: easy to steal and impossible to trace.

To recap, Bitcoin is an attempt to create a distributed, open-source form of virtual currency that relies not on gold bars in Fort Knox or the monetary policy of a central bank for its value, but on a computerized ecosystem. The project was started by programmer Satoshi Nakamoto (although that may or may not be his real name) in 2009. The Economist described the process quite well in a recent post, as did Stephen Chapman at ZDNet, and there is more information on a wiki devoted to the concept. There’s also a fascinating discussion of the criticisms about Bitcoin in a thread on Hacker News.

In a nutshell, Bitcoin generates currency at a predictable rate (which reduces the chances of an inflationary spiral like those that have occurred in countries with traditional currencies) through a computer-intensive mathematical process known as “Bitcoin mining.” However, since the currency only exists as ones and zeroes in a computer program — not unlike most of the money we use via credit cards, etc. — it can also be stolen by hackers, as one user has claimed that his Bitcoin bank account was.

Bitcoin can’t track the thief or reverse transactions

Although there is no way of knowing for sure whether this report is accurate or not, all transactions involving Bitcoins are public and can be seen through services such as BlockExplorer, and there appears to be a record of a transfer of those funds to a new user. One of the leaders of the Bitcoin movement told Ars Technica that not only is such a theft possible, but the project currently doesn’t have any way of tracking the lost coins or reversing any related transactions — a rather disturbing admission from someone running what amounts to a central bank for a new currency (Ars Technica also has a great backgrounder on Bitcoin).

Meanwhile, a Quora user named Adam Cohen (a developer with SeatGeek) ripped into the idea of Bitcoin recently on the Q & A service, calling it a “ludicrously bad idea” and an outright scam. Cohen said the economic assumptions underpinning the system were “laughable” and ignore hundreds of years of understanding about how currencies work. He added that “fortunately, it’s such an obviously flawed system that it will probably never grow to a point where it causes any ill-effects [sic], or even impact, to world economies.”

No reliable exchange for real currencies

Because of the way the global supply of Bitcoins is artificially limited (it grows at a predictable rate until there are 21 million and then stops), Cohen argues that the entire process is designed to enrich early adopters — many of whom seem to spend a lot of time obsessively checking the value of their Bitcoins on exchanges such as Mt. Gox. Cohen also argues that while there are private exchanges that allow you to convert your Bitcoins into “real” currencies, there’s no guarantee of exchangeability, because there is no central governing body for the payment system.

[B]ecause Bitcoin is completely decentralized, no one is completely invested in the long-term success of the system. No one is literally making the market, saying “no matter what happens, I’ll buy Bitcoins from you at some price”.

Like Cohen, former Cato Institute writer Tim Lee has also argued that Bitcoins represent a bubble that will soon pop. But that’s not the only issue that some have with a completely distributed, unregulated — and theoretically anonymous — system of currency. Not surprisingly, perhaps, a couple of senators aren’t happy with the way such a system can be used to buy and sell drugs and other illegal items over the Internet, something that has also torpedoed previous attempts to set up virtual currencies.

As its defenders point out, it will be difficult for the U.S. government to completely stamp out Bitcoin use, since there is no central repository for the currency and no central authority that can be targeted (there is a FAQ with some responses to popular misconceptions about Bitcoin, including the central authority question). But the combination of negative press about threats from the Senate and untraceable thefts of virtual millions could make it a lot harder for Bitcoin proponents to sign up new users for the fledgling currency. And without users, a currency isn’t much good at all, no matter how cool it sounds.

Post and thumbnail photos courtesy of Flickr users and Quazie Foto

27 Responses to “Bitcoin virtual currency may be worst of both worlds”

  1. the value of a BitCoin

    The biggest differecne between the value of a Bitcoin, or virtual nickel is:
    Outside of the Cult and pyramid scheme of the money for nothing non-asset based day trade, not a single person recognises this as currency.
    NOT ONE, outside of the little clown circus of greed barons being scammed by it.
    Yen fanc doller coinage or euro , recognised outside of the cult, Bitcoin LOL only for the morans.

  2. Silicon Shaman

    So, it’s basically an alpha, or best early beta, of a new form of currency. And people are moaning because it has bugs and not as many features as they’d like?!

  3. Julian

    This article is rubbish! Reader’s comments below explain why.

    “Those who sacrifice liberty for security deserve neither liberty nor security”. B.Franklin.

  4. What is interesting to see with this bitcoin hype is how uneducated writers still are when it comes to the question of what money actually is – especially the assumption that money, e.g. US Dollars, are tied to any real world values like gold is one of these modern fairytales that is repeated often – I can not understand that even after the big corporate crimes (aka as “financial crisis”) that US Citizens cost millions of dollars there is still such a lack of understanding of what money actually is.
    There is no whatsoever connection between “gold bars in Fort Knox” and the green papers in your pockets you call money. US Dollars are just printed 24/7, more and more of them, every day – that is actually one of the reasons US economy will have more and not less problems.
    There is no real value backing your money – except, of course, your house, your garden, your car and your wife that will belong to chinese investors in a not too far away future.
    Maybe then it will be too late to start thinking about what money actually is and how all this stuff works…

  5. None of these “downsides” of Bitcoin seem to be any different from the “downsides” of using fiat currency.

    Also, it’s worth noting that Adam is a developer, not an economist or a numismatist, and we know little about what credentials (if any) he may have.

  6. Ken Simpson

    “Although there is no way of knowing for sure whether this report is accurate or not, all transactions involving Bitcoins are public and can be seen through services such as BlockExplorer, and there appears to be a record of a transfer of those funds to a new user.”

    The Bitcoin “block chain”, containing every transaction that has ever taken place in the Bitcoin system, is downloaded and updated constantly by every participant in the Bitcoin system. I don’t think therefore that it’s accurate to say that, “there is no way of knowing for sure whether this report is accurate”.

    If the Bitcoins were actually stolen, the block chain will show us exactly where those coins have gone, and while over time the coins will fan out to additional recipient addresses, the first hops will provide investigators with valuable information about who stole the coins.

    Anyone who asserts that Bitcoin is untraceable is ignoring that traceability of transactions is a fundamental, absolutely intrinsic aspect of the Bitcoin system, without which it could not exist. In fact, the Bitcoin transaction log is probably the most strongly secured and verified transaction log in the history of mankind, because each step (aka block) in the log has been cryptographically signed using enormous computation that makes it essentially impossible to mess with.

  7. Miodrag S.

    I don’t really see any big difference between fiat currencies and this one, apart centralized nature of state issued ones. You are closing you eyes on present world’s currency – dollar? What is quantitative easing if not arbitrary printing of money? At least at bitcoin, you have a formula to predicts something. Also, I think you are aware that fiat currencies doesn’t have any tangible backing in real assets like gold and silver. All today’s fiat currencies are, essentially, virtual. Trust based.
    I don’t like bitcoin. But, only difference between bitcoin and dollar is that government says about dollar: trust us! We never failed you. It’s ok to use it.
    Stealing is a problem if there is any, but minor one, it could be fixed. It’s purely a technical problem and there are solutions for that.

  8. This piece has all the attributes that nonsense bad journalism suffers from. Faulty appeal to authority, ad hominem attacks, Statism, computer illiteracy, economic illiteracy, unbridled sensationalism hearsay etc.

    You sound just like those ignorant journalists on the Today Show from the 90’s sarcastically opining ‘what is the internet anyway’. In the future, people will look back at this article and the others like it, and you will look like someone who didn’t have any insight, couldn’t see the big picture, glossed over and ignored the facts and who missed it completely. You are exactly like the man who told that Beatles that guitar bands are over.

    There is little or no content in this piece from you directly. All you have done is made a compilation of what other people have said about Bitcoin, with hyperlink attributions and a clear bias towards articles that are arguing (very badly I might add) against Bitcoin.

    I suppose this is just about all we can expect from someone who thinks that its important that, “…16 of the 22 Bruins are Canadian — so the most Canadian team won” whilst we are in the middle of the greatest depression ever, wares are starting all over the place, the Federal Reserve is destroying the dollar, more people are on food stamps than ever before…

    You get the picture. Oops, no, sorry, you don’t, which is why you wrote this drivel.

    Go back to sleep Ingram.

  9. Prakash

    The writer didn’t understand that two sentences in this article right after one another, contradict each other.

    “The system is setup as to reward early adopters”
    “Because Bitcoin is completely decentralized, no one is completely invested in the long-term success of the system”

    The early adopters are not rewarded with usable cash or wealth. They are rewarded with BITCOINS, nothing more and nothing less. These bitcoins maintain value if and only if there is a community around them, using them. The early adopters are the ones with the maximum incentive to keep bitcoins valueable, developing the community and clients.

    This makes the bitcoin community structure more similar to that of a startup than a pyramid scheme. It might be the first structure of this kind in the world, melting together aspects of startups and open source. It might be a one-off, It might be a new way of doing things. The point is nobody knows as of now.

    Criticism is good for strengthening bitcoin, but please concentrate on valid criticisms.

    • Thanks for the comment, Prakash — that’s a fair point. I think what Adam Cohen was driving at is that if you are not an early adopter, the value of investing time and effort in Bitcoins decreases, since the supply is limited.

      • Lucian Armasu

        Eventually yes, but for now there is still tremendous potential. I think someone did the math that if Bitcoin were to replace all the currencies, 1 BTC would be valued at $3.3 million. Even if it only rises to 10%, or 1% of that, you can see why Bitcoin has a LOT of room to grow in value, and if you believe in its future, even $30 per bitcoin is very cheap.

        But I do believe Bitcoin’s value should rise somewhat proportional with the Bitcoin economy behind it.

  10. It’s the best of both worlds. Bitcoin is the perfect reserve currency.

    The problem is people are using their bitcoin wallet like their internet banking account, when it’s more like cash.

    The bitcoin private keys should be encrypted and in a vault at a bank, or on a USB in a person’s home safe. It should not on the computer connected to the net.

  11. jostmey

    What!? This is the worlds first real “Digital Currency”. It is fundamentally superior to using a credit card online, which is essentially giving out the key to your bank account. Bitcoins solve the problem of “How can I give you five dollars online.” You can’t do that with your credit card – not easily.

    The bitcoin community is starting to explode. The value of the currency is rising rapidly (a little too rapidly for comfort) and every type of goods or service is available for purchase. You can gauge just how much merchandise exists in the community by looking at sites that aggregate merchandise from multiple sources, like searchbitcoin or bitucopia.

    Bitcoins are scary because even if it fails as a currency, it will redefine how money works.

      • No One Of Consequence

        And LamePal will allow the person to take those 5 dollars right back after they file a complaint. Even when services are delivered as promised. All the while you are charged hideous fees. I’ll take Bitcoins over LamePal any day of the week.

  12. This argument is void of merit. The same characteristics that Bitcoin are criticized for are inherent in other currencies that are in use today. Large cash transactions are just as risky as leaving a digital wallet on an unsecured computer. If the money is gone, good luck tracing it. I think the moral of the story is keep small amounts of money in the spending accounts and larger amounts in accounts that are less accessible, like private banking accounts that are FDIC members.

    Likewise, if the senate was truly concerned about currencies that enable black market transactions, wouldn’t they be attempting to phase out paper, coin and all non-electronic currencies? There is absolutely no currency that is protected from debasement. Each currency set depends on value contributing citizens to establish it’s value. It depends on the value network it opens up for you. If it so happens that the best and brightest begin utilizing Bitcoins in their interest of growing their share of the currency they believe in, it is likely that the use of the now disadvantaged currencies will be thwarted with extra fees, similar to the $0.35 cent fee we see because of merchant services.

    The statement of lacking markets is just plain untrue:

    The transactions are pushing $1.5 million US dollars on one exchange and it is growing quickly. You can trade Bitcoins directly for cash or many other goods/services/currencies.

    With that said, Bitcoins isn’t perfect, but it is a step in the right direction. The purpose of currency is to transact value more freely. Implementing this in an open source and completely transparent system does many things. It enables sub economies to take place. For example, given the open source implementation with no central management, anyone is free to implement a sub-currency which implements the critical attributes, but with new dynamics and functional properties. This will allow currency prototyping to take place and enable rapid innovation in smaller, less weighty economic systems. Anyone who says this is a completely baseless idea may find themselves sorely mistaken.

    Is this idea not more aligned with efficient economic theory and the backbone of the laws that our forefathers built our country upon? Does it not grant more liberty and privacy to citizens? Does it not persist what we know to be the best economic theory in very open, transparent and adaptable ways? Does it not enable a test bed for economic theories?

    • I’ve read the thread on Hacker News as well, Michael — he didn’t retract much of what he said. He said that he regretted using the word “scam” because it implied that people were deliberately trying to defraud others.