Bitcoin confidence game is a Ponzi scheme for the 21st century

Bitcoin confidence game is a Ponzi scheme for the 21st century

Summary: It's captured the imaginations of enthusiasts all too ready to exchange it for real-world goods, but recent and repeated hacks of Bitcoin's underlying elements suggest the virtual currency is no more real than the Ponzi schemes of yesteryear – and it's only a matter of time until the faithful get burnt.

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Well, colour me surprised. A virtual currency, backed by absolutely nothing except the fierce belief in the integrity of a complex mathematical formula few of its proponents even understand, is proving to be little more trustworthy than the Zimbabwe dollar after hackers tested and defeated controls put in place to manage it fall at the first hurdle.

Bitcoin accepted at this cafe in the Netherlands (http://en.wikipedia.org/wiki/File:De_Waag_Bitcoin.jpg)
Bitcoin might help you get a cheap sandwich, but the owner won't be happy. CC BY-SA 3.0 Targaryen.

In developments that should surprise nobody, the disastrous decline of Mt Gox –which has filed for bankruptcy in the US after being systematically owned and dismembered by hackers – has been followed by hackers' theft of 12.3 percent of the Bitcoin stored at the Poloniex exchange.

This is the third Bitcoin exchange to fall already, and the hackers are only just getting started. As best known methods for compromising Bitcoin are rapidly shared worldwide and new, purportedly-secure currency aggregation points fall like Fort Knox in Goldfinger, Bitcoin theft will likely surge – and then die off, as flagging trust and demand drive its value through the floor.

It's not as if the weaknesses in the system haven't been well-known: Bitcoin was similarly shaken three years ago when a hacker snuck into Mt Gox's systems and managed to push the value of a Bitcoin from around $US13 to just one cent in the blink of an eye.

The repositories curiously entrusted to manage Bitcoin's integrity aren't the only weak point in the system: the virtual currency has given hackers of all stripes something real and tangible on which to focus their efforts.

The rise of Bitcoin-mining malware has not only allowed many of them to use other people's computers to make untold fortunes while they sleep, but shown just how effectively the Bitcoin algorithm – despite assurances to the contrary – is powering an ecosystem that is fundamentally open to malicious manipulation.

The rise of Bitcoin-mining malware has not only allowed many of them to use other people's computers to make untold fortunes while they sleep, but shown just how effectively the Bitcoin algorithm – despite assurances to the contrary – is powering an ecosystem that is fundamentally open to malicious manipulation.

Meanwhile, the poor punters are lining up to support Bitcoin because they believe in the importance of virtual currency. It seems like every second day news reports highlight well-meaning cafe owners who proudly display their geek cred – and complete lack of real business acumen – by pointing out that they accept Bitcoin.

Nobody, however, seems to be pointing out that nothing whose worth is so inherently and unpredictably volatile should be used as the basis for real-world buying and selling. At $13 that cafe owner might be willing to accept one of my bitcoins as payment for my sandwich, coffee and Danish – but when the money I paid him is worth $0.01 a few hours later, he won't be so happy. I suspect his landlord won't be so magnanimous.

Some of the people jumping into Bitcoin at this early date may be hoping to amass a treasure trove of virtual currency on the hopes that increasing future demand will turn them into real-world millionaires overnight. You know, like buying Apple shares or limited-edition Franklin Mint plates. Or, shares in Pets.com.

Sure, everybody likes to make a quick buck. But to pretend that Bitcoin is magically worthy of investment like long-established and carefully-regulated currencies like the British pound or US or Australian dollar, is nothing more than madness. Bitcoin is not a fiat currency and what it resembles, more than currency, is the notorious Ponzi schemes whose value was entirely based on the continuous addition of new investors whose principal funded returns for earlier investors.

Bitcoin will be the same: as level-headed investors realise they are better to put their money in commodities whose value can be compromised in seconds by clever hackers, the currency so enthusiastically embraced by today's punters that there's a cottage industry around Bitcoin ATMs will see demand drop so quickly that it will become all but valueless to anybody but the most optimistic speculators.

The governments (and citizens) of Mexico, Zimbabwe and countless other countries have learned firsthand just how problematic this can become, as rapid shifts in demand fuel the deflation of currencies that have left the once-rich penniless and redefined entire countries' economies.

Many digital-era counterculteralists argue Bitcoin's essential beauty is not only its virtual nature but the fact that it is decentralised, unregulated, and uncontrollable. Yet no viable currency can properly function without layer upon layer of careful control.

Sure, Bitcoin advocates argue that the underlying algorithm is sound and that the problems are procedural issues related to the individual organisations charged with servicing the market Bitcoin has created. That may be, but Bitcoin needs to exist as part of a real-world ecosystem managed with the same sorts of responsibilities, integrity, governance, and legal repercussions for breaches as are assigned to other currencies.

Many digital-era counterculteralists decry such regulation, arguing that Bitcoin's essential beauty is not only its virtual nature but the fact that it is decentralised, unregulated, and uncontrollable. Yet no viable currency can properly function without layer upon layer of careful control, and it's the height of blind optimism to suggest that Bitcoin will be any different.

Japan's government was set to regulate Bitcoin, by some reports, but then decided against it – arguing, in a sparkling case of circuitous logic, that it is not in fact currency and banning banks from selling Bitcoin. This is the same sort of argument by which governments do not regulate vitamins and food supplements with questionable benefits for the simple reason that they are considered to be foods rather than medicines.

Others might suggest that Bitcoin is building a market that will level off as demand surges, supply levels off, and market mechanisms stabilise. There may be some economic truth in this: the US dollar, for example, is so widely owned and fundamentally important to world commerce that the even the loss of millions in currency would barely register a blip.

But Bitcoin is not the US dollar, nor even the Zimbabwe dollar: it is the Santa Claus of currency, something whose very importance in society relies not on physical evidence but on the power of collective belief. With one core part of the Bitcoin ecosystem falling after another and Mt Gox already responsible for fleecing thousands of outraged customers out of $US446 million – enough to make even Ivan Boesky or Michael Milken wince – it seems hard to envision a future for Bitcoin that is much more than a speculator's paradise.

What do you think? Have you bought into the Bitcoin dream? Is it a pump-and-dump scheme that will fall by the time you've finished reading this article? Or am I just missing something? In which case, feel free to enlighten me – and the others that apparently just don't get it.

Topics: E-Commerce, Apps, Banking, Consumerization, Emerging Tech, Government, Legal, Tech Industry

About

Australia’s first-world economy relies on first-rate IT and telecommunications innovation. David Braue, an award-winning IT journalist and former Macworld editor, covers its challenges, successes and lessons learned as it uses ICT to assert its leadership in the developing Asia-Pacific region – and strengthen its reputation on the world stage.

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114 comments
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  • no be una...

    Tech journalists just de insist say Bitcoin na d future? Every tech website bitcoin this bitcoin that!
    ArcaneAce
    • This article is spreading FUD!

      I am sorry but I want to urge David to go and make a proper research about Bitcoin then update this article.

      First of all, a cafe owner might be willing to accept one of my bitcoins as payment for your sandwich, coffee and immediately convert that bitcoin into fiat currency using CoinBase or BitPay and reduce the risk of price drop to zero0000.

      Almost all merchants do that but of course it is much easy to spread out doubt then to do an actual professional research.

      Mt Gox failed because it was build based on old code, based on hack-able code and they are planning to give the bitcoins back according to the civil rehabilitation program. You have to realize that NO ONE WILL HACK YOUR BITCOINS if you store them on a paper wallet.

      There are 4 BILLION people unbaked on this planet and we can bank them with bitcoin for a very low fee or for no cost at all and do you want to trow this opportunity away because you don't like BITCOIN and you are too lazy to to a proper research?

      Remember, cryptocurrencies are "Inevitable", Says Google’s Jared Cohen!
      Hapsanul
      • not so fast buddy

        what is the basis for trust in bitcoin?

        there is none. you might argue that bitcoin can be exchanged for government backed currency. but you would note that if the bit coins appreciate even slightly an exchange will be broke.

        bitcoin and the theory of money and credit
        .....it seems there is a definite possibility that digital currency could break the plastic card cabal's feast of fees. in a p2p environment we just don't need to pay some outfit to process transactions for us
        the digital currency people have a lot to learn about money though before they can make something work. there are various types of money: commodity, fiduciary, fiat, and credit. to make fiat or credit work you need to power of courts and police from government. for fiduciary you must reliably redeem your notes in specie;

        commodity money has implicit trust: an ounce of gold ..... is what it is .... it is not a promise from someone as is fiduciary money -- or a threat -- as is fiat or credit money.

        i don't see people valuing digital currency as a commodity which seems to be the basis on which the concept is supposed to operate as "bitcoins" or currency units are derived by "mining "

        they have a great idea; it just needs work and I don't see which way they need to go.
        Mike~Acker
        • You can do all of that with the block chain technology.

          ethereum org

          with this one can do even more... even contracts ;)
          Hapsanul
        • Bitcoin has the same backing as the US dollar.

          None.

          The US dollar is worked on the ASSUMPTION that an equivalent "value" in some product.

          Currently the US dollar is not backed by either gold or silver. It used to be - the US dollar was at one time composed of "silver certificates" and "gold certificates" which had to be redeemed for the equivalent value in silver/gold. This brought about the Ft Knox repository of precious metals. Unfortunately, inflation has essentially wiped out the usefulness of Ft Knox, and the US dollar is no longer backed by anything but a promise.

          http://en.wikipedia.org/wiki/Silver_certificate_%28United_States%29

          http://en.wikipedia.org/wiki/Gold_certificate
          jessepollard
          • The US dollar is backed by the US government.

            apparently Bitcoin isn't backed at all.
            William.Farrel
          • Missinformed

            I am sure soon it will be backed. More and more merchants are accepting Bitcoins there are politicians pro bitcoin.
            Even if it is not backed at the moment, the technology is so great that this reason is not big enouth not to use BTC.
            What about internet, is it backed by anything?
            Hapsanul
        • Re: No So Fast Buddy

          The basis for trust in bitcoin is more-or-less the same for gold or other item that has a limited supply. So long as there are people willing to buy, then they have value.

          If bitcoin prices go up, exchanges do not lose money. An exchange it just that: they buy and sell bitcoins. Party A expresses a desire to buy. Party B expresses a desire to sell. The exchange matches A and B and executes the exchange, taking a commission. They exchange never loses.

          Where exchanges have failed, it has been due to hacking and poor security.

          Bitcoin looks like it has a promising future. People are interested to transact in the currency. What's really cool about Bitcoin is that it is a global currency. You can buy stuff anywhere in the world with it. If I were a merchant, I could open up sales to countries that I would not normally be able to trust. Equally important, I can hop on a plane and use Bitcoin when I land. It's not as widely accepted as the credit card, but if things continue as they are, it may be.
          paulej
      • "Built on old code"

        In other words, Bitcoin software might have bugs, or in practice, is guaranteed to have bugs that can be exploited by less than honest participants in a variety of ways. No surprise to anyone who programs for a living.

        So shall we assume that the Free Market will work out these sorts of glitches in due course without any effort on anyone's part?
        John L. Ries
        • Not a good argument.

          The old code has been checked and rechecked hundreds of time and improved several times. This network is running for more than 5 years and that should be a sign for you that there are no bugs.
          Maybe you should think about learning a little bit of C++ then think about start reading the code for yourself before making false accusations.
          What about this as an argument: The bitcoin wallet is build using the ECDSA (Elliptic Curve Digital Signature Algorithm), the same algorithm that is used for secured internet connections (SSH, HTTPS), the same technology used by banks in internet banking and wire-transfers.

          IF BITCOIN WILL FAIL BECAUSE ENCRYPTION FAILURE, ALL BANKS WILL FAIL!

          Why don't you check if there is a bug in your favorite online bank account that you use on your daily basis? Oh, I know why... because you don't have access... and you still trust them?
          Hapsanul
          • Lubarsky's Law of Cybernetic Entemology

            There's always one more bug.
            john-whorfin
          • Some people want to go back to stone age

            Then if you are so afraid of bugs then stop using the online banking system because you are sure there will be a bug. Stop using the computer and go back to stone age!
            Hapsanul
          • not fear, just reality

            Hapansul, you are the one who stated "This network is running for more than 5 years and that should be a sign for you that there are no bugs. " If you really believe that there are no bugs, you are kidding yourself. Not that the bugs in the bitcoin systems are any easier to exploit than the bugs in credit card and banking systems, which are obviously bug free because there are never any security breaches in these systems.
            john-whorfin
          • Banks VS Bitcoin

            Let's compare one with the other:

            Bitcoin Exchange websites are at the moment easy to hack because they are at their infancy. You know already two examples.

            However, banks look to me that are vulnerable despite having hundreds of years of experience:
            JPMorgan-Chase-bank-card-hacked_5
            Barclays-account-details-sale-gold-27-000-files-leaked
            uk-lloyds-technology-idUKBREA0P0PH20140127

            The bitcoin address is unshakable using the current technology.

            In order to spend money sent to a Bitcoin address, you just need to find a ECDSA public key (160 bit value). That will take, on average, 2 ^ 160 key generations.

            Supposing you could generate a billion (2 ^ 30) per second, you need 2 ^ 130 seconds. Doing this in parallel using a billion machines requires only 2 power 100 seconds. Getting a billion of your richest friends to join you gets it down to only 2 ^ 70 seconds. There are about 2 ^ 25 seconds per year, so you need 2 power 45 years.

            The age of the Universe is about 2 ^ 34 years so far - better get cracking!

            The bank pin is 4 digits, the private key is 51 digits: you have to be a fool not to see which one is better...
            Hapsanul
          • do you even read what you post?

            You start off citing the ease of hacking BitCoin Exchanges, then explain that it is virtually impossible to hack because it would require more time than the universe has existed. It still comes down to the fact that your initial claim, "that there are no bugs", is false.
            john-whorfin
          • No

            You don't understand.

            The Bitcoin EXCHANGE is easy to be hacked but not because of the Bitcoin protocol itself but because of the owner's lack of programming skills; and last but not least the BITCOIN ADDRESS (something that can exist outside of a bitcoin exchange) cannot be hacked with the current technology ergo, not in your life time at least...

            As MillyBitcoin commented here there is a lot of Misunderstanding and misinformation.
            Hapsanul
          • You're right, I don't understand

            Suppose I have a Bitcoin address and someone sends me $100 worth of Bitcoins. How do I turn that into US Dollars without using a Bitcoin Exchange?
            john-whorfin
          • Simple

            You can use Local Exchanges, you can use in person exchange. There are people exchanging BTC for Fiat currency in coffee shops where there is surveillance, even inside the banks. You can exchange BTC using the two way BTC ATM machines. There are ways to do it...
            Hapsanul
          • All of which...

            ...are exchanges, so you haven't answered his question.

            A better way of putting it would have been that there are a variety of exchanges available, to include trading Bitcoins for official currency in person.
            John L. Ries
          • Various exchanges

            With little risk or zero risk and therefore there with less bugs or no bugs at all. The BTC address is backed by mathematics while the person to person exchange or two way bitcoin ATM machine is backed by your ability to trade / use the machine.
            Hapsanul