Digital Gold

by Nathaniel Popper

  Given the issues at Mt. Gox and BitInstant—the two longtime giants of the Bitcoin world—investors and entrepreneurs in Silicon Valley were looking for alternatives. As an alternative to Mt. Gox, people saw some promise in Bitstamp, an exchange that had been founded by a Slovenian college student and a family friend back in 2011 and that had been growing slowly ever since. Wences and Micky sent one of Micky’s deputies to Slovenia to scope out the operations. The youngsters running Bitstamp looked like an Eastern European boy band, with their long hair and penchant for Adidas track suits. But their evident competence—particularly when they were compared with Mt. Gox—generated so much confidence that Wences and Micky began moving their trading to Bitstamp. Mt. Gox still had 80 percent of all Bitcoin trading, but Bitstamp’s market share began to creep up.

  For those looking to buy smaller quantities of Bitcoin—BitInstant’s specialty—people found their way to Coinbase, a San Francisco–based startup that had been opened by a veteran of Airbnb and a former trader at Goldman Sachs at the beginning of 2013. The company had managed to interest several investors and had maintained a bank account with Silicon Valley Bank. But even with Coinbase executives at the bank made it clear that the Bitcoin business was testing their patience. In order to stay on top of anti–money laundering laws, the bank had to review every single transaction, and these reviews cost the bank more money than Coinbase was bringing in. The bank imposed more restrictions on Coinbase than on other customers because Bitcoin inherently made it easier to launder money. A terrorist could potentially put dollars into Coinbase, buy Bitcoins, and then use the blockchain to send those Bitcoins to terrorist cells overseas. Because there is no identifying information attached to Bitcoin addresses, the terrorist cell could receive money without anyone noticing. That is very different from a traditional bank, in which every account is tied to a specific person or organization. Coinbase had to repeatedly convince Silicon Valley Bank that it knew where the Bitcoins leaving Coinbase were going. Even with all these steps, on several days in March Coinbase hit up against transaction limits set by Silicon Valley Bank and had to shut down until the next day.

  At the end of the month, an item was posted on SVBitcoin, an invite-only e-mail list for the Silicon Valley Bitcoin community: “The Time Has Come for the Bitcoin Community to Own a U.S. Based Federally Chartered Bank.”

  The author, an investor named David Johnston, wrote that the skepticism of traditional banks toward virtual currencies was the biggest roadblock facing Bitcoin’s growth. If people couldn’t send dollars from their bank to BitInstant or Coinbase, the surging interest in virtual currencies would be snuffed out.

  The community was hitting a roadblock that almost every movement striving to disrupt the status quo eventually reaches. The big ideals of Bitcoin had carried it a long way and were sound in theory, but eventually the community required some cooperation from the existing authorities—people needed the old banks to agree to move their money into the Bitcoin realm. This was like an anarchist commune that ran up against the unwillingness of local officials to continue delivering water and electricity. Such collisions with the recalcitrant real world are frequently where utopian schemes run into trouble.

  Johnston estimated that purchasing a licensed bank that could specialize in Bitcoin companies would require something like a $10 million investment up front. He offered to put up $1 million himself—thanks to the big rise in his own Bitcoin holdings—and he sought out ten more investors to join him. Charlie quickly wrote back saying it was a great idea. Wences responded next, offering to help fund the venture.

  But there wasn’t time for any big changes. On April 1, 2013, the price of a Bitcoin crossed the $100 threshold, a 670 percent increase since the beginning of the year.

  The price moves were now feeding on themselves, as speculators chased the climbing ticker, fueled by news articles from all the new acolytes, many of them tutored by Wences. Jeremy Liew, a venture capitalist at the firm Lightspeed Capital, which had money in Wences’s current startup, wrote an article in TechCrunch explaining that: “As a VC, my interest in the Bitcoin ecosystem is not ideological but mercenary. I see the opportunity for Bitcoin to disrupt multi-billion-dollar markets, but in doing so also create new big markets.”

  Within the companies handling all the money, however, the gaskets popping and wood warping were once again audible. Charlie didn’t have enough money at Mt. Gox to fill all the orders coming in. On April 5, with the price moving above $140, he asked the Winklevosses for a short-term loan of $500,000 so that he could increase his reserves.

  “I really wanna make 4pm wire cutoff so I can make sure we have enough money for the weekend in our accounts!” Charlie wrote feverishly.

  When they quickly sent over the funds, he wrote back: “Thanks guys, you are amazing.”

  Charlie was also running into issues at Mt. Gox, where he purchased many of the coins that he sold to BitInstant customers. With orders pouring in, Mt. Gox was so backed up it was taking half an hour for trades to go through. This exacerbated the price swings as people who thought they were buying at $160 weren’t getting their coins until the price was at $175.

  To compound matters, Mark Karpeles chose this moment to move ahead with big changes in some obscure but important codes that customers used to transfer money around, and did not fully brief customers—even big ones like BitInstant—on how to cope with the changes. This set off a set of increasingly panicked e-mails between Tokyo and New York.

  “You have been throwing us around like you always do,” Charlie wrote to Mark on April 9. “Beating around the bush and not being up front with us.”

  When Mark responded without answering Charlie’s basic question about some necessary coding language, Charlie exploded: “IF WE CANNOT ACCEPT MTGOX ORDERS WE ARE VIRTUALLY SHUTTING DOWN.”

  “Someone help us!!!!” Charlie wrote on the morning of April 10.

  That same day, the mania peaked when the price for Bitcoins on Mt. Gox surged to $260. In the first ten days of the month, the exchange had attracted 75,000 new accounts. On April 10 the number of trades coming in was three times higher than it had been just a day earlier. For a trade, the lag between being entered and being executed was more than an hour. As people sat waiting for their orders to go through, they saw the price shoot up and panicked, not wanting to pay $300 when they had intended to pay $200. Orders were canceled and people began to sell, hoping to lock in the profits they had realized over the past months. The effect was predictable. While Charlie was asleep in New York the price began crashing, and by the time Charlie showed up at the office, the price was down to $200. By lunchtime it was closer to $100.

  The BitInstant engineers congregated with their laptops on the small black sofa and chairs in Charlie’s office. Charlie had a bottle of rum on his desk and, in a spirit of good fun, was taking occasional swigs as everyone tried to figure out just what was going wrong. Even the wireless network in the office was failing because of the number of people in the building trying to help. When Yifu Guo, the creator of the Avalon mining chips, stopped by the office, Charlie was in a state of giddy panic, both scared and amused.

  “I’m flipping out. I’m yelling at everyone. Yifu, I’m drinking the rum from the bottle,” he said with a laugh.

  “I don’t know why you guys are all freaking out,” Yifu said, chuckling himself. “I’m not worried. The price is fine. It’s time to buy.”

  Things calmed down for a few hours after Mark Karpeles assured his users that the problems were due to the volume of trade, not to hackers. But hours after he wrote that, the hackers showed up and staged fierce denial-of-service attacks, forcing Mark to shut down the site altogether in the middle of the day.

  CHAPTER 21

  April 11, 2013

  The day after Mt. Gox shut down under the strain of heavy trading, the members of the corporate board of Lemon, Wences Casares’s digital wallet, showed up at the company’s Palo Alto offices for a lunchtime meeting. The price of Bitcoi
n sat more than 50 percent lower than where it had been twenty-four hours earlier. But the sudden downturn had done nothing to dim Wences’s faith in Bitcoin’s future. Instead, it had increased his conviction that the companies dominating the Bitcoin universe, like Mt. Gox, needed to be replaced, and that he needed to do more than just be a cheerleader for Bitcoin among the Silicon Valley elite.

  Lemon provided a way for customers to keep all their credit cards and coupons in digital form on their smartphones. Wences proposed to his board that they add a pocket for Bitcoins that would be a safe, reliable way to keep virtual currencies and potentially even to buy them. To get started, Wences suggested that Lemon could use $1 million of its remaining money to buy Bitcoins that could serve as an initial pool for customer purchases. This was actually a great time to buy coins, Wences argued, because the price was down after the latest price crash.

  Wences expected to see his board members light up—particularly Micky Malka, the chairman of Lemon’s board and one of the first people Wences had gotten excited about Bitcoin back in 2012. Instead, Micky furrowed his brow. Is this really what Lemon set out to do? Micky asked Wences. Lemon had finally started catching on as a digital wallet. Wouldn’t opening it up to virtual currencies engender all sorts of unknown legal risks?

  The other board members quietly listened to Wences’s explanation of why this was worth doing. They all knew it was dangerous in Silicon Valley to alienate an entrepreneur like Wences—there was no easier way to ensure that a company failed. But they didn’t jump to his defense either.

  After the meeting was adjourned, the board member who had looked the least skeptical, Eric O’Brien, pulled Wences aside and asked him: “How strongly do you believe in this—what are you personally doing?”

  Wences didn’t mince words: “I am personally allocating a percentage of my net worth to this that is borderline irresponsible because I believe in it so much.”

  Regardless of what the Lemon board wanted to do, Wences said, “I would advise you to invest as much money as you can stomach losing.”

  He told O’Brien to buy coins at Mt. Gox, but to move the coins off Mt. Gox as soon as the order went through.

  “It is either going to be worth zero or worth five thousand times what it is today.”

  IN THE DAYS that followed, Mt. Gox reopened for business and the price stabilized around $100. But many believed that the recent price crash proved the flaws in the whole concept. Felix Salmon, a financial columnist at Reuters, wrote a widely circulated article pointing out that the volatile price of Bitcoin made it nearly impossible to use for its most basic purpose, as currency. If consumers didn’t know whether a Bitcoin would be worth $10 or $100 tomorrow they would be unlikely to spend their coins and merchants would similarly be unlikely to accept them. Even this critic, though, saw something elegant in the network underlying Bitcoin.

  “For the time being, Bitcoin is in many ways the best and cleanest payments mechanism the world has ever seen,” Salmon wrote. “So if we’re ever going to create something better, we’re going to have to learn from what Bitcoin does right—as well as what it does wrong.”

  The day after the crash, the Winklevoss twins finally went public in the New York Times with their now significant stake in Bitcoin—worth some $10 million. The interest was not restricted to the United States. A few weeks after the crash, a national television station in China broadcast a half-hour segment on the new enthusiasts in that country, and several local entrepreneurs began setting up exchanges to buy Bitcoins using yuan.

  Despite the crash, everyone with a Bitcoin idea found that there was now no shortage of eager investors in Silicon Valley. In May, Pete Thiel’s Founders Fund announced that it was putting $2 million into BitPay, the payment processing company that allowed merchants to accept Bitcoin and end up with dollars in their bank—taking advantage of the Bitcoin network’s quick and cheap transactions.

  But the company that was attracting the most attention was Coinbase, founded by the veterans of Airbnb and Goldman Sachs. The twentysomething cofounders had clean-cut looks and soft-spoken ways that naturally engendered confidence. Investors liked that the pair avoided the ideological talk of overthrowing the Fed and instead sold their company as a safe and easy place for consumers to buy and hold coins that wouldn’t be subject to endless delays and scrutiny from the authorities. They also had real professional experience at well-known companies, something that had been in short supply in the Bitcoin world up to this point.

  After consultations with Wences, Micky decided to team up with the New York venture capitalist Fred Wilson to put $5 million into Coinbase. It was the largest publicized investment in a Bitcoin company to date, by a wide margin, and the first time an established venture capitalist like Wilson had put serious money into the space. The rest of Silicon Valley took notice.

  CHARLIE, MEANTIME, WAS taking advantage of BitInstant’s status as the only serious Bitcoin company in New York—the media capital of the world—to become a sort of public spokesman for Bitcoin in the press. He regularly invited reporters to a bar that he had invested in at the beginning of the year, EVR, the sort of dark, swanky Manhattan club that made its clientele line up in high heels on the sidewalk. The round leather booth in the back corner was Charlie’s standing nighttime office, with some top-shelf liquor on the table for guests.

  Those who knew Charlie back in Brooklyn were amazed at his transformation from a short, awkward teenager into a confident impresario who bragged about the ring that he wore, engraved with the private key to one of his Bitcoin wallets. But as always with Charlie, it was all somewhat less than it appeared. He still lived in his teenage bedroom in the basement of his parents’ house in Brooklyn. He left people with the impression that EVR was his bar, despite the fact that he had put in only about $15,000 and owned less than 1 percent of it. Meanwhile, Charlie’s company was racing furiously to keep up with all the new competitors, especially Coinbase, and Charlie was often missing when he was needed most, hanging out at the bar or talking with reporters. At one point, Cameron Winklevoss asked Charlie: “Do you want to be the proprietor of a bar or the CEO of a Bitcoin company? You can’t have it both ways.”

  Cameron, the more involved of the two twins, constantly pressed Charlie on why things weren’t getting done faster. When Coinbase’s $5 million investment was announced, Cameron warned Charlie that Coinbase could steal BitInstant’s thunder.

  “Just deliver the deliverables and stop fucking around,” Cameron told him.

  Charlie meekly submitted. “OK, I will push the team and myself harder.”

  IN TOKYO, MARK Karpeles was also learning that Mt. Gox’s first-mover advantage was not impregnable.

  On May 2, Mark was sued in a Seattle court by CoinLab, the company run by Peter Vessenes that had been scheduled to assume responsibility for Mt. Gox’s business in the United States earlier in the year. CoinLab accused Mt. Gox of breaching its contract by not handing over the customers. Troubles deepened a week later when the money in Mt. Gox’s two American bank accounts—some $5 million—was seized by federal agents, who accused Mt. Gox of violating federal money-transmitting laws. It wasn’t apparent at the time, but these moves were part of the net tightening around Silk Road, as law enforcement agents in Baltimore narrowed in on their prey. Prosecutors had secretly filed a sealed indictment on May 1 against Dread Pirate Roberts for narcotics trafficking and were prepared to arrest the mastermind as soon as they figured out who he was.

  Given all this turbulence, it was remarkable that anyone continued using Mt. Gox at all. In the world of trading, though, the most valuable thing an exchange can offer is liquidity or, more simply, people buying and selling. An exchange with the best technology in the world isn’t worth anything if no customers are there offering to buy and sell. Mt. Gox still had liquidity because it had attracted so many customers from its days as just about the only exchange around, and some customers would move only if others did as well.

  But a chasm was o
pening up between the early Bitcoiners and the new, more practical community of entrepreneurs, engineers, and investors. When some of the developers working on the underlying Bitcoin code set up a Bitcoin press center, it immediately led to fights about who was presentable enough to be listed as a contact for journalists, especially when Roger Ver was taken off the list. Erik Voorhees lashed out at those trying to smooth Bitcoin’s sharper edges.

  “It is embarrassing to see Bitcoin reduced to sniveling permission-seekers, too cowardly to speak about the real issues and the real reasons why this technology is so important,” Erik wrote. “Bitcoin is a movement, and those trying to distill it into nothing more than a cute new technology are kidding themselves and doing a terrible disservice to this community.”

  EVERYONE SEEMED READY for a truce from the bickering as the Bitcoin Foundation’s first-ever conference approached in late May. The foundation had booked the main convention center in the capital of Silicon Valley, San Jose.

  On the morning of the conference’s first day, Friday, May 17, the Valley news site TechCrunch went live with a story that officially announced the investment the Winklevoss twins had made in BitInstant, which had remained a secret even after they went public with their holdings of Bitcoin. The investment was put at $1.5 million. Even this article was the cause for a small tiff with Charlie, who had accidentally tipped off another reporter first.

  “Your communication is piss poor and gums up the entire operation,” Tyler Winklevoss wrote.

  But the tension quickly passed and Charlie and the twins showed up at the convention center to find that they were heroes of sorts to the assembling Bitcoin masses. Many of the conference attendees had been aficionados for years, waiting for the world to see the beauty of their pet project. Now these tall, statuesque celebrity twins were standing up for their cause. On Friday night, the twins delivered the keynote speech together, clad in sneakers and button-down shirts with rolled-up sleeves. They opened with a quote from Gandhi, and proceeded to cite Dr. Seuss and the Bitcoin pizzas purchased by Laszlo Hanecz. The next morning, when the general exhibition opened, one vendor was selling shirts with the smiling face of Charlie Shrem, in the style of Barack Obama’s famous “Hope” poster.