RedBeard's Curious Life

I hadn’t heard of BitCoins a couple of months ago, but they’re currently hitting a few mainstream media outlets. Nobody seems to have a solid handle on them or where they’re headed, but speculation has driven the trading value of BitCoin shares through the roof in the past year. I can’t quite tell if it’s a well-marketed ponzi scheme or a legitimate new-world currency, but I’m leaning quite heavily towards the former.

How do they work?

• Visit bitcoin.org for the semi-official description. Here’s my take…
• BitCoins are produced at a fixed (predictable and dwindling) rate over time by computing cryptographic hashes of various “difficulty”. One “successful” hash block is expected every 10 minutes.
• Transactions of BitCoins are conducted by signing some data with public and private keys, where the public key is used to announce the new owner, and the private key is used to renounce existing ownership. https://en.bitcoin.it/wiki/Transactions
• A successful hash block stores all of the transactions which have transpired in the intervening 10 minutes. https://en.bitcoin.it/wiki/Blocks
• Transactions and successful hash blocks are shared over a peer-to-peer network so they can be “verified” and the next block must refer back to a previous successful hash block, creating a “chain” of transaction histories.
• All machines on the network are racing to complete a successful hash, because they get the 50 BitCoins produced by it. GPUs are faster at hashing than CPUs, but a lone machine is quite unlikely to win the hash lottery; pools of shared machines have cropped up, where many machines cooperate to find a successful hash and then share the output proportionally among the pool members. http://bitcoinx.com/profit/
• The cost of producing a successful hash changes over time according to the hash rate of the network as a whole. A single machine may produce the first million bitcoins over the course of a year, but the next million may consume the resources of a million machines for a whole year, and the next million could be produced by a single machine again (although that last possibility is highly unlikely).

Beneficial Aspects

• Low or no transaction fees
  • Relative to credit cards, which charge at least 3% of the value of the transaction
  • Hash-computing machines may charge transaction fees on all or unusual transactions, of an arbitrary amount
• Potentially anonymous transactions
  • Transactions can be scattered across sender and recipient addresses which make it difficult to trace the owners of the sending and receiving addresses
  • Supposedly useful for buying goods and services on the internet (although the seller still needs to know some details in order to deliver)
  • Perfect for black market trading
• Predictable money supply
  • Supposedly immune to the whims of a central banking authority
  • Implies deflation (increasing value of currency) as the economy expands
• Effective currency by most measures
  • Durable (assuming data is immortal)
  • Portable, high value density
  • Easily divisible
  • Difficult to counterfeit (assuming cryptographic security)
  • Liquid (perhaps)

Problematic Aspects

• Cryptographically unproven
  • The block hashing algorithm searches for a hash in a given range
  • SHA-256 is not known to have specific collision attacks, but a range collision attack is probably far easier
• Too complex for many people to understand, in theory and practice
  • Theory: much more complicated than cash or commodities, and this is before any loans enter the picture
  • Practice: wallet management, transaction security, anonymizing, etc
• BitCoin production (mining) cost increases linearly with demand for production
  • The hash work expectation means that as more individuals enter the BitCoin production market, the higher the per-unit production cost for everybody in the market.
  • In order to sustain production, the value per unit must increase.
  • If the value does not increase sufficiently to provide profit incentive, producers will abandon the market.
  • This scheme heavily favors early adopters who enjoy cheap production and can then liquidate their assets for extreme profit.
• BitCoins have no intrinsic value, but a high production cost
  • Gold is costly to produce (mine) but also has aesthetic and utility value
  • Paper dollars have low production cost and low utility value (its value is derived from government backing)
  • With no intrinsic value, there is no price floor in an exchange, which may invite hyperinflation
• Irreversible currency destruction is possible
  • If you lose your wallet, the money in it is destroyed forever
  • Paper dollars can be printed to shore up money supply
  • Gold can be rediscovered and refined
• No fraud protection
  • Isn’t that what all those credit card fees cover?
  • Cash has similar flaws, but you typically exchange cash and real goods simultaneously in a real-world transaction with the option to back out if the goods are not correct.
• Anonymity is difficult to maintain
  • All transactions are visible to the world
  • If someone knows your public address, they can trace every transaction involving it
• Whole number of bitcoins is too small for practical use
  • The upper limit on the number of whole BitCoins (after 130 years of production) is 21 million
  • microbitcoins are not a friendly unit for people to deal with
• Transaction verification time is too slow for instantaneous purchases
  • One successful hash block every 10 minutes
  • That means AT LEAST a 10 minute wait before that block is distributed and verified
  • That block might not even include your transaction, if the computing machine didn’t like your offered transaction fee
  • If you don’t pay a sufficient transaction fee, your transaction might float around the network indefinitely
• Few legitimate means of buying or selling BitCoins for other currencies
  • Supposed exchanges accept cash, check, bank transfer, or a medley of unpopular secondary exchanges (no credit cards or PayPal)
  • None of those options is inherently reliable for online purchases or very good for anonymity
  • This really raises the stink level of the whole enterprise

Resources:

• http://www.quora.com/Is-the-cryptocurrency-Bitcoin-a-good-idea/answer/Adam-Cohen-2
• http://falkvinge.net/2011/05/29/why-im-putting-all-my-savings-into-bitcoin/