Soaring value of bitcoins raises fears of potential financial ‘cyberbubble’

by Anthony Faiola and T.W. Farnam

The Washington Post

A currency surging in value at a breathtaking rate over the past week belongs to no nation and is issued by no central bank. It can be used to buy gold in California, a hamburger in Berlin or a house in Alberta. When desired, it can offer largely untraceable transactions.

The coin in question now has a global circulation worth more than $1.4 billion on paper.

Yet almost no one, it seems, knows the true identity of its creator. In the United States, the mysterious money has become the darling of antigovernment libertarians and computer wizards prospecting in the virtual mines of cyberspace. In Europe, meanwhile, it has found its niche as the coinage of anarchic youth.

The currency is bitcoin, a kind of cybermoney initially traded among hackers and cryptologists, and increasingly traded on websites and exchanged for goods and services. Two years ago, one bitcoin was worth less than $1. Two months ago, the price for a single unit surged above $20 on a proliferation of cyber-exchanges from Tokyo to Moscow, and a sudden burst of new interest sent its value soaring to a record $147 on Wednesday. It has since fallen back after a series of hacker attacks. Yet, as of Thursday, bitcoin was still trading at more than $130.

Will all that crash and burn in a cyberversion of a financial bubble? Quite possibly, critics say. Will authorities — already concerned about the use of bitcoins to purchase drugs and launder money online — step in to regulate it? There are signs that may already be happening.

But for now, its diverse group of users ranging from the Free State Project and WikiLeaks to environmentalists and professional gamblers, call its surge a revolution in “financial free speech.”

For Jonathan Harrison — a former gold trader who ditched his London flat to join a group of virtual currency obsessives living in a dilapidated commune near Waterloo Station — what matters most is a sense that bitcoin is making him a fortune.

Some call it the purest form of capitalism: a version totally unfettered by monetary policy and politically driven economics. On a recent afternoon, Harrison constantly checked the value of his holdings in bitcoins and other cybercurrencies such as litecoin on his glowing smartphone. In less than 20 minutes, his portfolio’s value had surged by 7 percent.

“Some people say it’s anticapitalist, but it’s more nonconformist,” Harrison said. “It can’t be manipulated by governments, changed by monetary policy. I call it digital gold.”

In January 2009, Satoshi Nakamoto unveiled bitcoin to a mailing list of computer supergeniuses. He, or she, or them — Nakamoto is a pseudonym for a programming whiz, or whizzes, whose identity remains one of the great mysteries of hackerdom — effectively put a free software program on the Internet and invited the group to form a network of bitcoin “miners.” They could excavate bitcoins by using computers to solve complex mathematical puzzles, with units of the cybercurrency seen as a reward for the electricity spent on the algorithms.

Nakamoto seemingly emerged from nowhere a year earlier, uploading a white paper on bitcoin to an obscure Listserv. The writings suggested political motivations — a response to a global financial crisis that saw Western governments reach into the banking sector as never before. But Nakamoto also showed little interest in promoting bitcoin beyond an inner circle of global geekdom.

In the 1990s and 2000s, various visionaries attempted to launch cybercurrencies with little success. Yet Nakamoto succeeded where others failed through the elegance of bitcoin’s design. More bitcoins are created all the time. But over time, fewer and fewer will be generated. The finite number — bitcoins will max out at 21 million by 2140, compared to the roughly 11 million in circulation today — makes them a commodity that increases in value as more and more users fuel demand.

To avoid counterfeiting, bitcoins are accounted for on public ledgers. Holders of bitcoins, which are stored using electronic “wallet” software downloaded from the Internet, are kept anonymous unless they choose to disclose their identities.

Yet there is no centralized authority that regulators could home in on to shut the system down. Though government- and bank-free, the users pay a certain price for that freedom. U.S. bank deposits, for instance, are insured up to $250,000 by the Federal Deposit Insurance Corp. But last week, when hackers struck bitcoin wallet provider Instawallet, the company issued a statement saying it would refund clients holding more than 50 units only on a “case-by-case and best-effort basis.”

Nakamoto seemed to vanish more than a year ago, leaving other developers to advance the technology. A year later, initial waves of publicity and word of mouth created a surge in value that sent the price of one bitcoin soaring from less than $5 to almost $30.

There were suddenly two ways of getting bitcoins — mining them yourself or, more commonly, buying them from current owners using real-world money. However, after a series of high-profile hacker attacks, including a hit on the computers at Mt. Gox, the Tokyo-based exchange site that is the cybercurrency’s largest trading venue, its value collapsed, falling back below $10 and increasing only modestly until a few months ago. Another wave of attacks hit the exchange house last week but have thus far not caused equal damage.

No one knows what, exactly, is behind the currency’s staggering climb that started earlier this year and has accelerated in recent weeks. Some cite a change in the network’s programming in December that cut the number of bitcoins released each day. Others say new interest from Russians and others looking for safe havens after bank account seizures in Cyprus is behind the climb.

Bitcoin promoters credit new interest by venture capitalists. Yet Wall Street analysts who follow bitcoin say there is still no indication that major investors are seriously dabbling in them. Critics say those paying hefty fees for bitcoins are investing in a ghost currency whose value is fictional.

“What’s behind that billion-dollar value? Nothing, except some people would claim a billion dollars worth of burned electricity,” said Ben Laurie, a software engineer and visiting fellow at Cambridge University.

Though critics warn current buyers will themselves be burned if the price collapses, bitcoin’s rise already has early merchants ruminating about what might have been. George’s Famous Baklava in New Hampshire, for instance, sold a pan of dark chocolate pastry online for 14 bitcoins in 2012 — a sum worth about $1,890 today. “I’m already looking back on that and smiling,” the company’s owner, George Mandrik Skouras, wrote in an email.

The antiestablishment nature of bitcoin has also made it the preferred currency of antigovernment activists.

Harrison, the bitcoin trader, for instance, first learned about the currency after watching a viral video made by Amir Taaki, a former online poker player turned freelance software developer who now organizes bitcoin conferences. Taaki’s events have drawn interest from everyone ranging from money laundering experts to the likes of Cody Wilson, the American cryptoanarchist who is pioneering 3-D printing technology to create plastic guns.

The marketplace that accepts bitcoins is small but growing. At Room 77 in Berlin, you can use your smartphone to digitally pay for a hamburger in bitcoins. More often, you can shop online for a range of items including, as bitcoin enthusiasts admit, illegal drugs.

Once the province of hobbyists rigging together off-the-shelf computer parts, bitcoin “mining” is also rapidly evolving. The math puzzles that award bitcoins have become harder as more and increasingly powerful computers mine them. It has led cyberthieves to hijack computers via viruses that help them mine bitcoins. Legal miners such as Bennett Hoffman, a California-based enthusiast who once hunted bitcoins on his gaming computer, are joining up with business partners to invest in new professional bitcoin-mining machines that cost $30,000 each.

“Obviously, there’s always going to be a ton of risk involved,” Hoffman said. “I just really like the idea of bitcoin.”

The European Central Bank issued a report in October on the growing bitcoin use. Last month, a branch of the U.S. Treasury Department tackling money laundering issued guidance to online exchanges in the United States, warning that they must report large cash transactions and suspicious activity on their systems.

“In a way it is like . . . Monopoly money being used rather than your respective currency, not knowing who owns the bank and who is the dog, the car, the top hat or thimble,” said Rusty Payne, a spokesman for the U.S. Drug Enforcement Agency. “Bitcoins are virtually untraceable.”

  • http://www.salescopywriter.net/ Alan

    Well you’ve shown some weirdos and extreme cases but the more I look at bitcoins the more I like them. A decentralized open-source digital currency that can’t be faked, “inflated” by any central bank and which ignores international borders? That’s huge.

    • Jon

      What’s to keep Big governments and Wall Street Banks from manipulating Bitcoin prices by buying and selling large quantities with Fiat currency that they print? Then it would just be the stock market/Gold market/Wheat market etc. etc. all over again.

      • Jason McGee

        Not a thing, however that would only further legitimize the currency as a viable investment vehicle on par with any other asset. That said, those Fiat currencies are controlled by Central Banks via mechanisms like Quantative Easing and tweaking of Interest rates, that type of manipulation is not possible with Bitcoin. The value of Bitcoin will be entirely mark driven. Additionally, since BitCoins can be broken down to into denominations as small as .00000001 Bitcoins, there is plenty of headroom for a single bitcoin to grow in value.

        Think of it this way… 20 years from now, there will only be a few million additional bitcoins. Right now we have around 11-12 million bitcoins in circulation worth anywhere between 1 and 3 billion depending on who’s numbers you go buy. This is still the VERY BEGINNING of this currency. As more people want a piece of the bitcoin action, there simply will not be enough Bitcoins for everyone to have a piece of the pie. People have already begun selling fractional bitcoins. This will only further increase the value of the currency.

        If you look at this in the long term… if Bitcoin can survive and becomes accepted by the greater financial community as a liquid asset, there is a TREMENDOUS potential for growth. That 1 to 3 Billion dollars could explode. It’s a simple supply and demand equation really. There is scarcity and there appears to be a large amount of buyers. That scarcity will only increase, as well the potential number of users of Bitcoin. That would imply we only have one way to go… up.

        Now for the scary part…. If the financial sector boycotts Bitcoins, government action is takien to prevent the use of Bitcoins or if a fundamental flaw is found in the underlying BitCoin architecture the value could vanish overnight.

        So, that said I’m going to buy and hold.. at these prices I could potentially loose a couple of thousand bucks, or make millions. I think the potential is worth the risk. Sure, it has already appreciated from $.01 to over $150… Wish I’d gotten in back in ’09 when I thought it was a total scam… But there is so much potential for growth I still think it’s a good buy.

  • Bruce Swanson

    As more and more bitcoins are lost due to misplaced private keys, what cumulative effect will it have on bitcoin’s viability? To put it simply, what would a single bitcoin be worth if there were only one bitcoin left?

    • freedom4citizens

      Hardware wallets are on the drawing board which will keep secure private keys while enabling authorized transfers. A lot of ancillary technology will come as the price escalates. Already custom ASICs are mining away with the hashing power of thousands of PCs. The computing network supporting Bitcoin is the largest in the world for a specific task.