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Expert opinion

Blockchain - unchaining the world from fraud?

Thursday 14 April 2016 | 10:25 AM CET

Arthur Baxter, ExpressVPN: The greatest contribution from Bitcoin and Blockchain to eliminate fraud might not come from its applications in finance

Bitcoin’s relationship with fraud

Bitcoin’s relationship with fraud is a difficult one. On one hand, the digital currency has gained notoriety for its use in Ponzi and pyramid schemes, Cryptolockers, undelivered computing equipment and as payments for stolen credit card information.

Worse still, many of the Bitcoin clones (known as Altcoins) are built with the sole purpose of defrauding investors in so-called “pump and dump schemes”, as illustrated in the example of GAW Miners and their “Paycoin”.

On the other hand, Bitcoin is still seen as lowering, if not eliminating, much of the online fraud and abuse that is currently associated with PayPal and credit card use.

Shifting responsibility to the user

While some of the cost of credit card fraud is borne by the card issuing banks, usually it is the merchants that are hit the most. Not only do they lose their merchandise, but they may also see their standing with payment processors or banks deteriorate after inadvertently accepting stolen credit cards. The additional cost of not being able to sell to markets classified as high-risk, such as Nigeria or Indonesia, cannot even be quantified.

With Bitcoin, the risk of fraud for the merchant is non-existent after the transaction is confirmed. There is no way for the fraudster to “charge back” the Bitcoins. All sales are final, just like they are with cash transactions. Arbitration is either done by a party agreed upon by the seller and the merchant, or not at all.

That is great news for merchants in industries with high fraud rates, such as travel or computing. Precious metal dealers also see the advantages, with some dealers offering discounts as high as 4% for paying with Bitcoin rather than credit card or PayPal.

That, however, does not mean the potential for fraud has been eliminated. While a consumer is usually able to abuse the option to charge back a payment in a certain amount of time, this gives them the peace of mind to make a transaction, and the ability to defend against fraud by the merchant.

When paying with Bitcoin without an arbitration process in place, the risk of non-delivery falls back on the customer, who is left with nothing if the merchant turns out to be fraudulent. This can even happen to customers of well-known and large scale companies, as seen in the case of Butterfly Labs. The manufacturer of Bitcoin mining equipment is believed to have defrauded customers of over 50 million USD in Bitcoins.

The essential question is whether consumers will be willing to take on the risk of a merchant being fraudulent or unresponsive to their complaints in exchange for a payment discount. If merchants can offer a payment discount large enough due to their lower fraud risk, then Bitcoin payments can indeed offer a benefit for both consumers and merchants. If not, then Bitcoin’s potential to reduce fraud remains purely hypothetical.

However, there are some reasons for why such a shift of fraud towards the user might be a good thing. Users might be a better judge of the credibility of a store than the store is a judge of the credibility of the user. On the other hand, fraud would also likely shift away from impersonating individuals and towards impersonating stores and their representatives. And if the online retail market was to consolidate at the cost of gaining trust among consumers risers, that certainly wouldn’t be a good thing either.

Superior technology

In the credit card system, where merchants possess and maintain all the information necessary for anyone to make a payment, theft of credit card numbers and identities is disastrous.
Bitcoin is characterized by its use of public and private key pairs that make a push-system possible, in which the user authorizes and signs each individual transaction.

This makes it much harder to steal Bitcoins, and the compromise of point of sale systems or server infrastructure no longer puts all users and their funds at risk. Being able to lower the cost of maintaining sensitive data as well as insuring users against data loss can make Bitcoin further attractive to merchants, and increase the discounts they are able to offer to Bitcoin users.

The blockchain

While Bitcoin has yet to gain widespread acceptance as a currency and still faces suspicion and distrust from banks and regulators, it is commonly agreed that Bitcoin’s “underlying technology” - the Blockchain - displays great ingenuity and is itself an important innovation.

While generally poorly defined and not nearly as commonly used as Bitcoin, blockchains share and differ in a broad range of attributes, each of which makes it potentially attractive in battling online fraud.

The public and private key pairs, for example, and their push-system is a great advantage of any blockchain, not just Bitcoin.

Another important characterization of a blockchain is their transparency and distribution. The ledger is public and mirrored across several servers, each of which verifies the validity of each transaction and keeps a copy of the entire ledger. While this seems resource intensive at first, it also allows for high reliability and an instant detection of abuse.

Monitoring and detecting abuse would become a lot easier and faster, limiting the scope of damage fraudulent transactions could cause. However, the entire system also has serious privacy implications.

Bitcoin maintains privacy through its use of pseudonymous addresses, which a user can create with virtually no limits. Such a system would likely clash with laws and regulations when introduced to something like our credit card system, reintroducing the need for trusted and closed parties to maintain privacy, which potentially diminishes the advantages of using a blockchain.

Identity

The greatest contribution from Bitcoin and Blockchain to eliminate fraud, however, might not come from its applications in finance. One reason fraud is relatively prevalent online might be that the identities that traditional institutions like banks and governments screen are disconnected from our identities online.

While our legal identities are relatively easy to vet offline, they become easy to remotely imitate online. Social security numbers, identity cards, passports and credit card numbers function very poorly as identifiers online and are easily hijacked by criminals.

Blockchains, possibly even Bitcoin, might be the first successful implementations of identities made for an online world. They will make it possible for us to build an online reputation and maintain all the perks that come with it, such as trust and credit, while making it difficult to have these identities stolen due to the advantages of asymmetric encryption and transparent ledgers.

It will be a great advantage, and possibly even a deciding factor, if these identities are not maintained by a single entity, but rather kept by a decentralized system such as Bitcoin.

It remains unanswered how such an online identity system will integrate with our legal systems, but it can help to make many things possible that Bitcoin cannot, such as credit, which in return allows for recurring payments and a shift of risk away from the consumer.

Conclusion

Bitcoin might be less susceptible to hacks and theft than credit card numbers, but it essentially only shifts the risk from the merchant to the consumer. The consumer might be able to manage this risk better, but only the market will tell if consumers are willing to do this, and whether this shift is economically advantageous to both parties.

Blockchain technology can significantly help increase our financial infrastructure, but the question of whether this can be done easily on top of our existing financial system is yet to be decided.

Decentralizing identity is another attractive step that can help mitigate and lower fraud, but its practical applications are still, relative to Bitcoin, far away from being widespread and used.

About Arthur Baxter

Arthur Baxter is a Network Operations Analyst at ExpressVPN. Being part of a privacy-related company, Arthur and his colleagues like to practice what they preach, and Arthur prefers not to disclose his personal photo or further information about where he studies.

 

About ExpressVPN

ExpressVPN is a VPN service provider enabling users worldwide to anonymously browse the web. With over 1000 servers across 78 countries and new servers added each week, ExpressVPN provides uncensored access to international websites. ExpressVPN has been operating since 2009 and is a vocal advocate for internet freedom and privacy, being a financial supporter of non-profit organizations fighting to protect these rights.

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