Random Thoughts – Randosity!

Bitcoin: Scam or Currency?

Posted in banking, botch, business by commorancy on January 12, 2013

Note, if you’re not really into philosophical discussions about economics, money and technology, this is probably not the post you’re looking for.  Also, if you’re looking for technical details on exactly how Bitcoin is implemented, I suggest you seek your research elsewhere.

[Update for 3/1/2014] — Mt. Gox files for Bankruptcy

Mt. Gox, a bitcoin exchange located in Japan, has filed for bankruptcy stating the loss of around 744,000 bitcoins from its exchange wallet. More info in this Reuters article. How this loss occurred is up for speculation. Mt. Gox claims its loss stems from a known flaw in the Bitcoin protocol. Bitcoin protocol advocates claim the wallet that Mt. Gox used was designed so that it exacerbated the known but usually rarely occurring flaw, which ultimately led to the massive loss of the Bitcoin from Mt. Gox exchange. Because of the massive amount of debt incurred as a result of its loss (among other debts), the exchange has ceased operations and anyone who had Bitcoin (or any other currency) deposited there may be out of luck.

What this says is that is several things. The Achilles heel of Bitcoin is its decentralization and the lack of properly protected wallet systems. The fact that there is no authority to advocate for depositors when companies like Mt. Gox go bankrupt leaves Bitcoin in a majorly problematic state. This situation also advocates for using personal wallets stored locally over using third party companies where situations like Mt. Gox can arise.

Because of the decentralized currency, there is no one to turn to when your Bitcoin goes missing from a large privately run exchange. Situations like Mt. Gox are exactly the type of setbacks that prevent Bitcoin from really becoming a solid workable useful currency.

If you had Bitcoin deposited in Mt. Gox, I’d like to hear your experience. Please leave a comment below describing your experiences with Mt. Gox or any other exchanges.

Disclaimer

This article is written with the sole intent to discuss whether Bitcoin can succeed as a currency at all or whether it’s a scam.  This article is not here to discuss the technical merits of Bitcoin, how a Bitcoin is specifically implemented technically or whether those technical details are a valid.  Once again, this article is here to discuss if a Bitcoin has any value in the marketplace or is merely a scam.

If you really want to know how Bitcoin is implemented, there are many many technical white papers that discuss this in great detail and that are available from the below mentioned Wikipedia article and through Google searching.  This article’s author leaves it up to the reader to do the technical research on the Bitcoin implementation details if you are interested.  If you’re looking for that level of detail, you’re not going to find it here.

What is Bitcoin?

Bitcoin alleges itself to be a, more or less, a digital / electronic currency that uses decentralized electronic ‘banking’ techniques involving digital signatures to validate each coin and approve transactions (to validate authenticity of said coin).  As Wikipedia states about Bitcoin,

Bitcoin (abbrvBTC) is a decentralized digital currency based on the open source protocol created by a pseudonymous developer named Satoshi Nakamoto.[1] It is subdivided into 100-million smaller units called satoshis.

This technical implementation was designed to solve the problem of exact digital copies when in the digital form. Therefore, the way each Bitcoin is created means that it is unique, individual and can’t be double spent by the same person.  So, when you own a Bitcoin, only you owns that unique coin and no one else (until you spend it).

Want more details? Follow the Wikipedia link on Bitcoin or search Google.

What is a currency?

Bear with me as some of this may seem very simplistic, but we need to start simple and at the beginning to understand the issues involving Bitcoin. Currency is, simply, any object or thing that takes on a given value.  More specifically, it becomes a currency when many of these objects are mass produced that all look and feel identical.  For most currencies, we equate the value with these tangible objects by ‘size’ or ‘denomination’ of the object.  Most of the currencies in play today work with two types of duplicated objects: paper ‘bills’ and flat metal cylinders called ‘coins’.  These are tangible physical duplicated but unique objects. The denomination is then a specifier of that specific duplicated object.  In the US, the currency is named ‘dollar’.  But, it could be just as easily named ‘fred’ or ‘mxyzptlk’ (except that that word is probably trademarked by DC comics).  So, as in the US Dollar, it’s a piece of paper marked with the number 1 and the words ‘one dollar’ or a coin struck and marked with the words ‘one dollar’.   These unique objects are then the basis of a piece of currency or ‘money’. So, while these are the fundamentals to begin a currency, it doesn’t establish it as valid currency until other criteria have been met.

Simply striking out objects labeled with this information doesn’t make it become currency.  For example, you can mint any coin you like, but the simple act of minting a coin doesn’t make it worth money.  After all, you can go buy child’s play money or grab some of Hasbro’s Monopoly game ‘money’, but these are mere pieces of paper with ink and hold no value in a currency market.  For casinos, they have chips and metal coins, but again these hold no value until exchanged within the casino back to US Dollars (or whatever currency that that casino provides).  For example, while a casino will accept their own tokens and coins to play their games, these tokens and coins hold no value outside of the casino (except in the case as a collectible or because of they contain rare earth metals as discussed below).

So, what makes a currency become legitimate legal tender? 

Basically, it requires an ‘authority’ to decree that the currency exists, issue the currency and usually a government to back the currency.  By ‘backing’, I don’t mean that there’s something tangible backing up the currency (like gold or land), I mean that the government has a gun-wielding military force at its disposal.  Having such force at someone’s disposal gives that someone power.  With power comes the ability to enforce rules.  And then, rules establish policy, policy establishes currency, currency establishes an economy along with such things as capitalism and that establishes the ability to buy and sell things.  Keep in mind that buying and selling will happen with or without currency.  It’s just that currency makes it easier and more standardized.  So, instead of having to hand over a  bushel of apples in trade for a bail of hay for your horse (i.e., random bartering), you can hand over 25 dollars instead.  And because many people have all handed over around 25 dollars for a bail of hay, that establishes that a bail of hay is ‘worth’ around 25 dollars.  That also establishes at once, the value of 25 dollars and the value of a bail of hay.  It doesn’t necessarily establish the value of a bushel of apples until the apples are ‘sold’ multiple times at or close to a certain price.

That means people have to ‘buy into’ that that piece of currency paper (or coin) has a ‘value’ and that that ‘value’ is established by the words printed on it, along with the issuing body’s ability to enforce that this piece of paper is now considered ‘legal tender’.   That value is then further established by how much it can buy.  Remember that policy establishes what is ‘legal’ and the power to enforce that policy is what puts the power behind that piece of paper which is then considered ‘legal tender’.  The government and the issuing body (not necessarily the same thing) lend legitimacy to the currency by power, policy and the ability to enforce policy.  Note that tangible currency created by decree and enforced by power is called ‘fiat currency’.

Of course, ‘the people’ have to allow that government to wield the power.  The reason the people give the government power is in exchange for protections. So, in exchange for allowing the government to remain in power, the government will provide protections for the people in the form of such things as a police force, a fire department, a military and some types of health services.  Of course, these protections aren’t without costs (i.e., read taxes or payments using, of course, the decreed currency).  But, the protections are established by the government.

One additional thing is that not only does the government and the issuing body have to recognize the currency as valid, but so do other worldly governmental bodies.  So, a currency must be recognized as valid by other governments to be useful in those other locales. It’s not an absolute requirement, but unless other governmental bodies recognize the currency as valid, it cannot be used in exchange for other currencies.  Without being recognized by other countries, this then makes it hard to, for example, buy things from other countries with our currency. Once recognized, however, the currency can then be exchanged to other forms of currency around the world and purchases can be made.  And with that, foreign currency exchange is born, which is a much more lengthy discussion than is required here.

The bottom line is that ‘the people’ give their trust to the government to both decree and ‘back’ the currency as valid.  So then we all have to agree that the ‘dollar’ has value, what that value is and how much it will ‘buy’.

Digital vs Real World currency

Bitcoin does not have a governmental power behind it.  It does not have a governmental sanctioned entity issuing the currency.  It is not recognized by any governmental force as a legitimate or legal currency.  It was developed by a technical engineer with an open standard protocol and is backed by nothing other than a relatively strong encryption algorithm and a set of established exchanges (where to buy Bitcoin).  So, as long as the encryption algorithm cannot be cracked, each issued Bitcoin is a unique and individual entity.  If it ever is cracked, the whole Bitcoin system falls apart.

Let’s compare the difference between a tangible ‘dollar’ and a Bitcoin.  A tangible dollar is a physical unique piece of fiat currency.  That is, it’s a tangible thing you can put in your pocket, it has a unique serial number (at least the bills have these) and are so stamped by the issuing authority. Ignoring for the moment that these tangible ‘dollars’ can be reproduced (read counterfeit) by unauthorized entities, each ‘dollar’ is its own unique entity.  Counterfeit bills are usually identifiable because the ‘original’ issuer uses anti-counterfeit techniques that establish parts of the bill which cannot be duplicate easily.  However, counterfeiting is a problem with any currency.  Or, at least, in real world currency.  That’s why bills and coins are redesigned periodically.

So, when you have ten tangible dollars, they are real physical bills.  In a digital world, these rules can’t apply.  In a digital world, it’s all 1’s and 0’s.  These can be duplicated infinitely and freely without knowing that that digital file was ever duplicated.  So, for example, attaching and emailing a photo of your dog to your friend makes a copy of that photo.  And that photo is the exact same as the photo on your computer and the exact same as the one you posted on Flickr.

With a digital currency, this is a problem.  Enter Bitcoin.

Why Bitcoin?

Bitcoin creates each coin uniquely through a computer algorithm that generates guaranteed unique coin entities and to prevent counterfeiting.  So, each Bitcoin represents one unique digital coin that stands on its own.  Each coin was created by an issuing authority using that algorithm and each coin is then registered in a decentralized database of outstanding coins.  So, whenever you spend that unique Bitcoin, the decentralized database will log that coin’s ‘transaction’.  However, like any currency, the transaction does not need to be recorded. In reality, to verify the legitimacy of any digital Bitcoin(s) when spent, it should be cleared with one of the transaction databases.  Otherwise, you risk that it may be counterfeit or double spent.  Because the coin was created using a basically un-crackable bitsize combined with each being unique and because each coin is officially registered with the decentralized transaction registry, that coin in theory can only be spent once per transaction.  So, even if you manage to copy the coin and attempt to give it away to someone else, it’s still only one coin no matter who owns or spends it.  In other words, duplicating the coin file into multiple files still only yields one coin to spend.  So, duplicating the coin’s file does not duplicate the number of coins that it is.  It’s still only one coin and is valued at whatever one coin is worth.  If you give away a copy of the coin to someone else, you’ve effectively just given them one Bitcoin and you’ve lost it.  Or, you will have lost it if they spend it first.  Again, if you want exacting details on how all of this is implemented technically, please read the Bitcoin Whitepaper.

Suffice it to say that the coins are allegedly unique and the transaction service prevents double spending.  So, it effectively makes it useable currency in the sense that each coin is unique like paper money.  Which, of course, is the sole goal of the whole technical implementation.. to mimick real world money in a digital way.

Before I get into the spending of Bitcoins, let’s step back and ask, “What legitimizes this currency?”  The answer is, not much.  The ‘currency’ is not yet recognized by any governments that I know of.  Therefore, it is not listed on exchanges with the dollar.  In other words, to exchange any other currency, such as the dollar for Bitcoin, you have to go to a Bitcoin exchange.  Bitcoins are not openly exchanged at regular exchanges.  So, you’re handing over dollars (or other legal tender) to a Bitcoin controlled exchange in trade for Bitcoins.

Think of this like going to a casino.  To get a chip to use in the casino, you have to go to that casino’s cashier and exchange your dollars for casino chips.  Therefore, you’re at the mercy of that casino to 1) remain in business while you play and 2) to retain the value of the chips while you’re playing.  So, if the casino goes out of business and kicks you out of the casino with chips in hand, those chips are worthless.  If the casino refuses to exchange the chips back to dollars, again, they are worthless.  If the casino decides that a ‘one dollar’ chip is now worth ‘one cent’, again, you’re at the mercy of the casino.  This is effectively Bitcoin.

Scam? You decide!

So, this is the place where some people see Bitcoins as a scam.  If you don’t personally recognize the currency as legitimate yourself, then you will only ever see it as a scam.  The fact that you have to go to a Bitcoin controlled exchange (regardless of being ‘decentralized’, read peer-to-peer) to change dollars (or any other currency) to Bitcoins is suspect.  Let’s get to the heart of the matter.  Exchanging real money for Bitcoin may simply make the originators of Bitcoin rich with ‘legal tender’ at the expense of people buying into the ‘Bitcoin’ idea as currency, but in reality is destined to fail and become worthless digital files. Where do those dollars go when handed over to that exchange?  How is the exchange rate determined?  These are all questions not easily answered.  Oh, I’m sure the people running the Bitcoin exchange will come up with some colorful answers, but the reality is that who really knows?  Unless Bitcoins become traded at a national exchange level and through exchanges not controlled by Bitcoin exclusive exchanges, then we really don’t fully know where the dollars or euros or whatever went after becoming Bitcoins.  Of course, the flip side of this is that you effectively ‘bought’ Bitcoins with your ‘real’ currency.  By purchasing a Bitcoin, that comes to another issue regarding collectibility, but that’s discussed below.

So, on the one hand you have legal tender which is established, recognized and sanctioned that you can really spend for real world items. You are taking that money and exchanging it for Bitcoin which has extremely limited uses cases, limited spend venues, questionable exchange rates, limited denominations coupled with low supply, no governmental backing, not being recognized by governments and other authorities and the high probability that it will be used for less than legitimate purposes, and this is presently what Bitcoin is.  Looking at all of this coupled with giving some random entity real money in exchange for ‘Bitcoin’ can be easily seen as a highly speculative scam.  It has a high probability to be or become a scam and, at the same time, make someone (or a few someones) very rich with real legal tender in the process… possibly your supplied legal tender funding violence or other unsavory uses.

On the other hand, you have a possible new digital currency that could succeed if it gains enough traction in various marketplaces.  However, the risk vs reward for Bitcoin is clearly too high for real currency use.  So, that leaves speculation and collectability almost the entire reason to buy into the idea of Bitcoin, if that’s a reason at all.

Ignoring the fact that each coin is unique and can’t be easily counterfeit, you have to consider what things you can currently buy with Bitcoins.  Since it’s not recognized as legal tender or even valid currency other than in very limited uses and by limited ‘businesses’, this currency is ripe for scam artists.  That means, legitimate businesses (especially banking) shy away from things that are not considered ‘legal’ or that reside in the fringe of ‘legality’. Any such legitimate businesses will opt for ‘legal tender’, such as the US Dollar.  So, adoption by legitimate business is a huge hurdle for Bitcoin.  Especially in the banking sector.

In addition, because Bitcoins are now being considered as the standard for online gambling uses (to thwart restrictions on the US dollar in online gambling), this further reduces the legitimacy of this ‘currency’.  That is, you can’t run to your local supermarket and buy a loaf of bread with a Bitcoin, but you can place an online poker bet with it.  You can’t run to your local car dealership and buy a new car with Bitcoin, but you likely can buy some drugs with it.  You can’t buy school supplies with your Bitcoin, but you probably can buy a handgun with it in an underground market.  This doesn’t spell good things for Bitcoin’s success or legitimacy as a currency. Because online gambling is one of the biggest scams out there right now, this use case doesn’t make Bitcoin look better.  Considering that most of the online casinos reside outside the US, US laws don’t apply to wagers made at those casinos.  So, even if you win big, there’s no protection from simply losing all of your Bitcoin when they choose not to give you your winnings (the most likely outcome) or the exchange rate has changed so much as to have lost any gains you may have won.  When you invest in Bitcoin to use at a casino, you’re effectively gambling twice: Once at the casino with your wager and again when you go to exchange your Bitcoin back to legal tender.

The fact that you were using Bitcoin, which have few protections anyway and which is then used to place a bet at an online casino leaves you ripe for losing everything you’ve given to the casino.  Meaning, you’ve lost your dollars to the exchange and you’ve lost your Bitcoins to the scam casino who’s just bilked you.  If you do manage to get anything out of the casino, you have to try your luck at the exchange and hope you can get legal tender back out at any kind of a decent rate.

Is Bitcoin Legitimate Currency?

None of these uses cases, no matter how technically well designed that this currency is, validates or legitimizes Bitcoin as a useful or legal currency.  Sure, it might be able to protect you from counterfeiting, but it will never protect you from being scammed.  And, if you are scammed, there is no one you can turn to to get your Bitcoin back, let alone get your US dollars back.  With the US Dollar, you can turn to your bank or your police both.  If you know who the other party is, you can sue.  With Bitcoin, all that is likely off the table.  In the  digital wild west, there’s no Sheriff in town here.  So, you lose your Bitcoins and they’re gone.  Neither the cops, nor the feds nor the banks will help as Bitcoin is not recognized as legal tender.  And, this is one of many hurdles involving the use of Bitcoin.

Of course, you might be able to sue the exchange where you gave your dollars for Bitcoin, but if there is a transaction record that can be produced that proves you were handed Bitcoin, then any lawsuits will be fruitless.  If you exchange money for any other good or service (digital or otherwise) and delivery can be proven through a transaction record, there is really nothing that can be done there legally.  That you gambled with your Bitcoin and lost is your problem.

Worse, what of the exchanges?  How are they managed or audited?  Who runs them?  Are they even audited?  In this case, who watches the watcher?  I’ve read a rather disturbing blog article at Nerdr.com about how at least one of the Bitcoin exchanges is manually altering the Bitcoin price to their own whim.  So, what does that say of the other exchanges?

Collectible Commodity vs Currency

Bitcoin faces another serious adoption problem: supply.  Built into the algorithm at the decentralized exchange is managing how much Bitcoin is in circulation at any one time.  So, if you want to obtain Bitcoins, you probably can’t get them from an Exchange until they are issuing new Bitcoin.  And since new Bitcoin isn’t issue often, that leaves you to find someone with Bitcoin willing to sell it to you outside of the exchange and likely at collectible prices (which brings up collectibility of Bitcoin). If you do manage to get it, you’re likely to pay the ‘collectible’ price for the Bitcoin.  Basically, as of this writing, $10-15 might get you one Bitcoin assuming you can even find someone willing to sell you coin.  And, that’s the problem, supply.

For a currency to succeed, it has to remain liquid.  That is, there has to be enough currency in circulation all of the time that people can get it when they need it.  If it cannot be obtained, it cannot be used as a currency.  Which then comes to the difference between Bitcoin being a collectible commodity and being currency.  Clearly, even the US Dollar has numismatists (or currency collectors).  And, here’s the problem.  Collectible value markets operate outside of the currency market.  So, for example, the face value of a one dollar bill is one dollar.  But, to a collector looking for specific markers, that ‘one dollar’ bill might be worth 1000 dollars as a collectible.  As collectors pull money out of circulation marked as a collectible commodity, it removes that liquid currency from the market and, thus, it cannot be spent as its face value.  This means that the issuing body has to make up for the currency pulled out of circulation as a collectible and replace that currency with new liquid currency.

Bitcoin faces this exact problem.  Speculation collectors are holding onto their Bitcoin as a collectible, not as currency.  They are speculating that the collectible value of the currency will rise and they will be able to sell it to another collector at a much higher value than the monetary face value of the Bitcoin.  Worse, because Bitcoin doesn’t have stamped monetary denominations, it makes it all the worse at determining the face value of a single Bitcoin, let alone the collectible value of it.

Basically, the speculative collectors are hording the Bitcoin as a commodity and preventing it from becoming and remaining liquid currency.  So, each time an exchange releases more Bitcoin into the wild, it’s immediately snapped up by collectors rather than going into liquid motion to be spent.  Speculative collectors are the biggest problem that Bitcoin faces today.  As there’s so little currency in motion, it really cannot be used as a currency.  So, it’s really become a collectible item for people to hold onto and not spend.  In fact, there’s so much more incentive to hold onto Bitcoin than spend it, it’s basically paralyzed as a currency.

Bitcoin’s future

The Bitcoin designer was so focused on making sure that Bitcoin was secure and, at the same time, scarce that he/she probably didn’t realize it would become paralyzed by speculative collectors.  The reality of low supply of anything only breeds one thing, collectors.  Collectors do not spend or trade.  They collect and hold with the intention of selling at a much much higher price much later.  The only way out of this paralysis is to release so much more Bitcoin into the wild that the collectors have no incentive to hold it any longer.  And this is exactly what Bitcoin must do to succeed as a currency.  This is also exactly what the US Treasury does to avoid the same paralysis of money movement with the dollar.  Note that the release of new Bitcoin has to be so much that it’s impossible for any one collector to afford to horde.  While it may ruin the market for collectibility of Bitcoin (and also kill any paper profits that collectors may perceive they have) and also lower the value of Bitcoin, it will force Bitcoin to become liquid again.  Until this happens, Bitcoin will never become a liquid currency that can be used for anything more than speculation and the occasional wager, assuming you can even find Bitcoin to buy or spend.

Personally, I wouldn’t invest in Bitcoin other than as a collectible at this point and even that is questionable due to the volatility of that market. Bitcoin has no real uses as a currency, other than perhaps at offshore casinos and other mostly unsavory purposes.  Even then, it may not protect you from the IRS or US authorities (if in the US) when you win at a casino.  Right now, it’s more or less a novelty investment and even then there are better investment vehicles that offer safer and higher returns.

Demise of the Bitcoin?

There is one other thing that could potentially destroy Bitcoin.  If the US Government (or any government) were to take the idea of Bitcoin and implement something similar (and easier) as a national digital currency sanctioned and issued by the Treasury department, this would likely destroy Bitcoin’s main objective, to become the defacto digital currency.  The one thing that a US digital coin cannot destroy in Bitcoin, however, is the anonymous nature of the currency, that Bitcoin is not issued by a government (it is outside of government control) and the peer-to-peer decentralized nature of it.  In the end, those pieces probably don’t really matter.  That the new digital currency works, that it is usable, that it can buy milk and eggs and pay rent, that’s what’s important.  Were the US to legitimize its own digital currency, businesses would adopt this en-masse and people and businesses wouldn’t look twice at Bitcoin thereafter.  A US digital coin would become the defacto standard for digital currency, at least in the US.  Bitcoin would then, as it is now, be relegated to a digital underground currency used for purchases where government sanctioned money cannot be used without penalties.

It’s just a matter of time before the US Treasury department wakes up.  As the saying goes, “Fight fire with fire”.  Creating a national digital currency solves a lot of problems.  It reduces the amount of paper and metal that it must mint saving money buying the supplies for the production of tangible money, it ushers in an even more solid digital economy and it gets rid of Bitcoin all at the same time.

19 Responses

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  1. Brian said, on March 24, 2013 at 4:57 am

    Exceptionally well thought out. I feel enlightened.

  2. karim said, on March 14, 2013 at 9:49 am

    commorancy – you are stating that someone out there could be able to breach bitcoins encryption proticol. If so then they would be able to breach banks, hack email, pretty much be able to do what ever they want. Why would they bother with bitcoins?

    Furthermore to quote you, “The problem is, when there’s real monetary incentive not to disclose a found exploit, you’re then at the mercy of the people whom you ask to audit the code to be honest about what they find. This is why having several independent third party auditing firms working in concert auditing the code (and each other) would be the best (and only) way to ensure that any exploits found are fully disclosed.”

    This is why bitcoin is open source and audited by absolutely anyone who decides to read the code. I have never been given the opportunity to read the source code for the software my bank uses. Although my bank didn’t use a software glitch to scam me, they used their central power and authority to scam me and my family out of everything we owned. Not just once but a few times. Also open source and free tend to go hand in hand. I’d trust an open source programmer who donates his time and energy to the good of the people as opposed to corrupt bankers who fly around in private jets using tax payers money via bail outs. If you truly understood the scope of the problem you would be disconscerned to know that imperfect, non backed bitcoin is pretty much the best we have going for us. If governments weren’t so currupt then the average person would be quite wealthy. Think about it, how many people work 9-5 for most of their lives yet get no where. People are being royally scammed by their government and don’t even realise it. In your lifetime 99% of income is lost to taxes, inflation ect.

    All the points you have made do not apply to bitcoin. They apply to fiat currency. The government has the ability to print currency, THIS IS FRAUD. Everything you have said about bitcoin is inaccurate and actually applies to fiat. The issues you have pointed out apply to ALL currencies and Bitcoin is revolutionary in the fact that it solves many of these age old problems.

    • commorancy said, on March 16, 2013 at 8:26 am

      No, actually I’m not claiming that someone could ‘breach’ bitcoin’s encryption protocol. It’s even more fundamental than that. I’m claiming that someone could hack, alter or modify the mining code itself to produce as much bitcoin as they need. That doesn’t necessarily require any knowledge of encryption. In fact, this may have already been done. Note that hacking the mining protocol doesn’t require hacking the encryption of the coin itself.

      I agree that bitcoin is not a fiat currency because to become ‘fiat currency’ it requires governmental backing by laws. Clearly, bitcoin has no governmental backing or sponsorship that we know of. In fact, lets go one step further and realize that bitcoin is not a currency at all. If it cannot be spent in any meaningful way and there’s not enough of it in circulation to become liquid, then it cannot be a currency. What it currently is is a collectible. And, a collectible’s value is only as good as what another collector else will pay for it. Right now, that seems to be in the neighborhood of around $10-15 per bitcoin, assuming you can even get one. Of course, you can mine them yourself.

      As for hacking banks, that’s already happening. It’s called phishing attacks and they’ve been going on for years. So then, you get phished and you supply your bank credentials right to hackers who, in turn, log into your bank account and transfer all your money out. Corruption is not limited to government and politicians. If you believe that some random open source developer is in it solely to ‘help out the world’, you’re quite mistaken. Many open source developers do contribute to open source applications because they like doing so. In most cases, these are noble contributions when money is not involved. However, when real money comes into play, I can guarantee you that people understand this fact very clearly and not-so-savory people will join the ranks of the ‘open source’ developers looking for a quick payday. Some may actually succeed, we may just not ever know about it.

      Idealistically, I understand what bitcoin is trying to do and on a very base level I even agree with that ideal to a degree. Realistically, the world is fundamentally a different place. As the cliche goes, ‘Money is the root of all evil’, and rightly so. Money is something that has clearly long outlasted its stay in this world. The world doesn’t need money at all to make the world work. However, governments _need_ money to control the population. People don’t need money other than to placate their governments and ‘free enterprise’. People need food, clothing and necessities and we need to obtain it in a sane and rational manner. Currency offers that mechanism, but it also serves humanity’s lust for greed and power. There are other ways to make the world work besides handing over a printed piece of paper or a digital coin. We only continue this farce because that’s how humanity has been conditioned. We need to wake up and realize that money is not needed in this world for humanity to survive. Money really only serves one thing, to feed the greed and power. This always leads to those who have and those who have not. Other than to solve a way to exchange for goods and services, greed and power are really the only things that money has contributed to humanity.

  3. Beef said, on March 13, 2013 at 2:20 pm

    Excellent overview. I would only add that the greatest question of all is what kind of work generates the bitcoin. Yes, it’s called mining but not the one with pikes and shovels. And no, bitcoins will not pay for the electricity consumed by computers to do the “mining”.

    • commorancy said, on March 17, 2013 at 2:38 am

      Hi Beef,

      According to this What is mining actually doing Reddit post, mining solves two problems simultaneously for Bitcoin.

      1) The act of mining is actually ‘doing the books’. Basically, it keeps track of which Bitcoin transactions happen by using a distributed computing model like Seti@Home. So, each miner is actually calculating part of the general ledger and validating transactions.
      2) As incentive for tying your computer up doing this work, periodically if the stars line up correctly (or more specifically, the right number of leading zeros line up in the hash being computed.. and the nodes in the distributed computing model agree) you will be issued some fractional amount of a bitcoin. When the fractions add up to 1 bitcoin, you’ll be issued that bitcoin. This piece solves the problem of introducing more bitcoin into the pool.

      Basically, the reason for mining is to keep the bitcoin ledger accurate on what coin was spent where and by whom and, thus, supposedly prevent double spending. The reality is, the first spent transaction to make it through with a given coin ID is the winner even if it was not the person who was the rightful owner of that coin. Thus this prevents double spending, but it does not prevent theft. It also solves how to get more bitcoin into circulation. Adding more bitcoin into circulation through mining doesn’t really allow for introduction of coin in high enough numbers to keep the currency liquid. So, by relying on an algorithm that appears to release coin very slowly, it’s clear that it doesn’t introduce coin fast enough to allow bitcoin to actually become a true currency.

  4. Juán D. said, on January 13, 2013 at 3:27 am

    Hi Chris,

    I live in Venezuela and have discovered BitCoin 3 months ago. In my first try to use MtGox they stole my 40 BitCoins that I have deposited with them. I no long use BitCoin for anything because Bitcoin/MtGox is a devil scam.

    After this event, I have started a private investigation on MtGox. If you need the information that I have found to make a new article… maybe you will like it… it is dirt – there are everything… including bank wire fraud using Hong Kong Banks and much more. I will give it to you for free with satisfaction.

    Thanks for the great article.

  5. Chris Wilmer said, on January 13, 2013 at 1:58 am

    Great post. I think there’s one misunderstanding here though. Bitcoin exchanges are not operated by the people who developed Bitcoin. Anyone can run an exchange. Also, the exchange operators don’t take the US dollars, as your post implies. The other users of the exchange sell the bitcoins they own for USD. The exchange rate is just determined by the collective preferences of all of the users of the exchange.

    • commorancy said, on January 13, 2013 at 2:11 am

      Hi Chris,

      Actually, the exchanges had to start somewhere when the protocol was designed. It also takes legal tender (not Bitcoin) to run computers within datacenters including the servers tasked to run these Bitcoin exchanges. Can you guarantee who underwrites the payments for these exchange servers at these datacenters especially in the months when there’s no Bitcoin to exchange? As a result, the legal tender that is collected during the exchange from dollar to Bitcoin is then very likely split out to whomever is underwriting these payments along with other uses.

      As for the exchange rate, I won’t get into those discussions about the ‘collective’ as these tend not to be who you really think it is. Until or unless these are regulated and audited by outside third parties, nothing can be truly guaranteed. It can be stated how it is, but unless a certified auditing firm has audited every exchange for compliance, there’s no real way to know.

      Thanks.

    • commorancy said, on January 13, 2013 at 2:36 am

      Chris writes: “Also, the exchange operators don’t take the US dollars, as your post implies. The other users of the exchange sell the bitcoins they own for USD.”

      I wanted to take the time to discuss this piece separately. There are two types of Bitcoin. Those that already exist and are owned by owners and those coins that don’t yet exist. Those that already exist and that are owned by people already are like the dollar I have in my wallet. I can ‘sell’ that dollar to you at any price I choose. If you choose not to pay a higher price for that dollar, that’s your choice. That’s person to person commodity exchange. These are speculators holding existing bitcoin currency to sell themselves. But, we all know the federal reserve mints new currency regularly.

      Like the Federal Reserve, keep in mind that those existing Bitcoins had to come from somewhere and/or someone and were generated and sold at some point by an exchange (or a person who owns the algorithm to create more) for the first time. Which means that this creation mechanism is going to be tightly controlled by someone or the exchanges.

      While existing Bitcoin is being bought and sold by individuals, what about newly minted Bitcoin? Is it sold by the person or entity who ‘minted’ it or by the exchange where that newly ‘minted’ Bitcoin was was released?

      So, your argument that exchanges solely deal in ‘existing’ Bitcoin is a bit flawed. New Bitcoin has to be released and sold from somewhere or by someone. That someone who is releasing new Bitcoin is clearly making huge bank on that legal tender exchange as that is literally creating something from nothing. Those who hold existing Bitcoin, they’re not making so much. So, even if the exchanges aren’t the party releasing ‘new’ Bitcoin, whomever or whatever is creating new Bitcoin is making serious bank the first time it sells.

      Thanks.

      • Chris Wilmer said, on January 13, 2013 at 2:43 am

        Commorancy writes: “So, even if the exchanges aren’t the party releasing ‘new’ bitcoin, whomever or whatever is creating new Bitcoin is making serious bank the first time it sells.”

        Anyone can mint new bitcoins. It just requires downloading some open source software and running it. So, it’s true that whoever mints bitcoins can potentially “make serious bank” as you say, but anyone can do it. It is worth noting, however, that it requires a lot of electric power to mint a bitcoin (your computer has to run for a long time), and current estimates indicate that people minting new bitcoins today are doing it at a loss (http://blockchain.info/charts/miners-operating-profit-margin).

        • commorancy said, on January 13, 2013 at 2:55 am

          Hi Chris,

          Your statement makes one critically flawed assumption. That the original protocol author(s) didn’t create a backdoor for Bitcoin creation at will. The mining protocol is clearly documented, but relies on ‘mining’. That means, your computer has to spend a lot of time ‘solving’ for an equation and then you are ‘rewarded’ with Bitcoins at times. Clearly, though, this protocol was designed not to provide Bitcoins easily or quickly on purpose. The initial set of Bitcoins dumped on the market came from somewhere, and likely other than through mining which also likely indicates that there is a backdoor algorithm to create Bitcoins at will which completely bypasses the ‘mining’ operation and suggests that someone is truly ‘making bank’. Although. not the miners or the traders.

          The other unfortunate thing that the ‘mining’ feature does (besides let people ‘mint’ new Bitcoin) is mask anyone who may very well be using a backdoor creation tool. So, as long as the person who uses the creation tool is careful not to flood the market with more than a few Bitcoin at a time, it will look like they are simply mining.

          Thanks.

          • Chris Wilmer said, on January 13, 2013 at 3:26 am

            Well, the code is open-source, so that would make it difficult (although not impossible) to create backdoors.

            That being said, it is easy to verify that no bitcoins came through any backdoor process simply by looking at the public bitcoin ledger. Every bitcoin in circulation can be traced to a miner.

            • Satoshi's Cock said, on January 14, 2013 at 5:33 am

              Furthermore, many miners run custom mining software, not based on the original Bitcoin software. This software would break if the “official” client did something that was against the published rules.

              • Satoshi's Cock said, on January 14, 2013 at 5:38 am

                Also, any attempt to honor a backdoor by the “official” client would break any Bitcoin clients based on the separately-implemented BitcoinJ library.

                If there was a backdoor in Bitcoin, we would definitely know about it.

                • commorancy said, on January 14, 2013 at 6:48 am

                  Every software has exploits whether intentional or unintentional in design. Denying that an exploit is possible or that you would ‘definitely know about it’ is just plain ridiculous. Neither Microsoft nor does Apple know about all of its exploits nor would they ever claim to ‘definitely know about’ them all. If there was an exploit (backdoor) that could be used to gain Bitcoin faster, you might very well not know about it until someone came forward explaining how they exploited it. That’s why it’s an exploit. Specifically, were someone smart enough to find an exploit and knowing that they could sell the Bitcoin they receive from the exploit for real legal tender, there is very little chance they would give up “The goose that laid the golden egg” so willingly.

                  You can keep deluding yourself, but exploits happen every day of the week in every software package imaginable. Thinking that Bitcoin’s software is immune to exploits is the best way for someone to actually exploit it and you not to know about it.

                • Satoshi's cock said, on January 17, 2013 at 8:31 pm

                  Now you have changed the subject. We were talking about deliberate backdoors in the protocol itself. Coding flaws and backdoors that are not part of the protocol are a whole different animal.

                • commorancy said, on January 18, 2013 at 8:03 am

                  Actually, if you read closely, I said ‘whether intentional or unintentional in design’. No, I didn’t change the subject. Yes, it’s possible to write code knowing that it can be exploited. An exploit and a backdoor are two sides of the same coin. If someone intentionally writes code that can be exploited, that’s a backdoor. It doesn’t have to be obvious that that’s what it is. In fact, if you were intentionally writing a backdoor using an exploit, you wouldn’t exactly document it.

                  Knowing that Bitcoin would attempt to become a legitimate currency and knowing that it very likely could (and would) be exchanged for other types of legal tender does give rise to trust issues for anyone coding on this software. It is this same trust issue that exists for software that is written to control the NASDAQ and NYSE exchanges (which incidentally had a recent exploit that helped run up the market for a day). Just because you say that there are no exploits doesn’t mean that it is so. The only way to find an exploit is to have people actually go looking for them. The problem is, when there’s real monetary incentive not to disclose a found exploit, you’re then at the mercy of the people whom you ask to audit the code to be honest about what they find. This is why having several independent third party auditing firms working in concert auditing the code (and each other) would be the best (and only) way to ensure that any exploits found are fully disclosed.

                  There are many kinds of exploits, also. Some are straightforward and can be found quickly, some involve stack overflow exploits and can be bit harder to find, some are misconfigurations, some are regressions, some are simply bad coding design and, yes, some can even involve intentional coding design. For the Bitcoin software, when it is trying to become a legitimate currency, having _any_ exploits is bad for trust. If someone can produce any amount of Bitcoin at will, they can drive the price at Bitcoin exchanges. If that same someone can then drive the price of the exchange rate, that actually far reduces the value of what Bitcoin is.

                  In addition to the coding problem I mention, there’s also the legitimacy of the exchanges themselves. If these places are not being regularly audited by independent financial third party auditors, then how can you possibly know that these exchanges are being operated properly? If someone’s Bitcoin just randomly disappears from his/her deposit account, who’s responsible? What recourse does the user have? Is there any insurance in case of loss or theft? These are all questions that must be answered and they are questions that are required of any organization that handles, stores or transfers any kind of money such as those of banks, credit unions, credit card companies, insurance companies and savings and loan firms.

                  These are just the base fundamentals of operating a legitimate business involving money exchange. From one of the comments left on this blog, that person lost all of their Bitcoin while in the MtGox Bitcoin exchange without any resolution. What of situations like this?

                  The whole point to this article, which this entire comment thread has strayed far off of that topic, is whether Bitcoin can become a legitimate currency in the marketplace as it sits today. Based on this comment thread plus everything else I’ve read, I’d personally say, “Not at this time”. It’s still far far safer to invest money into the US Dollar, gold bullion or even the stock market than in Bitcoin for investment purposes. Then, there’s the problem of keeping enough Bitcoin liquid to actually use it as a currency. As most people are tending to hold onto their Bitcoin rather than spend it, that pretty much excludes Bitcoin from even being a currency. Were enough liquid Bitcoin available for the purpose of spending it, there are so few places that accept Bitcoin in exchange for goods or services, that it really offers no benefit over the US Dollar. And, the problems described in this paragraph alone are all fundamental issues that don’t really even involve the technical side trust problems that we’ve been discussing in this thread. Sidetracking that discussion in lieu of technical implementation discussions may seem to be a good way to divert attention away from these fundamental problems, but that insults the intelligence of the readers here. Most readers will see through that diversion quite rapidly.


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