introduction

with close to double-digit inflation and significant volatility in the markets, investors are looking for a secure asset in which to preserve value. bitcoin, though volatile, has drawn attention as a store of value due to its predictable, disinflationary emissions schedule and decentralized, uncensorable nature.

the purpose of this post is to outline the risk-benefit profile of bitcoin with a focus on the specific threats to this novel asset. i am ordering the risks from least to most important according to my own approximations. the benefits, which have been discussed elsewhere ad nauseum, will be outlined more briefly.


risks

private_key_compromise

though the most elementary, this one is probably the most common threat, especially to those new to cryptocurrency custody. lost seed phrases, accidental exposure of private keys, etc is a major but fully avoidable risk. no point in wasting any more words on it, but it deserves mention.

electrical_failure

a sufficiently large, long-term electrical grid failure caused by something like a coronal mass ejection could cripple the bitcoin network. without the ability to transact, the practical value of bitcoin would be zero. this type of failure would likely not be permanent and there could be portions of the globe that would be able to continue to use the blockchain, depending on the cause / size of the event. wallets would be intact, but at least some would be unusable. moreover, you would probably have bigger problems than bitcoin to worry about if the electrical grid in your region has failed! this type of risk is also not specific to bitcoin–as of 2020, approximately 90% of existing dollars are just numbers in a computer database ($18T/$20T). in fact, given the redundancy of the bitcoin network, one could argue bitcoin is a safer store of value than digital dollars in the event of a carrington-type event, meteor impact, etc which could fully wipe the ledgers of many regional banks without proper backups.

internet_segmentation

i am not the first to point out that the internet of the future may be more segmented than the current iteration. you could argue that the chinese internet is already somewhat separate from the rest of the world. russia has been testing its ability to completely disconnect from the internet over the last few years. with increasing segmentation, there is a risk of bitcoin forks by region.

while not ideal, this is not an issue unless software is changed in each region affecting compatibility with the legacy chain. an investor with a legacy_chain bitcoin would continue to hold it, but he/she would have more trouble transferring it as it would be necessary to connect to a network outside the home region. also, if a future world then became less segmented again, the network could, in theory, reconsolidate. while this threat creates inconveniences, it would not be catastrophic.

network_sustainability

mining block rewards are halving about every 4 years. what this means is that there is a time in the not-so-distant future when there will be no more block rewards–transaction fees will be the only revenue source for miners at this point in the bitcoin story. some simulations have indicated that there is a real threat here, especially in regards to the game theoretical differences between guaranteed block rewards and potential transaction fees.

rival_cryptocurrency

bitcoin continues to thrive off of its status as the first and the largest cryptocurrency by market cap. it is also widely considered to be the most decentralized, even by its critics. however, there is no law saying that bitcoin must continue to be the leading cryptocurrency in market value. ethereum maxi’s have been calling for a ‘flippening’ in total market cap for years and this soon-to-be proof of stake protocol seems to have the best chance at overtaking bitcoin.

if bitcoin lost its top spot, would it be destroyed? probably not. in the best case, holders of btc would just shrug and recognize that another similar technology has come along with a different set of strengths, the ability to build dapps, etc. in the worst case, investors would panic at the threat from the new king and rush to convert all of their funds over, crashing the price of btc in the meantime.

regulatory

as we sit in May of 2022, government regulatory bodies like the SEC continue to make threatening noises about the regulation of cryptocurrency. bitcoin frequently gets singled out for its role as a currency used in ransomware as well as for its environmental impact. given the wide adoption of bitcoin across the world and in the american / european private sector, it seems unlikely that regulators would consider an outright ban. however, they could create rules around centralized exchanges that hinder adoption (require “accredited investors” only, for instance). in the worst case, this could slow adoption and poison the price of the asset–the doomsday scenario would be a market cap so diminished that it could be attacked by a nation-state (see ‘51% attack’ section below).

51% attack

proof of work cryptocurrencies rely on a reasonable distribution of mining power. if any one entity were to control 51% of the network hash power, that entity would be able to censor and double-spend. a successful version of this attack would likely wreck the project completely.

some worry that through continued consolidation, bitcoin mining pools could become vectors of this type of attack.

cryptographic

the bitcoin blockchain is secured by miners who race to find a special number every 12 minutes or so. due to the nature of the inputs and the hash algorithm used, the likelihood of any miner finding the special number is directly proportional to the computing power of the hardware that miner employs. furthermore, once a transaction has been added to the blockchain, it becomes nearly impossible to reverse once buried sufficiently (the recommendation is usually 5 additional blocks after the block with your transaction).

mathematical or cryptographic breakthroughs would not threaten any sufficiently buried transaction, since the state of the blockchain is synced across all nodes. the bigger concern is around the security of doxxed bitcoin addresses, especially in the setting of advanced quantum-computing. secondarily, a breakthrough in the sha256 algorithm that allowed for a sudden increase in hash power for a single actor would be a vector for the ‘51% attack’ mentioned previously.


benefits

hard

only 21,000,000 will ever exist, making it the ultimate in hard money.

decentralized

no single entity controls bitcoin, protecting it from the whims of the the powerful. compare this to the central banks of fiat currencies.

censorship_resistant

anyone can use bitcoin and for any purpose, for better or for worse

digital

no physical weight and easy to transfer. with just a simple seed phrase, a user can move unlimited amounts of funding throughout the world.

easily_divisible

compare this to gold.

verifiable

compare this to gold (and fiat).

disintermediated_from_government

non-governmental money was the norm up until the last few centuries. bitcoin returns money to the people and separates it from government.


conclusion

are the risks worth the benefits? as always, the answer depends on your level of risk tolerance and the perceived risk of alternatives. fiat is being debased, gold is heavy and difficult to verify, real estate is illiquid and not easily divisible, etc, etc. one can see how btc has great potential, especially as it matures in terms of volatility and as its security continues to stand the test of time.