What is All this Business about Bitcoin?

Bitcoin is a digital crypto-currency. It’s distributed. It’s peer-to-peer, meaning that is controlled by the people that use it. There is no central authority controlling it. There are no international

Bitcoin is a digital crypto-currency. It’s distributed. It’s peer-to-peer, meaning that is controlled by the people that use it. There is no central authority controlling it. There are no international transaction fees. There are – for all intents and purposes, though some will cry foul at this – no rules as far as currency regulation goes. I am told you can get an actual BitCOIN and that there is even a Bitcoin ATM somewhere in Canada, but the actual currency, the actual money so-to-speak, is a chain of digital signatures that represent some fraction of a Bitcoin.

Whether you like it or not, Bitcoin is an incredibly convenient mechanism for money-laundering and for criminals seeking to conduct untraceable financial transactions on the Internet.

Sure, you can buy any number of legitimate things with Bitcoins. In fact, the number of legitimate goods that can be purchased using Bitcoins increases nearly every day, but you could also buy that stuff with traditional currency – albeit sometimes with the hassle of conversion rates and transaction fees. What you can’t do so easily with traditional paper currency is buy an illicit hacking tools, weapons, or conceal gains made selling drugs, stolen information, or other legally dubious things on the Internet, all of which is made easier by the digital currency.

Bitcoin emerged in 2008 as the research brainchild of an individual or group operating under the pseudonym Satoshi Nakamoto. When it first came to hold value, one Bitcoin was worth a small fraction of a dollar. Now a dollar is worth a small fraction of a Bitcoin. Many people are baffled by what a bitcoin is, how it holds value, and just generally how it works.

I have addressed the first question. Bitcoin is a digital crypto-currency. Instead of having a printed bill or a minted coin, you have a cryptographic string of characters. How a Bitcoin holds value is a complicated question, but not any more or less complicated than addressing how a Euro or a dollar holds value. The value of any currency increases and decreases based on a vast variety of market forces. Such is also the case with Bitcoins.

Explaining how the Bitcoin economy works is a tricky question too. Briefly, each bitcoin transaction is noted in a huge distributed database called BlockChain. There is a distributed network of “miners” who more or less control the currency. These miners, and anyone can be a miner if they’d like to though it isn’t an easy job, are tasked with spending computation power to secure Bitcoin transactions against transaction reversal (taking back money-spent). As the name suggests, the transaction data recorded into the BlockChain are called “blocks.” Each new block must contain within itself the hash (digital signature) of the block that came before it. Therefore, each new block makes note of the entire Bitcoin transaction record. Thus, if you have developed a legitimate block that is longer than the most contemporary public one, you can submit your new block and it will become the authoritative one. Miners that successfully create new blocks are awarded with newly made Bitcoins.

Whether you like it or not, Bitcoin is an incredibly convenient mechanism for money-laundering and for criminals seeking to conduct untraceable financial transactions on the Internet.

The creation of a block is essentially a challenging mathematical problem that is very difficult to solve but fairly simple to confirm once a solution has been proposed. Most newly generated blocks are collaborative efforts carried out by groups of miners that split the new Bitcoins awarded evenly among themselves.

These things aren’t merely a currency for criminals and the tech-nerds though. Establishment investors on Wall Street and abroad are seeing a lot of value in Bitcoins and are pouring money into it accordingly, which is precisely why the value if a single Bitcoin has exploded in recent months. The value of all existing Bitcoins added together right now is $3,539,862,626.7474995. Each individual Bitcoin is – while I write – worth $296.9179. At the beginning of the year, each Bitcoin was worth roughly $13. So you can see why people are investing in Bitcoin.

Cybercriminals aren’t so different from investors in that they gravitate toward value. As I am sure you have suspected by this point, there have been no shortage of attacks on the digital currency. There is malware that mines Bitcoins using botnets and trojans that compromise Bitcoin wallets (these are the places where users store their Bitcoins) and steal the Bitcoins from them.

The Kelihos botnet famously had a Bitcoin stealing function built into it. Earlier this year there was a piece of malware roping machines into its botnet on Skype. This botnet was then deploying the computer power of its victims in order to become a prolific Bitcoin miner. There was also the ZeroAccess trojan and another Mac trojan that mined Bitcoins as well. Beyond malware, researchers have found several vulnerabilities in Bitcoin wallets and applications.

More common even than malware and vulnerabilities are attacks on the marketplaces where Bitcoins are bought and sold. BitFloor, then the largest U.S.-based BitCoin exchange, suspended operations last year after attackers broke into a server and stole $250,000 worth of the virtual currency. Another breach last year targeting another exchange, Bitcoinica, resulted in the loss of $87,000 worth of Bitcoins. A DoS attack targeting the Mt. Gox exchange and the Bitcoin storage service instawallet knocked both services offline. Many speculated that the Mt. Gox crash initiated a precipitous fall in the value of Bitcoin in April of this year, though Mt. Gox denied those claims.

Now a pair of researchers from Cornell University, Ittay Eyal and Emin Gun Sirer, published an academic paper that says there is a fundamental flaw in the Bitcoin protocol that could give a relatively small group of participants the capacity to to become powerful enough that the group could take over the mining process and gather a disproportionate amount of the value in the system. Moreover, the researchers claim that if these so-called “selfish miners” gain control more than 25 percent of the Bitcoin-mining resources, they will be able to roll back recent BitCoin transactions and render the mining efforts of other parties useless.

“Ittay Eyal and I outline an attack by which a minority group of miners can obtain revenues in excess of their fair share, and grow in number until they reach a majority. When this point is reached, the Bitcoin value-proposition collapses: the currency comes under the control of a single entity; it is no longer decentralized; the controlling entity can determine who participates in mining and which transactions are committed, and can even roll back transactions at will. This snowball scenario does not require an ill-intentioned Bond-style villain to launch; it can take place as the collaborative result of people trying to earn a bit more money for their mining efforts,” the researchers wrote in a blog post highlighting the findings of their paper.

Of course, there are detractors.

“As with any other scientific research, the one on the alleged Bitcoin flaw has to be reviewed and analyzed by the community,” said Sergey Lozhkin, Senior Security Researcher, Kaspersky Lab. “But we already see that the nature of this ‘vulnerability’ lies in the field of economics rather than computer technology. Even if some group of people (or, more likely, a powerful government entity with almost infinite computing power) could gain a certain amount of control over Bitcoin mining process that would not necessarily mean the demise and fall of the digital currency. Thus, the hype initiated by authors of this work is understandable but not justified at all. At present time the largest threat for Bitcoin is politics, not technology.”

Lozhkin makes a great point. Politics is indeed a very large obstacle for Bitcoin. The Wall Street Journal reported earlier this week that the United States Senate was convening a committee hearing to discuss how the digital currency may facilitate the trade in illegal goods and how it might enable tax evasion.

More broadly, in the U.S. at least, the power to create money is granted to the Congress in the Constitution. It is therefore not clear if Bitcoin and Bitcoin mining is even legal in the first place.

Costin Raiu, director of the Kaspersky Lab global research and analysis team, elaborated further on what he believes is a flawed assumption at the center of this research.

“Theoretically, what the researchers say is possible, but the whole attack is based on the idea that some selfish miners can keep blocks hidden for longer periods of time,” Raiu said. “Statistically, this is impossible, because while selfish miners keep their blocks hidden, other “non-selfish” miners will discover those blocks and publish them in the BlockChain.”

Raiu went on to explain that while the vulnerability illustrated by Eyal and Gun Sire’s research does in fact exist, the risk posed by it however is incredibly small.

“But there is also another possibility – these researchers were intending to create some fake buzz which would make people sell their bitcoins,” Raiu continued. “The bitcoin market would crash, and, smart people would actually start purchasing the bitcoins when it hits a low. Then, other smart people completely dismiss the whole thing as a hoax, and price goes up again. And these smart people get rich.”

Other researchers have noted that Eyal and Gun Sire’s vulnerability fails to hold water as well.

Princeton’s Ed Felton describes that miners would be more incentivized to do what he calls fair-weather mining. An individual miner may certainly be compelled to join one of these large block generation groups, but, Felton wondered, why not double dip? Join the malicious mining group and a well-meaning one, switching back in forth between the two, contributing to whichever team is most likely to generate the longest block soonest.

So, should you or shouldn’t you use Bitcoin? We can’t answer that question for you. It definitely has it’s benefits: it’s seemingly easy to use, it’s truly international, more and more merchants are accepting it, you can buy things with Bitcoin that you can’t buy with traditional currency, no government can freeze your Bitcoin wallet, depending on your level of savvy, you can carry out fairly anonymous transactions, you can evade taxes, launder illicit earnings, and transfer all of these Bitcoins into traditional currency for a fee at an international exchanger, among many, many other things. The possibilities for Bitcoin are nearly endless, whether you mean well or are totally ill intentioned.

Feel free to use Bitcoins if you are interested, but know the risk. Wall Street knows the risk and they still invest, though Wall Street isn’t exactly a beacon of light for safe investment. Bitcoin wallets are clearly being targeted by cybercriminals, but so is your bank account. Criminals are attacking exchanges too, but so is your bank. My primary concerns are these: what happens if a government decides that Bitcoin is illegal? What happens if someone comes to control and overwhelmingly large amount of the currency? What happens if someone knocks an exchange offline for a serious amount of time? I’ll tell you what happens: a lot of people potentially lose a lot money.

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