The Glitch That Will Help Kill Bitcoin
As the world's first, and most popular, cryptocurrency, Bitcoin has by now suffered every possible setback a payment project could encounter. It was implicated in a huge drug bust when the Federal Bureau of Investigation took down the Silk Road electronic exchange. It has experienced regulatory pressure in forms ranging from trading restrictions in China to a recent threat of a complete ban by the Russian authorities. It survived a scare involving an apparently Ukraine-based operation taking over close to half of the currency's "mining". It absorbed Apple's decision to remove all related software from its app store. Now, a top Bitcoin exchange, where the cryptocurrency could be traded in for government-issued money, has hit a snag that forced it to stop Bitcoin transfers to outside addresses.
In the face of all this adversity, Bitcoin remains amazingly resilient, which could mean one of two things: Either it is here to stay, or the people who invested in it during a speculative bubble are reluctant to accept losses and still able to prop up the market with their trades.
The latest problem occurred when Japan-based MtGox, the biggest Bitcoin exchange outside China, halted outside transfers from its clients' Bitcoin wallets on Feb. 10. The exchange explained that this was due to a glitch in the Bitcoin software which made it possible to alter transaction details after the fact, creating the possibility of double spending, a nightmare the system was built to avoid. The technical problem is known as "transaction malleability." The Bitcoin Foundation, the nonprofit organization that maintains the software, quickly countered that MtGox was itself at fault. Gavin Andresen, the foundation's chief scientist, issued a statement saying the malleability problem has been known since 2011 and "any company dealing with Bitcoin transactions and have coded (sic) their own wallet software should responsibily prepare for this possibility." According to Andresen, users should not worry about the currency's vulnerability. Other Bitcoin developers urged MtGox to resume transactions, saying malleability was a non-issue.
Both MtGox and Andresen pointed out that bugs were inevitable in a young, experimental product. Bitcoin, however, is already more than that -- the system's market cap reached $14.4 billion at its December 2013 peak. The MtGox problem caused the Bitcoin's value to drop from about $700 to about $500; it then recovered to the previous level.
It is a wonder that it still costs so much despite all the adversity. It should be clear that regulators' misgivings about the currency will soon translate into restrictions and bans. If a major exchange can stop processing transactions and get into an argument with developers about a technical issue, trading is hardly seamless or safe. Finally, there are not too many real-life uses for the currency. The list of businesses that accept it makes it clear that surviving on Bitcoins alone would be a tricky proposition. Bitcoin is not even really anonymous, as many drug customers have assumed, even if you use a new address for every transaction.
The only reason to be part of the bitcoin universe today is speculation. The volatile exchange rate makes Bitcoin an interesting, high-risk financial instrument. Besides, those who bought into the dream of a decentralized digital currency two or three years ago, have reaped fabulous returns. The Bitcoin's historical performance has prompted thousands of people to invest in expensive "mining" equipment, and dozens to pour millions of dollals into huge "farms" filled with specialized hardware. There is now a community of people who are "all in" and therefore committed to propping up the market even though there is little substance to it.
Despite all the hype, the Bitcoin community is probably not large. It is hard to tell how many people actually use Bitcoins. Attempts at producing an estimate are decidedly unscientific, because people use multiple addresses for transactions. According to Blockchain.info, more than 140,000 addresses are now in use to process an average of 60,000 transactions per day, roughly the same number as a year ago and about 0.1 percent the number handled by MasterCard. The current level of Bitcoin activity is low enough that a few thousand "invested" individuals can prop up the exchange rate. For outsiders, however, it looks increasingly as though Bitcoin should be viewed as an experiment, a test case. Other electronic currencies will rise, and be more widely accepted, after all the regulatory and technical issues are resolved.
(Leonid Bershidsky writes on Russia, Europe and technology for Bloomberg View. Follow him onTwitter.)
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