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Much like the New York Stock Exchange, Bitcoin exchanges have suffered from their first massive loss -- a virtual "Black Friday", so to speak.  (Source: Google Images)

Some say Bitcoins could make buying illegal drugs easier. However, in reality Bitcoins are far from "untraceable".  (Source: YouTube/Beardo/Dirt Nasty)

Mt. Gox is the world's largest bitcoin exchange, but it's suffered from major liquidity issues in recent weeks. The recent massive inflationary drop is also a sign of poor controls at the exchange.
Currency experiences massive inflation in a single day, markets stay open

The day was October 28, 1929 and the sky was falling.  That Monday the DOW Jones Industrial Average (DJIA) fell 12.82 percent.  History books show that the next day the DJIA bled another 11.73 percent.  Vast amounts of wealth were wiped out in an instant.

Today modern exchanges automatically close to prevent such catastrophic sell offs.  Or, they do in the real world, at least.  But on June 10, a new kind of market -- Bitcoins suffered a massive decline, that may signal the start of the world's first digital depression.

I.  A 30 Percent Decline in One Day

This Friday the New York Stock Exchange (NYSE) was hammered, losing 172.45 points (approximately a 1.4 percent dip) to close below 12,000 for the first time since March 18, 2011 -- nearly three months ago.  Traders greeted signs of slowdowns in global markets with serious concern.

But as bad a day as Friday was for NYSE traders, it was far worse for those who invested in an increasingly popular digital currency -- Bitcoins (BTC).  At the opening bell at Mt. Gox, the world's largest Bitcoin exchange, a single BTC cost $28.919 USD.  By mid-day that total had plunged to $20.01 USD -- a drop of 30.8 percent.

Granted, in recent weeks the market for Bitcoins has soared upwards, nearly tripling, due to increased demand and built in technical issues.  So perhaps this inflation was merely reactionary.  Nonetheless, it took many by surprise, as inflation on this scale had never before been seen in the fledgling Bitcoin market.

But, wait let's not get ahead of ourselves.  Why should anyone care if the Bitcoin market crashed?

Well, today on Mt. Gox alone, approximately $2M USD in Bitcoins were bought and sold in 5,871 trades.  That's unusual in and of itself -- only a total of $19M USD in trading volume occurred over the past six months.

The bottom line is that several things are clear from today's trading.  

1. The Bitcoin market endured its first digital equivalent of a "bank rush" with people rushing to exchange their BTC for U.S. Dollars.  
2.  People have a large amount of money -- millions of USD sunk into Bitcoins lost big in the flash crash.
3.  Unlike modern markets, which automatically close to prevent massive inflation, the digital Bitcoin markets stayed open.
4.  Something major is moving the Bitcoin market in a sharp inflationary direction, in contrast to the predict deflationary trend

So what are Bitcoins and why is this intriguing?  Let's take a look.

II. What is a Bitcoin?

Bitcoins [wiki] are virtual currency similar to the Linden Dollars (L$) used by Second Life users.

However, unlike L$, which are ultimately controlled by Linden Labs, a company (or "governing body" in some people's eyes), BTC have no central authority.  The currency instead relies on a peer-to-peer system where everyone logs transactions and monetary events, prevent false transactions.

Also, unlike the L$, the focus of BTC is to exchange the virtual currency for real world services, not virtual ones.

People can obtain Bitcoins in two ways  -- buying them or generating them.  

To generate them, you have to run a complex math hashing algorithm, which tries to find a new bitcoin "block".  Parallel computing devices -- namely GPUs have shown themselves most capable for this task.  In fact with modern AMD GPUs it is possible to "break even" on your hardware costs by generating Bitcoins.

For more info about Bitcoin generation, refer to DailyTech founder Kristopher Kubicki's webpage bitminer.info.

The other method of gaining Bitcoins is to purchase them at an exchange -- the largest of which is Mt. Gox.  For a full list of exchanges, refer here.

III. Are Bitcoins Anonymous?

One of the biggest monkeys on the back of Bitcoins is public misconceptions about privacy.

For example a Reuters report quotes a letter from Senators Charles Schumer (D,New York) and Joe Manchin (D, West Virginia) wrote to Attorney General Eric Holder and Drug Enforcement Administration head Michele Leonhart stating:

The only method of payment for these illegal purchases is an untraceable peer-to-peer currency known as Bitcoins. After purchasing Bitcoins through an exchange, a user can create an account on Silk Road and start purchasing illegal drugs from individuals around the world and have them delivered to their homes within days.

Now this is somewhat misleading in that Bitcoins themselves can be more or less traceable than how the user communicates with uses their IPs.  Any time a transaction occurs, it's sent out from an initial IP to nodes on the Bitcoin network, which verify its authenticity.

Take Silk Road, for example -- the topic of a recent Gawker piece.  An IP accesses this site, which is known for selling narcotics illegal in the U.S.  If this is a user's direct IP, anyone who can sniff the traffic of the site can trace that user back to their home address, assuming cooperation of the internet service provider.

However, if you first route your IP through Tor -- an anonymizing service, you can make it extremely difficult for anyone to trace you.  This is because BitCoin "accounts" are regularly generated and a single individual holds keys to multiple microaccounts rather than a single large account.  To an outsider, this account is just a random-looking string -- nobody can tell who owns it.  But using your personal key, you can sign transactions on the accounts you own.

As long as the public/private key cryptography scheme is sound, and you anonymize your IP, even the government will have a relatively tough time tracking you.  The same can be said about any activity that occurs online.

That said, there's numerous ways your privacy could be compromised if you're buying drugs or performing elicit activities. Some points of possible attack include:
1. Failure to anonymize IP due to using your direct ISP-provided IP address.
2. Failure to anonymize IP due to misconfiguration of Tor or other anonymizer (a surprisingly common occurrence).
3. Tracking of physical goods associated with purchases.

Wait, you say, how could #3 occur?  Well, let's say you order a kilo of powder cocaine, using your Bitcoin treasure trove.  Well the kilo comes from a well known dealer who's being monitored by law enforcement for their real world activities.  Law enforcement note the package arrives at your house.  They wait for you to take it in and then begin using it.  They obtain a warrant and raid your house.

Remember, almost no "drug dealer" is going to be exclusively doing business via Bitcoins.  So they're likely engaging in real world transactions that will make it likely for law enforcement to inspect anything they decide to mail.

In other words Bitcoin does provide users with a bit of anonymity, but to claim it's generally "untraceable" in principle is pure paranoia on certain government officials' and journalists' part.  Bitcoin-driven transactions are very traceable; it's just that so far nobody has been interested in investing the large amount of effort it would take to trace them, as they have with copyright infringement or child pornography.

The DEA's response indeed seems to hint at this.  Reuters quotes agency spokeswoman Dawn Dearden as stating, "The DEA is constantly evaluating and analyzing new technologies and schemes perpetrated by drug trafficking networks. While we won't confirm or deny the existence of specific investigations, DEA is well aware of these emerging threats and we will act accordingly."

IV. A Big Problem -- Getting Money In Or Out

While the threat of the U.S. government taking some sort of action over anonymity fears is certainly looming over the Bitcoin market, a far more serious problem is liquidity.  In the traditional global currency markets, you can instantly exchange your currency for other foreign currencies on a number of exchanges.  These exchanges can take bank wires or funds from digital accounts, such as Paypal.

By contrast Bitcoin exchanges like Mt. Gox do not accept debit/credit transactions.  Up until last week they did accept eBay, Inc. (EBAY) subsidiary PayPal.  However, PayPal has blocked transactions to the site.  This is because PayPal has a policy against virtual currencies.

With an easy PayPal route gone, market liquidity was dramatically reduced.  This may be a major cause for the market crash.

Currently the most well published ways to convert Bitcoins to USD or vice versa is to use Dwolla or Liberty Reserve.  These methods are relatively straightforward, but transactions through these online billing services often move at a glacial pace, hampering liquidity.  API problems with Dwolla further exacerbated the liquidity issues in recent weeks at Mt. Gox.

You can also mail a check to a certain individual known as "Bitcoin Morpheus" listed at the exchange, who will add funds to your Mt. Gox account.  Granted this route might not be for the faint of heart as it seems rather "unorthodox" to say the least.

Now there is another method that could work slightly faster than any of the above.  For now you can use a variety of means to quickly buy L$ (Second Life currency) and then use the virwoxSLL exchange to exchange L$ to BTC.  The purpose of L$ and BTC is quite different, so it's unclear how long this route will stay viable, and many people don't realize you can get Bitcoins in this fashion.

At the end of the day Bitcoin has a very real liquidity problem.

V. What's Next for Bitcoin?

Unless Gawker and other media outlets can drum up enough unfounded paranoia about peer-to-peer currency to evoke some kind of draconian action by the U.S. federal government, it's unlikely that Bitcoins will go away.

However, market volatility poses a very serious risk to BTC users -- be they miners, traders, or merchants who accept BTC as payment for goods or services.  To that end, a major improvement would be for Bitcoin exchanges to implement mandatory market closures if the currency value dropped below a threshold.  In theory this would be relatively easy to implement, and we expect that it will be done at some point to prevent one-day flash inflation/deflation.

At the same time, a viable billing service must step up and offer people the ability to use credit or debit card billable transactions in USD to buy bitcoins quickly and directly on a major exchange (e.g. Mt. Gox).  If this can be done, market liquidity can be restored and the currency will once more flourish.

Last, but not least, concerns about deflation must be addressed as demand grows and production slows.  As mentioned in the introduction, if deflation is not controlled, reactionary inflation spurts could be experienced.  Indeed, a reactionary market movement could have been part of the cause for today's record-setting inflation.

It is possible that additional bitcoins could be distributed or other mechanism employed to prevent deflation, much as they are with standard currencies.  

Bitcoins are certainly a novel idea in their implementation details and purpose.  This article offers an introduction, but barely skims the surface of this phenomena and the true facts about it.

Ask some and they'll say Bitcoins are a scam/pyramid scheme.  Ask others and they'll say the Bitcoin market has the promise to offer sustained success.  There's valid arguments on both sides, but at the end of the day Bitcoins will still be around for the forseeable future.

In trading late Friday, Bitcoins recouped nearly half their losses, bouncing back to 24.34.  That's still a massive crash -- around 15 percent in one day.  But it shows that the market isn't dead.  The U.S. economy survived Black Friday and today sustains a massive amount of wealth.  Likewise, perhaps the Bitcoin movement can survive this tough time and find its way.  After all -- people are still buying Bitcoins.


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The ultimate form of nonsensical speculation
By someguy123 on 6/10/2011 7:21:46 PM , Rating: 3
Bitcoins have no trade value (unless you consider coffee mugs and drugs good trade value), no practical value, and run completely on speculation. There isn't even any movement to make this into a legitimate form of "e-currency". Instead there's just this sudden rush to purchase amd cards and crunch numbers in hopes that some sucker will buy your coins for obscene amounts of money.

It's shocking and saddening to see how much effort is being put into crunching and trading coins for USD, while there's literally no effort being put forth to create a goods market in an attempt to legitimize it as some form of currency.




By jostmey on 6/10/2011 7:23:46 PM , Rating: 2
I disagree that the only thing you can buy with bitcoins are coffee mugs and drugs. Check out sites like bitcoinbulletin, searchbitcoin, and tiptopgem to see an aggregation of items from multiple sources. Then you will see just how many items are for sale in the bitcoin community.


RE: The ultimate form of nonsensical speculation
By icanhascpu on 6/10/2011 7:24:44 PM , Rating: 2
quote:
Bitcoins have no trade value (unless you consider coffee mugs and drugs good trade value), no practical value, and run completely on speculation.


So just like every other currency.

Money is a tool to trade value, it doesn't have value more than that itself.


RE: The ultimate form of nonsensical speculation
By TSS on 6/10/2011 9:32:43 PM , Rating: 4
It's no longer a tool used to trade value, in todays world it's a tool to trade faith. Money doesn't represent value and hasn't in a long time.

Bitcoins don't represent value either. But unlike real money they don't even represent nothing, it represents the energy spent making that bitcoin. It took alot of looking around before i found it clearly explained. Hashes generated by an algorithm will find "blocks", and these blocks are worth bitcoins. What do these blocks do? Absolutely nothing. Not a god damned thing but use energy.

So you need to use a tangible, valueble resource to generate power, that can then be used to generate an intangible resource that represents nothing. Where as the dollar represents debt so the resources needed to keep track of the system are a consequence and should be minimized as much as possible.

Just imagine this: If the federal US debt was converted to bitcoins generated on an AMD 6950, you would need you'd need roughtly 627 billion BTC (at an exhange rate of $23). An AMD 6950 uses up 0,2kwh per hour so 4.8kilowatt a day generating roughly 0,5 BTC a day. So to generate 627 billion you'd have to use 6 trillion kilowatts. (calculated using http://bitminer.info/)

So to show how much power that is, wikipedia lists the USA's nuclear power generation as 101,229 megawatts (i'm going to assume that's per hour). Basically you'd have to run all the USA's nuclear power plants for 103 days in order to convert money worth thin air to money worth even less then thin air. Money created out of material debt, instead of metaphysical debt.

Now i'm by no means a scientist, i'm not even good at math so i might be way off on the above. However, i do know one thing, I'm never ever going to take something that actually destroys value as payment. You can take your faith and shove it.


By invidious on 6/10/2011 11:42:18 PM , Rating: 3
quote:
wikipedia lists the USA's nuclear power generation as 101,229 megawatts (i'm going to assume that's per hour)
You are confusing energy and power in your calculations. Watts are a unit of power, which is the rate of energy conversion, in this case joules per second. Watt-Hours are the energy commodity that is converted to BTC.


RE: The ultimate form of nonsensical speculation
By BansheeX on 6/11/2011 6:04:54 AM , Rating: 5
The dollar has an issuer while everyone else has to work for it. The issuers (The Federal Reserve) and their friends in government/wallstreet all benefit unfairly from the creation of new money and by the time it gets to real workers, prices have gone up to reflect the diminished scarcity. It is a hidden tax and one of the dumbest scams this country's braindead populace has ever allowed. Even when we were on a gold standard, bankers saw that redemption of gold receipts never came close to depleting all gold stored, so they figured they could issue fraudulent receipts for which no gold existed and loan it out at interest. That's what caused bank runs before we federally blanket insured every bank regardless of what they were doing with the money.

Money has value if it defeats the inefficiency of barter and is a good store of savings. Not every product makes a good money. Gemstones have grades and good fakes. Chickens die and require upkeep and can't be divided. Grain takes a ton of space. Oil takes a ton of space and is combustible. Clearly, few people learned even basic economics in government high school.

Neither gold nor bitcoins has an issuer. It's not a "waste of resources" that it can't be created at someone's whim, that is precisely WHY they are better money than government fiat nonsense. We could have milligram denominated, plastic-encased gold. We could also have bitcoins. And the fiat issuers of the world who debt enslave everyone are FREAKING OUT.


By Manch on 6/15/2011 4:33:24 PM , Rating: 3
quote:
Chickens die and require upkeep and can't be divided.


I agree with die and upkeep but have you ever had a bucket of KFC?


By TSS on 6/21/2011 8:41:42 AM , Rating: 2
It's not a waste of resources because it cannot be created on a whim. It's a waste of resources since it takes tangible resources and creates a number on the PC.

500 bitcoins. There. How is what i just typed ANY different from 500 actual bitcoins, excluding the difference the numbers are displayed on this website instead of an "official bitcoin" website?

What i'm argueing is the same difference between theft, and copyright. You turn a PC off and you cannot acces bitcoins. Bitcoins dissapear with elecricity. Gold doesnt.

That's why their fundementally different. The money we have now is stored on PC's. Bitcoins are stored on PC's. they both DO NOT EXIST. it's not tangible. The only difference is one number is typed in while the other requires lots of electricity before it can be typed in.

Thats why bitcoins are worse then dollars.


RE: The ultimate form of nonsensical speculation
By docbill on 6/11/2011 11:11:55 AM , Rating: 2
Actually, your analysis is faulty, in that it assumes a constant value for bitcoins in USD. If you were to convert the entire US economy to bitcoins as you did so, bitcoins would become progressively more valuable. There are only about 21 million possible bitcoins that can be generated. So if you were to somehow magically replace all the currencies in the world into bitcoins over night, and you had generated all the possible bitcoins, then each bitcoin would have a value of $3,000,000.

Now the reality of the situation, is because bitcoins increase in value, at any given time only 2% or so will be in circulation. That means the market a bitcoin in a worldwide bitcoin economy would be about $150,000,000 each. So you see even if one assumes only a small percentage of the world economy would be transacted in bitcoins, the eventual value of bitcoins in this possible future is absurdly high.

Last year, people were trading 10,000 bitcoins for a couple of pizzas. Now they are trading the same amount for the cost of houses. If the successful eventually the same amount will be traded for companies like Microsoft.

Of course governments of the world would never allow such a complete redistribution of wealth. So even all other considerations aside, the experiment is doomed to failure. But the question is how high will it go before it completely collapses? After the collapse, will there actually be enough usage to maintain some sort of value as medium of exchange?


RE: The ultimate form of nonsensical speculation
By someguy123 on 6/11/2011 5:39:41 PM , Rating: 2
Why must there be some currency conspiracy attached to everything pro-bitcoin?

The problem with bitcoin is that its proponents are doing very little in terms of goods/service trading compared to merely crunching and reselling bitcoins for profit based off speculation. Someone posted some interesting links to find things that people are willing to trade, but even then these sites tend to only trade what you would normally consider scrap for coins.

If you really want the almighty conspiracy spearing government to get rustled, make this into a viable currency and not just a method of milking speculators.


RE: The ultimate form of nonsensical speculation
By docbill on 6/12/2011 12:22:31 AM , Rating: 2
Who mentioned a conspiracy?


RE: The ultimate form of nonsensical speculation
By someguy123 on 6/12/2011 6:19:56 PM , Rating: 2
quote:
Of course governments of the world would never allow such a complete redistribution of wealth. So even all other considerations aside, the experiment is doomed to failure.


RE: The ultimate form of nonsensical speculation
By docbill on 6/12/2011 11:03:39 PM , Rating: 3
That is not a conspiracy, that is just as statement of fact. People in power will not surrender power. However, there is no conspiracy, because there is no threat to their power at this time. I'm just saying if anybody did come-up with a successful alternate currency, if it caused a major distribution of wealth, it would never be successful.


By mudgiestylie on 6/13/2011 6:44:21 PM , Rating: 2
Don't you mean if it caused a "fair" distribution of wealth, it would never be allowed to succeed?
http://en.wikipedia.org/wiki/Liberty_Dollar


By docbill on 6/13/2011 9:16:10 PM , Rating: 2
quote:
Don't you mean if it caused a "fair" distribution of wealth, it would never be allowed to succeed? http://en.wikipedia.org/wiki/Liberty_Dollar


No I don't. I just mean a "major" redistribution of wealth. Case and point with bitcoins. Ruffly 2% of the bitcoins are publically traded. We have no way of knowing how many people the 98% of the bitcoins that are being hoarded are being held by. But lets say bitcoins became the global currency. Then some small number unknown people would have 98% of the world wealth. I do not who those people would be, but it certainly would not be those who hold major economic power today. Even as one of those persons who does not hold the wealth today, I would object and demand my government do something about the new "kings" and "queens", as they would hold the power to completely wipe out the value of my retirement at a whim, and they would not have the experience to understand the long reaching consequences of their actions.


By docbill on 6/14/2011 9:12:23 AM , Rating: 2
quote:
http://en.wikipedia.org/wiki/Liberty_Dollar


After reading that article about Liberty Dollars, if I were trading in bitcoins I would be concerned about the legality.

I just found out about black markets for bitcoins. It seems like a huge risk for the trading site to do. If bitcoins are classified as a currency, it is probably all perfectly legal. After all, as far as I know there is no law that says I have to announce to the world if I trade USD for CAD or visa versa. I just need to file the appropriate government paperwork. The problem is if it is indeed classified as a currency under the law, then every American which has an account with more than an equivalent of $10,000 USD in bitcoins can fined sent to jail for failing to file a proper TD F 90-22.1 with the IRS. As near as I can tell since the bitcoin banks are not following banking laws, it would be impossible to file a proper TD F 90-22.1. (Although, if one made an honest attempt, chances are they would avoid the penalties and fines.) Most other countries have similar laws to avoid racketeering.

On the other hand, if bitcoins is classified as a stock, then the exchange sites are in violation of trading laws. US citizens & residents owning bitcoins could also be in trouble if they are not filing proper schedule B, and declaring gains in bitcoins as a capital gain.

The last way to classify bitcoins is as token, like a poker chips. The problem is under that classification, participating in the bitcoin market may be a form of illegal gambling...

Really, it is a no win scenario legally. Really, the only the only thing that has allowed it to last this long, is the confusion over which set of laws apply, and the total volume of trading has been below the radar. Especially, when on average the price has been going up, so there are no losers to complain they have been cheated.

The real question just who would be charged should the government go after people on this? I expect it would be those running bitcoin sites, some software developers &/or their employers, and people that could be traced having sold more than some threshold value of bitcoins for legal tender. This could include many bitcoin miners.


By Amincd on 6/12/2011 4:32:36 AM , Rating: 2
"Just imagine this: If the federal US debt was converted to bitcoins generated on an AMD 6950, you would need you'd need roughtly 627 billion BTC (at an exhange rate of $23)."

There can only be 21 million BTC, so rather than 627 billion BTC being created, the 21 million BTC would just see their value increase, and people will be trading microbitcoins (.000 001 BTC) instead of bitcoins.

"So to show how much power that is, wikipedia lists the USA's nuclear power generation as 101,229 megawatts (i'm going to assume that's per hour). Basically you'd have to run all the USA's nuclear power plants for 103 days in order to convert money worth thin air to money worth even less then thin air. Money created out of material debt, instead of metaphysical debt."

Your analysis is based on a faulty assumption about how many bitcoins can be created. The amount of energy devoted to creating each bitcoin would increase though, as there would be a greater need for security as the value of all bitcoins increases, but it would be nowhere near your estimate.

The cost of securing the bitcoins would replace the cost of all of the physical banks with the tens of thousands of security workers, the cost of building huge vaults, and the cost of driving armored trucks around with physical currency.


By icanhascpu on 6/14/2011 5:43:56 PM , Rating: 2
People value faith, so my original comment stands, and is just the simple version of what everyone else is saying.


RE: The ultimate form of nonsensical speculation
By th3pwn3r on 6/12/2011 11:09:56 AM , Rating: 2
Do you not know what drugs are worth?


By MrBlastman on 6/13/2011 10:48:17 AM , Rating: 3
The last time I checked, they are worth prison time... getting pounded in the backside by Bubba.

No thanks.


By NellyFromMA on 6/15/2011 4:40:04 PM , Rating: 2
What's wrong with coffee mugs and drugs? haha jk


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