May 21, 2013 – Since it’s raining today and I cannot cut the grass, I figured it’s a good day to get this one off my chest.
By The Cerebral Aesthetic Vagabond
I don’t mean to pick on bitcoin specifically, and this essay pertains to all virtual currencies, including devcoin, litecoin, namecoin, ppcoin, terracoin and probably many more I’m not aware of. I’m definitely not an apologist for fiat currencies, nor am I a “gold bug.” I simply evaluate my surroundings dispassionately and logically. So here’s what I think about bitcoin.
Fundamentally, I like the idea of competing currencies. Honest competition improves the health of any system, for it weeds out defects and enhances resiliency and stability. In fact, currency competition already exists because there are many sovereign currencies around the world that ostensibly compete against one another, despite increasing central bank policy collusion. The well known “dollar index” is a graphical depiction of this currency competition. Unfortunately, trading in multiple currencies is largely the domain of wealthy elites who straddle national borders.
I think part of the appeal of bitcoin is that it enables “ordinary” folks to trade in alternative currencies independently of national sovereignty, which is probably one reason why those same elites wish to target bitcoin, because they don’t control it and bitcoin gives the people too much freedom. Although I’ve come close to purchasing some bitcoins, if only as a token show of support for the concept, I harbor reservations that have prevented me from doing so.
As far as competing currencies go, I always thought Liberty Dollar was a good model, being essentially a privately issued currency based on precious metals. I consider it superior to bitcoin because it was based on something tangible, possessing secondary value as a precious metal. A recipient of a Liberty Dollar would receive a physical store of value that could be traded based on the value of its precious metal content alone. By contrast, you can’t pay your handyman with a bitcoin. Not surprisingly, Liberty Dollar was too great a threat to the centrally managed U.S. Dollar and so it was shut down for specious reasons. I fear bitcoin and its brethren will follow the same fate, which is one of the reasons I’ve been leery of purchasing any.
Contrary to claims, bitcoin is centralized and easy to attack because of its centralized nature, and anonymously as well. The recent shutdown by the U.S. Government of a major bitcoin trader illustrates how bitcoin is more centralized than people realize. If bitcoin were truly as decentralized as its theory of operation suggests, then the shutdown of a bitcoin trader or even many such traders would not have been newsworthy. After all, the whole point of decentralization is that the loss of a portion of the system is insignificant to the rest of the system. So instead of a central bank acting as a gatekeeper for a sovereign currency, bitcoin has a handful of major companies playing a similar role, and they must comply with government edicts regarding the movement of money.
Whereas printed currencies and precious metal bars and coins are individual stores of value, bitcoin is like a single hoard of currency or precious metal in which each bitcoin owner owns a share of that hoard, not unlike a precious metal ETF. When one person sends bitcoins to another, nothing tangible is transferred; instead, an electronic package of data indicating the number of shares to be transferred is sent into the bitcoin system and migrates to the recipient. The bitcoins one “owns” are actually pieces of data typically stored on their own computer in an electronic “wallet.”
Because the bitcoins are stored as myriad bits of data and because the computing is performed on a distributed network of computers, it is claimed that bitcoin is therefore decentralized. However, individual bitcoins have no meaning; they only have meaning within the context of the bitcoin “cloud,” in which an individual bitcoin represents a share of the entire collection of bitcoins. In that sense the entire bitcoin network, software and data collectively behaves no differently from a huge centralized system. It’s not possible for an individual computer to utilize bitcoins in any way without the rest of the bitcoin cloud being available!
For example, if I want to send bitcoins to my coworker sitting at the desk beside me, I cannot do it peer-to-peer, from my computer to his, but only by sending the bitcoins through the entire bitcoin cloud, which doesn’t really strike me as a truly decentralized system. Ironically, the currency-based banking system that’s been around for a long time is less centralized than bitcoin, for if I want to transfer money from one account at a bank to another at the same bank, that transfer is recorded within that bank alone and it is not necessary to involve the entire banking network in order to effect such a transfer. Similarly, if I want to withdraw money from my bank, I can go to the physical branch and receive money directly from that branch, again without involving the entire banking network. A precious metal coin or bar is also less centralized than bitcoin, for an individual can trade that store of wealth for something without involving anyone else in the transaction.
It does not matter whether any single hoard of stored value resides in a steel and concrete vault or in encrypted form in an internet “cloud.” Either way, the existence of any hoard of wealth in a single location – even a virtual one – makes it a tempting target for someone to attack, whereas millions of widely distributed individual stores of value would be too much trouble to attack, at least on a massive scale. Hackers, for example, don’t waste their time trying to crack the online passwords of individual bank accounts, but go after the bank’s central database where all the passwords are stored.
Bitcoin, because it’s in effect a single store of value – in the form of a distributed but highly interconnected database of encrypted virtual bitcoins – is a tempting target for malevolent forces. As far as I know such an attack has not yet occurred, but given enough time and ever more powerful computing resources, I think it’s only a matter of time until it does happen.
Although currency notes and precious metal bars and coins can be counterfeited (such as in the recently discovered instances of gold bars filled with tungsten), confidence in the currency or the precious metal is only undermined in proportion to the relative quantity of counterfeit items in circulation, and confidence can be improved by the removal of these counterfeit items, something which occurs on a continual basis.
Bitcoin, by contrast, is vulnerable to a systemic loss of confidence should an attacker successfully bypass bitcoin’s security mechanisms. Instead of destroying confidence in a few currency notes or precious metal bars, a successful attacker could destroy confidence in the entire bitcoin system in one fell swoop.
One of bitcoin’s greatest weaknesses is its dependence on a functioning electrical grid and a functioning internet, not to mention a large group of buyers and sellers willing to participate in the system. If the internet or the electrical system goes down, there is no way to extract the value from virtual bitcoins. By contrast, currency or precious metal coins or bars can be traded without the aid of computers or electricity, and were traded that way for thousands of years until a little more than a century ago. With peak oil and total economic collapse looming, not to mention already endemic criminality throughout our economic and political systems, I’m quite reluctant to park my meager wealth in a place from which I might not be able to get it back out.
Anonymity, one of bitcoin’s strengths, is also one of its weaknesses because it makes it possible for people to manipulate or undermine the asset anonymously. I can’t help but wonder if bitcoin’s exponential rise and subsequent crash a few weeks ago was engineered by governments seeking to protect the monopoly of their sovereign currencies. We may never know the answer because of the anonymous nature of bitcoin transactions.
Few, including me, completely understand how bitcoin works, meaning those who do understand how it works have an advantage over the rest, an advantage they may be tempted to exploit. Our incredibly complex financial system, for instance, gives people who understand how it works an advantage over the rest, an advantage they do exploit for profit. I imagine it’s only a matter of time before clever people apply the same nefarious skills in the virtual currency realm.
The complexity of bitcoin also gives those with superior computing power an advantage, which is why a cottage industry has emerged wherein people rig together networks of extremely powerful GPU processors for the purpose of “mining” new bitcoins. So if massive computing power can be used benignly to mine bitcoins, can massive computing power also be used maliciously to hack the bitcoin system or perhaps spy on it? Pondering the subject of immense computing power, a number of U.S. Government agencies with three-letter acronyms come to mind.
Bitcoin is so complex it raises a number of questions in my mind that I do not know the answers for:
Answers for all these questions are well established in the case of currencies and precious metals, but seem to be lacking in the case of bitcoin.
Contrary to popular belief, there is no such thing as intrinsic value. The value of everything is determined by human beings and is by no means permanent, although there do exist historical norms such as the value universally ascribed to precious metals. Thus, if humanity universally recognized bitcoins as valuable then my arguments above would be overshadowed by the reality of that mass recognition, but that is not yet the case, nor does it seem to me that bitcoin will ever become more than a faddish asset. For one thing, a lot of people who use currencies or recognize precious metals as valuable don’t even own a computer, the very thing that gives bitcoins any value at all. A lot more people would be leery of entrusting their wealth to a complex algorithm that resides in a nebulous “cloud” somewhere on the internet.
Any store of value has its own pitfalls: currencies can be counterfeited or intentionally debased, precious metals can be faked and bitcoins can be hacked, from within by unscrupulous individuals wielding powerful computing capabilities, and from without by tyrannical governments or others using anonymous market transactions. But bitcoin has a few more disadvantages as well: its dependence on a fully operational electrical and internet grid, the inability to physically hand somebody a bitcoin and bitcoin’s lack of tangible value. Granted, pure fiat currencies lack tangible value too but they are accepted everywhere as payment, and precious metals are universally recognized as valuable, neither of which claims can be made for bitcoin.
Finally, governments will never permit competing currencies to upstage their sovereign currencies. In just the last few months bitcoin suffered an exponential price rise followed by a brutal crash, which I suspect was engineered by governments. The U.S. Government has recently intimated its intention to “regulate” bitcoin as a commodity (as absurd as that sounds since it’s a purely virtual asset), the real intent being to prevent bitcoin from being anything other than a dollar proxy. And a few days ago the U.S. Government shut down a major bitcoin trader for specious reasons reminiscent of the shutdown of Liberty Dollar. The writing on the wall could not be any clearer.
In light of recent stunning, bubble-like price increases of bitcoin, perhaps it’s opportune to add one more caveat to the list. One of bitcoin’s purported “strengths” is that the number of bitcoins is finite, unlike fiat currency, which can be printed up in quantities approaching infinity. However, this presumption of a finite supply is illusory, for an unlimited number of crypto-currencies can be created! If one views the entire spectrum of crypto-currencies as a single pool, then there is no finite limit to the size of the pool. In fact, given the virtual nature of crypto-currencies, existing solely within computer memories, it’s easier to create more crypto-currency units than it is to create printed currency notes! Since I originally wrote this article years ago, at least one more popular crypto-currency has emerged, ethereum, which is siphoning funds away from bitcoin. If the fiat currency masters wanted to destroy crypto-currencies, they could flood the market with numerous competing “brands,” pump them up, wait for “investors” to pile in and then pull the plug.
For those die-hard crypto-currency devotees, here’s a sobering article: DO THE MATH: Here’s the rational analysis why 99% of current Bitcoin owners will never be able to sell Bitcoins for anything close to its imagined current value.
It appears more and more intelligent people are offering well thought out reasons to avoid bitcoin and its ilk, such as this article I read today: Digital 'Currencies' Are ALL A Scam. In the article, the author concurs with my observation that crypto-currencies aren’t finite, as is claimed, because any number of competing crypto-currencies can be created.
I hate to keep picking on crypto-currencies but more and more juicy details about them continue to trickle out of late. (Who knows, perhaps this trickle of damning evidence is being released by the opponents of crypto-currencies.)
Whenever I consider the long term viability of anything I look at the fundamentals with respect to the laws of physics. Anything that does not conform to the laws of physics or depends on a sustained imbalance may be maintained for a while, but eventually the laws of physics must be recognized, whereupon the system collapses. That’s exactly how I view crypto-currencies and this article is one reason why: Ethereum And Bitcoin Energy Consumption Surpasses Entire Countries' Power Budgets. The luscious title aside, the article can be reduced to this succinct, stunning sentence: “the average Bitcoin transaction requires 163 kilowatt hours (KWh) of electricity.” My eyeballs nearly popped out of my skull when I read that sentence. My average monthly electricity usage is about 200 KWh, so a single bitcoin transaction uses almost as much electricity as I use in an entire month! Mind you, that’s for one single bitcoin transaction! The cost for a single ethereum transaction is “only” 49 KWh, for the time being. The problem with crypto-currencies is that over time it gets increasingly costly to “mine” the currency, and as the usage of crypto-currencies increases it gets more costly and time consuming to process transactions. I’ve read that it now takes days to actually complete a bitcoin transaction because the backlog of transactions is so large and it’s so expensive in computing terms to process them.
To me, all these clues scream unsustainable. The electricity consumption by itself is sufficient to render crypto-currencies unsustainable. After all, somebody has to pay for that electricity. Electricity is relatively cheap where I live, yet 163 KWh still costs about $16.30. That’s the cost per bitcoin transaction! With such high transaction costs, would you use bitcoin to pay your next door neighbor’s kid for mowing your lawn, or to pay the girl down the street for babysitting your kids, or to pay for trinkets at a garage sale? By contrast, the cost per transaction for paper currency is nearly zero, even factoring in the cost of manufacturing the paper note, which is amortized over a very large number of transactions. In addition, the paper currency transaction is fully completed in the time it takes to hand the physical note to someone. Even credit card transactions are completed more rapidly than bitcoin transactions. And I repeat, the processing times and costs increase for crypto-currencies the more they are used.
Finally, crypto-currencies seem to suffer from a fundamentally inefficient design. They are designed to be decentralized, which is something I frequently advocate. However, there are times when centralized systems are more suitable. As I understand crypto-currencies, and I may be wrong, the “block chain” records every single transaction over time, which makes it a database of sorts. Furthermore, every single user of a crypto-currency has their own copy of this block chain. Whenever the block chain is modified, which is after every transaction, everyone’s copy of it has to be updated! That would explain why it takes an increasingly long time to process transactions: more transactions; more copies of the block chain to be updated. Nobody would ever design a traditional database system in which each user had their own copy of the database and each copy had to be updated whenever the database was modified. Instead, the database would be centralized and users would access it in an orderly manner. Any changes made to the database would be immediately available to all users. That is how credit card systems work: there is a centralized database that maintains the credit card records, which can be rapidly interrogated and altered from millions of point of sale terminals. Being decentralized, crypto-currencies inherently lack the efficiency of traditional database systems, which puts crypto-currencies at a speed disadvantage compared to traditional centralized payment processing systems. (In addition to the cost of the electricity, I can’t help but wonder about the cost of storing all those copies of the block chain.)
In spite of the contradictory shortcomings listed above, proponents assert that crypto-currencies are ideal for small, quick transactions. Perhaps the inception of a crypto-currency transaction seems convenient and rapid but that’s because the full costs and processing times are concealed. Although I myself don’t trust crypto-currencies, I have nothing against them and find them intriguing. I just don’t see how they can be sustainable in light of these physical realities.