Close to a year ago, I wrote an article describing Bitcoin. Let’s take a look at where this cryptocurrency has gone since then. Afterwards, I’ll dispel some common myths that I keep hearing about Bitcoin and cryptocurrencies in general.
First up for discussion is the price. Bitcoin advocates saw a bubble of over 1000$ per BTC back a year ago. Now it has fallen by 70% down to around 300$ and shows no sign of recovering. Trade volume has gone down drastically with most Bitcoiners being advised to hold their coins in hope the price will eventually recover. Most true believers still refuse to spend their Bitcoins as they believe the price will soon skyrocket “to the moon.”
Several venture capitalists banked on an expected userbase surge of tens of millions of users. Instead, we see about 2 million Bitcoin addresses with most of those being either empty or unused for years. Addresses are often created for accomplishing a single transaction which is why so many are created for so few users.
A major Bitcoin mining datacenter in Thailand burnt down. Poor construction and design were cited as contributing causes. A picture of this can be seen above.
Butterfly Labs, the most famous Bitcoin Miner company, was indicted on charges by the FTC. They’re in hot water over alleged financial misconduct as well as severely misleading customers. The trial is still in progress at the time of writing.
The Silk Road, most likely the largest user of Bitcoin outside of the Russian mob, was shut down again. The FBI, having infilitrated and mirrored all data, finally began arrests of users. For the unfamiliar, the Silk Road was primarily a drug marketplace where users could pay for drugs in Bitcoin. Drugs were then mailed to the home address of the user. With the seizure of the server data, the FBI will be busy for quite some time with arrests.
The much anticipated Bitcoin startup Neo and Bee raised over 6 million dollars worth of USD and BTC. However, it shut down with the CEO now being wanted by police for allegedly raiding the corporate wallet.
Bitcoin Magazine shut down. All staff writers were terminated in November. It is said to be due to a financial problem with investors.
Bitcoin search volume is down to about 20% its peak. Similar traffic problems have been noted across Bitcoin websites, forums, and other web resources.
Bitcoin Foundation founder Charlie Shrem was sentenced to two years in prison for money laundering. Shrem was accused of selling over a million dollars worth of Bitcoins in a money laundering scheme for the now-FBI controlled drug site, Silk Road.
Speaking of the Bitcoin Foundation, they’ve admitted that they’re out of assets to hire developers with. This is an interesting situation for a foundation devoted to what they claim to be a world-changing currency to be in.
Mt. Gox… where to begin? We saw the largest bitcoin exchange (ran about 70% of transactions) go bust and claim that almost half a billion dollars in Bitcoin were missing. Not only that, it also became clear that Mt. Gox (Original name: Magic the Gathering: Online eXchange) was doing massive trading manipulations to artificially inflate prices. Eventually, the company would file bankruptcy.
With that out of the way, let’s look over some common myths that have popped up:
Myth: Bitcoin is a free currency that is not controlled by governments or banks..
Fact: The absent founder of Bitcoin, Satoshi Nakamoto, owns the largest amount of Bitcoins. After the Bitcoin movement was politicized by radical libertarians, Satoshi vanished without a trace. If he returned and sold his BTC, he could fill every sell order on the market and crater the price to pennies.
As of the time of this writing, the second largest single holder of Bitcoin is the US government. Each criminal investigation into Silk Road and similar sites results in millions of dollars of Bitcoin being seized. Edit: The US government has begun liquidating their seized Bitcoins via auctions and is likely no longer the second largest holder.
Myth: The FED is ruining the economy by printing money. This is why inflation will doom the USD. Salvation lies in BTC.
Fact: Statistically, every bitcoin transaction results in about 20$ worth of bitcoin being created (at the ~350$:1 BTC exchange rate, 25 BTC per block reward rate, and assuming 400 transactions per block you get 350$* 25/400=21.8$/transaction). This is due to miner rewards. Just sent someone 5 dollars on the blockchain? You just caused 20$ to be printed. Sure, it would cap out around the year 2100 if it lasted that long.. Bitcoin is kind of a fun mix of inflation mixed with a philosophically deflationary currency. You don’t want to spend it because there are only a limited number so the economy is dead… but every day there are more BTC being produced. Luckily, a typo sends any transaction irreversibly to a black hole so that it disappears from the economy forever. hoep u tyep ur stringz rite… and all of your QR code scanners never make a mistake.
Myth: Using a decentralized financial system is better, cheaper, faster, and completely cuts out banks from financial transactions.
Fact: Bitcoin transactions are inherently slower due to multiple confirmations of a block being required. They are inherently less efficient due to the distributed nature of the infrastructure. Furthermore, the proof of work system is really just a linear security system. This is a complicated concept but it can be visualized as meaning that instead of one dollar spent giving 5 dollars’ worth of security, 1 dollar gives 1 dollar worth of security. In other words, the “good” security scheme will require 5 dollars of DDOS/hacking/penetration/whatever to overcome every dollar invested in security such as firewalls, honeynets, log review tools, etc. The Bitcoin system fails in this regard as anyone possessing 51% of the total network hash power controls the entire network. The natural defense to this is to increase the hash power distribution among all of the users… except mining rewards will always favor the centralized datacenter. At this point, a dedicated bitcoin mining rig (clustered ASICs) is the only type of bitcoin miner that will turn a profit. As a result, the overwhelming majority of the network hashing power is centralized in datacenters under the control of a few individuals.
Regarding speed: If I wanted to buy a hot dog, it would take up to half an hour for my payment to go through assuming I included a sufficient miner fee for a miner to pick it up. For the recommended 6 confirmations of the transaction, it would take an hour. If I did not include a fee to ensure my transaction was actually processed, it would take days. The merchant would have absolutely no clue if I gave them a legit transfer. This is a hard-coded problem. Finally, by removing banks from the equation you lose all forms of insurance against fraud and scams.
Myth: Bitcoin works so well that thousands of merchants (including Microsoft and Paypal) use it.
Fact: Almost all places (including Paypal) that are reported to accept bitcoin are actually being paid by one of two third party payment processors (Coinbase or Bitpay). Paypal never sees bitcoin. If Coinbase or Bitpay collapsed (which is possible since there’s been rumors of solvency problems as there appears to be no way for either company to be making money) then it would zero out the “list of merchants that accept bitcoin” since no one wants to touch it directly. Everyone wants to be paid in actual currency.
Myth: Transparency of Bitcoin via the public ledger is a good thing.
Fact: Do you want the entire world to know every purchase you have ever made in your lifetime. Trying to obfuscate your purchases doesn’t work either. Almost every bitcoin laundering/tumbling service has been beaten by tracking software.
Myth: Early adopters are all rich.
Fact: Most likely, you would’ve lost them by now from hacking, exchange collapse, scam, etc. Last year alone, half of the active bitcoin exchanges shut down, most often due to “hackers stealing everything” followed immediately by the owners disappearing.
Myth: Bitcoin transaction volume is improving.
Fact: Trade volume is generally declining. Very few transactions occur relative to the number of people involved in bitcoin. For years, about 80% of bitcoin transactions were from a dice gambling game because no one ever spent anything. Even now, most people on the bitcoin forums, reddit, etc will advise people to avoid spending bitcoin as “itll be worth 10,000$ a coin any day now…………… ” As a result, no one spends anything.
Myth: Bitcoin transactions are instantaneous while regular currency transactions can take days.
Fact: True, it takes several days for your bank transactions to be fully received. However, they instantly appear in the database as a pending transaction. Bitcoin does not have any kind of pending transaction which leaves the merchant to have to 100% trust that you just transferred the funds. Generally, 6 transaction confirmations (~1 hour) is considered minimum amount of time for a transaction to be considered valid. Until that point, you’re standing there with your stick of gum waiting for the transaction to be verified.
Myth: No chargebacks is a good thing!
Fact: There are no chargebacks in bitcoin. Bitcoiners love this because they’re convinced that merchants lose a ton of money to this, possibly because it is a tactic that they themselves would try. However, the reality is that very little money is ever lost through chargebacks and fraudulent chargebacks result in the individual losing their credit or debit card rather quickly. Instead, we see a system where there is absolutely no way to recover funds after you click the Submit button. Did the server hiccup and you sent money twice? Did the ebay salesman never deliver? Too bad! But with bitcoin!
Myth: There are no fees associated with Bitcoin:
Fact: Currently, the “NO FEES!” crowd can claim that as partially true because the fees are paid via mining rewards. Once mining gets towards the unprofitable point (as it already is for everything but high end ASIC based platforms), miners will rely more and more on transaction fees. Someone I know mathed it out and figured out that -every bitcoin transaction- costs about 20-30$ currently. That cost is paid out via inflating the currency through mining rewards. That puts it 4x as expensive as Western Union transfer to another country. To achieve similar mining rewards and to “keep the network as strong as it currently is”, a 10 cent pack of gum will cost 20$ in a decade or so if Bitcoin is still around. Block rewards serve as transaction fees except instead of coming from an individual, they are distributed to all bitcoin holders in the form of inflation. As mining becomes less and less profitable, miners will begin raising the threshold cost for processing transactions.
I submit a transaction with a 5 cent fee attached. For the sake of argument, we’ll say that there are 4 major mining pools. If A B and C have a threshold of 10 cents, I have to wait for D to pick up my transaction. If D sets their threshold at 25 cents, my transaction will not get processed.
Ok, so there has to be equilibrium, right? Well, eventually bitcoin price to USD will factor in. Where? Miner operation costs! Miners consume a ton of electricity. They’re basically space heaters that occasionally solve a math problem. Miners have a minimum amount of fees that they have to collect in order to stay profitable. Right now, only high end ASICs are profitable. That would suggest that as block rewards decline from halving (oh, rewards half every 2 years as the 21million BTC limit approaches), the miner fees must proportionally increase.
These are not problems that can be patched without invalidating the protocol. To fix this would require adoption of an “alt-coin” which the community has already soundly rejected as it invalidates their bitcoin investment. In nerd terms, a bunch of MMORPG beta testers want to keep using the 0.1 version of a game because they don’t want a character wipe to transition to the 0.2 version.
Myth: Mining difficulty will outpace processing power (See: Moore’s Law) to improve Bitcoin.
Fact: The algorithm itself doesn’t change. It’s just SHA-256 hashing with added or subtracted complexity factors based on desired difficulty.
Mining difficulty adjusts to maintain the same block completion time based on available network hash rate. If you bring online a massive mining datacenter that doubles network hash rate, mining difficulty will double within ~2 weeks. The new mining datacenter will receive roughly half of the bitcoins produced from now on. Mining reward rate is constant for every halving period (as mentioned earlier, every 2 years the reward halves as the BTC limit is approached). The only change is who gets what share of them.
Myth: Bitcoin is immune to targeted attacks.
Fact: One interesting flaw of Bitcoin is the “frisbee on the roof attack” where a malicious actor brings online a massive datacenter, knocks difficulty up to a very high value, then shuts the datacenter down immediately afterwards. As a result, block completion will take much longer and all transactions are halted until sufficient network hash capacity can be brought to bear on the system. Since no blocks are being solved, miner profitability goes to zero which reduces network hash rate further. Why? Smaller miners drop out which irrevocably drops the network hash rate to below the threshold required to solve the block.
If someone was willing to hire a team of professional ASIC designers and pay for a high end fab to build a few wafers of chips, they could destroy Bitcoin overnight.
Summary: The challenge is finding something that Bitcoin does that isn’t already done by something else. Most problems it claims to solve are already solved via a cheaper, faster, and more efficient route.