The Challenges Ahead for Bitcoin

Dan Kaminsky points out one of Bitcoin’s greatest weaknesses: the potential for a bad actor to gain control of more than 50 percent of the network’s computing power. If that happened, the bad actor could engage in all kinds of mischief, including reversing his transactions and preventing others’ transactions from being confirmed.

As Bitcoin’s computing power moves to specialized computers known as ASICs, the universe of persons who control the network shrinks—thus making it easier that a pool of just a few miners (or potentially just one), could take control of the network. Kaminsky suggests changing Bitcoin’s proof of work math to be more amenable to solution by general purpose PCs, thus ensuring the expansion of the the number of persons who control the network’s computing power—even if that means that criminal botnets will get in on the action.

Jim Harper argues that Kaminsky’s doomsday scenario is not likely to transpire because anyone who abuses control of the network will only be making themselves worse off. After all, what’s the use of controlling a network that no one trusts? Harper points to the fact that the largest Bitcoin mining pool voluntarily restricts itself to less than 50 percent. But this serves to make Kaminsky’s point. The fact is that what began as a decentralized system now relies on the voluntary action of a few individuals to avoid a crisis of confidence.

While I acknowledge Kaminsky’s critique, I tend to agree with Harper that, in the near-term at least, the individual self-interests of those in a position to overtake the network keep them in check. And in the long term, this episode of centralization may prove to be but a blip in Bitcoin’s evolution. As Jeff Garzik, one of Bitcoin’s lead developers, has pointed out, the market is responding to the growing demand for ASICs, with new entrants producing more and cheaper machines. This will have the effect of swinging the pendulum in the other direction, back toward greater democratization of computing power.

Why not just switch to math problems better suited to general purpose CPUs, the most democratized kind of processing power there is? Because specialized ASICs provide greater hashing power, and as Garzik says, “More mining power makes it more difficult to reverse bitcoin transactions. The more widely spread that is, the more difficult it is to shut down bitcoin itself.” In the end the network may come to enjoy greater computational power and greater decentralization.

Jim wonders what will be the next shoe to drop. “Will it be a flaw in the technical structure that results in calamitously skewed incentives? Or will it be the opposition of governments, who see the threats in unfettered value transfer and seek to censor it?”

My fear is that it could be both. In a time of $2 billion NSA data centers, and billions more in secret cybersecurity budgets, it would be trivial for certain governments to engage in a 51 percent attack with the intent of disrupting the Bitcoin network. I don’t mean to be conspiratorial. Such an attack by the U.S. government, for example, would be unprecedented, and at $1 billion the Bitcoin economy hardly threatens the dollar. So it’s more than unlikely that the U.S. government would resort to such a drastic measure anytime in the foreseeable future. That said, the greater total hashing power of the Bitcoin network, the more costly it is for such an attack to succeed, which further argues for a large market in ASICs.

Also from this issue

Lead Essay

  • Jim Harper reviews the traits that make a given class of items either useful as money or not. These are the traits that, for example, made gold and silver historically such widespread monetary standards. He finds that bitcoin possesses many of them to a very high degree, but that it very importantly fails on some. Bitcoin’s future is unclear in another respect as well: Established government and financial industry interests will do whatever they can to preserve what they view as their own turf. Still, the greatly increased use of digital currency seems inevitable to him in some form or another, and that form could well be private.

Response Essays

  • Dan Kaminsky argues that bitcoin’s success so far stems from the success of the Internet itself, and also from the failures of plain old money. Traditional payment methods all face serious challenges in our digitally connected world, and transaction costs to maintain our financial network make plain old money less and less attractive in contrast to its digital counterpart. But bitcoin isn’t perfect either, and the threat of large conglomerates abusing their power isn’t limited to plain old money. It can happen in the bitcoin network too.

  • Jerry Brito argues that bitcoin is far more than just money. It’s also a distributed-ledger payment system, which means it’s a lot like Visa, MasterCard, or PayPal, but with one key difference: There is no central authority managing the payments. As a result, bitcoin is open to becoming a lot more than “just” money. It can also be used as a token to represent claims on other items. As such, very small fractional bitcoins can function as bonds, stock certificates, property deeds, IOUs, or even decentralized futures markets. The full scope of these possibilities is vast, and we are only beginning to grasp the implications of bitcoin.

  • Chuck Moulton argues that bitcoin is a sound form of money. Its quantity is known, it expands at a known rate, and it will eventually stop expanding. As a result, fluctuations in the value of bitcoin are almost entirely a function of demand. Moulton suggests fractional reserve banking as a way of stabilizing bitcoin’s value. He goes on to suggest that nations might consider dollarizing to bitcoin as a way of preventing inflation, with the very significant caveat that “a second or third generation cryptocurrency may be the one to finally take hold.”

  • We are pleased to publish this contribution from Patrick Murck, Bitcoin Foundation General Counsel, who argues digital currency will disrupt traditional finance. This disruption is both very much intentional and likely to empower consumers who have not been able to take advantage of traditional financial services. Older financial system players are likely to resist, of course: They have a stake in the status quo.