Disadvantages / Dangers of Bitcoin – William Gaithersworth
“Stay away from it. It’s a mirage, basically… The idea that it has some huge intrinsic value is just a joke in my view.” — Warren Buffett
In the previous article, we covered a lot of the benefits of Bitcoin. With new technology, it’s easy to get caught in the hype around it and focus only on the positive aspects.
While Bitcoin does offer a lot of benefits over existing payment methods, there are also risks and downsides that for many people make Bitcoin less beneficial over existing methods. In this chapter, we’ll look at some of the dangers and disadvantages of Bitcoin.
Transaction Fees
When Bitcoin was created, transactions were free. This was one of the big appeals of Bitcoin that international transactions could be conducted for free. Originally, miners that added blocks of transactions to the Bitcoin blockchain would receive the block reward. This was originally sufficient to keep miners contributing computing power and resources to run the network.
As Bitcoin has gained in popularity, the number of miners competing for block rewards has increased, the block rewards decrease over time and the proof-of-work difficulty also increases. Miners receive the transaction fees of any transactions they add to a block on the blockchain.
While you can still send transactions with no fees on the Bitcoin network, they will not be prioritized over other transactions. A transaction with no fees will go to the bottom of the list of transactions miners will select, which will increase the time to complete that transaction.
Over time, there will eventually be no block rewards offered and miners will only receive the transaction fees. This could potentially result in higher transaction fees to compensate for the decrease and eventual removal of block rewards.
No reversal of transactions
There are no incorrect transactions as far as the Bitcoin network is concerned. When you send a transaction it can’t be disputed, changed or reversed. If someone gains access to your account and sends bitcoins to another address there is no bank or intermediary to challenge that transaction or report it as fraud.
If you send bitcoins to the wrong bitcoin address, there is no way to reverse the transaction and the bitcoins are lost. If you send money via bank transfer to the wrong address, it can be reversed. If someone gains access to your bank account or scams you then the transaction can be disputed.
Unauthorized transactions on a credit card are often covered by fraud protection even in the case they can’t be reversed. Bitcoin has no such security measures in place against fraud or errors.
During ICOs there have been numerous cases of scams, scammers provide a Bitcoin address to send bitcoins to apply for an offer.
People in a hurry to apply for fear of missing out, they copy and paste the address provided and quickly send bitcoins without checking the address is correct. After sending these bitcoins to the wrong address, there is no way to cancel, reverse or dispute the transaction and get the bitcoins back.
Cost of Running the Bitcoin Network
The Bitcoin network requires an enormous amount of electricity and computing resources to run. Bitcoin uses a proof-of-work algorithm that requires computers to solve a puzzle to proof they are contributing computing power and resources to the network.
The majority of the electricity and computing power contributed to the Bitcoin network is directed towards generating random numbers to solve the puzzle and prove resources were contributed. An average household in the U.S uses around 10,000 to 12,000 kWh of electricity in a year.
This amount of electricity is used to generate four bitcoins with a value of around $1,000 each. Professor John Quiggin (University of Queensland, Australia) calculated that every day the Bitcoin network uses as much electricity as it would take to run around 50 houses for an entire year.
The amount of energy consumption will only continue to increase as more people use Bitcoin. This could make running Bitcoin on a larger scale unfeasible or at least very costly compared to alternative options.
Lack of scalability
Electricity and computing resources are just some of the scalability limitations the Bitcoin network is facing. The number of transactions that the Bitcoin network is capable of handling is minuscule when compared to companies like Visa and MasterCard.
The Bitcoin network adds a block of transactions to the blockchain every 10 minutes. Each block generally contains fewer than 2,000 transactions, which equates to around 3 transactions per second.
The Bitcoin network potentially has the capacity to double the current rate of transactions added to the Bitcoin network, however, this is still only around 6 transactions each second.
When Visa conducted tests with IBM about the volume of transactions the Visa network was capable of handling, it was concluded that the Visa network could handle around 20,000 transactions each second.
This is a significant difference compared to the 6 transactions a second Bitcoin is currently capable of handling. Bitcoin also has no method to determine whether a transaction is invalid before it is added to the blockchain.
The same bitcoins can be sent multiple times but the transactions will only be rejected once one of the transactions is added into a block. You can’t double-spend bitcoins, however, if you have 10 bitcoins, you could send several transactions of 10 bitcoins to different people and all the transactions will show as pending.
Once a miner adds one of the transactions to the Bitcoin blockchain, the other transactions will be rejected. Many companies that accept bitcoins as payment, will wait for 6 confirmations until accepting a transaction as valid.
A confirmation is when another block is added onto the block that contains the transaction. A new block is added every 10 minutes, meaning it could take 60 minutes for a Bitcoin transaction to be accepted as valid.
With credit cards, as soon as you make a purchase, it is confirmed or rejected within seconds. Credit cards can now be used without inserting them into a machine and without a pin code or signature required. Purchasing items in a store with a credit card is as easy as tapping a credit card on a device that confirms the transaction almost instantly.
If a store has to wait for 6 confirmations before accepting a Bitcoin transaction, you would have to wait an hour in the store before the transaction is considered valid. People dispute this argument by referring to the already existing Bitcoin cards that can be used in stores to make purchases like a credit card.
However, many of these cards are Visa debit cards, that are not using bitcoins for the transaction but instead sell the bitcoins in the wallet for U.S Dollars, this is loaded onto the Visa debit card which is then used for the transaction. The transaction occurs in U.S dollars using the Visa payment network and is not a transaction in bitcoins over the Bitcoin network.
There are cryptocurrencies such as Litecoin that have faster transaction times with blocks of transactions added to the Litecoin network every 2 and a half minutes. Bitcoin does not have any plans to reduce the block confirmation times and is still divided over the future direction and scalability of the network.
Unless Bitcoin is able to resolve the scalability issues that it faces, many people see the future use of Bitcoin more like gold as a store of value and not as a viable alternative to credit cards and other payment methods.
More Transparency Results in a Lack of Privacy
Bitcoin wallets and transactions are transparent allowing everyone on the Bitcoin network to view them. With this transparency comes a lack of privacy that might make many people uncomfortable using it. It is generally accepted as good manners to avoid certain conversation topics such as religion, politics, and money.
It makes people uncomfortable for others to know how much they earn, how much debt they have or how much money they have in their bank accounts. The transparency of Bitcoin means that anybody can see transactions and balances for any address on the Bitcoin network. While addresses are anonymous, it is fairly easy to determine the owner of a Bitcoin address if payment is received from them.
With existing banking systems, if your friend sends you money, you don’t see the balance of their bank account or all the transactions they have made. With Bitcoin, if a friend sends you a payment, you can view all their transactions along with the current balance of that Bitcoin address.
Details about balances and transactions are publicly available to all people on the Bitcoin network. If you make a purchase at a shop, employees at that shop can link your identity to your Bitcoin wallet address and see all the transactions that you have made.
If there are regular payments going into the account, people may be able to determine how much money you earn. This could be uncomfortable if you are making a donation or payment to a local community or church group.
They could see how much money you have going into your account or your current balance compared to the amount you donated. They may form a negative opinion of you if your donation is small relative to the number of bitcoins you hold in that address.
They may also be able to determine where you have spent your money and judge you based on payments made that the members of that community may frown upon. Many of the computers contributing to the Bitcoin network are in countries such as China where the government has a record of human rights abuses.
Transactions between people and organizations that the Chinese government disapproves of could be used against people living or traveling to China. It is not just governments that could use this information, computer crime is very high in Russia and China where a large number of computers contributing to the Bitcoin network are located.
Criminals may be able to use information about transactions made to certain companies or organizations to blackmail or exploit people. There are other cryptocurrencies that have more privacy compared to Bitcoin.
There are also ways to better hide wallet addresses however for most people getting started with cryptocurrencies, they will mainly be using Bitcoin and basic transaction methods.
More Security May Result in Less Security
Bitcoin uses more advanced security and cryptography compared to existing systems. However, for many people, these methods are complicated and difficult to understand. This often results in these methods being less secure than traditional methods.
Using a basic password which you create for most sites is not as secure as a Bitcoin private key. If you look at a basic comparison about which method is more secure, then a Bitcoin private key is many times more secure. When you add the human factor, this is where the security of each method changes.
You can remember the 4-digit pin code of your bank card and the passwords for most sites however a Bitcoin private key is too difficult to remember. A common question you may notice online in the Bitcoin or cryptocurrency forums is how do I reset my password or gain access if I lose my private key.
The answer is that you can’t gain access to your bitcoins if you forget or lose your private key, so the recommendation is to write down the private key.
Banks always recommend that you never write down your pin code to your bank card. By writing down your Bitcoin private key, in order to remember it, you are potentially making it less secure than a 4-digit pin code for your bank card.
If you forget the pin code for your bank card or passwords for internet banking, you can usually reset them fairly easily by calling the bank or getting a text message to the phone number on file. If you forget or lose your Bitcoin private key, there is no way to reset it or gain access back.
You will lose all access to your bitcoins and wallet if you don’t have the private key. There are seemingly endless cases with Bitcoin where people have lost their private keys along with access to their Bitcoin wallet. The price of Bitcoin has gone from under 10 cents in 2010 to over $2,000 in 2,017. $10 worth of Bitcoin in 2010 would be worth over $200,000 7 years later.
With this massive increase in growth, it’s easy to understand how someone could have purchased a small number of bitcoins years ago, forgotten about them and lost the private key.
At the time they purchased the bitcoins, it was not a significant amount to worry about losing, however now they have lost hundreds of thousands or millions.
A famous case of this occurring is James Howells in the U.K, who had 7,500 bitcoins he obtained in the early days of Bitcoin. James threw out the hard drive with the private keys and bitcoins on it, at the current Bitcoin price that is worth more than $15 million dollars.
If James Howells had lost access to his bank account password, he could go into a bank, prove his identity and obtain his $15 million dollars back. With Bitcoin, there is no bank, financial institution or third party to contact to get access back.
Once a private key is lost, all the bitcoins connected to that wallet are lost as well. When a private key is lost, the bitcoins still exist in the network but nobody can access them.
This would be like James Howells going into a bank, they could show him his balance of $15 million dollars but he can’t access it. This is another example of how the security of the Bitcoin network results in less security as there is a higher risk you can lose complete access to your wallet and bitcoins in it.
The owner of the private key is the owner of the bitcoins in the wallet it can access. If someone has access to your private key, they are now the owner of the bitcoins on that wallet.
If someone gained access to your bank account, you could contact the bank and freeze withdrawals, dispute any unauthorized transactions, change your passwords and gain access to your accounts. Your bank accounts may have fraud protection and the bank may be insured against fraudulent transactions and be able to investigate unauthorized transactions.
With Bitcoin, the owner of the private key is the owner of the bitcoins. This would be like someone getting access to your pin code for your bank card and when you go to the bank to dispute the transactions and gain access back to your account they tell you that whoever has the pin code is the owner of the money in your account.
The private key is used as the authority, not your identity, which would be like the bank giving ownership of your account to anyone that has your pin code.
All the advanced security and cryptography built into Bitcoin often leads to people writing down passwords, being unable to reset passwords or losing their bitcoins. As mentioned at the start of this section, the additional layers of security result in less security for most people.
After reading this, you may be worried about using Bitcoin and fear you will lose all your bitcoins. There are alternatives that avoid many of the issues mentioned in this section, there are wallet options with companies that operate similar to existing financial institutions.
They act as custodian over your private keys, you can reset your passwords through email or phone and have customer service you can contact if there are issues, however, using these companies does remove certain benefits of using Bitcoin.
The differences between wallet options are covered later in the book. The end result of all this security, decentralization and removal of intermediaries is that most people are still more comfortable with the existing centralized, third-party intermediaries and standard passwords over Bitcoin’s advanced cryptography and security features.
As great as the technology underlying Bitcoin is, many people prefer to sacrifice those benefits in favor of what they are familiar with and comfortable with.
No Centralized Control is Not Always a Good Thing
“In financial markets, there’s always a mechanism to correct an attack. In a blockchain there is no mechanism to correct it — people have to accept it.” — Robert Sams, founder, and chief executive of London-based Clearmatics.
The design of the Bitcoin network is that no single entity has full control over the network. Changes to the network must be agreed upon by the majority of computers on the network.
While great in theory, this involves getting hundreds of thousands of users to agree on decisions. These decisions are not just putting forward an item and getting the users to decide yes or no, then taking the majority decision.
Anybody can put forward a proposal that requires a decision by the Bitcoin network. 40% of the network may agree on the first proposal, 40% may agree on the second proposal and the remaining 20% may be split over a range of alternative proposals.
No progress can be made until the majority of the network agrees on a decision, meaning development and progress can be stalled for months or longer with no majority agreement reached.
This majority required may be higher than 50% depending on the decision as well. An example of this was the two competing ideas about the future direction of the Bitcoin network.
One proposal was for Segregated Witness (SegWit) the alternative was for Bitcoin Unlimited. Neither proposal was able to get majority support to make the development changes.
While this disagreement was occurring, it caused Bitcoin transaction times to slow and a backlog of unprocessed transactions.
Bitcoin fell behind cryptocurrencies such as Litecoin that were able to implement improvements faster. Eventually, part of the network split off and created its own cryptocurrency known as Bitcoin Cash.
With centralized software or payment networks, companies are able to make changes and decide the future direction of the software. Bitcoin requires approval from a majority of the users on the network to make major changes.
This would be like Visa or MasterCard being unable to make changes unless the majority of people with those credit cards agree upon it. It is slow, time-consuming and when there is no majority agreement, it stalls the growth of the network.
Risk of Attack on the Bitcoin Network
No centralized control means that control is in the hands of whatever the majority of the network agrees upon. If someone is able to control over 50% of the computing power on the network then they are able to control the network.
Controlling over 50% of the computing power of the network is known as a 51% attack, they are able to decide which transactions are valid, they can also reverse transactions, reject transactions and double-spend bitcoins.
The risk of a 51% attack on the Bitcoin network is low due to the amount of computing power and cost required to perform an attack. A large amount of computing power on the Bitcoin network is run by large warehouses full of computers in Russia, China, and a few other countries.
If these organizations were to collaborate, they may be able to control the Bitcoin network or small cryptocurrency networks. The chance of one entity controlling 51% of the Bitcoin network may be low.
However, large Bitcoin mining operations control enough computing power that they can stall development, block a majority agreement being reached and cast deciding votes on the future direction of the Bitcoin network.
Untested new technology
Bitcoin is relatively new and still hasn’t gained mainstream adoption. There are already a large number of problems that are occurring including major scalability and security issues that will be discussed in the next sections. Bitcoin is revolutionary and could potentially become the world’s global currency.
However, the sentence: “_____ is revolutionary and could potentially become the next big / world’s global _____” has been used time and time again for countless new ideas that have failed.
Bitcoin may be more advanced than existing payment methods, however, that doesn’t mean people will use it.
Many of the advantages for Bitcoin are mainly applicable in countries under dictatorships, poorly run governments, countries with worthless currencies, corrupt or non-existent banking and legal systems.
For people living in countries with stable legal and financial systems, Bitcoin may not be preferable compared to existing options.
As more people use Bitcoin, it becomes increasingly unable to handle the increase in usage leading to slower transaction speeds and other problems. It is currently unclear whether Bitcoin will be able to overcome these issues and its possible Bitcoin may never be able to handle the transaction levels of Visa or MasterCard.
There are other cryptocurrencies that are making improvements much faster than Bitcoin. Another cryptocurrency such as Litecoin could replace Bitcoin as the main cryptocurrency for transactions.
Bitcoin is still a new technology, there may still be countless unknown problems it has yet to face. Whether Bitcoin can scale and overcome these issues or whether they will prevent Bitcoin from every being a viable alternative to credit cards and other payment methods is yet to be seen.
Published at Sat, 08 Feb 2020 23:24:21 +0000
{flickr|100|campaign}
