Bitcoin’s Appeal and Flaws Simply Explained

Limited Supply

National central banks make policy decisions to print money, set benchmark interest rates, wholesale lend to financial institutions or bailout companies that are too big to fail. Those decisions often lead, over time, to inflation and a decrease (in relevant terms) to a currency’s purchasing power.

For that reason, Bitcoin’s software code only allows a total of 21 million coins to ever be minted and put into circulation.

Minting New Bitcoin

More important than the limited supply of Bitcoin is the way in which new supply is created. Instead of a central bank decision to put more currency into supply, users can mint or ‘mine’ new Bitcoin by putting their computers, or designated computing processors, to work verifying transactions on the Bitcoin network. These users are then rewarded with small amounts of new Bitcoin, proportional to the amount of computing power they contribute to the network.

Bitcoin advocates like to say that ‘code is now law’. That is, Nakamoto’s code governs the currency and not a central bank.

Once 21 million Bitcoin are in circulation, many expect the value of the currency to increase, not deflate, simply because you cannot mine or issue additional coins. Of course, that position presumes demand and usage of Bitcoin does not dwindle. The argument goes, if demand for Bitcoin increases, and supply stays the same, presumably the price goes up.

Public Ledger, Private Parties

In traditional banking, transactions are kept private between banks and the transacting parties. There is no master transaction log of all payments which is a public record. Bitcoin does the opposite. Bitcoin posts all transactions to a public ledger that anyone can view, but keeps the identity of the participants private.

An Anonymous Founder

To add to the intrigue, Nakamoto remains anonymous. Nakamoto’s commitment to anonymity goes in hand with his or her commitment to ensuring no single individual or central authority represented the currency, let alone controlled it.

A Boost from the Criminal Underworld

The partial anonymity function of Bitcoin gave way to its adoption by criminals. The most notorious example is the now defunct Silk Road, which many compared as the eBay or Amazon of online drug and firearm sales. Silk Road brought buyers and sellers of illegal goods together from all over the world and combined an escrow service with Bitcoin to facilitate transactions. It has been estimated that as much as $1 Billion dollars in trade, in the form of Bitcoin, was processed on Silk Road.

Bitcoin’s early adoption arose, in part, from facilitating illegal trade, similar to the way Napster rose facilitating copyright infringement.

The demise of Silk Road drew a lot of public attention for Bitcoin, which ironically, likely led to more mainstream adoption from 2013 onward.

Central Points of Failure

Bitcoin relies on traditional banking systems to purchase or trade money in and out of the currency. That process is typically done by cryptocurrency exchanges like Binance, Coinbase, Kraken and many others.

With cutting fee hungry centralized payment processors and banks out of traditional money transfers being a main benefit of Bitcoin, it is hard not to see the irony of the growth and power of centralized exchanges, who charge similar fees and are now valued in the billions of dollars.

However, proponents of Bitcoin also argue that central exchanges are a necessary evil to drive adoption and give exposure to non-technical users. In the meantime, there is no doubt that the impressive growth of exchanges has made them appear to be more and more like the institutions Nakamoto wanted to cut out of economic transactions between two parties.

Private Keys and the Custody Issue

The technical nature of Bitcoin has also been a barrier to entry for many users. To be the true owner of a given number of Bitcoin, a user is assigned a private key, forming a long sequence of letters and numbers. To use those keys, display your Bitcoin balance and process transactions, users must have a software or hardware wallet. Some also elect to store their private keys offline in “cold storage” written down and locked away for safe keeping. For a novice user, those options can be daunting.

Not everyone is comfortable storing large portions of wealth in sequence of letters and numbers which could be lost, stolen or forgotten about. Others equally have difficulty trusting the makers of software and hardware wallets. But then again, not everyone was comfortable putting Visa numbers into websites in 1999.

It may also be that the majority of people prefer a central exchange being accountable for their funds and have no concerns about account seizure within the realm of established law. That is, not everyone holds libertarian views where they desire to exist outside the realm of legal systems and government authority.

The answer is simple, your Bitcoin is gone, for good.

In that instance, you (actually your estate) will be left wishing you had some central authority, who held custody of your coins and was subject to wills or estates laws to facilitate your coins being passed on. With an institution like Coinbase holding custody of your Bitcoin, like any other assets, courts can likely deal with their orderly distribution in the event of death.

Price Fluctuation

Bitcoin hasn’t really proven to work for daily consumer transaction as e-cash. With the inability to print new Bitcoin beyond 21 million coins, and its significantly fluctuating price, few people actually want to use Bitcoin to buy goods. There is too great a risk the dollar value of a user’s Bitcoin spent will fluctuate even from the time a transaction is agreed to, to the time it is processed, or goods delivered. Price fluctuations also make pricing goods and services in Bitcoin difficult.

Transaction Fees

The other main factor dissuading Bitcoin’s usage as a peer-to-peer e-cash solution is the unpredictable transactions fees on the Bitcoin network. Fees payable to miners to process transactions go up when there is large demand on the network and the blocks being mined are full. This had led to alternative currencies or ‘Alt-Coins’ trying to change block sizes and mining parameters.

Scalability

In addition to price fluctuations and transaction fees, Bitcoin has been plagued by concerns it just cannot scale. When the network is overloaded with transactions, not only do fees rise, but transactions are processed slower as they wait to enter the blockchain and be confirmed by miners. It is simply not feasible to buy a coffee with Bitcoin if a transaction takes 20 minutes to confirm. Nor will vendors adopt Bitcoin if there is even a small chance a transaction may take 20 minutes in the future.

Layer Two and the Lighting Network

Some believe the fix for slower and costlier transactions comes from placing a second layer on top of the Bitcoin network; the lightening network.

The Securitization of Bitcoin

The evolution of Bitcoin trading has also led to a futures market and the securitization of Bitcoin. Banks and investment firms continue to make submissions to regulators for the approval of a Bitcoin exchange traded fund or investment products which hold Bitcoin. This pushes Bitcoin further down the path to a speculative investment or store of value tantamount to digital gold, and not a peer-to-peer e-cash.

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Technology and e-Commerce lawyer — https://wireslaw.ca/.

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