Bitcoin, the leader of the cryptocurrency pack, has had quite a month. At the beginning of February Montreal got its first Bitcoin ATMs, and at the end one time leading exchange, Tokyo-based French-run MtGox, was filing for bankruptcy protection. With the Bitcoin value peaking in January at over $1000 and now hovering around $500, the easy money is on the whole thing being a ponzi scheme for overenthusiastic semi libertarians, who in the shadow of the MtGox collapse start sounding a lot like Henry Paulson after the collapse of Bear Stearns. Even though I have no personal stake in any of the cryptocurrencies, this view strikes me as simplistic and misguided, even if we should rightly point and laugh at those who temporarily find themselves singing for rescue from a system that was created largely by and for those trying to escape the possibly excessive interventionism that western state banks have indulged in for the last few years.
MtGox, famously a stillborn Magic the Gathering card exchange turned Bitcoin exchange, had somehow emerged as the leader in the then small market of Bitcoin exchanges, but failed spectacularly to keep up with growth in interest in the currency as a whole. To anyone watching Bitcoin this has been obvious for years, as the technical ineptitude of MtGox is not something that people should be surprised about. In a sense they were like the Twitter of Bitcoin, but never managed to get rid of the Fail Whales, and along the way started holding wallets of increasingly large amounts of money. The exchange has “hot” wallets, Bitcoin repositories from which trades are actively performed, and “cold” wallets, essentially the vaults which contain most of the real value, but are kept securely away from the rest to prevent problems. Unfortunately MtGox were slightly too confident about this, and failed to notice, until other recent technical problems forced an audit, that someone had slowly drained their cold wallets, in the process stealing Bitcoins worth about 473m USD.
That last bit is worth reading again. The Bitcoin community has created a trading situation in which a single exchange, but not the current largest, holds assets worth hundreds of millions of dollars, meaning the economy of the community as a whole is measured in billions. Doing what exactly? The Silk Road, an online marketplace known mainly as an easy place to order your choice of illegal substances, was shut by US authorities last year, and the replacement Silk Road 2.0 has struggled with the same technical issues that caused the MtGox audit, themselves finding the $2.7m they held in escrow to be stolen by the same mechanism that was used to attack the cold wallets at MtGox.
The annoying part of this is that even though MtGox or the Silk Road do not represent the overwhelming proportion of Bitcoin in circulation it does mean that a significant amount of Bitcoin are used or held by criminal organisations. Bitcoin works through a mining process that releases new coins as a function of computational effort expended and the number of coins there are in circulation. The more coins there are the harder it becomes to mine new coins, up until some hard baked limit, which can only be punched through if 50% + 1 of all current Bitcoin users go along with it. The theft from MtGox represented at least 5% of all currently possible Bitcoins, meaning that unless this limit is destroyed, those substantial holdings and the growth in their value only serves to benefit criminals, which is not something most people could reasonably support.
So why be positive about the Bitcoin future? Firstly, I would argue that most currencies have been through periods where substantial portions of the wealth in them are held by those who acted against the morals of broader society, and it didn’t hurt these currencies for trading opportunity. Much of what is regarded as old money was made by theft of one form or another, and it merely gets respectable with the passing of a couple of generations. Mainly though, the ultimate proof is the resilience in value of Bitcoin given the events at MtGox. Bitcoin still trades higher than the position it was in merely six months ago. The MtGox shock is causing a lot of dead weight to be shaken off and the remaining players know they have to be that much better to compete now. The result is a stronger situation for everyone.
I happen to believe Bitcoin isn’t the answer to easier online trading, but it is a step in that direction. The main issue I have is one of network availability. I believe that unless you have some digital token, analogous to cash, which is transferable and divisible without the actions of an intermediary, things won’t take off. That’s a really complicated problem, but protocols that get a surprisingly long way with it exist. Bitcoin as a protocol leans completely in the other direction, generally described as a distributed ledger, meaning that everyone keeps copies of all transactions, but you must be on the network to trade. While I don’t think this is the future of money it has inspired a couple of other ideas, such as a decentralised form of twitter or most impressively “namecoin” which is an alternative way to manage DNS, the method by which internet domain names such as “montrealrampage.com” get converted to their numeric forms to locate the computers hosting the content. Such a system would hypothetically be more resilient and resistant to efforts by countries enforcing censorship, which are values it’s far easier to get behind than the current wild west of Bitcoin proper.
Nigel Birkenshaw runs atomirex.