Stop Saying Bitcoin Transactions Aren’t Reversible

One of the criticisms leveled at Bitcoin by those people determined to hate it is that Bitcoin transactions are irreversible. If I buy goods from an anonymous counterparty online, what’s to stop them from taking my bitcoins and simply not sending me the goods? When I buy goods online using Visa or American Express, if the goods never arrive, or if they aren’t what was advertised, I can complain to the credit card company. The company will do a cursory investigation, and if they find that I was indeed likely ripped off, they will refund me my money. Credit card transactions are reversible, Bitcoin transactions are not. For this service (among others), credit card companies charge merchants a few percentage points on the transaction.

The problem with this account is that it’s not true: Baked into the Bitcoin protocol, there is support for what are known as “m-of-n” or “multisignature” transactions, transactions that require some number m out of some higher number n parties to sign off.

The simplest variant is a 2-of-3 transaction. Let’s say that I want to buy goods online from an anonymous counterparty. I transfer money to an address jointly controlled by me, the counterparty, and a third-party arbitrator (maybe even Amex). If I get the goods, they are acceptable, and I am honest, I sign the money away to the seller. The seller also signs, and since 2 out of 3 of us have signed, he receives his money. If there is a problem with the goods or if I am dishonest, I sign the bitcoins back to myself and appeal to the arbitrator. The arbitrator, like a credit card company, will do an investigation, make a ruling, and either agree to transfer the funds back to me or to the merchant; again, 2 of 3 parties must agree to transfer the funds.

This is not an escrow service; at no point can the arbitrator abscond with the funds. The arbitrator is paid a market rate in advance for his services, which are offered according to terms agreed upon by all three parties. This is better than the equivalent service using credit cards, because credit cards rely on huge network effects and consequently there are only a handful of suppliers of such transaction arbitration. Using Bitcoin, anyone can be an abitrator, including the traditional credit card companies (although they might have to lower their fees). Competition in both terms and fees is likely to result in better discovery of efficient rules for dispute resolution.

While multisignature transactions are not well understood, they are right there in the Bitcoin protocol, as much a valid Bitcoin transaction as any other. So some Bitcoin transactions are irreversible; others are reversible, exactly as reversible as credit card transactions are.

Bitrated.com is a new site (announced yesterday on Hacker News) that facilitates setting up multisignature transactions. Bitcoin client support for multisignature transactions is limited, so the site helps create addresses that conform to the m-of-n specifications. At no point does the site have access to the funds in the multisignature address.

In addition, Bitrated provides a marketplace where people can advertise their arbitration services. Users are able to set up transactions using arbitrators both from the site or from anywhere else. The entire project is open source, so if you want to set up a competing directory, go for it.

What excites me most about the decentralized arbitration afforded by multisignature transactions is that it could be the beginnings of a Common Law for the Internet. The plain, ordinary Common Law developed as the result of competing courts that issued opinions basically as advertisements of how fair and impartial they were. We could see something similar with Bitcoin arbitration. If arbitrators sign their transactions with links to and a cryptographic hash of a PDF that explains why they ruled as they did, we could see real competition in the articulation of rules. Over time, some of these articulations could come to be widely accepted and form a body of Bitcoin precedent. I look forward to reading the subsequent Restatements.

Multisignature transactions are just one of the many innovations buried deep in the Bitcoin protocol that have yet to be widely utilized. As the community matures and makes full use of the protocol, it will become more clear that Bitcoin is not just a currency but a platform for financial innovation.

29 replies to “Stop Saying Bitcoin Transactions Aren’t Reversible

  1. Josh Sacks

    Multisignature transactions don’t solve the underlying security problem.
    Keeping $1M in an account at BofA is secured not by a password, but rather by the underlying financial network. Even if an attacker can compromise your account, it’s very hard to steal large amounts of electronic USD since those transactions are all reversible.

    Imagine Apple holds $5B in USD at a bank. That bank account is protected by various levels of security. If someone were to compromise the security of the account it would still be very hard for them to steal any substantial amount of that money- any transfer they did would be reversed, and any financial institution they used would participate in tracking down the identities of the thieves.

    Now imagine that Apple holds $5B in BTC. If someone were to get access to their private info, they could transfer ALL $5B in a matter of a few minutes (maybe hours) and Apple would basically depend on law enforcement to physically capture the thief and compel them to turn over the BTC.

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  5. SectioAurea

    A measure of voluntary, temporary centralization and consensus offers many possibilities as an addition to existing capabilities of the blockchain already in widespread use. Distributed anonymous government systems may utilize this sort of function for electoral and court systems.

  6. Karel Ronkels

    Thing is: credit card transactions are not reversible. The receiver of your credit card payment retains the money paid. The credit card company will just make a claim in your name with their insurance department or company. So basically your credit card payments are covered by an insurance FOR WHICH YOU PAY.

  7. tom robinson (@tlrobinson)

    I agree, but you’re using a different meaning of “transaction” than is normally used in Bitcoin. I’d call it “payment” or something.

    It’s kind of like saying IP isn’t a reliable transport protocol, which is true, but a reliable transport like TCP can be built on top of it.

    Bitcoin *transactions* aren’t reversible, but *payments* can be.

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  9. Jeff Weiss

    I’m going to keep saying bitcoin transactions are not reversible. Because they’re not.

    The key is that “transaction” means something different in bitcoin, they can be much more complex than just one party sending to another.

    As for Josh’s comment, that’s largely true, but it cuts both ways. An authority cannot righteously take bitcoin (when they’ve stolen it), but authorities also cannot it for unjust reasons. The latter happens all the time, too, just ask Paypal users or any merchant about chargebacks.

  10. mr5iff

    what if the cheating seller bribes the abitrator(s)? or the abitrator(s) offer the seller a chance to bribe?
    Any incentive system prevents parties from bribery?

  11. Cybit

    Maybe YOU are Satoshi Nakamoto ;-)
    Seriously, the m of n transaction will help with the conclusion of sketchy or moderate risk transfers but it won’t help against theft. To mitigate theft, bitcoin should not be kept in web/online wallets but in client wallets (that increases over all security because the blockchain is kept in MORE places). Also, keeping a lot of bitcoin accessible to the internet is just stupid. Keep your holdings decentralized and keep as much in offline/cold storage as you can. A community currency system requires an intelligent and diligent community when it comes to financial hygiene.

  12. Eli Dourado Post author

    Since both Josh Sacks and Cybit raise the issue of security, I think it’s worth explaining how multisignature addresses can improve security for individual Bitcoin users.

    Let’s say I have a lot of Bitcoins that I want to store, and I’m worried that my private key will be compromised. What I can do is set up a 2-of-2 address where I hold both of the private keys associated with the address. I transfer my coins there and store the two keys in separate places. If one of the keys gets compromised, my balance is still safe, because two keys are needed in order to transfer the funds.

    We can get more complicated. I can use a 2-of-3 address, where I hold all three keys. That way, if I lose one, I can still access the coins, but if one of my keys gets compromised, my funds are still safe. And of course maybe someone with a lot of funds might prefer a 3-of-4 system or something even more exotic.

    The bottom line is that multisignature transactions can indeed improve wallet security, and I suspect that they will be widely used in this way in the future.

  13. dacoinminster

    Mastercoin (protocol layer running on top of bitcoin) supports “savings addresses” which have a time-window in which transactions can be reversed. This is a security feature against theft, and cannot be used for merchant disputes, since merchants don’t accept transactions from savings addresses for payment.

  14. David Franz

    This is incredible and should be publicized more in the bitcoin community. I did not know about this, but what a clever way to implement security for direct anonymous/merchant and customer transations! Start-ups will soon begin to implement this feature of the bitcoin protocol, right? You already mentioned one service that has started it already. Exciting that this feature is already tackled inherently by bitcoin!

  15. Anders

    In reply to Karel Ronkels: The receiver of your credit card payment DOES NOT retain the money paid. I have operated a web shop and when I had sent off goods to a customer using a stolen credit card, the card company did a “chargeback” and I ended up losing both goods and money. Vendor takes the risk, not the card company or insurance company.

  16. Jon Grah

    In reply to Josh Sacks claim that bitcoins can be stolen without recourse vs fiat currency which is protected (insured) against theft….Someone still has to pay for the loss of fiat currency. If someone were to hack your bank account, the bank would have to eat the cost. It’s not free, even though it may appear so. With bitcoin, the responsibility to secure the funds rests with the owner of the bitcoins. Responsibility is something that comes along with liberty. It’s difficult to teach this to someone who insists on being a victim in every situation.

    Bitcoin is poised to be an excellent complimentary currency. There is still a place for national/fiat currencies.

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