Meet miners, outlaws and sheriffs all striving to get ahead in the volatile new world of virtual money
THE past year has seen a 21st century gold rush, and speculators have been falling over themselves for a piece of the action. The discovery of gold always brings a world in its wake and bitcoin – a virtual currency “mined” using a computer – is no exception.
Video: How bitcoin works
There are miners chasing gold, crooks targeting the naive, black market traders operating outside the law and regulators trying to bring order to an upstart community.
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Read on to meet some of the movers and shakers in this brave new world.
The coin rush (Image: Andrew Degraff)
The miners
In late 2013, bitcoin miner Dave Carlson feared for the safety of his business. His 5000 square metre warehouse in Wenatchee, Washington, was packed with as much high-tech computing equipment as he could source and was churning out thousands of bitcoins – several million dollars’ worth – each month.
But pickaxes were in short supply. As the value of bitcoins rose, producers of the specialist computers designed to mine them couldn’t keep up with demand. “That’s how much of a gold rush it was for this past year,” Carlson says. “Our biggest fear was the smash and grab where someone would back a truck through the front of the building and load it up with as many of our rigs as they could get.”
With a core team of 10, Carlson’s small company, , is one of the largest bitcoin mining operations in the world. At one point he was making $50,000 an hour. Even a brief outage – lost equipment or internet connection – puts a big dent in your income.
Today, with the price of a bitcoin hovering around $200 – down from its $1000 high just over a year ago (see chart) – Carlson has a bigger problem: keeping his business afloat until the value goes up again. Bitcoin miners sell their bitcoin to pay costs, pushing bitcoin’s price down further. But as the value of a bitcoin falls, it becomes harder and harder to break even, fuelling a downward spiral.
Bitcoin mines are dotted across the globe. Together they constitute one of the most powerful computing operations in the world. The total power of the bitcoin network – all the mining computers added together – is almost 4 million petaflops (a petaflop is the equivalent of 1000 trillion calculations per second). This is far greater than the world’s top 500 super-computers combined. That kind of power comes at a price. Pioneers like Carlson have invested millions of dollars in the pursuit of the approximately 3600 bitcoin available to mine daily (see “What is bitcoin?“). To keep running costs down, Carlson set up his Washington mine near the Columbia river, where his computers can be powered and cooled using low-cost hydroelectricity.
runs a mining facility in a disused helicopter hangar in the far north of Sweden. Even being sited just 80 kilometres from the Arctic circle isn’t enough to keep the computers cool – it takes more than sub- zero temperatures to prevent 49,000 computer chips running round the clock from overheating. To help with the cooling, KnC Miner once flew 66 tonnes of heat sinks – small devices that would dissipate heat from those chips – all the way from China. “They said a boat was much cheaper,” says KnC Miner’s Sam Cole. “But a boat takes six weeks. We needed them tomorrow because tomorrow we can print money with them.”
Bitcoin mining is an unrelenting competition played at breakneck speeds. Every minute you spend sitting on your hands, or with your equipment sitting in boxes, you’re either losing money or someone else is striking it rich. “The cost of development is so high and you have to run at such a fast pace, it’s effectively an arms race,” says Cole. KnC Miner is open about its mining operation, to demonstrate its capabilities. “It’s almost a show of weapons like in the cold war,” he says.
Keep on mining (Image: Andrew Degraff)
It hasn’t always been a battle of titans. Bitcoin mining used to be the preserve of bedroom hobbyists, who mined bitcoin on their personal computers. It was something anyone could do. But before long, as ever more powerful machines joined the race, ordinary computers could no longer keep up.
In the arms race that followed, specialist hardware was built. These chips do one thing and one thing only: mine bitcoin. Pans and pickaxes gave way to explosives, diggers and drills. Having the latest kit made all the difference. For a time, MegaBigPower had chips that were 50 times faster than most miners had, says Carlson. “It allowed us to make pretty ridiculous profits for a while.”
It’s a different picture now. “We are coming to an end of an era,” says Jeffrey Smith, chief information officer for , an online marketplace for bitcoin services. “The investment in mining is huge, mining operations are gigantic, and in my opinion, only large investors will survive.”
The outlaws
Just as plucky pioneers in the California gold rush gave way to industrialised operations, bitcoin mining has become dominated by big money. But the financial incentives have also attracted outlaws. Hackers have targeted individual bitcoin users, bitcoin exchanges and, in at least one case, the flow of traffic across the internet itself, in pursuit of profit.
Between February and May last year, for example, a hacker took control of a router – a computer that directs internet traffic – at a Canadian internet service provider and redirected all mining traffic to a mine controlled by the hacker, effectively siphoning off other miners’ earnings.
By hijacking the traffic, the hacker told the mining hardware “you’re only going to mine the coin that I tell you to mine and by the way I’m keeping all the profits”, says Pat Litke of , . They believe the hacker was an employee of the service provider and that they made around $83,000 in four months.
However, the biggest bitcoin heists have been bank jobs rather than roadside hold-ups. Just this month, for example, European bitcoin exchange Bitstamp lost 19,000 bitcoins, or more than $5 million, in a hack.
“The biggest bitcoin heists have been bank jobs rather than roadside hold-ups”
But that pales in comparison to what some consider to be the biggest bank robbery ever. On 24 February last year, Tokyo-based Mt. Gox, bitcoin’s most famous exchange, went offline. Four days later, its CEO Mark Karpelès admitted that around 850,000 bitcoins had been stolen – the equivalent of losing about $500 million at the time. With a Tokyo police investigation ongoing, as well as bankruptcy proceedings and several lawsuits, exactly how Mt. Gox lost so much money is still unknown. Unnamed police sources in recent Japanese media reports have suggested the theft was an inside job. And at security firm WizSec in Japan – who himself lost around $40,000 when the exchange collapsed – believes an insider took advantage of Mt. Gox’s disorganised accounting procedures.
Maurice’s assessment fits with what we do know. In June, Karpelès finally broke his silence in an , and spoke of struggling to meet the demands of running a business.
But while the collapse of Mt. Gox is often cited as an example of bitcoin’s immaturity, the year-long market manipulation that preceded it is less well known. Maurice’s firm has been investigating the activities of two trading bots – dubbed Willy and Markus – that used fake money to buy almost 570,000 bitcoins from Mt. Gox. Some think that this directly led to an artificial inflation in bitcoin’s value.
“Karpelès was too busy doing other things to notice what was happening in the background,” says Maurice. “If exchanges let their guard down for a minute there’s going to be a compromise.” The bots suggest Mt. Gox never had its defences up in the first place.
Karpelès, who has since started a new web-hosting business – which doesn’t accept bitcoin payments – declined to comment on the theft when contacted by żěè¶ĚĘÓƵ. With regards to Willy and Markus, however, he claims that such things aren’t uncommon. “The market is quite often the home of market manipulation,” he says.
Some worry that large mining pools could also destabilise the whole enterprise. CEX.IO, which operates what was once the largest mining pool, GHASH.IO, has been criticised by the bitcoin community for controlling too large a piece of the total network. Worse, with bitcoin miners now being squeezed by the falling price, only a handful may survive, making the bitcoin network more centralised and vulnerable to attack.
Another concern is bitcoin’s links to the black market. Since bitcoin transactions aren’t tied to real-world identities, the currency allows illicit goods to be traded online anonymously.
Until recently, the most popular online hub for such trade was Silk Road 2.0. Like Amazon or eBay the site had trusted sellers and user reviews, but over 80 per cent of the thousands of products for sale were illegal drugs. Sites like Silk Road 2.0 – and there are thought to be at least 35 similar drug marketplaces – are inaccessible from normal browsers like Chrome or Internet Explorer. Instead they are hidden on a part of the internet, known as the dark net, that can only be visited through a browser called Tor.
Nevertheless, in the first four months of 2014 the highest-earning trader on Silk Road 2.0 made $7 million, according to research by at UK think tank Demos.
Hiding on the dark net and using bitcoin makes it harder to hunt down the site’s administrators. But it’s not impossible. The original Silk Road was run by an individual going by the name Dread Pirate Roberts. In October 2013, the site was shut down after the FBI arrested its alleged creator, Ross Ulbricht. In November 2014, the authorities caught up with Silk Road 2.0, shutting that down too.
But like a game of whack-a-mole, when one site goes down, others spring up in its place. “Dark net marketplaces are selling many more drugs than they were when the Silk Road was originally busted,” says Bartlett.
This is the seedy underbelly of bitcoin, but it mirrors a deeper anti-authoritarian ideology. “For its advocates, bitcoin is a strike for the individual and for individual liberty against the overweaning and overbearing power of central governments,” says Bartlett.
The regulators
In response, governments are doing their best to assert some control. Different authorities have taken different approaches, however. For example, Bolivia outlawed bitcoin in May last year and California legalised it a month later. In the UK, Chancellor George Osborne has pledged to create a “global centre of financial innovation” in part by encouraging bitcoin businesses. Admittedly, that encouragement has consisted mainly of positive words. In practice, businesses trading in bitcoins or offering bitcoin services find it hard to get insurance and bank loans.
However, it is New York’s attempts to regulate bitcoin by requiring businesses to apply for a “BitLicense” that has attracted the most ire. The proposals, spearheaded by the Superintendent of Financial Services for New York, Ben Lawsky, would broadly put bitcoin in line with existing banking regulations. They require businesses to keep a record of any bitcoin transactions for up to seven years, including the names and addresses of their customers and, where possible, the recipients of a transaction.
For many it’s a policy that undermines much of what bitcoin represents. Yet Lawsky and others cite what happened to Mt. Gox as an example of the dangers of leaving the industry unregulated. In public statement, Lawsky has argued that “setting up common sense rules of the road is vital to the long-term future of the virtual currency industry”. Much of the debate is the predictable back-and-forth when any industry is first regulated, but it’s a sign of how far a certain portion of the bitcoin community has come from its radical roots.
Far from being the preserve of radicals, bitcoin businesses are now backed by over $400 million of venture capital, and that number is increasing. The largest bitcoin companies now have former bankers and regulators on their payroll.
Bitcoin ATMs are also popping up around the world. Like online exchanges, these allow anyone to buy bitcoin with regular money. And the list of places that accept bitcoin as payment – which now includes the likes of Microsoft, PayPal and Expedia – grows by the month. Even small businesses are seeing the advantage of accepting bitcoins because it lets them avoid the high fees paid to credit card companies.
The next pioneers
However, bitcoin’s impact could be felt far beyond its role as a currency. The network behind bitcoin provides trust in the currency without the need for a central bank – and could do the same for any number of applications. In theory, the bitcoin network – or others built on the same principles – can back the exchange of any item. It could be used to verify the sale of cars or houses, say.
“Bitcoin’s impact could be felt far beyond its role as a currency”
OpenBazaar, for example, is an eBay-like marketplace that nobody controls. Instead, by running the software on your computer you connect directly with other buyers or sellers. The bitcoin network – which verifies all the transactions – provides trust in the system.
A similar idea drives the development of Lighthouse, a crowdfunding site built by bitcoin developer Mike Hearn. It will allow anyone to create a crowdfunding campaign for any project they desire, for free. “You don’t even need a site, really,” says Hearn. As long as the transactions are recorded by the bitcoin network, pledges could be made by email.
More radical still is , a project built on a new network based on bitcoin. Its transactions can encode arbitrary contracts that could be used for voting systems or business agreements, say. Its designers hope to reimagine civil law, with computer code replacing legalese, programmers taking the place of lawyers, and contracts enforced by computers rather than courts. “It effectively allows you to digitise law itself,” says Ethereum’s Gavin Wood.
With the growth of such projects, the bitcoin network could undermine not only the financial world as we know it, but anything that can be reduced to lines of code – and that means pretty much everything. While miners churn out thousands of bitcoins each day and mainstream bitcoin companies model themselves on existing financial services, programmers are creating tools that let individuals interact and trade directly, without the need for third parties. The gold rush may have peaked, but the new frontier is still largely uncharted.
What is bitcoin?
Bitcoin is a virtual currency. As such, bitcoins are not issued by a central authority but are nevertheless accepted as payment by individuals and a growing number of businesses. Instead of being minted, they are created by computers on the bitcoin network. About 3600 bitcoins are added each day.
A currency requires safeguards against counterfeiting and double spending if people are to trust it. The breakthrough idea behind bitcoin – first posted to a cryptography mailing list in 2008 by a person or group going by the name Satoshi Nakamoto – is a way to have this without having a central authority.
The radical potential of a currency that is independent from governments and banks soon caught the attention of libertarians around the world, and the early bitcoin community was born. Now it’s going mainstream.
Bitcoin’s bookkeepers
Trust in bitcoin is built into its bookkeeping. Whenever a transaction takes place – Alice sending a bitcoin to Bob, say – this is recorded in what is essentially a large database shared across all of the computers on the bitcoin network. This public ledger lets anyone see what transactions have taken place at any given time, though users remain anonymous.
The trust comes from the method used to guarantee that everyone has the same, up-to-date version of the database. And that’s where the miners come in.
“Mining” means using a computer to bundle the records of a set of bitcoin transactions into what is known as a block and adding it to the shared database, known as the block chain. But before the network accepts your block, your computer needs to solve a complex mathematical problem, partly based on the block’s contents. The first miner to solve the problem gets to add the block to the block chain – and gains 25 bitcoins as their reward, worth around $5000 at the time of writing.
The problem has been designed to take around 10 minutes for computers on the bitcoin network to solve. This ensures there is roughly a 10-minute delay between block chain additions, giving the entire network time to update itself when a block is added.
Miners often buy or sell mining capability through sites like CEX.IO – a process known as “cloud mining” – or gang together in mining pools, which helps to ensure they get a stable portion of the bitcoins created each day. As more miners with ever faster computers join the network, the difficulty of the problem adjusts automatically to maintain the delay.
The block chain is also extremely hard to tamper with, making it an accurate record of transactions. To make any alteration, you’d have to solve a problem for all blocks already in the chain, which is prohibitively difficult, or control at least 51 per cent of the hundreds of thousands of computers on the network.
However, without the backing of a central bank, bitcoin’s value is volatile. In the last few weeks, its price has fallen, forcing several mining operations to shut down until the price rises again. Bitcoin needs to be worth at least $320 to make mining profitable, says Jeffrey Smith of CEX.IO.
This article appeared in print under the headline “The coin rush”
