The rise of bitcoin

The rise of bitcoin

Homemade Money
ouve probably heard of Bitcoin, yet you probably have only a vague idea what it is. Youve no doubt seen a lot of news stories about it; after all, second only to the boom in Bitcoin prices has been the boom in news stories about the Bitcoin. Yet very few of them explained much about the technology. So what is Bitcoin, and why does it matter? The history of the currency is straight out of cyberpunk fiction, and could easily have sprung from the pages of William Gibsons Neuromancer or Neal Stephensons Cryptonomicon. A 37-year old Japanese cryptology specialist, Satoshi Nakamoto, came up with an idea for a new currency. It would be based not on a tangible standard, like gold, or a standard driven by economic power, like the dollar, but on something far more 21st century: pure computational power. The complete transaction history of Bitcoin is protected by the constant solving ofcomplex mathematical problems. These intensive computing tasks are undertaken bya distributed network of thousands of computers around the globe, a peer-to-peer system much like the one that distributes BitTorrent files. What that means in practice is that all the computers around the world running Bitcoin software each contain the blockchain, a copy of the history of all Bitcoin transactions and of the life of each of the possible 21 million Bitcoins. Each computer running the Bitcoin software called a Bitcoin miner keeps the transaction list up to date by encoding it using complex cryptography.
ASIC miners, the most up-to-date custom hardware, can crunch through Bitcoins programming problems more cheaply than anything else

Pseudo-currency Bitcoin has been all over the news for months. But what is it? Who uses it? And will your corner shop be taking itany time soon? Dan Griliopoulos investigates
Occasionally, as a by-product of this cryptography, these computers are given new Bitcoins, which rewards them for doing this work. This ensures that enough computational power is aimed at the continuation of the blockchain that it would be nearly impossible for anyone to hijack the currency using superior computing power. Even if they did, they would own so many Bitcoins themselves that it wouldnt be in their interest to do so. Once youve mined Bitcoins, or bought some online from someone who has which is as easy as buying foreign currency or using PayPal then you can spend them on all sorts of things, buy a pint of beer in some pubs via an app, or order illegal drugs to be delivered to your door using just a web browser.

Old money

Like any good Cyberpunk novel hero, Satoshi Nakamoto seems to have never existed. There is no-one of that name and age in Japan. Investigations by the New Yorker and Fast

Company found possible suspects for him, but their evidence is circumstantial. Nakamoto, to all intents and purposes, made the currency and vanished. He handed his project over to a few fellow cryptography fiends, including current Bitcoin head Gavin Andresen, and evaporated like morning dew. Its notable that neither the cryptography nor the concept of a virtual currency were original. Cryptography pioneer David Chaum described the first anonymous cryptographic cash system in 1982, later creating ecash in 1990. Other currencies such as Bit gold and Reusable Proofs of Work even followed the proof of work system that Bitcoin would later use. So the idea didnt spring from nowhere into the fantastical Nakamotos head; it was something that had been discussed, on and off, for nearly 20 years. But Bitcoin is not an easy technology to understand. Is it a real currency at all? Dr Eyjolfur Gudmundsson is lead economist for Eve Online (www.eveonline.com), an online game that uses its own internal currency, ISK. He thinks the question is nonsensical. Virtual currency is already a real currency, and all real currency is really just virtual since the value of a currency is in the minds of those that use that currency. So lets rather talk about electronic currency versus hard cash, he continued. Already more trade is done electronically than in real-life cash, so even real-life cash has become an electronic currency as well. In fact, there is no difference between virtual and real-life currency. So the question should rather be: when will a virtual currency become just as important and valuable as real-life currency in the mind of the consumer? This trend is happening right now and will only continue to grow in the next five years.

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The rise of bitcoin

The rise of bitcoin

Dr Stuart Jeanne Bramhall, who operates a global virtual barter-currency (https://www. community-exchange.org), agrees: 97 per cent of the US dollars that circulate are virtual; only about three per cent exist in the form of paper currency and coins. When you deposit $100 in a bank, the bank doesnt lock your $100 in the vault. They just record in their computer system that they owe you $100.

New money

Vitalik Buterin writes for Bitcoin Magazine. Bitcoin was not the first form of digital payment, but it was the first decentralised digital currency that exists only on the internet, he says. Those extra attributes areimportant: the fact that Bitcoin is independent of the legacy banking system orany physical material (such as gold) meansthe barriers to entry and the costs for dealing with it are much lower, allowing for near-zero transaction fees and letting startups design innovative technologies around it that would not be possible elsewhere. The decentralisation aspect helps particularly on the regulatory side. Sergey Brin once said they had been talking about introducing a digital currency at Google, Google Bucks, but decided against it exactly because it would be too difficult from a legal standpoint. With Bitcoin, control and ownership is distributed across the net, so just like BitTorrent it would be very hard, if

Most of the US dollars that circulate are virtual; only about three per cent exist in the form of notes and coins
not impossible, for nation states to legislate against it with any success. Transactions are extremely safe. The Bitcoin system is very secure, Buterin says. The closest the network got to being hacked was an incident in 2010 where an attacker was able to create 183 billion Bitcoins due to an integer overflow exploit, but the transaction was quickly reversed and the bug fixed. The cryptography elements of Bitcoin are going to hurt your head (they certainly hurt ours). The system works by generating a tough computing problem, which it estimates will be solved by the entire Bitcoin computing network in a given period (this is usually

around 10 minutes). As the computing power aimed at Bitcoin mining increases, so the problems complexity is automatically increased. The computer that solves the problem is rewarded with a number of Bitcoins (25 at the moment, though it halves every four years) and the cycle begins again. This process is called mining because, like mining in the days before effective geological surveys, its a matter of brute force; you dig as much as you can to make sure you get something out. The problem being solved also generates the blockchain. As we mentioned earlier, this is a history of all the transactions of Bitcoins since the last update, which all mining computers have a copy of. For a standard PC running the Bitcoin client, your chances of solving the problem in time are tiny; we estimate the average time for an average PC to mine its first Bitcoin is about 13 years. Expensive and power-hungry parallel hardware does the job better especially GPU hardware and the first entirely Bitcoin mining-specific hardware has just appeared, which is far more efficient. Most individual users join pools, where their mining time brings smaller, but more regular rewards, or create their own Bitcoin farms, where they have many bespoke computers running the client at once. If youre not using the bespoke hardware, though, its unlikely that youll be covering the cost of the electricity youre using to run all that kit.

Field Programme Gate Arrays can be programmed for specific tasks and networked via USB in huge numbers, ideal for Bitcoin mining

Show me the money

But why mine them at all? Well, assuming popularity is a form of success, Bitcoin has succeeded where other such new currencies have failed because its been supported. The key institutions are libertarian organisations such as Wikileaks and anarchist ones such as the now defunct super-hackers LulzSec. With the prospects of donations to organisations such as these fading as national banks around the world closed their accounts because of their quasi-legal nature, these organisations looked around for other donation methods. One of those they settled on was Bitcoin. These institutions didnt popularise Bitcoin

something a bit stronger than a pint. The most infamous of these is Silk Road, a marketplace that would not be possible without Bitcoin. Silk Road is an online marketplace where users can buy all sorts of illegal goods banned books, prescription-only drugs, illegal drugs and, once upon a time, serious firearms, though those have now been removed. You wont find Silk Roadby Googling it. Its somewhere between the Deep Web areas of the internet not touched by search engines and the darknet the areas of the that was down to Silk web that consist only of Road, more on which in a anonymised peer-to-peer moment but they did connections, where those Bitcoins can be transferred by bring it to public attention, who want to hide from phone,but remember its best to so much so that bleedingsocietys rules go, whether storethe majority of your coins in edge companies such as political or criminal (and if separate wallets WordPress, OK Cupid and you have to hide your Reddit now accept it as a payment method. political views here, these days theyre likely Even a few coffee shops in the more to be criminal views, too). You have to use the techno-savvy parts of the world have started TOR anonymising browser and know the accepting it, and you can now buy a pint with address to even find it. Bitcoins in the east end of London: at the Silk Road users (such as Meyer; see Pembury Arms in, unsurprisingly, Hackney. the box below) use Bitcoin as a way of The darker side of Bitcoin is its use in anonymising their online purchases. The online marketplaces, where you can get technology supplies them with a way of

Walking the Silk Road

How did you find out about Silk Road? Read about it on Wired, maybe. You have to use the TOR browser to use it, which has lots of built-in anonymising features. It masks IPs and stuff like that. Im not too hot on all the technical stuff, but I understood it when I was learning to do it. The address changes every now and then. Whats it like to use? Its the best way to buy drugs. Ive had good dealers and bad dealers, but Ive never had this level of service. You use a fake name foreverything, PGP encryption for sending messages, so only the intended recipient canread the message if they were to get intercepted somehow. It looks pretty basic, like a lot of e-commerce sites from the late 1990s. The search engines really basic and therange of categories of all the stuff you canbuy is down the side. Was it hard to set up? Bitcoin took ages to set up, downloading the full blockchain took four to five days, and my computer occasionally stuttered while it was doing it as it was using loads of system resources. Its going to get harder as the years go by, as the blockchain is only going to get bigger and bigger. I try not to think about it too much, because I sort of understand it, butthe more I think about it, the less I understand. Its a bit too complicated. How do you get your Bitcoins? I used to buy from Blockchain, but the banks stopped letting us use UK bank transfers. I wonder whether thats because they thought, this is dodgy illegal stuff we shouldnt do, as that doesnt normally stop bankers, or was it more: this is direct competition with our entire financial system; do we want Bitcoins to be a system that were supporting? I use Local Bitcoins now. You can use it to find someone in your area to buy and sell in person, but you can also do it online. I always

Meyer not his real name is a longtime Silk Road user. We talked to him about how it allows anonymous illegal purchases
do it online. I just have the client running on my PC, the standard Bitcoin one. How reliable is the system? It definitely seems to work. I thought it was too good to be true when I first heard about it. It tells you how many transactions people have completed, what percentage have been fine and if theyve had good feedback. Everyone can leave comments, how discreet the package was, whether it matched the weights, was it exactly what you were expecting. The sellers are motivated to give the best description of what theyre selling and give decent quality product because its going to affect their ability to make money down the line. Often the weight is slightly more than theyve said its going to be, to make sure theres no-one complaining. Ive bought cheap stuff, but they make it clear. Its definitely made me take things that I wouldnt have otherwise have taken because I wouldnt be sure of getting a clean supply, or at least going into it feeling better.

Any bad experiences? The cheapest one I did was when I tried to buy an ounce of weed from a guy in Mexico. It cost 25, compared to seven or eight times that much in the UK. I bought it, and he said it was going to take a month to arrive. He had about 80 per cent feedback, with the rest of the people saying it didnt turn up. I waited two months and no package arrived, and I got a friendly letter from the border force saying, weve intercepted a package of yours because it contained drugs. If you would like to appeal this, heres how you can get in contact with us. The implication was that they werent going to do anything else. It wasnt even my name, it was just my address. So I wont be ordering from them again. But thats the only package thats not turned up, out of 15 or 20 orders. I rate that better than street dealers. And I knew what the risk was anyway, because of the 80 per cent. I assume hes just throwing them in a bag. Hes not going to be running a really tight operation if his selling point is a really big bag of weed really cheap. Id pay double if it was vacuum-sealed. So you dont buy internationally much? It lists where its coming from on the site. Ive felt more comfortable with UK ones, just in terms of the package turning up, because it doesnt have to go through borders. In my head, that seems more secure. That would be

my line if I ever got caught: I never bought it, it just turned up at my house. Am I breaking the law by opening a package with someone elses name on it? Its not a major crime. And youve only bought drugs? Yes, Ive not tried to buy anything else. You can get ingredients for making drugs, and equipment, fake IDs, forgeries Ive used prescription drugs Ive got from there. When I signed up, the most recent blog post on there was why theyd decided to take the firearms section out. That was reassuring, I guess; Id prefer there not to be automatic weapons. How many users are there? Its hard to track how popular it is. A lot of the big sellers have got several hundred transactions under their belts. Theres a few that have a thousand or two. But there arent like hundreds of thousand of transactions. Some people will ask you to finalise early, so they get their feedback rating and money early. Some say I require this for customers from other countries. Some say if you do this, Ill give you slightly more. Its up to you, though. Its not a good idea generally. Are there any difficulties? Well, its common sense to use a fake name. But that means if the postman comes with a package and youre not there to sign for it, it

gets sent to the post office and you need ID to pick it up. So I always have to make sure Im around to answer the door when I need a package. Because I wouldnt just go and try to convince them, because [with] some of these packages, even when theyre vacuum-sealed, Ive been able to smell the drugs on them. Are you scared of getting caught? The only way I can think of getting caught is if the Bitcoin security gets undermined. If that happens, theyre going to have hundreds and thousands of people whove been doing this. Theyll be some kind of amnesty or something. They cant just arrest everyone. Theres talk of a US ban of Bitcoins. They can try and ban it all they like. How are they, in practice, going to do that? They could make its use illegal, but I dont know how they could stop people using it. You cant stop people sending emails. Theyd have to ban anonymisers, which is a huge step towards an anti-libertarian state, where having anything you want to hide is illegal. I dont connect with the political side ofit; I wouldnt call myself a libertarian. But I can understand the argument for economic systems being improved by having a currency within them that doesnt have a government controlling it. That seems rational. But I dont think its going to replace pounds sterling.

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The rise of bitcoin

The rise of bitcoin

securely transferring money to reliable sellers without the state intervening, something that we imagine traditional retailers such as Amazon would dearly like to emulate. Its easy to forget now how suspiciously Amazon was regarded when it launched, with many consumers worrying about their money disappearing or their bank account being emptied. Bitcoin transactions on Silk Road remove that uncertainty completely in many senses, its more secure than the traditional banking model and undoubtedly more secure than using a credit card.

The first thing you need to do is download a Bitcoin client. If you visit www.bitcoin.org, youll see the recommended clients. Were going to assume youre using the main Bitcoin client. Make sure you have at least 10GB free on your main hard disk, as thats where Bitcoin will store the blockchain. Now you have to wait for the blockchain to download. This can take an awful long time; as much as a week at its current size. You can order the blockchain on DVD if you really want, but wed recommend just waiting. Once youve downloaded the blockchain, your computer is now mining Bitcoins. Nowyou need to create a wallet (a folder in which the client stores your Bitcoins). Make a copy of the Wallet.dat file and store it on a thumb drive. If you lose the file, you loseall your Bitcoins. If youre interested in mining Bitcoins (something of a fools errand, given that it will cost you more in power to generate them than theyre worth) you can join a pool. These share computational power and share rewards. Well assume, however, that you just want money. Click receive money and youll get the code for that wallet.

1 2 3 4 5

300K

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Hash rate (GHz)

A step-by-step guide to getting Bitcoins

US dollars v Bitcoin exchange rate

600k 280

Bitcoin production rate

160,000 Hash rate

80,000

0 Jan 09

Jan 11

Jan 13

Bit-bot-net

0K Sep 10 Jan 11 Jan 12 Jan 13 May

As the price boomed, so did the number of people grinding out Bitcoins that is, the hash rate The price of Bitcoins has boomed recently. A pizza that three years ago cost 10,000 Bitcoins would now be worth around $3 million

Spending your Bitcoins may not be a security problem, but new crimes are popping up around the currency. If youre an evil hacker with thousands of virus-infected computers at your disposal, you can just use your botnet to mine for you. Or you can do the same as an unscrupulous programmer at the ESEA eSports network did, and hide it in a piece of pro-gaming software, causing gamers computers around the world to operate at maximum capacity and sometimes burn out all to mine Bitcoins for him. Richard Henderson is security strategist for the network security specialist Fortinet. Thehiding of the Bitcoin client inside the ESEA anti-cheating software is maybe the first time weve seen Bitcoin-based malware inside gaming software, he says. Whats interesting about this specific incident is that gamers installed this client and allowed it to update itself automatically, which meant they had no way of preventing the [later] installation of the Bitcoin mining client. Dmitry Bestuzhev, an expert who works for the major anti-virus firm Kaspersky Lab, isseeing a rapid growth in this monetisation of computer takeovers. More and more cybercriminals try to build malware capable ofmining Bitcoins, or stealing them from wallets or redirecting the victim to a fake website under a special technique called

As discussed in the article, Mt.Gox is under threat from the US government, but its still the best exchange for swapping real money for Bitcoins.

Proxy auto configuration, installed in the browser of the infected machine, he says. Of course, botnets dont cost the hacker anything compared to the bespoke hardware, as Henderson explains. The issue with customised hardware built specifically for mining Bitcoin is two-fold: theres the initial cost of the hardware, and then the ongoing cost of running the hardware. Botnets used tomine Bitcoin dont have to take those factors into consideration: everything is paidfor by the victim. On top of that, when were talking about botnets with tens of thousands of victims or more, its strictly a numbers game; solving problems to mine new

coins is effectively just throwing random solutions to a problem looking for a correct answer. [Having] more systems guessing means youre just as likely to stumble upon a correct solution as someone with tailormade hardware. Thankfully, its quite easy to spot when your computer has been bitbotted. The CPUof such machines works hard, says Bestuzhev. The biggest risk is for users who just leave their machines on all day and go out of the house or go to sleep. Such unattended machines can then easily mine money for cybercriminals. As Bestuzhev mentioned, ownership of a Bitcoin itself is potentially extremely vulnerable after all, its simply a string of code on a computers hard disk. When we manage an online banking account, the account itself and the database with the numbers are on the server side, the bank side. With the Bitcoins the situation is different. The wallet itself is stored on the hard disk, and this is a big risk. Many users store their Bitcoins in USB drives, rather than on the computer itself and standardised secure USB wallets are in development right now.

Bit bubbles

Dr Eyjolfur Gudmundsson is the lead economist in the popular game Eve Online. Its his job to make sure the games virtual economy works to further the enjoyment of the players

But the largest burst of usage weve seen recently hasnt been from those sorts of financial criminals, but the previously more respectable banks and private investors. Some of these may have been traditional panicked investors fleeing the stock market and

terrified by the high price of gold. But some of the reason for the move is that electronic currencies do have some advantages over paper currencies, such as privacy, zero transaction charges and security. Bitcoins success seems to have terrified the US government. It has started threatening Bitcoin suppliers and is making extremely negative noises towards the new exchanges that support Bitcoin. Mt.Gox, for example, an exchange that started out as a forum for trading Magic: The Gathering cards but now handles 80 per cent of all Bitcoin trades, hasfound itself under threat, with its assets being seized by the US authorities. However, Vitalik Buterin isnt concerned about this. The days of Bitcoin exchanges disappearing with hundreds of thousands ofdollars in customer funds are long over. Allthe exchanges that are still left standing have proven themselves to be reliable over the past two years, and have policies in place (such as storing over 90 per cent of funds in offline cold storage) to help ensure security. As for legality, the US governments FINCEN guidance in March 2013 clarified a lot of issues around thelegality of Bitcoin services; if youre not anexchange, you have nothing to worry about, and the exchanges are rapidly workingon compliance. Most of the exchanges are signing up to the money transmitter licences that will enable them to become recognised banking institutions. Thats not the only problem for the market, though. Mt.Gox has come under repeated distributed denial of service (DDoS) attacks in recent months. Then, on 10th April this year, the price for a Bitcoin fell from US$266 to $76 before bouncing back to $160. Fortinets Henderson says, These were most likely used by someone or multiple persons to profit from market instability. Other methods of market manipulation mirror those used in the real world of stocks and bonds, although at a much smaller scale. Its likely there are cabals of investors who are engaging in unethical practices. Ive seen speculation that the massive run-up of Bitcoin value recently may have been a perfect storm of media attention, pumping and dumping and churning in order to attract a lot of new attention to Bitcoin and, with it, new

investors which inevitably caused the price of a Bitcoin to shoot through the roof. Eves Dr Gudmundsson agrees. For the short-term trader, higher volatility means higher probability to make a short-term gain, so if city investors believe that one currency is undervalued then they would quickly move their funds towards that currency and move out again before it collapses again. So I would actually be more interested in knowing when they start to sell again.

Majority report

A potential problem for Bitcoin, but ones that becoming less prevalent as the currency grows, is known as the 51 per cent problem. We talked earlier about the blockchain the transaction history thats shared between all Bitcoin users and how this takes the form of a kind of consensual agreement between all the miners; if there are two competing histories in the system, then the one with the larger number of users is true. So for someone to change the history, and effectively destroy the ownership of all Bitcoins, theyd need to have 51 per cent of the computing power. Richard Henderson thinks its unlikely. Who would want to control 51 per cent of the miners with the intention of shutting

Dmitry Bestuzhev, from anti-virus firm Kaspersky Lab, has seen cybercriminals flock to exploit Bitcoins success

down the whole system? The owners of botnets that are mining coin wouldnt want toshut it down: theyre in the business of making money. Tinfoil hat aside, the only possibility is a nation state or a financial organisation interested in seeing the Bitcoin experiment fail and people who have bought into it lose a lot of money. My guess is that a lot of smart people on both sides of the fence are watching very carefully. The US government looks to be Bitcoins only real threat. Other secondary currencies, including the short-lived Liberty Dollar, have already been banned in the USA despite the fact that these currencies are, as Dr Eyjolfur Gudmundsson points out, indistinguishable from the coupon and points schemes that companies such as Tesco or British Airways run. A bigger problem is the unknown. As we said, Bitcoins top out at 21 million. At that point no-one, not even the people who created it, know how the market will react. DrGudmundsson thinks its a bad idea. Strictly limiting the money supply is nota good thing for any currency. It means more deflation, less economic activity and therefore lower economic value in the long run. Its where pure science meets groundbreaking social experiment the lets make this thing and see what it does approach that so traumatised A-bomb researcher Carl Sagan and other nave pure science researchers. That said, many of our experts trust the currency. Vitalik Buterin is a case in point. I keep a substantial portion of my funds in cryptocurrencies; some Bitcoin, about a third as much in Ripples (another new virtual cryptocurrency], he says. Its a volatile, but good investment; even if theres a 95 per cent chance it will go to zero, if theres a five per cent chance it will grow by another factor of 100 thats a 5x average return. I dont mind; I dont have time for it, and I move around too much these days to keep Singles or Avalons (specialised Bitcoin mining devices) with me. Of course, as a current investor in Bitcoin you would expect him to talk up the currency. Were not going to but if youre a gambling man, you might want to bet a small amount on a Bitcoin or two. After all, even the strangest science-fiction stories can have a tendency to come true.

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