Bitcoin – Chronicle of a Failure Foretold

Transaction malleability – a fraudulent, though most lucrative, way of receiving money without anyone actually sending it – is driving another nail into Bitcoin’s coffin. The digital money is by no means dead (yet), and could even perform a Phoenix trick, but its value tumbled all the same as the Tokyo-based Bitcoin exchange Mt Gox early February reported the software-related bug and halted Bitcoin transfers between the virtual wallets it manages and those of other exchanges.

The financial geeks of Mt Gox are said to be working with the core Bitcoin software developers to solve the issue that involves hashes and other exciting crypto sciences. As these coders plugged away to plug the hole, the Bitcoin exchange rate slumped to barely $500 from an earlier high of $1,200.

Digital currencies should be used only by the strong of heart or – at a pinch – by those who possess more money than they probably should. As Bitcoin jumped and leapfrogged to its all-time high, even some quite respectable pundits got caught up in the excitement, predicting that before long a single Bitcoin could be worth as much as $700,000.

Now that’s financial innovation at its very best: A currency you can’t actually touch or hold in in a wallet other than a virtual one being worth about half of Detroit’s housing stock. You just gotta love it.

“Bitcoin is deflationary money. Its growth is limited to 21 million coins ensuring continued appreciation in value.”

You also have to be rather daft in supposing the hash-generating software that underlies Bitcoin to be resistant to hacking when the stakes are that high. When obtaining just ten measly Bitcoins can potentially land a hacker or fraudster seven million in real money, that software is going to be cracked.

It’s not a question of technical prowess; it’s a philosophical one. No group of crypto geeks and geniuses can outsmart the collective intelligence and resourcefulness of the world’s hackers and fraudsters. Examples abound of powerful and cash-loaded companies that have tried – and utterly failed – to outwit this collective ingenuity. Ten or so years ago, Sony invested tens of millions of dollars to secure its music CDs against copying by home computer users. The system the company developed was hailed as a marvel of technology until – merely days after the first protected CDs hit the high streets – some guy in Germany discovered that marking the disc with a felt-tip pen at a spot near the inner rim could defeat the security system.

Microsoft has also repeatedly tried and failed at securing its software against hackers. Within a day after its then-CEO Bill Gates pompously declared that Windows 7 could not be hacked because of some supremely nifty security feature, the operating system was cracked wide open for all to use.

This is the Bitcoin conundrum: As the digital currency appreciates in value, the likelihood of it being undermined by hackers-turned-counterfeiters increases exponentially. The Bitcoin geeks can plug all the holes they want and unleash all might of cryptology, their efforts will prove to be in vain. The most interesting part of this equation is that the best crack will assuredly come in the form of some felt-tip pen, i.e. the simplest of solutions that produce a ‘duh’ moment.

Now, as such Bitcoin seems a swell idea, especially the part that has central banks and the governments they serve lose their power to manipulate the currency. This certainly appeals to anyone with even a single anarchic gene in their body. However, let’s be careful what we wish for. Yes, the system of fiat money that runs today’s world is bizarre in the extreme. Trillions of dollars and euros are called into existence at the stroke of a pen or the punching of a few keys.

This cannot be a good thing for anyone, save for the select few holding that all-mighty pen or keyboard. Fiat money is also inflationary and some people in some countries go wild with that power and inflict serious economic and financial damage. Venezuela comes to mind. As does Mr Mugabe’s Zimbabwe. As Aristotle noted way back when, it is better to rise from life as from a banquet – neither thirsty nor drunken.

Bitcoin is deflationary money. Its growth is limited to 21 million coins ensuring continued appreciation in value. That may seem like a good thing, but is actually a damaging feature. Deflation is understood to be a general decline in prices as a function of supply and demand. Why spend today, when your money may be worth more tomorrow?

To see what deflation does, just look at the housing market in Spain. Nothing moves because everybody thinks that real estate prices are likely to drop further. Only a fool buys today when he expects a lower price tomorrow. As a result millions of construction workers are idle.

One might even say that hackers would do Bitcoin a favour by minting counterfeit coins, by so doing upping inflationary pressure. But in fact, for all its appeal, Bitcoin is merely an interesting, albeit severely flawed, concept. It will be run through its paces, cause both awe and wonder as it moves from low to high and back again, and then ultimately be confined to the outer reaches of the financial world where it will reside in the company of other crackpot ideas such as universal income and unlimited growth. i