Bitcoin: Not a Bit and Not a Coin

nicklipinski

The founding principle behind Bitcoin is to eliminate the need for, and hence cost of, intermediaries in a payments system. The two key functions of payments intermediaries are to process transactions securely and to mediate disputes. Bitcoin addresses the first with cryptography and the second through requiring such a large amount of computer-processing to reverse reasonably-aged transactions that, to all intents and purposes, they are irreversible with current technology.

  • Bitcoin uses federal standards in cryptography (and particularly the encoding and authentication of data through “hashing” and digitally-signature respectively). This note describes them to illustrate that familiar terms used in the Bitcoin lexicon refer to ideas which will be unfamiliar to the majority of potential stakeholders. (For example, a “coin” is a chain of digital signatures).
  • As a result, Bitcoin differs dramatically from, say, PayPal or bank-sponsored P2P apps such as Chase QuickPay which rely on the digital representation of existing currency (and so the regulatory safeguards that go along with it), and not the extension of ideas such as “coin” and “currency” to objects and techniques in financial cryptography.

A key case for Bitcoin, of course, is that it is free of regulation but governments are unlikely to allow mass-adoption until it meets the same oversight standards as the rest of the financial services industry. This will require the crypto-currency movement to engage in an intensive education initiative with regulators around highly-technical subject matter.

Furthermore, unless users interact directly with the Bitcoin network through downloading the bitcoin client (from https://bitcoin.org/en/download), they will need to work with an intermediary and hence will bring into play the inherent weakness of a trust-based system that Bitcoin was intended to eliminate. This month’s collapse in prices on Mount Gox exchange (accounting until this month for approximately one-third of Bitcoin trading volumes) which today confirmed bankruptcy is a stark illustration; on other exchanges bitcoins are trading at near US$600.

Please see our published research for the full note.

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