Bitcoin Risk Analysis

Abstract

The surprise advent of the peer-to-peer payment system Bitcoin in 2009 has raised various concerns regarding its relationship to established economic market ideologies. Unlike fiat currencies, Bitcoin is based on open-source software; it is a secure cryptocurrency, traded as an investment between two individuals over the internet, with no bank involvement. Computationally, this is a very innovative solution, but Bitcoin’s popularity has raised a number of security and trust concerns among mainstream economists. With cities and countries, including San Francisco and Germany, using Bitcoin as a unit of account in their financial systems, there is still a lack of understanding and a paucity of models for studying its use, and the role Bitcoin might play in real physical economies. This project tackles these issues by analysing the ramifications of Bitcoin within economic models, by building a computational model of the currency to test its performance in financial market models. The project uses established agent-based modelling techniques to build a decentralised Bitcoin model, which can be ‘plugged into’ existing agent-based models of key economic and financial markets. This allows various metrics to be subjected to critical analysis, gauging the progress of digital economies equipped with Bitcoin usage. This project contributes to the themes of privacy, consent, security and trust in the digital economy and digital technologies, enabling new business models of direct relevance to NEMODE. As computer scientists, we consider Bitcoin from a technical perspective; this contrasts with and complements other current Bitcoin research, and helps document the realizable risks Bitcoin and similar currencies bring to our current economic world. This report outlines a comprehensive collection of risks raised by Bitcoin. Risk management is a discipline that can be used to address the possibility of future threats which may cause harm to the existing systems. Although there has been considerable work on analysing Bitcoin in terms of the potential issues it brings to the economic landscape, this report performs a first ever attempt of identifying the threats and risks posed by the use of Bitcoin from the perspective of computational modeling and engineering. In this project we consider risk at all levels of interaction when Bitcoin is introduced and transferred across the systems. We look at the infrastructure and the computational working of the digital currency to identify the potential risks it brings. Additional information can be seen in our forthcoming companion report on the detailed modeling of Bitcoin.