<nettime> Internet Digital Black Friday: First Bitcoin "Depression" Hits

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dailytech.com
Jason Mick (Blog) - June 10, 2011 7:05 PM
http://tinyurl.com/6b78e88

The day was October 28, 1929 and the sky was falling. That Monday
the DOW Jones Industrial Average (DJIA) fell 12.82 percent. History
books show that the next day the DJIA bled another 11.73 percent. Vast
amounts of wealth were wiped out in an instant.

Today modern exchanges automatically close to prevent such
catastrophic sell offs. Or, they do in the real world, at least.
But on June 10, a new kind of market -- Bitcoins suffered a massive
decline, that may signal the start of the world's first digital
depression.

I. A 30 Percent Decline in One Day

This Friday the New York Stock Exchange (NYSE) was hammered, losing
172.45 points (approximately a 1.4 percent dip) to close below 12,000
for the first time since March 18, 2011 -- nearly three months ago.
Traders greeted signs of slowdowns in global markets with serious
concern.

But as bad a day as Friday was for NYSE traders, it was far worse for
those who invested in an increasingly popular digital currency --
Bitcoins (BTC). At the opening bell at Mt. Gox, the world's largest
Bitcoin exchange, a single BTC cost $28.919 USD. By mid-day that total
had plunged to $20.01 USD -- a drop of 30.8 percent.

Granted, in recent weeks the market for Bitcoins has soared upwards,
nearly tripling, due to increased demand and built in technical
issues. So perhaps this inflation was merely reactionary. Nonetheless,
it took many by surprise, as inflation on this scale had never before
been seen in the fledgling Bitcoin market.

But, wait let's not get ahead of ourselves. Why should anyone care if
Bthe itcoin market crashed?

Well, today on Mt. Gox alone, approximately $2M USD in Bitcoins were
bought and sold in 5,871 trades. That's unusual in and of itself --
only a total of $19M USD in trading volume occurred over the past six
months.

The bottom line is that several things are clear from today's trading.

1. The Bitcoin market endured its first digital equivalent of a "bank 
rush" with people rushing to exchange their BTC for U.S. Dollars.     

2. People have a large amount of money -- millions of USD sunk into
Bitcoins lost big in the flash crash.

3. Unlike modern markets, which automatically close to prevent massive
inflation, the digital Bitcoin markets stayed open.

4. Something major is moving the Bitcoin market in a sharp
inflationary direction, in contrast to the predict deflationary trend.

So what are Bitcoins and why is this intriguing? Let's take a look.

II. What is a Bitcoin?

Bitcoins [wiki] are virtual currency similar to the Linden Dollars
(L$) used by Second Life users.

However, unlike L$, which are ultimately controlled by Linden Labs,
a company (or "governing body" in some people's eyes), BTC have no
central authority. The currency instead relies on a peer-to-peer
system where everyone logs transactions and monetary events, prevent
false transactions.

Also, unlike the L$, the focus of BTC is to exchange the virtual
currency for real world services, not virtual ones.

People can obtain Bitcoins in two ways -- buying them or generating
them.

To generate them, you have to run a complex math hashing algorithm,
which tries to find a new bitcoin "block". Parallel computing devices
-- namely GPUs have shown themselves most capable for this task. In
fact with modern AMD GPUs it is possible to "break even" on your
hardware costs by generating Bitcoins.

For more info about Bitcoin generation, refer to DailyTech founder
Kristopher Kubicki's webpage bitminer.info.

The other method of gaining Bitcoins is to purchase them at an
exchange -- the largest of which is Mt. Gox. For a full list of
exchanges, refer here.

III. Are Bitcoins Anonymous?

One of the biggest monkeys on the back of Bitcoins is public
misconceptions about privacy.

For example a Reuters report quotes a letter from Senators Charles
Schumer (D,New York) and Joe Manchin (D, West Virginia) wrote to
Attorney General Eric Holder and Drug Enforcement Administration head
Michele Leonhart stating:

    The only method of payment for these illegal purchases is an
untraceable peer-to-peer currency known as Bitcoins. After purchasing
Bitcoins through an exchange, a user can create an account on Silk
Road and start purchasing illegal drugs from individuals around the
world and have them delivered to their homes within days.

Now this is somewhat misleading in that Bitcoins themselves can be
more or less traceable than how the user communicates with uses their
IPs. Any time a transaction occurs, it's sent out from an initial IP
to nodes on the Bitcoin network, which verify its authenticity.

Take Silk Road, for example -- the topic of a recent Gawker piece. An
IP accesses this site, which is known for selling narcotics illegal
in the U.S. If this is a user's direct IP, anyone who can sniff the
traffic of the site can trace that user back to their home address,
assuming cooperation of the internet service provider.

However, if you first route your IP through Tor -- an anonymizing
service, you can make it extremely difficult for anyone to trace
you. This is because BitCoin "accounts" are regularly generated and
a single individual holds keys to multiple microaccounts rather
than a single large account. To an outsider, this account is just a
random-looking string -- nobody can tell who owns it. But using your
personal key, you can sign transactions on the accounts you own.

As long as the public/private key cryptography scheme is sound, and
you anonymize your IP, even the government will have a relatively
tough time tracking you. The same can be said about any activity that
occurs online.

That said, there's numerous ways your privacy could be compromised
if your buying drugs or performing elicit activities. Some points of
possible attack include:

1. Failure to anonymize IP due to using your direct ISP-provided IP
address.

2. Failure to anonymize IP due to misconfiguration of Tor or other
anonymizer (a surprisingly common occurrence).

3. Tracking of physical goods associated with purchases.

Wait, you say, how could #3 occur? Well, let's say you order a kilo of
powder cocaine, using your Bitcoin treasure trove. Well the kilo comes
from a well known dealer who's being monitored by law enforcement for
their real world activities. Law enforcement note the package arrives
at your house. They wait for you to take it in and then begin using
it. They obtain a warrant and raid your house.

Remember, almost no "drug dealer" is going to be exclusively doing
business via Bitcoins. So they're likely engaging in real world
transactions that will make it likely for law enforcement to inspect
anything they decide to mail.

In other words Bitcoin does provide users with a bit of anonymity, but
to claim it's generally "untraceable" in principle is pure paranoia on
certain government officials' and journalists' part. Bitcoin-driven
transactions are very traceable; it's just that so far nobody has
been interested in investing the large amount of effort it would take
to trace them, as they have with copyright infringement or child
pornography.

The DEA's response indeed seems to hint at this. Reuters quotes
agency spokeswoman Dawn Dearden as stating, "The DEA is constantly
evaluating and analyzing new technologies and schemes perpetrated
by drug trafficking networks. While we won't confirm or deny the
existence of specific investigations, DEA is well aware of these
emerging threats and we will act accordingly."

IV. A Big Problem -- Getting Money In Or Out

While the threat of the U.S. government taking some sort of action
over anonymity fears is certainly looming over the Bitcoin market,
a far more serious problem is liquidity. In the traditional global
currency markets, you can instantly exchange your currency for other
foreign currencies on a number of exchanges. These exchanges can take
bank wires or funds from digital accounts, such as Paypal.

By contrast Bitcoin exchanges like Mt. Gox do not accept debit/credit
transactions. Up until last week they did accept eBay, Inc. (EBAY)
subsidiary PayPal. However, PayPal has blocked transactions to the
site. This is because PayPal has a policy against virtual currencies.

With an easy PayPal route gone, market liquidity was dramatically
reduced. This may be a major cause for the market crash.

Currently the most well published ways to convert Bitcoins to USD or
vice versa is to use Dwolla or Liberty Reserve. These methods are
relatively straightforward, but transactions through these online
billing services often move at a glacial pace, hampering liquidity.
API problems with Dwolla further exacerbated the liquidity issues in
recent weeks at Mt. Gox.

You can also mail a check to a certain individual known as "Bitcoin
Morpheus" listed at the exchange, who will add funds to your Mt. Gox
account. Granted this route might not be for the faint of heart as it
seems rather "unorthodox" to say the least.

Now there is another method that could work slightly faster than any
of the above. For now you can use a variety of means to quickly buy L$
(Second Life currency) and then use the virwoxSLL exchange to exchange
L$ to BTC. The purpose of L$ and BTC is quite different, so it's
unclear how long this route will stay viable, and many people don't
realize you can get Bitcoins in this fashion.

At the end of the day Bitcoin has a very real liquidity problem.

V. What's Next for Bitcoin?

Unless Gawker and other media outlets can drum up enough unfounded
paranoia about peer-to-peer currency to evoke some kind of draconian
action by the U.S. federal government, it's unlikely that Bitcoins
will go away.

However, market volatility poses a very serious risk to BTC users
-- be they miners, traders, or merchants who accept BTC as payment
for goods or services. To that end, a major improvement would be
for Bitcoin exchanges to implement mandatory market closures if the
currency value dropped below a threshold. In theory this would be
relatively easy to implement, and we expect that it will be done at
some point to prevent one-day flash inflation/deflation.

At the same time, a viable billing service must step up and offer
people the ability to use credit or debit card billable transactions
in USD to buy bitcoins quickly and directly on a major exchange (e.g.
Mt. Gox). If this can be done, market liquidity can be restored and
the currency will once more flourish.

Last, but not least, concerns about deflation must be addressed as
demand grows and production slows. As mentioned in the introduction,
if deflation is not controlled, reactionary inflation spurts could be
experienced. Indeed, a reactionary market movement could have been
part of the cause for today's record-setting inflation.

It is possible that additional bitcoins could be distributed or       
other mechanism employed to prevent deflation, much as they are with  
standard currencies.                                                  

Bitcoins are certainly a novel idea in their implementation details
and purpose. This article offers an introduction, but barely skims the
surface of this phenomena and the true facts about it.

Ask some and they'll say Bitcoins are a scam/pyramid scheme. Ask
others and they'll say the Bitcoin market has the promise to offer
sustained success. There's valid arguments on both sides, but at
the end of the day Bitcoins will still be around for the forseeable
future.

In trading late Friday, Bitcoins recouped nearly half their losses,
bouncing back to 24.34. That's still a massive crash -- around 15
percent in one day. But it shows that the market isn't dead. The U.S.
economy survived Black Friday and today sustains a massive amount of
wealth. Likewise, perhaps the Bitcoin movement can survive this tough
time and find its way. After all -- people are still buying Bitcoins.



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