Armin Ronacher's Thoughts and Writings

Bitcoin is Not a Good Consumer Product

written on Monday, April 13, 2015

Writing critical essays about Bitcoin is probably not a very good idea, judging by past feedback on tweets. However the topic is burning on my heart and I really want to share my thoughts about it once and for all since I'm getting more and more the feeling I live in crazy land. Bitcoin brings out the worst in people.

I really do not believe that Bitcoin (or any other cryptocurrency for that matter) is a viable consumer product. Not now and not in 50 years. More than that it feels like we're all wasting a lot of time and money trying to figure out what to do with Bitcoin.

This is really not a very technical post because there is not much that should be said about Bitcoin on a technical level. While it might be a revolution in thinking, it's slow and wasteful and completely incapable of handling transactions on the volume of our banking system by itself.

If Bitcoin wins as technology then because the actual use of the technology works for large money transmitters (banks, credit card companies) and not a typical end user. I do however believe that for those applications other systems are more appropriate than Bitcoin.

The Need for Change

I do want to point out that I definitely see the need for change in the financial system and I have very little doubt that change is not coming. The way current transactions clear is pretty ridiculous given how far we have advanced with technology in other areas. If Bitcoin was just that, I would embrace it in a heartbeat. Unfortunately Bitcoin is 10% technology and 90% politics.

I absolutely do not agree with the idea that in the process of improving transaction infrastructure, we should do away with governments, banks and pretty much everything else. So while this criticism here applies to Bitcoin, Dogecoin, Peercoin and god knows what other cryptocurrencies are out there, it does not apply to Ripple or Stellar. If you are interested in the technical bits of Bitcoin, you might want to monitor those projects instead.

But enough about that, let's look at Bitcoin and friends.

Bitcoin the What Exactly?

Bitcoin is many things at once, and that makes it hard to write about it. It's an economic system, a currency, a distributed ledger and a community and some bizarre investment vehicle with ponzi incentives.

The Technical Bits

Bitcoin is hailed as the big technological innovation. It has been compared with the invention of the internet. At its core it's a very simple system but hidden behind a lot of finance-theory mumbojumbo that makes things appear more complex than they are.

I liked Graydon Hoare's description of Bitcoin:

[…] the problem space that “bitcoin” launched itself into:

The problem of acquiring — automatically — a system-wide consensus view of a data structure otherwise built using a totally open-ended membership, using content-addressed storage of “accounts” and a spine of linked hashes of the transactions causing them to change (the so-called “block chain”).

You could call it the problem of automatically selecting, at any given moment, an “official” branch out of all the forks of a git repository in existence in the world, so that everyone knows “where to look” to get “the official” current state of it. Only this git repository contains financial account balances and you have to be the owner of an account to change it (this part is comparatively easy cryptography).

Bitcoin throws a whole pile of obnoxious goldbug monetary theory and ponzi scheme incentives into the mix to spread itself, but at a protocol level that's all it's really trying to do.

Moreover, in order to resist sybil attacks — it's built to have open membership — it also uses cryptographic puzzle-solving (based on compute-power) to distribute the authority for selecting the official consensus-state. This has set up a ridiculous hardware-manufacturing arms race in a very particular flavour of compute-power (colliding prefixes of SHA256), burned a small country worth of oil, and produced a “transaction processing” network with extremely confusing and non-obvious failure modes that can sustain about the same rate of account-updates as, say, a team of human slide-rule operators. […] A single cell phone runs circles around it in transaction processing capability, and I tend to think this matters.

Bitcoin as it exists today is slow and does not scale. It also has a fundamental problem that bigger protocol changes require centralized agreement or the whole house of cards can collapses. I believe this inherently limits the total number of participants in the network and makes it more interesting for an inter-bank clearing system than an end user product.

A Look at the Target Audiences

But oddly enough, it seems like not many people are worried about that. And in fact, Bitcoin gets a lot of support by non banking institutions. So why might that be? Who are those people? And why are they interested in the Bitcoin so much?

Bitcoin for the Concerned Citizen

There is a certain demographic which see ill will and conspiracies around every corner. A second demographic sees governments as a beast from hell and taxes are what supports that monster. The intersections of those two groups seems to overlap scarily close with a sizable chunk of the “Bitcoin community”. If your base assumptions are that this world works like this, then I assume that many of the perceived benefits of Bitcoin (distributed, somewhat anonymous, non government controlled etc.) might make a lot of sense.

Let's assume for a moment that the world would work like this; wouldn't Bitcoin be the worst economic base in such a world? Without Internet there is no Bitcoin. This might not seem like a big problem, but when we go by recent examples of where people were faced with governments that clearly had bad intents, the availability of internet was very quickly “spotty” or gone entirely. When the Arab Spring took place the people in the countries most affected by violent revolutions either lost their internet access quickly through government control or because the infrastructure ended up destroyed. In either case using Bitcoin for everyday transactions would have been impossible.

Bitcoin is often called “digital gold” by supporters, but I'm not sure how much of Gold's properties actually apply to Bitcoin. It's not that I have a great understanding of assets (or economics in general) but I can understand the appeal of gold a lot. It's rare and the artificial creation of Gold is many times more expensive than the market price (let alone that it's much more likely that you produce a radioactive isotope). It's also easy to verify if what you're dealing with is really gold. It's also very physical: you will notice if someone tries to steal your gold and you can easily check if it's still there. Aside from all of those nice properties, it's also useful for humans for other things than keeping locked up as an asset as one can also make pretty things and useful things out of it.

Bitcoin on the other hand is none of that. You can't even tell if you own a Bitcoin or not. You might hold the private key to a Bitcoin wallet which might hold some amount of Bitcoin or not, but that's about the closest you will ever come to owning it. Even if you would be 100% sure that nobody ever figured out your private key, you might still not be sure if you actually have control over anything. The reason for this is that your Bitcoin is really only yours if the health of the network is guaranteed. If (for whatever reason) the world conspired against you the network can just take away your wealth or decide to no longer accept it.

While that might not sound very likely to right now, things along this could very well happen. There are already websites that blacklist Bitcoin addresses. Truth be told: I actually think that it would be good if Bitcoin would develop in a way that you can lock away currency. Freezing of accounts is a very important feature in a well functioning state, and currency systems like Ripple are working on freeze functionality. But even in the Bitcoin world, because movement of money can be tracked, there is really nothing that would stop this from happening and in fact, there are already exchanges which try to prevent the sale of stolen Bitcoin.

I'm pretty sure that for concerned citizens, gold is still the better idea. Probably until the government decides to outlaw it.

Bitcoin for Criminals

This is without a doubt, the most promising area for Bitcoin: the criminal element. There is not a day where a Bitcoin exchange gets hacked, or someone uses Bitcoin as a way to extort money out of people. Not exactly surprising because Bitcoin's biggest “strength” is its inability to link Bitcoin transactions to individuals and the irreversibility of them.

However independently of if Bitcoin was created as a ponzi scheme or not, the non legitimate uses for it are uncountable. Bitcoin has been successfully used to fund illegal online markets, to extort money out of victims, to take over stolen cloud infrastructure to mint coins, to washing money gained from stolen credit cards and much more. Bitcoin can not just just be used to attack people willingly engaging in the Bitcoin ecosystem, but also by harming people that have nothing to do with Bitcoin. A good example for that is the CryptoLocker ransomware which encrypts people's harddrives and asks them to pay in Bitcoin to unlock it. Before Bitcoin this sort of “business model” was too risky to pull off, but now it's easy and safe.

Bitcoin will always be valuable for criminals because Bitcoin is written with the idea in mind that oversight would be automatic and controlled by Bitcoin users, and not financial institutions or governments. As such it fundamentally lacks the necessary tools to deal with theft and money laundering. I'm pretty sure if Bitcoin wants to take off as a accepted financial product, it will eventually have to gain support for for binding payments to individuals.

Bitcoin for Investors

Bitcoin in itself is already of quite questionable nature. The incentives for investing are not too different from those of a pyramid scheme. Bitcoin at the end of the day is without value. The value of Bitcoin is entirely made up by the consensus of Bitcoin traders. However the initial developer decided that inflation is the root of all evil and as such (once all Bitcoins are minted) is inherently deflationary. Crazily deflationary in fact. Not just because the supply is fixed (and economies are expected to grow), but also because people lose coins.

While Bitcoin's monetary base inflates like crazy until 20 years or so from now, there is a natural tendency to hoard coins (colloquially apparently called to “hodl”) for as long as possible.

This is interesting for traders because it means that their coins will lose value on the short term, but if they keep the dream alive for long enough, they probably gain in value. As such communities of early adopters form who try to advocate for the currency for more people to join and for the demand of the currency to go up. This will increase the value of the coin (and as the minting of new coins becomes more and more expensive) will reward the early adopters much more than the ones that join late. I assume the ones who make money of Bitcoin currently (other than early investors) are miners that manage to get away with burning CPU cycles on cheap electrical energy that they get from somewhere.

Bitcoin for the Deceased

While dead people are clearly not a customer base for Bitcoin, dead people are a fact of life. People die, and usually in the worst possible moment. One thing that many dead people have are assets and a significant number of dead people also have next of kins that would like to inherit something. When one of my childhood friends unexpectedly passed away I was able to witness what this can mean to friends and families. It's not enough that everyone is in grief, dying is a lot of work. There are bills to pay, there are property to return or split up, there are contracts to terminate, Facebook profiles to close and many other things to consider.

Passing away is a very regulated process. Most things in life are specifically designed so that death is considered.

Bitcoin does not consider death. When you die and nobody but you knows your private key, your assets are gone.

So you need to protect against this somehow by … what exactly? Maybe you are supposed to share your private key, maybe put it in a bank? Under your mattress? But hey, when you die and lose your coins, everybody else gets a bit richer anyways.

Bitcoin for Everyday People

This is the place where I will do a pitch about how I do banking in Austria. My bank of choice provides me with an overall banking experience that is pretty close to perfect. Because it's in the SEPA region, any transactions I do in the Eurozone settle for free (and typically same or next day), my credit and debit cards support NFC, my phone receives a text why my credit card is charged, for online banking the 3D secure enabled stores ask me for 2FA when doing new transactions. Lastly the Online Banking Experience is beautifully designed and just fun to use.

Sure, not all banks are the same, but I have never been so happy to send people money. It's fun, and it's magical and when compared to a few years ago it's just very impressive to see how times change. It also shows you how ridiculously fast the credit card network is. I bought a ticket via my Mastercard for the train to the airport once, but the machine was out of paper after charging my card. It managed to print the receipt but not the ticket. Before the machine even managed to start printing the first thing I already received a text that my card was charged. Before the error occurred on the device, I got a refund confirmation on my phone. The whole operation took less than 5 seconds but the Mastercard network already processed two transactions and did that through systems interconnected to my bank. Say what you want, but banks modernize.

Not that most non technical people care about this stuff anyways. But they care about being able to pay conveniently and to send money around quickly. The vast number of transactions that people do via their online banking is to local services (electricity, flat rent, mortgage payments, etc.). For internet purchases pretty much everybody uses a creditcard. I know the Bitcoin community likes to point out how 16 digit numbers are a ridiculous security concept and right they are. Except modern creditcard transactions rarely use that information. NFC terminals make it very impossible to skim data and for small transactions no PIN is required. In the future we will probably see a more widespread adoption of other confirmation methods that no longer require a PIN input (see apple pay). This evolution is already happening and you can see more and more NFC terminals popping up. Internet payments have been equipped with 3D secure for ages and it won't take long until it will become pretty much mandatory.

The end result of all of this is that it becomes a lot safer for your average consumer to do online shopping and banking. It might not be the same everywhere yet (and it's certainly underdeveloped in many countries; including the US), but there is progress. And that progress is backwards compatible which is a huge thing.

Bitcoin? What would my parents get from that? Credit card transaction fees are lower than the cost (and risk) of conversion of currency from and to bitcoin and are factored into the price. All the other points of bitcoin are working against the consumer: they are harder to handle or secure, there is no bank provided escrow or insurance system, there is no well documented flow of how to do transactions, refunds etc.

Bitcoin for Merchants

Right now, you can milk money off Bitcoin users. Overstock is successfully doing that. But other than that I don't see why a Merchant would try to add Bitcoin. It's more work, it makes accounting unnecessarily hard and there really is no user reason for it. Maybe you can that way accept payments from countries that you are not allowed to do financial transactions with, but then, you're probably already quite in a tricky legal situation.

So What To Do With It?

All of the above would make it sound like Bitcoin is for nobody. While I really don't think that given the available technologies, Bitcoin is the one to be looking out for, it might be the one that wins. But it would probably only be used for settle transactions between Banks and not by end users. For that the network is neither strong enough nor user friendly. I fully expect that the “currency” aspect of Bitcoin will be dead in less than five to ten years.

I believe that ultimately Bitcoin gets too much wrong, and the biggest problem with it is that it's based on a wrong idea.

Bitcoin is based on the idea that you can replace trust with computation. I'm pretty sure there are fancy papers that explore the topic of trust in detail, but the crux of it is, that trust is more of a chain.

While the mantra of the Bitcoin community appears to be “vires in numeris” when it should rather be “omnis fides in alia fide iacet”. It's trust all the way down. You can't do away with trusting people. You need to trust the Bitcoin developer, the server that provides the Bitcoin client, the integrity of the SSL connection by trusting the CA. You trust your computer to work the way you think it does and you have to trust the largest miners.

That Bitcoin's greatest fear, the 51% attack is unlikely to happen is not so much a law of nature, it's the Bitcoin user's trust in that a group of miners would not try to harm their investment. At the end of the day however Bitcoin users trade the trust in their banks for trust in something else. I would be a lot more worried about an anonymous and unregulated network like Bitcoin being gamed by a criminal who has too much money and attempts a 51% attack and getting away with it, than banks colluding. As terrible as abuse in the financial system is, it very rarely results in individual loss. Typically it's a shared loss we all have to pay with our taxes.

Bitcoin thinks that by replacing trust with a game of who has the bigger miner it has found some sort of solution to human misbehavior. I really don't believe that.

There are Other Things out There

The reason I finally decided to write about some of my problems with Bitcoin is not that I inherently hate the idea, but because there are so many better solutions for the problem of international money transmission out there.

On the one hand there are already established systems like Transferwise for making international payments cheaper already now, there is Western Union which despite all the bad reputation it has, is a life saver for many people out there. One should not discredit old financial institutions that innovate. There are many banks who are doing great work in revamping their offerings.

On the other hand there are really interesting newcomers such as Ripple and Stellar which try to build decentralized payment systems that do not come with their own world-view but try to integrate into our modern banking world. I think they deserve much more attention than they currently get.

This entry was tagged bitcoin and thoughts