Overcoming Bitcoin’s Flaws

For all the promise that Bitcoin has for transforming the financial world and improving the future outlook of millions, maybe billions, there is no denying that there a few things to worry about.

The things that keep us up at night are, in no particular order:

  • the whales
  • the transaction rate scalability problem
  • the ability of people to secure their bitcoins.

The Whales

The problem of the whales is two-fold: the first problem we’ve gotten a close look at over the last few weeks after time-and-again we saw thousands of bitcoins dropped on exchanges totally over-powering the buy demand and forcing the price of Bitcoin into what seemed for a time like a death spiral. It’s not clear who, or what entity, was dropping coins like that, but whoever it was, they had to have had huge stores of coins in the first place in order to drop them. Satoshi Nakamoto, the creator of Bitcoin, is supposed to have around a million bitcoins deposited into the addresses where they were originally mined. Satoshi might be waiting for the price to rise to the point where he (she or they) can reveal himself to be a god among men, may have the intention of never touching the coins, or may even have lost the private keys so that those coins will forever sit beyond the reach of any person. As a whale, Satoshi doesn’t worry me very much, though, since he does not seem to be very interested in making use of the coins – and it would be noticed instantly if any of them were spent. It’s highly likely that Satoshi is very successful outside of Bitcoin and may not feel the need to profit from it any more than he has.

Then there are the early miners who were able to get thousands of bitcoins before anyone really knew that they were worth anything. For sure, these early experiments deserve some rich rewards for trying, developing, and seeing the value of Bitcoin before anyone else did. If not for them, no one else would have ever heard of Bitcoin. If Bitcoin suddenly explodes in value, we’re probably in for some ostentatious displays of wealth, some interesting fights between these new super-wealthy and governments who want their cut, and the slow, or quick, erosion of these fortunes in a variety of different ways – from gambling to philanthropy. In the end, many of the coins owned by the whales will find themselves back in circulation

I’m tempted to say that over time we’ll see a more equitable distribution of bitcoins across the population, but I’m afraid that would be just a little too naïve. No, there is always going to be wealth disparity. Bitcoin was not created to get rid of wealth inequity, but only to take the control of money out of the hands of governments and central bankers. This at least puts money back in the hands of the people – and that’s something.

In the short-term, whales, including the US government who own about 90,000 DPR coins. Any early adopter who decides to upgrade his lifestyle can send the price of Bitcoin into a tailspin, and this will remain true until adoption and transaction volumes have risen to a point where 1,000 BTC trades are easily absorbed by the market. In the long-term, they will be no more than the Gateses and Buffetts of the Bitcoin world.

Scalability

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At the moment, the de facto number of Bitcoin transactions that can happen is about 3-7 a second. This is many thousands of transactions lower than would be needed if Bitcoin were to displace credit cards, for example. And that’s not the only problem: as more transactions are added, the size of the blockhain, or the accounting ledger Bitcoin uses, gets. As of this writing, it’s approaching 30 gigabytes and growing. This is important as anyone who wants to run the original Bitcoin software and be a Bitcoin ‘node,’ or one of the relay stations that supports the speed and security of the Bitcoin network, needs to download and maintain all this information. What’s worse, many of the projects that are being built on top of Bitcoin that plan to use the blockchain for contracts or other purposes will add bloat to the network.

As bad as a problem scalability and bloat may seem, these are technical issues that are likely to find technical solutions. Scalability is being handled by increasing the size of blocks and bloat by proposals to trim the blockchain or only require the use of headers. Further, the continued development of computers will make future computers better able to handle the memory storage required.

Security

This one is the real elephant in the room. The number of hacks and scams in the Bitcoin world are an embarrassing and undeniable reality, and they are also just the kind of red-meat that critics and reporters go after when talking about Bitcoin. Someone just getting interested in Bitcoin and casually reading up on it is going to read about the slew of hacks against what were purportedly professional companies. If they go on Reddit, they will see another slew of ‘my wallet got hacked’ posts. The impression many will walk away with is that even if Bitcoin has a lot of potential, they require just too much technical expertise to secure, and therefore the reader will decide they are better off with their credit card which has a dispute department even if they also do impose ridiculous fees.

It’s true that securing Bitcoin can be tricky, but not everybody needs to have super-strong security. If you have hundreds of coins, then there is a real point to learning how to use the best security – creating offline wallets on machines that never touch the Internet or creating paper wallets on machines booted from a CD or USB so that you can be sure there is no keylogger to steal your keys or passwords. For most people, commonsense security will be enough. For example, there is one individual who put a backup copy of his password-protected wallet online with a request for anyone to steal his funds if they are able. As of this writing, no one has been able to do so.

Here are some simple steps to keep in mind:

  • Never leave your coins on an exchange or on any wallet where you don’t control the private keys. If you trade on an exchange, as soon as you’re done, move your coins off. This simple tactic would have saved me 1.2 bitcoins from the Mt. Gox debacle.
  • Never invest your money in an arbitrage scheme or any other Bitcoin business that promises really good returns. There are a set of scams that are real Ponzi schemes and will set up what seem to be great investment opportunities only to disappear with their investors’ money in a couple of months. The sad thing is that many investors in these scams appear to know they’re scams, but think they can get their money out with profits while the business is still trying to appear honest. Very recently, we saw Cryptodouble.com appear from the depths, rake in a thousand or so bitcoins, and disappear again. The Bitcointalk.org board that I linked to is full of people on the first page of a 77 page thread saying that it was flashing red as a Ponzi.
  • Use a strong, unique password on whatever wallet you use, including paper wallets. And then, don’t lose them. Random letters, numbers and symbols will keep you the most secure. This is what the person at Stealmywallet.com did.
  • Use a deterministic wallet like Electrum. These wallets will issue a 12 or more word ‘seed’ which they will then use to create all the wallet addresses to be used. This seed, plus your password, will be your lifesaver should your computer crash. If you use a wallet that doesn’t create addresses from a seed, then be very sure you are backing up often as, if your computer crashes, you won’t be able to recover any address your wallet created after your last backup. It’s easy to make a mistake with these, so going with wallets that create addresses from a seed is the safest.
  • Use good computer security: scan often for spyware and malware using a variety of antivirus software, use a firewall, install an anti-keylogger, use unique, strong passwords for anything that’s important to you, never click on a link sent to you in an email or open a document if you don’t really know what it’s for, and always check the address bar of websites to make sure they are the website you mean to be on.

In general – most people who have lost bitcoins due to a hack have done so because they’ve gotten careless themselves. As Bitcoin matures, tools and techniques for securing bitcoins will become easier and more foolproof. For right now, it’s important, but by no means impossible, to keep your bitcoins safe.

In summary, it’s easy to see that Bitcoin is far from perfect and that there are a lot things that can and do go wrong with it. Some of these might even make Bitcoin non-viable were it not for the fact that the other financial system is even more non-viable and becoming more so with each passing day. Bitcoin may present its challenges, but there are solutions to those – and from our perspective, it’s better to start the learning curve earlier rather than later.