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Bitcoin has seen a huge price bubble in the last few weeks - but it's not the first one, and the currency has survived them before. Right With the Ship

Bitcoin or bit-con? Meet the crypto-currency that's taking over the internet

We explain the online-only currency that’s been making waves this week – and meet some Irish people with a lot to lose…

IF YOU HAD €1,000 to invest at the start of the year, you may have been tempted to leave it in a savings account for a few months, or perhaps – if you were feeling speculative – invested it in shares on the stock market.

Putting €1,000 in a savings account would probably not have made you any money by now – the interest would probably be paid only on an annual basis, so you’d be waiting until Christmas for your pile of cash to grow – and even then, only by around €20 when DIRT is subtracted.

You could, perhaps, have put your money into shares in AIB, in which case you could be quite happy: this week its shares traded for 9c each, up from 6c each on New Year’s Day. That’s a gain of 50 per cent.

If you’d gone with Paddy Power, you would be looking at a return of 7.3 per cent. If you’d invested in Ryanair, your investment would have risen by nearly 21 per cent.

However, there is one investment which would have vastly outperformed any of those – turning your €1,000 into over €5,000. But that’s only if you invested at the right time – if you invested last week, you could already be broke.

Welcome to the barmy and volatile world of Bitcoin: the electronic-only ‘crypto-currency’ that might just change international finance for good.

1. A currency like you’ve never seen before

To explain it in basic terms, Bitcoin is a currency designed for purely electronic use. There are no physical coins or banknotes with Bitcoins: they exist only as a series of ones and zeroes zipping through the ether of cyberspace.

Just like traditional currencies, Bitcoins can be traded and exchanged for other currencies, with its value – relative to other currencies – rising and falling in line with the laws of supply and demand.

The main difference between Bitcoin and others, aside from its existence in purely electronic format, is that Bitcoin is almost totally ungoverned and almost totally ungovernable. It is not issued by a nation or its central bank: it lives an existence outside of the boundaries and control of a nation-state.

This has its pros and cons: a currency issued by a major country with a stable economy will have a very stable value over time. If the currency hits a crisis, the central bank can step in and do whatever is needed to save the currency and keep its value steady – usually by printing more money.

This sometimes has its downsides. Central banks can use their power to print cash in an aggressive fashion: this week Japan announced that it would be massively increasing the supply of yen, hoping to kickstart an economy that has been static for 20 years.

That’s good if you’re a business owner, but bad news if you’re a saver: the more yen that exist in the world, the less valuable each one is. If a central bank turns on the tap and allows new money to flow into the system, you get inflation – and the value of your savings begins to fall.

2. No central bank, no rules (but no fall-back)

Bitcoin turns this entire idea on its head. With no central bank, it lives on a network created and operated by users around the world, whose Bitcoin software communicates continually with other programs to keep a ‘log’ of all Bitcoins spent in the world.

This gets around the problem of ‘double spending’, which plagued earlier online currencies. Other systems, if attacked, could be manipulated so that a single coin could be spent twice – and, as we’ve seen, any system that allows money to be manufactured in huge scales is destined for failure.

Bitcoin breaks this model by using a nifty system which requires every transaction to be logged by every other user. If Adam wants to send 1 Bitcoin to Eve, the details of the transaction are immediately sent to the entire world.

The world is not told that the users are Adam and Eve, however. Every Bitcoin user has an ‘address’ – a unique 34-character combination of letters and numbers – which works as an account number.

So when Adam wants to send money to Eve, he asks Eve for her address and sends the money to that address. The rest of the world is simply told that 1 Bitcoin has been sent to Eve’s address – for example, ’1EDRfpadJ8cYpCZEnmq3UQ4NinxQo6JQcp’.

The Bitcoins appear in Eve’s account almost immediately; an hour later, when the transaction has been included in six updates to the log (which is formally every ten minutes), the transaction is finalised permanently, and the entire world knows where that coin has gone.

That’s not to say that the currency is impenetrable: if your Bitcoins are stored in a web-based wallet, the website could itself be compromised; if they’re stored in a desktop client, the integrity of the machine itself is all that stands in the way of a theft.

Here, the anonymity becomes a downside: any thief can create a new address, send your money to their account, and use the web of anonymity to send the cash around the world before you might even notice it’s missing.

3. How steady are the foundations?

(Flickr: 11950mike)

There are other architectural flaws. Last month, a new edition of the Bitcoin software was released – but a coding error meant that the log of payments ‘forked’, depending on whether a user had the old or new software.

This meant that some users had slightly different records of who held what – completely undermining the whole point of the system, as it became theoretically possible for the same coin to be spent twice, depending on who “owned” it in the first place.

“This appeared to be because of an incompatibility between different versions of the software that bitcoin ‘miners’ use,” explains Dr Fergal Reid, who co-wrote an analysis of Bitcoin anonymity (or lack thereof) while studying for a PhD in UCD two years ago.

“If there is a problem, where software disagrees about the format in which the history is stored, then this can cause the single shared consensus to be broken. That’s what happened in that case,” he says.

The architectural flaw, however, was countered by honesty and positivity among Bitcoin’s users. Within hours, users on message boards and exchanges had diagnosed the problem, and collectively decided to reset the ‘log’ of transactions – reversing all the payments that took place after the fork emerged.

“They all agreed that the best thing to do was for everyone to just switch back to [version] 0.7″, abandoning the botched version 0.8, Reid explains.

“As the miners really have all the computing power, they really can control things like this, if they all agree, and so they all switched back. Transaction processing got held up for a while, but they got everything sorted out in the end.”

An amended version of the software – version 0.81 – was quickly produced, and the currency continued – with only a few hours of downtime in between.

4. So where do new coins come from?

Another difficulty that has been faced by other currencies in the past is the problem of where new currency comes from. There’s no point having an online currency if it has the same sort of governance as a real one – where someone can fire up the printing presses and make every coin less valuable.

But likewise, no currency can ever work if a person has a monopoly on it. A new country will find it tough to get others to accept its currency, if they suspect that the new central bank will print so much new money that every unit becomes worthless.

Bitcoin’s architectural strong point is the way in which new coins are created. Everybody who runs a Bitcoin program on their computer or phone, while logging and validating the transactions of other users, can simultaneously ‘mine’ new coins.

This is done in a complicated, mathematical way, but essentially different users try to solve complex mathematical problems using their computers. Every 10 minutes, users compare their answers, and the best answer ‘mines a block of 25 new Bitcoins’.

The Bitcoin architecture is designed so that this rate will halve in the year 2017, to 12.5 coins every ten minutes, and then halve again every four years until a limit of 21 million coins is reached in the year 2140.

5. The value of ones and zeroes

Richard Nixon. It’s his fault. (Bob Schutz/AP)

This leads to a philosophical question: where the actual value is in Bitcoins. If they exist only in the digital world, as elaborate and complex strings of 0 and 1, where is the hard currency behind it?

The response of Bitcoin enthusiasts is simple: all money, whether governed by a central bank or living independently within defined limits like Bitcoins, is fictional anyway.

Central banks used to hold stocks of gold, and issue banknotes and coins as a representation of that gold. When they were first used, banknotes were basically a voucher for this gold – instead of carrying out lumps of gold, people gave each other vouchers instead.

But in 1971 Richard Nixon changed all this, deciding that the US dollar could no longer be directly converted to gold. Other countries, whose currencies were pegged to the dollar, had no option but to start allowing the value of their currencies to float around.

Since then, the value of a currency has been set only by simple laws of supply and demand – so ultimately, the value of a currency is a question of trust. If people don’t think your money can be trusted, they lower the price.

When originally outlining the architecture of Bitcoin, Satoshi Nakamoto – its (probably) pseudonymous inventor – put it like this:

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.

His idea is shared by many. Cameron and Tyler Winklevoss, the twins who claimed Mark Zuckerberg had stolen their idea for Facebook, have invested a lot of their out-of-court settlement in Bitcoins.

“We have elected to put our money and faith in a mathematical framework that is free of politics and human error,” Tyler told the New York Times this week. (The twins’ investments in Bitcoin have been taken ‘offline’, backed up on USB keys and stored in safety deposit boxes at various banks.)

6. A currency, or a commodity?

Not everybody shares their faith, however. Reuters blogger Felix Salmon reckons the currency is more like a commodity, because of the finite number of coins (there are only 11 million coins out there right now) – and a poor one at that, because you don’t get a block of gold to hold afterwards.

What’s more, there aren’t many exchanges which will buy your euro, or dollar, and give you a Bitcoin in exchange – meaning that when the market gets jittery (as it did this week – but more on that later), you can find yourself locked in with nobody who’ll exchange your Bitcoins for actual coins.

Nonetheless, the value has continued to creep up: the more people have heard about Bitcoin, and the more people who use it, the value has kept creeping up.

“Whatever you think about it as an economic system – and it has taken some flack from economists, due to its ‘deflationary’ nature – its a very impressive technological structure,” Fergal Reid says.

“Many technologists, have been talking about an on-line currency for a long time.  Bitcoin is possibly the first online currency that looks like it has a shot at adoption, and it seems to have captured the imagination of a lot of early adopters – this definitely makes it worth paying attention to.”

He says the security concerns are legitimate, because a determined hacker will be able to bury their way into most systems – and only the most security-savvy users can make themselves effectively secure from an attacker looking to turn a profit.

That aside, as long as someone takes the necessary precautions, he says, the vulnerability of poor security cannot be a permanent one.

“Techies have been talking about online cryptocurrencies for years, and Bitcoin is the first system that looks like it has a potential shot at adoption, so that makes it pretty exciting,” he says.

7. The rise and rise (and fall and fall and rise again)

An artist’s impression of Bitcoin prices in the last fortnight. (Flickr/Stellajo1976)

Which brings us to the question of price bubbles, and what’s been happening in Bitcoin in the last week.

The massive spike of Bitcoin prices in the last few weeks is nothing new. In 2011, Gawker posted a feature about a website called ‘Silk Road’ – which can only be accessed after first installing special software on your computer – which accepted Bitcoin as payment for hard drugs.

The system seemed pretty elegant: users could add some LSD to their shopping cart, send some Bitcoins to the address of the dealer – instantly, with no transaction fees, and with almost total anonymity – and receive their products, discreetly packaged, in the mail a few days later.

Before the Gawker piece, you could buy one Bitcoin for about $4. The exposure from Gawker attracted massive numbers of other users, who pushed the price up to $33 – partially as a result of people who wanted to buy mail-order drugs, but mostly from people who saw the price rising and wanted to make a quick buck.

The boom didn’t last – but the price never sank back to its previous level, and stayed at around $17 for a while afterwards.  There have been some slumps since then, but by January the price was back to about $13.50 and fairly stable.

And then… Cyprus happened.

8. The quickest bubble in history

The attraction behind leaving your savings in a bank – in theory at least – is that your money is safe there. If you leave your money in a mattress, and your house burns down, you’re out of luck – but even if a bank is robbed, or collapses altogether, the bank and government will work together so you won’t be left out of pocket.

The Cyprus bailout changed all of that, with the groundbreaking – and widely reviled – proposal to take a slice out of people’s bank accounts. Those with balances under €100,000 – the amount ‘guaranteed’ under EU law – would lose 6.75 per cent of their savings. Naturally, people ran to the ATMs, trying to get their money out before the levy kicked in.

That got people wondering: is there anywhere where we can leave our money, where it isn’t vulnerable to some sort of tax or levy – somewhere where money is untouchable?

People started talking about Bitcoin again, and the price started to balloon – but on a way bigger scale than in 2011. This time the media coverage was mainstream – and the more people who learned about Bitcoin, the more people decided to use it as a safe haven, and the more people tried to make a quick buck.

Those trying to take a quick profit  did. A week before Cyprus, you could buy 1 Bitcoin for about €35. A week after Cyprus, it cost €75. Last weekend, it was €120. Last Wednesday afternoon, it was over €200.

The huge surge in price meant that anyone who invested three weeks ago made a tidy profit – but anyone who had bought Bitcoins years ago, when you could pay under €1 for a single coin, became millionaires overnight.

One such user, who became instantly rich, registered the name ‘Bitcoinbillionaire‘ on Reddit – and started ‘tipping’ other users, sending them Bitcoins which had been seemingly bought (or mined) a long time ago, and which had gone from worthless to priceless.

One user was gifted 20 Bitcoins, the equivalent of €3,600 at that moment. In all, by one calculation, the ‘billionaire’ gave away over €10,000.

9. Swings and roundabouts

Shane O’Brien, an IT manager from Blackrock in Dublin, never invested hard cash in Bitcoins – but in 2011, when he was building a powerful new PC and after Gawker brought the currency to prominence, he installed the Bitcoin software and tried to exploit his machine’s power through mining.

By last year, between optional transaction fees and mining, he had accrued a decent wallet. “I got 44 of them about this time last year, which I sold for whatever reason, at about US$4 each,” he says, pocketing what appeared to be a tidy profit of about €170.

He told me he wishes he’d waited a little longer. His 44 Bitcoins, at their peak price on Wednesday, would have been worth €11,400.

Jamie Farrelly, a 19-year-old student living in Meath, can see the practical and ideological advantages of Bitcoin – but admits to being compelled by the idea of an easy profit.

“To be honest, the huge price increases were one of the main things that attracted me to Bitcoin, just like most other people who have started to get in on the action,” he told me this week.

I only bought some coins four days ago. You mightn’t think that it’d be possible to make money within just four days, but at the current prices I’m up around 50 per cent already.

“It’s kind of weird in a way, because I honestly thought that I was probably too late to the party to make any decent money, but it seems like the price is still on the increase,” he wrote.

That was on Tuesday.

People queue at an ATM outside a closed branch of Laiki Bank in Cyprus, trying to get their money out before a deposit levy kicked in. (Petros Giannakouris/AP)

10. What goes up…

But then the bubble burst. Last Wednesday, a critical mass of buyers decided they wanted to guarantee their profits, and turn their Bitcoins back into cash. The problem was that, as soon as people started selling, nobody wanted to buy any more.

After briefly touching €260 on Wednesday afternoon, the price fell to to €230 by 6pm – and then to €210 by 7pm, and down to €140 by 9pm. And it kept falling.

The storm seemed to have passed by that night – the price recovered to around €130 and seemed to be holding steady – but on Thursday afternoon, another wave of attempted sales brought another collapse in the price.

The flood was so fierce that MtGox, the most popular exchange website, decided to shut down for 12 hours in an effort to restore calm. When it reopened, at 3am on Friday morning, the price was €130. By 3pm yesterday, it had fallen back even further, to €52.50.

If you’d invested in Bitcoin on Wednesday afternoon, by Friday your investment would have lost more than 80 per cent.

For people like Richard Falkvinge, it can be a difficult rollercoaster to ride. Falkvinge is the founder of Sweden’s Pirate Party, and a passionate believer in the ability of Bitcoin to transform payments between ordinary people around the world.

He admits that he has a “significant position” in Bitcoin, which he hopes will provide his retirement some day (“until then I’m trying not to touch it too much”, he says).

“It’s completely wild. You start out with a [Bitcoin account] which has grown to nothing I’ve ever owned before, and then you have a very large amount of money just erased over dinner,” he told me.

So how do you live with your life savings on the line, lurching from priceless to worthless so quickly? “You just have to emotionally block it out, to be honest,” he believes.

It helps to think of it as toy money – although it isn’t, obviously – because if you start to wrap your head around losing six or seven digit amounts over dinner, then you’re just going to go insane.

On the other hand, you just gained as much in the previous week…

11. What future?


Where Bitcoin goes in the future is anybody’s guess – though most supporters agree that this week’s price instability isn’t good for its perception, if it means people consider Bitcoin an investment and not a currency in itself.

“What we’ve seen over these last days is there’s a lot of kinks to work out in the fabric of the system,” Falkvinge says.

“But long-term, I see a lot of new upstarts; I see a lot of new entrepreneurs, I see a lot of ideologically driven people wanting to build an infrastructure for Bitcoin. And that infrastructure is not there yet. But as it grows, I think the ecosystem gets better at handling these kinds of wild swings in the exchange rate.”

Ultimately, he believes, Bitcoin’s future is not in everyday use. He says you’ll never pay for a pint in Bitcoins (though there’s a bar in New York which is now accepting it) – but if you’re sending money abroad, it will become obvious that the best day is by using Bitcoin or some other cyber-currency that emerges in the future.

“I think Bitcoin has the potential to become the de facto international trade currency, replacing the dollar in that area,” he says – like a financial version of Esperanto, a language created specifically to be easy to learn so that everyone would use it as a second language.

Another user, Irish-based Pawel Makulski, is setting up a consultancy company to help Irish businesses accept Bitcoin payments online. He sees a future where “everything is possible” for the currency.

“I am nearly certain that Bitcoin will become largely accepted currency, especially now when it’s clear – at least in the United States – that it is perfectly legal to accept Bitcoin as payment,” he told me in an email.

“I am also certain that very soon we will see many businesses based on Bitcoin – like banks, stock markets, insurance, pension schemes.”

Even 19-year-old Farrelly – who would be looking at a pretty big loss if he sold his Bitcoins now – is hopeful of a bright future.

“People are starting to lose faith in the currency that they’ve been using for as far as they can remember, and it’s no wonder after seeing the Cypriot government taking 60 per cent of some people’s money,” he reckons.

I’m not saying that Bitcoin is definitely going to be the future, but there’s a chance that it could be.

12. The price of everything, and the value of nothing

For now, for Jean-Pierre Rupp, the rise and fall of the price is not much a concern. Rupp moved his savings to Bitcoin in 2011, and the rise in price since then – even subtracting the various bubbles – mean he could live off the gains for life.

He now spends his days building intensely powerful machines to mine for Bitcoin professionally – something which wasn’t viable when Bitcoins were cheap (the cost of electricity was more than the value of the coins), but which could now be very lucrative.

Rupp was amused by the Chicken Licken users who feared the sky was falling in on Wednesday night. For him, Bitcoin has all the qualities needed to become proper money – more so than anything else.

“It is algorithmically guaranteed to be scarce (scarcity), it can redundantly backed up making it a very durable and resilient asset (durability), it is divisible up to a hundred million units (divisibility), it is extremely easy to transfer internationally (fungibility), and it can be readily verified for authenticity (recognisability),” he told me in an email.

Rupp says traditional currencies like the euro or dollar – or even silver and gold – have these properties to a lesser extent, meaning they’re less fit to act as money.

“I expect Bitcoin to take a large chunk of the currency market, and maybe even to overtake all other forms of money in the market,” he says.

Shane O’Brien, however, warns that there are still architectural flaws in the currency. Professional miners have begun to pool their resources and share the proceeds of their industrial mining efforts – and one such ring is coming dangerously close to being too big.

Because mining ability is directly related to computing power, the group is almost close to accounting for over 50 per cent of all new coins, and 50 per cent of processing power – which gives them the possibility of creating another deliberate fork in the system.

“If somebody else verifies transactions, and the people who are controlling the chain [...] just choose to ignore those transactions and roll back to a previous state,” the very fabric of the currency could be torn apart, he says. “People might not always be nice enough to fix it.”

But this requires ill-intent on the part of the miners – who are unlikely to kill off a currency that could make them millionaires. The user-enforced solution to last month’s fork is proof that users will not allow Bitcoin to disappear easily.

Perhaps as long as there are users like Rupp, who now depend on the currency for their livelihood, the government-free currency could be around for a long time to come. He says so himself: “I promise you this will be big.”

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