Some Bitcoin claims are false, others are partially true but useless. This piece examines some.

Claim: Bitcoin is cheaper than alternative forms of purchases.

Reality: This claim has two problems. First the alternatives cited usually offer many additional features lacking in bitcoin and also are the most expensive. Second, the verification methods and distributed ledger requirement of bitcoin impose costs that another payment processor can avoid. Thirdly, the bitcoin transactions are currently actually rather expensive, but the cost is hidden from people because they are paid with newly created coins.

On the first item, bitcoin advocates generally cite credit card merchant fees of 2-3%. These are not “true costs” to the system as many cards pay rebates of 1-1.5%. Credit cards also provide for the customer dispute resolution, fraud protection, the ability to borrow money, and other services. For many transactions debit cards and ACH are far cheaper; however merchants often encourage credit card usage because they can get customers to spend more.

A better reference is Visa Inc’s total expenses and transaction volumes. In 2014 Visa processed about 65 Billion transactions worth a total of $7.3 Trillion and shows expenses of approximately $5 Billion. This amounts to about 0.07% of the transaction volume $0.09/transaction and would include not only operating the network, but also services such as dispute resolution and marketing. (Visa Inc. 2014 Annual Report )

Secondly, bitcoin transaction integrity requires a ledger with all valid transactions that have unspent bitcoins be distributed to thousands of nodes across the internet. Searching through this ledger is how one verifies that the party who is making a purchase actually has the bitcoins.

Furthermore, the verification process that time stamps the transactions in a way they cannot be altered relies on “proof of work” which must consume enough electricity that someone would be unable to afford the computer power to redo it. This involves using repeated guesses to find a “magic number”, called a nonce, that when put through calculation engine with the transaction information yields a valid answer—referred to as the “hash”. This answer is one of the inputs for the verification of the next block of transactions. Thus each block is chained to the later one in the “block chain”

Why is this so costly? Someone could “unspend” their bitcoins by altering their transaction in the ledger and finding a new “magic number” that produces a suitable hash. Because this hash is required for verifying the next block, they would need to redo that block and all following ones in order for their change to become accepted. In the mean time the other miners add new blocks that would need verification. If they have more computing power than the rest of the miners, they can redo the verification of all the newer blocks. This works only if at some point in the future they catch up. To prevent this, the amount of electricity and hardware required to validate a block must be expensive enough for this to be impossible.

The real question is not whether this is efficient. It is whether economies of scale and decreasing costs of storage, communication, and computation will make this inefficiency insignificant.

Thirdly, the miners are now paid $5-$10 per transaction verified. This is hidden from consumers and merchants because the bitcoin system is printing money (i.e. new bitcoins) to pay the verifiers. Although greater usage would likely reduce this cost it is not clear what the real limit is. Thus the low cost is “vaporware”.

Claim: Bitcoin uses trust in math instead of trust in people.

Reality: First you need to trust the people claiming the math does what it says. Secondly, you have to trust that nobody—fraudster or terrorist—obtains the computing power required to alter transactions. This is not just a theoretical possibility, some mining firms have come close to obtaining enough computing power. It is possible for a few to collude to change the ledger.

More importantly, if you are purchasing an expensive item with bitcoins you likely need to have more trust in people because bitcoin transactions are irreversible. With a credit card or ACH you can dispute the transaction if the merchandise is not what is promised or the merchant goes bankrupt between the time she accepts your funds and the time your purchase is shipped.

Finally, to use bitcoin you either need a wallet program or an online firm, such as Coinbase. As people who used the Mt Gox exchange found out, trust in both the ethics and operational skills of exchanges and software developers is required.

Claim: Bitcoin is more secure than alternatives because it is based on mathematics.

Reality: You can find plenty of people who have had Bitcoins lost or stolen. Some headlines: “BTER cryptocurrency exchange loses #1.1m worth of bitcoin in suspected hack (2/16/2015, International Business Times, http://www.ibtimes.co.uk/bter-cryptocurrency-exchange-loses-1-1m-worth-bitcoin-suspected-hack-1488103)”, “Bitstamp loses up to $5.2M in Bitcoin Hack” (CFO Magazine, 1/6/2015, http://ww2.cfo.com/technology/2015/01/bitstamp-loses-5-2m-bitcoin-hack/), “Canadian Bitcoin Exchange loses $100K in Unorthodox Attack” (Coindesk, 3/20/2014, http://www.coindesk.com/canadian-bitcoin-exchange-lose-100000-in-attack/), and “UK man tries to retrieve $7.5 million bitcoins from dump” (Cnet Nov 29, 2013, http://www.cnet.com/news/uk-man-tries-to-retrieve-7-5-million-in-bitcoins-from-dump/).

While Bitcoin solves the problem of someone hacking the merchant to get your credit card number, it introduces a whole new set of vulnerabilities that have nothing to do with the math. In order someone to spend their bitcoins they need a very long number referred to as a “private key”. If you keep this number on your computer and your hard drive crashes, you lose your bitcoins unless you have backed up that drive. Furthermore, someone could spend your bitcoins if they hack into your computer via malware. For consumers, this is not a problem with money in an FDIC insured bank account.

A mistake in transmitting the address to which you are sending bitcoins can cause the bitcoins to be irretrievably lost, as there will be no private key that can unlock those coins. While checksums should prevent simple typos from causing this, they do not prevent sending the bitcoins to a defunct address that is valid. A programming bug caused Mt. Gox to send some bitcoins to address “0”. (See Ken Shirriff’s Blog, “The Programming Error That Cost Mt Gox” )

One solution is to use a “reliable” third party to hold your bitcoins. These third parties are a form of bank—but they lack the regulatory oversight and a lot of the internal controls of an FDIC bank. Failure of these third parties is not a hypothetical problem. Just ask people who lost bitcoins to the Mt. Gox failure. There have been several others already.

Claim: Bitcoin is a great success because so many merchants are accepting it.

Reality: It is consumer acceptance, not merchant acceptance that matters. A merchant can arrange through various bitcoin service providers to accept bitcoins at little cost. This is irrelevant because the only reason consumers have to use bitcoins is ideological distrust of the US government. Using a credit card or debit card is much easier than bitcoin—no currency conversion calculations, no buying bitcoins and cutting and pasting addresses between applications. Plus consumers often get various rebates and “rewards” for using credit cards.

The bitcoin advocates will point out merchants must pay the credit card processor about 2-3% of the transaction and spread it out among all consumers. This is irrelevant because most merchants accept this situation in order to get customers to spend more. A merchants who don’t want to pay the higher fee of credit cards, can already provide consumers who use debit cards, cash, or ACH payments better pricing. In many cases they don’t, because they believe that accepting credit cards without directly charging for the privilege is good marketing. Bitcoin does not change this dynamic.

Some merchants do provide discounts for debit card or ACH transactions; in those cases people may use them, but it seems highly unlikely that people would want to go through the trouble of using bitcoins for some transactions and dollars for others.

Update as of Feb 2019: There still is little consumer usage of Bitcoin. Some merchants who have previously accepted it have decided it is not worthwhile to maintain this capability for the few customers who use it.

Claim: Bitcoin is money 2.0—better than real money.

Reality: Bitcoin adoption as currency would be a step backwards. Nations ended the gold standard because economies grew and needed liquidity faster than people could mine new gold. Not only is the total amount of bitcoins limited to 21 million; the supply actually shrinks as private keys are lost. Bitcoin is more like money -2.0.

Such a fixed supply of money is inherently deflationary. This benefits individuals who have the ability to hoard the supply rather than help allocate social resources to productive enterprises. The boom-bust cycles due to the loss in liquidity from hoarding caused societies to abandon rigid money supplies, such as the gold standard.

Claim: The dollar (or other currency) has lost some huge percentage over the last 100 years. A common refrain is for people to complain about how much value a dollar or other currency has lost over the past 100 years.

Reality: Currency is meant to facility commerce, not to make its holders rich by hoarding. The measure of a successfully managed currency is how well the underlying economy performs.. If you bought a high performance car and let it sit in your driveway for 100 years, should you be upset that it doesn’t work any more? The fact that the dollar has lost some huge percentage over the past 100 years is only relevant if you held dollars in a vault. If you had instead helped society identify productive usages of resources by investing the money, you would have gotten a fair return on average.

Claim: Bitcoin is an antidote to oppressive regulations.

Reality: With or without bitcoin we still have the same forces that caused governments regulate existing financial institutions , whether critical social problems such as terrorism, fraud, and money laundering or desires of special interest.

Claim: Bitcoin will help the poor in developing countries because it avoids bank fees and government rules that prevent people from holding more stable foreign currency.

Reality: Any country that imposes capital controls and taxes or restricts holding of foreign currencies would apply similar restrictions to bitcoin if it ever became popular. Ecuador, Bangladesh, and Bolivia have already banned virtual currencies, including bitcoins[i].

In claims about money transfers, bitcoin advocates conveniently pick the most expensive companies, such as Western Union, and exclude consideration of costs and risks from changing bitcoins to the local currencies that are used.

In reality—bitcoin money transfers are inherently more costly than direct transfers. A direct money transfer to a foreign country requires an exchange of one currency for another combined with a transmittal of information between ledgers—often managed by a bank or a mobile phone company. In contrast the bitcoin process requires two currency translations—one from the sender’s currency to bitcoin and the other from bitcoin to the local currency. Agents making currency exchanges need capital and requiring hedging transactions to avoid losing money if currency markets move in the wrong direction. In addition rather than being recorded on just a few ledgers of a handful of intermediaries; the bitcoin transaction must be broadcast to every one of thousands of bitcoin nodes.

Even if some bitcoin provider offers to do all of this for free, one should keep in mind that investors will be willing to subsidize these activities as a marketing strategy—either to grow the business to the point they can raise the fees or profit from a stash of already mined bitcoins.

update as of Feb 15, 2019: Although Bitcoin traffic has expanded in a few countries, notably Venezuela, it constitutes less than 1% of the countries’ GDP. The suffering masses in Venezuela are not converting any of the unstable currency they obtain into bitcoin or dollars; they are exchanging it for food and medicine. Along with people trying to evade their oppressive government, corrupt government officials could be using Bitcoin to avoid sanctions by the United States and other countries. If this were not a problem, we could just allow anyone in Venezuela to open US bank accounts and exchange US bank deposits (i.e. USD) and allow banks to play the same cat and mouse game with opening new websites when the government blocks them.

Claim: Bitcoin adoption democratizes finance.

Reality: The inventor of bitcoin is alleged to hold almost 5% of all bitcoins that will ever exist. As of January 2014, 47 individuals were estimated to hold 30% of all bitcoins, and 10,000 people held 80% of all bitcoins[ii].

Bitcoin advocates claim the Bitcoin system is a counter to the “special interest” and “entrenched elite.” The reality is they have created a new special interest group of top hoarders and technology investors, who hope to become fabulously wealthy if they can pump up the value of bitcoin—regardless of the consequences to others.

Claim: Larry Summers a former Treasury Secretary has said good things about Bitcoin.

Reality: Larry Summers is an adviser to venture capital firms that have a stake in Bitcoin and related technologies. Also his comments are more geared towards opportunities to improve various technologies, which can be done without Bitcoin.

Claim: Bitcoin is the new gold, a store of value.

Reality: This is another way of saying Bitcoin is a pyramid scheme. Mike Novogratz, one of the highly visible crypto-fund managers promoting Bitcoin admits this in an interview with Bloomberg [iii] , “Yes and no. I do believe Bitcoin is going to be digital gold. That means it’s the only one of the coins out there that gets to be a legal pyramid scheme. Just like gold is.” The problem is that 1) gold is a lousy investment and 2) gold at least has a backstop–usage in jewelry and electronics–which are somewhat functioning as drivers of changes in market prices.

The only utility for Bitcoin is selling it to another buyer. Although with legitimate investments, people generally realize much of their investment profits by selling to another buyer, even in the absence of a buyer the investment provides some form of utility–dividends, earnings, rent, coupons, or in the ability to pay taxes, in the case of fiat.

[i] Legality of Bitcoin by country, http://en.wikipedia.org/wiki/Legality_of_Bitcoin_by_country, Wikipedia retrieved 2/15/2014

[ii] How Bitcoin is Like North Korea, Joe Weisenthal, http://www.businessinsider.com/bitcoin-inequality-2014-1 , Business Insider, Jan 12, 2014, retrieved 2/15/2014

[iii] Schatzker, Eric,”Mike Novogratz Explains Why He is Still All In on Cryptocurrency”, Interview with Bloomberg on Dec 11, 2018.