Irreversible transactions in Bitcoin network can only be refunded by the receiving party. It is a key difference from credit card transactions that can be canceled. It's no exaggeration to say that the entirety of bitcoin's system of blockchain.
When used correctly, Bitcoin's base layer transactions on the blockchain are irreversible and final. It's no exaggeration to say that the entirety of bitcoin's system of blockchain, mining, proof-of-work, difficulty etc, exist to produce this history of transactions that is computationally impractical to modify.
In the literature on electronic cash, this property was often refer to as "solving the double-spending problem". Double-spending is the result of successfully spending some money more than once. Bitcoin users protect themselves from double spending fraud by waiting for confirmations when receiving payments on the blockchain, the transactions become more irreversible as the number of confirmations rises.
Other electronic systems prevent double-spending by having a master authoritative source that follows business rules for authorizing each transaction. Bitcoin uses a decentralized system, where a consensus among nodes following the same protocol and proof-of-work is substituted for a central authority. This means bitcoin has special properties not shared by centralized systems. For example if you keep the private key of a bitcoin secret and the transaction has enough confirmations, then nobody can take the bitcoin from you no matter for what reason, no matter how good the excuse, no matter what. Possession of bitcoin is not enforced by business rules and policy, but cryptography and game theory.
Because bitcoin transactions can be final, merchants do not need to hassle customers for extra information like billing address, name, etc, so bitcoin can be used without registering a real name or excluding users based on age, nationality or residency. Finality in transactions means smart contracts can be created with a "code-is-law" ethos.
Traders and merchants who accept a payment immediately on seeing "0/unconfirmed" are exposed to the transaction being reversed. An attempt at fraud could work that the fraudster sends a transaction paying the merchant directly to the merchant, and sends a conflicting transaction spending the coin to himself to the rest of the network. It is likely that the second conflicting transaction will be mined into a block and accepted by bitcoin nodes as genuine.
Merchants can take precautions (e.g., disable incoming connections, only connect to well connected nodes) to lessen the risk of a race attack but the risk cannot be eliminated. Therefore, the cost/benefit of the risk needs to be considered when accepting payment on 0/unconfirmed when there is no recourse against the attacker.
The research paper Two Bitcoins at the Price of One finds that the protocol allows a high degree of success by an attacker in performing race attacks. The method studied in the research paper depends on access to the merchant's Bitcoin node which is why that even prior to this paper, recommendations for merchants include disabling incoming connections and to choose specific outgoing connections.
Another attack the trader or merchant is exposed to when accepting payment on 0/unconfirmed. The Finney attack is a fraudulent double-spend that requires the participation of a miner once a block has been mined. The risk of a Finney attack cannot be eliminated regardless of the precautions taken by the merchant, but the participation of a miner is required and a specific sequence of events must occur. Thus the attack is not trivial to perform and only makes sense for the attacker when the gains from the attack are significant. Just like with the race attack, a trader or merchant should consider the cost / benefit when accepting payment on just one confirmation when there is no recourse against the attacker.
Also referred to as a one-confirmation attack, is a combination of the race attack and the Finney attack such that a transaction that even has one confirmation can still be reversed. The same protective action for the race attack (no incoming connections, explicit outgoing connection to a well-connected node) significantly reduces the risk of this occurring.
It is worth noting that a successful attack costs the attacker one block - they need to 'sacrifice' a block by not broadcasting it, and instead relaying it only to the attacked node.
Alternative history attack
This attack has a chance to work even if the merchant waits for some confirmations, but requires relatively high hashrate and risk of significant expense in wasted electricity to the attacking miner.
The attacker submits to the merchant/network a transaction which pays the merchant, while privately mining an alternative blockchain fork in which a fraudulent double-spending transaction is included instead. After waiting for n confirmations, the merchant sends the product. If the attacker happened to find more than n blocks at this point, he releases his fork and regains his coins; otherwise, he can try to continue extending his fork with the hope of being able to catch up with the network. If he never manages to do this then the attack fails, the attacker has wasted a significant amount of electricity and the payment to the merchant will go through.
The probability of success is a function of the attacker's hashrate (as a proportion of the total network hashrate) and the number of confirmations the merchant waits for. An online calculator can be found here
For example, if the attacker controls 10% of the network hashrate but the merchant waits for 6 confirmations, the success probability is on the order of 0.1%. Because of the opportunity cost of this attack, it is only game-theory possible if the bitcoin amount traded is comparable to the block reward (but note that an attacking miner can attempt a brute force attack against several counterparties at once).
Also referred to as a 51% attack or >50% attack. If the attacker controls more than half of the network hashrate, the previous attack has a probability of 100% to succeed. Since the attacker can generate blocks faster than the rest of the network, he can simply persevere with his private fork until it becomes longer than the branch built by the honest network, from whatever disadvantage.
No amount of confirmations can prevent this attack; however, waiting for confirmations does increase the aggregate resource cost of performing the attack, which could potentially make it unprofitable or delay it long enough for the circumstances to change or slower-acting synchronization methods to kick in. Bitcoin's security model relies on no single coalition of miners controlling more than half the mining power. A miner with more than 50% hash power is incentived to reduce their mining power and reframe from attacking in order for their mining equipment and bitcoin income to retain it's value.
Successful Double-Spends in Practice
In November 2013 it was discovered that the GHash.io mining pool appeared to be engaging in repeated payment fraud against BetCoin Dice, a gambling site. Dice sites use one transaction per bet and don’t wait for confirmations. GHash.io claimed they had investigated and found a rogue employee who had been doing the double spending, who was fired. However no evidence supporting this was provided and the incident left a permanent cloud hanging over the pool. Regardless, it didn’t seem to hurt their market share much: most miners probably never heard about the incident at all.
Although bitcoin's base layer blockchain transactions are irreversible, consumer protection can be implemented on a layer on top.
For example using an escrow agent is a powerful technique especially when combined with multisignature smart contracts. Also bitcoin sites such as online casinos rely on their long-standing reputation and some regulated brokers and exchanges simply rely on the legal system.
- Bitcoin Attacks in Plain English by David Perry
- Thorough discussion of zero-confirm on-chain transactions in bitcoin by Bram Cohen