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The Rise and Fall of Bitcoin

By Benjamin Wallace

In November 1, 2008, a man named Satoshi Nakamoto posted a research paper to an

obscure cryptography listserv describing his design for a new digital currency

that he called bitcoin. None of the list s veterans had heard of him, and what

little information could be gleaned was murky and contradictory. In an online

profile, he said he lived in Japan. His email address was from a free German

service. Google searches for his name turned up no relevant information; it was

clearly a pseudonym. But while Nakamoto himself may have been a puzzle, his

creation cracked a problem that had stumped cryptographers for decades. The

idea of digital money convenient and untraceable, liberated from the oversight

of governments and banks had been a hot topic since the birth of the Internet.

Cypherpunks, the 1990s movement of libertarian cryptographers, dedicated

themselves to the project. Yet every effort to create virtual cash had

foundered. Ecash, an anonymous system launched in the early 1990s by

cryptographer David Chaum, failed in part because it depended on the existing

infrastructures of government and credit card companies. Other proposals

followed bit gold, RPOW, b-money but none got off the ground.

One of the core challenges of designing a digital currency involves something

called the double-spending problem. If a digital dollar is just information,

free from the corporeal strictures of paper and metal, what s to prevent people

from copying and pasting it as easily as a chunk of text, spending it as many

times as they want? The conventional answer involved using a central

clearinghouse to keep a real-time ledger of all transactions ensuring that, if

someone spends his last digital dollar, he can t then spend it again. The

ledger prevents fraud, but it also requires a trusted third party to administer

it.

Bitcoin did away with the third party by publicly distributing the ledger, what

Nakamoto called the block chain. Users willing to devote CPU power to running

a special piece of software would be called miners and would form a network to

maintain the block chain collectively. In the process, they would also generate

new currency. Transactions would be broadcast to the network, and computers

running the software would compete to solve irreversible cryptographic puzzles

that contain data from several transactions. The first miner to solve each

puzzle would be awarded 50 new bitcoins, and the associated block of

transactions would be added to the chain. The difficulty of each puzzle would

increase as the number of miners increased, which would keep production to one

block of transactions roughly every 10 minutes. In addition, the size of each

block bounty would halve every 210,000 blocks first from 50 bitcoins to 25,

then from 25 to 12.5, and so on. Around the year 2140, the currency would reach

its preordained limit of 21 million bitcoins.

When Nakamoto s paper came out in 2008, trust in the ability of governments and

banks to manage the economy and the money supply was at its nadir. The US

government was throwing dollars at Wall Street and the Detroit car companies.

The Federal Reserve was introducing quantitative easing, essentially printing

money in order to stimulate the economy. The price of gold was rising. Bitcoin

required no faith in the politicians or financiers who had wrecked the economy

just in Nakamoto s elegant algorithms. Not only did bitcoin s public ledger

seem to protect against fraud, but the predetermined release of the digital

currency kept the bitcoin money supply growing at a predictable rate, immune to

printing-press-happy central bankers and Weimar Republic-style hyperinflation.

Photo: Michael Schmelling

Bitcoin's chief proselytizer, Bruce Wagner, at one of the few New York City

restaurants that accept the currency.

Photo: Michael Schmelling

Nakamoto himself mined the first 50 bitcoins which came to be called the

genesis block on January 3, 2009. For a year or so, his creation remained the

province of a tiny group of early adopters. But slowly, word of bitcoin spread

beyond the insular world of cryptography. It has won accolades from some of

digital currency s greatest minds. Wei Dai, inventor of b-money, calls it very

significant ; Nick Szabo, who created bit gold, hails bitcoin as a great

contribution to the world ; and Hal Finney, the eminent cryptographer behind

RPOW, says it s potentially world-changing. The Electronic Frontier

Foundation, an advocate for digital privacy, eventually started accepting

donations in the alternative currency.

The small band of early bitcoiners all shared the communitarian spirit of an

open source software project. Gavin Andresen, a coder in New England, bought

10,000 bitcoins for $50 and created a site called the Bitcoin Faucet, where he

gave them away for the hell of it. Laszlo Hanyecz, a Florida programmer,

conducted what bitcoiners think of as the first real-world bitcoin transaction,

paying 10,000 bitcoins to get two pizzas delivered from Papa John s. (He sent

the bitcoins to a volunteer in England, who then called in a credit card order

transatlantically.) A farmer in Massachusetts named David Forster began

accepting bitcoins as payment for alpaca socks.

When they weren t busy mining, the faithful tried to solve the mystery of the

man they called simply Satoshi. On a bitcoin IRC channel, someone noted

portentously that in Japanese Satoshi means wise. Someone else wondered

whether the name might be a sly portmanteau of four tech companies: SAmsung,

TOSHIba, NAKAmichi, and MOTOrola. It seemed doubtful that Nakamoto was even

Japanese. His English had the flawless, idiomatic ring of a native speaker.

Perhaps, it was suggested, Nakamoto wasn t one man but a mysterious group with

an inscrutable purpose a team at Google, maybe, or the National Security

Agency. I exchanged some emails with whoever Satoshi supposedly is, says

Hanyecz, who was on bitcoin s core developer team for a time. I always got the

impression it almost wasn t a real person. I d get replies maybe every two

weeks, as if someone would check it once in a while. Bitcoin seems awfully well

designed for one person to crank out.

Nakamoto revealed little about himself, limiting his online utterances to

technical discussion of his source code. On December 5, 2010, after bitcoiners

started to call for Wikileaks to accept bitcoin donations, the normally terse

and all-business Nakamoto weighed in with uncharacteristic vehemence. No, don

t bring it on, he wrote in a post to the bitcoin forum. The project needs

to grow gradually so the software can be strengthened along the way. I make

this appeal to Wikileaks not to try to use bitcoin. Bitcoin is a small beta

community in its infancy. You would not stand to get more than pocket change,

and the heat you would bring would likely destroy us at this stage.

Then, as unexpectedly as he had appeared, Nakamoto vanished. At 6:22 pm GMT on

December 12, seven days after his Wikileaks plea, Nakamoto posted his final

message to the bitcoin forum, concerning some minutiae in the latest version of

the software. His email responses became more erratic, then stopped altogether.

Andresen, who had taken over the role of lead developer, was now apparently one

of just a few people with whom he was still communicating. On April 26,

Andresen told fellow coders: Satoshi did suggest this morning that I (we)

should try to de-emphasize the whole mysterious founder thing when talking

publicly about bitcoin. Then Nakamoto stopped replying even to Andresen s

emails. Bitcoiners wondered plaintively why he had left them. But by then his

creation had taken on a life of its own.

Bitcoin 101

Bitcoin 101

How They re Made

Bitcoin s economy consists of a network of its users computers. At preset

intervals, an algorithm releases new bitcoins into the network: 50 every 10

minutes, with the pace halving in increments until around 2140. The automated

pace is meant to ensure regular growth of the monetary supply without

interference by third parties, like a central bank, which can lead to

hyperinflation.

How They re Mined

To prevent fraud, the bitcoin software maintains a pseudonymous public ledger

of every transaction. Some bitcoiners computers validate transactions by

cracking cryptographic puzzles, and the first to solve each puzzle receives 50

new bitcoins. Bitcoins can be stored in a variety of places from a wallet on

a desktop computer to a centralized service in the cloud.

How They re Spent

Once users download the bitcoin app to their machine, spending the currency is

as easy as sending an email. The range of merchants that accept it is small but

growing; look for the telltale Bitcoin 101symbol at the cash register. And

entrepreneurial bitcoiners are working to make it much easier to use the

currency, building everything from point-of-service machines to PayPal

alternatives.

Illustrations: Martin Venezky

Bitcoin enthusiasts are almost evangelists, Bruce Wagner says. They see the

beauty of the technology. It s a huge movement. It s almost like a religion. On

the forum, you ll see the spirit. It s not just me, me, me. It s what s for the

betterment of bitcoin.

It s a July morning. Wagner, whose boyish energy and Pantone-black hair belie

his 50 years, is sitting in his office at OnlyOneTV, an Internet television

startup in Manhattan. Over just a few months, he has become bitcoin s chief

proselytizer. He hosts The Bitcoin Show, a program on OnlyOneTV in which he

plugs the nascent currency and interviews notables from the bitcoin world. He

also runs a bitcoin meetup group and is gearing up to host bitcoin s first

world conference in August. I got obsessed and didn t eat or sleep for five

days, he says, recalling the moment he discovered bitcoin. It was bitcoin,

bitcoin, bitcoin, like I was on crystal meth!

Wagner is not given to understatement. While bitcoin is the most exciting

technology since the Internet, he says, eBay is a giant bloodsucking

corporation and free speech a popular myth. He is similarly excitable when

predicting the future of bitcoin. I knew it wasn t a stock and wouldn t go up

and down, he explains. This was something that was going to go up, up, up.

For a while, he was right. Through 2009 and early 2010, bitcoins had no value

at all, and for the first six months after they started trading in April 2010,

the value of one bitcoin stayed below 14 cents. Then, as the currency gained

viral traction in summer 2010, rising demand for a limited supply caused the

price on online exchanges to start moving. By early November, it surged to 36

cents before settling down to around 29 cents. In February 2011, it rose again

and was mentioned on Slashdot for achieving dollar parity ; it hit $1.06

before settling in at roughly 87 cents.

In the spring, catalyzed in part by a much-linked Forbes story on the new

crypto currency, the price exploded. From early April to the end of May, the

going rate for a bitcoin rose from 86 cents to $8.89. Then, after Gawker

published a story on June 1 about the currency s popularity among online drug

dealers, it more than tripled in a week, soaring to about $27. The market value

of all bitcoins in circulation was approaching $130 million. A Tennessean

dubbed KnightMB, who held 371,000 bitcoins, became worth more than $10 million,

the richest man in the bitcoin realm. The value of those 10,000 bitcoins

Hanyecz used to buy pizza had risen to $272,329. I don t feel bad about it,

he says. The pizza was really good.

Perhaps bitcoin s creator wasn t one man but a mysterious group a team at

Google, maybe, or the NSA.

Bitcoin was drawing the kind of attention normally reserved for overhyped

Silicon Valley IPOs and Apple product launches. On his Internet talk show,

journo-entrepreneur Jason Calacanis called it a fundamental shift and one of

the most interesting things I ve seen in 20 years in the technology business.

Prominent venture capitalist Fred Wilson heralded societal upheaval as the

Next Big Thing on the Internet, and the four examples he gave were Wikileaks,

PlayStation hacking, the Arab Spring, and bitcoin. Andresen, the coder,

accepted an invitation from the CIA to come to Langley, Virginia, to speak

about the currency. Rick Falkvinge, founder of the Swedish Pirate Party (whose

central policy plank includes the abolition of the patent system), announced

that he was putting his life savings into bitcoins.

The future of bitcoin seemed to shimmer with possibility. Mark Suppes, an

inventor building a fusion reactor in a Brooklyn loft from eBay-sourced parts,

got an old ATM and began retrofitting it to dispense cash for bitcoins. On the

so-called secret Internet (the invisible grid of sites reachable by computers

using Tor anonymizing software), the black-and-gray-market site Silk Road

anointed the bitcoin the coin of the realm; you could use bitcoins to buy

everything from Purple Haze pot to Fentanyl lollipops to a kit for converting a

rifle into a machine gun. A young bitcoiner, The Real Plato, brought On the

Road into the new millennium by video-blogging a cross-country car trip during

which he spent only bitcoins. Numismatic enthusiasts among the currency s

faithful began dreaming of collectible bitcoins, wondering what price such

rarities as the genesis block might fetch.

As the price rose and mining became more popular, the increased competition

meant decreasing profits. An arms race commenced. Miners looking for horsepower

supplemented their computers with more powerful graphics cards, until they

became nearly impossible to find. Where the first miners had used their

existing machines, the new wave, looking to mine bitcoins 24 hours a day,

bought racks of cheap computers with high-speed GPUs cooled by noisy fans. The

boom gave rise to mining-rig porn, as miners posted photos of their setups. As

in any gold rush, people recounted tales of uncertain veracity. An Alaskan

named Darrin reported that a bear had broken into his garage but thankfully

ignored his rig. Another miner s electric bill ran so high, it was said, that

police raided his house, suspecting that he was growing pot.

Amid the euphoria, there were troubling signs. Bitcoin had begun in the

public-interested spirit of open source peer-to-peer software and libertarian

political philosophy, with references to the Austrian school of economics. But

real money was at stake now, and the dramatic price rise had attracted a

different element, people who saw the bitcoin as a commodity in which to

speculate. At the same time, media attention was bringing exactly the kind of

heat that Nakamoto had feared. US senator Charles Schumer held a press

conference, appealing to the DEA and Justice Department to shut down Silk Road,

which he called the most brazen attempt to peddle drugs online that we have

ever seen and describing bitcoin as an online form of money-laundering.

Meanwhile, a cult of Satoshi was developing. Someone started selling I AM

SATOSHI NAKAMOTO T-shirts. Disciples lobbied to name the smallest fractional

denomination of a bitcoin a satoshi. There was Satoshi-themed fan fiction and

manga art. And bitcoiners continued to ponder his mystery. Some speculated that

he had died. A few postulated that he was actually Wikileaks founder Julian

Assange. Many more were convinced that he was Gavin Andresen. Still others

believed that he must be one of the older crypto-currency advocates Finney or

Szabo or Dai. Szabo himself suggested it could be Finney or Dai. Stefan Thomas,

a Swiss coder and active community member, graphed the time stamps for each of

Nakamoto s 500-plus bitcoin forum posts; the resulting chart showed a steep

decline to almost no posts between the hours of 5 am and 11 am Greenwich Mean

Time. Because this pattern held true even on Saturdays and Sundays, it

suggested that the lull was occurring when Nakamoto was asleep, rather than at

work. (The hours of 5 am to 11 am GMT are midnight to 6 am Eastern Standard

Time.) Other clues suggested that Nakamoto was British: A newspaper headline he

had encoded in the genesis block came from the UK-published Times of London,

and both his forum posts and his comments in the bitcoin source code used such

Brit spellings as optimise and colour.

Play Dough

Key moments in the short and volatile

life of bitcoin.

Even the purest technology has to live in an impure world. Both the code and

the idea of bitcoin may have been impregnable, but bitcoins themselves unique

strings of numbers that constitute units of the currency are discrete pieces of

information that have to be stored somewhere. By default, bitcoin kept users

currency in a digital wallet on their desktop, and when bitcoins were worth

very little, easy to mine, and possessed only by techies, that was sufficient.

But once they started to become valuable, a PC felt inadequate. Some users

protected their bitcoins by creating multiple backups, encrypting and storing

them on thumb drives, on forensically scrubbed virgin computers without

Internet connections, in the cloud, and on printouts stored in safe-deposit

boxes. But even some sophisticated early adopters had trouble keeping their

bitcoins safe. Stefan Thomas had three copies of his wallet yet inadvertently

managed to erase two of them and lose his password for the third. In a stroke,

he lost about 7,000 bitcoins, at the time worth about $140,000. I spent a week

trying to recover it, he says. It was pretty painful. Most people who have

cash to protect put it in a bank, an institution about which the more zealous

bitcoiners were deeply leery. Instead, for this new currency, a primitive and

unregulated financial-services industry began to develop. Fly-by-night online

wallet services promised to safeguard clients digital assets. Exchanges

allowed anyone to trade bitcoins for dollars or other currencies. Bitcoin

itself might have been decentralized, but users were now blindly entrusting

increasing amounts of currency to third parties that even the most radical

libertarian would be hard-pressed to claim were more secure than federally

insured institutions. Most were Internet storefronts, run by who knows who from

who knows where.

Sure enough, as the price headed upward, disturbing events began to bedevil the

bitcoiners. In mid-June, someone calling himself Allinvain reported that 25,000

bitcoins worth more than $500,000 had been stolen from his computer. (To this

day, nobody knows whether this claim is true.) About a week later, a hacker

pulled off an ingenious attack on a Tokyo-based exchange site called Mt. Gox,

which handled 90 percent of all bitcoin exchange transactions. Mt. Gox

restricted account withdrawals to $1,000 worth of bitcoins per day (at the time

of the attack, roughly 35 bitcoins). After he broke into Mt. Gox s system, the

hacker simulated a massive sell-off, driving the exchange rate to zero and

letting him withdraw potentially tens of thousands of other people s bitcoins.

As it happened, market forces conspired to thwart the scheme. The price

plummeted, but as speculators flocked to take advantage of the fire sale, they

quickly drove it back up, limiting the thief s haul to only around 2,000

bitcoins. The exchange ceased operations for a week and rolled back the

postcrash transactions, but the damage had been done; the bitcoin never got

back above $17. Within a month, Mt. Gox had lost 10 percent of its market share

to a Chile-based upstart named TradeHill. Most significantly, the incident had

shaken the confidence of the community and inspired loads of bad press.

In the public s imagination, overnight the bitcoin went from being the currency

of tomorrow to a dystopian joke. The Electronic Frontier Foundation quietly

stopped accepting bitcoin donations. Two Irish scholars specializing in network

analysis demonstrated that bitcoin wasn t nearly as anonymous as many had

assumed: They were able to identify the handles of a number of people who had

donated bitcoins to Wikileaks. (The organization announced in June 2011 that it

was accepting such donations.) Nontechnical newcomers to the currency,

expecting it to be easy to use, were disappointed to find that an extraordinary

amount of effort was required to obtain, hold, and spend bitcoins. For a time,

one of the easier ways to buy them was to first use Paypal to buy Linden

dollars, the virtual currency in Second Life, then trade them within that

make-believe universe for bitcoins. As the tone of media coverage shifted from

gee-whiz to skeptical, attention that had once been thrilling became a source

of resentment.

Photo: Michael Schmelling

Illustration: Martin Venezky

More disasters followed. Poland-based Bitomat, the third-largest exchange,

revealed that it had oops accidentally overwritten its entire wallet. Security

researchers detected a proliferation of viruses aimed at bitcoin users: Some

were designed to steal wallets full of existing bitcoins; others commandeered

processing power to mine fresh coins. By summer, the oldest wallet service,

MyBitcoin, stopped responding to emails. It had always been fishy registered in

the West Indies and run by someone named Tom Williams, who never posted in the

forums. But after a month of unbroken silence, Wagner, the New York City

bitcoin evangelist, finally stated what many had already been thinking: Whoever

was running MyBitcoin had apparently gone AWOL with everyone s money. Wagner

himself revealed that he had been keeping all 25,000 or so of his bitcoins on

MyBitcoin and had recommended to friends and relatives that they use it, too.

He also aided a vigilante effort that publicly named several suspects.

MyBitcoin s supposed owner resurfaced, claiming his site had been hacked. Then

Wagner became the target of a countercampaign that publicized a successful

lawsuit against him for mortgage fraud, costing him much of his reputation

within the community. People have the mistaken impression that virtual

currency means you can trust a random person over the Internet, says Jeff

Garzik, a member of bitcoin s core developer group.

And nobody had been as trusted as Nakamoto himself, who remained mysteriously

silent as the world he created threatened to implode. Some bitcoiners began to

suspect that he was working for the CIA or Federal Reserve. Others worried that

bitcoin had been a Ponzi scheme, with Nakamoto its Bernie Madoff mining

bitcoins when they were worthless, then waiting for their value to rise. The

most dedicated bitcoin loyalists maintained their faith, not just in Nakamoto,

but in the system he had built. And yet, unmistakably, beneath the paranoia and

infighting lurked something more vulnerable, an almost theodical

disappointment. What bitcoiners really seemed to be asking was, why had

Nakamoto created this world only to abandon it?

If Nakamoto has forsaken his adherents, though, they are not prepared to let

his creation die. Even as the currency s value has continued to drop, they are

still investing in the fragile economy. Wagner has advocated for it to be used

by people involved in the Occupy Wall Street movement. While the gold-rush

phase of mining has ended, with some miners dumping their souped-up mining rigs

People are getting sick of the high electric bills, the heat, and the loud

fans, Garzik says the more serious members of the community have turned to

infrastructure. Mt. Gox is developing point-of-sale hardware. Other

entrepreneurs are working on PayPal-like online merchant services. Two guys in

Colorado have launched BitcoinDeals, an etailer offering over 1,000,000 items.

The underworld s use of the bitcoin has matured, too: Silk Road is now just

one of many Tor-enabled back alleys, including sites like Black Market

Reloaded, where self-proclaimed hit men peddle contract killings and

assassinations.

You could say it s following Gartner s Hype Cycle, London-based core

developer Amir Taaki says, referring to a theoretical

technology-adoption-and-maturation curve that begins with a technology

trigger, ascends to a peak of inflated expectations, collapses into a

trough of disillusionment, and then climbs a slope of enlightenment until

reaching a plateau of productivity. By this theory, bitcoin is clambering out

of the trough, as people learn to value the infallible code and discard the

human drama and wild fluctuations that surround it.

But that distinction is ultimately irrelevant. The underlying vulnerabilities

that led to bitcoin s troubles its dependence on unregulated, centralized

exchanges and online wallets persist. Indeed, the bulk of mining is now

concentrated in a handful of huge mining pools, which theoretically could

hijack the entire network if they worked in concert.

Beyond the most hardcore users, skepticism has only increased. Nobel

Prize-winning economist Paul Krugman wrote that the currency s tendency to

fluctuate has encouraged hoarding. Stefan Brands, a former ecash consultant and

digital currency pioneer, calls bitcoin clever and is loath to bash it but

believes it s fundamentally structured like a pyramid scheme that rewards

early adopters. I think the big problems are ultimately the trust issues, he

says. There s nothing there to back it up. I know the counterargument, that

that s true of fiat money, too, but that s completely wrong. There s a whole

trust fabric that s been established through legal mechanisms.

It would be interesting to know what Nakamoto thinks of all this, but he s not

talking. He didn t respond to emails, and the people who might know who he is

say they don t. Andresen flatly denies he is Nakamoto. I don t know his real

name, he says. I m hoping one day he decides not to be anonymous anymore, but

I expect not. Szabo also denies that he is Nakamoto, and so does Dai. Finney,

who has blogged eloquently about being diagnosed with amyotrophic lateral

sclerosis, sent his denial in an email: Under my current circumstances, facing

limited life expectancy, I would have little to lose by shedding anonymity. But

it was not I. Both The New Yorker and Fast Company have launched

investigations but ended up with little more than speculation.

The signal in the noise, the figure that emerges from the carpet of clues,

suggests an academic with somewhat outdated programming training. (Nakamoto s

style of notation was popular in the late 80s and early 90s, Taaki notes.

Maybe he s around 50, plus or minus 10 years. ) Some conjecturers are confident

in their precision. He has at best a master s, says a digital-currency

expert. It seems quite obvious it s one of the developers. Maybe Gavin, just

looking at his background.

I suspect Satoshi is a small team at a financial institution, whitehat hacker

Dan Kaminsky says. I just get that feeling. He s a quant who may have worked

with some of his friends.

But Garzik, the developer, says that the most dedicated bitcoiners have stopped

trying to hunt down Nakamoto. We really don t care, he says. It s not the

individuals behind the code who matter, but the code itself. And while people

have stolen and cheated and abandoned the bitcoiners, the code has remained

true.

Benjamin Wallace (benwallace@me.com) wrote about scareware in issue 19.10.

http://www.wired.com/magazine/2011/11/mf_bitcoin/all/1