- One of the more startling scenes in markets recently has been the stunning rise (and today’s fall) of bitcoins
Since the hackers, smugglers, armadillo hat-wearing conspiracy theorists(1) and submarine builders that actually use these are now all millionaires, it would be good to know if we can join them.
For those unaware (and advance apologies if you’re all over this) bitcoins are a digital cryptocurrency. Not digital in the sense that they can be transferred online – which they can – but digital in the sense that defines their whole DNA.
They were created by Satoshi Nakamoto who published a brilliant paper in 2008 outlining how the whole thing would work. Suitably he had never been heard of before, has barely been heard from since, and probably doesn’t exist.
In a nutshell it makes clever use of hashing, where you apply an algorithm to some data (text, numbers, a timestamp) to come up with the ‘hash’: a series of random numbers. Since changing one part of the original data completely changes the ‘hash’, you can tell if it’s been tampered with.
Of bitcoin there is much to like. You can ‘mine’ them, they can be transferred anonymously, stored and encrypted on any private hard-drive and every transaction is confirmed by the whole BTC community.
If you haven’t heard of the Silkroad (great name) its existence may surprise you. It’s a dark, dingy hole of the internet were dealers and unsavouries make a brisk business in illicit substances only accessible through a secure Tor browser.(2)
For pure interest’s sake, it’s worth taking a look. This is the link. You will see everything from heroin to OTC medicines, all at very reasonable prices, and bitcoins are the only accepted tender.
(taken from Businessweek)
You place your order encrypting your mailing address with a public key, pay in bitcoin, and the dealer sends you your purchase hidden in an envelope or box. As with any self-respecting online marketplace, you can see feedback from other purchases and an average rating. Amusingly, many also have clearly laid out repayment policies.
While the dealer is relatively secure – he passed over no defining or incriminating data – there is still a crack or two. If you place an order, at some point you’re going to have to take delivery, and herein lies the risk. But I’m sure you can think of some clever ways of getting around that, and a cursory glance suggests business is booming.
With some fanfare, newspapers recently noted that the value of bitcoins in circulation was worth over 1 billion dollars and apparently this is supposed to be impressive.
Everyone from Forbes to people who should no better, like Felix Salmon, rushed over themselves to apply that tired and rusty word ‘bubble’ to the case at hand, as though noticing that something has gone up significantly and saying ‘Look! A bubble!’ somehow makes up for the vast majority of market calls they’ve got completely, utterly and publicly wrong.
How big do you think the market for illicit drugs is?
Whenever it looks like something is running short and the price is going to rocket, the narrowly-read point to Mlathus and invariably miss the supply response that pushes the price below what it was initially.
At some point I’m going to write a post on this. The ‘instability’ of our much maligned market system gleefully pointed at and criticised by well fed critics is precisely why, with nearly 7 billion people on this planet, we haven’t run out of food yet, and why in the 90s, billions were lost laying uneconomic cable across vast oceans that set up the next decade of growth, development and ‘bubbles’, and there are similar examples across the economy, from railroads to ships to mining.
In this case, the creation of bitcoins has been carefully and tightly designed.
If you were wondering if you could create bitcoins that were accepted by everyone else, you certainly can. It’s called mining (whoever coined the terms really nailed the language). Anyone can apply their computer’s CPU to discovering new bitcoins, which become harder and harder to calculate. Naturally, all the low lying fruit has been collected, and you’ll need to join a pool to do this with any chance of success.
Everyone has gleefully noted that this market is very efficient. The amount of bitcoins you mine almost precisely matches up with the cost of electricity to run your mining software. As bitcoins become harder and harder to mine, the supply impact on price will naturally diminish, and for mining to make any sense, the price will have to rise for the process to be economic.
Interestingly, this means that coins mined today will be worth far more CPU and electricity tomorrow by design of the system.
An additional restriction is that the total supply of bitcoins is capped at 21 million.
Bitcoins have so far proven secure by the only known method: publishing the entire system to see if anyone can hack it. As you can imagine, a pool of anonymous digital money is about as tempting as anything is ever going to be to the shady state and private players capable of doing this.
While bitcoins themselves seem to be secure, there are weaknesses in other parts of the ecosystem. Your personal bitcoins can be stolen if not encryped properly, and the largest USD-BTC exchange, Mt Gox, has been attacked before and is apparently under severe DDoS attack now. There has been plenty of speculation that hackers attack these exchanges to manipulate the market, dash confidence and give themselves a chance to buy BTC on the cheap.
If governments were serious about shutting down the Silk Road and the like, attacking vulnerabilities in the architecture would be quite a good way of doing it.
But as long as the Bitcoins themselves remain intact, then this will work, and having gone up 4-5x in the past 30 days, dropping 50% or more is not so much a surprise.
Note: talking about market percentages using percentages can be very misleading, as the denominator changes every time.
Supply and Demand
So, on the supply side we have mathematically restricted and limited mining, at rates that are barely economic, while on the demand side we are left with a market full of 1) armadillos hoarding everything they buy/mine in preparation for the end of the world and 2) drug dealers, arms smugglers and their clients for whom there are simply huge inherent advantages of transacting in bitcoins.
You don’t need to be an economist (I’m not) to realise that $2.5 billion BTC in circulation is small-fry for these guys. So… which side of this trade do you want to be on?
Once you start googling things like this, you invariably come across some pretty whack stuff.
One of the more chilling was the concept of assassination markets.
Imagine a site accessible only through Tor, with public key encryption and all payments were made in bitcoin, much like the Silk Road.
A user could submit someone to be assassinated, either a public figure, or simply their photo and details. Other members would be able to contribute bitcoins to the cause. If that person was taken out, the whole sum would go to whoever could prove they would do it. This would be the hard part, but there are ways, for example, by revealing a pre-encrypted explanation of how you intend to do it.
If this had been set up a year ago, the kitty would be worth many times more than anyone actually contributed. A disturbing thought.
A saving grace, to use a silkroad analogy, is that the same way a delivery always puts the purchaser at risk but hides the sender, the hit man would still be subject to the usual methods of law enforcement. We can only hope that state resources would have more success in shutting down a site like this than they have with the Silkroad.
Taking this further: https://adamantic.wordpress.com/2013/05/16/thriving-hive-2/
(1) Don’t ever wear or eat an armadillo, they carry leprosy.
(2)Tor allows you to surf anonymously, and by routing your surfing through a number of computers, each only aware of the identity of the one in front and behind, your ID is intrinsically and securely encrypted. Also of interest, you can specify what location you want the final computer to access the internet from. This would allow you, were you so inclined, to watch geographically restricted TV – occasionally very handy for Australians. Read all about it and download here.
(3) There are ways to make things properly secure. For example in codebreaking, a letter-substitution one-time pad is uncrackable, a concept that most people I’ve mentioned it to don’t believe. There are still system weaknesses.. for example, where you keep your one time pad or in this case, how you take delivery, but the actual system itself is fundamentally secure.
Also, my favourite bitcoin post is this one.