by David Gerard
In April 2011, anarcho-capitalist and businessman Roger Ver, who had made his fortune with computer parts business Memory Dealers, heard a segment about Bitcoin on the libertarian podcast Free Talk Live. Ver promptly went to Mt. Gox, the Bitcoin exchange mentioned on the show, and bought $25,000 worth of Bitcoins, single-handedly pushing the price up from $1.89 to $3.30 over the next few days. He would spend the next few years buying and advocating Bitcoin, branding himself “Bitcoin Jesus.”
The earliest minor bubble grew and popped in June 2011, after an article on the Silk Road darknet market, mentioning Bitcoin, in Gawker. 1 BTC momentarily peaked at $30, before dropping to $15 after Mt. Gox was hacked in June, and slowly declining to $2 by December. By a year later, in December 2012, it had risen to $13. (With minor wobbles such as the August 2012 crash when the Pirateat40 Ponzi scheme collapsed.)
In this era, Bitcoin was largely evangelised by advocates for its hypothetical use cases and political possibilities. The actual use case was buying drugs on the Silk Road, the first notable darknet market, which started in January 2011. Mining at home could still be profitable at this time.
The bubble really got going in early 2013. By March, the price had hit $50 and The Economist warned that this was really obviously a bubble, noting how closely the price tracked Google searches for “bitcoin”.56 It hit $266 in April after a month of going up 5-10% daily, crashed to $130 in May and $100 in June, and rose steadily through the rest of the year – with occasional hiccups when Mt. Gox, by now the largest Bitcoin exchange, handling 70% of all Bitcoin transactions, had unexpected delays in allowing customers to cash out in US dollars.
The Silk Road was busted in early October and Bitcoin plummeted from $145 to $110. But it rose again with increased interest from China, with highly efficient mining operations starting up with custom-made ASIC mining chips, and local exchanges gaining great popularity.57 The price started November at $350, and peaked at $1250 – or at least that was the spot price on Mt. Gox, and users were once again reporting problems withdrawing dollars. In December it started at $500, jumped to $1000 and fell back to $650 – the standard bubble peak had passed.
Mt. Gox stumbled along for a few months then finally collapsed, taking everyone’s deposits with it; it later came out that they had been insolvent since at least 2012. The price declined through the rest of 2014, bottoming out just below $200 in early 2015. As a currency, Bitcoin did somewhat worse in 2014 than the Russian rouble and the Ukrainian hryvnia.
It is important to note that Bitcoin advocates believed the late 2013 peak was not a bubble, but the natural upward progression of the price as Bitcoin increased its share of the economy; e.g., Rick Falkvinge’s March 2013 piece “The Target Value for Bitcoin Is Not Some $50 or $100: It is $100,000 to $1,000,000.”58 The collapse came as a complete shock to many; when Mt. Gox went down, Reddit /r/bitcoin posted and pinned suicide hotline numbers.
The art of the steal
As a financial instrument born without regulation, Bitcoin quickly turned into an iterative exploration of precisely why each financial regulation exists. A “trustless” system attracts the sort of people who just can’t be trusted.
Many crypto scams are quite complex; some are simpler than you might expect. Many are everyday dodgy investment opportunities but with Bitcoin. It can be difficult to distinguish malice from incompetence. The general problem is that you don’t know who or where these people are, and they routinely just disappear with everyone’s money.
Scams common to the cryptocurrency world include:59
Ponzi schemes: in which early investors are paid using money from later ones. These are so attractive to crypto fans that when Ethereum took blockchains and added “smart contracts” (programs that run on the blockchain), the first thing people did was write automatic “honest” Ponzis.
High-yield investment programmes: a variety of Ponzi scheme. You might think it obvious that no investment scheme could pay 6% interest per week sustainably, particularly when it claims a “secret” investment strategy, but what worked on Bernie Madoff’s victims works on Bitcoiners.
Coin doublers: send it a small amount of bitcoins and you’ll get double back! (No reason is given why anyone would just double your money.) Send a larger amount straight after and … you won’t. You’d think people would catch on, but years later these keep popping up and finding suckers.
(There’s another layer of scam in there: the “doubler” never sends back coins. But it’s publicised with a “warning” about the scam. Others think “hold on, if I only send coins once it’ll never see me as a repeat user!” They send in a small amount of coins, which of course is not doubled. It’s a scam which relies on the sucker thinking they’re the scammer.60 A similar scam ran in the game RuneScape.61)
Mining software: if you aren’t designing your own mining chips and running them off super-cheap power, you won’t have been able to break even mining Bitcoin since late 2013. But people keep claiming you can still mine on your PC. The software frequently includes malware.
Mining hardware: there are real sellers of mining hardware (though you are unlikely to come out ahead of costs). The scam is to run it for months “testing” it: customers pay for hardware, you use their money to build it and you mine with it for the few months it’s viable before you send it to them. Butterfly Labs was the most notorious culprit,62 but far from the only one. (Butterfly’s co-founder turned out to have a conviction for mail fraud;63 Bitcoin scammers are often serial scammers.)
Cloud mining: you invest in remote mining hardware. Many such schemes appear indistinguishable from Ponzis; there is generally no evidence the money-printing machine you’re renting even exists.
Scam wallets: sites offering greater transaction anonymity, but which just take everyone’s bitcoins after a while.
Biased “provably fair” gambling: “Provably fair” gambling sites generate their random numbers in advance then send you a cryptographic hash of the sequence of numbers, so you don’t know the numbers ahead of time but you can verify the hash afterwards.64 Some sites, if you don’t grab the hash, then use a biased sequence of numbers instead.65
Scam versions of normal services: exchanges, bitcoin mixers, shopping deal sites and so on. You have no idea who these people are, and every now and then they’ll just take your bitcoins or link you to phishing or other scam sites, possibly including the gift of malware.
Fortunately, Bitcointalk.org deals harshly with scammers: it may add a “scammer” tag to someone’s forum name, or list their site in the “List of Bitcoin Scam Sites” thread.
Many Bitcoin advocates consider the scammers worth it to be free of government regulation. Anarcho-capitalist Jeffrey Tucker wrote an amazing apologia, “A Theory Of The Scam,”66 in which he admits Bitcoin is suffused with fraud, but posits that “scam artists are the evil cousins of genuine entrepreneurs” and are actually a sign of health for an area – so, since good things had scams, this scam-riddled thing must therefore be good! (With all this horse poop there’s gotta be a pony in here.) No doubt subprime-mortgage-backed collateral debt obligations, Business Consulting International and Bernard L. Madoff Investment Securities LLC were just severely underpriced investment opportunities.
Pirateat40: Bitcoin Savings & Trust
Now that Pirateat40 closed down his operatations thanks to all the fud that was going on and growing on the forum, I expect everyone that spreads this fud, accused and insulted Pirate and the people that supported him to apologize. Not only did Pirate brought us a great opportunity for investors (once in a lifetime actually), he did help stabilise and grow steadily bitcoin price, volume exchange, and thus contributed to the success of bitcoin. For that, Pirate, I want to thank you. You’ve done a wonderful work, and I hope you’re stay around here.
– Raphael Nicolle, founder of the Bitfinex exchange, just after Bitcoin Savings & Trust collapsed67
By 2012, as the Bitcoin subculture was heating up, high-yie
ld investment programmes – i.e., Ponzi schemes – had begun manifesting in the bitcointalk.org “Lending” section. One user even literally called high-yield investment programmes a “Bitcoin Killer App”.68
The most famous of these was Bitcoin Savings & Trust, opened in late 2011 by Trendon Shavers, a.k.a. Bitcointalk forum user Pirateat40 (named after the song “A Pirate Looks at Forty” by Jimmy Buffett). It offered interest of 7% weekly – or about 3300% annually – on investments over 25,000 BTC. Hands up anyone who can see a problem here …
Investment was strictly limited and accounts were much-coveted. Pirateat40 was a VIP Donor (50 BTC) to Bitcointalk; he built up a strong forum reputation and got other highly-rated people to resell his investment programme, offering “Pirate Pass-Through” bonds. Those who pointed out that this had all the really obvious signs of being a Ponzi scheme had much lower forum reputations, especially after saying this.
Pirateat40 claimed to be making his money from Bitcoin market arbitrage, including selling bitcoins in person or in large quantities. Others were not reassured; he had so many bitcoins in his scheme that others worried at the effect on Bitcoin itself when the scheme collapsed.69
On 17 August 2012, basic arithmetic reasserted itself. Pirateat40 announced the closure of Bitcoin Savings & Trust. He said he had 500,000 BTC (about $5.6 million) in the fund as of its closure and that he would be returning it to investors.70 Apart from some refunds to friends and long-time investors, this of course didn’t happen.
On 17 September, Pirateat40 announced on IRC that “the earliest estimated time that coins can begin moving is Friday, Oct 12th” (not that any coins actually moved on 12 October). He also declared that “Those looking to file a suit against me or BTCST will not be eligible for repayment” and “Threats are taken seriously by myself and my attorney. A few of you will find out how serious I mean.”71
Burnt investors tracked him down. They found his name, they found where he lived, they even found his business that had closed at the same time. They initially had some trouble convincing the authorities not only that this was really money, but that they had given it to some guy on an Internet forum called “Pirate” on the strength of him saying “sure, I’ll double your bitcoins, no worries.”
The SEC started investigations and depositions in late 2012. It turned out Shavers didn’t have a lawyer after all, and spilled the beans on his entire operation in deposition, including admitting to destroying evidence (server logs) that had specifically been subpoenaed.72 He did finally find a lawyer, who set up a Bitcoin donation address to fund the case since Shavers’ assets had been frozen.73
The SEC filed a civil enforcement action against Shavers in July 2013.74 As well as running the scheme as a Ponzi, he had taken about 150,000 BTC to day trade on Bitcoinica and Mt. Gox, from which he took about $150,000 to spend personally. His lawyer’s entire defense was that bitcoins were not “money” under US law because they were not legal tender; the judge didn’t buy it, and Shavers was required in September 2014 to pay back $40.7 million.75 He was also prosecuted for criminal securities fraud for the Ponzi in November 2014,76 pled guilty in September 2015 and was sentenced to one and a half years in jail.77 The lawyer later maintained that the SEC only went after Shavers because they were upset they hadn’t caught Bernie Madoff in time, and not at all because Shavers stole millions of dollars from people.78
The astounding thing is how successful such an obvious Ponzi had been. Pirateat40 held about 7% of all bitcoins in circulation at the time. Some Bitcoiners offered insurance against Bitcoin Savings & Trust failing, then put the insurance premiums into the scheme; or just didn’t pay up when it went down. Others offered investment schemes that were pass-throughs to Pirateat40’s scheme, while swearing up and down they weren’t.
Bitcoin exchanges: keep your money in a sock under someone else’s bed
“Be your own bank” is actually very hard – particularly with “no chargebacks”, meaning that in the event of a theft or even a mistake you’re completely out of luck – so almost everyone who uses cryptocurrencies keeps their coins on an exchange. Exchanges also let you trade between different cryptocurrencies, crypto assets and conventional currencies, and some even offer short-selling and other margin trading, which are enormously popular.
Bitcoin exchanges were started by amateur enthusiasts. Most were computer programmers whose approach to anything outside their field was “I know PHP, how hard could running an exchange be?” As Dunning and Kruger pointed out in 1999,79 this approach tends not to work out so well.
In real securities trading, you can presume the exchanges themselves are not going to mess you around, and indeed that they’re basically competent. You can’t assume either with crypto exchanges. The gateways to the world of real money are stringently regulated – you’ll need to give amazing quantities of government ID to these people you know nothing about – but inside the exchanges it’s the Wild West.
Hacks, supposed hacks and exchanges just disappearing with all their customers’ money remain dismally regular occurrences. As of March 2015, a full third of all Bitcoin exchanges up to then had been hacked, and nearly half had closed.80 Since the exchanges are largely uninsured, unregulated and not required to keep reserves, depositors’ money goes up in smoke.
It’s not just scamminess on the part of the proprietors, but sheer jawdropping incompetence:
Bitomat, then the third-largest exchange, were keeping the whole site’s wallet file on an Amazon Web Services EC2 server in the cloud that didn’t have separate backups and was set to “ephemeral,” i.e., it would disappear if you restarted it. Guess what happened in July 2011? Whoops.81
Bitcoinica was its sixteen-year-old creator’s first serious PHP project. He read up on PHP, Ruby on Rails, personal finance and startups, and wrote an exchange.82 It collapsed in May 2012: “No database backups … Everyone had root.”83 The exchange’s remaining funds were lost in further hacks, after the administrators turned out to be using their (leaked) Mt. Gox password as their LastPass password.84
BitPay claimed to be fully insured. It suffered a “phishing” attack in December 2014, when an attacker broke into an outside partner’s computer and sent an email posing as the CFO to the CEO and chairman telling them to send 5,000 BTC to the attacker. The insurer refused to compensate the company, pointing out they had taken out a policy that only covered BitPay computers and physical cash on BitPay’s premises, and bitcoins didn’t count as physical cash.85
AllCrypt ran their exchange off a MySQL database … and were running WordPress on the same database, and their WordPress got hacked such as to allow access to the exchange data.86 The same thing happened to Bitcoin lending startup Loanbase.87
Cryptsy appeared to collapse from a “hack” in January 2016 with much apology from the proprietor; the court-appointed receiver’s report details how the proprietor ran off with all the bitcoins and moved to China to start a new exchange.88
Kraken publicly blamed web content distribution network Cloudflare for its website problems.89 Cloudflare’s CEO went so far as to publicly tweet that Kraken hadn’t paid its bill in months. “Let’s get the facts straight. Credit card provided for payment expired. After 3 warnings you were downgraded to a free account.”90
To be fair, conventional banks say “Yes, Mr. Smith, I’m sorry, but it seems we misplaced all your money irretrievably. Yes, yours in particular. It’s gone. Forever. No, I’m sorry, but we aren’t liable. Have a nice day!” all the time. No wait, they don’t do anything of the sort. Not since regulation, insurance and central bank backing were put into place.
The rise and fall of Mt. Gox
I’m Roger Ver, long time Bitcoin advocate and investor. Today I’m at the Mt. Gox world headquarters in Tokyo, Japan. I had a nice chat with Mt. Gox CEO, Mark Karpelès, about their current situation. He showed me multiple bank statements, as well as letters from banks and lawyers. I’m sure that all the current withdrawal problems at Mt. G
ox are being caused by the traditional banking system, not because of a lack of liquidity at Mt. Gox. The traditional banking partners that Mt. Gox needs to work with are not able to keep up with the demands of the growing Bitcoin economy. The dozens of people that make up the Mt. Gox team are hard at work establishing additional banking partners, that eventually will make dealing with Mt. Gox easier for all their customers around the world. For now, I hope that everyone will continue working on Bitcoin projects that will help make the world a better place.
– Roger Ver, July 2013, during the first rumblings at Mt. Gox.91 (He later apologised.92)
Bitcoin got its first big publicity push with the announcement of version 0.3 on technology news site Slashdot on 11 July 2010.93 94 95
At this time, Jed McCaleb was a programmer at a loose end. He had previously developed eDonkey, an early file sharing network, which was shut down in late 2005 after being sued by the Recording Industry Association of America. He then went on to develop a game, The Far Wilds, leaving that to its community in 2009.
McCaleb saw the Slashdot post, tried and failed to buy some bitcoins, and thought an exchange would be a good idea. (Early Bitcoin core developer Martti Malmi had an exchange site, but it wasn’t very usable.96) He had run the “Magic: The Gathering Online Exchange,” a trading site for an online card game, for a few months in 2007, using the domain name mtgox.com;97 he quickly wrote some exchange software in PHP and reused the name because his girlfriend liked it.
McCaleb announced the site on 17 July and it was an immediate hit, because people could buy and sell bitcoins via PayPal – using his personal account. Furthermore, users could keep both dollars and bitcoins there on the exchange to trade more quickly.
