Bitcoin's Biggest Problem: It's a Den of Thieves

I've had a curious eye on Bitcoin for a few years now.  Through various posts on HN I've followed its ups and downs including the big hoopla over the exchange rate for a Bitcoin reaching parity with the dollar, a figure that is now eclipsed by today's going rate of $12/BC.

For those that haven't paid similar attention, here's how Wikipedia describes Bitcoin:

Bitcoin is a peer-to-peer electronic currency .. which can be sent, received and managed through various independent websites, PC clients and mobile device software.

At its roots, Bitcoin is based on some rather clever mathematics, ironically the same primitives that keep our credit cards secure when buying things online.  But while credit cards are centralized systems, with Visa, Mastercard and friends acting as the managers of who has what, Bitcoin is more clever.  It is a truly distributed system, everybody knows everything, all the Bitcoin clients forming a congress of sorts on what the state of the world's Bitcoin economy actually is.

This has some very neat advantages, the largest being that no one entity controls Bitcoin, instead it is a community all agreeing to use a currency with particular rules, with some clever algorithms keeping everybody honest.  No single government, much less corporation, can dictate what happens to Bitcoins.

Another great advantage is that it also allows for almost complete anonymity, while your Bitcoin 'wallet address' is public, as are the transactions that go in and out of it, nobody really knows who that address belongs to.  Since it is incredibly easy to set up digital bitcoin wallets, it is easy to launder bitcoins as well, masking the sources and destinations of transactions.

These two great strengths: no central authority, and complete anonimity, unfortunately also create the perfect environment for fraud.  Since there is no central authority able to reverse transactions, and since there is no way to track down someone you send Bitcoins to, the Bitcoin community sometimes seeems like a den of thieves.

One need only look at the long list of failed attempts to allow the purchase of Bitcoins through PayPal or credit cards to have this point driven home.  Since both credit cards and PayPal allow reversal of charges, it is easy for crooks to buy Bitcoins, have them deposited to their anonymous wallet, then have the charges reversed.

This fact makes acquiring Bitcoins a rather obnoxious affair, with one party or the other having to give tremendous trust to the other.  I recently tried to buy a moderate number of Bitcoins on one of the trading facilitators, Bitcoinary, and ran into this head on.  After agreeing on a price, I sent over the money for the Bitcoins over PayPal and was immediately faced with a seller getting cold feet, nervous that I would reverse the charges after he sent the Bitcoins over.  No amount of convincing worked to assuage his fears, offers to call, online reputation, etc.. Despite offering to forego far more privacy than any consumer ever would, he refused to complete the transaction, the deal finally falling through.

This is not a good sign for Bitcoin.

Though Bitcoin is a fine digital currency, it is hard seeing it take off for consumers the same way credit cards have.  While centralized payment systems like credit cards have their disadvantages, they offer one very large advantage as well: they act as an arbiter in the case of disputes.  The buyer and seller both agree that "Papa Visa" knows best and with that confidence consumers open their wallets.

Bitcoin has none of that.  Yes it is decentralized, yes it is amazing to see payments go through so quickly and so cheaply, but what happens when it goes wrong?  I can trust tiny merchants with my credit card because I know if something goes wrong I have a recourse, there is no such recourse with Bitcoin.

So we are back to the same trust issue I ran into on Bitcoinary, a chicken and egg problem. Customers will be leery to spend with new merchants without a reputation, and new merchants will find it hard to build that reputation without customers.

Note that I did eventually find a seller on Bitcoinary who would trust me, so it isn't completely hopeless, just a lot lot harder than it should be.

As has been pointed out numerous times, "trust enables people to do business with one another". Trust creates an environment where everybody can stop worrying about being ripped off and get on with business.  A currency that allows complete anonymity yet has no central authority to manage disputes fails this trust test. That single fact is why I don't see Bitcoin taking off long term in its current form.

It might not be completely hopeless. One way to manage situations where neither party trusts the other is to have a third party in between which is trusted by both: escrow. There is no reason Bitcoin couldn't support such a party in its ecosystem, built on Bitcoin, but adding trust to the equation. With that will come overhead however, and I'd be surprised if we didn't find ourselves back to the 3% transaction fees so common in the credit card world.

In short, while Bitcoin is irresistable crack to software geeks for its sheer cleverness, I just don't see it having the right attributes to break out into a larger world of consumer spending.  Either way it will be an amazing thing to watch grow and evolve.  Who knows, maybe, just maybe I'll someday be able to find someone willing to give me dollars back for my Bitcoins without losing my shirt in the process.