Market Overview

4 Risks Bitcoin Must Overcome

4 Risks Bitcoin Must Overcome

Every honest bitcoin proponent will tell potential investors that bitcoin is high risk and not to invest a person’s life savings. But exactly what are those risks?


The biggest is regulatory risk. Bitcoin makes value transfers more efficient by allowing transfers to go directly between two people instead of involving a payment processor.

For example, when one swipes Visa to pay for gas or to buy an airline ticket, Visa facilitates the transaction. Visa takes on the risk of fraud and also incur expenses to process the transaction and provide customer support, among other things. Bitcoin transactions are similar to cash transactions in that the sender gives and the seller receives no third parties.

This means companies like Visa, Mastercard, Western Union and Moneygram could have a lot to lose if bitcoin is successful.

Related Link: Bitcoin Industry Growing Pains Create Risk For Investors

The other big loser are regulators who have rules in place to prevent money laundering and to protect consumers. These rules are enforced through banks and payment processors. In pure bitcoin transactions, there are no companies to regulate.

This means both regulators and big companies are potentially interested in having regulations that attempt to kill bitcoin or reduce its use.

The Napster Example

Napster was a peer-to-peer music sharing service released in 1999. It threatened record labels profits because people could now get songs more conveniently and at a lower cost. The record labels sued Napster and even individual file sharers. The labels were successful in bankrupting the investor-financed company, but they were unsuccessful in stopping the file-sharing technology.

Banks and regulators will discover the same thing.

Digital cash cannot be regulated out of existence -- it is too useful. It can only be pushed underground and prevented from benefiting law-abiding citizens. However, this creates massive risk for investors.

Just like with Napster, if bitcoin is put under onerous regulations like those proposed in New York, bitcoin investors will incur heavy losses.

Better Technology

Things move fast in the technology space There are already hundreds of bitcoin competitors. Bitcoin does have a huge lead right now, as venture capital money, brand recognition and entrepreneurship have given bitcoin what seems to be an insurmountable edge.

However think about AOL, Netscape, BlackBerry and MySpace -- all these companies dominated their space and then quickly ceded their dominance. The same risk exists for bitcoin. If a better digital currency was created and bitcoin couldn't compete, there is the possibility that a newcomer could overtake bitcoin’s lead.

Related Link: Why Bitcoin's Growth Should Explode

Technical Risk

There also exists the possibility that technical reasons will hinder bitcoin. This risk, however, seems the most unlikely. Researchers, hackers and security experts have been searching for security flaws since 2009 and have come up empty.

The challenge for bitcoin developers is to ensure bitcoin scales at a global usage. Developers need to make sure the system stays secure while being able to process trillions of transactions per year.

Design Risk

The last risk is that bitcoin’s incentives need to be designed correctly. The system currently works by having volunteers process transactions. These volunteers are called miners and are financially compensated for their effort. If the incentives for the miners aren't designed correctly and for some reason in the future that can’t be changed, then the bitcoin system could collapse.

Bitcoin is just starting to become useful. Infrastructure like payment processors and exchanges needed to be built. With those in place, huge merchants are beginning to accept bitcoin, remittances are being tested and bitcoin is starting to go mainstream.

Bitcoin might be the best investment opportunity in a generation; if these risks are realized, bitcoin may soon be just a memory.

Disclosure: At the time of this writing, David Smith has a long bitcoin position and owns So What’s Bitcoin?

Posted-In: BitcoinEducation Tech General Best of Benzinga


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