The Cryptocurrency Conundrum: Why Bitcoin and its contemporaries have failed to convince me

It would have been pretty difficult to avoid hearing anything about Bitcoin in the past few months, given its jump from being a mere curiosity known only by technical enthusiasts to a potential investment that mainstream economists and journalists are watching avidly. Some of the advocates for Bitcoin and other cryptocurrencies say that they offer a completely different paradigm for currency transactions, while others are interested in the investment opportunities.

However, the recent bankruptcy and collapse of Mt. Gox, one of the premier Bitcoin exchanges, along with increased scrutiny on the nature of cryptocurrencies by various treasury agencies has caused the price of Bitcoin to jump around like a hyperactive kangaroo. I fail to be convinced of the long-term viability of Bitcoin or other contemporary cryptocurrencies, neither as an investment nor as a unit of currency. I will focus on Bitcoin here, since it is the cryptocurrency with the highest market capitalisation and correspondingly the most interest, along with being the basis for most other cryptocurrencies out there.

Admittedly, as a technical enthusiast, there are some details of cryptocurrencies and by extension, Bitcoin, that I find interesting. The idea that cryptographic protection is built into the protocol, thus stymieing attempts at counterfeiting, has merit particularly from the perspective of e-commerce. Commercial activities have taken off on the internet to an astounding extent, despite the decided vulnerabilities in current payment mechanisms, especially from the perspective of security. Having a secure, well-supported method of payment that is outside the commercial interests of any single party could be useful for improving the weaknesses that currently exist in internet commerce.

Unfortunately, the few advantages that Bitcoin can indisputably claim over conventional currencies are not enough to make up for the many things that can be held against it. These problems begin at the generation (i.e. “mining”) phase, spiralling out from there and include both the computational side and economic factors.

The generation of Bitcoin is done by a process called “mining”. Bitcoin mining effectively involves solving SHA-2 cryptographic hashes for a certain set of criteria, trying to find the most complex way of arriving at that result. I can already see a problem here. As far as I can tell, the only people who actually need to solve cryptographic hashes are security organisations such as the NSA and professional cryptographers. Bitcoin doesn’t fall under the purview of “professional” cryptography – it is simply rewarding computational make-work that has no relation to legitimate problems that distributed computing would resolve. In this regard, Bitcoin is no better than fiat currency, since you’re only trading off the trust of a government’s ability to pay its debts for the trust of computer cycles.

Actually, since I don’t trust computer cycles as a backing for a means of payment unless those computer cycles have been used for something useful, I have to regard Bitcoin as worse than fiat currency. It’s not like there aren’t plenty of things that could be done with those computer cycles either; everything from protein folding to Mersenne prime number solvers to running through the data of a large-scale scientific experiment could be done with the distributed computational power of computers currently used for Bitcoin mining, but instead, they’re being used to solve bloody cryptographic hashes. That’s one strike already for Bitcoin and we haven’t even got past the generation phase.

While we’re on the subject of mining, bitcoins used to be generated effectively by the CPUs of home computers, but as the difficulty of generating bitcoins has increased (as part of a process which I’ll talk about below), the mining process gradually transitioned towards the use of GPGPU techniques, then onto the current trend of application-specific integrated circuits (or ASICs). These ASICs, as the name implies, are not general-purpose computers, but are specialised for the purpose of Bitcoin mining. So, not only does Bitcoin mining involve the make-work job of throwing away computer cycles – and electricity, by extension – on solving cryptographic hashes, but it’s led to the creation of computers for which that is their raison d’être. Great work, Satoshi Nakamoto, whoever the hell you are.

To be fair, though, once you get past the mining stage, the nature of the Bitcoin protocol looks alright from the perspective of computer science – for a while, at least. Bitcoins are stored using a digital “wallet”, to which the user provides an address which takes the form of a long hexadecimal number. Payments can be made to other Bitcoin users by knowing their addresses. However, we hit a stumbling block here when it comes to using Bitcoin as a means of payment for e-commerce. Bitcoin has a one-way system for transfers, which for various reasons is not suitable for most purposes in the field of e-commerce. What about refunds, for instance? That isn’t covered very well within the Bitcoin protocol. Nor are transaction cancellations, which would have particularly interesting, if not especially desirable consequences regarding micro-transactions within smartphone or tablet apps, where an alternative to payment by credit cards would be rather desirable.

Let’s just consider the case of a parent who has just handed their child their smartphone and returns to find that the child has bought several hundred dollars of in-game purchases in some shitty freemium game. This sort of scenario can happen and has happened in several high-profile cases – and certainly, the parent isn’t going to want to keep all of those in-game purchases. Some people may say that the burden should be placed on the parent and if they didn’t want it to happen, they should have been more careful, but really, I can sympathise with the parent on this one.

I mean, let’s say your child is whining about something they want, which happens regularly. You’re busy trying to get some work done around the house or something and you just want a break from the moaning going on in your ear. So, you hand your smartphone to the child hoping that they’ll find something that will shut them up for just one moment. Unfortunately, you forgot to sign your account out of the smartphone’s store and of course, Murphy’s Law will dictate that the one time you forgot to sign out will be the time when the child wants to make his way through the catalogue of crappy in-game purchases. By saying that you should be more careful as to let your child mess around with your phone, you could just as well insinuate that you should be more careful as to have children in the first place and that argument doesn’t tend to go down well.

Bitcoin is even more vulnerable than credit cards to this sort of scenario; credit cards usually have limits, whereas somebody with a Bitcoin wallet could spend the lot and all you’d have would be the recordings of the transactions on the address. Good luck getting your money back as well, since these transactions can’t be cancelled when it turns out that you’ve made a mistake – or that the product that you ordered is late or whatever problem you’re having. Not a very good thing for a currency, wouldn’t you think?

Returning to a point which I made above, Bitcoin mining has become more difficult as time has progressed, which has prompted the use of ASICs. Part of the reason why Bitcoin mining has become more difficult is because of an inherent detail of the protocol and of Bitcoin in general – there is a finite number of bitcoins that can be generated. Only 21 million bitcoins will ever exist, generated at a steady rate per week – which requires the generation of bitcoins to be more difficult as more computational power is used to generate them – and the rewards will diminish with time. Danger, Will Robinson! Talk about an economic faux-pas: what we’ve fallen into here is an inherently hyper-deflationary currency.

Inflation and deflation are not two sides of the same coin, but both are considered to be deleterious to some extent in an economic system. However, mainstream economists tend to consider inflation less harmful than deflation and fiat currency systems that are in use today have a small, but usually controlled rate of inflation. The reason that economists prefer inflation to deflation is that such a scenario encourages people to buy things since the value of their money will decrease rather than increasing with time, along with being more helpful to debtors rather than creditors – a debt made for a certain amount in a deflationary system will continue to accrue value, which discourages entities from taking out debts in the first place. When those debts would be used to catalyse the growth of a new business, then there becomes a case where deflation becomes harmful to economic growth. The once-vaunted Japanese economy, which looked set to take over from the United States of America as the world’s biggest economy in the 1980s, has suffered from deflation since the early 1990s. With Bitcoin, you would therefore use a system which actually incorporates deflation – and at a huge rate – into its very form of being. I’ll leave you to draw the conclusions.

Another problem for Bitcoin from an economic perspective is its volatility. As I’ve said above, the price of Bitcoin jumps around from day to day like a hyperactive kangaroo, and sometimes, hundreds of dollars per bitcoin can ride on various decisions by speculators and treasury agencies wary of the potential effects of Bitcoin alike. The recent collapse of Mt. Gox sums this up nicely; in the last month, the price of bitcoins has jumped between more than $700 per bitcoin to a trough of less than $480 on February 25th, when Mt. Gox went offline, before promptly jumping back up to more than $600. Bear in mind, this was in a single month – if the dollar went haywire like that, there would be hell to pay! Would you really risk spending money with the potential for it to add another half again onto its value, or receive it with the risk of it almost halving in value? If you would, you’re braver than I am – or infinitely more foolhardy.

We need to note here what Mt. Gox actually stood for – it was originally an initialism for “’Magic: The Gathering Online’ Exchange”. No, you’re not reading that wrong – it was originally a site for the exchange of cards from a fantasy collectible card game. Actually, no, I have that slightly wrong – it was originally a site for the exchange of digital, virtual cards from the online version of a fantasy collectible card game which only exist at the whims of Wizards of the Coast. This is what I find to be one of the most terrifying things about any ideas of moving to Bitcoin as a currency – putting your money into the hands of a bunch of nerds who have no real clue about anything but the mathematical tendencies of economics and have probably convinced themselves that their computer science experience gives them insights into the economic world while only understanding that small portion of it. That, to me at least, seems like a big mistake waiting to happen – and I say that as a nerd with no real clue about anything but the mathematical tendencies of economics who has convinced myself that my computer science experience gives me insights into the economic world while only understanding that small portion of it.

Another group of people who are very vocal on the issue of Bitcoin and who are correspondingly very worrying are the Randite libertarians who have embraced Bitcoin and its decentralised nature. Randites are particularly annoying to deal with, because of their odious selfishness-led philosophies and their propensity to believe any sort of ludicrous fantasies as long as they work against the aims of organised government. It doesn’t help that the very founder of their Objectivist ideals was a hypocrite who railed against government assistance, yet seemingly felt no shame in using it herself, nor does it help that Alan Greenspan, who, as Chair of the Federal Reserve, presided over the biggest recession since the Great Depression, is a self-confessed Randite. I think that’s the piece of straw that broke the camel’s back on that issue, although interestingly, even Alan Greenspan doesn’t think that Bitcoin is a good idea. You’d think he’d have first-hand experience of a financial bubble, wouldn’t you?

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