The upside and downside to Bitcoin

Article from Stanford’s CS181W: Computers, Ethics, and Public Policy project.

The Bitcoin is arguably the world’s first successful decentralized “crypto” currency. Transferred directly from person to person and free from financial or legal regulation, Bitcoins represent a modern, networked approach to finance. The underlying technical implementation, backed by military-grade key access and cryptography, ensures that transactions are secure and verified.

Below, the advantages and disadvantages of this currency are broken down:

Disadvantages

Like any currency, there are disadvantages associated with using Bitcoin:

·        Bitcoins Are Not Widely Accepted

Bitcoins are still only accepted by a very small group of online merchants. This makes it unfeasible to completely rely on Bitcoins as a currency. There is also a possibility that governments will force merchants to not use Bitcoins to ensure that users’ transactions can be tracked.

·        Wallets Can Be Lost

If a hard drive crashes or the wallet file is corrupted, Bitcoins have essentially been “lost”. There is nothing that can be done to recover it. These coins will be forever orphaned in the system. This can bankrupt a wealthy Bitcoin investor within seconds with no possibility of recovery.

·        Bitcoin Valuation Fluctuates

The value of Bitcoins are constantly fluctuating according to demand. As of June 2, 2011, one Bitcoin was valued at $9.9 on a popular bitcoin exchange site. It was valued to be less than $1 just 6 months ago. This constant fluctuation will cause Bitcoin accepting sites to continually change prices. It will also cause a lot of confusion if a refund for a product is being made. For example, if a t-shirt was initially bought for 1.5 BTC and returned a week later, should 1.5 BTC be returned even though the valuation has gone up? Or should the new amount (calculated according to current valuation) be sent? Which currency should Bitcoin be tied to when comparing valuation? These are still important questions that the Bitcoin community still has no consensus over.

·        No Buyer Protection

When goods are bought using Bitcoins and the seller doesn’t send the promised goods, nothing can be done to reverse the transaction. This problem can be solved using a third party escrow service like ClearCoin, but then escrow services would assume the role of banks, which would cause Bitcoins to be similar to a more traditional currency.

·        Risk of Unknown Technical Flaws

The Bitcoin system could contain unexploited flaws. As this is a fairly new, widely accepted system, a new found flaw could give tremendous wealth to the exploiter at the expense of destroying the Bitcoin economy.

·        Built in Deflation

Since the total number of Bitcoins is capped at 21 million, it will cause deflation. Each bitcoin will be worth more and more as the total number of Bitcoins maxes out. This system is designed to reward early adopters. Since each bitcoin will be valued higher with each passing day, the question of when to spend becomes important. This might cause spending surges resulting in the Bitcoin economy fluctuating rapidly and unpredictably.

·        No Physical Form

Since Bitcoins do not have a physical form, it cannot be used in physical stores. It would always have to be converted to other currencies. Cards with stored Bitcoin wallet information have been proposed, but there is no consensus on a particular system. Since there would be multiple competing systems, merchants would find it unfeasible to support all Bitcoin cards and therefore users would be forced to convert Bitcoins anyway, unless a universal system is proposed and implemented.

·        No Valuation Guarantee

Since there is no central authority governing Bitcoins, there is no minimum valuation guarantee. If a large group of merchants decide to “dump” Bitcoins and leave the system, its valuation will decrease greatly;  immensely hurting users who have a large amount of wealth invested in Bitcoins. The decentralized nature of Bitcoin is both a curse and blessing.

Advantages

The following are some of the major advantages of using Bitcoin versus other currency systems:

·        No Third-Party Seizure

Since there are multiple redundant copies of the transactions database, no one can seize Bitcoins. The most someone can do is force the user, by other means, to send the Bitcoins to someone else. This means that governments can’t freeze someone’s wealth. Thus users of Bitcoins will have complete freedom to do anything they want with their money.

·        No Taxes

There is no way for a third party to intercept transactions of Bitcoins and therefore, there is no viable way to implement a Bitcoin taxation system. The only way to pay a tax would be to voluntarily send a percentage of the amount as tax.

·        No Tracking

Unless users publicize their wallet addresses publicly, no one can trace transactions back to them. Only the wallet owners will know how many Bitcoins they have. Even if the wallet address was publicized, a new wallet address can be easily generated. This greatly increases privacy when compared to traditional currency systems whereby third parties potentially have access to personal financial data.

·        No Transaction Costs

Sending and receiving Bitcoins requires users to keep the Bitcoin client running and connected to other nodes. Essentially, Bitcoin users will be contributing to the network of sharing authorizing transactions, reducing transaction costs.

·        No Risk of “Charge-backs”

Once Bitcoins are sent, the transaction cannot be reversed. Since the ownership address of Bitcoins will be changed to the new owner, it is impossible to revert. Since only the new owner has the associated private key, only he/she can change ownership of the coins. This ensures that there is no risk involved when receiving Bitcoins.

·        Bitcoins Cannot Be Stolen

Bitcoins’ ownership address can only be changed by the owner. No one can steal Bitcoins unless they have physical access to a user’s computer and transfer Bitcoins to their account. Unlike conventional currency systems, where only a few authentication details are required to gain access to finances, this system requires physical access that makes it much harder to steal.