4 systemic flaws with Bitcoin that need to be addressed now (but not the ones you've heard a thousand times)
It seems like everyone and their mother has an opinion about why Bitcoin is bad. You've heard them all, and they're mostly nonsense. Bitcoin will never be worth anything, they said until Bitcoin was trading at $18,000 apiece. Bitcoin is only used by drug dealers, they said before being adopted as payment systems by everyone from pizza shops to lawyers (myself included). Bitcoin is too unsafe and stable, they said before financial crises, massive corporate data breaches, currency crises, sovereign debt defaults, and the general disarray of global trade and banking interposed itself between their mouths and your riches.
So yes, most alleged critical flaws of Bitcoin have turned out to be nonsense. Probably nothing will ever stop truly decentralized, truly distributed digital currencies. But that being said, I have, during my time as an attorney working with several cryptocurrency businesses from exchanges and investment houses through initial coin offerors and developers, identified what I see as four non-obvious but potentially catastrophic problems for widespread adoption of Bitcoin or any other similar virtual currency.
Don't worry, none of them are that Bitcoin is evil, worthless, or fake.
1. The slow attrition of "lost" coins means that Bitcoin will inevitably be exhausted by dumb or careless people
Five years ago, the good people over at Wired magazine declared that Bitcoin was worthless and destroyed the keys to their own wallets as a proud display of how confident they were that Bitcoin would never amount to anything. Five years later, they still haven't figured out how to get access to what is now about $120,000 worth of Bitcoin.
Like many idiots, the staff of Wired magazine has permanently removed a few Bitcoins from circulation. There is no way - it is actually impossible - to ever recover these lost coins. The key cannot be recovered, because nobody knows it. No system has stored it anywhere. They are totally gone from circulation.
They would have done less damage to the financial system if they had put 120,000 $1-bills in a pile and burned them because dollar bills can be replaced very easily. At its normal rate of 38 million new notes per day, it would take the US Mint about four and a half minutes to replace that. Lost Bitcoins, however, cannot really be replaced. While Bitcoins are being mined all the time and introduced into circulation, they have already been "created" in the sense that the computer code by which Bitcoins are implied or inferred is already running. There is a maximum supply of 21 million Bitcoins which will all be in circulation by about 2140. Bitcoins that are permanently excluded from circulation by being trapped by idiots in places to which the access keys have been lost have essentially been destroyed. But unlike burned dollar bills, the circulating supply at this time has no built-in technique for rebalancing the supply to make up for the idiot problem.
These isolated incidents are a trivial problem so far. But given enough time, even an extremely slow attrition of lost keys or otherwise "destroyed" coins is a tremendous problem. It seriously accelerates the deflationary nature of Bitcoin. Given a long enough timeline, all Bitcoins will eventually be lost on the simple mathematical fact that any attrition rate greater than 0/year, multiplied by the hopefully infinite total lifespan of digital civilization, means that all Bitcoins will definitely be lost in the future.
Some mechanism needs to be created to address this because it is a brute mathematical fact that if attrition is greater than zero and supply is finite, then the supply will inevitably be totally lost to attrition. Even if it takes thousands or millions of years, Bitcoin is necessarily a temporary phenomenon as a systemic feature of its own design.
2. A lurking GDPR compliance nightmare is built into the blockchain
The General Data Protection Regulation is coming. It's mere weeks away as of this writing. Businesses are scrambling to implement their compliance regimes. I won't make you fritter away the rest of your evening listening to all of what the GDPR exactly entails, but here is the key element for purposes of this article: all third parties who may receive the personal data of any customer based in the UK or the EU must be fully disclosed to that original customer, clearly and completely.
For most businesses this is not a huge deal. If your website is going to forward customer account information over to Salesforce or Mailchimp or some other common data aggregation tool, your compliance is pretty easy - you inform the customer of this information in plain language, you give them the right to opt out, and you give them the power to make you "forget" this information on command. But with Bitcoin, this is much easier said than done.
It is in the nature of the distributed ledger to propagate a customer (a "data source")'s information to thousands of computers and across thousands of networks simultaneously. The whole point of the distributed ledger is that you enable an "election" every ten minutes to verify each sender, holder, and transaction occurring between them. This means that on paper, if someone builds in any kind of personal identifying information to the blockchain, that information is there permanently, and it is readily accessible by anyone.
The GDPR requires that any such third-party access be explicitly disclosed in exacting detail and in plain English. If you sell products to someone and accept Bitcoin in the transaction, are you going to disclose the identity of every single third-party - that is to say, the name of every person and business on the planet that uses Bitcoin - to your customer? Good luck. You'd better start now.
Having many clients in the cryptocurrency space and others in need of GDPR compliance work, I have puzzled over this problem many times and frankly I don't have an answer for it yet other than that a legislative carve-out to protect distributed ledgers or related blockchain-based technologies from a hyper-literal reading of the GDPR is absolutely essential. Otherwise, the GDPR is a de facto ban on the use of Bitcoin, or really any other virtual currency (all Ethereum-based smart contracts, for example, have the exact same impossible compliance problem), from anywhere in the European Union or the United Kingdom.
3. The perfect balance between asset and currency means that accurate taxation and regulation is impossible
Is Bitcoin a currency or an asset?
Easy: Bitcoin is a currency. People use it to buy and sell things, or to contract for services. I've accepted retainers in Bitcoin, and paid for everything from office supplies to digital cats using one virtual currency or another. Nobody does that with assets - assets are for investing in, currencies are for spending.
Easy: Bitcoin is an asset. People buy it and hold onto it hoping that it will appreciate in value so they can sell it. Most Bitcoin transactions are not the purchase or sale of goods or services, they're purchase and sale by and to speculators. Nobody does that with currencies - speculators don't trade currencies or hold them for long periods of time; currencies naturally lose value over time through inflation.
So which is it?
The problem is that there are perfectly-balanced good reasons for stating that Bitcoin is an asset and that Bitcoin is a currency. It broadly shares features of both. Bitcoin paradoxically bears features that are facially apposite to both assets and currencies but inconsistent with each other - Bitcoin is highly liquid, yet its main action is in its secondary market. It is mostly bought as an investment, but its loudest champions proclaim its utility as a means of exchange. It was designed, packaged, sold, and shipped as a currency, but has mostly wound up in the hands of investors.
Caveat investor, I say - let the investor beware. Right now, Bitcoin is taxed at the federal level as an asset, and yet most states require that persons in the business of buying and selling them acquire money-changers' licensure. A proper regulatory framework cannot develop to accurately capture something that is both an asset and a currency, however. In the broad agenda of tax law and financial regulation, assets and currencies occupy completely separate universes, with their own purposes, social goods, and raisons d'etre.
Like the looming GDPR nightmare for cryptocurrencies, this problem's fix can only be found in the wisdom of regulators. Which is a huge problem, because...
4. Regulators are dumb, and they have been completely captured by wealthy donors whose interests are entirely at odds with the social agenda of decentralized finance.
Earlier this year, we were treated to the amazing spectacle of the US Senate holding hearings about the future of virtual currencies and what should be the appropriate regulations for them. A large group of mostly elderly people who have no idea how technology works, what blockchain is, or probably even how to use their own computers were tasked with implementing effective, pro-innovation regulations for a technology so sophisticated that only a handful of PhDs around the planet have the slightest idea how it works. Oh, GOOD.
The systemic problem in regulation-making is that the regulators do not understand their regulators. Nobody watches the watchmen on this one - the regulators answer to no one but their wealthy donors, which is yet another layer of elderly wealthy people who have neither the intellect or the need to understand the on-the-ground details of how Bitcoin works. They are at the mercy of the recommendations usually made by a patrician class of corporate patrons whose pecuniary interest is decidedly against the success of distributed and independent financial networks.
In short, the rules are in the hands of people who are not smart enough to make rules, and who instead defer to the advice of people whose wealth and livelihoods are directly challenged by the success of cryptocurrencies. This is not a recipe for success. We will not see pro-innovation regulation so long as there continues to be a revolving door of money and influence between mainstream financial institutions and the regulators themselves. Best of luck with that.
These are all potentially lethal flaws with Bitcoin. These reasons are not the bullshit reasons your friends gave you back when Bitcoin was traded at $2 a head (hopefully you held). These are reasons that are baked into the very nature of Bitcoin. They cry out for solutions. I don't know what those solutions are. Maybe some day we'll be able to trust political institutions to find those solutions. Today isn't that day for me.