Posted on 11/03/2015 10:08:42 AM PST by Another Post-American
BITCOIN RISKS AND SKEPTICISM
With bitcoin skyrocketing again (up 16.44% in the last 24 hours as I write this, per Coinmarketcap.com) I wanted to outline reasons to be cautious about getting involved with Bitcoin. Bitcoin is a revolutionary advance in financial technology, but there is a learning curve involved and many serious pitfalls for unwary users.
This will not be a general primer on bitcoin or how it works. I'll field any questions on those lines to the best of my ability, but first and foremost I want to give people a list of risks to consider before investing or using bitcoin. (Most of the reasons I am seeing here on Free Republic so far as based on simple prejudice or misconceptions, and thus make a lousy basis for an informed judgment on the subject.)
BITCOIN RISKS
1. Risk of Losing Your Bitcoins.
Bitcoins exist in the form of entries on a shared, cryptographically secured ledger. Only someone with a private key for a given account can make a transaction entry on the ledger, sending the coins to another account. If you lose that key (held in a bitcoin wallet software) you lose the ability to send any coins tied to it. This can happen if your hard drive crashes and you didn't back up the wallet, or if you made a paper wallet and lose your only copy of it. (Since bitcoin keys are just long character strings, you can print them out and not have them on any computer anywhere until needed.)
So you should be cautious about using bitcoin if you do a poor job of backing up or tend to lose things. If you are using a personal wallet and you lose the keys (or your password to access the keys in the wallet), there is no 1-800 number you can call to save you.
Ways to mitigate this risk: You could keep your bitcoins with trusted 3rd parties online, such as exchanges like Coinbase or Xapo. But that creates a risk of theft (see Risk #2 below). You can create multiple backups or copies of your software or hardware wallet and distribute them in safe places (again, increasing the risk of theft per Risk #2).
The best strategy is to use Multi-signature technology, which is becoming much more widespread with bitcoin in the last year or two. With "M of N" multi-sig, it takes M keys out of N total in existence to send bitcoins from your account. (You can specify the M and N parameters when you set it up, such as 2 of 3 or 5 of 7).
This way you can distribute copies of the keys as needed, and not worry that the loss of one key will expose you to theft or make your bitcoins impossible to access. (In addition, 2-factor authentification is available from every 2-bit bitcoin exchange I've ever dealt with, whereas I still can't get it on my Fidelity accounts - what's up with that, Wall Street??)
The only downside is that it is more of a hassle to transact with multi-signature accounts, so it is less useful for a daily use account.
2. Risk of Theft (online).
Yes, you've all heard of Mt. Gox. While bitcoin is secure if held properly, a large portion of people choose to give their bitcoins to someone else for safekeeping, creating the risk of theft by 3rd parties. If you choose to go this route (and it's hard to avoid entirely, such as when exchanging currencies), pick your online exchanges carefully.
In the pre-Gox era the bitcoin scene was dominated by nerd-in-a-garage type outfits,
with a regular litany of security breaches and scams. Things have changed considerably since the collapse of Mt. Gox in early 2014, as Wall Street has taken notice of bitcoin and better funded, more professional venture capitalists have established bitcoin exchanges and online wallet services.
As a result, I've noticed a big drop in reports of hacked services, and things seems especially good with the first-tier services (like Coinbase and Xapo). We haven't seen the last of bitcoin hackers, but they are steadily being pushed to the fringes and targeting the remaining amateur outfits that are still out there.
3. Risk of Theft (offline).
Just because you choose to keep your bitcoin in a wallet on your own computer doesn't mean you are safe. Hackers intensely target software wallets with malware and viruses. So if you have trouble keeping yourself virus-free, be careful about this option. Some people advise having a computer that is ONLY used for financial transactions, and never for games, web browsing and so on. That's probably good advice, even for people still using only fiat systems, given all the hacking going on.
Likewise, many bitcoiners consider paper wallets the safest option - but they don't seem to consider that people have been stealing physical goods (like case or, say, a paper wallet with your private key) for a long time. Use the M of N multisignature strategy I mention above.
4. Scams
You can lose your fiat currency to scammers as easily as bitcoin, but be aware that scammers seem to be targeting bitcoin much more intensely. Probably because they wrongly believe that bitcoin provides them anonymity (see Risk #5 below). If you are the sort that has fallen for scams in the past, be especially careful with your bitcoin.
For example, just because someone posts a message that the Red Cross accepts bitcoin donations with a public key for such donations, that doesn't mean the key is really held by the Red Cross. One stunt I've seen scammers pull is to take a legitimate post for donations and copy and paste it elsewhere on the web, altering the public key address to their own. So be cautious about sending funds to an address that you have not personally verified with the recipient to be sure it is theirs.
5. Lack of Anonymity.
Did you think using bitcoin made you anonymous? Think again. EVERY transaction ever done with bitcoins is publicly recorded, forever, in the bitcoin blockchain. People just think they have privacy because they think no one will know they hold account "xyz234..."
But for a variety of reasons, the odds are high that over time your bitcoin keys are going to be linked with your real-world identity. You can fight this, but in an era of KYC laws, hacked databases and data mining by Google, etc., it's going to be more difficult than you imagine.
So already I'm seeing a string of news reports of bitcoin hackers who do get tracked down eventually after they try to actually spend some of their ill-gotten wealth. If you aren't comfortable with the idea of your friends/family/neighbors/etc.
potentially being able to look up all your bitcoin transactions, that would be a reason to avoid bitcoin. Of course you may also want to rethink your use of online fiat banking, the way things are going, on that count...
(There are a slew of other cryptocurrencies working on the problem of anonymity with varying levels of success, and I see them as vital to the long term health of cryptocurrency. For example, what business is going to want to let its competition see every detail of their transactions if they start using cryptocurrency? So it's not just about drugs and Silk Road as many skeptics naively assume, it's a concern for just about everyone. How it will play out in a KYC regulatory environment is anyone's guess at this point.)
6. Bitcoin Could Be Illegal.
Bitcoin has only been declared illegal in one or two countries at this point (I'm thinking Bolivia and maybe Ecuador or Peru). But if you had valid reason to think it might be made illegal where you live, that would certainly be a valid reason to be cautious about using it.
Keep in mind that just because a government official is hostile to bitcoin, doesn't mean that is official government policy. A Russion Ministry of Finance official just mouthed off that bitcoin users should be imprisoned for four years. That doesn't mean it's likely to happen. The trend has been in rather the opposite direction the last few years, apart from those leading technological innovators like Bolivia. (OK, I apologize for the sarcasm...)
Realistically, if bitcoin were going to be declared illegal in western nations, they would have done so in years past when operations like the Silk Road flourished.
Today, with the flood of investment from Wall Street and the hype about blockchains, concerns about the use of bitcoin for illicit activities are receding. It's like fearing that automobiles will be banned in 1910 because some people were using them for surreptitious trips to a brothel.
7. Bitcoin Faces Competition.
There are literally hundreds of competitors to Bitcoin today, based on the same technology. (Just check out Coinmarketcap.com) Isn't it likely that some will prove better, ultimately rendering bitcoin worthless?
I made this argument myself in my early involvement with bitcoin - if Bitcoin is the Model T of cryptocurrency, what happens when competitors like Dash and Litecoin gain traction?
The fallacy here, though, is that bitcoin is not frozen technologically. A Model T was a Model T. Ford Motor Company couldn't update it once sold. Whereas the software protocols behind bitcoin are subject to refinement and innovation without affecting the financial parameters that make bitcoin valuable.
So if faster transaction blocks, or higher transaction capacity, or anonymity, or anything else that can be achieved with cryptocurrency are ever urgently needed, bitcoin can be updated to include these improvements. (This can involve controversy and price risk, as anyone observing or participating in the warfare over the still unresolved blocksize debate can attest.) In the meantime, Bitcoin enjoys a tremendous first mover advantage over the competition, which won't be going away anytime soon.
8. Bitcoin Security Could be Breached
For bitcoins to hold value, the blockchain record of transactions must remain incorruptible. So far, despite massive hacker activity and hostility from governments, banks, and other powerful entities, the blockchain has withstood all attacks. Your passwords can be lost or stolen, but the blockchain itself has remained secure. Could this change?
It's not impossible, though it is unlikely for the foreseeable future. The encryption technology used for bitcoin is strong enough that conventional computers will never be able to decrypt it, not if the entire universe were composed of such computers for unimaginable lengths of time.
But there is speculation that quantum computers could defeat the current encryption standards. If such computers became a reality and nothing was done, the blockchain could be rewritten or private keys stolen, destroying bitcoin. More likely though, announcements of such technology would lead to the deployment of algorithms not vulnerable to quantum computers (my understanding is that such things already exist), so this is not an existential risk.
CONCLUSION
Bitcoin is an exciting new technology with the potential to change the financial world. As such, it's worth educating yourself and becoming familiar with it,
particularly if a financial crisis develops with your fiat currency and you need an alternative, quickly. For this reason I encourage folks to begin learning about bitcoin and become familiar with handling it. But I also want them to be aware of the risks and not get too excited about it in a way that puts them at financial risk. The principle of diversification is probably the first thing that anyone with disposable income should learn, and it applies here no matter how bullish you get with bitcoin.
One last ping for a while...
One thing about bitcoin, is change happens fast. Since I posted the OP a few minutes ago:
1. The price of Bitcoin has increased over $22 to $416.
2. Bitcoin has been banned in Taiwan, as a knee-jerk reaction to the kidnapping of a Hong Kong billionaire by criminals who demanded the ransom be paid in bitcoin. The ruling was made by an unelected Financial Supervisory Commission, not lawmakers. (So if they’d ask to be paid in cash... ?)
Have you used any coin-tumbling service? Altcoins?
Nice summary. Thank you.
In one case an ordinary guy noticed that some stolen coins were being sent to a mixer. So he threw a couple cents worth of bitcoin into the mixer at the same time. It laundered his money with the stolen funds, and allowed him to tracked the outbound funds. The thief tried to mix his stolen coins dozens of times, and the guy just kept pace with him, tracking it with pennies at a time. Eventually the thief just gave up. People who think they are a guarantee of anonymity are kidding themselves.
Oh, as regards altcoins, I mined dozens of them all through 2014. I still hold small positions (very small) in Dash, Litecoin, Dogecoin, Monero, Bitcoindark, NXT, Pesetacoin, EFL and a few others. And so far as I can tell, I’m the largest holder of Piggycoin outside the development team. ;-)
I’m just hedging my bets, and I use Piggycoin to pay my kids for chores and as an incentive for various things.
Bitcoin looks good, from a technological standpoint. But I still can’t see bitcoin ever really taking off as a currency. If people believe that bitcoins will hold their value better than another currency, they have no incentive to spend them. They will spend dollars, and horde bitcoins. If people don’t believe that bitcoin will hold their value, then it has no pressing advantage over other, more widely accepted, currencies. Why take the risk on a new currency, that may or may not ever become widely accepted, if I also believe that the new and risky currency will go down in value?
I am sure that you have run into this argument before. What is the generally accepted response to this, in the bitcoin community?
I can empathize; best I can suggest is to wait for a pullback or some negative news that causes an over-reaction in the opposite direction.
Can I have bit coin pings for 100, wink?
Merchants have an incentive to encourage their customers to spend bitcoins with them, because bitcoin is the most trouble-free method of payment. There is no counterfeiting with bitcoin. No forged or bounced checks. No credit card chargebacks or investigations. No credit card fees! Verification that a spend has been accepted by the network (as distinct from confirmation of X blocks) is achieved within seconds. No need for armored cars or other security.
This all saves merchants real money. So I anticipate that as they get used to using bitcoin and the benefits are proven, they'll begin to offer small discounts to anyone paying with bitcoin. I estimate this will be in the range of 3% (slightly more than what you get with a rewards credit card). That will incentivize people to spend their bitcoins.
This is already happening on a small scale, and folks like me already shop with bitcoin regularly. I get 2-3% off with my rewards credit cards, but that pales in comparison with the savings I get at Purse.io buying anything I want at Amazon using bitcoin. (Typically 15-20% off.)
Yep, you are added!
Thanks for you answer. I was hoping you would say something like this. I would really like to see bitcoin thrive, and if there are tangible savings at the merchant-level, then that may just be part of the answer. Two follow ups, if you don’t mind:
First, do those savings scale up? Is Walmart going to see an advantage similar to a small store?
Second, are there any advantages to employers paying wages in bitcoin? Better yet, are any companies already paying wages in bitcoin?
If you have a Bitcoin ping list, please add me. Thanks
Me too? Thanks
You guys are added!
Heh, the price just dropped $20+. I should list whiplash from watching the price changes today as part of the risks. :-)
Well, I'm an engineer not someone involved in corporate finance, so I feel out of my depth tackling that one. I am confident there would be savings at both ends of the scale, but where the greatest advantage would lay, I can't say.
Second, are there any advantages to employers paying wages in bitcoin? Better yet, are any companies already paying wages in bitcoin?
There is a 3rd party payment processor that was announced some months ago. I remember because they were going to make their service free for a while. It let employees choose to have some portion of their paycheck be converted to bitcoin automatically. Wish I could remember their name.... Bitwage! That's it. Bitwage.com
Besides them, I know there are various small outfits paying employees here and there in bitcoin. Of course mostly these are bitcoin-focused companies themselves. And there are a few people who are living entirely on bitcoin, though that clearly takes some effort and creativity at this point.
Apart from using Purse and a few other opportunities, I'm still more of a saver than a spender with bitcoin myself. I expect that's how it is for most people within the bitcoin ecosystem. Which goes to your point about bitcoin hoarding vs. spending.
I can only speak for myself. New currencies often have legitimacy crisis. If a large country, seemingly acting reasonably, introduces a new currency, it is easier. Euro is one such example. If an individual, who keeps his true identity secret, introduces a currency and keeps some for himself, this becomes a much dicier proposition.
Some of the key factors that a customer considers are:
One desired quality of money is that the tokens themselves should have minimal cost; preferrably zero. Paper money comes close to that, as paper is reasonably inexpensive. Electronic money as they exist today in banks and on our credit cards have zero cost. This is good because the token itself should not be an expensive good. You do not want to pay for your cup of coffee with an original painting by a famous artist - even if the nominal value of that "coin" is one cup of coffee. This issue also affected gold coins, as they had value close to their face value - and that resulted in debasement of coins.
Unfortunately, BTC is not free. BTC costs a lot of money (electric power) to produce. This is a waste. This also results in a situation when nobody can offer BTC as a handy replacement for barter items, as you have to purchase the coin first - and the act of purchase of a coin has nothing to do with the exchange that the coin facilitates.
Here is an example, with barter and with BTC.
BARTER. Bob built a chair and wants to sell it. Alice wants to buy that chair. Bob needs a loaf of bread, and Alice just baked one. They exchange goods. Bob now has bread, and Alice can sit on her new chair. All the work was exchanged, and none were leaking to 3rd parties.
BTC. Bob built a chair and wants to sell it for 1 BTC. Alice wants to buy that chair for 1 BTC. However Alice does not have 1 BTC. Each BTC costs, in whatever money, close to its face value. Alice takes one loaf of bread to the exchange and procures one BTC from the miner Mike for that bread. Now Alice comes back and gives the 1 BTC to Bob, and collects her chair. Bob still wants his bread, and Alice doesn't have her bread anymore.
What would happen now in our "normal" economy? Bob would go to Mike the miner, give him 1 BTC, and take the bread. This would complete the exchange because the value of the token (paper money or iron/nickel coins) is nearly zero.
This is different in the BTC world. When Bob goes to Mike and offers him his BTC, Mike says that he already gave one half of his bread to the power company, and another half to the company that made a BTC mining machine for him. He has no bread to sell anymore!
You can see now that the high cost of the token is now sunk into tokens themselves. The society has to bear the extreme expense of calculating otherwise pointless and valueless numbers, just so they could be exchanged for very inexpensive goods. This is one of many issues that plague digital coins. To put it simply, digital money must be very inexpensive to generate and to process. BTC does not offer either - minting of coins is very expensive, and transfers of BTC require massive worldwide calculations. Compare with cash, which costs nothing to print and the only person who counts it is the clerk at the store. Plastic cash (cards) costs even less.
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