On the Bitcoin

I am writing this post a few weeks in advance, so – who knows – maybe this whole post will be outdated by the time its scheduled publication date comes around.

Update on the 6th of March 2014 – This whole article was written before the Mt Gox collapse.

What is Bitcoin?

Bitcoin (BTC for short) is, in effect, a globally shared ledger of transactions. BTC is commonly expressed as a currency and system for transacting the currency.

Conventional currencies are exchanged for Bitcoin using exchangers.

Bitcoin Brief

I have been keeping an eye on Bitcoin since around 2009/2010. At first, the reaction among most people in the online payments industry that it was just another Liberty Reserve with a cryptological twist. Its sole purpose could surely only be deep-web black-market ecommerce. And sure enough, for a long time, it remained almost exclusively in use for drug trade, copyright-infringement-friendly web hosting, and money laundering through anonymous prepaid cards.

Then Liberty Reserved was no more. In May 2013, it was shut down and a vacuum appeared for anonymous/high-privacy payment methods. Common Liberty Reserve alternatives – Perfect Money and such – didn’t jump in and take on Liberty Reserve clients, because they too feared being shut down.

Focus instead shifted to this now four years old cryptocurrency: Bitcoin. It was decentralized, so there was no risk of it being shut down.

More and more, gray-zone ecommerce adapted Bitcoin to attract customers who had previously used Liberty Reserve. The earliest adopters were web hosts. An industry made up of tech-savvy people and early-adopters of technology, it very quickly became expected of these hosts to offer Bitcoin.

Not wanting to fall behind, more and more regular web hosting companies started taking Bitcoin.

At the same time, it started going up in value and exchangers started going from being the kind of shady operations expected of digital currency converters.

Then another important event occurred. Notorious narcotics et al. market place Silk Road was shut down and its owners arrested. Now, clandestine websites are like hydras. If you cut its head off, there will be two new ones to replace it. Silk Road and similar sites are back in action. But what’s important here is that because of the way media portrayed Silk Road and Bitcoin, it effectively cleaned up Bitcoin’s reputation.

Bitcoin Today

Today, Bitcoin is so big and influential, that it has spurred several governments to comment on it or plan for regulations.

Norway does not consider Bitcoin money, but as a taxable asset.

Sticking to its tradition of laissez-faire business-friendliness, Singapore decided not to interfere.

Germany has followed a route similar to Norway’s. It is considered a private money (privates Geld).

A big blow, however, fell on the currency when China said it was forbidding Chinese banks from trading in Bitcoin and declared it not a currency.

Malaysia does not recognize Bitcoin as a currency and cautions against using it.

Bitcoin ATMs have been blocked in Taiwan.

Slovenia says Bitcoin can be a taxable source of income.

There is a pending motion in the parliament of Switzerland to address it and potentially consider it a foreign currency.

Bitcoin Privacy and Anonymity

Wrongly, Bitcoin is often spoken of as an anonymous payment method. In fact, it is probably the most public of all means of payment in the world.

When you send money to someone using Bitcoin, that transaction is registered in the globally shared public ledger. Your and the recipient’s Bitcoin addresses are there for everyone to see.

Compare this to a bank transaction, which is only seen to the banks, the sender, the recipient, and SWIFT (or other such system). The only way to disclose further information will involve breaking banking secrecy, which is limited to authorized persons.

If you know someone’s Bitcoin address, you can see all transactions to and from that address. It is a time-consuming and resource-intense task to do, though.

While it’s easy to generate new Bitcoin addresses, in order to fund your new address, you need to either top it up from an exchanger or make a public transaction from your former or someone else’s address.

Exchangers are the next weak link in the chain. Since all transactions are public, transactions from an exchanger to you are public. These transactions can thus be used to compel an exchanger to disclose all information it has about clients. While in the past lax if any due diligence was performed on customers, exchangers are increasingly opting for or being forced into regulation. This means they have to collect certain information about you, which can be handed over to authorities.

A service called tumbling is frequently advertised as a way to launder Bitcoin. This is complete nonsense, since the tumbling, which is just a series of transactions, is public.

Bitcoin is not private, since all transactions are public. Bitcoin is also not anonymous, unless you earn your Bitcoins from within the Bitcoin system and make no connection between yourself and your personal finances.

The Real Costs of Accepting Bitcoin

A few middle-men service providers have popped up to facilitate the process of accepting Bitcoin. While the per-transaction and recurring fees are lower than most traditional payment methods, these middle-men are applying a spread of 10 – 20%. This means that if 1 BTC is sold at 1,000 USD on average from the major Bitcoin exchangers, the Bitcoin payment service providers will sell 1 BTC for 1,100 to 1,200 USD.

While Bitcoin is often touted as being cheaper than credit card payments, it is in fact vastly more expensive.

Since BTC is not considered a currency or unregulated in a lot of countries, companies in some jurisdiction may have to exchange BTC to conventional currencies for fiscal reporting. Exchanging adds another per-transaction cost.

Because the exchange rate for BTC varies enormously, something sold for 2 BTC – which at the time was 2,000 USD – can the next day be worth 1,500 USD. If you didn’t exchange when 1 BTC was 1,000 USD, you lost 500 USD or 25% of the sale value. The BTC shows no indication of stabilizing. It has, in fact, been more volatile in the six or seven months than all time before then. The only solution to this is for BTC to become an asset which is worth and possible to keep on its own, without the need to exchange to conventional currencies.

It is expected that in the future, transaction fees will also be incurred simply for sending money even without a middle-man service provider. In order to fully understand this part, I strongly suggest you watch at least the first video linked under Further Study below.

Bitcoin uses something called transaction chains (think of it as batch payments) which go into blocks. While currently all transactions go into a transaction chain, Bitcoin supports transaction fees and it is assumed that once Bitcoin is more established and more coins have been mined (when the amount of the so called block rewards is no longer an incentive enough), only transactions with a transaction fee will be processed and transactions will be processed from highest fee to lowest. Transactions fee is an optional value, but there is little reason to believe that anyone would spend their own technical resources – which are finite and cost money to maintain – would process transactions for free. If anyone does, it will be a small number of volunteers, and you can expect transactions to take far longer than the current average of 10 minutes.

Limitation of Bitcoin

The biggest limitation lies in that the currency has very little exposure outside of special interests. More and more merchants are starting to accept Bitcoin, though.

The aforementioned transaction cost is something that could potentially completely throw a wrench in the works and stop the Bitcoin machine. If the only way to transact in Bitcoin costs more than conventional payment methods and currencies, the only advantage to using Bitcoin is its (perceived) anonymity.

There is also a finite number of Bitcoins. There can never be more than 21 million Bitcoins and even though the Bitcoin protocol supports working with as small decimals as 0.00000001 BTC (often called a satoshi, named after the supposed BTC inventor), the entire BTC system is limited to 2,100,000,000,000,000 (2.1 quadrillion) units.

This, however, doesn’t account for lost BTC. Since Bitcoins are a purely digital concept and are stored in hard drives and memory sticks, any Bitcoin lost in a hard drive crash is lost from the entire Bitcoin system. It is unknown how many BTCs have been lost but over time, it will likely impact the overall financial ecosystem.

I won’t go into economic theories and political ideology here, but suffice to say that the opinions on a finite financial system vary greatly. While governments can print more money for conventional currencies, Bitcoin is locked to 21 million.

The Future of Bitcoin

Whether the future for Bitcoin is a bright one or not depends what you expect.

Its limitations are probably so great that it will never compete with other currencies on a large scale and, for example, replace any nation’s currency.

However, it may continue to thrive as an alternative currency and payment method. How well this goes depends on four things:

  1. Adoption. Large players need to start accepting Bitcoin as a form of payment.
  2. Independence. It must become attractive to hold and use Bitcoins on a daily basis and eliminate the need to exchange to conventional currencies.
  3. Regulation. Bitcoin runs the risk of being regulated to death. If governments decide to accept it or leave it be, Bitcoin will live on.
  4. Perception. While Bitcoin’s reputation is improving, it’s still unknown to most people and many that know it think of it just as a means to buy and sell illegal or covert goods and services.

Adoption and Independence are in a bit of catch-22. One can’t happen without the other. This requires some merchants to act as pioneers.

Regulation and Perception go hand in hand. If regulation is reasonable, Bitcoin will acquire a clean reputation and hence acquire improved public perception.

Further Study

Bitcoin Regulation Survey (January 2014)




9 Comments on "On the Bitcoin"

  1. I’ve been following since the beginning as well. However I never bought any and I remember when Bitcoin was $2 and I thought that was way too high and assumed it was going to zero. Now I’m not so sure but still feel it will go to zero even though I love the concept so much.

    Did you buy any Bitcoins at the start? Any recommendations on where you think the price is headed?

    • Cryptocurrencies are technologically interesting but they presently offer no advantage over real money, as mentioned earlier.

      Bitcoiners are pushing so hard for merchants to accept Bitcoin and when merchants finally do accept bitcoin, they typically see next to no sales through bitcoin. The costs of operation often turn out to be prohibitive. It’s a catch-22. Bitcoiners want to hold bitcoin as an investment and never spend it, but at the same time want market penetration to grow so that price will go up.

      There is about as much incentive to a merchant to implement bitcoin as there is to implement some obscure e-wallet payment method. They effectively cost about the same, have the same amount of users, and will still be converted to real money when it comes to preparing financial statements.

      Lately, it seems not a week goes by without some bitcoin related company going bust, getting hacked, or failing to deliver on promises. From what I can see, the trust for bitcoin has only decreased since this blog post was published.

      Bitcoin probably has a few more years before it’s dead (overregulated, outlawed, or a trend that faded) or replaced by a better cryptocurrency. The volatility will continue but it’s essentially gambling.

  2. I was an early, or not so early but end or 2011 adopter of bitcoin, have a good sum of them, what would your recommendation be if I want to enjoy them offshore rather than onshore?

    • If you want to spend your bitcoins, all you would need is a bank account somewhere (offshore or not), exchange your bitcoin, and request payout to your offshore bank account. Shouldn’t be a problem with most banks, as long as you stay away from countries that have outlawed bitcoins. You might have to explain to the bank where the money is coming from, but that should be a one-off.

      • You can reduce the cost of accepting bitcoin with:
        Coinbase and Bitpay which automatically converts bitcoins to fiat and you end up getting the exact amount of the sale price, lets say 19.99 at the end if you choose to. Don’t remmember if its bitpay or coinbase which offer 0% fees for the first 1,000,000 USD processed through them, then a flat 1% fee. Companies like:
        http://www.overstock.com/ and http://www.tigerdirect.com/ just enered this 2014 into taking bitcoin which are quite large companies in the US.

        There is a huge community on reddit around bitcoin http://www.reddit.com/r/bitcoin

        No more less to say theres a really good exchangers atm (like Bitstamp) and some shady ones like BTC-E (which I would like to know if you have information about it? company has quite many layers on it, mostly based, banking, etc)
        You can follow up the price and major exchangers here:

        There is also MANY services forming around, you can see that on daily bases or weekly in the reddit subdirectory of bitoin, an interesting one I saw is an extension named Zinc, http://www.businessinsider.com/zinc-save-bitcoin-extension-for-amazon-2014-3 which enables you to buy in many HUGE retailers like amazon, wallmart and many others and still it gives you a disccount (they find or use coupons to get you even disccounts in the final price)

        IMHO i find a bright future for bitcoin if it starts getting a wider audience and if it had a reduced volatility.

        About volatility you can notice the last heats i think was mostly because the:
        1) CHINA regulations against banks and other finance sectors (havent read much about it but this impacted a lot in price)
        2) MT GOX collapse

        would be cool to read more about your thoughts on bitcoin tho

        • The bitcoin community is quite big but very often (I’m told) considered elitist and thus unattractive; moreso than many other cryptocurrencies, such as the hard-to-take-seriously dogecoin or more serious ones like litecoin and peercoin. When dogecoin is in mainstream media, it’s something whimsical and good. It’s a charitable community which spreads its name through fundraisers and other good deeds.

          When is bitcoins in the mainstream media? When it’s about Silk Road (drug trade), the collapse of Mt. Gox, or tax and regulation.

          This affects the public opinion.

          But the probably biggest problem with cryptocurrencies is that they don’t offer any advantage to the average person.

          Let’s say you’re an average Joe, having your monthly salary deposited into a bank account. You can access use the funds immediately with a debit card (through ATM or using it at terminals) or use your credit card to buy now and pay later. Maybe you live somewhere where NFC is common and you pay instantly either by just waving your card or your smartphone. Fast, easy – and in case of fraudulent use, you are protected.

          You can set aside some of your money in investments and savings. Domestic transactions are cleared the same or next day. If you are concerned about national, regional, or global financial climate – you can easily open a foreign bank account and move money abroad. This transaction will clear in usually two – three banking days.

          For fast person-to-person transactions (i.e., transferring money to your friend who just paid for lunch after you forgot your wallet at home), more and more mobile wallets are popping up. These wallets are tied to bank accounts and cards, so there’s no need for any cryptocurrencies there.

          At what point would you benefit from converting your hard-earned money to bitcoin? Until there is a good answer to that question – an answer so good it will start to convince the general public – cryptocurrencies will not become mainstream and continue to just be something a group of special-interest people use.

        • BTW, here is an interesting blog post on bitcoin called “What Comes After Bitcoin?”: http://paymentsviews.com/2014/03/20/what-comes-after-bitcoin/

      • ahhhh and about the tumblers, as far as I know, correct me if im wrong some tumblers like bitcoinfog or silkroad tumbler used to have 2 pools that mixed the coins? “breaking” the transaction from A to B, so the A transfered to pool Y and B got paid by pool Z?

        if so that would prevent the follow up of one transaction to another

        • That might be, but it wouldn’t be impossible for a dedicated adversary to connect the dots even if there is a break. 100 BTC goes from your wallet to a tumbler. The tumbler than takes 10 times 10 BTC from 10 different pools and sends to another wallet that belongs to you. It depends on how much information the adversary has. Let’s say you use one wallet to shop at Overstock and another wallet to purchase something illegal. Your adversary can assign an identity to the first wallet by compelling Overstock to disclose all purchase information and order history. If your second wallet can then be connected to your first wallet, for example through using pattern recognition software on the tumbler’s transactions, you aren’t anonymous anymore.

          The tumbler itself is also a link in the chain one should consider. They aren’t unstoppable and if a competent authority considers tumbling to be money laundering or facilitation of money laundering (a predicate crime), I don’t see how a tumbler could stand a chance to not be forced to disclose all information. Your adversary would then be able to see the tumbler’s records of customers and tumbles. Dots easily connected at that point.

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