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Wednesday, March 2, 2011

Bitcoin - A Decentralized Digital Currency


I've been theorizing on how to make an inflation-proof and fraud-proof digital currency which was also decentralized. The task seems next to impossible to fulfill. However, that doesn't mean that other people aren't trying. Meet Bitcoin.

http://www.bitcoin.org/faq


Bitcoin uses a network of nodes in order to attempt to control its currency without the inevitable betrayal that comes from centralization. It is designed so that inflation of Bitcoin currency (creation of new Bitcoins) requires significant CPU processing time. Furthermore, Bitcoin is totally digital. While the intentions and philosophy behind the Bitcoin are good, I still think that Bitcoin is doomed to inevitable failure. And here's why.




(1) To maintain a network of nodes which know about every other node, a pre-agreed central "meeting place" is required. Yes, bootstrapping can take care of already-known nodes - until their IPs change. And without a central meeting place, no new nodes could join the network efficiently and without human effort. To prevent inflation of Bitcoins, it becomes essential that every single node in operation knows every other node currently operating. And that means the speed and efficiency of a central meeting place is a necessity. Needless to say, a central meeting place would be the first thing destroyed if the state wants Bitcoin to die.


(2) Without a perfectly efficient control system (ideally impossible with the chaotic nature of the internet, and many many other factors), it becomes easy for hackers and profiteers to abuse the Bitcoin system by double-spending, or triple-spending their Bitcoins. If ten profiteers were to agree and simultaneously receive a single Bitcoin from an eleventh profiteer, what would happen? 9 new Bitcoins would be fraudulently created. If Bitcoin chose not to devalue the newly-created Bitcoins, then we would have rampant inflation. If Bitcoin chose to devalue them, then we would have charge-back fraud. This is the main problem with any theory for decentralized digital currency.


(3) The incentive for integrity must be placed on the managers of the transactions. With the Bitcoin design, nodes only get to generate Bitcoins via a fixed CPU rate - this is unconnected to the transactions they process. Which means, whether your node is behaving fraudulently or not, you still get to generate your Bitcoins. It also means that the operator of a node has no incentive to improve or maintain the quality of the transactions. A per-transaction fee, siphoned directly from the buyer/seller into the node operator's wallet, would be a better choice for providing the incentive for node operator integrity.


(4) A decentralized currency will offer so many wonderful opportunities for people to customize their business. But, Bitcoin doesn't seem to take advantage of that. Node operators should have to compete with each other to provide the best service at the lowest cost, so that the free market can determine who has integrity and who does not. However, with the way Bitcoin operates, every node is treated as equal with no distinguishing differences and no chance to setup such distinguishing differences.


(5) Bitcoin relies upon identifying every person behind every transaction, not with names, but with a digital key. All the state would have to do is knock on some doors and seize the computers running the nodes (or just copy the hard drives) and then they would be able to view the entire transaction history of any identity, because each node keeps a list of all prior transactions to try and prevent fraud, and every transaction has the identities of both parties etched into it. Second, tying your identity to your money and to every transaction you make means that other people can possibly take advantage of that, given that they somehow find out your identity key or find out how to use such in a clandestine manner. I think that the ideal decentralized digital currency should not identify people as they transact their business.

*EDIT* Reading more into Bitcoins, I realized that they do periodic reminting. During a remint, after audits for double-spending, every Bitcoin is stripped of its previous transaction history in order to reduce its filesize back to an optimal level. So at the very least, only the most recent couple of months worth of history would be available for state inspection. *EDIT*


(6) Bitcoin claims that transactions can be made without trusting a middleman (claiming that nodes cannot be tampered with or manipulated into defrauding transactors). This is, from my experience, absolutely untrue, because the incentive to defraud lies there with every node operator. And with no per-transaction fee, every node operator will feel the pressure to create their own per-transaction fees, in defiance of or in secret from the Bitcoins development team and customers. Furthermore, once the 21 million Bitcoins have been generated, there can be no new Bitcoins created by nodes, and node operators will no longer have any incentive whatsoever to continue performing their services - prompting operator fraud to emerge. Also, contrary to the above claim by Bitcoins - the Bitcoin 'middlemen' (nodes) perform necessary security functions and are the only way to facilitate transactions, so customers have no choice other than to use and trust the middleman.



I am a big fan of knowing that a program will work before I code it. I like to eliminate all questions of infeasibility before I begin bringing a project into fruition. If I ever do release a Decentralized Digital Currency, you can bet it will have these problems addressed (assuming it is possible at all to address them in a DDC). But in the meantime, the best DDC we currently have is Bitcoins. Even with the problems I think I see, Bitcoins is a far better choice for a currency than the depreciating fiat dollar bills we all use.

19 comments:

  1. Inflation proof huh? That might have ramifications for whichever economy wants to adopt it...

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  2. whoa very well thought out idea o_o

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  3. Sounds complicated. I will stick with regular money for now no matter how screwed up it is

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  4. Wow this does sound kinda complicated but I think it would work.

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  5. people are so material these days i dont think the dollar will every go out of style. if it's not in your hand it's not worth it to have.

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  6. identities recorded...i'll stick to private voluntary barter currencies until that gets addressed. also having never heard of bitcoins i'm wondering how spendable they actually are.

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  7. I've been looking into Bitcoin lately. Thanks for this post, it cleared up a few things about it. Now I'm not so sure I want to use it though.

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  8. very interesting, this could be very promising!!

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  9. its a good idea, but will people really switch over?

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  10. Thats pretty awesome, a lot of potential here.

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  11. This topic is very hard to grasp but... you're right, we will eventually need a new currency system that is digitalized and international.

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  12. Thanks for the post, some new ideas I've never heard about o;

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  13. This kind of thing could be really useful... It's tiring to get screwed by fluctuating exchange rates, and with how common international trading is these days, a solid global currency is called for.

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  14. well, your doubts about the system do seem a bit harsh, eventually every kind of coin gets devalued over time, and no system is full proof, but thats deep thinking you did there

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  15. well said. in all seriousness, what economy would totally adopt a digital currency?

    even with the advent of the credit & debit cards, we're still printing money.

    following +1

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  16. These bitcoins are really cool! And a way to launder money LOL not that I would do that

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    Electric Addict Set #3

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  17. #5....mark of the beeeaassstt! >_>

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  18. sounds like a good idea. hopefully somebody will improve upon it.

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