Broker Check
Bitcoin, Cryptocurrencies, and Blockchain - Part II

Bitcoin, Cryptocurrencies, and Blockchain - Part II

January 08, 2021
Share |

Week of December 14, 2020

Bitcoin, Cryptocurrencies, and Blockchain

Part II

In 2008 someone going by the pseudonym Satoshi Nakamodo innovated prior cryptographic and computer technology, and wrote a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”.  Shortly thereafter, Satoshi mined the first Bitcoin called the Genesis Block. This created not only the first cryptocurrency using blockchain, it was the first use of blockchain.  My goal in studying Satoshi’s white paper and researching Bitcoin was to understand how it worked, the technology behind it, and why it was deemed completely secure and anonymous - in order to determine its value as a long-term placeholder of wealth.  This took me down a DEEP rabbit hole, however I was not gleaning more knowledge.  What I really wanted to understand was the cryptology behind blockchain/bitcoin, what mining entailed, and the security of the bitcoin assets held in the blockchain.  Finally, through a lot of reading and diligent attempts to understand completely, I came up with the following:  I’m not smart and/or technologically astute enough to understand the finer points of cryptology or blockchain technology.  However, as I will lay out below, I don’t believe those finer points matter.  

Let’s take it on it’s face that Bitcoin itself is unbreakable.  Trust the cryptologists and the technology that once you have Bitcoin on the blockchain ledger it is secure from theft,  completely anonymous, and is a placeholder of wealth.  So what is blockchain and Bitcoin?  Blockchain is a ledger, that’s all.  Think a sheet of graph paper (for those of you over 45 years old) or an Excel spreadsheet.  That ledger marks Bitcoin in and Bitcoin out.  All Bitcoin transactions are noted on that ledger - but the transaction is not accepted into the ledger until Bitcoin miners solve an incredibly complex equation that verifies the transaction (this is where the rabbit hole got deep, I would appreciate it if anyone out there can help my feeble brain understand).  Once a transaction has been accepted by the mining process it is marked on the ledger.  That ledger cannot be changed once the miners have approved the transaction because it is stored on many different nodes (computers) that would require changing the blockchain ledger on every node (another rabbit hole, I’m going to have to trust them on this).  So you could never try to use the same bitcoin twice in a transaction because once it is verified it is gone off of your ledger and it appears on someone else’s ledger.  You cannot double-spend the same bitcoin so it eliminates fraud.

This leads us to the next question:  So what is a Bitcoin?  It is nothing.  It is a series of numbers and letters.  That’s it, you own a series of numbers and letters that compose and give you access to one Bitcoin (or a fraction, Bitcoin can be divided all the way down to one Satoshi which is 100 millionth of a Bitcoin).  What makes Bitcoin a potential placeholder of wealth?  By design there are only 21 million Bitcoin available to mine.  So there is a finite amount of Bitcoin, an incredibly encrypted process of verifying transactions, and a cost to produce Bitcoin (it takes a huge amount of electricity and computer power to approve a Bitcoin transaction, so there is an outlay of expenses to verify the transaction.  There is a parallel to gold miners needing equipment and energy to mine gold.  You put in the effort and money and you are rewarded with gold.  In Bitcoin the people and computers mine by solving the mathematical equations approving the transactions and they are rewarded by receiving Bitcoin.  The mining reward is cut in half approximately every four years.  So today a miner might get 10 Bitcoins for their work, but in four years they will only receive 5.  It is estimated that by 2140 all Bitcoin will have been mined.  To date nearly 90% of Bitcoin has been mined.).  These traits make Bitcoin a potential placeholder of wealth.

Taking the above at face value, why don’t I think it matters whether the blockchain/Bitcoin technology is unbreakable?  The first, and weakest, argument is: How do we know which cryptocurrency comes out as the most valuable placeholder of wealth?  There are literally thousands of blockchain cryptocurrencies out there.  However Bitcoin was the first to the table and most well known so it will probably be the best placeholder of wealth of current cryptocurrencies.  Second, I don’t believe there is any way that central banks and governments will allow cryptocurrencies to go unchecked.  Whether it is federalizing cryptocurrencies (probably not a possibility with Bitcoin due to its coding), legitimizing crypto currencies with required central bank oversight, or criminalizing the use, it is probable there will be some type of government intervention (China is already developing their own crypto currency and the EU is looking into it.  China sees this as yet another way to track all of their citizens and transactions.).  Third, and in my opinion the most important: cryptocurrencies need exchanges in order to buy on the secondary market (after they have been mined), you need a digital wallet to store your cryptocurrencies, and you need a password to access the exchanges and your digital wallet.  These all present openings for dishonest players (or pure negligence in losing a password) to steal Bitcoin since these are all outside of the blockchain encryption protection.  These backdoors do have security, but so do credit card companies and I’m sure that most, if not all, bank clients have had some type of fraud on their card.  So, taking the position that the Bitcoin blockchain could never be compromised: it still does not eliminate the potential open backdoor exposure to thieves.  Everyone of these backdoor vulnerabilities can and has been used to steal Bitcoin (over $11 billion in cryptocurrencies have been stolen and over $40 billion have been lost to date).  I highly recommend reading the book “American Kingpin”.  It gives a fascinating and true read on the dark web, Bitcoin use in illegal markets, the theft of Bitcoin, and the vulnerability of the “backdoors” in not just theft but in penetrating the anonymity of blockchain.

In sum, I do not believe that Bitcoin is the completely unbreakable storage of wealth that it is purported to be.  Accepting the argument that the Bitcoin blockchain technology itself is unbreakable, it still does not prevent dishonest players from using  the backdoors described above.  Does this make Bitcoin a true storage of wealth?  I think there are too many obstacles long term for Bitcoin to remain a viable asset without government oversight.  Gold and even cash are physical objects and they can be used outside the government’s watchful eyes.  I do believe that cryptocurrencies will be adopted by central banks, however people will demand protection from governments attempting to use this as a means of tracking their citizens.  In my opinion, the greater and more exciting potential long-term use of blockchain technology is not in cryptocurrencies but in other innovative and potentially disruptive ways.  In the final installment of this series I will explore some of those possibilities.