If you’ve heard of any application of blockchain technology, it’s likely bitcoin. Roop Gill explores the history of the digital currency and the impact it has had to date. [This article was first published in the Blockchain Issue of Tech City News Magazine, which came out in spring, 2016.]
Money, as we knew it, changed in 2008. The ripple effects of the financial crisis paralysed the global economy. British financial institutions were nursing losses of $2.8tn. The damage in America reached $10.2tn. What followed was a whirlwind of recession, buyouts and quantitative easing. People started to lose faith in the ability of governments to effectively manage money.
In November of the same year, a low-profile member of The Cryptography Mailing List on metzdowd.com published a paper. The person, or group, gave their name as Satoshi Nakamoto. The user profile said they were from Japan, but their email address was from a German service. The research paper described a new type of global and decentralised digital currency, not to be handled by any middleman or government. They called it bitcoin.
What is it?
Bitcoin is a currency that is created, stored and traded electronically. Unlike physical coins or paper notes, bitcoin isn’t a tangible item you can pull out of your pocket and spend at the supermarket. Bitcoins live in digital wallets with unique identifiers. However, since Nakamoto’s release of the bitcoin protocol in 2009, the cryptocurrency has come a long way. You can now buy most things on your shopping list with bitcoin, although it’s easier to find bitcoin-accepting merchants online than it is on your local high street.
Bitcoin is the first application of blockchain technology – all bitcoin transactions are pseudonymous and recorded in a digital ledger, which is maintained by bitcoin ‘miners’. Mining is the process of recording transactions while creating new bitcoins. When any bitcoin is moved, it broadcasts to the bitcoin network. Powerful CPUs on the blockchain network compete with each other to solve a cryptographic puzzle and the first miner to solve each puzzle is awarded new bitcoin.
The difficulty of each puzzle is increased as the number of miners on the network increases and the number of bitcoin created is halved after a certain number of blocks. There are only a finite number of bitcoin that will ever be created – 21 million to be precise.
The early rise
The currency’s exclusivity, coupled with an increase in global interest in alternative finance, led to bitcoin’s astronomical rise in price. The first bitcoin was publicly traded in April 2010, going for 0.3 cents. Less than a year later, it caught up with the American dollar. By June 2011, it was peaking at $29.57.
Over the next couple of years, the bitcoin ecosystem flourished: bitcoin exchanges were set up, a Bitcoin Foundation was created, merchants opened up to bitcoin, bitcoin ATMs become a thing and digital currency news entered mainstream media. The bitcoin owners club was no longer made up of just early adopters, cryptographers or evangelists – students, traders, artists and everyday consumers were using bitcoin. You could buy food, cars and even yachts with it. You could go on luxury holidays. Heck, even space travel was possible with bitcoin.
The price of bitcoin shot up until it peaked at a little over $1,150 at the end of November 2013 and a number of entrepreneurs rode the wave of this bitcoin boom.
Jonathan Levin, founder of two bitcoin-focused companies – Coinometrics and Chainalysis – said many entrepreneurs saw bitcoin’s potential in these early years.
“I think the continued loose monetary economic policy was being called into question and the VCs saw this as a technology that had the potential to radically transform the way business operates, and so started placing bets,” said Levin.
People were getting creative with the use of bitcoin. It started being used in international remittances – you could send money anywhere in the world with very small transaction fees and no middleman. Foreign workers looking to send money back to their families in places like India, China and the Philippines could turn to services like Rebit, ArtaBit and CoinCove – all startups offering remittance services using bitcoin.
Micropayments and tipping became another popular practice in bitcoin. Businesses started setting up donation boxes on their websites where you could leave a bit-tip. The Chicago Sun-Times erected a bitcoin paywall as an experiment. You could anonymously donate to any business, charity or cause of your choice. But, this also became a problem.
The pseudo-anonymous nature of bitcoin inevitably lends itself to becoming a currency used in nefarious contexts. It’s been a hit on the dark web – the hidden underbelly of the internet – with the number of people buying drugs online rising 13% in 2014, coinciding with the rising popularity of bitcoin.
Although various bitcoin-accepting marketplaces for illegal goods have popped up over the past few years, Silk Road is undeniably the most notorious. When the FBI shut the operation down in 2013, law enforcement agents seized 144,000 bitcoins (worth approximately $28.5m at the time) belonging to the site’s owner, Ross Ulbricht – who’s now serving a life-sentence in an American prison.
The Silk Road fiasco, which was widely covered by the global media, served to taint bitcoin’s reputation further as the payment method of choice for criminals. The case also made headlines across the world following the discovery that former secret service agent Shaun Bridges had stolen hundreds of thousands of dollars in bitcoin during the US government’s investigation into the now-defunct marketplace. Bridges has since been sentenced to six years in prison.
Widely cited as bitcoin’s first prisoner, Charlie Shrem, ex CEO of BitInstant and former Bitcoin Foundation board member, was arrested in 2014 for allegedly violating anti-money laundering laws while he worked at his bitcoin exchange startup. Prosecutors in the case accused Shrem and bitcoin trader Robert Faiella of conspiring to launder $1m worth of bitcoin to help Silk Road users make illegal purchases.
Bitcoin suffered another blow to its already tainted reputation in early 2014 with the closure of Japan-based bitcoin exchange Mt Gox. Once the world’s most popular bitcoin exchange – at its peak it accounted for up to 80% of the digital currency’s trading volume – Mt Gox was launched in 2010 by its former CEO Mark Karpeles and halted operations four years later amid allegations of untoward activity.
Following the closure, speculation about what had been going on at the exchange was rife. Although it was first believed to have been an outside job, possibly a hack, it was later revealed the disappearance of approximately $350m worth of bitcoin was an inside job. Karpeles, first arrested in Japan in August last year, has now been charged with embezzlement.
Bitcoin sceptics used the narrative of Mt Gox to highlight the inviability of the digital currency and the way in which its trustless network could be exploited by hackers and other cyber criminals.
Although perhaps the most notorious hack in bitcoin’s relatively young history, due to the sheer size of funds lost, the closure of Mt Gox has been followed by subsequent hacks of bitcoin exchanges in other parts of the world. Bitstamp suffered the loss of $5m in bitcoin in January 2015. In July of the same year it was reported that six of the exchange’s employees had been targeted during a week-long phishing attempt.
On top of this swathe of negative press, bitcoin has also been linked to the financing of terrorist groups such as ISIS/Daesh with intra-governmental bodies such as Financial Action Task Force alleging that its trustless nature potentially make the currency very attractive to criminals.
While bitcoin can, and is, being used in criminal activities, its supporters are quick to point out that cash is also highly anonymous, yet doesn’t receive the same bad press.
Siân Jones, head of the European Digital Currency & Blockchain Forum, said: “EU policymakers, legislators and the European Central Bank might look closer to home in their efforts to combat terrorism and money laundering.”
She explained that €500 notes are favoured by criminals and account for 30% of the €1tn Euro banknotes in circulation, despite not being a common means of payment.
Jones works with EU policymakers and stakeholders to help shape regulatory policy around digital currencies. While some purists believe governments should not interfere with bitcoin at all, Jones stresses the importance of “smart regulation”.
Adam Vaziri, founder of Diacle, a compliance firm that specialises in FinTech, agrees. He believes that, for bitcoin to become widely used, it needs to be “rooted in the real world”.
“Consumers pay for goods, services and assets that exist in the real world. Whether one likes it or not, we are affected by the laws and customs that govern our daily lives. We are all subject to the laws that regulate our behaviour in places we stand or in which our businesses operate.
“You can’t regulate cryptocurrency per se unless you regulate access to the internet. You can sensibly regulate cryptocurrency intermediaries: exchanges, payment processors, of course,” he explained.
The EU is currently accelerating the timelines to regulate those intermediaries and New York already has regulation in place – digital currency companies are required to obtain a BitLicense in order to operate legally in the state. Until there is more regulatory clarity, many people will continue to steer clear of cryptocurrency.
Regulation isn’t the only hurdle bitcoin has to overcome in order to achieve mainstream adoption. Volatility is another. Those who bought their bitcoin for more than $1,000 in 2013, found the same unit was only valued at $250 the following year. Unfortunately, bitcoin faces quite the predicament – it requires greater liquidity (more users and more transactions) in order for its volatility to decrease, but it’s struggling to gain the volume of users it requires as they are put off by its volatility.
Dave Birch, director at Consult Hyperion, a secure electronic transactions consultancy, isn’t convinced bitcoin will ever get to mainstream adoption.
“I don’t think bitcoin is money,” he said. “Economics textbooks will tell you money is unit of account, money is a medium of exchange, money is store of value, money is a mechanism for deferred settlement. And bitcoin doesn’t fulfil any of those.
“The volatility pretty much rules out the use as a mechanism for deferred payment. The speculation doesn’t make it an obvious store of value. The expense and slowness doesn’t make it an obvious medium of exchange. And for it to be a unit of account, other currencies would have to valued against it, which they are not,” Birch added.
While some argue it’s a pointless and dangerous experiment, with the potential to bankrupt swathes of people who have decided to take a punt, others argue it’s the most important innovation since the internet. The latter believe bitcoin is in its infancy and, given more time, will achieve its full potential and completely overhaul currency as we know it. Whichever camp you’re in, bitcoin and its underlying technology have certainly made an impact and it doesn’t look like it’s going to go away any time soon.
This article was first published in the Blockchain Issue of Tech City News Magazine, which came out in spring, 2016. To receive the next issue of the magazine, subscribe here.