Contributors

Wednesday, February 26, 2014

Death Knell for Bitcoin?

Mt. Gox, the main bitcoin exchange, will apparently declare bankruptcy.  The exchange was robbed of 740,000 bitcoins, "worth" $350-400 million. The exchange rate for bitcoin is now about $580, down from over $1,200 a few months ago.

How did this happen? The main problem with digital currency is that it's just a string of bits that can be copied any number of times. Since you can potentially use the same bitcoin to buy stuff from 10, 1,000 or a million different people, you need some mechanism to prevent that:
HENN: In the conventional banking system - trusted third parties, like banks and credit card companies - keep ledgers to make sure I can't do that. But bitcoin solved this problem by creating a public record of every transaction. So if I buy something from you with a bitcoin, a record of that transaction is shared and recorded across the entire bitcoin network - everyone knows.

The theory is that public ledger make it impossible for me to spend a bitcoin twice. Because after I spent it, everyone would know that coin was actually yours. You know, one of the appeals of this system is that it eliminates those trusted third parties, those banks and credit card companies, and at least in theory could make moving money around the world much, much cheaper.

BLOCK: OK. But wait, Steve. If you're telling me that every transaction is supposed to be recorded in a publicly-shared ledger, right, how does it happen that thieves could apparently manage to steal, what you say, could be $350 or $400 million from this exchange, Mt. Gox?

HENN: Well, that's a great question. So sharing and recording all these transactions on the bitcoin network it turns out takes some time. So for this and a couple other reasons, the community developed kind of a short-cut: A temporary ID number that would be attached to each transaction and making tracking transactions in the short-term easier. But these temporary ID numbers can be faked.

Apparently people were approaching Mt. Gox with fake ID numbers, telling the exchange they hadn't received the bitcoins they were owed. And then Mt. Gox was relying on these numbers and giving the thieves real bitcoins. This may well have drained Mt. Gox's resources to the point were it's now insolvent.
The main draw of bitcoin is that there's no governing central authority keeping track. This is also the main drawback of bitcoin: there's no governing central authority keeping track, or protecting or insuring you. The people whose bitcoins were stolen have no recourse. There's no FDIC insurance. Unlike the Target credit card number theft, there's no Visa or Mastercard to shield consumers from losses. There's utterly no way to track down who ripped off Mt. Gox and their customers: anonymity is the entire point of bitcoin.

The impetus for using bitcoin for legal transactions is a little hazy. When you buy something on the Internet you still need it sent to your house. That's hardly anonymous: the seller has to keep computerized records of your address, so your anonymity is only protected by how careful and competent your supplier is. Even if you're buying something digital, like porn, it still has to come to you over the Internet, which after the NSA spying scandal turns out to be not very anonymous.

If you're concerned about hiding transactions from your spouse (like a surprise birthday gift, or that porn bill), you can often pay through a PayPal or similar account, which is a lot easier to keep secret than a joint credit card.

Anything you buy in person can be bought with cash, which is even more anonymous than bitcoin because it doesn't require any computers or connection to the Internet. Using it won't leave any digital footprints that lead the NSA back to your door, and your spouse won't find it in the browser history that you forgot to clear.

At this point, bitcoin is the domain of drug dealers, gun runners, money launderers and crooks. But there's another den of thieves itching to get in on the action.

Barry Silbert, of SecondMarket, is in discussions with several banks to create an exchange to trade bitcoins. Only large institutions would be allowed to join. Some of these same institutions advised their clients to invest in bogus CDOs while betting against those same financial instruments; they gambled away trillions of dollars on bad real estate deals and trashed the world economy. What could possibly go wrong when they start advising their clients to invest in the totally unregulated market of bitcoin futures?

Maybe someday there will be a reliable digital currency that has the virtues of bitcoin but none of the problems. But today's digital currencies are little different from the gold players create in World of Warcraft -- which when I checked today had an exchange rate of $12.80 for 10,000 gold. Not quite bitcoin territory, but what can you expect for killing a bunch of orcs? And the crazy thing is that bitcoins are created in essentially the same way: just crunching numbers on a computer.

The bitcoin market is like the Wild West, only there are no Earp brothers or Texas Rangers. It's just a bunch of crooks and their libertarian tech geek enablers. Since a huge percentage of Mt. Gox's customers are criminals dealing in drugs and money laundering, it's no surprise they were robbed blind.

When you sleep with dogs you get fleas.

2 comments:

Larry said...

As likely as not an inside job. If it was, how is it any different than embezzlement of "real" money? If it was a digital break-in, how's that really any different than other kinds of heists (some of which are also digital in nature)? "Mining" Bitcoins is odd when you first hear of it, but how much odder is it than a government simply creating it out of nothing? I'm half-surprised you're not predicting the death of cash because it's the preferred exchange for drugs, illicit sex, and other illegal acts that like to be hidden and anonymous. We haven't yet reached that wet dream of statists, yet, though.

Larry said...

Not that I'm any great enthusiast for Bitcoin. It's an experiment. An interesting experiment, to be sure, and only a fool would be putting serious money into it.