Lesson

Examining threats to Bitcoin Economy

Your own Bitcoin holdings are only as safe as the Bitcoin ecosystem itself. It’s faced potentially life-ending challenges in the past, and it’s likely to face them again in the future. Let’s look at some of them. First, technological threats. There are vulnerabilities in Bitcoin itself. Historically, the biggest one has been the possibility of someone gaining control of over 50% of the network, what’s usually called a 51% attack. Anyone who does that can change the ledger, pretty much at will.

The Bitcoin network is much too big for any individual to do that now, but miners who have grouped together into pools can. If someone could launch an attack that coordinated a few of the top pools, they would win. By the way, as I write this, most of the biggest pools are based in China, which utterly dominates Bitcoin mining activity. Another problem is caused by the Bitcoin network’s lack of scalability. It’s currently stuck at under a dozen transactions per second.

By comparison, the Visa network manages over 20,000 transactions per second. Several proposals have tried to solve the problem, but none has been successful as I write this. The network is enormously wasteful. Miners worldwide consume enough energy to power millions of homes. Differences in energy prices could consolidate mining power in the hands of those with access to cheap power.

Finally, security of a Bitcoin wallet or miner or exchange is only as good as the computers running it. It’s bad enough when someone cracks your computer, it’s worse when you lose your life savings because of it. There are also economic threats to Bitcoin. Its unstable value prevents it from being fully used for anything but speculation. People don’t want to receive salary or priced goods in a currency that’s such a gamble. Bitcoin also doesn’t have much utility.

By comparison, Ethereum is a programming platform, Ripple is recognized by financial institutions around the world, but Bitcoin just is. If utility proves important, money may flee from Bitcoin to other, more useful, cryptocurrencies. Right now, Bitcoin is too hard to buy, too hard to use, and too hard to sell for the average consumer. Further, with occasionally high transaction fees, it’s historically not been good for everyday spending.

Finally, miners are struggling to make any money on Bitcoin. It’s common to spend thousands of dollars on equipment, only to see it become obsolete before you can even turn a profit. Next, we come to regulatory threats. First, let’s be clear, no government can effectively stop you from sending or receiving Bitcoin, but what it can do is stop you from converting it into rubles or yen.

China and Russia, both of which have Bitcoin restrictions, are the 800 pound gorillas that can affect Bitcoin’s value with just one swipe of the pen. Even if governments don’t restrict Bitcoin directly, they can make it expensive and troublesome enough to make people abandon it. Finally, criminal activity could affect Bitcoin. Although the blockchain is completely egalitarian, the Bitcoin ecosystem isn’t, and it could be damaged by controlling a surprisingly small number of people.

The folks who run the biggest mining pools, for example, or firmware engineers at the company that makes most of the Bitcoin mining equipment, or whoever manages the list of safe Bitcoin wallets on bitcoin.org. Theft on the Bitcoin network can be automated very easily. If a security flaw is found in a miner or a wallet, there will be attacks on everyone who runs it, within days or even hours. Finally, there’s no recourse when Bitcoin is lost. If someone gets their hand on it, it’s gone, and there’s nothing you can do about it.

Now this list is far from complete, and new kinds of attacks could spring up at any moment. Which ones turn out to be a problem remains to be seen.