Bitcoin’s Emerging Weaknesses

Bitcoin’s true innovation is one of trust. Through some clever cryptography and a proof of work scheme, Bitcoin has established a network of trust in which everyone can agree on a common ledger without having to place their faith in any one individual or central institution. In order to be sure that transactions are legitimate all that one needs to trust is mathematics (pretty safe bet there) and that no one person controls more than 50% of the network’s computing power. This innovation is quite remarkable and has led many to believe that Bitcoin’s design will revolutionize not only the way we pay for things, but also the way we conduct our lives online.

Given this fact, it is interesting to see how recent developments within the Bitcoin network have served to diminish the effect of this innovation. Within certain places in the Bitcoin community people are indeed imparting significantly large amounts of trust to individuals and institutions, the exact thing that Bitcoin’s technology was designed to make unnecessary. This phenomenon has strengthened with the recent rise in the currency’s popularity and it would seem that as Bitcoin becomes even more popular, its users are increasingly likely to undermine its biggest strength, its decentralized and inherently skeptical nature.

The reason for this decrease in skepticism has to do with the benefits afforded to individual Bitcoin users. The complexity of the Bitcoin system has made certain services necessary. Exchanging BTC for fiat currency is an example of one such service. Pooled mining capabilities and further Bitcoin software development are two other areas of activity that serve the Bitcoin network a great deal. Without these types of services the Bitcoin network would fail to function as effectively as it has. Unfortunately it has been difficult for these services to operate without the need for some amount of trust to be granted by the user. The result has been an incredibly robust and decentralized payment system, with a somewhat vulnerable service community built around it. This has posed issues for Bitcoin in the past and it is my belief that it will continue to be an issue well into the future.

The Bitcoin Elite

On March 11th, 2013 something happened on the Bitcoin network that was not supposed to happen. A node running software version 0.8 inadvertently mined a block that was not recognized by nodes running version 0.7. This caused what is known as a blockchain fork, with the version 0.7 nodes contributing to one transaction ledger, and the 0.8 nodes building upon a separate ledger. The amazing innovation behind Bitcoin, the ability for a decentralized system to agree upon ONE transaction ledger was thus compromised. Until the fork was fixed it would be possible for a user to double spend a single bitcoin, once in the 0.7 blockchain and once in the 0.8 blockchain.

This problem, and what was done to fix it, highlights one of Bitcoin’s recent failures of skepticism. Led by a handful of key Bitcoin developers, The Bitcoin Foundation, the same group who released the bugged 0.8 version software, realized the issue and managed to convince those running version 0.8 to abandon the upgrade and revert back to version 0.7. This effectively destroyed the 0.8 ledger and all the bitcoins contained within it. In essence this small group of Bitcoin developers exercised a power that in a fully decentralized system should not have existed. It would seem that the need for expertise in the field of Bitcoin software development has forced some members of the Bitcoin community (whether they wanted it or not) into positions of elevated authority. This trust is necessary in order to ensure that the network evolves and expands as needed, but is completely contrary to the fundamental idea Bitcoin was founded on.

BTC Guild

Bitcoin Network Computing Power – Source: BitcoinCharts.com

Another good example of the failure of skepticism is the mining pool BTC Guild. At the time of this post BTC Guild controls approximately 40% of the total network computing power. Similar to the Bitcoin Elite, this has served to elevate BTC Guild and those that run the pool (intentionally or not) to a position of somewhat increased authority. Every day thousands of nodes trust that the intentions of the mining pool are not deceitful, and that their contribution to the pool’s computing power as well as the bitcoins that it earns them, will be dealt with legitimately.

All else being equal it seems likely that those mining with BTC Guild would rather not be in the trusting position that they are. The reality is that the service that BTC Guild provides, mainly a decreased variance in mining revenue, outweighs its risks, and that for many individuals the choice to mine with BTC Guild is a simple matter of risk and reward.

Mt. Gox

Mt. Gox’s transaction volume represents a significant concentration of trust and is the largest example of Bitcoin’s inflating failure of skepticism. According to BitcoinCharts.com, Mt. Gox handles approximately 70% of all Bitcoin to fiat exchanges. Hundreds of thousands of bitcoins are passed through the exchange everyday. This has elevated Mt. Gox to a position of authority and at the same time it has created a significant network vulnerability. Similar to BTC Guild, many Mt. Gox users would likely prefer to not be so trusting of the exchange, especially considering the significant attention it is likely to draw from those wanting to disrupt the Bitcoin network. However, Mt. Gox provides the best exchange service, and because of this people will continue to bare the risk of possible attacks or deceitful activity.

Interestingly enough, there appears to be a self regulating mechanism built into the Bitcoin community that does not allow these failures of skepticism to significantly threaten the network. Since all members of the community are invested in the health of the network (either through owning bitcoins, accepting them as payment, or even just ideologically) individuals have a significant incentive to protect the legitimacy of the transaction system. Even the somewhat influential institutions themselves are subject to the same incentives, and as such are unlikely to compromise the network with intentional illegitimate actions. Recently BTC Guild announced a policy that attempts to limit the size of their pool to 40% of the total network computing power. The Bitcoin Elite are obviously heavily invested in the success of Bitcoin and as such I would find it very unlikely that they would act against the requests of the majority. Likewise Mt. Gox has been under significant pressure lately to increase their security and other exchanges are being implemented as we speak in order to diminish Mt. Gox’s enormous market share. It is entirely possible that the incentive to protect the network brought about by the significant downside risk of network failure is actually a more noteworthy security feature than Bitcoin’s impressive proof of work and cryptography schemes that so many people praise.

For all its benefits I think that Bitcoin’s original vision of a completely trust free network will need to be abandoned. Although the underlying payment system functions very effectively in this way, I find it hard to believe that the large number of other interactions and services that are required for Bitcoin to fully flourish will ever be conducted in a completely trust free manner. After all, even the simple act of buying an item online requires at least a minimum amount of trust that the payee is going to actually ship the item. The future of Bitcoin will be a middle ground somewhere between the centralized nature of fiat currency and the completely skeptical decentralized vision made possible by Bitcoin’s innovative design. A key factor in the success of building on this middle ground will be the willingness of the community to minimize the weak points presented by the myriad of services and interactions that are needed in order for Bitcoin to fully flourish. By recognizing the benefits of a healthy, decentralized transaction network, individual actors within that network will be more likely to discourage the authority that has typically been granted to select individuals or groups. In this way we can keep Bitcoin as the purest form of democratic expression, one that will hopefully inspire all other aspects of our global citizenship.