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Understanding Bitcoin: The Definitive Pros and Cons List

Courtesy: Pixabay

It has been nine years since bitcoin was released. For many, the first cryptocurrency changed the way we look at money, data, and business in a meaningful and lasting way. For others, bitcoin is a bubble waiting to burst; a fad that will ultimately amount to nothing.

To address this debate, we have decided to create a pro and con list for bitcoin. While we are not trying to influence or convince you in any form of the value of bitcoin, understanding the issues surrounding the cryptocurrency will hopefully make you a better, more informed investor.

 

Pros:

It is decentralized.

When bitcoin was introduced, it was sold as being decentralized and anonymous. While the claims of anonymity have fallen by the roadside, bitcoin remains the model of decentralization. With a large market capitalization and with no reserve in perpetual hold by the founder or by a controlling organization, there is no one organization that have asserted control of the coin.

This is not to say that there have no close calls. The Chinese mining company Bitmain currently control 40 percent of bitcoin’s total hashing power and is approaching 51 percent, where it is theoretically possible for Bitmain to create an alternative blockchain which they can use to block transaction confirmations. Prior to this, the mining pool Ghash.io achieved 51 percent control of the total hashing power, but relinquished control voluntarily.

Bitmain is discouraged from engaging in a 51 percent attack as such an attack would bleed confidence from bitcoin, deflating the coin’s price and the value of its block rewards. However, as recent 51 percent attacks on Bitcoin Gold and Bitcoin Cash have demonstrated, the best defense is an engaged, decentralized network where the cost to gain majority control is higher than any profit that can be gained from the attack.

 

Compare to other cryptocurrencies, it is stable.

As the litany of news reports have shown, it has become fashionable among bitcoin skeptics to speculate when bitcoin will collapse. The short answer to this is that it can’t.

Unlike other cryptocurrencies, bitcoin has inherent value. As the cryptocurrency is not fungible, each coin has its own identity and history. As the proof-of-concept for the cryptocurrency model and for the blockchain concept, the 21 million bitcoin will have value to bitcoin enthusiasts and computer science historians long after the bitcoin market collapse. As a commodity with inherent value, bitcoin will never hit zero worth.

More importantly, bitcoin is the reserve currency for many cryptocurrencies, including Ethereum and Ripple. What this means is that a significant amount of these coins’ value have been converted to bitcoin. While this offered ballast for the coins in their formation, it offers a security blanket for bitcoin now. It is unlikely that these reserve amounts will be sold or moved, offering assurance against the massive sell-off that would be needed to sink the bitcoin market.

While bitcoin is volatile price-wise, it is complicated. A single fail point would not be enough to make bitcoin collapse. There would need to be a cascading failure among several fault lines for bitcoin to theoretically approach its inherent value.

 

It is widely acknowledged and accepted.

When most people think cryptocurrency, they automatically think of bitcoin. It helps that bitcoin was the most valuable commodity by return-on-investment for two years running. Many would-be investors dreamed of hitting it rich on bitcoin, which helped with its name recognition.

This expanded recognition has encouraged many merchants to accept bitcoin as a payment option. From a merchant’s point-of-view, it is a no-brainer. It is a payment option that has no or low transaction fees, which made it a popular option to credit cards. There are even bitcoin ATMs, bitcoin debit cards, and bitcoin transfer kiosks. It has been documented that it is possible to live and travel on bitcoin, given enough research and preparation.

Many governments on both the local and national level are researching how to allow bitcoin for the payment of government debt. A pilot program is already in place in Florida, where residents can pay their taxes and DMV fees with bitcoin.

 

It is the reserve currency for most cryptocurrencies.

As mentioned before, many cryptocurrencies’ worth are tied to bitcoin. This is important, as these coins’ success buoy bitcoin. It is not uncommon to see a bitcoin-reserved cryptocurrency’s positive news cause a price rally with bitcoin.

Similarly, price fluctuations with bitcoin tend to be reflected in the bitcoin-reserved cryptocurrencies. This makes bitcoin a “leader currency” which – like the U.S. dollar and the Euro – can create global ripples in the market under the right circumstances.

Due to its reserve status, there is a brisk market for bitcoin futures and bitcoin derivatives. As the traditional commodity market takes notice of bitcoin-driven instruments, bitcoin’s future becomes more secure, despite its volatility. Fidelity is actively researching developing a trading desk to offer cryptocurrency products in its investment portfolios. This decision is largely due to the exponential growth of bitcoin from 2016 to 2017.

 

Cons:

The coin is not fungible.

Unlike other cryptocurrencies, an individual bitcoin is traceable and is not replaceable with another bitcoin. What this means is that the bitcoin you used for a certain transaction will always be associated with that transaction for as long as the bitcoin exists.

This is due to the fact that all of bitcoin’s transaction data is recorded to a transparent blockchain. Block data clearly lists a bitcoin’s public identifier in the transaction record, as well as the wallet details of the parties involved. When bitcoin was created, this was intended to ensure that all transactions were auditable, adding trust to a trustless system.

The advent of criminality to bitcoin changed things. Events, such as the Darknet illicit goods marketplace the Silk Road, showed how bitcoin could be used to skirt or to break the laws of the land. It became common for law enforcement to identify bitcoin used in criminal purchases or money laundering and “blacklist” them, making their future use a red flag.

If someone was unlucky enough to have a “blacklisted” bitcoin, its use can trigger law enforcement scrutiny. As a bitcoin cannot simply be replaced by a central bank, this put the owner of the tainted coin in the unfortunate position of having an unspendable coin.

The notion that all bitcoins are not the same is a serious problem. Exchanges have been known to block bitcoin that have been involved in thefts. Others would block bitcoin known to have been involved in gambling, drugs, prostitution, or other vices. This is creating a discriminatory system between clean bitcoin that can be accepted anywhere and compromised bitcoin that can be accepted only where there is not a background check. The net effect of this is a drain in the true capitalization of the bitcoin market.

Worse, this is creating quasi-centralization. In order to determine the “cleanness” of a coin, one would have to go to a central repository which would do the blockchain search. This is investing the power to determine worth of all bitcoin to a select few parties.

 

Pricing is too volatile.

The bitcoin market is small compared to the commodities market. This smallness makes each purchase and sale relevant to the price of bitcoin. While, in a major commodity market, the purchase and selling of a commodity can influence a price by an eighth of a cent one way or another, in bitcoin, price shifts measured in dollars are not uncommon, especially if a large order was processed.

This is a problem that is common for all cryptocurrencies, but for bitcoin, it is acute because bitcoin is the reserve currency of the cryptocurrency market. Similar to the U.S. dollar, where bitcoin goes, the market follows.

Additionally, there is too small a pool of subject matter experts in place with bitcoin to prevent unscrupulous actors from controlling the price to their own end. The U.S. Justice Department is currently investigating claims that a group of traders have engaged in spoofing and wash trades with the bitcoin market. Spoofing is when traders create a slate of orders, only to cancel them once pricing starts to move in the desired direction. The idea is to create the illusion of major market action to trigger news followers to act accordingly without actually risking anything. Trade washing is when a trader trade a commodity with himself. This creates the allusion of market movement, which might trigger an investor stampede, while no assets actually changed hands.

This coin shuttling is now thought to have been the trigger for the unprecedented rise of bitcoin’s price in 2017 – from about $1,000 to nearly $20,000 per coin. Once the coin juggling happened and the stampede began, consistent media coverage kept the hype up and demand high. With oversight of the crypto market light, there is the potential for another stampede to happen, at the expense of the investors that did not sell before the spike collapsed.

 

As the primary cryptocurrency, it is the target of government criticism.

There is a growing chorus of nations that either ban bitcoin or limit its use. For some, like Canada, the United States, and The United Kingdom, the ban comes in the form of a banking ban, where banks ban their credit products from being used to buy bitcoin and other cryptocurrencies. Some banks go farther and ban its customers from having any association with cryptocurrencies whatsoever.

Other countries ban bitcoin because use of the coin interferes with their plan to create their own national cryptocurrency. Ecuador, for example, has no national currency. Since the collapse of the Ecuadorian sucre, the nation has been using the U.S. dollar as its official currency. In lieu of creating a new currency – which may be complicated by objections by the IMF – Ecuador has opted to create a national digital payment platform. This would not replace the dollar, but allow for the payment of services and transfer of funds to those with diminished access.

Finally, there are countries, like Algeria and Bolivia, that bans bitcoin outright and in its entirety. The problem with bitcoin is that – technically – the transfer of fiat currency to and from bitcoin is a type of money laundering, as the transfer itself is not automatically reported. Without an established system of Know Your Customer/Anti-Money Laundering compliance, there are no guarantees that bitcoin or any other form of cryptocurrency is being used for just legitimate purposes.  Many of the nations that allow bitcoin also insist that blockchain companies comply with KYC/AML regulations.

 

It is not scalable.

With any decentralized blockchain system, size is concern. The larger the network is and the more users are present, the more transactions must be processed. As a decentralized cryptocurrency requires each node to process and record each transaction to its own copy of the blockchain, a large network will eventually draw long transaction times, high transaction costs, and an immense electrical draw.

This is the case with bitcoin today. Prior to SegWit, it was not uncommon for transactions to take several hours to confirm. Even with the changes to the consensus system, it can take an hour to get the six confirmations needed to consider a transaction complete.

The obvious answer is to reward nodes that invest in larger and more powerful servers, similar to the consensus system used for Dash. This, however, is allowing a select percentage of the network to take an unproportioned amount of the network’s hash rate. In other words, this is imposing a system of centralization on top of a decentralized network.

While bitcoin is developing solutions such as the Lightning Network – which moves transactions “off-chain” to be dealt with by micropayment channels – to help deal with this, the question of scalability remains an open one for the time being.

 

Its consensus system makes upgrade difficult to implement.

Speaking of SegWit, the move to resolve bitcoin’s scalability and malleability issues were not universally accepted. A group of investors open rejected it, forking the blockchain and creating a new cryptocurrency. Bitcoin Cash.

The reason for the rejection was simple; the proposed SegWit – instead of changing the block size to eight megabytes, as originally proposed – would effectively separate transaction data into its signature and its confirmation data, with the confirmation data being saved as usual, but the signature being compressed to 0ne-fourth its size. In effect, this constituted squeezing more information in the same size box.

With bitcoin, there is a committed group that is determined to keep the coin as close as possible to Satoshi Nakamoto’s vision. As the first cryptocurrency, bitcoin has historical weight, and it is the goal of this group to keep bitcoin “intact.” Due to this, proposals to fix or improve bitcoin will fall along familiar battle lines. Some proposals would be changed until the bare minimum is done to resolve the problem, while others will be rejected out of hand – causing forked derivatives like Bitcoin Cash, Bitcoin Gold, Litecoin, Bitcoin Classic, Bitcoin Unlimited, and Bitcoin Private.

Without the ability to quickly act on matters of security and stability, bitcoin will forever be ruled by politics. To what extent this will play out is anyone’s guess.

 

It’s not anonymous. One of the biggest letdowns bitcoin offers is the fact that forensic science has advanced to the point that it can – with some degree of accuracy – determine the parties of any transaction recorded on the bitcoin blockchain. The reason for this is simple: bitcoin was not built for privacy.

The best way to equate what happens when a transaction happen on bitcoin is to imagine a bank manager with a ledger. When a transaction happens, the manager records the debit card number of the transaction’s initiator on the ledger. He then records the recipient’s debit card number and make the transfer. The ledger itself only shows the two set of numbers and the transferred amount. However, if a police officer was to look at the ledger and knew that the numbers were debit card numbers, all he would have to do is find the right bank to find the names of the parties.

Similarly, the wallet identification recorded on the blockchain offers a fingerprint which law enforcement can use to identify the involved party. All he/she have to do is find the right wallet provider.

Without any mechanism to disguise the parties involve or to “juggle” the coins received, bitcoin is – more or less – transparent. While this may has been the intent, it has led those that were sold on bitcoin for its privacy to look elsewhere.

1 Comment
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