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Two major problems with bitcoin, and how to solve them

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The last year has been tough for bitcoin. There were scandals such as the hacking and bankruptcy of Mt. Gox, one of the largest bitcoin exchanges in the world. And there was the steady decline in the bitcoin market price, which accomplished the remarkable feat of making it an even worse investment than the Russian ruble last year.

But it hasn’t all been bad news. Investments in the system increased almost 100-fold from their 2012 levels. The number of bitcoin ATMs went from zero to a few hundred. In fact, last year might have been the year when bitcoin reached its peak excitement among investors and hackers.

But even with these investments, the number of bitcoin transactions per day—a good indication of how much the system is used—remains low. In other words, the average consumer is hardly using the system and 2015 may very well be a make-or-break year. If popular usage doesn’t catch up with investments, people may definitively lose interest, and the money confined to a niche market. What can done to make sure that doesn’t happen?

Bitcoin poses at least two problems. First, the system offers anonymity in a way that can be useful to those engaged in criminal activities. This stems from the fact that users do not have to reveal their real identity to use the system. They simply transfer money from one bitcoin address to another address, a unique number similar to a bank account number.

Given the public nature of the block chain, the shared ledger where each bitcoin transaction is recorded, the system is more open and transparent in some respects. Anyone can know how much money is owned by any address. Money movements from one address to another are publicly known, too. But, if the appropriate steps are taken, it is easy to create a bitcoin address and use it in a way that cannot be linked to a real individual.

This, however, is very much the result of choices in the design of the system: anyone may create a bitcoin address at a whim, as long as it is unique. But the Bitcoin Foundation—the organization that has authority over the bitcoin protocol—could change that. Before creating a new address, users could be forced to authenticate with a trusted organization. This organization would securely store information about identities, and this information could be revealed to law-enforcement agencies only when a request for access is legally approved.

Similar certification authorities like Symantec (which bought Veri Sign in 2010) already exist to provide authentication certificates needed for Web site encryption and many other Internet services. A new network of trusted organizations could be created for bitcoin, or it could establish partnerships with these well-established certification authorities.

Anonymity is not an inherent feature of bitcoin. If we don’t want it to become the preferred payment system for purchasing recreational drugs, prohibited sexual material or your favorite illegal good, it can be redesigned. These changes would not have a big effect on the advantages of bitcoin for law-abiding users, but they would do a lot to deter crime.

As a case in point, brothers Cameron and Tyler Winklevoss recently announced plans to create a regulated bitcoin exchange called Gemini. Known as the Winklevoss twins in the new tech industry, and famous both for being among the largest (if not the largest) holders of bitcoin (and because of their bitcoins-167578473-george-frey-getty-compressor over the origins of Facebook) the two men want to create a new exchange in compliance with financial laws. Gemini is a clear counter movement to the anonymous and anti-establishment philosophy under which bitcoin was born half a decade ago.

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The second problem with bitcoin may be summarized as follows: this money may be more volatile and prone to devaluation because it is not backed by secure assets. Currencies like the US dollar are backed by the state. In other words, one may trust that the US dollar will have value as long that the American state functions well, holds assets, and has the capacity to levy taxes to finance itself. Since bitcoin is un backed, its value may fluctuate greatly (and it did). People may prefer backed money like the US dollar, leading to bitcoin’s progressive devaluation.

On the problems of volatility and devaluation, two things should be kept in mind. First, bitcoin may not be backed by a state, but it has advantages other types of money don’t have. It is fast, reliable and cheap to use. The bitcoin system can transfer significant amounts of money to the other side of the planet, within minutes, at almost no cost. Wiring money through existing interbank transfer systems is much more expensive and slow in comparison. If these advantages make bitcoin sufficiently attractive, it will keep its user base and, therefore, its value.

Second, the fact that bitcoin is not backed by secure assets is also a question of design. Nothing stops someone from creating a backed money. Ecuador, for instance, wants to launch its own bitcoin-like money to be used alongside the U.S. dollar. A monetary authority will regulate the system, and it will by backed by liquid assets. If Ecuador can do it, more backed systems could be launched.

None of these steps in isolation will save the bitcoin system; but together, they may solidify it as viable and trustworthy enough to be one part of the global financial system, instead of languishing on the fringes.

Dominic Martin is a philosopher whose research is focused on questions of ethics, economics and the social responsibilities of business.

 

24 Feb, 15

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