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Nothing more than a collapsed tower of toxic sludge.
—Mark T. Williams[1]

Bitcoin (code: BTC) is an Internet-based digital currency and payment network; it uses strong cryptography to prevent users from duplicating money. Bitcoin's independence from the control of governments, corporations, or other centralized entities tends to appeal to libertarians, anarcho-capitalists, and technophiles.[2] At the same time, it also does not enjoy the security and protection which those large bodies can ostensibly provide, making it a volatile and often insecure asset.

Bitcoin was first proposed by a person known only by the apparent pseudonym of "Satoshi Nakamoto" in late 2008, at the height of the banking crisis.[3][4]

The currency needs lots of computers to process and record transactions. The solution to this is "mining," in which Bitcoin users run software to do all the necessary work.[5] Every time someone successfully "finishes" a work package, they receive bitcoins in return. This provides an incentive to keep the currency running, but also attracts a lot of prospectors and speculators looking for easy money, and scammers who consider them suitably exploitable suckers.[6]

In 2014, the cryptocurrency hit a sharp decline after a principal exchange, Mt. Gox, shut down following what may have been the largest recorded cybertheft in history, matching the Enron bankruptcy in scale.[7][8]

Contents

[edit] Economics

It's like a house on fire with freshly baked cookies inside.
—Pyro Cat[9]
The seasteading of numismatics. And it's going to get even funnier.

The notable bit about Bitcoin is that it is intended to be entirely decentralised; there is no central bank backing it. Previous virtual currencies, such as E-Gold, Flooz, Beenz, Lindens, or WoW gold have always had an organisation behind them. This lack of a monetary authority means that, were governments to try to do something about it, they would not have a central point of attack.[10] Bitcoin therefore presents a rare sandbox/universe-in-a-jar scenario for observing market interactions in a free banking[wp] system, as Austrian schoolers have always wanted — this time in the context of post-industrial economies.

Bitcoin is an entirely imaginary currency (i.e., has no use-value), but not particularly more so than US dollars, and could be a general currency if 300 million people similarly behaved as though it was one, i.e., would do work in exchange for it.[11] Its biggest problem as an exchange medium is that it is not widely accepted, and that trading is thus very thin indeed.

There is also the matter of built-in deflation. As more and more bitcoins get mined, it requires more and more processing power to mine new ones.[12] Also, if your wallet file is deleted, your bitcoins are gone for good.

"Babbage" at The Economist took it seriously and found it quite interesting,[13] but has since muted his praise.[14] Other economists have criticized the idea (to the point of calling it a scam), citing inherent design problems.[15][16][17] Paul Krugman refrains from poking fun at the concept, but considers it a reimplementation of the gold standard, with the economic problems that implies.[18] Warren Buffett has called it a "mirage."[19] About 25% of the European Central Bank's report on "Virtual Currency Schemes" is about Bitcoin,[20] and both the European Banking Authority and US Consumer Financial Protection Bureau have warned about major consumer protection issues.[21][22]

You can buy actual stuff with bitcoins! Mostly internet services, geek toys, phone sex,[23] illegal drugs[24] and, of course, Bitcoin mining hardware.[25] And actually useful things like beer and pizza.[26][27] To allow payment with a high-volatility currency like Bitcoin, it is common for merchants to price their goods in the local standard currency, but receive payment via Bitcoin converted at current market rates.[28]

The trouble with re-implementing the gold standard in the 21st century is that financial attacks, just like cryptographic attacks, don't get less effective with time — if you apply attacks evolved in a hundred years of Red Queen's race against regulation, then remove the regulation, the subeconomy in question is utterly defenseless. As one quant on HackerNews outlined:[29]

Bitcoin takes the monetary system back essentially a hundred years. We know how to beat that system. In fact, we know how to nuke it for profit. Bitcoin is volatile, inherently deflationary and has no lender of last resort. Cornering and squeezing would work well - they use mass in a finite trading space. Modern predatory algos like bandsaw (testing markets by raising and suddenly dropping prices), sharktooth (electronically front-running orders), and band-burst (creating self-perpetuating volatile equilibria in a leverage-sensitive trading space, e.g. an inherently deflationary one), would rapidly wreak havoc. There is also a part of me that figures regulators will turn a blind eye to Bitcoin shenanigans.

And we can now see this in practice: the $1200/BTC peak in late 2013 was caused by the market manipulation known as "painting the tape";[30] Mt. Gox in particular appears to have suffered chronic tape-painting.[31] Note that the "free market" completely failed to deal with fraud in this environment: all other exchanges were tracking Mt. Gox's blatantly skewed prices.

[edit] The 51% attack

Bitcoin relies on distributed consensus: the blockchain — the public log of all transactions — is what a majority of mining capacity says it is. Since mining is the "core of the Bitcoin protocol," there is the possibility of what is termed a "51% attack," where miners could consolidate into a cartel with above 50% of the mining power (yes, a de facto monopoly) and so could ratify the entire blockchain to do anything they like.[32] But this was considered unlikely because Bitcoin enthusiasts were highly distributed individualists.

This worked quite well early on. However, proof-of-work algorithms benefit from economies of scale,[wp] and centralisation follows directly. So as mining became more difficult and demanded more specialised resources, single mining "pools" became a substantial fraction of Bitcoin. In June 2014, the GHash mining pool reached 51%, leading to a call to do... something; Bitcoin advocates are not quite sure what to do to actually solve the problem.[33]

Economically, it would be foolish for GHash to just kick over the board because they could — cornering the market in an insubstantial good is only worth it while people trust the value of the insubstantial good — but the actual problem is that the group with 51% of all mining capacity will be able to "undermine the rules of the currency itself."[34] GHash quickly backed down to under 50% and claims it wants to fix the deeper problem,[35] but the economic incentives of "selfish mining" remain.

Cornell researchers have identified many more subtle attacks one can make even with less than 50%,[36] and it is worth noting that GHash had previously conducted a "49% attack" — wherein a large miner gets bogus transactions accepted into the blockchain, just not with certainty — against a gambling site.[37] They blamed this on a rogue employee, but this in itself shows that individuals can be motivated to trash a whole system for temporary personal gain. Again, real financial systems have government regulation for this specific threat.

[edit] Hardware

So who's doing the maths? The answer is the most powerful distributed computing project in the world.[38] While other distributed computing systems are investigating protein folding or sifting through radiotelescope data for signs of intelligent communication from the stars, bitcoins are being generated by people running hashing algorithms to process transactions on a poorly-traded virtual currency.

But it's long past the point where you can do any decent amount of processing on a standard desktop system (or, as some less-than-ethical Bitcoiners have, sneaking processing code into Javascript on web pages, or simply deploying a Trojan on someone's Windows box). Bitcoin miners tend to have huge clusters of high-throughput CPUs (usually graphics cards, lately FPGAs with Bitcoin-hashing algorithms loaded onto them) running many copies of the hash algorithm as fast as possible.[39] There are even "companies" set up to cater to Bitcoin miners, providing pre-clustered rigs (some are even making Bitcoin ASICs[40] — yeah, good luck recycling those); although their frequently-sketchy workmanship isn't exactly going to endear them to IT pros or the FCC, they're still better than some of the firetrap rigs that Bitcoiners have put together for themselves.[41] The many bizarre and frankly stupid cooling schemes are usually good for a laugh as well, including one Darwin Award applicant who poured a bucket of liquid nitrogen on the floor next to his rig to cool it.[42]

The irony of all this is that once hardware and power costs are factored in, it's hard to make a profit off of Bitcoin mining. Many less-savvy Bitcoiners filch their power from someone else and don't factor in the equipment cost at all.

Bitcoin is also an environmental disaster, using up to 982 megawatt-hours a day literally wasted on computing hashes. That's about 31,000 homes or half a Large Hadron Collider,[43] spent producing nothing of actual value. (Thus, Bitcoin runs on libertarians externalising their costs to others.) If only someone had come up with a distributed currency based on protein folding.

[edit] Advocates

The mathematics is robust, so many highly vocal internet libertarians think this is all that is needed, because they don't understand people, know very little about economics and apparently nothing of how reliable financial computing infrastructures are built — real banks tend to use mainframes in highly redundant configurations, not AWS virtual servers without backups — and generally show terrifying naïveté and incompetence. This then bites them in the arse when they discover that running a Magic: The Gathering Online card exchange site is insufficient experience to securely run a currency exchange,[44] or discover they have no backups.[45] Many were sufficiently naïve as to fall for, not just a Ponzi scheme, but a Ponzi scheme that had already been tried in EVE Online's in-game currency.[46] You also have people who understand this level of computer science, but still keep their wallet.dat file in plain text on a Windows box, ready for reaping by malware or DDoS.[47][48] This is the sort of thing that gets bitcoins called "Dunning-Krugerrands."[49]

The decentralised nature attracts libertarian extremists (go read any Bitcoin forum for more wacko libertarianism than you ever thought possible). There are Bitcoin advocates who are not annoying Randroid fools, but the ones who are tend to drown out all the others. It is unsurprising, then, that some business writers have accused them of cultish behaviour;[34][50] some proponents are simply aghast that anyone might not consider it valuable for services rendered.[51]

One of the otherwise-saner advocates is Rick Falkvinge, founder of the Swedish Pirate Party, who has put all his savings into bitcoins.[52] Though, he also details its problems.[53] He is a big fan of Bitcoin not as a general currency, but as a pure medium of exchange, substituting for PayPal or credit cards and changing back into a more popular currency at each end — as the Visa/Mastercard/PayPal oligopoly's willingness to block recipients they, the American government or fundamentalists don't like, starts to become a practical problem.

Andrew Napolitano from Fox Business Network supports Bitcoin as well. In a move that may make many of his fans cry, Ron Paul does not.[54]

[edit] Bitbanks

There are multiple Bitcoin "banks," but most of this seems to revolve around doing things with bitcoins,[55] leading to accusations of cargo cult economics. And scams. Lots of scammers in the Bitcoin community, who are punished by the harshest method imaginable: getting a "scammer" tag on the BitcoinTalk.org forum.

One Bitcoin exchange, Bitcoin-Central (now called Paymium), has achieved bank status in France.[56] Their aim is to supply an alternative to PayPal, and their central bank backing on balances only applies to accounts in euros rather than in bitcoins. On the other hand, other players in the Bitcoin field have had to suspend operations because US banks view companies involved with Bitcoin as too high risk to do business with,[57] or have had to suspend US dollar withdrawals for undisclosed reasons.[58]

[edit] China

Despite Western-oriented services being portrayed as synonymous with the Bitcoin "brand" — Mt. Gox was still responsible for 90% of all Bitcoin transactions by the end of 2012,[59] so this isn't entirely unwarranted — Chinese exchanges actually overtook it in output before its collapse.[60] This presents another serious problem for the cryptocurrency moving forward: attempts by the US government to impose regulations post-Gox pale in comparison to recent pressure by Beijing to crack down on the Chinese market.[61]

[edit] The scheme

[This] Bitcoin crash is traumatic. I haven't seen this many libertarians cry since they found out Ayn Rand took Social Security for eight years.
—Drew Fairweather[62]
The trouble with a thinly-traded currency: a typical one-day plummet in price, that happens whenever someone dumps some coins.

In order to prop up the initial system, Bitcoin mining was designed to bribe early users with exponentially better rewards than latecomers could get for the same effort. This effectively makes Bitcoin a pump-and-dump scheme wherein these early adopters, who have more bitcoins than anyone else ever will, hype it up so they can offload their bitcoins onto fools who think they'll strike it rich as speculators, or whomever else will accept them as payment. Basically, this means the system runs on opportunism, especially among people who like the idea of decentralized techno-money. Although this setup is defended as an acceptable trade-off and/or a fair reward for propping up the system,[63] this presumes that it will actually result in a widespread, reliable currency.

In the meantime, speculators and opportunists have remained Bitcoin's main users: according to one 2012 study, only 22% of existing bitcoins were in circulation at all, there were a total of 75 active users/businesses with any kind of volume, one (unidentified) user owned a quarter of all bitcoins in existence, and one large owner was trying to hide their wealth accumulation by moving it around in thousands of smaller transactions.[64] Meanwhile, businesses, from family stores to multimillion-dollar corporations, have jumped onto Bitcoin to seem forward-looking and get a cut of the Bitcoin action. But go on, dive in and get rich.

[edit] More mundane problems

The real and overriding issue with Bitcoin is that it does practically nothing that isn't already possible, while also introducing flaws of its own:

  • For the average person it's far more hassle than it's worth when the rest of the world takes traditional currencies (or "fiat" on Bitcoin communities, who use it as a snarl word) and that there's nothing they can buy with Bitcoin that they can't buy with the money they already have. Responses to this range from wishful thinking that this will be irrelevant when Bitcoin takes over the world and then goes to the Moon, to assertions that people will choose Bitcoin despite its comparative lack of utility simply because they like the idea.
  • No protection. Much is made of Bitcoin's efficiency for buying things online, without mentioning that there's almost nothing you can buy with Bitcoin you can't buy with the money you already have, that a credit or debit or debit card already lets you buy things online with minimal hassle, and that moreover if you get defrauded and you paid via Bitcoin you are, as they say, shit out of luck, because Bitcoin is by its nature irreversible. Escrow is touted as a solution for this, but such a thing would fail to work for (for example) custom goods where the payment price is required to make the product sold, or for faults which develop months after purchase which would otherwise be covered by chargeback protection. When Butterfly Labs stiffed people who paid for their mining equipment, Bitcoiners who paid with filthy fiat via PayPal were able to raise chargebacks and get their money refunded, which many did gleefully.[65] Those who paid with Bitcoin had no recourse other than the courts.
  • A great deal of online retailers who supposedly accept Bitcoin actually charge whatever the fiat price of the product would be at the current exchange rate, or use startups like BitPay which allow businesses to take the Bitcoin but then immediately receive dollars in exchange. This raises questions about how stable Bitcoin's "economy" is when a lot of its participants wouldn't be involved if they couldn't get actual money out of it.
  • Being a distributed computing project means that Bitcoin transactions are at the mercy of not only network latency (like credit or fund transfer transactions) but the time it takes for the transaction to be processed and stored around the network. In most cases, this takes approximately ten minutes — barely usable for network orders, but problematic for point-of-sale use. (The beer-selling example doesn't bother reconciling in real time, as the owner is treating the Bitcoin risk as a marketing expense.)

Whenever some of these objections are raised, the common Bitcoiner reply is to think about things from the merchant's point of view — that they pay less in fees (which isn't necessarily true), that they might get chargebacks (which can be defended against, and generally don't happen to merchants who don't actually scam people or rip them off). This ignores that most people don't care, and the few that do see enough benefit and convenience from being able to get fraudulently taken money returned to them that it doesn't actually bother them.

[edit] Other distributed cryptocurrencies

A number of copycat cryptocurrencies exist as a consequence of the Bitcoin experiment, only a few of which, such as Litecoin and Ripple, are at all notable. A few of these have significant distinctions from Bitcoin, such as Namecoin which is part of a decentralized ".bit" DNS project, Freicoin which incorporates demurrage to discourage speculative hoarding, and Devcoin which was designed to pay as rewards to open source developers, but most of them are simple forks of the Bitcoin code, using "libcoin."[66] Since the media attention on Bitcoin in early 2013,[67] a glut of such "coins" has flooded the market, with increasingly silly names like BBQcoin, Memecoin, Junkcoin, Sexcoin, and Shitcoin.[68] And don't forget Coinye West.[69]

[edit] Dogecoin

Dogecoin[70] is a (formerly) joke cryptocurrency created by merging a fork of the Litecoin script (itself a fork of the Bitcoin script) with a peculiar picture of a Shiba Inu. Unlike Bitcoin, Dogecoin sees actual use as a currency via its use as for tipping people over the Internet.[71] Its popularity, as well as the Dogecoin community's lack of libertarian evangelism (though they have similar hopes to get rich off the things), has angered certain portions of the Bitcoin community.[72] Dogecoin fans are also notably less dickish than Bitcoin fans, though that's not hard.

[edit] The moral of the story

In a gold rush, the money's in selling shovels. Cash up front, please.

[edit] External links

[edit] Footnotes

  1. Bitcoin virtual currency is on verge of collapse, Los Angeles Times
  2. What is Bitcoin and how does it work?, Mashable
  3. The Rise and Fall of Bitcoin, Wired
  4. The Gospel according to St. Satoshi (the original Bitcoin paper)
  5. 7 things you need to know about Bitcoin, PCWorld
  6. Meet the Suckers, it's like dot-com investing all over again! (5/6 are still in the game.)
  7. Bitcoin Exchange Mt. Gox Goes Offline Amid Allegations of $350 Million Hack, Wired (Later revised to half a billion USD.)
  8. What the Bitcoin theft might look like if it happened in the real world, Maclean's
  9. Bitcoin hits $1000
  10. You would be picturing the Randgasms right about now.
  11. The real litmus test for a currency, of course, is whether you can buy sex with it. Bitcoin passes for phone sex, so let's end the Fed!
  12. Technically, the more miners, the more processing power is required. If most miners are suddenly raptured in the apocalypse, however, the difficulty suddenly drops. So "more and more" is not always true — if Bitcoin deflates in the future, enough that miners quit mining, it suddenly becomes easier to mine, which seems like a nice negative feedback loop to prevent extreme collapse. (We stress the "seem" here; the very survival of Bitcoin depends on the increase of its userbase, so wanting deflation in this aspect — and the fact that over half of the 21 million BTC limit has been mined already — is awfully contradictory.)
  13. Bits and bob (Babbage, The Economist, 2011-06-13); print version
  14. Bitcoin bank heist (Babbage, The Economist, 2014-02-26)
  15. There Are Smart Kinds of Money and Dumb Kinds of Money, Brookings Institution
  16. The Bitcoin Question: Currency versus Trust-less Transfer Technology, OECD
  17. In Search of a Stable Electronic Currency, The New York Times
  18. Golden Cyberfetters, The New York Times
  19. Buffett: ‘Stay Away’ From Bitcoin (The author's belief that the currency should be rebranded as 'Bitgold' is particularly ironic because that was the name of one of its precursors.)
  20. Virtual Currency Schemes: October 2012, ECB
  21. Warning to consumers on virtual currencies, EBA
  22. CFPB warns consumers about bitcoin 'Wild West', The Hill
  23. "Anything goes. Can roleplay."
  24. The Underground Website Where You Can Buy Any Drug Imaginable (Adrian Chen, Gawker, 2011-06-01); Silk Road has since been busted by the FBI and revived, and then busted again. (There are also lots of other marketplaces including Black Market Reloaded and Sheep Marketplace Never mind.)
  25. Anyone want to spare a grand?
  26. Disruptions: Betting on a Coin With No Realm, The New York Times
  27. London's Bitcoin pub, Wired
  28. How to accept Bitcoin
  29. Professional Traders Show Interest in Bitcoin
  30. Bitcoin's Vast Overvaluation Appears Caused by Price-fixing, Falkvinge
  31. Bots were responsible for bitcoin’s stratospheric ascent, anonymous report claims, GigaOM
  32. The Economics of Bitcoin Mining: Bitcoin in the Presence of Adversaries, Princeton University (They describe it more ominously as a "Goldfinger attack.")
  33. Prices Fall As Bitcoin Confronts Doomsday Scenario, Business Insider
  34. 34.0 34.1 The Doomsday Cult of Bitcoin, New York Magazine
  35. Ghash.io: We Will Never Launch a 51% Attack Against Bitcoin
  36. How a Mining Monopoly Can Attack Bitcoin
  37. Bitcoin security guarantee shattered by anonymous miner with 51% network power, Ars Technica
  38. Wikipedia's list of distributed computing projects listed Bitcoin at 312,000 teraflops equivalent as of November 2012; second place was Folding@home at 8,588 teraflops as of February 2012. Bitcoin actually uses integer calculations, so that number's fudged, but it's still the largest by a ridiculous margin. Actual participant numbers were much smaller: a few thousand for Bitcoin, a few hundred thousand for Folding@home.
  39. If you should find someone selling dozens of graphics cards for cheap, you might want to avoid purchasing — used Bitcoin gear probably won't live long.
  40. Digital Drills: The Monster Machines that Mine Bitcoin, Gizmodo
  41. The Bitcoin Mining Accidents blog has disappeared, but you may enjoy the most famous tale from it, of heatstroke-induced brain damage from an overheating Bitcoin rig.
  42. Somehow he didn't asphyxiate.
  43. Bitcoin’s Environmental Problem
  44. Inside the Mega-Hack of Bitcoin: the Full Story (Jason Mick, Daily Tech, 2011-06-19)
  45. "No database backups ... Everyone had root."
  46. Suspected multi-million dollar Bitcoin pyramid scheme shuts down, investors revolt, The Verge
  47. Bitcoin-stealing trojan spotted in the wild and Mac Bitcoin-stealing malware spreads via cracked versions of Angry Birds and other apps
  48. Bitcoin’s skyrocketing value ushers in era of $1 million hacker heists, Ars Technica
  49. In mathematics we trust
  50. The Bitcoin personality cult lives on, Financial Times
  51. The average Bitcoin evangelist.
  52. Why I'm Putting All My Savings Into Bitcoin, Falkvinge
  53. "Bitcoin's Four Hurdles," parts 1, 2, 3, and 4
  54. Ron Paul Slams Stability of US Dollar and Bitcoin in Pro-Gold Rant, The Raw Story
  55. Firm says online gambling accounts for almost half of all Bitcoin transactions, Ars Technica
  56. Virtual cash exchange becomes bank, BBC
  57. Bitspend ceases trading due to frozen accounts
  58. Mt. Gox temporarily suspends USD withdrawals
  59. Bitcoin trading volume since 2010
  60. Timeline: a history of Bitcoin in China in 2013
  61. Bitcoin’s Uncertain Future in China, United States-China Economic and Security Review Commission
  62. "Look at the big picture!"
  63. FAQ – Economy on the "official" Bitcoin Wiki.
  64. A look at the Bitcoin network transaction history
  65. Refunds!
  66. Libcoin on GitHub
  67. Because Cyprus.
  68. The Shitcoin term has already been in use by Bitcoin detractors to describe Bitcoin, and by cryptocurrency enthusiasts for coins with no potential and those which have already failed. In October 2013 someone did the obvious and introduced a Shitcoin for real.
  69. Coinye developers say they're abandoning project as Kanye West escalates legal battle, The Verge
  70. To the moon!
  71. Online Donors Send Jamaican Bobsled Team To Sochi, NPR
  72. Call the whambulance
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