Then months ago, I wrote a column about Bitcoin, the faddish crypto-currency that was beginning to explode in popularity and exchange value at the time (“The bitcoin phenomenon: The future of currency or geeky fad?” April 4).
In the past few weeks, the word “bitcoin” has started popping up in conversations among people even here in the financially unsophisticated Philippines, so it seems useful to take another look and see what difference a year (well, almost a year) has made.
In the last six months of 2013, usage of the virtual currency increased by 75 percent, with the market value of the mass of bitcoins already in circulation skyrocketing from a little over $1 billion to $12.6 billion; the currency is finding its way into the mainstream, with a number of businesses, particularly online retailers, now accepting Bitcoin for purchases. And in a move that may either be visionary or incredibly stupid, big-name Silicon Valley venture capital firm Andreessen-Horowitz recently put up $25 million to fund CoinBase, a digital wallet hosting company similar to PayPal, but operating exclusively with bitcoins.
That move may very well signal the eventual demise of Bitcoin, although it would probably be a mistake to write off the concept of “crypto-currency” entirely. Satoshi Nakamoto, the individual (or group—no one is really sure, as the name is an alias) who created Bitcoin five years ago characterized it as a “proof of concept,” rational enough on paper but potentially susceptible to unforeseen flaws that could only be revealed once the virtual currency was put into actual circulation. Those flaws are being revealed, and the reason they herald a collapse of Bitcoin in particular, if not crypto-currency in general, is that the flaws undermine the fundamental principles of the concept.
The biggest appeal to Bitcoin users was its anonymity, the idea that transactions could be carried out with no more identifying information than a digital address for a Bitcoin “wallet,” and the code identifying the specific bitcoin or fraction thereof being exchanged. Two recent studies, however, have pointed out a basic shortcoming of the system: Because a large part of its security is based on transaction transparency, every Bitcoin transaction must pass through a third-party clearing “node” (which is also where new bitcoins are created), and every node contains the entire transaction history of every bitcoin that has ever existed; moreover, the transaction history by design has to be publicly accessible.
In October of last year, a group of researchers from the University of California at San Diego and George Mason University published the results of their study, in which they were able to narrow Bitcoin users to the operators of transaction clusters; in a more recent and still-unpublished study, researchers from the University of Heidelberg and tech giant NEC were able to individually identify about 40 percent of the users in a batch of transaction data they analyzed. Although it has been hotly denied by both the Bitcoin “community” and the US authorities, there are reliable reports that the hunt for and eventual capture of Silk Road founder Ross Ulbricht was aided by tracking him through Bitcoin transactions.
The second feature of Bitcoin, related to its apparent anonymity, was that it was an entirely peer-to-peer currency, relying on no central authority to set its value or facilitate transactions. Except for the digital clearing nodes, this was the case in early transactions, but as the currency has gained mainstream acceptance, it has inevitably been saddled with conventional, centralized process management; CoinBase, the various online trading markets where bitcoins are bought and sold for “real” money, and the necessary transaction protocols used by online retailers, all defeat the sentimental ideal of Guy Fawkes mask-wearing crypto-anarchists that a public economy outside the control of government could be created. As Bitcoin has grown, so has the number of rules that have to be imposed to keep order.
“The Man” Bitcoin advocates are trying to avoid might not be the government, however, but wolves among their own herd. About a month ago, users were thrown into a panic when the biggest cooperative of bitcoin “miners,” a group called GHash.IO, nearly reached the critical threshold of 51 percent of all transaction-clearing calculations in a single day; at that level, a single “miner” or group of miners could effectively dictate the market value of bitcoins. GHash members claim the threat was inadvertent—and in fact, the public learned about it from a huge volume of message posts from GHash members on forums like Reddit, pleading with each other to disconnect from the network to avert disaster—but now that cat is out of the bag, and only the hopelessly optimistic would not assume that eventually someone will make an attempt to give Bitcoin its own Silver Tuesday. As it is now, GHash and the second-largest mining group, BTC Guild, routinely control about 60 percent of the transaction value at any given time.
And the arrest of Silk Road’s Ulbricht raised more alarms for the bitcoin market; at the time he was arrested, Ulbricht held about 5 percent of the total number of bitcoins in existence (then worth around $80 million), and has been understandably uncooperative with the authorities in revealing where they are. If they are eventually found and seized by the US, or if they are merely lost, that will trigger a crash of the bitcoin market.
Bitcoin certainly appears to be an expensive dead-end, something its creator (or creators) always said might be the result of the experiment if taken far enough. For those whose sentiments or sense of future possibilities won’t allow them to let go of the idea of a crypto-currency, the concept may still find its footing; not surprisingly, Bitcoin has spawned imitators such as the Australian-based “Dogecoin” (Yes, it is actually based on that amusing but already stale Shiba Inu dog meme. Wow.), and there will be more. With enough people working on the various problems of crypto-currency that have surfaced, such as finding where it fits in real-world regulatory schemes, improving security, and developing stable markets for it, one has to think it is only a matter of time before it becomes safe and useful on a large scale. But unless you’ve got it to burn, you’re probably well-advised to hang on to your real money for a while yet.