Bitcoin Risks and Skepticism

With bitcoin skyrocketing again (up 16.44% in the last 24 hours as I write this, per Coinmarketcap.com) I wanted to outline reasons to be cautious about getting involved with Bitcoin. Bitcoin is a revolutionary advance in financial technology, but there is a learning curve involved and many serious pitfalls for unwary users.

This will not be a general primer on bitcoin or how it works. I'll field any questions on those lines to the best of my ability, but first and foremost I want to give people a list of risks to consider before investing or using bitcoin. (Most of the reasons I am seeing here on Free Republic so far as based on simple prejudice or misconceptions, and thus make a lousy basis for an informed judgment on the subject.)

Bitcoins exist in the form of entries on a shared, cryptographically secured ledger. Only someone with a private key for a given account can make a transaction entry on the ledger, sending the coins to another account. If you lose that key (held in a bitcoin wallet software) you lose the ability to send any coins tied to it. This can happen if your hard drive crashes and you didn't back up the wallet, or if you made a paper wallet and lose your only copy of it. (Since bitcoin keys are just long character strings, you can print them out and not have them on any computer anywhere until needed.)

So you should be cautious about using bitcoin if you do a poor job of backing up or tend to lose things. If you are using a personal wallet and you lose the keys (or your password to access the keys in the wallet), there is no 1-800 number you can call to save you.

Ways to mitigate this risk: You could keep your bitcoins with trusted 3rd parties online, such as exchanges like Coinbase or Xapo. But that creates a risk of theft (see Risk #2 below). You can create multiple backups or copies of your software or hardware wallet and distribute them in safe places (again, increasing the risk of theft per Risk #2).

The best strategy is to use Multi-signature technology, which is becoming much more widespread with bitcoin in the last year or two. With "M of N" multi-sig, it takes M keys out of N total in existence to send bitcoins from your account. (You can specify the M and N parameters when you set it up, such as 2 of 3 or 5 of 7).

This way you can distribute copies of the keys as needed, and not worry that the loss of one key will expose you to theft or make your bitcoins impossible to access. (In addition, 2-factor authentification is available from every 2-bit bitcoin exchange I've ever dealt with, whereas I still can't get it on my Fidelity accounts - what's up with that, Wall Street??)

The only downside is that it is more of a hassle to transact with multi-signature accounts, so it is less useful for a daily use account.

Yes, you've all heard of Mt. Gox. While bitcoin is secure if held properly, a large portion of people choose to give their bitcoins to someone else for safekeeping, creating the risk of theft by 3rd parties. If you choose to go this route (and it's hard to avoid entirely, such as when exchanging currencies), pick your online exchanges carefully.

In the pre-Gox era the bitcoin scene was dominated by nerd-in-a-garage type outfits,

with a regular litany of security breaches and scams. Things have changed considerably since the collapse of Mt. Gox in early 2014, as Wall Street has taken notice of bitcoin and better funded, more professional venture capitalists have established bitcoin exchanges and online wallet services.

As a result, I've noticed a big drop in reports of hacked services, and things seems especially good with the first-tier services (like Coinbase and Xapo). We haven't seen the last of bitcoin hackers, but they are steadily being pushed to the fringes and targeting the remaining amateur outfits that are still out there.

Just because you choose to keep your bitcoin in a wallet on your own computer doesn't mean you are safe. Hackers intensely target software wallets with malware and viruses. So if you have trouble keeping yourself virus-free, be careful about this option. Some people advise having a computer that is ONLY used for financial transactions, and never for games, web browsing and so on. That's probably good advice, even for people still using only fiat systems, given all the hacking going on.

Likewise, many bitcoiners consider paper wallets the safest option - but they don't seem to consider that people have been stealing physical goods (like case or, say, a paper wallet with your private key) for a long time. Use the M of N multisignature strategy I mention above.

You can lose your fiat currency to scammers as easily as bitcoin, but be aware that scammers seem to be targeting bitcoin much more intensely. Probably because they wrongly believe that bitcoin provides them anonymity (see Risk #5 below). If you are the sort that has fallen for scams in the past, be especially careful with your bitcoin.

For example, just because someone posts a message that the Red Cross accepts bitcoin donations with a public key for such donations, that doesn't mean the key is really held by the Red Cross. One stunt I've seen scammers pull is to take a legitimate post for donations and copy and paste it elsewhere on the web, altering the public key address to their own. So be cautious about sending funds to an address that you have not personally verified with the recipient to be sure it is theirs.

Did you think using bitcoin made you anonymous? Think again. EVERY transaction ever done with bitcoins is publicly recorded, forever, in the bitcoin blockchain. People just think they have privacy because they think no one will know they hold account "xyz234..."

But for a variety of reasons, the odds are high that over time your bitcoin keys are going to be linked with your real-world identity. You can fight this, but in an era of KYC laws, hacked databases and data mining by Google, etc., it's going to be more difficult than you imagine.

So already I'm seeing a string of news reports of bitcoin hackers who do get tracked down eventually after they try to actually spend some of their ill-gotten wealth. If you aren't comfortable with the idea of your friends/family/neighbors/etc.

potentially being able to look up all your bitcoin transactions, that would be a reason to avoid bitcoin. Of course you may also want to rethink your use of online fiat banking, the way things are going, on that count...

(There are a slew of other cryptocurrencies working on the problem of anonymity with varying levels of success, and I see them as vital to the long term health of cryptocurrency. For example, what business is going to want to let its competition see every detail of their transactions if they start using cryptocurrency? So it's not just about drugs and Silk Road as many skeptics naively assume, it's a concern for just about everyone. How it will play out in a KYC regulatory environment is anyone's guess at this point.)

Bitcoin has only been declared illegal in one or two countries at this point (I'm thinking Bolivia and maybe Ecuador or Peru). But if you had valid reason to think it might be made illegal where you live, that would certainly be a valid reason to be cautious about using it.

Keep in mind that just because a government official is hostile to bitcoin, doesn't mean that is official government policy. A Russion Ministry of Finance official just mouthed off that bitcoin users should be imprisoned for four years. That doesn't mean it's likely to happen. The trend has been in rather the opposite direction the last few years, apart from those leading technological innovators like Bolivia. (OK, I apologize for the sarcasm...)

Realistically, if bitcoin were going to be declared illegal in western nations, they would have done so in years past when operations like the Silk Road flourished.

Today, with the flood of investment from Wall Street and the hype about blockchains, concerns about the use of bitcoin for illicit activities are receding. It's like fearing that automobiles will be banned in 1910 because some people were using them for surreptitious trips to a brothel.

There are literally hundreds of competitors to Bitcoin today, based on the same technology. (Just check out Coinmarketcap.com) Isn't it likely that some will prove better, ultimately rendering bitcoin worthless?

I made this argument myself in my early involvement with bitcoin - if Bitcoin is the Model T of cryptocurrency, what happens when competitors like Dash and Litecoin gain traction?

The fallacy here, though, is that bitcoin is not frozen technologically. A Model T was a Model T. Ford Motor Company couldn't update it once sold. Whereas the software protocols behind bitcoin are subject to refinement and innovation without affecting the financial parameters that make bitcoin valuable.

So if faster transaction blocks, or higher transaction capacity, or anonymity, or anything else that can be achieved with cryptocurrency are ever urgently needed, bitcoin can be updated to include these improvements. (This can involve controversy and price risk, as anyone observing or participating in the warfare over the still unresolved blocksize debate can attest.) In the meantime, Bitcoin enjoys a tremendous first mover advantage over the competition, which won't be going away anytime soon.

For bitcoins to hold value, the blockchain record of transactions must remain incorruptible. So far, despite massive hacker activity and hostility from governments, banks, and other powerful entities, the blockchain has withstood all attacks. Your passwords can be lost or stolen, but the blockchain itself has remained secure. Could this change?

It's not impossible, though it is unlikely for the foreseeable future. The encryption technology used for bitcoin is strong enough that conventional computers will never be able to decrypt it, not if the entire universe were composed of such computers for unimaginable lengths of time.

But there is speculation that quantum computers could defeat the current encryption standards. If such computers became a reality and nothing was done, the blockchain could be rewritten or private keys stolen, destroying bitcoin. More likely though, announcements of such technology would lead to the deployment of algorithms not vulnerable to quantum computers (my understanding is that such things already exist), so this is not an existential risk.

Bitcoin is an exciting new technology with the potential to change the financial world. As such, it's worth educating yourself and becoming familiar with it,

particularly if a financial crisis develops with your fiat currency and you need an alternative, quickly. For this reason I encourage folks to begin learning about bitcoin and become familiar with handling it. But I also want them to be aware of the risks and not get too excited about it in a way that puts them at financial risk. The principle of diversification is probably the first thing that anyone with disposable income should learn, and it applies here no matter how bullish you get with bitcoin.

Thanks again for your response. I am certainly going to check out Purse. I still feel like I don’t really know whether to approach Bitcoin as an investment, or as a currency, but you convinced me to do some dabbling.

Still, it will be strange to invest in something which seems to have a built-in inverse relationship between price and value (price, relative to dollars, and value, in terms of its value as a currency). It would certainly seem to violate a basic rule of investing!

The society has to bear the extreme expense of calculating otherwise pointless and valueless numbers, just so they could be exchanged for very inexpensive goods. This is one of many issues that plague digital coins.

Proof of work (= energy expenditure) is the price to pay to generate a trustless system. Therefore, IMO, the energy expended by PoW is an interesting offset to human malfeasance, conniving and greed.

Now, there might be other, more efficient ways to offset human pathology, but bitcoin's implementation is successful enough, at this time.

Proof of work (= energy expenditure) is the price to pay to generate a trustless system. Therefore, IMO, the energy expended by PoW is an interesting offset to human malfeasance, conniving and greed.

I wonder how then the BTC differs from gold as currency. The same proof of work was present then, as gold is hard to mine (at least in Europe, before they came to Americas.)

In this aspect gold is better because it is useful (for jewelry, electronics, science) and it does not depend on social acceptance to have value. BTC has no inherent value, and thus all the work that went into minting the BTC hinges on acceptance. As you can see, BTC combines the worst characteristics of currencies - it is hard to mine, like precious metals, but it has no inherent value, like paper money.

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