Is Bitcoin Safe? Experts Pick Sides
Perhaps you’ve heard about the U.S. dollar’s recent strength as well as the torrid pace with which the stock market has set all-time records. But guess which type of asset actually performed the best in 2016. That’s right; you won big if you bet on bitcoin, with the cryptocurrency more than doubling in value over the calendar year. In fact, it wasn’t even close, as bitcoin’s 126% gain far outpaced the likes of Brent crude oil (53%), sugar (30%), silver (18%), and the S&P 500 (10%). Even more astounding, the dollar price of one bitcoin has increased from just $0.06 in July 2010 to $1,182 as of February 24, 2017.
Still, it hasn’t always been smooth sailing. The value of a bitcoin plummeted more than 78% between November 2013 and January 2015 before subsequently rebounding. And when you couple such volatility with the currency’s relative lack of regulation, dark-web origins and black-market connections, it’s understandable why many people still question its safety.
In the interest of making this cryptocurrency a bit less cryptic, we posed one simple question – “Is bitcoin safe?” – to a panel of leading experts. You can check out their bios and responses below. And if you’d like to join in the debate, feel free to share your thoughts in the comments section at the end of the page.
Bitcoin Is Not Safe
“Due to the nature of Bitcoin, its value is inevitably very volatile. By design, the Bitcoin supply is capped at a fixed amount in the long run. Because of its limited supply, the value of Bitcoin is destined to increase relative to the overall economic activity. This tends to encourage hoarding of bitcoin, which limits market liquidity. The result is that a small number of players, many speculators, can influence the Bitcoin value significant in a short period of time.”
- Baizhu Chen // Associate Professor, University of Southern California
“The perceived value of any currency is based on what is standing behind it. For example, the dollar has the reputation and the history of the U.S. economy under-pinning the value. It has been a while since we have had a precious metal (gold or silver) as a basis for our currency. That said we still have the history and reputation of the country supporting the dollar. In the European Union, they have a similar foundation for the Euro. Bitcoin has no such under-girding. The only value is a perceived value by those who use it.”
- Ken Dick // Research Fellow, University of Nebraska at Omaha
“Bitcoin has no real value other than the artificial value set by the people trading in Bitcoin. To me, this is like trading in stock of a company who has no product or service, only stock. People will argue that bitcoin is not like stock, but is a currency and therefore will always have value. This is a false assumption since there is nothing standing behind the value of Bitcoin. We have all seen currency being devalued overnight even if there is a government standing behind it. Also, all it would take is a major country to declare Bitcoin illegal because it supports money laundering or some other reason, to cause the value to drop.”
- Doug Jacobson // Professor, Iowa State University
In the shorter-term, heightened geopolitical or monetary uncertainty bodes well for Bitcoin. In that sense, Bitcoin has a safe haven component, since it, at times, does well when the markets are in turmoil. We have seen that during the 2012 Cypriot crisis and China's recent struggle to prop up their fixed exchange rate.
The medium-term trend will depend on whether the world stays in a low growth environment provoking continued quantitative easing and negative interest rates (which is good for Bitcoin), or whether central banks normalize their balance sheets. This is really the key question, in my view.
Whatever one thinks of the longer term monetary environment, and hence longer term Bitcoin returns, it is certainly not free from the risk of sizeable price declines. Further, these declines are often sudden due to limited liquidity. Significant short term price swings will also be associated with Bitcoin specific events like adoptions or bans by particular institutions/countries; although I think digital currencies are here to stay and will continue to proliferate in transaction use.
The electronic coins are not a universally accepted medium of exchange, nor does an institution exist that has the requisite power to guarantee their use, ensure their stability, or protect their value. The lack of oversight makes the payment system vulnerable to manipulation, while the anonymity of the transactions makes it attractive to those engaged in criminal activity, money launderers, and tax evaders. Its connection to illicit activity has severely damaged Bitcoin’s reputation and served to limit its adoption. In fact, the number of merchants willing to use the payment system remains relatively small.
If Bitcoin involves a degree of risk as a medium of exchange, it is an even riskier store of value. To the extent that Bitcoin does have value, it is because people treat the digital tokens as an investment. But as even a superficial glance at Bitcoin’s exchange rate against the dollar reveals, the market for the tokens is highly volatile. That reflects the absence of any regulatory agent that might support the virtual currency’s value, but also the relative illiquidity of demand for it.
To the extent that there is demand for Bitcoin, it acts like a commodity. Like gold, the tokens are fungible, but not completely and universally so; like gold, trading the tokens involves a hedge against inflation, precisely because the electronic coins aren’t money but rather a bet on the future depreciation of actual money.
So Bitcoin’s strengths are the same as its weaknesses -- and that makes it a very risky investment. Bitcoin appeals to those who see the electronic tokens as embodying the future of money -- digital. There is no doubt that the math behind Bitcoin is imaginative and elegant. The algorithms that regulate its transactions also seem far more democratic than the central banks that issue and regulate national currencies. And as a challenge to the dollar’s hegemony, Bitcoin seems to promise a more global distribution of the benefits Americans currently reap as the clearing and storehouse of world.
Ultimately, however, the absence of a trustworthy regulatory authority will severely limit the adoption of this virtual currency as money. Once people begin to realize that and treat the digital tokens like the commodity they are, their value will adjust accordingly.
I see two major issues relating to the safety of Bitcoin. The first is that Bitcoin has no real value other than the artificial value set by the people trading in Bitcoin. To me, this is like trading in stock of a company who has no product or service, only stock. People will argue that bitcoin is not like stock, but is a currency and therefore will always have value. This is a false assumption since there is nothing standing behind the value of Bitcoin. We have all seen currency being devalued overnight even if there is a government standing behind it. Also, all it would take is a major country to declare Bitcoin illegal because it supports money laundering or some other reason, to cause the value to drop.
The second issue is the safety of any Bitcoins you own. There have been cases when Bitcoins have been lost or stolen and there is no way to get them back. In this way they are like owning cash, if lost, stolen or destroyed you are out the money.
So, using bitcoin as an investment strategy is very risky and to me resembles a Ponzi scheme.
The other issue with this digital currency is the ethical issue of the perceived anonymity provided by the block chaining. This leaves us with non-traceable transactions, thus supporting exchanges that may be illegal in nature. This has been observed through the website Silkroad.com.
Yes, bitcoin is safe, at least for now, but what about us, bitcoin's clients? There are many dangers, some more credible than others. Can a dishonest player reverse a transaction already in the bitcoin ledger? (Probably not, provided that transaction has been there long enough.) Can someone divert money from my bitcoin account? (Yes, if you reveal your secret keys. Some recent malware surreptitiously scans your file system looking for them.) Can a cabal of evildoers take control of the bitcoin ledger? (Not yet. But the bitcoin ledger is increasingly driven by fewer and fewer "miners," and there is cause for alarm if their number becomes too small.)
Each of these dangers merits an article of its own, but here I will focus on a more subtle danger. Bitcoin is the best known of a number of systems centered around a "blockchain," a kind of tamper-proof decentralized ledger. Blockchain-based systems are often unclear about “fairness” guarantees. For example, can one client's transactions be systematically delayed or ignored? Or, in a blockchain-based stock trading system, can one client's purchase orders be systematically rescheduled to run after a rival client's purchase of the same stock (so-called "front-running'')? The idea that third parties such as governments cannot favor or impede certain class of transactions, a property known as censorship-resistance, is often touted as one of the key benefits of bitcoin and similar systems. If we turn our attention to the system's participants, however, the situation is unclear, and dangers still lurk.
A blockchain-based system provides fairness transparency if it answers these two questions. First, does the system clearly specify its fairness guarantees? (For example, it is legitimate to ignore transactions from known money launderers, but all other transactions are processed first-come-first-served.) Second, can the system provide evidence that clients have been treated fairly? While it may be difficult or impossible to flag a single instance of a fairness violation, blockchain systems should be designed so that systematic and repeated fairness violations can eventually be detected with high confidence. A specification is worthless if violations can't be detected, and a detection mechanism is useless if fairness can't be defined.
Here are some simple design principles that contribute to fairness transparency. First, each non-deterministic choice is a temptation to cheat. Whenever possible, replace non-deterministic choices with deterministic rules, and provide a way to prove to the client those rules were followed. Second, track all unavoidable non-deterministic choices in a tamper-proof public log, so clients can detect unusual statistical patterns.
Providing fairness transparency for blockchain-based systems is still an open research question, but the first step is to recognize the danger.
Second, Bitcoin is not a legal tender. No creditor is required to accept it for the settlement of a debt. Individuals are not forced to hold Bitcoin because it cannot be used as a payment for taxes. If one day Bitcoin becomes unattractive to people as a medium of exchange for whatever reasons, its value will go down the drain.
Third, because Bitcoin transaction is irreversible, there is no recourse if an error is made. If one accidentally pays $11111.11 instead of $1111.11, the conventional banking system allows remedy while Bitcoin transaction has none.
Fourth, Bitcoin is not immune to hackers. Verification cost will go up as fewer amount of Bitcoin are left for mining. To verify the past transaction encoded in the blockchain will require more and more computing power which will make policing counterfeiting more difficult. Further, Bitcoin exchange and wallet services can be vulnerable. In 2015, Bitstamp lost 19000 bitcoins due to a security breach.
Because of this uncertainty, it trades a lot like a stock. Right now, you can get almost $1,200 US dollars for one bitcoin. A year ago, it was only worth a little over $400. While this is a nice rate of return, a stable (safe) currency does not fluctuate in value this much. Buying Bitcoin is akin to buying a speculative tech stock -- you could make a lot of money or you could lose your entire investment. Not only that, it has been extremely volatile, a daily price change of more than 10% is not a rare event with Bitcoin, already happening 3 times this year. Compare that to the Euro or Yen, which typically fluctuate less than 1% in a day. This volatility most likely won’t decrease until Bitcoins rate of adoption increases, not only among individuals but among large institutions.
Bitcoins are not only unsafe from an investment perspective but there are a lot of regulatory risks as well. Bitcoin and digital currencies in general are more private and not tracked or controlled by any central agency or government. This makes them a favorite payment method for drug dealers and money launderers and has become the primary currency used on the “Dark-Web” for other nefarious activities. Governments will want to crack down on this by increasing regulations, even going as far as making its use illegal. This would bring into question its viability as a currency, reducing the use and ultimately the value.
What’s most interesting is that for all its current faults, as the currency matures and becomes more widely accepted, it could become safer than many of the more well-known currencies. It’s not subject to manipulation by central banks and due to limits on its production could be a better store of value. But for now, Bitcoin is not safe by any means, but then again, neither was the U.S. Dollar when it was first introduced.
Let's say I decided to create a digital currency, a “Murray,” which would be priced at $100 per unit. (I prefer hundred dollars because I'm very partial to saving $100 bills as part of my emergency fund.) Each Murray could be divided into smaller units depending upon the needs of the buyer or seller.
This year I would issue 100,000 Murrays and therefore I, the issuer, would pocket a cool $10 million in 2017. Not being a techie, I would hire savvy web designers and security experts to provide a platform where the public could buy as many Murrays up to hundred thousand units the first year and have confidence that their Murrays are secure. However, given the expertise of hackers around the world, no website can be 100% protected from them.
To make the Murray as widespread digital currency as possible, I could limit the initial purchase to 100 Murrays, with an individual limited to 100 purchases of Murray's per month the first year. The more people who use the Murrays in the marketplace the greater acceptance of Murrays, and a new “money” will compete with the U.S. dollar or any other fiat currency. Or will it?
To make the Murray a relatively scarce "commodity," each year beginning in 2018 no more than 10,000 Murray's would be available for sale at $100 per unit. Thus, as the creator of the new digital currency, the Murray, my cash flow would be $1 million per year ad infinitum.
Once the initial supply of Murrays is introduced at $100 per unit, will its price fluctuate according to the venerable law of supply and demand? Of course. Given the relatively scarce supply of Murrays, individuals can bid up the price of each unit of Murray to their hearts content. But why would people pay more than $100 for each Murray?
Even if I promised anonymity to each buyer of a Murray, what would be the point of using a Murray instead of cash, a checking account, and credit card or for that matter travelers checks to make purchases in the marketplace?
The limited supply of Murray's would suffer from a grave defect; it could not be used to make loans of any substantial amount especially in the corporate sector. Thus, one of the critical weaknesses of a crypto currency is its limited use.
Moreover, the federal government would probably crackdown on the Murray for a very simple reason; it does not like competition to its monopoly of issuing fiat money.
Substitute bitcoin for the Murray and you can see the problem with any crypto currency: it may seem like a statement against the Federal Reserve's money monopoly but in the final analysis it is not money, and the government will probably shut it down just as the government confiscated the American people's gold in 1933. In short, bitcoin is not safe.
If people want to have an alternative to the U.S. dollar, they should put some of their Benjamins in gold and silver coins to protect themselves from the Federal Reserve’s inflationary policies.
Bitcoin Is Safe
What these systems have in common is one thing: Centralization. Your Venmo and PayPal balances are both managed by single companies. If they get hacked then your account is exposed. In order to process a simple transaction for coffee your credit card information has to be passed through several intermediaries, all of whom are at risk of being hacked. If even one gets hit, then you may find yourself dealing with a serious financial headache. With so many tempting targets it’s no surprise that hacks dominate the news.
Centralized databases rely on so-called “perimeter security” for protection. These are the typical cybersecurity tools you hear about, like firewalls. But not only are hackers constantly developing tools to circumvent these defenses, you also have to trust that every company with your information is maintaining vigilance.
Enter Bitcoin. Open, decentralized, blockchain networks like Bitcoin take an approach to security that could not be more different than this perimeter model. There is no perimeter around the Bitcoin protocol. The software that powers it is open source; its database is distributed among thousands of network participants and available for audit by anyone. Bitcoin transaction messages travel over the Internet Protocol unencrypted for all to see, and the network is peer-to-peer: built from a web of all users’ computers.
Despite this openness, the database of all bitcoin transactions -- the fabled blockchain -- has never been hacked. What’s truly revolutionary about bitcoin is its underlying consensus process that helps all of the computers on the network come to agreement over what new entries are valid and should be included in the blockchain, and what entries are an attack and should be ignored. It’s an entirely new approach to security which has proven itself for years now.
Bitcoin is a very safe way to transact with and store value. But there is a trade-off here. Bitcoin is cash. Just like cash, if someone takes it from you, it is gone. There are companies out there that work much like banks and will hold your bitcoins for you. Like PayPal and Venmo, these are centralized services that also rely on perimeter security, and in the past some have been hacked. But you don’t have to use these services if you don’t want. You are free to store and manage your bitcoins yourself just as you can with cash, but now with the added benefit of being able to transact privately online.
Recently, bitcoin rapidly gained popularity, and hence the frequency and complexity of the hacking attempts also intensified. If user’s bitcoins are stolen, then it is tricky to recover them because bitcoin transactions, once written in the blockchain, are irreversible. High impact attacks on big names like Bitfinex, Coinwallet and Bitstamp dented bitcoin’s reputation to some extent. The natural question after multiple successful attacks is, “is bitcoin safe?” -- and the short answer is yes!
But the security depends on multiple factors like responsible user behavior, bitcoin exchanges’ security standards and practices, and bitcoin miners’ honesty. None of the attacks on bitcoin wallets and exchanges defeated blockchain or the core bitcoin algorithm. Instead, irresponsible user behavior and/or sloppy security practices of the bitcoin exchanges were exploited.
We are not implying that bitcoin has no security flaws. Bitcoin relies heavily on socioeconomic factors and it is imperative for the correctness of the algorithm that majority of the bitcoin miners behave honestly. This requirement of bitcoin has been exploited to develop some “theoretical attacks,” most of which have impractical requirements. For example, temporary block withholding is a powerful attack but requires that the attacker controls at least a third of the mining power. As bitcoin becomes more widespread it might come under more pragmatic and powerful attacks from big players. One such attack, called altcoin infanticide, has been observed to be successfully carried out by bitcoin miners against new competing currencies with low mining capacity. Also, as the stability and correctness of the system relies on the miners if majority of them collude, then all bets are off. We cannot completely discard the possibility of such attacks, especially with the current policy of cutting down the mining rewards.
All successful bitcoin hacks till date occurred due to either the users not following the recommended security practices or the exchange platforms getting compromised. In the latter case, sometimes exchanges had enough funds to recover from the hack. For instance, Bitstamp lost 18,866 BTC from its hot wallet due to a phishing attack but it recovered from the hack. Social engineering attacks (e.g., phishing) and getting around outdated security practices like 2FA (2 Factor Authentication) remain the most popular attacks.
Bitcoin exchanges are continuously improving security by adding innovative features like cold wallet and multi-signature. In conclusion, bitcoin is still secure against all pragmatic attacks and will likely stay that way, but as is true with any security protocol -- all parties involved in the protocol, i.e., bitcoin exchanges and the end users -- must follow the recommended security practices.
Bitcoin Can Be Safe And Risky
- “Regulators have, at least historically, been quite accommodating to cryptocurrencies, probably because their regulatory frameworks already handle the notion of multiple currencies -- given that some of these currencies are backed by nothing more than the say-so of central bankers in small countries, it is a no brainer that Bitcoin, with its strong guarantees, fits well into the existing frameworks. And while I believe the quantum computing threat is real, it is also nowhere in the near future and progress towards it will be slow and in measured steps that give us plenty of time to react.”
- Emin Gun Sirer // Associate Professor, Cornell University
“Recent research by the academic community (Garay et al. and Pass et al.) has formally proven that Bitcoin’s core Nakamoto blockchain protocol satisfies consistency and liveness, assuming that the attacker controls less than 51% of the hashpower.”
- Elaine Shi // Professor, University of Maryland
“Bitcoin is safe, if you use it appropriately as a medium of exchange. Its algorithms have been extensively reviewed and it has a reasonable track record in practice, albeit with some hiccups along the way.”
- Carl Landwehr // Research Scientist, George Washington University
But none of these risks actually matter. We have technical responses to many of these threats now. Malte Moeser, Ittay Eyal and I designed Covenants to stem thefts of coins from cold storage. We provided a patch for selfish mining, and my colleagues Elaine Shi and Rafael Pass pioneered Fruit Chains that can stem selfish mining attacks altogether. Regulators have, at least historically, been quite accommodating to cryptocurrencies, probably because their regulatory frameworks already handle the notion of multiple currencies -- given that some of these currencies are backed by nothing more than the say-so of central bankers in small countries, it is a no brainer that Bitcoin, with its strong guarantees, fits well into the existing frameworks. And while I believe the quantum computing threat is real, it is also nowhere in the near future and progress towards it will be slow and in measured steps that give us plenty of time to react.
What I do fear in Bitcoin isn't anything technological -- we have that under control -- but social. Money is, at the end of the day, a social construct. Despite the narrative about how cryptocurrencies are "protected by maths," even Bitcoin is subject to pressures from people. Bitcoin has evolved tremendously since its inception: we now have new features such as multisignature, we have fixed a number of bugs, including some that caused forks in the chain and even the creation of large numbers of coins. And indeed, to reach millions of more users, the system has to evolve: it has to adopt scalability measures and the ecosystem around it has to improve the user experience. I worry, at once, that it may become ungovernable and unable to enact some of the much needed changes, and that it may become captured by commercial interests that tug it in directions that serve a particular class of users and use cases at the expense of others. Humans, as is often the case, are the weakest element.
No, for possibly many reasons, and we focus on two below:
First, the bitcoin community and IC3 faculty (Eyal and Sirer) demonstrate the selfish mining attack, where a minority coalition can reap as much as 2 times their fair rewards under a “right” set of conditions. Recently, a group of Princeton researchers further show that when Bitcoin’s block reward dwindles, and when miners obtain payout primarily from transaction fees, selfish mining style attacks become more powerful.
Such selfish mining attacks break fairness and incentive compatibility; consequently, participants will be incentivized not to follow the honest protocol. If more than half of the computing power chose to deviate, Bitcoin’s consistency and liveness guarantees will be completely broken.
Second, as solo miners today would take years to reap their first reward, mining pools form to allow people to get paid more frequently. Such mining pools, however, harm the decentralized nature of Bitcoin. The largest mining pool has exceeded 51% of the mining power in the past, and had such a mining pool behaved maliciously, all Bitcoin’s security guarantees would be broken.
Fortunately, there is now a solution to all known and unknown selfish mining attacks, and in the meanwhile remove the need for mining pools.
In joint work with Rafael Pass and others in IC3, we design and build a new blockchain protocol called Fruitchain that fundamentally addresses all such attacks, known and unknown, in a mathematically rigorous manner. Fruitchains offers the first game theoretically secure blockchain, providing a coalition-safe, approximate Nash equilibrium. We mathematically guarantee no matter how an attacker behaves, she can at most increase her rewards by an arbitrarily small epsilon fraction, as long as the attacker controls minority hashpower. Thus, Fruitchains disincentivizes miners from deviating from the honest protocol, thus reinforcing an equilibrium state where everyone is incentivized to behave honestly seeing that most other users are.
As IC3 faculty Rafael Pass and others mathematically demonstrate, in Nakamoto’s blockchain, the block mining difficulty must be large to ensure security. In Fruitchains, however, the block mining difficulty can be made very small. Solo miners can obtain rewards on the order of days rather than years (and meanwhile we achieve almost comparable transaction throughput and confirmation time as Bitcoin). This removes the need for forming mining pools.
There are now a number of reputable exchanges that enable customers to buy Bitcoin safely and legally online. None of the cryptographic primitives behind Bitcoin have, to this day, shown major weaknesses. The system as a whole has shown tremendous resiliency for the past eight years it has been in existence, and works well.
Why is Bitcoin not safe:
Contrary to what a lot of people think, Bitcoin is not anonymous, but pseudonymous. All transactions are publicly available and traceable. So, if one can associate a given Bitcoin address to Alice's identity (e.g., by obtaining the information from an online exchange where Alice bought her Bitcoin), all of her purchases are traceable. Very rapid fluctuations in value are still the norm, making Bitcoin a very risky investment if used for speculation.
For the ordinary person in a country like the United States, where there is a stable banking system and many investment alternatives, bitcoin as an investment is a risky proposition. And there are other cryptocurrencies being developed that may supplant it. But using it to send money to relatives in other countries may save substantial banking fees and be relatively quick.
Caution: do not assume that your bitcoin transactions are automatically untraceable or anonymous. Unless you take considerable care in using the system, it may be possible for a motivated person to track your transactions. Caveat: Although I've studied bitcoin's mechanisms, I have never engaged in a bitcoin transaction, and please do not construe this statement as financial advice.
Investing in Bitcoin is like investing in many other types of asset classes. It is risky and unless you can afford to lose all the cash that you would invest and you have no set time frame in needing to get out of the market, I would highly advise against it as of today.
Bitcoin is a cryptocurrency also known as a digital asset or a virtual currency. These terms can be used interchangeably. You cannot touch it. You are not holding those cute gold coins with the letter “B” on it. You are not buying a physical asset like gold or silver. A virtual currency allows for peer-to-peer payments over the internet that can be exchanged without a third party -- meaning lower transaction costs and greater efficiency. A bitcoin transaction -- like a cash transaction -- is not reversible and can only be refundable by the receiver of the payment. An owner of bitcoins should also know the inherent risks involved in holding the digital asset as an investment.
Market and Volatility risk:
There are many cryptocurrencies being traded and the debate is open as to which one will prevail in the end. However, Bitcoin, the first and most popular one launched in 2009 is the most widely used today. Currently, Bitcoin is trading around $1,065 up over $600 from a year ago. The current appreciation of the currency makes it a very speculative trade. Prior to the recent appreciation, the price of bitcoins fell over 60% in 2013 and over 75% in 2014 making it quite a volatile currency.
Regulation/Political or Country Risk:
Since cryptocurrencies are still in the early stages, there is no proper governance. Bitcoin is an unregulated, decentralized virtual currency. No one controls it. Governments and central banks around the world are still trying to understand what regulations should be in place to protect consumers.
At the moment, the United States’ SEC (Securities and Exchange Commission) is trying to decide if they should approve a Bitcoin ETF (Exchange traded fund). This decision has been in the works for three years and next month it is expected that they will provide ruling. If it gets the appropriate approval, bitcoin prices will most likely move higher -- a lot higher.
China is currently worrying about their currency restrictions and capital outflows via cryptocurrency exchanges. China constitutes the majority of the global bitcoin trading volume and if China moves to tighten restrictions/regulations on the cryptocurrency exchanges it could cause this market to spiral.
Security and Liquidity risk:
In 2014, Mt. Gox, the largest bitcoin exchange at the time, suspended trading and closed its website due to hackers stealing over 850,000 bitcoins, an estimated $460 million value. This led to Mt. Gox to eventually go bankrupt. The risk of hackers and malware is still a major concern, as is liquidity risk -- the inability to convert a security to cash without a loss of capital or income. There is always the risk that when you are ready to redeem your bitcoins that there will be no one ready to buy the bitcoins from you.
Despite the above-mentioned risks, it is my opinion, that the use of virtual currencies and the underlying technology behind it will have a major impact on our global payment systems in the future.
Let’s peel away the layers of the basic question and focus on my separate question: why might someone want to know whether Bitcoin is safe?
If you want to buy Bitcoin for investment purposes, my answer is, “it depends.” Why? Because trading values of Bitcoin fluctuate -- and, sometimes they fluctuate a lot. Since February 24, 2016, Bitcoin have fluctuated in value from less than $500 to a high of $1,206.60. So, if you are investing your next week’s grocery money in Bitcoin, you might think again. If your investment horizon is longer, you might be fine. But, if you don’t know the investment broker or advisor well, a different answer might obtain. The SEC has prosecuted at least one Bitcoin investment Ponzi scheme.
Next, you might ask whether it is safe to use Bitcoin you currently own to pay for goods or services you are purchasing. Here, the same answer -- “It depends” -- applies, but it does for different reasons. If you know the person selling goods and services and that person will agree to be paid in Bitcoin, you are pretty safe. This is because all errors in transferring from your holding to the seller depend on getting the identification of the Bitcoin being used as a form of “currency” perfect. Or they depend on the actions of any trusted intermediary you may use to effectuate your payment -- if they get the instructions right, or acts in time at all. The seller’s willingness to take payment in Bitcoin is another factor in deciding whether it is “safe” to use Bitcoin. Not all sellers will be willing. And you’d need to define up front the “exchange” value to be used for this purchase.
If you want to send value quickly and inexpensively to a person outside the United States, then the answer is “Bitcoin is safe.” Particularly if the sender has the technical capacity to handle the transfer of funds himself or herself. It is less “safe” if the sender does not know the identity or reputation of every intermediary needed to complete the transfer.
By now, you see that Bitcoin’s ”safety” is less about the technology underlying Bitcoin, and more about who wants to use it and whether they need an intermediary to complete the transaction at hand. Does the user know much about intermediaries they need to make an investment, use Bitcoin in lieu of a bank-based cross-border funds transfer or remittance payment, or as a medium of payment for goods or services? And how has our person managed the risks of Bitcoin’s fluctuating store-of-value record?
The remarks in this invited comment do not reflect the views of the Trustees of Indiana University or of the Uniform Law Commission.
Scalability is an issue. Bitcoin's transaction capacity is currently capped at approximately 7 TPS ("Transactions Per Second") where VISA regularly handles over 2,000 TPS. There is an ongoing debate on how to scale bitcoin's transaction capacity to a point where it may be suitable for mass adoption, but the lack of consensus has created a rift among the bitcoin community. That said, some promising solutions (lightning networks) are starting to emerge.
From an economic perspective, bitcoin is not yet mature enough to be a safe or stable investment, at least not in the short term. While bitcoin has historically performed extremely well year over year, the price remains extremely volatile and subject to drastic, unpredictable market swings.
The conventional wisdom among Bitcoiners is to never invest more than you can afford to lose entirely. As previously mentioned, the current market capitalization of bitcoin is $19 billion, which is relatively minuscule compared to mature investment vehicles such as bonds, equities and national currencies. This means that a small group of motivated "whales" (high net worth individuals, private companies or governments) and/or news events can have a significant and immediate impact on the price of bitcoin.
However, the security of the Bitcoin protocol is only one component in the security of the entire Bitcoin system. Bitcoins are digital objects protected by a digital signature which states who owns a particular Bitcoin. Bitcoins are transferred by “signing them away” to a different user. The security of the Bitcoin one owns is entirely predicated on the security of the secret key(s) used to sign them away. Should those keys be stolen from you and your Bitcoins are easily transferred to another user, with no recourse.
So while the protocol itself may be secure, that's not very reassuring if users do not undertake adequate measures to protect their bit coins and the keys associated with them. Time and again, the Bitcoin ecosystem has been plagued with thefts and losses due to bad key management. These thefts have affected individual users who store their own bitcoins as well as exchanges that store coins for their customers.
The only way to combat these thefts and securely store bitcoins is to use multisignature/threshold signature wallets to split key storage among multiple devices (or to store coins with an exchange that correctly employs such practices). Additionally, bitcoins should be stored in cold storage, or non-network-connected devices, whenever possible.
In sum, while we believe that Bitcoin is secure at the protocol level, there is still lots of work to be done to ensure the security of user’s coins. Thefts are quite common in Bitcoin, and due to the pseudonymity and irreversibility of Bitcoin transactions, it is not generally possible to recover stolen funds. Splitting control among multiple devices in a way that is resilient to some of those devices being lost or stolen is the most promising path to bring real security to Bitcoin users.
Perhaps the most natural interpretation of “safety” is to ask whether malicious Bitcoin users can steal money. A determined adversary can steal another user’s Bitcoins by infecting their electronic devices with malware, hacking into a centralized repository, or physically stealing another user’s paper wallet. Indeed, there have been several hacks of Bitcoin exchanges that resulted in significant losses (e.g., Mt. Gox) as well as reports of irregular activity by exchanges that may be linked to money laundering.
However, keep in mind that similar attacks are used to steal fiat money -- often with even higher frequency (e.g., credit card information breaches, Wall Street Ponzi schemes). There are two important differences: (1) credit cards can be replaced, whereas stolen Bitcoin are virtually impossible to recover, and (2) Bitcoin companies are currently less regulated than standard financial companies. Although regulation does not necessarily improve security, some measure of oversight can force companies to at least think carefully about security measures and/or the legality of their actions. Nonetheless, Bitcoin markets are becoming increasingly regulated. Over time, we may see exchanges and other Bitcoin-related companies forced to comply with security and financial regulations similar to those currently governing the finance industry.
Another common concern centers on privacy. We implicitly trust banks to keep our financial transaction histories private, with exceptions for special cases like subpoenas. However, in Bitcoin, the public blockchain can be used to view every transaction ever generated; the only privacy protection is the fact that users are identified by pseudonyms, or public keys. However, researchers have repeatedly shown that an adversary with side information can often discover the owner of a given public key. Although researchers are actively working to improve the anonymity of Bitcoin, the core implementation used by most clients today poses significant privacy risks, even for the average user.
Overall, there are several risks associated with using Bitcoin. The theft-related risks look very similar to current threats in the traditional financial system, whereas the privacy risks are more pronounced and inherent to the Bitcoin technology. Over time, we have mitigated risk in current financial systems through a combination of oversight and technical innovation. Ultimately, the same seems to be (gradually) happening for Bitcoin and other cryptocurrencies.
Image: StockFinland / iStock.
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