A Wild Few Weeks for Bitcoin
Thursday, June 23, 2011 at 2:16PM We first wrote about Bitcoin here in our blog ("This Non-Fiat Currency is Up Over 1,000% in the Last Month") on May 24, only about a month ago.
Since then it has gone on a wild ride that makes speculating in junior mining companies look like safe, non-volatile investments!
First, within days of our mention of Bitcoin it rose from $7 to $30! It was the world's first case of hyper-deflation!
However, soon after, on one trading platform, Bitcoins plummeted to $0.01! From hyper-deflation to massive hyperinflation in a course of a few weeks! Who said the internet hasn't sped things up?
But it wasn't as bad as it looked. What actually happened is that someone stole the password of someone who held a few million dollars worth of bitcoins and sold them all on the Mt. Gox exchange over the course of a very short time period.
Because Bitcoins are a new idea the market for them is not very liquid. There was only a million dollars worth of bids, approximately, on the Mt. Gox exchange and once the thief took out all the bids, Bitcoins were showing a "price" of $0.01 on the Mt. Gox exchange.
The thief didn't get very far... it appears that they were only allowed to withdraw $1,000 worth of their sales before the theft was identified. Mt. Gox quickly shut down the exchange and is now in the process of cancelling all trades that occurred after the thief began selling.
Mt. Gox expects to have things back to normal soon... and with very little harm done except for to the reputation of Bitcoin. But, it should be noted, this has nothing to do with the hack-a-bility of Bitcoins. Bitcoins weren't hacked. Someone just stole a password and sold the coins on an exchange. It's no different than if someone had stolen your internet banking password... Moral of the story: Guard your financial passwords VERY carefully!
One of my favorite humans, Doug Casey, recently made some comments about Bitcoin. As always, it was very interesting and insightful.
I then came across another interesting commentary on Bitcoin from another great blog, the Por Que No Argentina blog. That blog, by the way, is a great source of information on Doug Casey's amazing property development in Cafayate, Argentina.
The person who made the comments on that blog is also a resident of Doug Casey's development. That, also, is why we think it is one of the best places in the world to expatriate to. These are the type of people and minds that are gravitating to what we call Galt's Gulch in Argentina. If you'd like more information on Galt's Gulch in Argentina, click here.
Here are the comments, from Gary Kinghorn (owner of lot N-27 in Galt's Gulch) on Bitcoin:
I just read Doug and Louis’ weekly Conversations with Casey on Bitcoins. I had a very similar take initially, but I think Bitcoins are much more interesting than they are giving them credit for. I’ve actually spent a good amount of time understanding how this system is different than other alternative currency systems, and why it could have some merit at some point in the future, even if there are a number of “implementation details” to work out on the way to viability.
The first common misperception about Bitcoins is that they are backed by nothing, and hence that Goldmoney (also digital money, but backed by gold) must be superior. Or that Bitcoin is another form of fiat currency. This is a flawed argument if you flip it around and compare Bitcoins, not to Goldmoney, but to gold itself.
The value of gold is largely a reflection of the amount of work that is consumed in mining and refining it, along with its ideal suitability as “money”. A gold coin represents a large amount of land, highly refined, with the input of a great deal of energy, labor and capital. Similarly, Bitcoins are representative of the computing power, energy, and capital required to create them. A fast, expensive computer has to run for many days to create a Bitcoin. Just like most mining operations, it is a very difficult proposition to do profitably.
In fact, the creation of a Bitcoin is called “mining”*. There’s even a burgeoning industry of “mining consultants”, although the Bitcoin analogy of a Doug Casey has clearly not emerged yet. Bitcoin mining is risky, it’s somewhat random, and it’s very competitive between the number of people that are trying to mine at the same time. It’s probably never been a profitable venture, unless you assume greater prices in the future. So, in fact, the recent price rises that we’ve seen were not so much due to “greater fools” pursuing an unbacked currency, but a reflection of the more competitive nature of creating Bitcoins, the corresponding increases in computer cycles required to generate them, and the approximate costs of that computing power increasing. Naturally, the speculators come in to play that increase, amidst the early hoarders cashing out, and with the small size of an early market, you’ve got a formula for volatility, no question.
But if Bitcoins are “backed by nothing”, well, nothing backs gold either. It’s just a mineral dug up out of the ground with no inherent use other than jewelry. The fact that gold is not someone else’s liability is its supposed strength, and you can say the same about Bitcoins. Gold’s value relative to other strong conductors limits its industrial use considerably. The fact that gold looks better than a Bitcoin, and can also be used as adornment is an advantage that’s hard to argue; but it’s also true that its value as jewelry comes from its value as a rarity and its perceived value based on its ideal inherent properties as money. One could argue Bitcoins have all these same properties in terms of rarity, divisibility, convenience (OK, these are the implementation details that need to be worked out, but should be with time), and durability. When it comes to transporting wealth, say from the US to Argentina, would you rather try to carry $500,000 in gold past the TSA, or $500,000 in Bitcoins? So, maybe, in fact, they are more portable than gold, certainly one aspect of their convenience. With a well-protected wallet (encrypted with a long password), they are 100% theft-proof.
As we all know, bad money drives out good money. In other words, Federal Reserve Notes are bad money, getting more and more worthless, and hence these are the first things to be used as currency (legal tender laws aside). The stuff that’s appreciating in value, like gold and silver is driven into hiding and hoarded by investors. They are not used as “currency”, at least today. But the real measure of Bitcoin value to society will not be determined today, but in the future when the fiat currencies have served their purpose and humanity is scrambling to find a replacement. How would Bitcoins have fared in the currency collapse in Argentina when local scrip was put into circulation and quickly forged? How would Bitcoins have helped in Zimbabwe last decade when people were digging in their backyard for gold dust to buy bread to survive? Today’s Bitcoins may have not solved the problems of these countries completely, but one can envision a future where even most third world citizens have a cell phone to carry a Bitcoin wallet, and every family has a home computer to mine a few hundredths of a Bitcoin per day.
In our dystopian future, very few people are going to have gold, or even silver to conduct many meaningful transactions. Bitcoins may well be the only currency at that point for the common man (the non-Casey subscribers), aside from the family silverware, neighborhood scrip and other local currencies with far deeper flaws than Bitcoins.
One of the main advantages to Bitcoins is that it is completely peer-to-peer. In a computer sense, this means that there is no “issuing authority”, no central repository, no managing group, etc. With amazing foresight, even the inventor has remained completely anonymous, adding something to the mystery and attraction of Bitcoins. There is no liberty dollar creator to arrest on trumped up tax charges, there’s no stockpile to confiscate, there’s no repository to raid. When compared to Goldmoney, who’s to say James Turk can’t be “taken out”, his vaults confiscated, or his database of users and transactions compromised. When compared to gold itself, there is no way the govt. could confiscate Bitcoins under any scenario, as long as there is electronic communication between users. If fiat currencies collapse, it’s very likely gold and silver could be completely taken out of the equation, but not Bitcoins. The volatility that gold and silver are going to go through are going to whipsaw most casual Americans through an emotional wringer on a day to day basis, for the ones that can get their hands on the precious metals. Just look at January 1980 for a preview. This may well be the case with Bitcoins, as we have already seen, but that is NOT to say gold and silver are always a “consistent store of value” by comparison.
Finally, the casual observer of Bitcoins is overlooking a real opportunity in my opinion. Let’s compare Bitcoins to facebook. Bitcoins have quickly garnered an almost religious-like cult following among its early adopters. Rather than dismiss this as an aberration, perhaps we should pause and better understand why. These are not just naïve videogamers and crypto-hackers. The adoption rate of Bitcoins could at some point in the future compare with the community of facebook users. Who wouldn’t have loved to have gotten in on the facebook craze back in the early Harvard days, by either being one of the early programmers, or being one of the first to benefit from the early market penetration and advertising models that were created.
Already the earliest Bitcoin miners (when there was comparatively little competition) are online millionaires, and are starting to cash out. If Bitcoin really becomes practical and widely used, even just for online purchases, the opportunities to add value with a simple service are going to be legion. The price of Bitcoins is going to go up by orders of magnitude, and the early adopters are going to (continue to) receive a windfall. Like any gold rush, there will be lots of losers, but there is also plenty of opportunity. The security flaw exposed in the largest exchange last weekend shows the need for a number of more stable, secure exchanges as the community grows. The lack of merchant terminals at your average Starbucks creates an opportunity for a simple payment app on a cell phone and a corresponding terminal at the merchant site. The lack of convertibility into physical dollars, or other currencies, in many locations is a clear opportunity to provide a valuable service. There is plenty of room for people who wish to provide capital, and a great opportunity for speculators as well. Think of investing in Bitcoin today as akin to investing in an early stage start-up in Silicon Valley, or a speculative mining venture. You still can’t rule out a four bagger.
Believe me, I know enough about Bitcoin to know all the downside risk, the limited viability, the potential for fraud, and the wild-west nature of this emerging technology. It may very well not survive at all. I know many of my arguments are hand-waving, but I’m playing the devil’s advocate, not because I have all the answers, but because I know nobody has the answers to rule out the future viability of this system. Would I invest much in it today? I doubt it, and I would only do it because I’m fully versed in as many issues as I can be. How would I invest if I did? Mining? Probably not. Speculation? Only in small amounts. Bitcoin-related services and products? Well, maybe, but I am a technologist and I can see a potential path to getting tech products off the ground. Are the risks great? Yes. But to dismiss Bitcoins as a “straw in the wind” is to be making a serious mistake in my opinion.
Truth be told, only last week I made my first small investment in Bitcoins after testing the viability of mining them for a couple of weeks. Unfortunately, I got some of my funds locked up in the now famous Mt.Gox security breach temporarily, but I expect all the funds to be recovered in short order, and it was a small test amount anyway. I am not deterred by this setback, and I don’t think the Bitcoin community will be for long. Other exchanges are operating normally and prices quickly returned. Mt. Gox is rolling back many of the trades in the unusual sell-off so the fraudulent “flash crash” will be undone. It’s just part of the learning process, and the growing pains in something as fundamentally important as a new currency.
*Since somebody is bound to ask: What exactly do you mean “mining” a Bitcoin on a computer? Very simply, bitcoins are computer files that are cryptographic key blocks (a.k.a. a hash) that are assembled out of blocks of very large numbers. Putting together a hash block is not unlike a brute force cracking of a password. In mining, you have to try millions and millions of number blocks until you “find” the right one. The bitcoin network limits the amount of coins that can be minted to asymptotically approach 21,000,000 by the year 2030. Transactions may be common with 1/1000 or 1/10,000 of a coin as deflation seems built in by design. As computers get faster, and more people start mining, the blocks that are required to create a coin will correspondingly get longer and more difficult so that the mining rate is never exceeded. A good geologist in gold mining has a big advantage over a poor geologist, but in bitcoin everyone is equally looking in the dark so to speak, and it’s a bit more random, but you also don’t have the unpredictability of mining accidents, geopolitical instability or dependence on the price of oil. Want to try mining quickly on your own? Go to http://www.bitcoinplus.com and click on “Generate Bitcoin”, then “Start Generating” to start.
Earlier in my career as a network security guy, I worked at RSA, which designed and produced many of the foundational cryptographic algorithms used in these kinds of applications, which was what initially attracted me to study bitcoin, along with my interest in alternative currency systems, of course. Upon cursory research, the design is incredibly elegant and well thought out. From an engineering perspective alone, bitcoin is something like looking at the Hoover Dam for an industrial engineer. It’s a testimony to somebody’s great design and the belief in that design of a large and growing community of talented programmers in the open source community, and throughout the world.
Reader Comments (6)
Jeff:
You may find this recent series on Bitcom posted here at FOFOA of interest:
http://fofoa.blogspot.com/2011/06/bitcoin-open-forum.html
http://fofoa.blogspot.com/2011/06/bitcoin-open-forum-part-2.html
http://fofoa.blogspot.com/2011/06/bitcoin-open-forum-part-3.html
Good article. Glad to see you haven't bought into all the FUD floating around, and props on noting the difference between Bitcoin and Mt.Gox: a lot of the articles I've seen floating around leave the reader with the impression that Bitcoin itself was hacked.
The mining explanation, however, was a little hand-wavy for my tastes. Here is a more in-depth explanation for anyone who is interested:
First you should understand what a "hash" is, as I will be using the word throughout my explanation. Simply put, a hash is (for our purposes) a unique string of letters and numbers derived from some arbitrary set of data using a computer algorithm. (For the engineers and computer scientists in the audience, the algorithm in this case is a double round of SHA-256.)
When a person sends a transaction over the Bitcoin network, that transaction gets broadcast to all the nodes on the network. Miners pick up this transaction and, if it appears valid, add it to the block of transactions they're currently working on. The first transaction in this block is always a transaction from nowhere to the miner's own wallet. This is the miner's base reward for mining. Right now this stands at 50 BTC, but it is set to halve every 210,000 blocks (about 4 years.) The first decrease, to 25 BTC per block, will happen around the middle of 2012. In addition to this base reward the miner also gets all the transaction fees included in the transactions in their block.
Aside from transactions, the block also includes the hash of the block which came before it as well as a random number called a "nonce." The miner calculates the hash value of their block, including the nonce. The hash value is converted to a numeric value and then compared to a target value provided by the network. If it is less than the target value, the block is considered "solved. (This target value is adjusted either up or down every 2,016 blocks in an attempt to make the network solve exactly six blocks every hour.) If it is greater than or equal to the target, the miner increments the block's nonce and recalculates the block's hash. They continue this process until the block has been solved, either by them or by another miner on the network.
When a block is solved, the solved block broadcast to the network, all the other miners on the network check the block's validity. If the miner's submitted block does not conform to the network's rules as the miner who received the block understands them, then the miner rejects the "solved" block and continues trying to solve their own block. If it does conform to the rules, the miner adds the solved block to their collection of solved blocks, stops trying to solve their own block, and moves on to calculating a fresh block of transactions. (This collection of solved blocks is called the "block chain," because every block includes the hash value of the block that came before it, effectively chaining each block to the previous one.)
Recommended resources for the technically-minded (more in-depth than this was):
Another high-level explanation
What is a block header?
What is a block?
I also noticed, after starting to mine last weekend, that the increments are very small once 'mined'.. and would take a long time to mine a single bitcoin with my laptop.. Too bad. As much as I like investing in things, I find it hard to buy anything that I cannot, at leat at some point, physically handle. Maybe if the price were to actually drop to a very low level, I might buy some, but not at this point. Silver is tyhe way to go for now.
You wrote about one version of what happened with Mt. Gox, which seems to coincide with their public statements. Here is a conflicting account, please take this into consideration:
http://forum.bitcoin.org/index.php?topic=20207.0
You've oversimplified the event by saying that the hacker/thief is the same party as who withdrew the $1000 worth of BitCoins. This appears to not be the case.
BitCoin markets can be manipulated just like any market. That's the real story behind this event, not merely the hacking.
You make me want to go into politics.
I am planning to volonteer for the NDP in B>C for few hours.
And since you do and say what you do you greedy anarchist selfish gangster,
( lol )
WHAT IS WRONG IN TRYING TO SET UP A BILLION DOLLAR CHARITY TO INITIATE THE INTERNET IN AFRICA>
And FYI we never had any bankers valuing us more than about 300 million. And the only reason we did is because we owned HOLLINGER CONTENT ON THE INTERNET< BUT YOU could not figure it out.
Keep proving your hetorosexuallity
You should reread what you yell.
you laugh at the fact that obama gets the peace prize. But you predict absolute hell for the usa and a collapse of there money.
Well think about what you are saying goldbug.
Clearly if you are right then if the USA is still doing okay then by reading your stuff he should get the peace prize.
God some of you uneductaed well read guys are funny someitimes. tell einstein that eductuion is brainwashing ?????????????