Bitcoin: A licence to print money or useless virtual currency?

T3 looks into the online phenomenon that could make you rich

A revolutionary electronic currency is shaking the global money tree. It began as a toy for geeks but is now making millions for investors – and criminals

What did you use to make your last purchase? Cash, credit, debit card? Maybe it was another late-night bid now, pay later spree on eBay? However you spent your hard-earned dosh, your transaction was certainly handled by a third party.

Visa, Mastercard, Lloyds, Barclays, PayPal, the list of middlemen goes on and on, but someone called Satoshi Nakamoto wants to change all that and give you the chance to become considerably richer, too.

If Nakamoto had been born a decade earlier it’s possible that the world’s current economic turmoil could have been avoided. No bankrupt countries, bail outs, austerity measures or rioting youths.

Nakamoto is the inventor of Bitcoin, the world’s first decentralised digital currency. Virtual money that doesn’t need a broker, bank or government, designed to let people buy and sell without the interference of anyone. It’s open-source currency, and it’s becoming very popular indeed.

Bitcoin began quietly in late 2008 when Nakamoto published a PDF outlining his concept to a cryptography (information security) email list, claiming that his brainchild would “allow online payments to be sent directly from one party to another without going through a financial institution”.

After outlining the agenda, the software, which could be used to exchange Bitcoins, was released on January 3 2009. Buried in the original block of code was a line taken from that day’s Times newspaper which read, “Chancellor on brink of second bailout for banks”.

“This was probably intended as a proprietorial date stamp for the software, but it was almost certainly also a swipe at the economic meltdown caused by irresponsible banking,” says Gavin Andresen, a software developer and Bitcoin’s technical lead.

“Bitcoin is unique in that it’s the first digital currency that doesn’t need a central bank to monitor transactions,” explains Jeff Garzik, a member of the core team of four developers who maintain Bitcoin’s immense security software. “Previous attempts like Beenz and Flooz all needed that monitoring because of ‘double-spending’.”

David Birch, director of Consult Hyperion, a consultancy firm specialising in electronic transactions, explains the concept of double-spending: “Digital products are non-rivalrous. That is to say, if you have a copy of an MP3 album, for example, and I take a copy, there’s still enough for everyone else who wants one.” Good news for music fans.

Not such good news if you’re trying to create a brand new online global currency. “What makes money work is that there’s a limited supply. If you use a quid at the pub today, you can’t go out and spend that same quid for a full English in the morning.”

It’s for this reason that a third party has always been needed to guarantee that the correct amount is taken from the payer’s account and added to the payee’s. Bitcoin solved the tricky double-spending dilemma by sharing the database of transactions across a peer-to-peer network.

“It’s shared trust technology and we have over 100,000 computers on the internet collectively working to verify every single Bitcoin transaction,” Garzik boasts. “This means that Bitcoin’s verification network is more powerful than the world’s largest supercomputers. In fact, there’s more technology dedicated to securing Bitcoin than you will find on the analysis of nuclear tests.”

The idea seemed flawless. Utopian ideas often do. But a new, more sinister purpose for Bitcoin has become apparent.

In early June 2011, Gawker.com published a story about Silk Road, an online marketplace where customers can buy anything from LSD to black tar heroin and even leave feedback to rate the quality of the product.

Most damagingly, the Gawker story revealed that since Silk Road’s emergence online in February 2011, the site only accepted payment for its illicit wares in Bitcoins because they were “untraceable”.

As soon as the story went viral, Bitcoin was dubbed “outlaw currency” and faced a firestorm of questions about its validity from US government officials and law agencies. Overnight, it ceased to be a Utopian economic unit of exchange and became, in the public’s view, little more than drug tokens for criminals.

However, Jeff Garzik is adamant that Bitcoins are misunderstood. “Bitcoins aren’t anonymous and transactions are totally traceable,” he insists. “It’s just that no law enforcement agency has wanted to invest the large amounts of manpower and time needed to trace guilty parties as they have with things like copyright theft.”

So Nakamoto hasn’t invented a new way for drug dealers to launder money? “Far from it,” Garzik continues. “Bitcoins are fully open source, totally transparent. You can review the entire code and the public transaction ledger, which is where every Bitcoin transaction is stored on the web for everyone to see.

All law enforcement has to do is get a court order and look at a computer’s ISP logs, which will implicate the user behind any Bitcoin transaction. Unfortunately, the technology was hijacked by dumb kids.”

“What unit of global currency hasn’t been connected with some major criminal enterprise at some point?” asks Andresen. “You can’t stop dollar bills from being used to buy drugs, but no one’s calling the dollar a currency for criminals.”

Bitcoin rode out the Silk Road scandal, perhaps proving that there’s no such thing as bad publicity. As proof of this you only needed to check out MtGox, the currency’s biggest exchange, where in January 2011 the total value of US dollars to Bitcoins traded was $146,000.

In the first two weeks after the story was published, online Bitcoin trades totalled an incredible $21 million. It seems possible that increase was because more people were aware of the currency after the scandal, rather than because criminals were queuing up to use it to buy handguns.

Bitcoin Watch, which tracks the currency’s economy, claimed that for every person using the electronic cash to buy a gram of Afghani hash from Silk Road, there were another ten using it to buy goods or services from legitimate sites.

In April 2011, one Bitcoin was worth just 75 cents on MtGox, whereas just two months later the currency was trading at $18.80 per Bitcoin. With over 6.2 million of them on the market at the time, that added up to over $160 million of wealth floating around cyberspace.

The market levels suffered from fluctuations, but the peaks and troughs on MtGox were no different to those experienced by dollars or sterling on the Dow Jones or the FTSE. Everything was happening at light speed.

In just a matter of months it had generated massive profits for investors, as well as scandal and intense government scrutiny. The currency that naysayers described as online monopoly money for computer nerds was no longer playing around. With that level of growth what came next on Bitcoin’s compressed timeline was inevitable: greed.

At 3am on June 20 2011, one hacker managed to compromise a Bitcoin account containing almost $500,000 dollars worth of the currency and transfer it all to another.

Days later, this attack was followed by a more sophisticated hack on MtGox itself. It only took an hour for the hacker to steal 400,000 Bitcoins, which amounted to six per cent of all the virtual currency in circulation at that time, at a price of $17.50 per coin. Sale of the coins could have netted the thief $7m, but because the transfer was so huge it plunged the value of each coin to just $0.01.

The MtGox exchange was taken offline and every trade that happened during or after the hack was rolled back. Over 60,000 users’ details were also compromised in the attack. Shortly after the hack this message appeared on Pastebin.com, a website where you can screen text online for a set period of time:

“I have hacked into MtGox database. Got a huge number of login password combos. MtGox has fixed the problem now. Too late, ’cause I’ve already got the data. Will sell the database for the right price. Send your offers to: gfc06@hotmail.com.”

We’ll save you the bother of replying to gfc06; a buyer was obviously not forthcoming because in a matter of hours the whole database was made public on the net.

After the attack and the consequent crash, the market recovered well, and the price levelled out at around $17.50 USD again, but the damage had been done. Nakamoto’s miracle monetary system had been shown to be vulnerable. The sharks of the online world sensed blood in the water and began to aim their botnets at Bitcoin.

It was Symantec, the online security expert, which first warned in early June that botnets, a huge web of linked computers that can be controlled remotely, could participate in Bitcoin “mining” and potentially net their operators huge sums.

Because there is no Royal Mint equivalent issuing new Bitcoins, they are “mined” in batches of 50. “This scarcity is partly how Bitcoins derive their value,” says Harvard economics professor David Laibson. “Unlike real resources, from printed money to precious metals, there is no as-yet-undiscovered mother lode waiting to be tapped that will destroy or disrupt value.”

Anyone can mine for Bitcoins if they want to. All they have to do is install the relevant software, which carries out calculations to check the integrity of the transactions list. Previous transactions are confirmed and an increasingly complex proof-of-work problem needs to be solved. Whichever computer around the world solves the problem first receives the princely sum of 50 Bitcoins.

The more computer power you have at your disposal, the greater the likelihood that you will be able to compute the problem and grab the coins for yourself. This process has generated an online “Bitcoin rush”, with individual miners going to extraordinary lengths to extract their precious bounty from the coded coalface.

Users on mining forums discuss cooling their computers in dry ice to allow the processors to run faster, customising specialist chips or creating super-efficient fans to cool their overheated machines.

One miner even reported the surge in his electricity use was so significant that his house was raided by the police, who believed that he might be running a cannabis farm on the premises. Another suffered heat stroke after he fell asleep next to his four machines which were busily Bitcoin mining in the middle of a hot summer’s day.

However, none of these operations can compare to the hardware might of online hacker groups who rely on botnets. Anyone with access to a botnet has the tools necessary to make some serious Bitcoin.

Credible reports suggest some individuals connected to Anonymous have botnets with more than 100,000 active computers. A network of this size has the potential to generate up to 500 coins a day – worth almost $6,000 at current rates.

It’s a potential problem that Bitcoin is well aware of. “Just as a bank will go to great lengths to protect their money from sophisticated heists, we are going to even greater lengths to protect our currency from the influence of botnets,” says Garzik.

“I still believe that Bitcoin is a worldwide currency that’s starting to reach the level at which it will be stable. In fact, right now, I believe it is undervalued.”

Of course, the true test of a currency is whether or not it can survive outside the rarefied environment of the Bitcoin exchanges and infiltrate the common man, on the internet and on the street.

Currently, about $30,000 worth of Bitcoins exchange hands every day in electronic transactions. Nicholas Carlson is a software developer, who posted on Reddit in June 2011 that he was available to “code for Bitcoin”. “

Just a few days after that post I accepted my first job offer,” says Carlson. “After some negotiation I was contracted for 12 hours work for five Bitcoins per hour. When I was done and the client was happy, the Bitcoins were in my wallet within ten minutes.” Of course, Carlson’s wallet is entirely virtual.

When you download the Bitcoin software from bitcoin.org you also install a “wallet” on your hard drive. This is a public address that people can send Bitcoins to.

“Whenever anyone sends me a coin, they are actually sending a cryptographically signed message, which links their coin with my address,” Carlson explains. “This transfers ownership to me and I am then free to spend it by transferring it to another person’s wallet using the same technique.

Or I can just trade it for dollars, which is what I did, earning more than I had done for previous jobs where I was paid in US currency.”

But will Bitcoin remain a niche product that purely exists to be exchanged between like-minded IT professionals? After all, if you walk down an average British high street you won’t see too many “Bitcoin accepted here” signs hanging in shop windows.

Even in early adopting New York and San Francisco there are only a handful of street vendors that accept the currency.

Bitcoin diehards realise that it’s going to take a while to change the perception of the money. “We all understand that it might be the next big thing, or it could become a footnote in internet history,” says Andresen.

“Even if it does become a success story, I fully expect more market instability, failures of Bitcoin-related businesses and other hitches that I can’t even begin to fathom right now.”

If it does fail, experts agree that the key principle of Nakamoto’s vision, the fact that it is a community currency, could be the reason. “Fiat currencies, the ones where the notes or coins and their digital versions are underwritten by the government, have one huge advantage over Bitcoins,” says Harvard economics professor David Laibson.

“They don’t involve the kind of self policing that a community currency does. The harnessing of peer-to-peer technology may appeal to coders and anti-capitalist hackers, but most people don’t want to be responsible for ensuring the legitimacy of the money in their pocket, virtual or otherwise. They would rather have the authorities shoulder that burden.”

Even after everything that has happened in the global markets in recent years, and the supposed distrust of financial institutions, this is still the mindset that Bitcoin must fight to change if it is going to avoid being another good idea gone bad.

“At least with sterling or the dollar you can turn around and blame the bankers, rogue traders or governments if things start going badly,” continues Laibson. “If Bitcoins start to bomb then users only have themselves to blame.”

Of course, one person who they could blame is Bitcoin’s enigmatic inventor, Satoshi Nakamoto. At least they could if anyone could face to face or who knows any more about him than what’s already out there on his Wiki.”

Then again, it’s entirely possible that the name is just a smoke screen for a collective of developers who created the identity to ensure protection and publicity for their fledgling currency.

In any case, it appears Nakamoto has left the project. “I haven’t had any contact for months,” reveals Garzik.

Yet for Bitcoin’s true believers, the currency is more than just one man’s vision; it’s a tool of civil liberty in a world where liberties are being steadily eroded.

“For a long time banks and credit-card companies have built up detailed profiles of consumer’s spending patterns and have had no issue with selling that information to the highest bidder,” says Garzik.

“The more people get tired of things like this, the more attractive Bitcoin will become, because financial institutions are cut out of the loop entirely.” The more people want to use the currency, the more incentive businesses will have to accept Bitcoins.

Maybe this is what Satoshi Nakamoto, whomever he, she or they may be, intended to highlight by going to such great lengths to protect the anonymity of Bitcoin’s genesis.

Anyone could be Satoshi Nakamoto. Simply by trading the currency you are contributing to the success of the idea. Is it any wonder then that you can now buy t-shirts online bearing the slogan: “I am Satoshi Nakamoto”? Payment in Bitcoin only, of course.