The perils and pitfalls of Bitcoin

Anuj Raina | NT

Bitcoin is a new type of digital money and, just like with all money, you can store it, exchange it, and make payments with it. The key to what makes Bitcoin different from national currencies like the US Dollar, the Euro or the Japanese Yen lies in its decentralized structure and opt-in model. With centralized ‘fiat money’ (literally money by decree), currency is issued by central banks, and citizens are forced to use the money of their nation. Bitcoin, by contrast, is an opt-in currency that is controlled by the ‘consensus’ or the will of its users.

The idea of digital money—convenient and untraceable, liberated from the oversight of governments and banks—had been a hot topic since the birth of the Internet. One of the core challenges of designing a digital currency involves something called the double-spending problem. If a digital dollar is just information, free from the corporeal strictures of paper and metal, what’s to prevent people from copying and pasting it as easily as a chunk of text, “spending” it as many times as they want? The conventional answer involved using a central clearing house to keep a real-time ledger of all transactions—ensuring that, if someone spends his last digital dollar, he can’t then spend it again. The ledger prevents fraud, but it also requires a trusted third party to administer it. Bitcoin did away with the third party by publicly distributing the ledger, called the “blockchain.” Blockchain is a system of recording information in a way that makes it difficult or impossible to change, hack, or cheat the system.

A blockchain is essentially a digital ledger of transactions that is duplicated and distributed across the entire network of computer systems on the blockchain. Each block in the chain contains a number of transactions, and every time a new transaction occurs on the blockchain, a record of that transaction is added to every participant’s ledger. The decentralised database managed by multiple participants is known as Distributed Ledger Technology (DLT).

During the past year of COVIDinduced market mania, cryptocurrencies have gone up so much — Bitcoin is up about fivefold, while many other crypto projects are up far, far more — that even reluctant Wall Street institutions have begun to tiptoe into the arena. Since then, the Bitcoin bulls have only grown more optimistic. The total value of all cryptocurrencies is now estimated at $2.5 trillion, and as of this writing, a single Bitcoin trades for around $65,000. Meanwhile, governments around the world are eyeing Bitcoin’s advance warily. Major economies, including the United States, refuse to recognize it as legal tender. They have good reasons for doing so.

Bitcoin can circumvent capital controls

Governments often institute capital controls to prevent outflows of a currency because exports could debase its value. For some, this is another form of control exerted by governments on economic and fiscal policy. In such instances, the stateless nature of Bitcoin comes in handy to circumvent capital controls and exporting wealth. One of the more well-known instances of capital flight using Bitcoin has occurred in China. The country’s citizens have an annual limit of $50,000 to purchase foreign currency. A report by Chainalysis, a crypto forensics firm, found that more than $50 billion moved from China-based Bitcoin wallets to wallets in other countries in 2020, meaning Chinese citizens may have converted the local currency to Bitcoin and transferred it across borders to sidestep government regulation.

Bitcoin ties to illegal activity

The ability to bypass existing financial infrastructure for a country is a blessing in disguise for criminals because it enables them to camouflage their involvement in such activities. Bitcoin’s network is pseudonymous, meaning users are identified only by their addresses on the network. It is difficult to trace the provenance of a transaction or the identity of an individual or organization behind the address. Besides this, the algorithmic trust engendered by Bitcoin’s network obviates the need for trusted contacts at either end of an illegal transaction.

Not surprisingly, Bitcoin is a favored conduit for criminals for financial transactions. The most famous example of a crime involving Bitcoin was the Silk Road case. Briefly, Silk Road was a marketplace for guns and illegal drugs, among other things, on the Dark Web. It allowed users to pay in Bitcoins. The cryptocurrency was held in escrow until the buyer confirmed receipt of goods. It was difficult for law enforcement to trace parties involved in the transaction because they only had blockchain addresses as identification. Eventually, however, the FBI was able to take down t