Confessions of a Bitcoin sceptic

I could be fabulously wealthy right now. When I first wrote about Bitcoin, the price was $14.65 USD, and as of writing, the price is hovering just above $12,500 after undergoing a few ups and downs since December. If I had bought 10 BTC that day for a $146.50 USD investment, those 10 Bitcoins would be worth over $125,000.

That’s quite a large “what if”.

I am what is known by Bitcoin proponents as a “nocoiner”, a person who knew about BTC early on, but did not invest. However, I sleep quite well at night as I am certain that even if I had invested then, I would have sold coins in many of the various stages in which the price has been going up. But most importantly, many of the doubts that I had back then still remain, with various new problems arising.

So what are the issues? (for an earlier look at some regulatory problems, see this article).

Failure as a method of payment

One of the earliest promises of Bitcoin was that it would be an unparalleled decentralised, open source currency where transactions would be fast, cheap and transparent as they would be lodged in a distributed cryptographic immutable public ledger called the blockchain. The currency is not issued by central body, but rather mined by people around the world who dedicate computing power to perform transaction verifications and are rewarded for their efforts.

Reality has been very different. While Bitcoin has been in existence since 2009, the number of places which accept it as a means of payment has remained limited, and on the contrary, some corporate adopters have stopped taking it altogether, such as Dell and Steam.

There are various reasons for the lack of success as a payment method. One of the main problems is price instability, just in the last couple of months the price of Bitcoin has gone on a roller-coaster ride, jumping from $7,000 to $19,000 in one month, and then down to $9,000 and then up to about $12,000. This volatility makes BTC particularly unsuited for merchants, as they could risk a wild variation in price in a short period of time that could dissipate profits. During the latest crash, the price dropped 12% in three hours, a variation that is unacceptable and is unsuited for a stable currency.

Many people were willing to ignore these problems as long as the price went up, but this creates another problem that has been identified with Bitcoin, deflation. When prices go up, we get what I call the “Bitcoin pizza” problem. In 2010 a software developer called Laszlo Hanyecz paid for a pizza with 10,000 BTC; as of today, that pizza is worth over $120 million USD, and it has its own Twitter account. The problem with a deflationary currency, and particularly one that has gained so much value in the last years, is that nobody wants to spend it and hoarding becomes an issue, this has become its own Internet meme, and it’s known as “hodling“. Nobody wants to spend their bitcoins, so they become useless as payment method.

But the main problem in recent months with using Bitcoin as a currency is that transaction times and fees have become prohibitive, the average transaction confirmation time as of today being 263 minutes, and the average transaction fee at an astounding $25 USD average, and it got to over $50 during December 2017. There are various reasons for this, including the size of each mined block, the reward given to miners, and the limit in the number of transactions per second to ensure decentralisation. The issue is therefore systemic, and one could argue that the more successful Bitcoin gets, the more useless it becomes as a currency.

Several solutions have been proposed for this, including changing the code itself (a hard fork), and changing elements of the ecosystem to bypass Bitcoin’s scaling limitations (soft fork). A few hard forks have been made, such as Bitcoin Cash, but this is a controversial solution that still splits the community. The preferred solutions right now are Segregated Witness (SegWit), and the Lightning Network (LN), but these have been criticised for various reasons. In particular, LN seems to be a highly problematic implementation that necessitates the existence of funds and mandates lending, which could actually complicate the environment even further.

Store of value

As a response to Bitcoin’s difficulties as a currency, proponents have been advocating it as something entirely different, it is actually a store of value, digital gold instead of digital dollars. They say that Bitcoin’s viability is not as a payment method, but it rather rests in its superior technology, on its use of the blockchain, and on its scarcity (there is a limited amount of BTC). So instead of buying gold or making other investments to store your hard-earned fiat currency, you should convert it into Bitcoin.

There are of course various problems with this. Firstly, there is an assumption that prices will continue to go up, but this rests on several assumptions. Just because the price has gone up in the past, it doesn’t mean that it will continue to go up in the future. On the contrary, as BTC’s value went up, the various scalability issues came to the forefront, and its unique inability as a payment method dissuaded potential investors, so with no new money flowing in, the price dropped. Those who bought BTC at $19,000 because they thought that the price could only go up were left holding the bag.

Moreover, the lack of transparency in the ecosystem still bothers me, just as it did from the start. Satoshi Nakamoto‘s identity remains shrouded in mystery, and there are still large amount of coins held by unidentified people. Moreover, over the years there have been lots of heists, robberies and hacking attacks against Bitcoin users, leaving large numbers of coins in the hands of real criminals. Similarly, since its inception it was used by criminals in the Dark Web as a method of payment for drugs and other unsavoury practices. This means that large amounts of BTC are held by shady characters and criminals, as well as anonymous people who do not respond to anyone. Call me crazy, but investing in a currency that is controlled by so many obscure interests does not fill me with confidence of it being a sound store of value.

Unregulated intermediaries

While Bitcoin and other cryptocurrencies are entirely decentralised on paper, their success depends in large part on the existence of exchanges and other intermediaries. As mining has become prohibitive for everyone but dedicated conglomerates with large amount of computing power, the only way to obtain Bitcoin is to receive it for payment, or to purchase it with fiat currency or with other cryptocurrencies. As BTC is no longer viable as a currency, this usually means that to get your hands on some Bitcoin you need an exchange that can perform the transaction. There are other intermediaries that perform other functions, such as wallets to hold BTC, derivatives, and even lending. A lot of these activities are heavily regulated in “regular” financial markets for a reason, intermediaries of these nature are handling funds and investments in ways that require quite a large amount of trust and transparency.

Exchanges are the chink in the armour of Bitcoin’s decentralisation, and throughout its short history there have been a large numbers of amateurish and even fraudulent intermediaries (see Mt.Gox). The reason for this is that for a while exchanges operated completely free of regulation, which is actually something that doesn’t seem to bother some Bitcoin enthusiasts. As more regulators started paying attention to exchanges, an interesting split seems to have occurred in the community. On the one hand we have legitimate regulated intermediaries that seem to be operating following the letter of the law, and on the other hand we have a number of dodgy and obscure exchanges that appear to be operating outright scams and ponzi schemes in areas where regulators have been reluctant to intervene. The latest horror story is Bitconnect, an exchange and lending operation that is running both a cryptocurrency (BCC), and a blatant ponzi scheme that appears to have left investors in the cold with large losses. There had been warnings from many in the community that Bitconnect was not operating properly, but this did not stop investors pouring money into the exchange, until it shut down earlier this month.

This is a big problem for the cryptocurrency environment right now. Regulation is anathema to many of the libertarian and anarchic enthusiasts who see Bitcoin as the perfect response to what they see is a corrupt union of governments and traditional financial institutions. Regulation is therefore feared, but it is precisely that same regulation that is supposed to be in place to stop scammers and fraudsters taking advantage of ill informed investors. Moreover, any photogenic millennial with a couple of months of trading experience can go on Youtube to provide investment strategy, and sometimes outright shilling in favour of fraudulent businesses such as Bitconnect. In the era of the demise of expertise, memes and “influnecers” rule.

The latest questionable practice is Tether (USDT), which is Bitcoin’s attempt to peg crytptocurrencies to some fiat value while bypassing strict national regulation. Tether is a cryptocurrency token that is allegedly supported by US Dollars, in other words, for each Tether in existence, the issuers claim that there is a USD supporting its value, so it’s nominally pegged to the USD. However, the company has obscure origins, and for a while its operations were kept secret, which did not stop many exchanges accepting it. Thanks to the Panama Papers we have learned that Tether was created in the Virgin Islands (which should already raise some eyebrows) by the operators of Bitfinex, one of the largest BTC exchanges. Further research unveiled that Tethers are supposedly held in a tiny Polish bank, further providing doubts about the operation. And to put the icing on the cake, during the current crash, as the price dropped to $9,000 USD Tether’s operators started printing tokens to an alarming rate, up to $650 million in the last week alone, bringing the total amount of Tethers to $2 Billion USD. Needless to say, there are worries that Tethers are being used to artificially maintain the price of Bitcoin during a downturn, as the printed value created out of nothing is being used to buy cryptocurrencies.

If Tether and Bitfinex are eventually the subject of regulatory oversight, this could lead to a huge crash for Bitcoin, so stay tuned (and follow Bitfinex’ed on Twitter for updates).

What is clear is that it should be suspicious that any hint of regulation tends to send the price of Bitcoin tumbling as some exchanges could be running price manipulation in an unregulated market, such as painting the tape and wash trading. Moreover, researchers have found that it is possible that a single actor was able to manipulate the price of Bitcoin from $150 to $1000 in the time of Mt.Gox.

Security and replicability, old concerns

As Bitcoin’s value went up, so did the potential for hackers to try to steal them. While Bitcoin itself is protected by strong cryptography, users are vulnerable to attacks that try to steal their coins. Hackers have been successfully targeting exchanges exchanges and users, managing to steal hundreds of thousands of BTCs; a list of stolen coins over the years contains over 1.8 million BTC have been stolen in major incidents, and this does not include everyday attacks. Strong encryption does not protect against fraudsters and scam artists. The security issues with Bitcoin are hard to assess, but there are various security issues with very high risk, such as general security, subversive miner strategies, loss of keys and man-in-the-middle attacks.

The other problem is that when your coins are gone, they are gone for good (I should know, I still have 0.01 BTC in a broken hard drive). If any coins are stolen, the community will either blame the victim, or say “sorry for your loss”. The victim blaming is an interesting phenomenon. When someone complains that they were hacked or their coins stolen, people in the community will often criticise the security measures of the hacked person, and it seems like to be able to operate in the Bitcoin environment, one needs security skills that rival those of a bank. I have always seen this as a huge obstacle for adoption.

Growing complexity

Related to the last point, the complicated nature of Bitcoin and the cryptocurrency environment presents problems for mainstream interest. During the years, I have tried to explain cryptocurrencies to people who know that I am interested in Bitcoin, and I often lose their interest; “too complicated” is a common reaction. The problem is that even Bitcoin proponents admit that there is a large learning curve to understand the technology properly, and understand it they must, otherwise they will get hacked. So we have an interesting paradox, Bitcoin enthusiasts ridicule the mainstream for not understanding BTC, but at the same time yearn for wider adoption that will bring the price up, justifying their early adopted status. Needless to say, both practices are incompatible.

Things are made more complicated by the proliferation of cryptocurrencies and Initial Coin Offerings (ICOs), producing a soup of acronyms that can confuse even those interested in the space. And if you don’t know your ETH from your LTC, or your BTC from your BCH; if you can’t identify what a SegWit is (which you should totally be using), then you are laughed out of the community.

The result is a decreasing number of techies and geeks that can make the price go up. And this is all that matter to some.

Environmental cost

The computational power dedicated to mining has continued to increase over time. In Bitcoin, computing power is called the hash rate, and the unit of measure is the hash/second, meaning a calculation per second. Ten tera hashes per second (Thash/s) means that the network is performing 10 trillion calculations per second, with the hash rate at the time of writing standing at over 19 million Thash/s. Whichever way you measure it, that is an astounding amount of computing power used to produce value, which could have a large impact on the environment. Researchers found that the entire Bitcoin network uses energy that exceeds the use of 159 countries. Even under normal circumstances, such a staggering amount of energy expenditure might prompt questions about Bitcoin’s carbon footprint and other related environmental problems.

Breaking the Blockchain?

While Bitcoin may have a lot of issues, a lot of people have decided to back its underlying database technology, the blockchain. Even if Bitcoin tanks, the blockchain will remain.

The blockchain is a decentralised, distributed, cryptographic public ledger. This sounds very impressive, and proposals have been made to implement a blockchain in everything from music licensing to bananas. While I have been considerably more enthusiastic about the blockchain’s potential than cryptocurrencies, this initial enthusiasm has waned in recent years. The main problem is that for all its promises, blockchains are difficult to implement, and could prove to be less efficient and more cumbersome than existing solutions.

While blockchain hype has been increasing, some scepticism started seeping in. Many projects that started out as blockchain ended up implementing different technologies, this is because institutions thinking of developing a blockchain face time constraints, barriers to adoption, and sheer complexity. More interestingly, of 26,000 blockchain projects listed in the open source repository GitHub in 2016, only 8% survive to this day.

Perhaps the most scathing and interesting attack against blockchain hype has come from Kai Stinchcombe, who made a lot of waves by pointing out that in ten years the practical uses for the blockchain have been minimal, or even non-existent. While I disagree with the categorical statement, he does a good job of dissecting various case studies in favour of the blockchain, and finds them wanting.

Another fantastic critic of blockchain hype and Bitcoin in general is David Gerard, with his awesome book “Attack of the 50 Foot Blockchain“.

Concluding

I often dread writing about Bitcoin because the topic tends to attract people who are completely in favour of the cryptocurrency, and sometimes these do not take criticism lightly. Anyone who is a BTC sceptic is quickly labelled a paid shill by Wall Street, a FUD merchant, an uninformed person who doesn’t understand the amazing technology, a Statist, a nocoiner loser, a bitter person who sold their BTC too early, or a combination of the above.

These are my honest opinions as someone who is mildly adept at the technology and who has been following Bitcoin from early on, I have no other motive than my endless pursuit of writing things that interest me. It’s possible that I will be wrong and Bitcoin will continue its unstoppable trip towards world domination. I doubt it, but I’m not bothered either way.

However, it is precisely this type of religious reaction from the community that often makes many of us highly sceptical. In a fantastic Twitter rant against Bitcoin, the always excellent Sarah Jeong said:

“I am the target demographic for blockchain based solutions. I am the paranoid 1% who purposefully inconveniences her life for decentralization and cryptographic solutions. I am the rare case and I fucking hate bitcoin”

I couldn’t put it better myself.