Here’s an explanation of what bitcoins are, how exchanges work, and why the demise of the exchange, Mt. Gox, means many people may have lost a lot of money.
Q: What’s a bitcoin?
A: Bitcoins are basically just lines of computer code that are digitally signed each time they travel from one owner to the next. They are the basic unit of a new online economy which runs independently of any company, bank, or government. Because bitcoins allow people to trade money without a third party getting involved, they have become popular with libertarians as well as technophiles, speculators — and criminals.
Q: Who’s behind the currency?
A: It’s a mystery. Bitcoin was launched in 2009 by a person or group of people operating under the name Satoshi Nakamoto and then adopted by a small clutch of enthusiasts. Nakamoto dropped off the map as Bitcoin began to attract widespread attention, but proponents say that doesn’t matter; the currency obeys its own, internal logic.
Q: What’s a bitcoin worth?
A: Like any other currency, bitcoins are only worth as much as you and your counterpart want them to be. In its early days, boosters swapped bitcoins back and forth for minor favors or just as a game. One website even gave them away for free. As the market matured, the value of each bitcoin grew. At its height three months ago, a single bitcoin was valued at $1,200. On Tuesday, it was around $500.
Q: Is the currency widely used?
A: That’s debatable. Businesses ranging from blogging platform Wordpress to retailer Overstock have jumped on the Bitcoin bandwagon amid a flurry of media coverage, but it’s not clear whether the currency has really taken off. On the one hand, leading bitcoin payment processor BitPay works with more than 20,000 businesses — roughly five times more than it did last year. On the other, the total number of bitcoin transactions has stayed roughly constant at between 60,000 and 70,000 per day over the same period, according to bitcoin wallet site blockchain.info.
Q: Is Bitcoin particularly vulnerable to counterfeiting?
A: The Bitcoin network works by harnessing individuals’ greed for the collective good. A network of tech-savvy users called miners keep the system honest by pouring their computing power into a blockchain, a global running tally of every bitcoin transaction. The blockchain prevents rogues from spending the same bitcoin twice, and the miners are rewarded for their efforts by being gifted with the occasional bitcoin. As long as miners keep the blockchain secure, counterfeiting shouldn’t be an issue.
Q: If that’s the case, what’s all this talk about fraud?
A: A lot of the mischief surrounding Bitcoin occurs at the places where people store their digital cash or exchange it for traditional currencies, like dollars or euros. If an exchange has sloppy security, or if a person’s electronic wallet is compromised, then the money can easily be stolen.
Q: Is that what happened to Mt. Gox?
A: It’s not entirely clear what happened to the Tokyo-based exchange, which has sometimes been criticized for poor security. It suffered a crippling theft in 2011, and several experts have since accused the exchange of ignoring warnings about a software glitch which could enable hackers to silently drain the business of its bitcoins. The glitch was recently fixed, but not before Mt. Gox imposed a ban on bitcoin withdrawals, feeding speculation that the exchange was out of money.
Those fears appear to have been confirmed late Monday when Bitcoin enthusiast Ryan Selkis posted an 11-page-long “Crisis Strategy Draft” allegedly leaked by a Mt. Gox insider. The draft appeared to show the exchange secretly trying to grapple with the loss of more than 740,000 bitcoins over several years — a titanic sum several times the value of its assets.
Q: So does that means it’s all over for Bitcoin?
A: Some fear that a sudden loss of confidence in online exchanges’ ability to protect their stored bitcoins could kill off the currency’s appeal.
A coalition of Bitcoin businesses sought to portray Mt. Gox, once the biggest and best known bitcoin exchange, as an isolated case of incompetence but the document published by Selkis speaks in apocalyptic terms about what would happen were the scale of its losses to become public.
“The likely damage in public perception to this class of technology could put it back 5-10 years, and cause governments to react swiftly and harshly,” it says. “At the risk of appearing hyperbolic, this could be the end of Bitcoin, at least for most of the public.”
That may indeed be hyperbole. Bitcoin’s value fell sharply once the document started circulating but has stabilized around $500 per bitcoin, suggesting that many already assumed Mt. Gox was insolvent. And at $500, the cybercurrency’s value is still 17 times what it was at this time last year, meaning some still see a bright future for Bitcoin.
Q: What about Mt. Gox’s customers?
A: If the draft strategy document is correct, Mt. Gox has lost some $370 million worth of bitcoins and has liabilities of $55 million against only $33 million in assets — more than $5 million of which has already been frozen by the U.S. government. That’s a catastrophic balance sheet as far as Mt. Gox’s customers are concerned.
One of them, Kolin Burges, has been picketing the exchange’s office building since Feb. 14 in the hope of getting back $320,000 worth of bitcoins he invested there.
“I may have lost all of my money,” said Burges. “It hasn’t shaken my trust in Bitcoin, but it has shaken my trust in bitcoin exchanges.”
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