On March 16th, the Cypriot President Nicos Anastasiades, who’d been in office for about a month, announced a strategy to solve the country’s banking crisis. This plan, which would be funded in part by confiscating money directly from every single bank account in Cyprus—even the very smallest—met with instantaneous and violent opposition from the country’s citizens.
Offstage, the European Union, led by a group of adamant Germans, Finns, and Danes, as well as the I.M.F. and the European Central Bank, pointed a cannon at Anastasiades’s head: if he didn’t move forward with this plan, the Cyprus banks would go bust and their hapless customers would lose pretty much all their money, instead of a measly 6.75 per cent. However, under great pressure from their constituents, Cypriot M.P.s rejected the proposal and sent Anastasiades back to the drawing board.
The following Monday, the price of the decentralized electronic currency bitcoin rose from forty-five to fifty-five dollars on the major exchanges, and by Wednesday it had nipped up to sixty-five dollars. The financial media generally agreed that the two dramas are related. According to Bloomberg Businessweek, it appears that Spaniards are liable to have been particularly active buyers of bitcoins that week, having taken the debacle in Cyprus as the likely sign of a forthcoming governmental plunder of their own savings. The evidence coming out of Spain is circumstantial—a spike in Google searches for “bitcoin,” and another on mobile-app downloads of Bitcoin-related software were widely reported—but the pieces appear to fit. Subsequent developments (including the announcement of an eleventh-hour bailout deal for Cyprus) have so far failed to stabilize the euro or cool the bitcoin fever, with the price over a hundred and three at the time of writing.
That a number of panicked Europeans appear to have reckoned the wildly volatile, vulnerable, and tiny bitcoin market a preferable alternative to their own banking system, even temporarily, signals a serious widening of the cracks between the northern and southern E.U. countries in the wake of the euro-zone debt crisis. It also illustrates the broader collapse of trust that is threatening the world of global banking and fiat money.
The weakness in existing currencies stems from lack of faith in institutions—particularly central banks, which are often in league with commercial and investment banks. When a government bails out a failed bank or insurance company—in essence, by printing money—the net effect is that the currency as a whole is debased, in favor of a few and at the literal expense of everyone else, which amounts to a fair description of today’s global financial system. Hence the sudden appeal of bitcoins, which appear, for the moment, at least, to be immune to the machinations of inept or crooked bankers and politicians.
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In many ways, bitcoins function essentially like any other currency, and are accepted as payment by a growing number of merchants, both online and in the real world. But they are generated at a predetermined rate by an open-source computer program, which was set in motion in January of 2009. This program produced each one of the nearly eleven million bitcoins in circulation (with a total value just over a billion dollars at the current rate of exchange), and it runs on a massive peer-to-peer network of some twenty thousand independent nodes, which are generally very powerful (and expensive) G.P.U. or ASIC computer systems optimized to compete for new bitcoins. (Standards vary, but there seems to be a consensus forming around Bitcoin, capitalized, for the system, the software, and the network it runs on, and bitcoin, lowercase, for the currency itself.)
Bitcoin releases a twenty-five-coin reward to the first node in the network that succeeds in solving a difficult mathematical problem requiring a certain amount of brute-force computation (known as a proof-of-work calculation.) The solution is then broadcast throughout the network, and competition for a new block and its twenty-five-coin reward begins. (There’s a good rundown of the technical aspects of Bitcoin on the Bitcoin wiki; there’s also a wonderfully pellucid explanation of the proof-of-work angle from Paul Bohm, on Quora.)
At first, anyone armed with an ordinary computer could download and run the Bitcoin software and gather (or “mine”) bitcoins. The more computing power you can dedicate to Bitcoin calculations, though, the better your chances of arriving first at each solution. This feature of the system, by design, resulted in a kind of computational arms race that strengthened the network by rewarding increased computing power. Four years into the Bitcoin project, only very powerful, purpose-built machines have enough muscle to keep pace with existing network nodes.
In this way, bitcoins are mined like gold used to be, in quantities that are small relative to the total supply, so that the supply grows slowly. There is an upper limit of twenty-one million new coins built into the software; the last one is projected to be mined in 2140. After that, it is presumed that there will be enough traffic to keep rewards flowing in the form of transaction fees rather than mining new coins. For now, the bitcoins are initially issued to the miners, but are distributed when miners buy things with them or sell them to non-miners (such as jumpy Spanish bank depositors) who desire an alternative currency. The chain of ownership of every bitcoin in circulation is verified and registered with a timestamp on all twenty thousand network nodes. This prevents double spending, since no coin can be exchanged without the authentication of some twenty thousand independent cyber-witnesses. In order to hack the network, you would have to deceive over half of these computers at the same time, a progressively more difficult task and, even today, a very formidable one.
In 2008, Satoshi Nakamoto, the founder of Bitcoin, whose real identity is not known, cleverly combined existing peer-to-peer network technologies, cryptographic techniques, digital signatures, and the potential power of network effects to design and develop the Bitcoin system. Nakamoto was very clearly motivated in this effort by the fallout from the 2008 financial crisis. When the experiment was launched and the first fifty bitcoins (the so-called genesis block) were mined, in January of 2009, he (or she, or they) included this line of text along with the data: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”
Until his disappearance from the Web, around the spring of 2012, Nakamoto was a visible participant on cryptography forums, where he discussed Bitcoin freely, and published a nine-page paper outlining the details of the project. These posts reveal that even in 2008, Nakamoto was able to respond to concerns regarding the scalability of bitcoin with remarkable prescience; he clearly understood the ramp-up of computing power that would be required for producing bitcoins as the system grew.
Only people trying to mine new coins need to run network nodes And at first, most users ran network nodes, but as the network grew beyond a certain point, mining increasingly became the domain of specialists with server farms of specialized hardware.
A casual review of Nakamoto’s various blog posts and bulletin-board comments also confirms that, from the first, Bitcoin was devised as a system for removing the possibility of corruption from the issuance and exchange of currency. Or, to put it another way: rather than trusting in governments, central banks, or other third-party institutions to secure the value of the currency and guarantee transactions, Bitcoin would place its trust in mathematics. At the P2P Foundation, Nakamoto wrote a blog post describing the difference between bitcoin and fiat currency:
[Bitcoin is] completely decentralized, with no central server or trusted parties, because everything is based on crypto proof instead of trust. The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts… With e-currency based on cryptographic proof, without the need to trust a third party middleman, money can be secure and transactions effortless.
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Much of what has been written so far about bitcoins has centered on the perceived dangers of their relative anonymity, the irreversibility of transactions, and on the fact that they can be used for money laundering and for criminal dealings, such as buying drugs on the encrypted Web site Silk Road. This fearmongering is a red herring, and has so far prevented the rational evaluation of the potential benefits and shortcomings of crypto-currency.
Cash is also anonymous; it is also used in money laundering and illegal transactions. Like bitcoins, stolen cash is difficult to recover, and a cash transaction can’t readily be traced back to the source. Nor is there immediate recourse for the reversal of transactions, as with credit-card chargebacks or bank refunds when one’s identity has been stolen. However, I find it difficult to believe that anyone who has written critically of the dangers of bitcoin would prefer an economy where private cash transactions are illegal.
Contrary to hysterical media reports, such as this recent video from the Guardian, the Bitcoin-software community is loosely governed not by wild-eyed kids camping out in half-deserted lofts but by what appears to be a rational and sober group of adult administrators who run the Bitcoin Foundation. This organization was modelled on the Linux Foundation, according to Gavin Andresen, who is currently the Bitcoin Foundation’s chief scientist. As the lead developer for the project, Andresen is paid a salary by the Bitcoin Foundation. He has been involved full-time in Bitcoin since the spring of 2011.
Like the Linux Foundation, the Bitcoin Foundation is funded mainly through grants made by for-profit companies, such as the Mt. Gox exchange, Bitinstant, and CoinLab, who depend on the stability and continued maintenance of the underlying open-source code.
“The Linux Foundation provides a bit of a center for Linux, and to pay the lead developer, Linus Torvalds, so that he can do nothing but concentrate on the kernel,” Andresen said. “It’s a tricky thing, once you get to be a certain size as an open-source project, how do you sustain yourself? Linux is the most successful open-source project in the world, so we thought it would make sense to use that as a model.”
Gavin Andresen is one of the few people in the world who are known to have corresponded directly with Satoshi Nakamoto. (Joshua Davis tried to track him down for The New Yorker in 2011.) When I said I’d like to know more about Nakamoto, Andresen burst out laughing.
“So would I!” His laughter had a credibly rueful edge to it.
He was active on the bitcoin forums through December of 2011. He told me he was going to get busy, and then he stopped posting on the forums. A few months later, he disappeared, and as far as I know nobody has heard from him since then.
Whenever I corresponded with him, it was always on Bitcoin forums or e-mail, we never even real-time text chatted. He was always very businesslike, no personal details, always strictly about the project.
Indeed, a casual review of Nakamoto’s writings online reveals him to be unfailingly cool and collected; the only time I noticed him becoming a little heated was in a few forum posts in December of 2010, when WikiLeaks supporters began soliciting bitcoin donations for WikiLeaks. Nakamoto rejected the idea unequivocally. According to Andresen,
Satoshi just felt the project was still too small to take that much attention. He didn’t want WikiLeaks to jump in at that point, and they didn’t… but a year later they did, and it was fine. I think people realized once I got invited to speak at the C.I.A. that there was no kind of hiding. They, whoever “they” are, already knew about this project. Satoshi was obviously a lot more private, and more worried about what government would do than I am.
I asked Andresen to explain to me the degree to which he and his colleagues are worried about government interference in Bitcoin.
I think if the U.S. government decided that Bitcoin was a bad thing and told me, “Stop doing what you’re doing,” I’d stop doing what I’m doing, quite frankly. But that wouldn’t be very effective, because there are people all over the world who could pick up and reimplement it, for example in different programming languages; if you browse the Bitcoin forums you’ve seen the enormous chaos and energy there. There’s all sorts of people doing all sorts of things—many of them crazy things that will never succeed, but some of those will be the next big things in Bitcoin.
As it happens, a few days ago, the Financial Crimes Enforcement Network (FinCEN), the federal agency that enforces laws against money laundering, announced new guidelines requiring certain “virtual currency” trading entities to register as Money Services Businesses (M.S.B.s). Though the Bitcoin Foundation’s general counsel, Patrick Murck, was somewhat critical of the new guidelines, this move went a certain distance toward calming Bitcoin speculators and others who’d been worried that the government would take more drastic steps against the mining, transfer, and exchange of bitcoins. Andresen is among those who sees the new FinCEN guidelines as a positive development.
In my opinion, the FinCEN guidance is fantastic news: it gives Bitcoin users and businesses clear rules on how they will or won’t be regulated. It is great for ordinary users, because FinCEN said that using bitcoins to buy products or services is perfectly legal. And, long-term, it is great for businesses, because they now know how FinCEN will classify them and what regulations they must obey here in the U.S.
That said, it might cause problems for some smaller U.S. bitcoin-based businesses, who might have been hoping that they wouldn’t be regulated at all. The bigger bitcoin businesses have been anticipating this for a while, so I don’t think it will affect them.
But what about new government regulations that may arise down the road: making it illegal to accept bitcoins as payment, for instance, or outlawing or regulating the exchanges? It might not be so difficult to shut Bitcoin down, and that has to be producing a lot of downward pressure on more widespread acceptance, I suggested.
If you’re asking me what I would expect to happen… I would expect that some country or another will try to do that. You have the same kinds of arguments about the Internet and the free flow of information across the world. And we’ve seen countries like China, that try to either ban the Internet or restrict it. I don’t think you can just hop on the Internet in North Korea.
So I’d expect some countries that really want to control their currency, to control transactions, to do the same with bitcoin. The question is whether really big countries—like the United States or France or Russia—decide to do that or not. I don’t think anybody really knows.
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A confluence of key factors is responsible for the current spike in bitcoin values—the situation in Cyprus and the recent FinCEN announcement are widely thought to be among them. But perhaps a more important development is that a number of high-profile online businesses, among them WordPress, Reddit, Namecheap, and Mega, have recently begun accepting bitcoins in payment for their services. There are now many thousands of individuals and businesses already doing business in bitcoins. At bitcoinstore.com, you can buy electronics—including cameras, musical instruments, blood-pressure monitors, and computers—using just bitcoins. There are bitcoin-only casinos, like SatoshiBet, and a bitcoin-based Intrade-style prediction market called Bets of Bitcoin. The infrastructure for implementing the storage and exchange of bitcoins, too, is exploding: vendors, exchanges, facilitators of in-hand trades, dealers in bitcoin debit cards. There are systems for producing “paper wallets” that you can print out for the safe storage of bitcoins, and secure e-wallets for those with a tendency to misplace papers.
The physical bitcoins illustrating most every bitcoin story on the Web are available for purchase, too. They are called Casascius coins, and they are sold by Mike Caldwell through his Web site, casascius.com. These coins contain a private key on a card embedded in the coin and sealed with a tamper-evident hologram.
Caldwell, who lives in Utah, owns a payroll-software business and has about thirty employees. He is not affiliated with the Bitcoin Foundation—he is simply an interested and highly informed participant in the bitcoin market. The name Casascius came from the acronym for “call a spade a spade,” with a vaguely Latinized suffix. The widely adopted Bitcoin motto often appears on Casascius coins: “Vires In Numeris,” which is a rough translation into Latin of the English phrase “strength in numbers.” He is a strong believer in the future of Bitcoin, and has been investing in the currency for a long time. He told me, “After the first crash”—in June of 2011—“there was a panic; people heard that one Web site had been hacked, and erroneously assumed that Bitcoin was a failure. I bought all the way down.”
But Caldwell also thinks the road ahead is likely to be a bumpy one.
I believe Bitcoin will have hiccups and issues in the future… scalability limits. And there will be bugs, and times where people experience delays getting their transactions confirmed. These will cause temporary crises of confidence as the developers team up to solve the various issues. But Bitcoin will also evolve and move past them. The day that Hollywood succeeds in using technology to stomp out the music and movie pirates on the Internet, that’s when they’ll stomp out Bitcoin. I think most people know Hollywood will never win. Bitcoin will always win in the long game.
Caldwell used to mine coins himself, but gave it up eventually: “I considered the maintenance too high in opportunity cost for me personally,” he told me. I asked him what, as an ordinary Bitcoin participant, he thought of the new FinCEN regulations. Are they the thin end of the wedge in terms of government interference? How does the “guidance” affect today’s bitcoin miners in practical terms? Will they all have to register as M.S.B.s? He doesn’t regard it as a threat yet.
Since mining yields pocket change for most, even if it were technically a violation of the way FinCEN sees the law, mining without registering would be like “laundering” a twenty-dollar bill by taking it to the grocery store and asking for two tens… it’s hardly worth the resources for anyone to care about it, no matter how illegal they decide it should be.
Where he does see an issue, however, is in the anonymity that is prized by bitcoin adherents.
Mining produces bitcoins that are extremely anonymous. The most anonymous bitcoins you can get, system-wide, are ones you mined yourself. The mined coins have no origin, no history, no nothing. They just appear out of thin air.
This anonymity becomes particularly problematic, from a regulator’s viewpoint, in the context of criminal activity—for example, hacking attacks that succeed in robbing people of their bitcoins:
We will see many more “man in the middle” attacks, and they will cause disruption; there will be times when it becomes possible to hack into a site or get in the middle of a transaction and hijack the payment address, causing people to send an irreversible payment to a criminal instead of who they thought they’d sent it to. Imagine getting a fake but realistic-looking invoice in the postal mail from a real vendor everyone pays (let’s use the electric company for my example), and you are tricked into sending the payment to a criminal’s P.O. box or mailing address. This doesn’t happen much today, because the criminal’s address would attract law enforcement, and so would their depository bank account. But with bitcoin, an address has no identifying quality and is unseizable, so criminals will do this and get away with it, and people are going to learn the hard way that they have to be vigilant about this.
Caldwell’s political views with respect to Bitcoin are connected, like Nakamoto’s, with a belief in the potential value of cryptography. “Until now, society has underutilized cryptography. If people accept it more broadly, cryptography can facilitate many things: the exchange of money, transparent elections, transparent government.”
The common picture of bitcoin users has been that they’re all long-haired anarchists, libertarians, and weirdos who would do away with government entirely, if they could. But in response to a question about his politics, Mike Caldwell had this to say:
I am not an anarchist; I believe in the rule of law and a civilized society. But I also believe that unchecked power is a threat to the common good, and that anything that the public can do to challenge that power is a benefit to society. As an individual, if you accept bitcoin in exchange for your goods or your work, that is a vote for economic fairness.
So is bitcoin going to save the global economy, or is it today’s answer to seventeenth-century tulip mania? Gavin Andresen offered a word of caution.
I still tell people that Bitcoin is an experiment: only invest time or money you can afford to lose, because Bitcoin is still an experiment. The longer it keeps going in the face of volatility and technical glitches happening, the more we’ll know.
But trust takes time.
Illustration by Grafilu.