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Currency flaws

July 29, 2011

The value of the digital currency has risen rapidly since its inception in 2009. Increasingly drawing the attention of the tech community and governments alike, Bitcoin is not without its flaws.

Gold coin
Bitcoin proponents say assigning assigning value to a piece of metal is no less strangeImage: picture-alliance/ZB

Last Sunday, Martin Harrigan, a communications researcher at the University College Dublin, published an academic paper outlining why the emerging digital currency, Bitcoin, is not as anonymous as some people might think. In June 2011, WikiLeaks famously announced that it was accepting "anonymous" donations via Bitcoin.

Bitcoin, which was developed in 2009, is a purely online digital currency that is fully convertible to euros, US dollars and other world currencies. At current exchange rates, one Bitcoin is worth approximately 9.5 euros, or $13.75. The system works largely through cryptography, and lets its users "mine" for Bitcoins through software on their computers that plug away at large, complicated puzzles.

Martin Harrigan
Martin Harrigan's paper outlines why Bitcoin is not an anonymous payment systemImage: Martin Harrigan

Over time, Bitcoins become harder and harder to mine, and Bitcoins will cease to be generated once they reach 21 million Bitcoins, and thus, theoretically, will preserve their value. It is not regulated or controlled by any organization, government or other financial authority. In June 2011, the American senator, Chuck Schumer, of New York, mentioned Bitcoin by name in conjunction with a website that sells illegal drugs and only accepts Bitcoin as currency. However, Jeff Garzik, one of Bitcoin's primary developers, has repeatedly told journalists: "Attempting major illicit transactions with Bitcoin, given existing statistical analysis techniques deployed in the field by law enforcement, is pretty damned dumb."

In a blog post in May 2011, Rick Valkvinge, the founder of the Swedish Pirate Party, wrote that he had converted all of his savings into Bitcoins, citing the fact that the value of a single Bitcoin has gone up by more than one thousand times over the last 14 months. Bitcoin's proponents say that one of its main advantages is that it is fully peer-to-peer and open source, so that it can be monitored by the community that uses it. Further, it can be instantly exchanged between two people, without going through a bank or other financial institution.

To learn more, Deutsche Welle turned to Martin Harrigan to explain Bitcoin and his research.

Deutsche Welle: How did you first get involved in Bitcoin?

Martin Harrigan: Last year, myself and a colleague of mine at the University College Dublin we got chatting one day and he had gotten interested in Bitcoins and he had bought some himself and we started talking about the mechanics of how it works. And I guess one thing that troubled us a little bit is that if I send a Bitcoin to you, I have to notify the entire network of this so I have to tell everyone that an identity that I have to prove that I'm in control is being sent to an identity to you and you have to prove that you're in control of.

euros and dollars
Bitcoins can be exchanged for euros or dollarsImage: Bitcoin

So what's wrong with that?

This idea of publicly broadcasting your Bitcoin activity sounds possibly dangerous. Many people have described Bitcoin as a digital analog of cash. So, like, I can give you cash without getting the banks involved. The claim was that I could also give you Bitcoins without getting the banks involved, and so, in some sense, there would be no record of this. But with Bitcoins, everyone gets notified. Everyone on the peer-to-peer network can see that somebody sent Bitcoins to somebody. We thought this was interesting, because if you consider all the activity of Bitcoins in one day - say someone sends Bitcoins to somebody else and then he sends that on to another person, then it might be possible to generate a network, to figure out where the Bitcoins are going.

So you're saying that given that it produces a trail, and it has to produce the trail for the system to be trusted, that it's not as anonymous as people claim?

Well, to be fair, originally the system was never described as anonymous, but the developers would say that it's rather pseudo-anonymous. So you use some identifier and that's all that can be traced back to you. There are two things: The first is that the media often say that Bitcoin is anonymous, and I would say that anyone that works in the development of Bitcoin would agree that these reports are wrong.

The second thing is that Bitcoin has this unusual property that if I receive Bitcoins from two sources, A and B, I can generate one identity to receive the Bitcoins from A and I can generate a second identity to receive the Bitcoins from B and there's no way to link these two identities. However, maybe in a couple months time, I can perform another Bitcoin transaction and where I send these Bitcoins to C. This third transaction can link A and B. So by joining the Bitcoins together in my wallet, A and B, and sending them to C, I've revealed that previously the two identities that I used to receive the money from A and B are controlled by the same person.

WikiLeaks famously announced in June 2011 it would accept donations via BitcoinImage: AP

So it has this worrisome property that later transactions can give you information about the identity of the people that performed the earlier transactions. And if you couple this with the fact that some people - sometimes intentionally - put on Bitcoin forums, on the Web, or on their Twitter accounts, they often make their identities public. So you might have one identity you're willing to make public if you want to accept Bitcoin donations, but the danger is that that can be linked with your other, more private, identity. So by looking at the logs that the system is producing, people can piece together to see that these three, four or five identities are controlled by the same person. And if you can link that to something that somebody posted online, then you can possibly identify the person that performed these transactions.

This gets into a whole series of questions about what is the nature of money and how do you arbitrarily assign value to something that is purely digital? In some ways that's no different than saying that this small piece of money in my hand is a euro, and that has value.

Yes, absolutely. When you go online for the first time to a Bitcoin exchange and part with your dollars or your euros for Bitcoins it is a disconcerting feeling that you've just parted with real money because in exchange you just have some sort of digital token. But when you then exchange those tokens back for euros or dollars or are able to buy something on a website, you begin to realize that it is capable of carrying value. But it is strange the first time you use it.

Bitcoin allows monetary transfers without going through a third-party, like PayPalImage: AP

What's the motivation for people to use Bitcoin? It seems that it's gotten a lot of uptake in the geek, cryptography crowd. What's the main motivating factor for people to use Bitcoin?

Well, if we assume that Bitcoin became very popular and would be accepted by many merchants and used by a lot of people, it's because it has a lot of advantages over a system like PayPal. The transaction fees are much lower, and it's relatively instant. You don't have to wait for a trusted third party to get involved. And it's one currency that can be used all over the world. You don't have to use your euros or dollars. There are no exchange rates and there are no fees for exchange rates.

There's also no charge-backs. Anytime you make a payment with PayPal or with your credit card, there's a classic scam where a customer makes a payment and then revokes that payment, but then the merchant has to do something in order to get their goods back. And the cost of handling all this and the fees that go to credit card companies, they are all removed with Bitcoin. You don't have to pay any company to handle the payment. There's no restriction that banks are only operating five days a week, and closed on the weekends, Bitcoin operates 24/7 and you don't have to rely on these third-parties. It has a lot of extremely interesting advantages. I can see some sort of descendant of Bitcoin becoming popular in the future.

Interview: Cyrus Farivar
Editor: Nathan Witkop

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