Wow, thanks for the great explanation! Your post has alleviated my second fear (Loss Prevention) with this sentence:
Unlike above, everyone would happily accept this small change in the bitcoin software since it doesn't hurt anyone and has a very good reason. So we can keep dividing bitcoins till kingdom come without issue.
As for my first fear (Counterfeiting) I will go through your points and ask a few questions. I probably should have stated that most of my concerns in this regard really only come into play after we are no longer generating Bitcoins legitimately or if someone (or group of someones) is simply being malicious.
Just like in the real world, where if everyone else on the planet starts treating your banknotes differently you are up a creek without a paddle, there is no protection against *everyone else* changing the way they use bitcoin.
Speaking more technically, to fork the blockchain effectively the majority of the network's processing power must agree to the change. And for a change as drastic as increasing the total number of bitcoins, everyone who wanted the change would have to start using a new Bitcoin program. If you chose not to upgrade your program you could still keep going as always with those who also did not upgrade. The value of your bitcoins, and the services available to you such as buying and selling for other currencies, etc. would depend on the people using that original software, and whether they would provide those services.
Speaking practically, no serious user of bitcoin, including the exchanges, major bitcoin businesses, etc. are going to accept a version of the program that changes the rules without a very good reason such as closing a security loophole. There is no practical scenario where your value in bitcoin is going to be swept away unexpectedly by the network, because everyone else on the network has that same concern.
Based on what you said here, it sounds like what I will call "mob rule" although that might not be the most apt term. Basically it means that a majority can foist things onto a minority. Since Bitcoin is open source, anyone can write and distribute his own version of the software. If someone, even simply being malicious, decides he wants to devalue Bitcoins all he has to do it write a client that allows all of those using it to gain Bitcoins when they use his implementation. He can even use this as a selling point for those considering his application. While many people (most of us here included) would see the negative effect of inflating the money supply, those who are doing it probably wouldn't and in any case they may not care, as the people who initially receive "newly minted" receive the full benefit of it.
I guess I am just really trying to understand how an "attacker" who controls more than 50% of the network's computing power is prevented from creating new coins.
The method of coin creation is "hardwired" into Bitcoin, so even with all the world's supercomputers put together an attacker can't just put pretend coins into the mix--any blocks that do that won't be accepted by anyone else. Blocks are only accepted if they follow the rules. The only thing an 'attacker' could do is compete fairly for that set amount of coins that is being generated--and this costs that person just as much in hardware, electricity, etc. as anyone else.
The only real hardwired security I can see is the fact that honest nodes control the network, everything else is specific to the implementation being used by each Bitcoin user. Am I wrong here?
No worries--it can take a while to actually fit in to your head just how beautifully bitcoin solves all the potential problems with digital currency. I just discovered it a couple months ago and I'm still in awe of it. I'm also very happy that my investment has roughly tripled in that time. Both theoretical and actual substance working together--a rare event for our planet indeed!
You are very right, I initially was very skeptical and have narrowed my fears down to this (now one thanks to you!) problem/concern.