LIKE ANY COIN, Bitcoin has two sides. The upside is privacy and convenience. Unfortunately, the downside is also privacy and convenience.
Bitcoin is both a boon and a threat, which, in this era of hyper-connectivity, we must understand either to leverage or avoid it. I would advise the latter.
While you can buy a pint in Dublin with your bitcoin wallet, one of our banks this week confirmed that they are unwilling to offer accounts that trade in bitcoin as it is an unregulated currency. As a peer-to-peer system, bitcoin is without central authority and it is this lack of sovereignty which makes it vulnerable to more than hackers.
Who is Satoshi Nakamoto?
Bitcoin was apparently introduced as open source software in 2009 by pseudonymous developer Satoshi Nakamoto.
No-one really knows if Satoshi is a real person. This may not have previously been important to currency holders who lost $473m last month when the largest Bitcoin exchange, Mt Gox, was hacked. However, I’d say that it is now.
That loss sent the Tokyo-based Bitcoin exchange (the world’s biggest) into bankruptcy.
Following the recent collapse of Mt Gox, Canada-based virtual currency exchange Flexcoin was forced to close down after flaws in its software code saw hackers make off with bitcoins worth around €440,000.
Despite being the darling of the tech frontier, surely we can now see that the red flags being waved around this “currency” are far from virtual.
Bitcoin payments are irreversible
To get started with bitcoin, you need a wallet – software that allows ownership of a balance so you can send and receive the currency.
Unlike many credit card transactions, bitcoin payments are irreversible. If you suffer from buyer’s remorse, your only alternative is persuading the seller to give you a refund. This shouldn’t apply when you are buying your pint, but think of the things that you mostly pay for online – they are generally the ones that won’t fit or have to be cancelled.
Bitcoin uses public-key cryptography, a system in which wallet access requires two keys, a public key to encrypt and a private key to decrypt. A transaction transfers ownership of bitcoins to a new address that contains both the correct public key and a digital signature proving possession of the associated private key. The “signature” is not a person’s name, but proof of the private key. In this sense, the transaction is anonymous – though not necessarily forever.
Your wallet needs bitcoins, which you acquire by accepting them as payment for goods or services or by buying them from a person or an exchange.
In theory, bitcoins cannot be counterfeited because each transaction is related to a shared public ledger called a block chain and each must balance with the ledger. Fraud is also theoretically impossible because the private key used to sign a transaction provides mathematical proof that a payment has come from the wallet’s owner.
Through a process called mining, nodes (behind which are people) on the bitcoin network independently confirm the legitimacy of each transaction in relation to the block chain. The “miners” receive new bitcoins for their work – which is how new bitcoins are added to the “money” supply.
Prices are tremendously volatile
Since bitcoins are mined rather than minted by centralised fiat, they are theoretically immune to inflation. However, in practice, prices are tremendously volatile.
While, bitcoin offers certain security advantages, your wallet, like anything else connected to the internet can be hacked. And if you misplace your private key password, your wallet and everything in it is lost forever.
Recently US Federal Reserve Chairperson Janet Yellen said that the Fed has no ability to control bitcoin as it falls outside the banking system.
The fact that we do not know who owns and manages the bitcoin exchanges is not the end of the world – most people still believe that the Federal Reserve is owned by the US government whilst in reality it is owned by a collection of private banks that get a 6 per cent return on their investment. However, the difference is that it is managed and regulated by Congress.
So, should we be worried that it is impossible to track down bitcoin owners?
Recently one of my staff downloaded a ransom virus called CryptoLocker, which is a Trojan horse ransomware programme that encrypts your files and then presents an offer to decrypt them for a ransom payable only in bitcoins.
As an additional incentive, the message includes a countdown timer to a deadline after which the private key – essential to decryption – will be destroyed and you will be forced to avail yourself of a “service” the extortionists offer at a much higher price than the original ransom.
Criminals love the new online currency that allows money to change hands without personal contact, a bank, or middlemen.
As an experimental medium of exchange, bitcoin is a mix of high potential, high risk, and unanswered questions. That means the bitcoins that were used to pay the ransom to unlock my colleague’s computer might be worth a lot more than the $300 spent – or a lot less. In short, bitcoin today is a high-risk proposition.
An experiment with unpredictable outcomes
Finally, the anonymity of bitcoin is deceptive.
Transactions are stored publicly and permanently on the network. It is entirely possible that one day anyone will be able see the balance and transaction history associated with any bitcoin address.
What they cannot see is the identity of the user behind an address – unless it is revealed in some subsequent transaction outside the bitcoin universe. Then your bitcoin life becomes an open book.
That is why shady characters use it for shady things, including CryptoLocker extortion. This is the dark side of currency with no home, unbacked by the “full faith and credit” of any state.
Today, bitcoin remains an experiment with unpredictable outcomes.
Peter Casey is Founder and Executive Chairman of Claddagh Resources, an Irish-based global recruitment and search business that places high level executives with some of the world’s largest and most influential consulting and IT firms. He is a panellist on RTE’s Dragons Den and has written a book on the Tata Group – one of the world’s most successful multinational companies – which will shortly be published.