Banking and payment expert Simon Lelieveldt believes [Bitcoin users] are living on borrowed time. "There is always a power base underlying a currency," he said, speaking at the Digital Money Forum in London in March. "Bitcoin is not going to fly because there is no central bank or power base. It's doomed to fail."
And then, at the end:
"To be clear, I would say the same about the euro," said payment expert Lelieveldt.
My personal answer? No. But who cares what I think. It's simply non productive, and frankly non-scientific, to stand up and say "Here's why bitcion is going to fail..." because it doesn't matter, it has already served its purpose.
The correlation between MtGox/USD  and GLD daily returns over 12 April 2011 - 30 March 2012 is 0.02; a linear regression produces a 0.151 beta (GLD daily returns independent) with a coefficient of determination of 0.0004. GLD had a period return of 14% with an average daily return (standard deviation) of 1.4% (0.1 percentage points); MtGox/USD had 531% with 10.2% (1.3 percentage points). It thus seems like it could have a place in a portfolio above (in terms of risk) small cap and emerging market stocks (on your worst day in GLD you lost 5.5%; in MtGox/USD 35.8%. Also, GLD delivered 2.7 times the return per unit of risk). Methodology note: since MtGox trades every day and GLD only on trading days, I used closing prices for trading days.
Bitcoin takes the monetary system back essentially a hundred years. We know how to beat that system. In fact, we know how to nuke it for profit. Bitcoin is volatile, inherently deflationary and has no lender of last resort. Cornering and squeezing would work well - they use mass in a finite trading space. Modern predatory algos like bandsaw (testing markets by raising and suddenly dropping prices), sharktooth (electronically front-running orders), and band-burst (creating self-perpetuating volatile equilibria in a leverage-sensitive trading space, e.g. an inherently deflationary one), would rapidly wreak havoc. There is also a part of me that figures regulators will turn a blind eye to Bitcoin shenanigans.
1) If you know how to nuke the bitcoin system for profit, are you doing so? It's not clear to me that you personally would be able to corner and squeeze as easily as you think, because I believe most bitcoins are held by a small group of people with a long term interest in a viable bitcoin economy.
2) HFT is usually justified by its practitioners as improving the stability and liquidity of the market, but here you characterize it as a fundamentally predatory tool if applied to bitcoin. What do you think about it in general?
That actually makes the actions of a serious predatory trader even more dangerous, since the total pool of available bitcoins is smaller due to the number of people just sitting on their bitcoins. In fact, it could be worse, especially if the trader causes the market to drop, which could make the investors bail out of the market, lowering the price of bitcoins even further. The trader then buys up the bitcoins for a song and a dance.
Now, if people weren't hoarding bitcoins, it would be much less of a problem. If the majority of the currency was liquid and actually flowing, it's much harder to corner the market on it.
This isn't necessarily HFT-specific. HFT is constrained by a lot of rules-both regulatory and exchange-specific-that attempt to stop this kind of damage(for example, NASDAQ has the right to void any trade chain that takes place if they deem it necessary), as well as a massive amount of competition from other players in the market. With Bitcoins, there aren't any of these rules, either on the exchange level or regulatory. There is not anything to stop a trader, either using HFT algorithms or just manually executing the trades, from applying these techniques.
A currency's value isn't a function of how much of it is outstanding but how much is transacted in it. If "most bitcoins are held by...people" holding on speculation, they contribute to holding its value down (don't think of stocks with dividends, think of fx). They also make the market smaller and less liquid.
2) The quote cycling HF market making algos use to discover prices disappears in a liquid market. If done in penny stocks, on the other hand, it would scare the hell out of everyone when a market order executes against a discovery bid way out on Pluto.
When these slips happen the HF guys get hurt - that's why they pull their servers causing the liquidity cuts they're criticised for. Thus, they work to predict when that kind of slip-up will happen. I'm reversing the logic and saying I'll force the slip-up and take advantage of the volatility right after, something with uncertain pay-off in liquid markets (you burn yourself in spawning the unstable equilibria) but more definite pay-off in illiquid ones.
Note that I wouldn't recommend trading Bitcoins at a high frequency for the same reason that HFs don't mess with penny stocks. The pay-off is too low compared with the infrastructure investment required. I'd probably also blow my cover with the exchanges.
Hope that answers your question!
wouldn't it be difficult to cause such HFT havoc on a currency that is not that frequently traded (relative to big exchanges)? After all, someone has to be on the other side of all those HF trades. Also, since it's heavily decentralized wouldn't that make it more difficult to execute trades in high quantities?
How do you "corner and squeeze" a market that can't be shorted? You can manipulate GLD down by issuing naked shorts (essentially counterfeited against collateral). But you can't counterfeit Bitcoin. If you want to drop the market price of Bitcoin, you have to sell actual BC that you had before and don't have now.
Then, to actually profit, you have to find a way to buy those BC back for less than you sold for. This isn't going to happen unless your smart algo finds an equal and opposite stupid algo that it can rape. Who gets raped and why?
(If you ask me, it's BC that's a well-designed market and Wall Street that's a funky, broken anachronism. A lot of stupid pointless volatility would go away if we eliminated synthetic securities and lenders of last resort, and replaced the ancient order-matching system with a central limit-order book. Then, you'd have to actually add information to the system in order to profit - rather than profiting by raping other algos, and more plausibly retail traders, with "sharktooth and band-burst.")
let's move on to something else
As for the economic critiques, of course bitcoins are no panacea. These critiques are relevant to any market; the punchline of the article was even "I'd say the same about the Euro"
Unfortunately, Bitcoin is not "men with guns entering your house or server location and taking your drive" proof.
At this point, Bitcoin is being treated as a speculative instrument. It does not share the same status as gold, being a store of value, and thus it will not move based on the fears and hopes of fiat currencies. From that standpoint, it should be entirely uncorrelated from the fiat banking system and traditional investments. Be careful if you are trading for Bitcoins denominated non-USD, as those prices will move with exchange rates as well.
From a regulatory standpoint, Bitcoin is in limbo. Right now, it's no different than trading bottle caps, but when the regulators come down on it, there will be a different story.
In short, the two forms of investment risk you face are volatility price risk and regulatory risk.
Also, consider that over 80% of the foreign exchange market is accounted by 6 currencies or so: US dollar, yen, euro, British pound, Swiss franc and Australian dollar. Traders barely bother with the Brazilian real or Indian rupee, even though these currencies are much more likely than bitcoin to be around in 5 years.
How so? As bitcoin is a p2p network, it is likely to be around whatever happens. The only thing that could happen would be that internet breaks down - pretty unlikely, I think. Even when internet breaks in several pieces, each "local internet" will just use their own bitcoin - the block chain will be split in to several. After the two "local internets merge", the blockchain which has more computation behind it, will win.
In discussion, you should separate two things a) bitcoin's economic value/utility b) bitcoin network itself. I'm pretty sure that bitcoin itself will be here about forever, however it is pretty unclear if anyone will use it.
Or maybe people would simply lose their interest in to bitcoins, or start using something else. Maybe Google will invent their own bitcoin, and everyone starts using that. Or maybe something else happens.
When the USG starts shutting down the exchanges, which will happen any minute now, Bitcoin will go to zero and stay there. Everyone who thought their BTC was worth USG will want out - and find that the doors are now locked. The BTC price won't even be epsilon. It'll be zero.
The monetary design of Bitcoin is sound. The political design, not so.
The USG has been successful killing payment companies before (eg e-gold, epassporte, neteller), but those were of course centralized systems. Bitcoin is decentralized, which is why its supporters believe that it is here to stay regardless of the actions of any particular government.
The US dollar is a centralized system. US financial regulation is in effect worldwide (except now Iran, I guess). If you have a decentralized system dependent on a centralized one, it's a centralized system.
Bitcoin is not dependent on the USD for its operations, just for its value. The day after MtGox (for instance) is indicted, everyone will be selling and no one will be buying. Also, all payment processors everywhere will cut off all Bitcoin exchanges everywhere.
(Everywhere excluding Iran, I guess. Is Bitcoin big in Iran?)
But what about your neighbor Bob's place? You buy him dinner, and the next day a string of bits comes your way via Tor (or somesuch.) There is no need to utter the word "Bitcoin" during said dinner. A wink, a nudge, etc. will suffice. The next day, Bob does the same with his neighbor Charlie. And so on.
And, naturally, if Bob were a traitor, he could rat you out to the Gestapo. But he could just as easily rat you out for [insert extremely popular but highly-illegal-in-the-USA activity here.] No digital cocaine required - the analog kind will do. And if you haven't any under your bed, Bob will helpfully leave a kilo in your toilet tank.
Most people have already had plenty of practice exchanging highly-illegal strings of bits. Now they will just need to learn to give each other "free" stuff as well.
Bitcoin hasn't reached the critical mass needed for this kind of thing, but there is no reason why it could not.
Consider hawala (http://en.wikipedia.org/wiki/Hawala) which is doing quite well despite draconian bans. On which currencies do hawala transactions depend? All of them and none of them.
I wouldn't say 'big' exactly, but the participation is non-zero:
It will be interesting to see what happens at the end of this year when the block reward halves.
1) 'monetary' inflation will decrease, because the rate of bitcoin creation will drop from 7200BTC/day to 3600BTC/day
2) miners will be earning half as much when denominated in BTC
If the decrease in inflation doesn't cause a large enough corresponding increase in price, mining would be less profitable, causing some fraction of miners to drop out, and meaning longer transaction confirmation times (for at most 2 weeks, while the network adjusts to the change in capacity).
My guess is that the huge change in inflation will adequately compensate both miners and investors, and cause a significant enough increase in price to avoid lengthening confirmation time.
EDIT: by inflation, I mean 'monetary' inflation, rather than price inflation.
To be clear, it wouldn't be two weeks. The network adjusts every 2016 blocks, which under normal circumstances would be approx. 2 weeks. Typically it's a little less as new hash power comes online, but in the case of a drastic loss of hash power, it could be much much longer than two weeks. We saw that with namecoin where it took almost half a year between adjustments (or would have, if developers hadn't intervened with merge mining).
My guess, however, is that the price will be more stable, given that the effect of any bad news won't be so amplified by the minting of new coins. Currently, the supply of coins is growing rapidly (just over 30% per annum). After the block reward halves, that rate will be below 13% per annum.
As others have mentioned, I'm also curious to see how the halve will affect the network's hashing rate (and therefore, security).
add: I heard someone talk about India buying oil from Iran using gold now - if gold replaces the petrodollar, that might trigger something. The sanctions on Iran could ultimately affect bitcoin by way of new oil trade with Iran in gold that doesn't include the Western bloc of nations. Oil4bitcoin might make an interesting website.
She said EU law required only euros to be accepted as legal tender, but this was superseded by German law that allows those involved in a contract to determine its content. So Bitcoin is at least not illegal there."
It wasn't even a year ago when the German organization BVDW (The Federal Association of Digital Economy) put out an alert: "We assume that, on substitute currencies' like Bitcoins sooner or later be banned by legislation,"
edit: Disclosure: I made a bunch of money getting in on bitcoin early and then selling out at around $22. It was at that point where I looked at the whole system and determined the attack vector.
Also the only way to get bitcoins securely is to buy and sell them for cash. And even then there are ways of figuring out who is who.
The next thing will be the right thing, but this isn't it. The long term picture for bitcoin, unless completely overhauled, is bleak.
So, please enlighten us: how is Bitcoin "mathematically flawed"?
Unrelated Question: Why do you have a pgp cast5 encrypted message in your profile?
The reason why options work is because there are clearinghouses that will guarantee the transaction. Without a regulated clearinghouse, you're subjecting yourself to counterparty risk, which as we discovered in 2008, is a significant risk especially during market crashes.
> Also the only way to get bitcoins securely is to buy and sell them for cash. And even then there are ways of figuring out who is who.
This is ridiculous. The psuedoanonymity of bitcoin allows for laundering services which enhance your plausible deniability. You can't practically figure out "who is who" if I send a delayed transaction through a popular laundry service.
Is your point that the Bitcoin market is still very small and can be manipulated?
(for reference, HN discussion was here: http://news.ycombinator.com/item?id=2596475)
But... the guy has made it clear he believed bitcoin's value would rise, so selling a put option at - say - current value would be advantageous to him. Offer a low enough strike price, high enough premium, and word your offer in layman's terms ("you get money now and might get money later if bitcoin rises or might have to pay money if it falls") and he could be tempted to enter in an appropriate contract.
It would actually be very useful to have a liquid options market to help producers and merchants overcome the current volatility.
As I understand it the bitcoin rewards of mining go down over time. If the rewards go down over time, eventually it won't be profitable to mine bitcoin. So the speed of transactions goes down and the network becomes weaker because theres less cooperating computer time on it.
Maybe I just don't get bitcoin. But if true that seems like a fundamental problem.
Alternatively, a really busy Bitcoin network will be limited by the maximum block size and people will pay for priority inclusion in a block. However, this limitation is totally artificial and doesn't scale with the increasing amounts of bandwidth and disk space available. Miners have an incentive to "suck up" to Bitcoin users - without them their mining has no point. If the Bitcoin users demand bigger block sizes so they don't have to pay transaction fees I think miners will have to take the partial hit from bigger blocks rather than the total hit of lack of blockchain use.
The idea is the following: If the amount that can be mined per unit of computation is decreased, then fewer will be created. And if there are less of them being created and more of them demanded, then their value increases. So this balances out. Also, computational power gets cheaper with the passage of time.
The largest caveat I see there is the part about more of them being demanded. (or equivalently, the market equilibrium of demands for bitcoin holdings shifting towards greater demand)
> "If the rewards go down over time, eventually it won't be profitable to mine bitcoin."
No. Because the other part of mining is that you get transaction fees for it. Mining isn't a luxury, it's necessary for the network to function (otherwise double-spending isn't prevented). So as time goes on and less coins can be made by mining, transaction fees will increase to compensate and keep mining profitable.
> Also, computational power gets cheaper with the passage of time.
But, mining does not get cheaper because the network (by design) adjusts the mining difficulty to keep the incoming block rate constant. So in relative terms, mining will never become significantly more or less expensive with time.
> The largest caveat I see there is the part about more of them being demanded.
Not a problem. This is solved because bitcoins are infinitely divisible (up to 8 decimal places currently and this can be extended if needed). So if there's more demand, the value of coins increases but you can still trade them in whatever meaningful quantities you like. This isn't something you can do with cents, but you can trade one millionth of a BTC just fine.
"Not a problem. This is solved because bitcoins are infinitely divisible"
I detect confusion here.
I'm not talking about lack of divisibility, but a lack of demand. Increased divisibility doesn't facilitate demand. It's just a nice feature of something that could be money or commodity.
Water is infinitely divisible but that doesn't get it demand. If people don't exercise demand for bitcoin, (as in, they don't want it) divisibility doesn't solve the problem.
I don't think that's why consumers would fear it being unstable. It's probably more that they're afraid most of the current users aren't using it for its intrinsic advantages over regular currencies, but are rather investing in it as speculators (and will, therefore, eventually pull out). Since it was designed in a way that made early adopters super rich, it lends the appearance of being the very kind of investment bubble that Bitcoin advocates criticize the banking industry for creating.
The quote encoded in the genesis block by Satoshi (creator of bitcoin) was probably a criticism of fractional reserve banking rather than investment bubbles per se. "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks"
But there are plenty of bitcoin advocates who tirelessly criticize bitcoin speculators for causing its price volatility. Not that price volatility is unique to the bitcoin market (its the same with oil, stocks, gold/silver, commodities in general, real estate, bonds, etc. etc.).
I've no interest in trading bitcoin, but I am interested in learning about making Python bots (in order to hack web games for fun and profit), which is how I found this project.
A quick google search turned up this blog about bitcoin trading for those who are interested:
On the one hand, it solves the problem of seeding the network with coins. Otherwise, how could you kick this off in a fair way?
Secondly, mining "solidifies" transaction blocks, which acts as transaction verification for the network. Mining basically acts as prevention of "double spending" of coins.
Finally, mining keeps the money supply scarce (necessary for any currency) because despite everything just being bits, you can't just fake new coins without expending enormous amounts of computing power -- you need to prove you've done the work by solving hashes.
The bitcoin wiki has pretty good technical explanations of all of this.
There's plenty of discussion on what this cloud-supercomputer could be doing in addition to its current task. Problem is, the nature of mining introduces several limits on the types of computational problems miners try to crack.
Here's a post describing the qualities a bitcoin-appropriate computational problem would have.
In addition to this the implementation is known to be technically flawed and vulnerable to attack. The system is easily disrupted by a sufficiently interested and funded party.
> The first is that it is insecure. As seen by the constant incidents of stolen and lost bitcoin's.
If this is the standard by which you deem a currency insecure, you may want to be more specific. Physical goods are also susceptible to theft.
> Physical currency is much more secure than a string of bits sitting on a hard drive
This isn't really substantiated by anything, and I implore you to read about paper wallets. But you're also ignoring another useful characteristic of bitcoin: coins cannot be counterfeited, unlike any other currency. They are crytographically ensured.
The security of your funds is not inherently endangered by the network by any means. I can accept bitcoin donations anonymously and there is no way they can be targeted without additional context. With physical transactions, there is always location.
> The second is that it's much less convenient than cash.
Cash is much less convenient than digital transactions. Have you heard of a credit card? Cash is only useful for anonymity.
> The third is that the distribution system is set up as ponzi scheme where early adopters reap enormous amounts of wealth if they recruit more bitcoin users(which is why the bitcoin astroturfing is so persistent), people generally don't like participating in ponzi schemes.
The currency incentivizes its own operation, yes, but this is not even close to a ponzi scheme -- you should look that term up. The technology does not distinguish early adopters from other participants.
Theft and loss of bitcoin is much much more common than theft and loss of any normal currency. Insecure.
Bitcoins are data, and data is very easily lost. What if the hard drive with your wallet on it fails? When a hard drive fails at a bank your money is still secure. Storing bitcoin on a home computer is not even close to as secure as storing money in a bank.
>Cash is much less convenient than digital transactions. Have you heard of a credit card? Cash is only useful for anonymity.
Bitcoin is much less convenient than cash and credit cards. Nobody accepts bitcoin as payment. And as far as I know there is no existing way to link a bitcoin account with a credit card. I'm not saying the flaws are unfixable just that they are huge flaws with bitcoin. I'm criticizing bitcoin for what it is, not what it could be.
>The currency incentivizes its own operation, yes, but this is not even close to a ponzi scheme -- you should look that term up. The technology does not distinguish early adopters from other participants.
The bitcoin distribution system is a big problem. Whatever you call it, it is an unfair and unstable system where early adopters profit when more people adopt the currency, and late adopters end up holding a risky asset with unstable value. Without a backing authority stabilizing the price, alternative currencies are just toys and far too risky for normal people to get involved in.
That's a pretty big conclusion to jump to. People using the currency have more of a burden to protect their bitcoins from hackers, I'll admit, but it is not fair to blanket describe the currency as insecure because of the practices of some lousy companies.
> Bitcoins are data, and data is very easily lost. What if the hard drive with your wallet on it fails?
Did you read about "paper wallets" like I mentioned? It's not a problem for most people, but if it's a problem for you, there are ways to avoid it.
> Bitcoin is much less convenient than cash and credit cards. Nobody accepts bitcoin as payment.
Is this really your argument against bitcoin individually? What you described applies to pretty much any currency in its infancy. Either way, my defense of bitcoin's convenience is of the mechanisms of exchanging them, not something as arbitrary as acceptance. You seem to be clasping to straws.
> The bitcoin distribution system is a big problem. Whatever you call it, it is an unfair and unstable system where early adopters profit when more people adopt the currency, and late adopters end up holding a risky asset with unstable value.
Hilarious. Can you give me one reason your last sentence didn't just describe an investment? Do you realize any other stock, commodity or currency will also naturally favor early adopters, because they can buy something when it's low and sell when it's high? What drawbacks could there possibly be for a system like that anyway?
I also don't understand what you mean by "bitcoin distribution system", would you like to clarify?
Nitpicking here, but what is described applies to non-government-mandated currency or payment methods. Infant currencies can indeed very quickly gain widespread acceptance if introduced and mandated by government, as recently demonstrated by the euro.
In that sense, if not insecure, it certainly isn't resilient.
The math works out such that there are a precise number of bitcoins in the system, ~21M IIRC.
> The amounts are infinitely divisible.
8 decimal places.
Is that alot? Yes, but my point was that the current system is leaky. The rate of leakage may not be too bad now, but as the adoption rate goes up more careless nontechnical folks will get involved. Those people will fail to backup their wallets; that BTC will evaporate is an inevitable consequence of success.
This is a client-specific value, and not a necessary property of the protocol. They can become arbitrarily divisible by simply modifying the client code.
Of course new clients will not be compatible with old clients.
That's not a useful feature for me. Receiving counterfeit currency is very low on my list of concerns in life. It is a useful feature for governments, who would no longer need to ensure its currency isn't being counterfeited, but governments don't like this currency for a number of other reasons.
If it was possible to print notes that could not be easily detected as counterfeit -- millions would be printed and it would devalue the entire currency.
So bitcoin can't be devalued by "printing" fake "bills." That's a good prerequisite, but it's not a practical improvement for me over the current currencies.
Well, the value in bitcoin is that it can't be printed by anyone, even the goverments, uncontrollably - there will be only specific amount at max in circulation at specific time.
This might not be valuable to you, but it certainly will be for many else. Many people don't like the thing that goverments keep devaluing their fiat currencies.
A well-funded hostile government, bringing a lot of computing online aimed at "attacking" BitCoin would be a valid concern. I accept it's a tiny risk.
http://www.fin.gc.ca/budget06/bp/bpc3d-eng.asp names the amount for National Counterfeit Enforcement Strategy in 2006 as $9 million. I don't think these are the total expenses on preventing counterfeits, but it's within an order of magnitude. The official population count in the 2006 census was 31,612,897, so let's say the number of people who have paid any tax that year is around 30 million. Corporate taxes would complicate the "per taxpayer" calculation a little bit, but they would only make the amount smaller.