# a blog about things that I've been thinking hard about

# Some Different Ways That Your Bitcoin Investment Could Fail

26 April, 2013
Almost certainly, in a few years time, bitcoins will be worth much more than they are now, or, they will be worth zero. This article lists some ways that your bitcoin investment could fail completely.
by Philip Dorrell

## Why Invest in Bitcoin?

Bitcoin is a crypto-currency, a new type of money, and in some ways it is better than any existing form of money. It is certainly more flexible and cheaper to transfer than any other form of money that can be used on the internet. Also, the design of Bitcoin limits the possible number of bitcoins ever to 21 million.

As I write this article (or more specifically, as I write this particular sentence), the price of bitcoins is US$135 each.

If we multiply that price by 21 million (even though the current number of bitcoins is a somewhat smaller number), we get US$2.835 billion, which divided by a world population of about 7 billion, is about 40 US cents each.

Which isn't much.

The total value of a currency has to equal the average holding of the currency multiplied by the number of holders. So if, for example, the average holding of Bitcoin increases by a factor of 100 to a value of US$40, the value of each bitcoin has to increase by the same factor, i.e. to a value of US$13500 each (assuming conservatively that by this point the number of bitcoins has reached its maximum – if it hasn't, then the price per bitcoin would be even higher).

All this makes buying bitcoins seem like a very good investment, if one is at all optimistic about what the global demand for bitcoin as a currency is going to be.

The downside is that there are many ways that the value of an investment in bitcoins could fall to zero.

Which is what this article is about.

## Two major modes of failure

The value of N bitcoins with a price of P (e.g. in $US) is N × P.

There are two basic ways this value could reduce to zero:

1. The price P falls to zero.
2. The number of bitcoins N falls to zero.

The first type of failure corresponds to the failure of Bitcoin itself. In the second type of failure, Bitcoin does not fail, but somehow your holding of bitcoins gets reduced to zero.

## Mode 1: Bitcoin Fails

For Bitcoin itself to fail, it has to somehow cease to be useable as a currency for making financial transactions.

We can sub-divide this mode of failure into three sub-modes:

- 1a Intrinsic, where Bitcoin fails to satisfy its own requirements for integrity and security.
- 1b Extrinsic, where one or more external agencies attack the infrastructure of Bitcoin to such an extent that it ceases to function as intended.
- 1c Bitcoin does not directly fail, but some other internet currency is invented which is even better than Bitcoin, so everyone uses that instead, so demand for Bitcoin holdings falls to zero.

### Sub-mode 1a: Intrinsic Failure

An intrinsic failure of Bitcoin would correspond to an as-yet undiscovered technical error in the design of Bitcoin which cannot be mitigated quickly enough to prevent the failure of the operation of Bitcoin.

Possible examples are:

- The secure hash algorithms (SHA-256 and RIPEMD-160) used by Bitcoin could be "broken", in the sense that collisions could be found, or (even worse) a reversing function for the algorithm could be found that allows multiple data values to be found for any chosen hash value.
- The ECDSA crypto-algorithm that defines the private/public key pairs for Bitcoin addresses (in effect Bitcoin accounts) could be broken, so that private keys could be directly recovered from knowledge of the addresses.
- An error in the peer-to-peer design of Bitcoin could allow some small group of actors to collaborate to subvert the integrity of Bitcoin.

### Sub-mode 1b: Extrinsic Failure due to External Attack

If the governments of the world decided that Bitcoin should not exist, then probably it would cease to exist.

In theory Bitcoin might continue to operate as a currency only used privately and secretly for illegitimate transactions, somehow overseen by a group of enthusiastic volunteers operating outside the laws of those countries that determined to destroy it.

In practice this is unlikely, and if it is possible, then the future value of Bitcoin holdings to investors who wish to avoid illegality would be much reduced. (Like, where do you go to cash your illegal bitcoins?)

Although Bitcoin is vulnerable to a determined multi-government attack, it seems unlikely that anything less than a full multi-government attack could cause Bitcoin to fail, if there is no failure in the basic security and integrity mechanisms built into the design of Bitcoin.

### Sub-mode 1c: Competition

If one crypto-currency can be created, then so can another, or even many crypto-currencies.

Right now Bitcoin is the crypto-currency. It's rather hard to predict what it would take for a competing crypto-currency to replace Bitcoin as a preferred crypto-currency. There's already Litecoin, which is just like Bitcoin, but has a supposedly more egalitarian mining protocol.

We should not discount the possibility of a government-sponsored alternative to Bitcoin. Although given that one of the advantages of Bitcoin is its non-centralisation, any convincing government-based competitor would have to be somehow supported by the government (or governments), yet not overly controlled by that (those) same government(s).

## Mode 2: Your Bitcoin Holding Reduces To Zero.

In this failure mode, Bitcoin itself continues to operate happily, but somehow something bad happens to your bitcoin holding.

This type of failure can be divided into two in two different ways, giving rise to a total of four sub-modes.

The first division is the distinction between loss and theft:

- With loss, you lose access to your bitcoins because you lose the private key.
- With theft, you lose your bitcoins because someone else (the thief) finds out your private key and transfers the bitcoins to their own bitcoin address.

A minor variation in losing your private key is when you transfer bitcoins to an address which is apparently valid, but for which there is no known private key. This variation is possible, but it requires considerable effort and contrivance to achieve it, so it is not a significant risk in practice.

The second division is determined by whether you are totally responsible for managing your bitcoin addresses and the associated private keys, i.e. your bitcoin wallet, or whether someone else is.

And in the case where you delegate management of your bitcoin wallet to a second party that you have some type of account with, failure further divides into three types:

- You lose, or have stolen, your credentials to the account.
- The second party loses, or has stolen, the bitcoins they are managing for you.
- The second party steals the bitcoins from you.

If you just lose your account credentials, then there might be some way to recover the account, depending on how you identified yourself when creating the account. If the account credentials are stolen, then the thief will most likely transfer the bitcoins to themselves as quickly as possible, and you are probably out of luck.

If the second party loses (or has stolen) some of their account holders' bitcoins, then hopefully they can make up the losses. But if too much is lost, then the second party might go bankrupt, and again you are out of luck.

If the second party steals your bitcoins from you, then I can only suggest you contact the police (in their country, or in your country, whatever seems best, good luck with that).

### Loss and theft of private keys

How you might lose your private keys or have them stolen depends quite a lot on where you keep them.

If you are holding them privately, there are basicly three places you can keep them (from which you can choose one or more):

1. Stored in a digital format (and this further sub-divides into online and offline)
2. Printed out on paper
3. In your head, i.e. memory

These places correspond to three different types of wallet, i.e. "digital", "paper" and "brain".

A minor variation is when you don't store the private keys directly, but rather store some value from which the private keys can be generated, such as the seed value for a deterministic wallet, for example if you use the Electrum bitcoin client to manage your bitcoins. (In which case the seed is the thing that you don't want to lose and you don't want it to be stolen.)

### Mode 2a: Loss of private key

Methods for losing private keys are mostly what you would expect:

- Digital media can be physically lost, like forgetting where you put your USB key. They can fail internally, and they can be destroyed by external events, such as fire.
- Pieces of paper can be lost, and they can be destroyed by fire. Internal failure is less likely, but ink can fade and smudge, if you make a poor choice of printing technology.
- Memories are easily lost – people forget things all the time.

### Mode 2b: Theft of private key

There doesn't exist any technology for "stealing" memories, so your memory wallet is probably the safest against theft. Unless perhaps the bad guys know that you have a brain wallet, so they kidnap you, and torture you, or torture your loved ones, and force you to give up the details.

For the other types of private key storage, theft can be divided into two major categories:

1. Offline physical theft, where the thief comes into your house or office, and steals the USB stick, or the laptop, or the piece of paper.
2. Online theft, where the computer system with access to the wallet gets hacked, and the hacker causes that computer to either send the private key details to the hacker, or possibly, the hacked computer is made to directly transfer the bitcoins to the thief's bitcoin address.

The risk of online theft can be reduced if you generate bitcoin addresses in an offline computer (unfortunately the calculations are too laborious to do by hand), and then the public addresses only are copied to an online computer for the purpose of receiving bitcoins that you have purchased somewhere. (The offline computer then has to never be connected to the internet again, or you have to completely erase all its existing data and reinstall a fresh operating system before you do connect it.)

## Conclusion

There are quite a few ways that you can lose the value of your bitcoin investment. For some of them you can do something about the risk, and some of them are risks that are beyond your control.

But all of these risks need to be taken into account when considering the pros and cons of buying bitcoins with money that you may or may not be able to afford to lose.

Also, I probably haven't thought of all the ways that a bitcoin investment could fail. So suggestions are welcome.

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