“Killer” Criticisms of Bitcoin That Are Really Just Flesh Wounds

by Kyle Bennett on Monday, April 8, 2013 at 11:00pm

Bitcoin is experimental, there’s no doubt about it. As such, it is prone to unknowns, and unknown unknowns, that could theoretically derail the entire project. Some of those unknowns could be fundamental, a flaw in the bitcoin algorithms themselves, or they could be in the current implementation of it.

The ecosystem of trade and exchange around it is even more experimental, with a wild-west feel to it that hasn’t been felt since the early days of the internet. Most of the tools are crude and hastily built; they are incomplete and fragile, and look it. Some have worked fairly well, some have failed in small ways, and a few have failed in big ways.

Yet, bitcoin and it’s associated tools are far from unexamined darts thrown blindly at the wall. The stakes, even now before it matures into a full-fledged currency, are huge. The math has been examined. The math has been tested. The decentralization hypotheses about it have been tested as well. The tools have been exercised far beyond what their creators expected.

It has so far passed all of its tests, even if individual tools did not. All of the failures have been recovered from at the system level, even if some individuals have never (and will never) recover the losses they incurred from them.

Still, there remain a handful of points that uninformed critics imagine to be fatal blows to the heart of the system. Ideas that such critics naively assume nobody involved in bitcoin has ever thought of before, so that anybody continuing to engage in bitcoin activity can only be hopelessly naive, willfully blind or actively predatory. They toss them out like hand-grenades and imagine they’ve blown the system to bits, even if those in it have failed to notice.

1. It’s a scam, a ponzi scheme

It is important, for this, and the other points, to distinguish between the two contexts in which bitcoin discussion exists: bitcoin itself, and its ecosystem. The first is the nature of bitcoin itself, the algorithms that make it work and the logic that flows from them and gives bitcoin the properties attributed to it. The second is the ecosystem built on that math, the buying and selling and trading, the exchanges and the tools that have been created.

On the first level, bitcoin cannot be a scam. Not only are the algorithms public, but so are the transactions. There is no information that is known only through someone’s authority, that we can only trust to the extent we trust that person. There may be ignorance, there may be mistakes, but there is no fraud. There is nothing hidden that could be the basis for a fraud.

However, fraud is always possible in the associated interactions between people, and on websites. The market for bitcoin, that of the spectacular four month rise in prices, very well could be manipulated. There could be a cabal of big money pumping it up and waiting to spring their trap on the suckers who have bought it at artifically inflated prices. The operators of the exchanges could be engaging in any number of fraudulent schemes, just the same as any other online vendor could be.

But none of that has any relevance to bitcoin per se, to the math. Even if the worst were true, it would not make bitcoin a scam. It is almost unimaginable that such latent fraud is true on a wide scale. There are so many players, there is so much at stake in legitimate transactions and building a reputation, that it is hard to see the upside for anyone who is esablished, let alone for all of them. Yes, there have been and probably will be small scams by individual players. That’s life. That’s freedom. Get used to it.

2. It’s a bubble

This is, in my opinion, undoubtedly true. Others disagree. But it is irrelevant to the nature of bitcoin. “Tulips” has become a knee-jerk talking point, but it pays to remember that when the Tulip Mania collapsed, people did not stop planting tulips. They merely stopped speculating on their price. The value of tulip bulbs did not evaporate.

So it is with bitcoin. If and when this bubble collapses, it will not end bitcoin. It will dampen the enthusiasm, it will take the wind out of the speculators’ sails, it may even diminish or delay adoption by buyers and sellers, but it will not wipe out the usefulness of bitcoin.

The “bubble” will burst, or it won’t, and in either case, bitcoin will go on. It might go on with less hype, less fanatic energy, and less hand-wringing, but on it will go.

3. It’s not backed by or based on anything

This is the critics’ most potentially sound economic analysis. It is actually reasonable to believe this is a real problem. There are even some who are enthusiastic about bitcoin that think it might be a fundamental time-bomb. People ranging from the gold bugs to Armchair Austrians (I am one) to von Mises himself would take this argument seriously.

The gold bugs have gotten used to distinguishing precious metals from fiat currency on the basis of *matter*. Gold cannot be inflated arbitrarily because it has to be mined. That takes money and effort, and it requires enough demand to make the price worth the investment. The Austrians have a theory about the devolopment of money from the “most marketable good”, leading to the conclusion that only those things with a non-monetary use-value can have monetary value.

The gold bugs’s argument is more obviously wrong. They’ve conflated gold’s distinguishing feature from fiat currencies with required features for being money. But bitcoin shares this distinction from fiat currencies in that bitcoin cannot be inflated for the same reason gold cannot. Not because it is molecules, but because it requires work, energy, and capital. Even more, unlike gold, bitcoin has a fixed supply that cannot be exceeded.

That the market values gold is no more and no less arbitrary than that the market values bitcoin. Gold is not redeemable in anything, it is not backed by anything, it just is. So with bitcoin. Both are valued because they are useful as money. It is a common misconception to say that things are useful as money because they are valued. We don’t say that power tools are useful for construction because they are expensive. The fact that gold makes jewellery and electrical contacts is nice, and provides a modicum of fallback security for gold, but it is not a major component of its market price. It, like bitcoin, has properties that put it far above most other commodities in terms of usability as a medium of exchange. That is where the value comes from. It is the right tool for a particular kind of job.

The Austrian theory is about the evolution from trade goods to money as a universal trade good, but it is a hasty generalization. It is a generalization from a single class of commodity; we have no previous known examples of any other kind, such as bitcoin, of a class of money being deliberately created as such without going through the path of natural evolution.

Oh wait, I’m sorry, we do have examples. Fiat currencies. There are all kinds of problems with fiat currency, but among them is not that they do not serve as money. They clearly do. The world runs entirely on them. Many of us believe that they are not healthy, not sustainable, but that is not because they didn’t evolve from something with prior non-monetary value. It is because their ongoing soundness is at the mercy of a small group of people acting on interests that conflict with the interests of most of the people who use that money.

Still, if bitcoin is to fundamentally fail, it will most likely be on this basis. But as it sits now, the conclusive belief that it *must* fail on those grounds is completely unsupported. On the other hand, there is no theoretical reason a currency must be a prior trade good, good logic about why it is unnecessary, and ample evidence to back that logic up.

4. It can be hacked

A lot of this stems from Hollywood and sensationalistic “journalism”, both playing on a general lack of understanding of what is at root a very arcane and technical field of expertise. It is bolstered by many high-profile security breaches that seem to confirm it.

There’s an almost mythical power attributed to “hackers”, as if they were some kind of superhuman race of villains who can do anything to anything made from digitial information. There is a belief that no matter what the state of the art, it is an arms race and just a matter of time until it is overtaken.

This belief ignores math. Bitcoin is based on cryptographic algorithms. Those algorithms are widely considered to be absolutely unbreakable by any known technology and by any likely to come along in the forseeable future. This is not just a blind assumption, nor a “white swan” belief, but a rigorously developed set of mathematical theorems. For instance, common cryptography in use today can be show to require (for the brute-force method of trying every combination), that every atom in the universe be devoted to the task for tens of billions of years. And it is trivially easy to make that twice as hard. Just as trivially easy to make it 4 billion times harder, and so on. The only other theoretical way to break it involves a class of math problems that is equally difficult, and for which no shortcut method has ever been found or even hinted at.

None of the known security breaches have been accomplished by mathematically breaking such algorithms. They have been accomplished through social engineering – taking advantage of carelessness on the part of users – or by finding implementations that have flaws or routes into a system that were not properly protected.

Algorithms, no matter how sound, have to be implemented and used by fallible human beings. Some digital cryptographic implementations have been broken. The flaws were recognized, and that knowledge applied to other implementations. Many implementations have been ruthlessly attacked, and remain unbroken. The US government – the most capable crytographers the world has ever known – admits that it cannot break these algorithms, and this is one case where even the most cynical believe them.

The bitcoin implementation is new, but it has been severly tested in addition to being analyzed by hordes of both experts and laymen. The reward for finding a flaw is enormous, yet none has yet been found and exploited. Bitcoin’s implementation could have a flaw, but so far none is known to exist; the likelihood of it is vanishingly small, and getting smaller every day. The pure assumption that, if it is digital in can be hacked, is superstition.

5. It’s been hacked

Fueling the above superstition is the history of “hacking” that has occured in the bitcoin ecosystem. The largest exchange was broken into in 2011, and a substantial amount of bitcoins were stolen. It was a bank robbery. More recently, an online wallet site was similarly hacked, and a large amount of money taken. There have been denial of service attacks on several bitcoin related websites, there have been more minor data breaches throughout bitcoin’s history.

Still, bitcoin itself has *never* been hacked. Or if it has, the hacker mysteriously chose not to take anything after succeeding in breaking the algorithm, and never told anyone. Care is certainly needed in the use of bitcoin tools, but care is also needed when dealing with any other monetary transaction. Banks get robbed all the time without the robbery rendering US Dollars worthless. Dismissing bitcoin because of the careless or mistakenly insecure way some people use it is more an indication of somebody wanting to find a reason to dismiss it than of any logical conclusion.

6. It is used for illegal things

Too bad.

Illegal use says nothing about the soundness of the tool used. Dollars are used to buy illegal drugs, child pornography, and dangerous weapons far more than bitcoin ever has. Knives that are perfectly suitable for slicing meat have been used to kill people. Thinking that use for illegal activity is a criticism of the soundness or usefulness of bitcoin is like thinking that axes are unfit for chopping down trees because there are axe murders.

7. It is not really anonymous

This criticism is half correct. It is not anonymous, it does not make transactions invisible and divorce them from any identifying information. It cannot. The tradeoff for decentralization and security from double-spending is the ability to verify the transaction history. The tradeoff for the ability to trade “anonymously” across the internet regardless of location is that the sender and reciever be uniquely identified *as such*.

What it is is pseudonymous. It uses pseudonyms. I emphasized “as such” because that is all that needs to be identified – that the person that has valid keys to this numerical ID is sending money to the person that has valid keys to this other numerical ID. There is no need to identify the sender and reciever *as individuals*, and in fact avoiding that is one of the primary motivations behind bitcoin.

What can be done, given the public record of transactions, is what spies and code-breakers – intelligence analysts – call “traffic analysis”. That is identifying the patterns of movement, even though the individual actors (and even, in the case if spycraft, the information that is moved) remain unknown, there is enough information contained in the movement itself to identify the overall behavior of specific individuals. If any one piece of information can be tied to an actual identity – a name, for instance – every other piece in the chain of traffic that is attributed to that individual also now becomes associated with his identity. Traffic analysis is what they are referring to when they say a warning of terrorism is based on “chatter”.

This does not mean it is impossible to keep your identity and your bitcoin pseudonym separate, but it does take some attention and work. But even so, privacy is not the only motivation behind bitcoin. The other two are its resistance to manipulation of supply, and the ease with which it can be transmitted across the world without relying on the honesty and good-will of a third party. Anonymity is not a fundamental requirement for something to be useful as money. The other benefits would remain even if the privacy were proven to be a complete failure.

8. It is unregulated

This is a double-edged criticism. On one hand, it is often used like #6, to discredit bitcoin not as unsound, but as unseemly. To that I again reply, too bad. If it is too unseemly for you don’t use it.

On the other hand, a somewhat more reasonable criticism along these lines is that without regulation, it cannot ever be safe, it cannot ever be sound, and it cannot ever be the basis for enforceable contracts.

This is a “who will build the roads?” criticism. Positing that a third party is necessary for transactions to be successful and safe is to propose that individuals are unfit to make and implement their own choices. This is a dispute that goes far beyond bitcoin, but bitcoin is a significant hinge on which that larger argument might turn.

Not only is bitcoin unregulated, and itself unregulatable (see the following point), it can make other kinds of activity unregulatable as well. It threatens to make a whole class of “crimes” for which the only evidence is financial records undetectable, or too expensive to routinely track down and punish.

Those people who are dead set in their belief that safety, security, and efficacy can *in general* only be provided by third party regulation will not want to use bitcoin. Those of us who don’t believe it are willing to take the chance. Theory, history, and contemporary empirical evidence are on our side.

The criticism is not one that can be conclusively dismissed, but neither can it be conclusively established, and I along with many others are completely convinced it is untrue. It is a highly controversial question, and not only is bitcoin just one aspect of that controversy, but bitcoin was intended, at least in part, to be a vehicle for *testing* it. Arguments of this kind made against bitcoin alone are misplaced, that argument belongs to a far larger context, one in which most people have already given their answer. Those of us for who the answer is “no” have put our money where our mouths are. We’re not afraid to put it to a real-world test. If you are so convinced the answer is yes, why are you afraid to watch us try?

9. It will be regulated out of existence

Seemingly in contradiction to the previous criticism, this is often thrown out as a spiteful retort after the other arguments have been exhausted. It is often expressed not as criticism, but as a wish, as a kind of “curse on your house” parting shot meant to insult rather than inform.

It is always possible that regulators will find a way to quash the bitcoin system. Of course, that sheds no light on the soundness of bitcoin itself, only on the ethical soundness of the regulators, and perhaps the soundness of judgement on the part of those who enter the bitcoin world too recklessly.

Still, any such regulation will not be of bitcoin transactions, but of bitcoin users. This is an important distinction. The power to regulate traditional banking and currencies comes from the fact that exchanges are typically mediated (except pure face to face cash transactions). There is always a third party involved, and all a regulator needs to do is to require the relatively smaller number of mediators to do the regulation for them. This is far easier than convincing the vast number of individual actors, most of whom are hostile to such regulation to one degree or another, to regulate their own activity.

Yet the latter is the only avenue open to the aspiring regulators of bitcoin. There are no mediators to convince, bribe, pressure, or force to do their bidding. It is only at the interface between bitcoin and the traditional legacy systems where any such leverage can be applied. Beyond that, the only method available is widespread threats of punishment aimed at each user as an individual. This can perhaps be optimized by targeting first people such as large sellers of goods, who do a disproportionately large number of transactions, but it is far from certain that even that would have the desired effect.

Since bitcoin is unregulatable at the system level, regulation can only occur at the edges, at the users, not at the use. For this reason, it would appear impossible to regulate it out of existence, not only because it is, at its root, an idea, and and idea can’t cease to exist, but also because they’ll never be able to conclusively determine that nobody at all is using it. It can be driven deep underground. It can be reduced to a small cadre of those who won’t be cowed by threats, but, unless it falls of its own accord, it can not be driven to extinction.

Kyle Bennett, April 8, 2013