LAST Friday, the digital currency world was badly rattled by the announcement (via a blog post, naturally – these people are nothing if not hip) by one of the five key lead developers behind Bitcoin that the so-called ‘cryptocurrency’ was “dead.”
Mike Hearn, who is generally regarded as probably the second most senior developer in the now more-than-a-decade old Bitcoin project, said in his blog that Bitcoin had “failed,” and that he was ending his involvement and selling off his own holdings of the digital currency. This was a complete reversal of his outlook as recently as last August, and had a predictable effect on the sensitive Bitcoin trading markets—within a few hours, the price tumbled $40, or a little more than nine percent.
The specific reason why Hearn bailed out on the Bitcoin project was a disagreement he and another top developer fell into with their colleagues. The disagreement was over the adoption of a new version of the basic Bitcoin software that would have expanded the system’s capacity to process transactions and allow its processing rate to increase as the number of transactions grew. That particular evolution is important, because Bitcoin’s current transaction processing speed pales in comparison to conventional payment systems; if the digital currency is to compete fairly with ‘regular’ currency, it has to achieve something close to parity in terms of efficiency and security.
The dispute over the new programming, however, is more political than technical. Most of the big bitcoin “miners”—operators of large, fast computers that verify transactions, most of whom are located in China—have not adopted the new software (the implication is that it would require expensive upgrades of their systems), and therefore have been able to effectively block its deployment. Without it, Hearn said, the entire Bitcoin system will soon exceed its capacity, making it vulnerable to fraud and errors such as dropped transactions.
Convincing merchants and consumers to use the digital currency has never been nearly as easy as Bitcoin acolytes anticipated; under the unreliable circumstances Hearn envisions happening soon, it will be next to impossible.
And as soon as Bitcoin investors realize that inevitability, Hearn believes, the price of bitcoins will collapse, because since its inception, the very high value the currency has commanded has been entirely based on perceptions of its future potential; when that future disappears, so does the value.
According to Hearn, Bitcoin’s failure is fundamental because the way it operates now has completely undermined the intent with which it was conjured up in the first place. In his blog post he wrote, “What was meant to be a new, decentralized form of money that lacked ‘systemically important institutions’ and ‘too big to fail’ has become something even worse: a system completely controlled by just a handful of people.”
It’s easy to see why that happened; in a sense, the technology outsmarted itself. Although anyone with a computer can hypothetically engage in ‘mining,’ or processing transactions—which is where the real profit in Bitcoin lies, as the system is designed to pay a reward or fee for each completed block of transactions—in order to do it at a reasonable speed, a large amount of computing power is necessary and that comes at a considerable cost. In order for mining to be profitable, bitcoin prices have to remain above about $225. That puts effective control of the system into the hands of a relatively small number of ‘miners,’ which is not what the original concept intended.
Had Bitcoin caught on as an actual form of payment, things might have turned out differently, because the regulating influences over the system would have included the perspectives of merchants and consumers. But as it is, more than 99 percent of all bitcoin transactions are in the exchange markets (bitcoin-to-other currencies, either conventional currencies like the dollar or the yuan, or the few alternative digital currencies that still attract some trading activity), which further limits the scope of Bitcoin in terms of applicability and user population.
Proponents of Bitcoin are die-hards, however; some are still completely enamored with the concept and just can’t let it go, but for most, it’s a matter of trying to preserve a huge investment. Their persistence is what has kept Bitcoin and the whole concept of digital currency going for so long, surviving high-profile disasters such as the collapse of big exchanges due to security breaches or outright fraud, and legal crackdowns on Bitcoin-friendly marketplaces like Silk Road.
Given that record of stubborn durability, Bitcoin will probably survive being abandoned by one of its key developers. But it will only do so because it lends itself well to a closed system of market trading, and because Bitcoin is a little like Frank Zappa music: It is unique enough that it sounds like it might just be important in some way, enough that people who suspect it is just dissonant racket intended to make the listener uncomfortable are, at least for now, still willing to give its small, rabid fan base the benefit of the doubt that “you just haven’t heard the right album yet.”