The Bank of Canada released a working paper this month that contains a bold claim: “Lesson 1: Digital currencies will be counterfeited.” The paper is on the lessons that private bank notes from many decades ago hold for digital currencies today. Much of the paper consists of an excellent history of bank notes. But the paper also contains claims about digital currencies, specifically, private, non-Central Bank affiliated digital currencies like Bitcoin. This blog post explains why the working paper's Lesson 1 claim about digital currency counterfeiting is not correct.
The working paper states that bank notes have always been counterfeited. They then go on to explain several problems with digital currencies that have nothing to do with counterfeiting (such as "fraud" and "cyber attacks") and conclude with:
“It is also the case that counterfeiting for a digital currency would be much more catastrophic than for paper currency. ... But one counterfeit digital currency ‘coin’ would almost certainly quickly undermine the confidence in the whole system because it would be much more likely that the other ‘coins’ can be counterfeited too.”
But why is the paper wrong? Can Bitcoin be counterfeited?
There has never been a counterfeit bitcoin. Distributed, decentralized digital currencies offer a new paradigm of money that can finally be free of counterfeiting by relying on cryptography and massive computer networks. After almost a decade of experience with this technology and no examples of counterfeiting, I don't think it's fair to say that counterfeiting is inevitable.
In the 8 years that Bitcoin has been operating there has never been a single instance of a "counterfeit" bitcoin. No one can create bitcoins other than as part of mining, which is built into the software and secured by the largest network of computing power that the world has ever built. Despite many years of operating as a public network, with the source code completely known to every participant in the system, and billions of dollars at stake, no one has counterfeited a bitcoin.
Why has a "counterfeit" bitcoin not been created? Because there is a network of devices around the world that do approximately 3 million trillion checks per second as part of the "mining" system, and tens of thousands of computers that verify the authenticity of transactions by ensuring that the inputs of one transaction are the result of outputs of a previous transaction.
In order to counterfeit a bitcoin, someone would have to somehow find a flaw in the system that allows them to create coins that slip by the distributed network of computers dedicated to preventing that form of cheating. Although it's theoretically possible in the sense that anything is possible, there's been a long history of that not happening despite every incentive in the world for someone to do it. If anyone was able to counterfeit a bitcoin they would be in a position to steal many millions of dollars without any repercussions. Many, many people have tried. None have succeeded.
Every day, Bitcoin offers a multi-million dollar prize to the world and no one has collected it. Given that experience, why is counterfeiting inevitable?
The Bank of Canada working paper presents no evidence for the authors' very bold claim that "digital currencies will be counterfeited" other than that traditional paper notes have been counterfeited. This assertion misunderstands the relationship between paper notes and digital cryptographic currencies. They are fundamentally different and one is protected by the largest computer network in the world, running cryptographic functions that are used in many systems worldwide and have been impervious to subversion to-date. Paper and digital currencies are different and the lesson of paper counterfeiting doesn't carry over analogously. Just because it's possible to draw parallels between paper and digital currencies doesn't mean that the mistakes of paper currency have been carried over to digital currency.
In fairness to the authors, it's possible that they don't mean Bitcoin (or systems based on it). They use the rather vague term "decentralized digital currency" which could apply to very weak systems that do allow counterfeiting. It's also possible that they could be referring to companies purporting to possess bitcoins that they don't (like Mt.Gox), but that wouldn't be counterfeiting. But I think in the context of the article, it's fair to say that the authors were thinking of Bitcoin when they wrote Lesson 1.
Will Bitcoin be forever counterfeit-free? That's a big claim. But it's a fact that there's never been a counterfeit bitcoin.