The Bitcoin Boom

 

The Bitcoin Boom

www.newyorker.com/online/blogs/elements/2013/04/the-future-of-bitcoin.html

 

Posted by Maria Bustillos

 

 

On March 16th, the Cypriot President Nicos Anastasiades, who'd been in

office for about a month, announced a strategy to solve the country's

banking crisis. This plan, which would be funded in part by confiscating

money directly from every single bank account in Cyprus-even the very

smallest-met with instantaneous and violent opposition from the country's

citizens. Offstage, the European Union, led by a group of adamant Germans,

Finns, and Danes, as well as the I.M.F. and the European Central Bank,

pointed a cannon at Anastasiades's head: if he didn't move forward with this

plan, the Cyprus banks would go bust and their hapless customers would lose

pretty much all their money, instead of a measly 6.75 per cent. However,

under great pressure from their constituents, Cypriot M.P.s rejected the

proposal and sent Anastasiades back to the drawing board.

 

The following Monday, the price of the decentralized electronic currency

bitcoin rose from forty-five to fifty-five dollars on the major exchanges,

and by Wednesday it had nipped up to sixty-five dollars. The financial media

generally agreed that the two dramas are related. According to Bloomberg

Businessweek, it appears that Spaniards are liable to have been particularly

active buyers of bitcoins that week, having taken the debacle in Cyprus as

the likely sign of a forthcoming governmental plunder of their own savings.

The evidence coming out of Spain is circumstantial-a spike in Google

searches for "bitcoin," and another on mobile-app downloads of

Bitcoin-related software were widely reported-but the pieces appear to fit.

Subsequent developments (including the announcement of an eleventh-hour

bailout deal for Cyprus) have so far failed to stabilize the euro or cool

the bitcoin fever, with the price over a hundred and three at the time of

writing.

 

That a number of panicked Europeans appear to have reckoned the wildly

volatile, vulnerable, and tiny bitcoin market a preferable alternative to

their own banking system, even temporarily, signals a serious widening of

the cracks between the northern and southern E.U. countries in the wake of

the euro-zone debt crisis. It also illustrates the broader collapse of trust

that is threatening the world of global banking and fiat money.

 

The weakness in existing currencies stems from lack of faith in

institutions-particularly central banks, which are often in league with

commercial and investment banks. When a government bails out a failed bank

or insurance company-in essence, by printing money-the net effect is that

the currency as a whole is debased, in favor of a few and at the literal

expense of everyone else, which amounts to a fair description of today's

global financial system. Hence the sudden appeal of bitcoins, which appear,

for the moment, at least, to be immune to the machinations of inept or

crooked bankers and politicians.

* * *

 

In many ways, bitcoins function essentially like any other currency, and are

accepted as payment by a growing number of merchants, both online and in the

real world. But they are generated at a predetermined rate by an open-source

computer program, which was set in motion in January of 2009. This program

produced each one of the nearly eleven million bitcoins in circulation (with

a total value just over a billion dollars at the current rate of exchange),

and it runs on a massive peer-to-peer network of some twenty thousand

independent nodes, which are generally very powerful (and expensive) G.P.U.

or ASIC computer systems optimized to compete for new bitcoins. (Standards

vary, but there seems to be a consensus forming around Bitcoin, capitalized,

for the system, the software, and the network it runs on, and bitcoin,

lowercase, for the currency itself.)

 

Bitcoin releases a twenty-five-coin reward to the first node in the network

that succeeds in solving a difficult mathematical problem requiring a

certain amount of brute-force computation (known as a proof-of-work

calculation.) The solution is then broadcast throughout the network, and

competition for a new block and its twenty-five-coin reward begins. (There's

a good rundown of the technical aspects of Bitcoin on the Bitcoin wiki;

there's also a wonderfully pellucid explanation of the proof-of-work angle

from Paul Bohm, on Quora.)

 

At first, anyone armed with an ordinary computer could download and run the

Bitcoin software and gather (or "mine") bitcoins. The more computing power

you can dedicate to Bitcoin calculations, though, the better your chances of

arriving first at each solution. This feature of the system, by design,

resulted in a kind of computational arms race that strengthened the network

by rewarding increased computing power. Four years into the Bitcoin project,

only very powerful, purpose-built machines have enough muscle to keep pace

with existing network nodes.

 

In this way, bitcoins are mined like gold used to be, in quantities that are

small relative to the total supply, so that the supply grows slowly. There

is an upper limit of twenty-one million new coins built into the software;

the last one is projected to be mined in 2140. After that, it is presumed

that there will be enough traffic to keep rewards flowing in the form of

transaction fees rather than mining new coins. For now, the bitcoins are

initially issued to the miners, but are distributed when miners buy things

with them or sell them to non-miners (such as jumpy Spanish bank depositors)

who desire an alternative currency. The chain of ownership of every bitcoin

in circulation is verified and registered with a timestamp on all twenty

thousand network nodes. This prevents double spending, since no coin can be

exchanged without the authentication of some twenty thousand independent

cyber-witnesses. In order to hack the network, you would have to deceive

over half of these computers at the same time, a progressively more

difficult task and, even today, a very formidable one.

 

In 2008, Satoshi Nakamoto, the founder of Bitcoin, whose real identity is

not known, cleverly combined existing peer-to-peer network technologies,

cryptographic techniques, digital signatures, and the potential power of

network effects to design and develop the Bitcoin system. Nakamoto was very

clearly motivated in this effort by the fallout from the 2008 financial

crisis. When the experiment was launched and the first fifty bitcoins (the

so-called genesis block) were mined, in January of 2009, he (or she, or

they) included this line of text along with the data: "The Times 03/Jan/2009

Chancellor on brink of second bailout for banks."

 

Until his disappearance from the Web, around the spring of 2012, Nakamoto

was a visible participant on cryptography forums, where he discussed Bitcoin

freely, and published a nine-page paper outlining the details of the

project. These posts reveal that even in 2008, Nakamoto was able to respond

to concerns regarding the scalability of bitcoin with remarkable prescience;

he clearly understood the ramp-up of computing power that would be required

for producing bitcoins as the system grew.

 

    Only people trying to mine new coins need to run network nodes And at

first, most users ran network nodes, but as the network grew beyond a

certain point, mining increasingly became the domain of specialists with

server farms of specialized hardware.

 

A casual review of Nakamoto's various blog posts and bulletin-board comments

also confirms that, from the first, Bitcoin was devised as a system for

removing the possibility of corruption from the issuance and exchange of

currency. Or, to put it another way: rather than trusting in governments,

central banks, or other third-party institutions to secure the value of the

currency and guarantee transactions, Bitcoin would place its trust in

mathematics. At the P2P Foundation, Nakamoto wrote a blog post describing

the difference between bitcoin and fiat currency:

 

    [Bitcoin is] completely decentralized, with no central server or trusted

parties, because everything is based on crypto proof instead of trust. The

root problem with conventional currency is all the trust that's required to

make it work. The central bank must be trusted not to debase the currency,

but the history of fiat currencies is full of breaches of that trust. Banks

must be trusted to hold our money and transfer it electronically, but they

lend it out in waves of credit bubbles with barely a fraction in reserve. We

have to trust them with our privacy, trust them not to let identity thieves

drain our accounts. With e-currency based on cryptographic proof, without

the need to trust a third party middleman, money can be secure and

transactions effortless.

 

* * *

 

Much of what has been written so far about bitcoins has centered on the

perceived dangers of their relative anonymity, the irreversibility of

transactions, and on the fact that they can be used for money laundering and

for criminal dealings, such as buying drugs on the encrypted Web site Silk

Road. This fearmongering is a red herring, and has so far prevented the

rational evaluation of the potential benefits and shortcomings of

crypto-currency.

 

Cash is also anonymous; it is also used in money laundering and illegal

transactions. Like bitcoins, stolen cash is difficult to recover, and a cash

transaction can't readily be traced back to the source. Nor is there

immediate recourse for the reversal of transactions, as with credit-card

chargebacks or bank refunds when one's identity has been stolen. However, I

find it difficult to believe that anyone who has written critically of the

dangers of bitcoin would prefer an economy where private cash transactions

are illegal.

 

Contrary to hysterical media reports, such as this recent video from the

Guardian, the Bitcoin-software community is loosely governed not by

wild-eyed kids camping out in half-deserted lofts but by what appears to be

a rational and sober group of adult administrators who run the Bitcoin

Foundation. This organization was modelled on the Linux Foundation,

according to Gavin Andresen, who is currently the Bitcoin Foundation's chief

scientist. As the lead developer for the project, Andresen is paid a salary

by the Bitcoin Foundation. He has been involved full-time in Bitcoin since

the spring of 2011.

 

Like the Linux Foundation, the Bitcoin Foundation is funded mainly through

grants made by for-profit companies, such as the Mt. Gox exchange,

Bitinstant, and CoinLab, who depend on the stability and continued

maintenance of the underlying open-source code.

 

"The Linux Foundation provides a bit of a center for Linux, and to pay the

lead developer, Linus Torvalds, so that he can do nothing but concentrate on

the kernel," Andresen said. "It's a tricky thing, once you get to be a

certain size as an open-source project, how do you sustain yourself? Linux

is the most successful open-source project in the world, so we thought it

would make sense to use that as a model."

 

Gavin Andresen is one of the few people in the world who are known to have

corresponded directly with Satoshi Nakamoto. (Joshua Davis tried to track

him down for The New Yorker in 2011.) When I said I'd like to know more

about Nakamoto, Andresen burst out laughing.

 

"So would I!" His laughter had a credibly rueful edge to it.

 

    He was active on the bitcoin forums through December of 2011. He told me

he was going to get busy, and then he stopped posting on the forums. A few

months later, he disappeared, and as far as I know nobody has heard from him

since then.

 

    Whenever I corresponded with him, it was always on Bitcoin forums or

e-mail, we never even real-time text chatted. He was always very

businesslike, no personal details, always strictly about the project.

 

Indeed, a casual review of Nakamoto's writings online reveals him to be

unfailingly cool and collected; the only time I noticed him becoming a

little heated was in a few forum posts in December of 2010, when WikiLeaks

supporters began soliciting bitcoin donations for WikiLeaks. Nakamoto

rejected the idea unequivocally. According to Andresen,

 

    Satoshi just felt the project was still too small to take that much

attention. He didn't want WikiLeaks to jump in at that point, and they

didn't. but a year later they did, and it was fine. I think people realized

once I got invited to speak at the C.I.A. that there was no kind of hiding.

They, whoever "they" are, already knew about this project. Satoshi was

obviously a lot more private, and more worried about what government would

do than I am.

 

I asked Andresen to explain to me the degree to which he and his colleagues

are worried about government interference in Bitcoin.

 

    I think if the U.S. government decided that Bitcoin was a bad thing and

told me, "Stop doing what you're doing," I'd stop doing what I'm doing,

quite frankly. But that wouldn't be very effective, because there are people

all over the world who could pick up and reimplement it, for example in

different programming languages; if you browse the Bitcoin forums you've

seen the enormous chaos and energy there. There's all sorts of people doing

all sorts of things-many of them crazy things that will never succeed, but

some of those will be the next big things in Bitcoin.

 

As it happens, a few days ago, the Financial Crimes Enforcement Network

(FinCEN), the federal agency that enforces laws against money laundering,

announced new guidelines requiring certain "virtual currency" trading

entities to register as Money Services Businesses (M.S.B.s). Though the

Bitcoin Foundation's general counsel, Patrick Murck, was somewhat critical

of the new guidelines, this move went a certain distance toward calming

Bitcoin speculators and others who'd been worried that the government would

take more drastic steps against the mining, transfer, and exchange of

bitcoins. Andresen is among those who sees the new FinCEN guidelines as a

positive development.

 

    In my opinion, the FinCEN guidance is fantastic news: it gives Bitcoin

users and businesses clear rules on how they will or won't be regulated. It

is great for ordinary users, because FinCEN said that using bitcoins to buy

products or services is perfectly legal. And, long-term, it is great for

businesses, because they now know how FinCEN will classify them and what

regulations they must obey here in the U.S.

 

    That said, it might cause problems for some smaller U.S. bitcoin-based

businesses, who might have been hoping that they wouldn't be regulated at

all. The bigger bitcoin businesses have been anticipating this for a while,

so I don't think it will affect them.

 

But what about new government regulations that may arise down the road:

making it illegal to accept bitcoins as payment, for instance, or outlawing

or regulating the exchanges? It might not be so difficult to shut Bitcoin

down, and that has to be producing a lot of downward pressure on more

widespread acceptance, I suggested.

 

    If you're asking me what I would expect to happen. I would expect that

some country or another will try to do that. You have the same kinds of

arguments about the Internet and the free flow of information across the

world. And we've seen countries like China, that try to either ban the

Internet or restrict it. I don't think you can just hop on the Internet in

North Korea.

 

Nope.

 

    So I'd expect some countries that really want to control their currency,

to control transactions, to do the same with bitcoin. The question is

whether really big countries-like the United States or France or

Russia-decide to do that or not. I don't think anybody really knows.

 

* * *

 

A confluence of key factors is responsible for the current spike in bitcoin

values-the situation in Cyprus and the recent FinCEN announcement are widely

thought to be among them. But perhaps a more important development is that a

number of high-profile online businesses, among them WordPress, Reddit,

Namecheap, and Mega, have recently begun accepting bitcoins in payment for

their services. There are now many thousands of individuals and businesses

already doing business in bitcoins. At bitcoinstore.com, you can buy

electronics-including cameras, musical instruments, blood-pressure monitors,

and computers-using just bitcoins. There are bitcoin-only casinos, like

SatoshiBet, and a bitcoin-based Intrade-style prediction market called Bets

of Bitcoin. The infrastructure for implementing the storage and exchange of

bitcoins, too, is exploding: vendors, exchanges, facilitators of in-hand

trades, dealers in bitcoin debit cards. There are systems for producing

"paper wallets" that you can print out for the safe storage of bitcoins, and

secure e-wallets for those with a tendency to misplace papers.

 

The physical bitcoins illustrating most every bitcoin story on the Web are

available for purchase, too. They are called Casascius coins, and they are

sold by Mike Caldwell through his Web site, casascius.com. These coins

contain a private key on a card embedded in the coin and sealed with a

tamper-evident hologram.

 

Caldwell, who lives in Utah, owns a payroll-software business and has about

thirty employees. He is not affiliated with the Bitcoin Foundation-he is

simply an interested and highly informed participant in the bitcoin market.

The name Casascius came from the acronym for "call a spade a spade," with a

vaguely Latinized suffix. The widely adopted Bitcoin motto often appears on

Casascius coins: "Vires In Numeris," which is a rough translation into Latin

of the English phrase "strength in numbers." He is a strong believer in the

future of Bitcoin, and has been investing in the currency for a long time.

He told me, "After the first crash"-in June of 2011-"there was a panic;

people heard that one Web site had been hacked, and erroneously assumed that

Bitcoin was a failure. I bought all the way down."

 

But Caldwell also thinks the road ahead is likely to be a bumpy one.

 

    I believe Bitcoin will have hiccups and issues in the future.

scalability limits. And there will be bugs, and times where people

experience delays getting their transactions confirmed. These will cause

temporary crises of confidence as the developers team up to solve the

various issues. But Bitcoin will also evolve and move past them. The day

that Hollywood succeeds in using technology to stomp out the music and movie

pirates on the Internet, that's when they'll stomp out Bitcoin. I think most

people know Hollywood will never win. Bitcoin will always win in the long

game.

 

Caldwell used to mine coins himself, but gave it up eventually: "I

considered the maintenance too high in opportunity cost for me personally,"

he told me. I asked him what, as an ordinary Bitcoin participant, he thought

of the new FinCEN regulations. Are they the thin end of the wedge in terms

of government interference? How does the "guidance" affect today's bitcoin

miners in practical terms? Will they all have to register as M.S.B.s? He

doesn't regard it as a threat yet.

 

    Since mining yields pocket change for most, even if it were technically

a violation of the way FinCEN sees the law, mining without registering would

be like "laundering" a twenty-dollar bill by taking it to the grocery store

and asking for two tens. it's hardly worth the resources for anyone to care

about it, no matter how illegal they decide it should be.

 

Where he does see an issue, however, is in the anonymity that is prized by

bitcoin adherents.

 

    Mining produces bitcoins that are extremely anonymous. The most

anonymous bitcoins you can get, system-wide, are ones you mined yourself.

The mined coins have no origin, no history, no nothing. They just appear out

of thin air.

 

This anonymity becomes particularly problematic, from a regulator's

viewpoint, in the context of criminal activity-for example, hacking attacks

that succeed in robbing people of their bitcoins:

 

    We will see many more "man in the middle" attacks, and they will cause

disruption; there will be times when it becomes possible to hack into a site

or get in the middle of a transaction and hijack the payment address,

causing people to send an irreversible payment to a criminal instead of who

they thought they'd sent it to. Imagine getting a fake but realistic-looking

invoice in the postal mail from a real vendor everyone pays (let's use the

electric company for my example), and you are tricked into sending the

payment to a criminal's P.O. box or mailing address. This doesn't happen

much today, because the criminal's address would attract law enforcement,

and so would their depository bank account. But with bitcoin, an address has

no identifying quality and is unseizable, so criminals will do this and get

away with it, and people are going to learn the hard way that they have to

be vigilant about this.

 

Caldwell's political views with respect to Bitcoin are connected, like

Nakamoto's, with a belief in the potential value of cryptography. "Until

now, society has underutilized cryptography. If people accept it more

broadly, cryptography can facilitate many things: the exchange of money,

transparent elections, transparent government."

 

The common picture of bitcoin users has been that they're all long-haired

anarchists, libertarians, and weirdos who would do away with government

entirely, if they could. But in response to a question about his politics,

Mike Caldwell had this to say:

 

    I am not an anarchist; I believe in the rule of law and a civilized

society. But I also believe that unchecked power is a threat to the common

good, and that anything that the public can do to challenge that power is a

benefit to society. As an individual, if you accept bitcoin in exchange for

your goods or your work, that is a vote for economic fairness.

 

So is bitcoin going to save the global economy, or is it today's answer to

seventeenth-century tulip mania? Gavin Andresen offered a word of caution.

 

    I still tell people that Bitcoin is an experiment: only invest time or

money you can afford to lose, because Bitcoin is still an experiment. The

longer it keeps going in the face of volatility and technical glitches

happening, the more we'll know.

 

    But trust takes time.

 

 

Read more:

http://www.newyorker.com/online/blogs/elements/2013/04/the-future-of-bitcoin

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