Today I got involved in a conversation about Bitcoin. I decided I would write about it for a little bit since I figured there might be some interest. I’ll try to be as objective as possible though I think my stance on the current state of Bitcoin will come out anyway. Oh well.
First of all, what is a bitcoin? A bitcoin is a value stored in a bitcoin address. There is no physical form for bitcoins other than what Bitcoin aficionados have created. Usually these take the form of manufactured discs with stickers that obscure the private key associated with a bitcoin address. Think of it like putting a username and password for a bank account with a 1$ balance on a piece of paper then gluing it face down on a disc of metal. You then use that as a 1$ coin that can be redeemed for your bitcoin by destroying the coin and obtaining the password. The downside to this is that thus far, every physical bitcoin coin has been compromised by security experts using tamper-seal breaking techniques.
What about these bitcoin addresses? Well, your bitcoins are sent to the address to be stored in your wallet. Think of it as being kind of like a bank account. Bitcoins are transferred by subtracting from one account while adding to another. There is no individually traceable coin. However, all transactions are publicly stored. Anyone that engages in bitcoin mining must first download the full ledger of all bitcoin transactions in a data file called the “blockchain.” There are blockchain parsers available to track transactions. Bitcoin was initially designed to be completely anonymous; however, engaging in a transaction with an individual gives you enough data to see every transaction they have ever made using one of these parsing tools.
I can hear you asking “well, how do I get one?” The most cost effective way is to post on a website offering to meet someone in a cafe to trade a USB key for cash. More on that later. Some choose to “mine” for bitcoins. The developer of Bitcoin wanted to reward individuals for allowing their computers to help process Bitcoin transactions. Since Bitcoin was developed as a proof of concept rather than a finished project, parts of it were not thought out as carefully as they might. Yes, you heard correctly: Bitcoin was a prototype system not terribly dissimilar from an engineer’s senior design project. It unexpectedly “went viral” and the creator disappeared once the anti-establishment types co-opted the project. Anyway, back to mining! Basically, spare CPU cycles were meant to process the encryption system. Once a “block” had been solved, the person that solved that “block” was rewarded with some bitcoins. It was discovered that GPU processors were far more efficient at this calculation than CPUs… and thus the mining arms race began. The network automatically adjusts the “block solving difficulty” based on total hashing power on the network. Thus, the generation rate of Bitcoins is relatively constant (although it’s theoretically possible that a “frisbee on the roof” scenario could develop if a substantial amount of processing power disappeared instantly: There would not be enough processing power to solve the present difficulty and no transactions would occur for an extended period of time) which also sets an upper limit on the number of transactions that can be processed. If Bitcoin is to ever become mainstream, it will have to be in another iteration that has this crippling problem fixed. Anyway, once GPU mining was discovered to be superior to CPU mining, many began stringing together video cards in custom-made computers. This led to building FPGA miners and finally to the forging of ASIC chips. These ASIC miners cost tens of thousands of dollars and may never recoop the purchasing cost since most are of poor quality and fail. Currently GPU mining is usually not profitable as the electricity consumption rate is more costly than the value of bitcoins produced. This does not stop people from doing it, however. There is a belief that one day, Bitcoin will be the global currency with a value of millions of dollars per coin. That is what drives creations like those posted throughout this article.
One common topic regarding Bitcoin is the subject of charge backs. Namely, all transactions are final. This is regarded as a positive feature by most Bitcoiners. However, bitcoins are regularly stolen via hacking, fraud, or other criminal activity. It is commonplace for Bitcoin “exchanges” where bitcoins are stored to disappear overnight with all funds being stolen. Why should you use an exchange? Bitcoin wallets (where private keys for addresses are stored) are usually kept on flash drives and disconnected from any computer system. Loss of a wallet (via compromise or loss of the physical media) is the same as permanently losing your bank account. Many thousands of bitcoins have been lost simply due to harddrive failures or losing a private key printout. The only way to be completely safe is complete isolation of your wallet with several backup copies including physical media. Malware specifically targeting Bitcoin wallets is becoming more commonplace as the currency sees more adoption. There are even several ransomware programs that require payment via Bitcoin.
Is the Bitcoin protocol really as decentralized as they say? Well, not really. Since Bitcoin mining is based on your total hash rate, most Bitcoin miners join a mining pool. Over the years, the majority of network hashing power has been centralized to two main mining pools. As a result, two people control the Bitcoin protocol. This was seen to great effect during a protocol patch reversion where the two mining pool leaders decided to roll the accepted client connection to a previous version. One interesting side effect of this is called the 51% attack. By controlling 51% of the hashrate of the network, a malicious user could generate bonus transactions that look identical to valid transactions. Though controlling 51% of the network hashrate would be nearly impossible to do by a private individual, a government entity could probably do so if they had the need.
What are some other problems? Well, there are a limited number of bitcoins that can be mined which makes it deflationary currency. As most readers know, a slightly inflationary currency is the currency that actually gets spent. If you know your future value of money will be higher than your present value of money, there’s no reason to invest it unless your ROI is expected to exceed the deflation rate. Since there is a hard cap on the currency amount, Bitcoin strongly discourages spending and encourages eternal hoarding.
Speaking of the value of a given bitcoin, how do you actually make money off of them? Well, you have to sell them. However, most banks regard Bitcoin as a money laundering tool since that is where many (if not most) of the transactions go towards. The bulk of remaining transactions are either gambling (I don’t have up to date data but one dice game is so popular that it significantly slows down the network) or drug sales via Silk Road. Well, until the FBI shut down Silk Road and copied the server data then began en-masse arresting people. The owner of Silk Road was arrested for trying to purchase assassins to kill former employees. Yeah, I’m serious. Anyway, many Bitcoin exchanges can’t actually exchange Bitcoins for money anymore. That has left millions of dollars tied up in limbo. The current best way to cash out bitcoins is by trading a USB drive in person. There’s definitely nothing odd about carrying a USB key worth tens of thousands of dollars and trading it for cash at a Starbucks. Definitely no way that could end poorly!
With all that being said, cryptocurrencies offer a great potential for global commerce. Bitcoin does provide a method for sending funds internationally when all other methods fail. The transaction fees behind Bitcoin are often less than those charged by banks and credit cards. Transaction fees are voluntary in Bitcoin; however, your transaction is processed with a priority given by the fees you are offering. Transactions can take as little as 10 minutes (blockchain completion time) or several days depending on the transaction fees offered.
I believe there is a place for cryptocurrencies in our global economy but Bitcoin requires much more development before it is a viable candidate for that role. Already numerous forks of the Bitcoin protocol have surfaced including Litecoin, Feathercoin, Dogecoin, and dozen of others.