Digital Gold

by Nathaniel Popper

  The Bitcoin arms race had begun.

  THE TYPE OF chip was not the only thing about Bitcoin mining that had changed since late 2010. Over the course of 2011 and 2012, more and more users were joining collectives that pooled their mining power. These mining pools allowed lots of people to combine their resources, with each person getting a proportional fraction of the total winnings, thus increasing the chances that everyone would get something every day.

  The pools, though, generated concern about the creeping centralization of control in the network. It took the agreement of 5 percent of the computing power on the network to make changes to the blockchain and the Bitcoin protocol, making it hard for one person to dictate what happened. But with mining pools, the person running the pool generally had voting power for the entire pool—all the other computers were just worker bees. As a couple of pools harnessed significant computing power, some people worried that the operators of those pools could conspire to change or undermine the rules of Bitcoin.

  But an incident in March 2013—the network’s most significant technological failure to date—was a reminder of how the incentives built into the Bitcoin network could still work as Satoshi had hoped. Gavin Andresen, now the chief scientist of the Bitcoin Foundation, was in his den in Massachusetts after dinner, when he saw some online chatter about disagreement between computers or nodes on the network over what block the nodes were trying to mine—was it the 225,430th block since the network began back in 2009, or the 225,431st?

  Gavin quickly realized that this was what had long been known as the biggest potential danger to the Bitcoin network: a “hard fork,” a term coined to describe a situation where one group of computers on the network went off in one direction, agreeing about which node had mined each block, while another group of computers on the network moved in another direction, agreeing on a different set of winners for each block. This was disastrous because it meant that there was disagreement about who owned which Bitcoins. So far, there had been a split only on the last few blocks—not the whole blockchain history—but if it wasn’t fixed, there would essentially be two conflicting Bitcoin networks, which would be likely to result in no one trusting either of them, or Bitcoin itself.

  “this seems bad,” a user on the chat channel wrote a few minutes after the problem first appeared.

  “‘seems’ is putting it lightly,” another shot back.

  “We have a full fork,” one of the most respected developers, a Belgian programmer named Pieter Wuille, pronounced a few beats later.

  The price of Bitcoin dropped from $49 back to $45 in a half hour, erasing all the previous week’s gains.

  Mark Karpeles joined the discussion a half hour later, and quickly stopped processing all transactions at Mt. Gox; a few minutes after that, Erik Voorhees said his gambling company, SatoshiDice, was doing the same.

  By the time Gavin entered the conversation, it was clear that the problem was not the result of one node overpowering the network or of any sort of malice. Instead, computers that had downloaded a recent update to the Bitcoin software were accepting blocks—and awarding new Bitcoins to miners—that were not considered legitimate by the old software and the computers still running it. Generally, if a block was accepted by a majority of nodes, it would be accepted by everyone, but the old software, version 0.7, had a rule that specifically did not allow a type of block that the new software, version 0.8, did allow.

  The solution to this was clear: everyone on the network had to agree to move en masse to one of the two versions and adopt the blockchain accepted by that software. But there were no rules for deciding which version to pick—and once a version was chosen, no one knew how long it would take for all the nodes to get on board.

  After racing through the possibilities, Gavin concluded that the most fundamental rule of Bitcoin was the democratic principle that the blockchain with the most support was the official one. In this case, the version created by the new software, 0.8, had a lot more computing power behind it. That was, in no small part, because the most sophisticated miners, especially the large pool operators, had been among the first to update their software. Gavin thought that if they had the most power, everyone else needed to update to join them. In addition to having more power, the miners on the new software had newly generated coins that they would be unlikely to want to give up.

  Gavin quickly faced resistance from almost everyone else involved in the conversation; most participants believed that only the large miners would be responsive enough to change their software to fix the problem. Somewhat surprisingly, the operators of the biggest mining pools quickly agreed that they would revert to the old software, version 0.7. The operator of the prominent pool BTC Guild said that just switching his pool alone would get a majority of the computing power back on the earlier software. Doing this would mean losing the Bitcoins that had been mined since version 0.8 came out. But the losses would be much greater if the entire Bitcoin network lost the confidence of users.

  “There is no way the 0.8 chain can continue in this situation,” the operator of BTC Guild, who went by the screen name Eleuthria, said.

  The developers on the chat channel thanked him, recognizing that he was sacrificing for the greater good. When he finally had everything moved about an hour later, Eleuthria took stock of his own costs.

  “It could’ve been worse if I hadn’t been able to start moving back to 0.7 quickly.” But, he wrote, “this fork cost me 150–200 BTC”—over $5,000.

  For the broader Bitcoin ecosystem, the price had fallen to $37, some 20 percent, within a few hours, and some online reports struck an ominous note.

  “This is a dark day for Bitcoin. Implications for the exchange rate will likely be huge,” a site called The Bitcoin Trader announced.

  The incident had indeed revealed the sort of unanticipated problems that frequently occur in decentralized networks, which rely on lots of different members, with all their vagaries, acting independently.

  But almost as soon as Eleuthria had fully switched his servers over to version 0.7 the price began recovering, and within hours people were talking about how the event had actually demonstrated some of Bitcoin’s greatest strengths. The network had not had to rely on some central authority to wake up to the problem and come up with a solution. Everyone online had been able to respond in real time, as was supposed to happen with open source software, and the users had settled on a response after a debate that tapped the knowledge of all of them—even when it meant going against the recommendation of the lead developer, Gavin. Meanwhile, the incentives that Satoshi Nakamoto had built into the network had again worked as intended, encouraging people to look out for the common good over short-term personal gain.

  A WEEK LATER, Gavin was back at his desk in the den not long after dinner, when an unexpected announcement popped up. It came from the Financial Crimes Enforcement Network, or FinCen, the division of the Treasury Department responsible for monitoring money laundering and enforcing the Bank Secrecy Act. In opaque bureaucratic terms, the release stated its intent to “clarify the applicability of the regulations implementing the Bank Secrecy Act (‘BSA’) to persons creating, obtaining, distributing, exchanging, accepting, or transmitting virtual currencies.”

  Reading behind the legalese, Gavin could see that this was the United States government’s first statement on the legality of Bitcoin.

  “oh wow,” Gavin Andresen wrote on the chat channel before passing along a link to the announcement for everyone else.

  Everyone had feared that at some point the authorities would step in and declare virtual currencies illegal. As Gavin and others furiously scanned the lengthy document, the doomsayers were quick to give their read.

  “this kills the Bitcoin,” one user on IRC responded to Gavin.

  But as Gavin and others read on, they saw that it was not, in fact, all bad. Yes, the document noted that anyone selling virtual currency for “real currency or its equivalent” would now be considered a money transmit
ter—a category of business subject to lots of stringent federal rules. But the release also made clear that many parts of the virtual-currency universe—including miners—were not subject to these regulations. More important, Jeff Garzik, the programmer in North Carolina, noted, the basic implication of the message cleared up the biggest single cloud: “this solidifies Bitcoin status as legal to possess and use for normal people.”

  Indeed, Gavin said: “More legal/regulatory certainty is definitely a good thing . . . even if we might not like the regulations.”

  Over the next few days, Bitcoin companies all raced to understand the specifics of the FinCen guidance. Exchanges clearly needed to register as money transmitters, but what about companies like BitInstant that just worked with exchanges? And did exchanges also need to register as money transmitters with each state, as companies like Western Union had to do?

  In New York, Charlie got an e-mail from one of BitInstant’s lawyers: “I don’t think this is good for the community.”

  But for the broader Bitcoin universe, the basic message of the guidance was encouraging: the United States government was not planning to come in and shut down the virtual currency. The next day the price of Bitcoin surged from $52 to $59, and by Thursday it was above $70.

  The financial crisis sweeping Europe added yet another boost to the price. The banks on the Mediterranean island of Cyprus were on the verge of collapsing in mid-March when European authorities put together a bailout plan. The hitch was that all savings in Cyprus’s banks were to be docked by 10 percent. The government, in other words, was confiscating money from private bank accounts. BusinessWeek ran a story that conveyed the seeming promise of Bitcoin: “BITCOIN MAY BE THE GLOBAL ECONOMY’S LAST SAFE HAVEN,” the magazine’s headline said. Russians who kept their money in Cyprus’s banks were rumored to be buying up Bitcoin, which no government could confiscate.

  The prices certainly suggested that someone with lots of money was buying. In California, Wences Casares knew that no small part of the new demand was coming from the millionaires whom he had gotten excited about Bitcoin earlier in the month and who were now getting their accounts opened and buying significant quantities of the virtual currency. They helped push the price to over $90 in the last week of March. At that price, the value of all existing coins, what was referred to as the market capitalization, was nearing $1 billion.

  On March 27 the forums and the news site Reddit lit up with calculations of what value, for a single coin, would take the market capitalization over $1 billion, and the number settled on was $91.26. This calculation was largely theoretical: most of the outstanding coins had been purchased for pennies or a few dollars in the early years, and if everyone tried to sell for $91, the price would plummet. But it marked a psychological line in the sand that was, if nothing else, fun to talk about. That day, Cameron Winklevoss, who had taken responsibility for the twins’ buying and selling of Bitcoins, was watching the price closely, first from the twins’ office and then from home. After midnight, as he was preparing to go to bed, he saw the price approach the magical border of a billion. As the number crept closer and closer, he placed a small order on Mt. Gox that would be executed only if the seller agreed to a price above $91.26. The order was quickly filled and he watched the value of a Bitcoin on Mt. Gox—determined by the last order—jump to $91.27. Twitter and Reddit went wild. The next morning, Cameron gleefully reported to Tyler that it was their money that was responsible for sending the value of all Bitcoin over $1 billion for the first time.

  CHAPTER 20

  March 2013

  The surging price of Bitcoin helped bring out of the woodwork some of the early Bitcoiners who had dropped from view.

  In February, Martti Malmi posted an entry on his company’s website describing his early days in Bitcoin. A month later, Hal Finney recounted his own story on the Bitcoin forum. By this time, his ALS had progressed to the point where he was essentially paralyzed, relying on tube feeding and a respirator. He spent most of his time in the same living room where he’d first worked on Bitcoin four years earlier, his old computers stacked up on the desks around him. But Hal could still communicate and type using a computer that tracked his eye movement, and he diligently worked on a few coding projects and regularly checked in on Bitcoin to see how his pet project was doing. As he watched the price go up, he asked his son to burn the private keys to his Bitcoin wallets onto a DVD, and put the DVD in a safe-deposit box at a bank. Some of his coins, though, he had his son sell, in order to pay for all the medical care he needed to stay at home.

  “I’m pretty lucky overall,” Hal wrote. “Even with the ALS, my life is very satisfying. But my life expectancy is limited. Those discussions about inheriting your Bitcoins are of more than academic interest. My Bitcoins are stored in our safe deposit box, and my son and daughter are tech savvy. I think they’re safe enough. I’m comfortable with my legacy.”

  THIS SHOULD HAVE been the best of times for the existing Bitcoin businesses, and in certain ways it was. In March alone, sixty thousand new accounts were opened on Mt. Gox, and the monthly trading commissions rose above $1 million for the first time ever, more than triple what they had been a month earlier.

  But even after all their earlier struggles, the staffers at Mt. Gox were not ready for this surge in business. Mark Karpeles now had a staff of eighteen, and a deputy with real business experience, whom he put in charge of all the company’s dealings with the outside world. But Mark gave this deputy no power over the company’s actual operations and kept firm control of Mt. Gox’s essential accounts. Mark also continued to struggle with prioritizing his responsibilities. He was two years into running the world’s largest Bitcoin exchange, but he had still not attended a single Bitcoin event abroad—a fact that he blamed on the sickness of his cat, Tibanne, who needed daily shots that Mark believed only he could administer.

  Meanwhile, in late 2012 Mark had agreed to hand over his American customers to Peter Vessenes and his company CoinLab, which had an American bank account. But when it came time to hand over the customer files in March, Mark flinched, worried about some of the terms in the contract he had already signed. This left Mark’s customers relying on Mt. Gox’s Japanese bank, which put strict limits on the number of wires the company could send out each day. Even the simple task of opening an account with Mt. Gox required a three-week wait for approval from Mark’s team.

  For BitInstant and other companies that had to work with Mt. Gox, the reason behind the problems seemed simple: sheer incompetence. Charlie Shrem’s BitInstant was now the main driver of trading volume to Mt. Gox, but when there were problems Charlie’s e-mails to Mark Karpeles would go unanswered for days or even weeks.

  Wences Casares had never fully trusted Mt. Gox and had been looking for a better place to store his coins. When he put them into his own digital wallet, he realized that all his private keys—the signature that allowed his coins to be spent—were sitting on his computer or phone, waiting for the first hacker who got access to his computer. Someone who had the private key for one of Wences’s Bitcoin addresses could, essentially, impersonate Wences. Wences decided to work on a system with his Argentinian friend Fede Murrone to store their private keys out of the reach of hackers. They started by putting all their private keys on a laptop, with no connection to the Internet, thus cutting off access for potential hackers. After David Marcus, Pete Briger, and Micky Malka put their private keys on the same offline laptop, the men paid for a safe-deposit box in a bank to store the computer more securely. In case the computer gave out, they also put a USB drive with all the private keys in the safe-deposit box.

  CHARLIE HAD KEPT BitInstant ahead of the regulatory curve. Back in 2012 he had registered the company with FinCen as a money transmitter. In March, though, the company was still trying to bounce back from the departure of Erik Voorhees and his friend Ira Miller, who had moved to Panama to develop their own company after the falling-out with the Winklevoss twins.

  The new team Char
lie brought on immediately spotted significant flaws in the way the company was being run. For starters, Charlie was the only one with access to the company’s bank accounts. Many day-to-day operations required Charlie to manually intervene. The new lead developer called for the entire site to be taken down and rebuilt. But there wasn’t time as new customers were pouring money into the site. The new staff members were jammed into every corner of the small offices Charlie and Erik had moved into the previous summer.

  On top of the internal problems, Charlie was also having trouble finding a reliable bank account, even as a registered money transmitter. Since the end of 2012, Charlie had opened accounts with KeyBank, PNC, Wells Fargo, and JPMorgan Chase—and all of them had been shut down. It became apparent to others in the company that Charlie had not been entirely up-front with the banks about the nature of his business. Charlie had generally opened the accounts without explaining that BitInstant customers would be depositing and withdrawing money on a daily basis. When the banks saw the thousands of transactions every day—a strain on their compliance officers—they decided the BitInstant business wasn’t worth it.

  This pointed to a broader issue with Charlie that was frustrating the Winklevoss twins and was clearly an outgrowth of his childhood desire for acceptance. Charlie loved telling people what they wanted to hear. He would always give the twins optimistic predictions for projects and would fail to alert them to impending problems until the last moment, in the hope that the problems would go away. This optimistic approach was great for a salesman, and Charlie had been a great salesman. But it was not such a great habit for a manager, who needed to find a way to deal with problems, not ignore them.