Bitcoin's Growing Pains: Intermediation and the Need for an Effective Loss Allocation Mechanism

This paper examines a phenomenon largely overlooked in existing literature: as Bitcoin matures into a mainstream consumer payments system with the rise of intermediation and hosted wallet services, it is slowly transforming from a purely decentralized peer-to-peer currency into something that (ironically) more closely resembles the bank-intermediated payment systems of the past. This paper explains how this transformation creates complicated issues of loss allocation not anticipated by Bitcoin’s founder. Further, it argues for the need of an effective legal mechanism to efficiently and fairly allocate losses between intermediaries and users. The first section of this paper will explain how Bitcoin transactions work when users manage their own personal wallets, describing both the transaction mechanics and risks of loss. Then, it will explain how hosted wallet services have changed these mechanics and risks, as well as why a set of loss allocation rules is necessary. Finally, the paper will recommend a set of loss allocation rules based on the policy rationales that drive rules under other existing payment systems law.