Irreversible Transactions

However, there are some types of financial transactions that are completely irreversible. The most common transaction of this type is a transfer of physical, paper money. If the ATM machine goes crazy one day and spits out $10,000 in cash that you don't actually own and you decide to bury that money in the woods that evening, no legal contract, action by the bank, or action by the government will ever be able to recover that cash; if you decide not to tell them where you buried this money, it is not directly reachable by the legal system.[1]

Bitcoins have this same property, which is why people sometimes call it digital cash. If you give somebody bitcoins using a standard Bitcoin transaction, nothing you can do or say can ever reverse that transaction. Such a transaction is enforced using pure mathematics and is not a party to any legal contract, in itself.

Combining Reversible and Irreversible Assets

Now we can finally understand why it is often a hassle to buy bitcoins. When you buy an irreversible asset using a reversible asset it leads to something call an impedance mismatch: While it is possible to build efficient financial systems that involve reversible transactions (our modern financial system) and those that involve irreversible transactions (as is currently found in the world of cryptocurrencies), it is difficult to exchange assets between these two categories.

This is why banks have such strict cash withdrawal limits at ATMs and why it can take several days to buy a bitcoin. In both cases, the institution has no way of reversing the irreversible transaction if something goes wrong and needs to take extra precautions that the reversible half of the transaction has a high probability of completing successfully before agreeing to the transaction, especially if large amounts of money are involved.

If you are sent raspberry hand soap by mail via an Amazon purchase, this is arguably also an irreversible transaction. However, such products, if obtained fraudulently, are hard to sell to another party (unlike Bitcoin). This is another reason why an online seller of soaps is less at risk of fraud than a company selling bitcoins.

Why Irreversible Transactions Are Arguably Superior

Many people, when they hear that Bitcoin transactions are irreversible, will have the following thought: "I kind of like the fact that I can reverse a credit card transaction if someone sells me a deficient product." However, it is still straightforward to perform reversible transactions with Bitcoin. Many systems exist for doing this, usually using a feature in Bitcoin called multi-signature transactions, which we will discuss in some detail in later chapters.

It is true that currently, with standard Bitcoin transactions, the protections a buyer has when buying something off of the Internet are not as strong as those built into the credit card system. This is a weakness of Bitcoin and something the Bitcoin community needs to strive to resolve. But the fact is that both reversible and irreversible transactions are useful depending on the circumstances. For instance, if you are selling a bicycle to a stranger for $100, you probably wouldn't want a potentially reversible asset in exchange, such as a personal check. Instead, you would say to the stranger, "cash only please" (or maybe "Bitcoin or cash only please" after you finish this book).

Therefore, because Bitcoin allows for reversible transactions wile your Visa credit card will never allow for a strictly irreversible transaction, one can argue that irreversible financial instruments are superior: They are a more basic building block on top of which more complicated forms of transactions can be built, including reversible financial transactions with enforcement via traditional contracts, if desired.

In conclusion, we believe it can be a bit unfair to criticize the design of Bitcoin for the fact that bitcoins are hard to purchase with a credit card or bank wire. Part of this difficulty is caused by the design of the traditional financial system itself.

  • [1] Of course they might be able to seize another ten thousand dollars you own from another source, but that would not constitute a "reversal" of the original transaction for the sake of this discussion.
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