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The Rise and Fall of Bitcoin
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Author: Benjamin WallaceBenjamin Wallace
11.23.11
02:52 pm
The Rise and Fall of Bitcoin
Illustration: Martin Venezky
Illustration: Martin Venezky
In November 1, 2008, a man named Satoshi Nakamoto posted a research
paper to an obscure cryptography listserv describing his design for a
new digital currency that he called bitcoin. None of the list's
veterans had heard of him, and what little information could be
gleaned was murky and contradictory. In an online profile, he said he
lived in Japan. His email address was from a free German service.
Google searches for his name turned up no relevant information; it was
clearly a pseudonym. But while Nakamoto himself may have been a
puzzle, his creation cracked a problem that had stumped cryptographers
for decades. The idea of digital money—convenient and untraceable,
liberated from the oversight of governments and banks—had been a hot
topic since the birth of the Internet. Cypherpunks, the 1990s movement
of libertarian cryptographers, dedicated themselves to the project.
Yet every effort to create virtual cash had foundered. Ecash, an
anonymous system launched in the early 1990s by cryptographer David
Chaum, failed in part because it depended on the existing
infrastructures of government and credit card companies. Other
proposals followed—bit gold, RPOW, b-money—but none got off the
ground.
One of the core challenges of designing a digital currency involves
something called the double-spending problem. If a digital dollar is
just information, free from the corporeal strictures of paper and
metal, what's to prevent people from copying and pasting it as easily
as a chunk of text, "spending" it as many times as they want? The
conventional answer involved using a central clearinghouse to keep a
real-time ledger of all transactions—ensuring that, if someone spends
his last digital dollar, he can't then spend it again. The ledger
prevents fraud, but it also requires a trusted third party to
administer it.
The Rise and Fall of Bitcoinby Benjamin Wallace (41.9 MB .mp3)
Bitcoin did away with the third party by publicly distributing the
ledger, what Nakamoto called the "block chain." Users willing to
devote CPU power to running a special piece of software would be
called miners and would form a network to maintain the block chain
collectively. In the process, they would also generate new currency.
Transactions would be broadcast to the network, and computers running
the software would compete to solve irreversible cryptographic puzzles
that contain data from several transactions. The first miner to solve
each puzzle would be awarded 50 new bitcoins, and the associated block
of transactions would be added to the chain. The difficulty of each
puzzle would increase as the number of miners increased, which would
keep production to one block of transactions roughly every 10 minutes.
In addition, the size of each block bounty would halve every 210,000
blocks—first from 50 bitcoins to 25, then from 25 to 12.5, and so on.
Around the year 2140, the currency would reach its preordained limit
of 21 million bitcoins.
When Nakamoto's paper came out in 2008, trust in the ability of
governments and banks to manage the economy and the money supply was
at its nadir. The US government was throwing dollars at Wall Street
and the Detroit car companies. The Federal Reserve was introducing
"quantitative easing," essentially printing money in order to
stimulate the economy. The price of gold was rising. Bitcoin required
no faith in the politicians or financiers who had wrecked the
economy—just in Nakamoto's elegant algorithms. Not only did bitcoin's
public ledger seem to protect against fraud, but the predetermined
release of the digital currency kept the bitcoin money supply growing
at a predictable rate, immune to printing-press-happy central bankers
and Weimar Republic-style hyperinflation.
Bitcoin's chief proselytizer, Bruce Wagner, at one of the few New York
City restaurants that accept the currency.
Photo: Michael Schmelling
Nakamoto himself mined the first 50 bitcoins—which came to be called
the genesis block—on January 3, 2009. For a year or so, his creation
remained the province of a tiny group of early adopters. But slowly,
word of bitcoin spread beyond the insular world of cryptography. It
has won accolades from some of digital currency's greatest minds. Wei
Dai, inventor of b-money, calls it "very significant"; Nick Szabo, who
created bit gold, hails bitcoin as "a great contribution to the
world"; and Hal Finney, the eminent cryptographer behind RPOW, says
it's "potentially world-changing." The Electronic Frontier Foundation,
an advocate for digital privacy, eventually started accepting
donations in the alternative currency.
The small band of early bitcoiners all shared the communitarian spirit
of an open source software project. Gavin Andresen, a coder in New
England, bought 10,000 bitcoins for $50 and created a site called the
Bitcoin Faucet, where he gave them away for the hell of it. Laszlo
Hanyecz, a Florida programmer, conducted what bitcoiners think of as
the first real-world bitcoin transaction, paying 10,000 bitcoins to
get two pizzas delivered from Papa John's. (He sent the bitcoins to a
volunteer in England, who then called in a credit card order
transatlantically.) A farmer in Massachusetts named David Forster
began accepting bitcoins as payment for alpaca socks.
When they weren't busy mining, the faithful tried to solve the mystery
of the man they called simply Satoshi. On a bitcoin IRC channel,
someone noted portentously that in Japanese Satoshi means "wise."
Someone else wondered whether the name might be a sly portmanteau of
four tech companies: SAmsung, TOSHIba, NAKAmichi, and MOTOrola. It
seemed doubtful that Nakamoto was even Japanese. His English had the
flawless, idiomatic ring of a native speaker.
Perhaps, it was suggested, Nakamoto wasn't one man but a mysterious
group with an inscrutable purpose—a team at Google, maybe, or the
National Security Agency. "I exchanged some emails with whoever
Satoshi supposedly is," says Hanyecz, who was on bitcoin's core
developer team for a time. "I always got the impression it almost
wasn't a real person. I'd get replies maybe every two weeks, as if
someone would check it once in a while. Bitcoin seems awfully well
designed for one person to crank out."
Nakamoto revealed little about himself, limiting his online utterances
to technical discussion of his source code. On December 5, 2010, after
bitcoiners started to call for Wikileaks to accept bitcoin donations,
the normally terse and all-business Nakamoto weighed in with
uncharacteristic vehemence. "No, don't 'bring it on,'" he wrote in a
post to the bitcoin forum. "The project needs to grow gradually so the
software can be strengthened along the way. I make this appeal to
Wikileaks not to try to use bitcoin. Bitcoin is a small beta community
in its infancy. You would not stand to get more than pocket change,
and the heat you would bring would likely destroy us at this stage."
Then, as unexpectedly as he had appeared, Nakamoto vanished. At 6:22
pm GMT on December 12, seven days after his Wikileaks plea, Nakamoto
posted his final message to the bitcoin forum, concerning some
minutiae in the latest version of the software. His email responses
became more erratic, then stopped altogether. Andresen, who had taken
over the role of lead developer, was now apparently one of just a few
people with whom he was still communicating. On April 26, Andresen
told fellow coders: "Satoshi did suggest this morning that I (we)
should try to de-emphasize the whole 'mysterious founder' thing when
talking publicly about bitcoin." Then Nakamoto stopped replying even
to Andresen's emails. Bitcoiners wondered plaintively why he had left
them. But by then his creation had taken on a life of its own.
Bitcoin 101 ———–
Bitcoin 101
How They're Made
Bitcoin's economy consists of a network of its users' computers. At
preset intervals, an algorithm releases new bitcoins into the network:
50 every 10 minutes, with the pace halving in increments until around
2140. The automated pace is meant to ensure regular growth of the
monetary supply without interference by third parties, like a central
bank, which can lead to hyperinflation.
How They're Mined
To prevent fraud, the bitcoin software maintains a pseudonymous public
ledger of every transaction. Some bitcoiners' computers validate
transactions by cracking cryptographic puzzles, and the first to solve
each puzzle receives 50 new bitcoins. Bitcoins can be stored in a
variety of places—from a "wallet" on a desktop computer to a
centralized service in the cloud.
How They're Spent
Once users download the bitcoin app to their machine, spending the
currency is as easy as sending an email. The range of merchants that
accept it is small but growing; look for the telltale Bitcoin
101symbol at the cash register. And entrepreneurial bitcoiners are
working to make it much easier to use the currency, building
everything from point-of-service machines to PayPal alternatives.
Illustrations: Martin Venezky
__"Bitcoin enthusiast__s are almost evangelists," Bruce Wagner says.
"They see the beauty of the technology. It's a huge movement. It's
almost like a religion. On the forum, you'll see the spirit. It's not
just me, me, me. It's what's for the betterment of bitcoin."
It's a July morning. Wagner, whose boyish energy and Pantone-black
hair belie his 50 years, is sitting in his office at OnlyOneTV, an
Internet television startup in Manhattan. Over just a few months, he
has become bitcoin's chief proselytizer. He hosts The Bitcoin Show, a
program on OnlyOneTV in which he plugs the nascent currency and
interviews notables from the bitcoin world. He also runs a bitcoin
meetup group and is gearing up to host bitcoin's first "world
conference" in August. "I got obsessed and didn't eat or sleep for
five days," he says, recalling the moment he discovered bitcoin. "It
was bitcoin, bitcoin, bitcoin, like I was on crystal meth!"
Wagner is not given to understatement. While bitcoin is "the most
exciting technology since the Internet," he says, eBay is "a giant
bloodsucking corporation" and free speech "a popular myth." He is
similarly excitable when predicting the future of bitcoin. "I knew it
wasn't a stock and wouldn't go up and down," he explains. "This was
something that was going to go up, up, up."
For a while, he was right. Through 2009 and early 2010, bitcoins had
no value at all, and for the first six months after they started
trading in April 2010, the value of one bitcoin stayed below 14 cents.
Then, as the currency gained viral traction in summer 2010, rising
demand for a limited supply caused the price on online exchanges to
start moving. By early November, it surged to 36 cents before settling
down to around 29 cents. In February 2011, it rose again and was
mentioned on Slashdot for achieving "dollar parity"; it hit $1.06
before settling in at roughly 87 cents.
In the spring, catalyzed in part by a much-linked Forbes story on the
new "crypto currency," the price exploded. From early April to the end
of May, the going rate for a bitcoin rose from 86 cents to $8.89.
Then, after Gawker published a story on June 1 about the currency's
popularity among online drug dealers, it more than tripled in a week,
soaring to about $27. The market value of all bitcoins in circulation
was approaching $130 million. A Tennessean dubbed KnightMB, who held
371,000 bitcoins, became worth more than $10 million, the richest man
in the bitcoin realm. The value of those 10,000 bitcoins Hanyecz used
to buy pizza had risen to $272,329. "I don't feel bad about it," he
says. "The pizza was really good."
Perhaps bitcoin's creator wasn't one man but a mysterious group—a team
at Google, maybe, or the NSA.Bitcoin was drawing the kind of attention
normally reserved for overhyped Silicon Valley IPOs and Apple product
launches. On his Internet talk show, journo-entrepreneur Jason
Calacanis called it "a fundamental shift" and "one of the most
interesting things I've seen in 20 years in the technology business."
Prominent venture capitalist Fred Wilson heralded "societal upheaval"
as the Next Big Thing on the Internet, and the four examples he gave
were Wikileaks, PlayStation hacking, the Arab Spring, and bitcoin.
Andresen, the coder, accepted an invitation from the CIA to come to
Langley, Virginia, to speak about the currency. Rick Falkvinge,
founder of the Swedish Pirate Party (whose central policy plank
includes the abolition of the patent system), announced that he was
putting his life savings into bitcoins.
The future of bitcoin seemed to shimmer with possibility. Mark Suppes,
an inventor building a fusion reactor in a Brooklyn loft from
eBay-sourced parts, got an old ATM and began retrofitting it to
dispense cash for bitcoins. On the so-called secret Internet (the
invisible grid of sites reachable by computers using Tor anonymizing
software), the black-and-gray-market site Silk Road anointed the
bitcoin the coin of the realm; you could use bitcoins to buy
everything from Purple Haze pot to Fentanyl lollipops to a kit for
converting a rifle into a machine gun. A young bitcoiner, The Real
Plato, brought On the Road into the new millennium by video-blogging a
cross-country car trip during which he spent only bitcoins. Numismatic
enthusiasts among the currency's faithful began dreaming of
collectible bitcoins, wondering what price such rarities as the
genesis block might fetch.
As the price rose and mining became more popular, the increased
competition meant decreasing profits. An arms race commenced. Miners
looking for horsepower supplemented their computers with more powerful
graphics cards, until they became nearly impossible to find. Where the
first miners had used their existing machines, the new wave, looking
to mine bitcoins 24 hours a day, bought racks of cheap computers with
high-speed GPUs cooled by noisy fans. The boom gave rise to mining-rig
porn, as miners posted photos of their setups. As in any gold rush,
people recounted tales of uncertain veracity. An Alaskan named Darrin
reported that a bear had broken into his garage but thankfully ignored
his rig. Another miner's electric bill ran so high, it was said, that
police raided his house, suspecting that he was growing pot.
Amid the euphoria, there were troubling signs. Bitcoin had begun in
the public-interested spirit of open source peer-to-peer software and
libertarian political philosophy, with references to the Austrian
school of economics. But real money was at stake now, and the dramatic
price rise had attracted a different element, people who saw the
bitcoin as a commodity in which to speculate. At the same time, media
attention was bringing exactly the kind of heat that Nakamoto had
feared. US senator Charles Schumer held a press conference, appealing
to the DEA and Justice Department to shut down Silk Road, which he
called "the most brazen attempt to peddle drugs online that we have
ever seen" and describing bitcoin as "an online form of
money-laundering."
Meanwhile, a cult of Satoshi was developing. Someone started selling I
AM SATOSHI NAKAMOTO T-shirts. Disciples lobbied to name the smallest
fractional denomination of a bitcoin a "satoshi." There was
Satoshi-themed fan fiction and manga art. And bitcoiners continued to
ponder his mystery. Some speculated that he had died. A few postulated
that he was actually Wikileaks founder Julian Assange. Many more were
convinced that he was Gavin Andresen. Still others believed that he
must be one of the older crypto-currency advocates—Finney or Szabo or
Dai. Szabo himself suggested it could be Finney or Dai. Stefan Thomas,
a Swiss coder and active community member, graphed the time stamps for
each of Nakamoto's 500-plus bitcoin forum posts; the resulting chart
showed a steep decline to almost no posts between the hours of 5 am
and 11 am Greenwich Mean Time. Because this pattern held true even on
Saturdays and Sundays, it suggested that the lull was occurring when
Nakamoto was asleep, rather than at work. (The hours of 5 am to 11 am
GMT are midnight to 6 am Eastern Standard Time.) Other clues suggested
that Nakamoto was British: A newspaper headline he had encoded in the
genesis block came from the UK-published Times of London, and both his
forum posts and his comments in the bitcoin source code used such Brit
spellings as optimise and colour.
Play Dough ———-
Key moments in the short and volatile
life of bitcoin.
Even the purest technology has to live in an impure world. Both the
code and the idea of bitcoin may have been impregnable, but bitcoins
themselves—unique strings of numbers that constitute units of the
currency—are discrete pieces of information that have to be stored
somewhere. By default, bitcoin kept users' currency in a digital
"wallet" on their desktop, and when bitcoins were worth very little,
easy to mine, and possessed only by techies, that was sufficient. But
once they started to become valuable, a PC felt inadequate. Some users
protected their bitcoins by creating multiple backups, encrypting and
storing them on thumb drives, on forensically scrubbed virgin
computers without Internet connections, in the cloud, and on printouts
stored in safe-deposit boxes. But even some sophisticated early
adopters had trouble keeping their bitcoins safe. Stefan Thomas had
three copies of his wallet yet inadvertently managed to erase two of
them and lose his password for the third. In a stroke, he lost about
7,000 bitcoins, at the time worth about $140,000. "I spent a week
trying to recover it," he says. "It was pretty painful." Most people
who have cash to protect put it in a bank, an institution about which
the more zealous bitcoiners were deeply leery. Instead, for this new
currency, a primitive and unregulated financial-services industry
began to develop. Fly-by-night online "wallet services" promised to
safeguard clients' digital assets. Exchanges allowed anyone to trade
bitcoins for dollars or other currencies. Bitcoin itself might have
been decentralized, but users were now blindly entrusting increasing
amounts of currency to third parties that even the most radical
libertarian would be hard-pressed to claim were more secure than
federally insured institutions. Most were Internet storefronts, run by
who knows who from who knows where.
Sure enough, as the price headed upward, disturbing events began to
bedevil the bitcoiners. In mid-June, someone calling himself Allinvain
reported that 25,000 bitcoins worth more than $500,000 had been stolen
from his computer. (To this day, nobody knows whether this claim is
true.) About a week later, a hacker pulled off an ingenious attack on
a Tokyo-based exchange site called Mt. Gox, which handled 90 percent
of all bitcoin exchange transactions. Mt. Gox restricted account
withdrawals to $1,000 worth of bitcoins per day (at the time of the
attack, roughly 35 bitcoins). After he broke into Mt. Gox's system,
the hacker simulated a massive sell-off, driving the exchange rate to
zero and letting him withdraw potentially tens of thousands of other
people's bitcoins.
As it happened, market forces conspired to thwart the scheme. The
price plummeted, but as speculators flocked to take advantage of the
fire sale, they quickly drove it back up, limiting the thief's haul to
only around 2,000 bitcoins. The exchange ceased operations for a week
and rolled back the postcrash transactions, but the damage had been
done; the bitcoin never got back above $17. Within a month, Mt. Gox
had lost 10 percent of its market share to a Chile-based upstart named
TradeHill. Most significantly, the incident had shaken the confidence
of the community and inspired loads of bad press.
In the public's imagination, overnight the bitcoin went from being the
currency of tomorrow to a dystopian joke. The Electronic Frontier
Foundation quietly stopped accepting bitcoin donations. Two Irish
scholars specializing in network analysis demonstrated that bitcoin
wasn't nearly as anonymous as many had assumed: They were able to
identify the handles of a number of people who had donated bitcoins to
Wikileaks. (The organization announced in June 2011 that it was
accepting such donations.) Nontechnical newcomers to the currency,
expecting it to be easy to use, were disappointed to find that an
extraordinary amount of effort was required to obtain, hold, and spend
bitcoins. For a time, one of the easier ways to buy them was to first
use Paypal to buy Linden dollars, the virtual currency in Second Life,
then trade them within that make-believe universe for bitcoins. As the
tone of media coverage shifted from gee-whiz to skeptical, attention
that had once been thrilling became a source of resentment.
Illustration: Martin Venezky
More disasters followed. Poland-based Bitomat, the third-largest
exchange, revealed that it had—oops—accidentally overwritten its
entire wallet. Security researchers detected a proliferation of
viruses aimed at bitcoin users: Some were designed to steal wallets
full of existing bitcoins; others commandeered processing power to
mine fresh coins. By summer, the oldest wallet service, MyBitcoin,
stopped responding to emails. It had always been fishy—registered in
the West Indies and run by someone named Tom Williams, who never
posted in the forums. But after a month of unbroken silence, Wagner,
the New York City bitcoin evangelist, finally stated what many had
already been thinking: Whoever was running MyBitcoin had apparently
gone AWOL with everyone's money. Wagner himself revealed that he had
been keeping all 25,000 or so of his bitcoins on MyBitcoin and had
recommended to friends and relatives that they use it, too. He also
aided a vigilante effort that publicly named several suspects.
MyBitcoin's supposed owner resurfaced, claiming his site had been
hacked. Then Wagner became the target of a countercampaign that
publicized a successful lawsuit against him for mortgage fraud,
costing him much of his reputation within the community. "People have
the mistaken impression that virtual currency means you can trust a
random person over the Internet," says Jeff Garzik, a member of
bitcoin's core developer group.
And nobody had been as trusted as Nakamoto himself, who remained
mysteriously silent as the world he created threatened to implode.
Some bitcoiners began to suspect that he was working for the CIA or
Federal Reserve. Others worried that bitcoin had been a Ponzi scheme,
with Nakamoto its Bernie Madoff—mining bitcoins when they were
worthless, then waiting for their value to rise. The most dedicated
bitcoin loyalists maintained their faith, not just in Nakamoto, but in
the system he had built. And yet, unmistakably, beneath the paranoia
and infighting lurked something more vulnerable, an almost theodical
disappointment. What bitcoiners really seemed to be asking was, why
had Nakamoto created this world only to abandon it?
If Nakamoto has forsaken his adherents, though, they are not prepared
to let his creation die. Even as the currency's value has continued to
drop, they are still investing in the fragile economy. Wagner has
advocated for it to be used by people involved in the Occupy Wall
Street movement. While the gold-rush phase of mining has ended, with
some miners dumping their souped-up mining rigs—"People are getting
sick of the high electric bills, the heat, and the loud fans," Garzik
says—the more serious members of the community have turned to
infrastructure. Mt. Gox is developing point-of-sale hardware. Other
entrepreneurs are working on PayPal-like online merchant services. Two
guys in Colorado have launched BitcoinDeals, an etailer offering "over
1,000,000 items." The underworld's use of the bitcoin has matured,
too: Silk Road is now just one of many Tor-enabled back alleys,
including sites like Black Market Reloaded, where self-proclaimed hit
men peddle contract killings and assassinations.
"You could say it's following Gartner's Hype Cycle," London-based core
developer Amir Taaki says, referring to a theoretical
technology-adoption-and-maturation curve that begins with a
"technology trigger," ascends to a "peak of inflated expectations,"
collapses into a "trough of disillusionment," and then climbs a "slope
of enlightenment" until reaching a "plateau of productivity." By this
theory, bitcoin is clambering out of the trough, as people learn to
value the infallible code and discard the human drama and wild
fluctuations that surround it.
But that distinction is ultimately irrelevant. The underlying
vulnerabilities that led to bitcoin's troubles—its dependence on
unregulated, centralized exchanges and online wallets—persist. Indeed,
the bulk of mining is now concentrated in a handful of huge mining
pools, which theoretically could hijack the entire network if they
worked in concert.
Beyond the most hardcore users, skepticism has only increased. Nobel
Prize-winning economist Paul Krugman wrote that the currency's
tendency to fluctuate has encouraged hoarding. Stefan Brands, a former
ecash consultant and digital currency pioneer, calls bitcoin "clever"
and is loath to bash it but believes it's fundamentally structured
like "a pyramid scheme" that rewards early adopters. "I think the big
problems are ultimately the trust issues," he says. "There's nothing
there to back it up. I know the counterargument, that that's true of
fiat money, too, but that's completely wrong. There's a whole trust
fabric that's been established through legal mechanisms."
It would be interesting to know what Nakamoto thinks of all this, but
he's not talking. He didn't respond to emails, and the people who
might know who he is say they don't. Andresen flatly denies he is
Nakamoto. "I don't know his real name," he says. "I'm hoping one day
he decides not to be anonymous anymore, but I expect not." Szabo also
denies that he is Nakamoto, and so does Dai. Finney, who has blogged
eloquently about being diagnosed with amyotrophic lateral sclerosis,
sent his denial in an email: "Under my current circumstances, facing
limited life expectancy, I would have little to lose by shedding
anonymity. But it was not I." Both The New Yorker and Fast Company
have launched investigations but ended up with little more than
speculation.
The signal in the noise, the figure that emerges from the carpet of
clues, suggests an academic with somewhat outdated programming
training. (Nakamoto's style of notation "was popular in the late '80s
and early '90s," Taaki notes. "Maybe he's around 50, plus or minus 10
years.") Some conjecturers are confident in their precision. "He has
at best a master's," says a digital-currency expert. "It seems quite
obvious it's one of the developers. Maybe Gavin, just looking at his
background."
"I suspect Satoshi is a small team at a financial institution,"
whitehat hacker Dan Kaminsky says. "I just get that feeling. He's a
quant who may have worked with some of his friends."
But Garzik, the developer, says that the most dedicated bitcoiners
have stopped trying to hunt down Nakamoto. "We really don't care," he
says. It's not the individuals behind the code who matter, but the
code itself. And while people have stolen and cheated and abandoned
the bitcoiners, the code has remained true.
Benjamin Wallace ([email protected]) wrote about scareware in issue 19.10.
#19.12
#bitcoin
#features
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