This Bitcoin Business Is Entirely Out of Hand

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A hacker-thief has supposedly lifted $500,000 in Bitcoin currency, sending shivers through the tech community and headlines across the web. But here's the funny thing about the virtual currency: were it not for the exploding hype about Bitcoin over the past few weeks, the reported megaheist would only be worth a few dollars. Bitcoin is a two-year old virtual currency based on a theoretically fascinating economic model that guarantees anonymity of the members in the market and eschews a centralized power. With a single Bitcoin unit currently worth about $20, half a million dollars is an astounding and astoundingly misleading figure fueled by media buzz, crazy speculation and hacker fear mongering around Bitcoin. But the story of how it all happened is fascinating--and oddly revelatory as an analogy to our actual economy.

This hoax is another in a chain of stories cascading out of the recently pretty underground Bitcoin community, who were framed as the lynchpin in an anonymous, underground drug market called Silk Road in a June 1 story on Gawker--the tech blog Launch had published a warning story about Bitcoin two weeks prior. Using Bitcoin, an anonymous peer-to-peer virtual currency, internet users could log onto Silk Road, a comparably anonymous peer-to-peer marketplace, and buy practically any drug in the world. (To say Gawker is built for such salacious scoops is an understatement.) The story garnered nearly half a million pageviews, and awash in media exposure, the value of the Bitcoin skyrocketed. One thing led to another, and then the U.S. Senate launched an investigation. But before going into too much detail about the status quo, a bit more about how Bitcoin works.

Bitcoin is sort of like that fake Federal Reserve experiment you did in your high school economics class, except it's real and a bit more utopian. The bank in the experiment--in this case the pseudonymous creator of Bitcoin, Satoshi Nakamoto--offered up a limited number of currency units to be purchased by investors, who could then trade the currency with each other or use the currency for transactions. Maintaining the currency's value would require the bank to forge more units to allow for the market to expand or to take units out of the market to control inflation. Theoretically, an automated system for creation and maintenance of the money supply could handle the risk of inflation in the absence of a central bank to control the money supply. At least that's what Milton Friedman argued, when he called for the abolition of the Federal Reserve.

That basic formula with the utopian "decentralized" caveat drives the Bitcoin model. Nakamoto forged the original 50 units of Bitcoin (BTC) currency in 2009 supplying a small number of users with the money and outlining an algorithmic system through which more units could be created. Each unit bore a unique code that, instead of being printed on notes, was saved onto a hard drive. Essentially, creating more units required drafting more codes using cryptographic techniques called hashing and forced work. Nakamoto outlined a formulaic and democratic process for how this would work in such a self-policing way that relied both on users and on the predefined process that would cap the total supply of Bitcoin. Users would store their currency on their machine's hard drive in a digital wallet with a unique address. If a thief stole the wallet--or essentially, hacked the file's code--the money was gone. Just like real cash. However, in a sea of faceless, nameless, and otherwise unidentifiable proxy IP addresses, thieves would be tough to catch. (It's worth consulting an excellent, more in-depth explainer on how Bitcoin works published last week in The Economist.)

Now back to the heist. First reported by Gawker's Adrian Chen--who also reported the original Silk Road story--the story of the cyberheist resembles the would-be horrid stepchild of a Steve McQueen movie and a Lulzsec prank. Posting under the apropos handle, Allinvain, the robbed Bitcoin investor reported the incident in a forum post, which at the time of this posting garnered nearly 65,000 views:

Hi everyone. I am totally devastated today. I just woke up to see a very large chunk of my bitcoin balance gone to the following address:
1KPTdMb6p7H3YCwsyFqrEmKGmsHqe1Q3jg
Transaction date: 6/13/2011 12:52 (EST)
I feel like killing myself now. This get me so f'ing pissed off. If only the wallet file was encrypted on the HD. I do feel like this is my fault somehow for now moving that money to a separate non windows computer. I backed up my wallet.dat file religiously and encrypted it but that does not do me much good when someone or some trojan or something has direct access to my computer somehow.

The first reply to the original post revealed the amount: "Wow, > 25 grand in this address... Intense."

Allinvain claims in subsequent posts to be an early adopter of Bitcoin. Having joined the forum on May 18, 2010, when the currency was worth only pennies, Allinvain certainly became interested in Bitcoin early on, but it's hard to say how intense the heist had actually been. The Bitcoin community remained fairly small for the first year and a half of the currency's existence, and only around the time of the sensational story on Launch. about Bitcoin-as-dangerous did the currency really acquire any real value. Look at the first spike in the currency's value, around the mid-May coverage on Launch. When Chen published his exposée on the Silk Road drug market on June 1, the graph turns into a hockey stick:

Chen commented on the impact of his Silk Road post with the headline: "Everyone Wants Bitcoins After Learning They Can Buy Drugs With Them." He takes some credit:

The Bitcoin market is notoriously volatile, and it's all but certain that there's a Bitcoin bubble. If anything, the revelations about Silk Road have delayed the popping of the bubble now that folks realize there's actually something you can do with the stuff besides buying alpaca socksand web design services. You're welcome!

The following dip represents a flurry of bad news for Bitcoin. The U.S. government, who can legally regulate Bitcoin transactions in this country, announces on June 8 that they would crackdown on Bitcoin, prompting the upside-down hockey stick. The Economist publishes their explainer on the currency, "Bits and bob," on June 13th, and the graph spikes again. The heist news appears not to have impacted the market, perhaps because despite the hyperbolic value quoted in headlines, not that much money was stolen.

But the peripheral stories are fun. One developer, Nick Carlson, interviewed Wednesday by Beta Beat explains how he performed development work for a wage in Bitcoins. Carlson knew that when he took a 12-hour job paying 60 Bitcoins--worth a $30 per hour at the time, paltry compared to his regular rate of $75 to $150--the wage would be an investment. Over time, and with enough exposure, the currency would appreciate, and it did. Those 60 Bitcoins could have netted him $2,000 at the market's peak exchange rate of 33 USD per 1 BTC. Rather than cashing out, however, Carlson bartered for a new Android phone and reinvested the rest. Carlson told Beta Beat:

If the currency is to be successful, it needs a wide and robust economy. At the moment, there aren’t many merchants accepting Bitcoin. I think that’s a reflection of the lack of software for businesses. We’re going to need to see software and services which make it easy for businesses  to accept Bitcoin. Those sort of solutions have been slowly coming to market, but at a lower rate than I would like. As a developer, hopefully I can help in this area.

A few weeks ago, Beta Beat interviewed another Bitcoin believer, Bruce Wagner. Host of The Bitcoin Show, a web TV series that actually exists, Wagner compares what had previously been an experiment in virtual economics to the experiment in communications that became the internet. Despite the easy assumption that Bitcoin is a crazy bubble of hype worth nothing at all, Bitcoin could prove just as powerful as the internet itself with enough exposure and democratic support, he argues:

It’s a bubble, but it’s an unbreakable bubble, one that is just going to keep growing and growing and growing … It’s kind of like the early days of the dot-com. People heard about this thing called the Internet and they didn’t know what it was, didn’t know what to do, so they bought every [stock] that ended in a dot-com and of course they all lost their shirts. This is kind of like this, but you actually can buy a piece of it, like the Internet but you can own a piece of it.

Wagner argues his case for Bitcoin's legitimacy kind of poorly, but that utopian vision of a virtual currency sticks. Media exposure—more specifically Adrian Chen's Silk Road blog post—could be credited with creating millions of dollars worth of virtual wealth. Which is funny because that's sort of how the real wealth is often created. But Bitcoin's example media influence is so clear and linear, they should teach it in journalism schools or something. If enough people bet on it, Bitcoin could pay dividends, and with the right touches by influential forces, namely the media and the government, it would become somewhat of a standard. After all who else is betting big on a virtual, extra-national currency? Oh, that's right, Facebook is.

Correction: An earlier version of this post incorrectly misattributed the above quote from Bruce Wagner about the Bitcoin bubble to Dr. Larry White, an economics professor at George Mason University. While he has studied Bitcoin, White does not host a Bitcoin web show.

This article is from the archive of our partner The Wire.