The Rise and Fall of Bitcoin

Eugen Leitl eugen at
Thu Nov 24 09:14:06 PST 2011

The Rise and Fall of Bitcoin

By Benjamin Wallace | November 23, 2011  | 2:52 pm  | Wired December 2011

Illustration: Martin Venezky

In November 1, 2008, a man named Satoshi Nakamoto posted a research paper to
an obscure cryptography listserv describing his design for a new digital
currency that he called bitcoin. None of the listbs veterans had heard of
him, and what little information could be gleaned was murky and
contradictory. In an online profile, he said he lived in Japan. His email
address was from a free German service. Google searches for his name turned
up no relevant information; it was clearly a pseudonym. But while Nakamoto
himself may have been a puzzle, his creation cracked a problem that had
stumped cryptographers for decades. The idea of digital moneybconvenient and
untraceable, liberated from the oversight of governments and banksbhad been a
hot topic since the birth of the Internet. Cypherpunks, the 1990s movement of
libertarian cryptographers, dedicated themselves to the project. Yet every
effort to create virtual cash had foundered. Ecash, an anonymous system
launched in the early 1990s by cryptographer David Chaum, failed in part
because it depended on the existing infrastructures of government and credit
card companies. Other proposals followedbbit gold, RPOW, b-moneybbut none got
off the ground.

One of the core challenges of designing a digital currency involves something
called the double-spending problem. If a digital dollar is just information,
free from the corporeal strictures of paper and metal, whatbs to prevent
people from copying and pasting it as easily as a chunk of text, bspendingb
it as many times as they want? The conventional answer involved using a
central clearinghouse to keep a real-time ledger of all transactionsbensuring
that, if someone spends his last digital dollar, he canbt then spend it
again. The ledger prevents fraud, but it also requires a trusted third party
to administer it.

Bitcoin did away with the third party by publicly distributing the ledger,
what Nakamoto called the bblock chain.b Users willing to devote CPU power to
running a special piece of software would be called miners and would form a
network to maintain the block chain collectively. In the process, they would
also generate new currency. Transactions would be broadcast to the network,
and computers running the software would compete to solve irreversible
cryptographic puzzles that contain data from several transactions. The first
miner to solve each puzzle would be awarded 50 new bitcoins, and the
associated block of transactions would be added to the chain. The difficulty
of each puzzle would increase as the number of miners increased, which would
keep production to one block of transactions roughly every 10 minutes. In
addition, the size of each block bounty would halve every 210,000
blocksbfirst from 50 bitcoins to 25, then from 25 to 12.5, and so on. Around
the year 2140, the currency would reach its preordained limit of 21 million

When Nakamotobs paper came out in 2008, trust in the ability of governments
and banks to manage the economy and the money supply was at its nadir. The US
government was throwing dollars at Wall Street and the Detroit car companies.
The Federal Reserve was introducing bquantitative easing,b essentially
printing money in order to stimulate the economy. The price of gold was
rising. Bitcoin required no faith in the politicians or financiers who had
wrecked the economybjust in Nakamotobs elegant algorithms. Not only did
bitcoinbs public ledger seem to protect against fraud, but the predetermined
release of the digital currency kept the bitcoin money supply growing at a
predictable rate, immune to printing-press-happy central bankers and Weimar
Republic-style hyperinflation.  Photo: Michael Schmelling

Bitcoin's chief proselytizer, Bruce Wagner, at one of the few New York City
restaurants that accept the currency.

Photo: Michael Schmelling

Nakamoto himself mined the first 50 bitcoinsbwhich came to be called the
genesis blockbon January 3, 2009. For a year or so, his creation remained the
province of a tiny group of early adopters. But slowly, word of bitcoin
spread beyond the insular world of cryptography. It has won accolades from
some of digital currencybs greatest minds. Wei Dai, inventor of b-money,
calls it bvery significantb; Nick Szabo, who created bit gold, hails bitcoin
as ba great contribution to the worldb; and Hal Finney, the eminent
cryptographer behind RPOW, says itbs bpotentially world-changing.b The
Electronic Frontier Foundation, an advocate for digital privacy, eventually
started accepting donations in the alternative currency.

The small band of early bitcoiners all shared the communitarian spirit of an
open source software project. Gavin Andresen, a coder in New England, bought
10,000 bitcoins for $50 and created a site called the Bitcoin Faucet, where
he gave them away for the hell of it. Laszlo Hanyecz, a Florida programmer,
conducted what bitcoiners think of as the first real-world bitcoin
transaction, paying 10,000 bitcoins to get two pizzas delivered from Papa
Johnbs. (He sent the bitcoins to a volunteer in England, who then called in a
credit card order transatlantically.) A farmer in Massachusetts named David
Forster began accepting bitcoins as payment for alpaca socks.

When they werenbt busy mining, the faithful tried to solve the mystery of the
man they called simply Satoshi. On a bitcoin IRC channel, someone noted
portentously that in Japanese Satoshi means bwise.b Someone else wondered
whether the name might be a sly portmanteau of four tech companies: SAmsung,
TOSHIba, NAKAmichi, and MOTOrola. It seemed doubtful that Nakamoto was even
Japanese. His English had the flawless, idiomatic ring of a native speaker.

Perhaps, it was suggested, Nakamoto wasnbt one man but a mysterious group
with an inscrutable purposeba team at Google, maybe, or the National Security
Agency. bI exchanged some emails with whoever Satoshi supposedly is,b says
Hanyecz, who was on bitcoinbs core developer team for a time. bI always got
the impression it almost wasnbt a real person. Ibd get replies maybe every
two weeks, as if someone would check it once in a while. Bitcoin seems
awfully well designed for one person to crank out.b

Nakamoto revealed little about himself, limiting his online utterances to
technical discussion of his source code. On December 5, 2010, after
bitcoiners started to call for Wikileaks to accept bitcoin donations, the
normally terse and all-business Nakamoto weighed in with uncharacteristic
vehemence. bNo, donbt bbring it on,bb he wrote in a post to the bitcoin
forum. bThe project needs to grow gradually so the software can be
strengthened along the way. I make this appeal to Wikileaks not to try to use
bitcoin. Bitcoin is a small beta community in its infancy. You would not
stand to get more than pocket change, and the heat you would bring would
likely destroy us at this stage.b

Then, as unexpectedly as he had appeared, Nakamoto vanished. At 6:22 pm GMT
on December 12, seven days after his Wikileaks plea, Nakamoto posted his
final message to the bitcoin forum, concerning some minutiae in the latest
version of the software. His email responses became more erratic, then
stopped altogether. Andresen, who had taken over the role of lead developer,
was now apparently one of just a few people with whom he was still
communicating. On April 26, Andresen told fellow coders: bSatoshi did suggest
this morning that I (we) should try to de-emphasize the whole bmysterious
founderb thing when talking publicly about bitcoin.b Then Nakamoto stopped
replying even to Andresenbs emails. Bitcoiners wondered plaintively why he
had left them. But by then his creation had taken on a life of its own.

Bitcoin 101

How Theybre Made

Bitcoinbs economy consists of a network of its usersb computers. At preset
intervals, an algorithm releases new bitcoins into the network: 50 every 10
minutes, with the pace halving in increments until around 2140. The automated
pace is meant to ensure regular growth of the monetary supply without
interference by third parties, like a central bank, which can lead to

How Theybre Mined

To prevent fraud, the bitcoin software maintains a pseudonymous public ledger
of every transaction. Some bitcoinersb computers validate transactions by
cracking cryptographic puzzles, and the first to solve each puzzle receives
50 new bitcoins. Bitcoins can be stored in a variety of placesbfrom a
bwalletb on a desktop computer to a centralized service in the cloud.

How Theybre Spent

Once users download the bitcoin app to their machine, spending the currency
is as easy as sending an email. The range of merchants that accept it is
small but growing; look for the telltale symbol at the cash register. And
entrepreneurial bitcoiners are working to make it much easier to use the
currency, building everything from point-of-service machines to PayPal

Illustrations: Martin Venezky

bBitcoin enthusiasts are almost evangelists,b Bruce Wagner says. bThey see
the beauty of the technology. Itbs a huge movement. Itbs almost like a
religion. On the forum, youbll see the spirit. Itbs not just me, me, me. Itbs
whatbs for the betterment of bitcoin.b

Itbs a July morning. Wagner, whose boyish energy and Pantone-black hair belie
his 50 years, is sitting in his office at OnlyOneTV, an Internet television
startup in Manhattan. Over just a few months, he has become bitcoinbs chief
proselytizer. He hosts The Bitcoin Show, a program on OnlyOneTV in which he
plugs the nascent currency and interviews notables from the bitcoin world. He
also runs a bitcoin meetup group and is gearing up to host bitcoinbs first
bworld conferenceb in August. bI got obsessed and didnbt eat or sleep for
five days,b he says, recalling the moment he discovered bitcoin. bIt was
bitcoin, bitcoin, bitcoin, like I was on crystal meth!b

Wagner is not given to understatement. While bitcoin is bthe most exciting
technology since the Internet,b he says, eBay is ba giant bloodsucking
corporationb and free speech ba popular myth.b He is similarly excitable when
predicting the future of bitcoin. bI knew it wasnbt a stock and wouldnbt go
up and down,b he explains. bThis was something that was going to go up, up,

For a while, he was right. Through 2009 and early 2010, bitcoins had no value
at all, and for the first six months after they started trading in April
2010, the value of one bitcoin stayed below 14 cents. Then, as the currency
gained viral traction in summer 2010, rising demand for a limited supply
caused the price on online exchanges to start moving. By early November, it
surged to 36 cents before settling down to around 29 cents. In February 2011,
it rose again and was mentioned on Slashdot for achieving bdollar parityb; it
hit $1.06 before settling in at roughly 87 cents.

In the spring, catalyzed in part by a much-linked Forbes story on the new
bcrypto currency,b the price exploded. From early April to the end of May,
the going rate for a bitcoin rose from 86 cents to $8.89. Then, after Gawker
published a story on June 1 about the currencybs popularity among online drug
dealers, it more than tripled in a week, soaring to about $27. The market
value of all bitcoins in circulation was approaching $130 million. A
Tennessean dubbed KnightMB, who held 371,000 bitcoins, became worth more than
$10 million, the richest man in the bitcoin realm. The value of those 10,000
bitcoins Hanyecz used to buy pizza had risen to $272,329. bI donbt feel bad
about it,b he says. bThe pizza was really good.b Perhaps bitcoinbs creator
wasnbt one man but a mysterious groupba team at Google, maybe, or the NSA.

Bitcoin was drawing the kind of attention normally reserved for overhyped
Silicon Valley IPOs and Apple product launches. On his Internet talk show,
journo-entrepreneur Jason Calacanis called it ba fundamental shiftb and bone
of the most interesting things Ibve seen in 20 years in the technology
business.b Prominent venture capitalist Fred Wilson heralded bsocietal
upheavalb as the Next Big Thing on the Internet, and the four examples he
gave were Wikileaks, PlayStation hacking, the Arab Spring, and bitcoin.
Andresen, the coder, accepted an invitation from the CIA to come to Langley,
Virginia, to speak about the currency. Rick Falkvinge, founder of the Swedish
Pirate Party (whose central policy plank includes the abolition of the patent
system), announced that he was putting his life savings into bitcoins.

The future of bitcoin seemed to shimmer with possibility. Mark Suppes, an
inventor building a fusion reactor in a Brooklyn loft from eBay-sourced
parts, got an old ATM and began retrofitting it to dispense cash for
bitcoins. On the so-called secret Internet (the invisible grid of sites
reachable by computers using Tor anonymizing software), the
black-and-gray-market site Silk Road anointed the bitcoin the coin of the
realm; you could use bitcoins to buy everything from Purple Haze pot to
Fentanyl lollipops to a kit for converting a rifle into a machine gun. A
young bitcoiner, The Real Plato, brought On the Road into the new millennium
by video-blogging a cross-country car trip during which he spent only
bitcoins. Numismatic enthusiasts among the currencybs faithful began dreaming
of collectible bitcoins, wondering what price such rarities as the genesis
block might fetch.

As the price rose and mining became more popular, the increased competition
meant decreasing profits. An arms race commenced. Miners looking for
horsepower supplemented their computers with more powerful graphics cards,
until they became nearly impossible to find. Where the first miners had used
their existing machines, the new wave, looking to mine bitcoins 24 hours a
day, bought racks of cheap computers with high-speed GPUs cooled by noisy
fans. The boom gave rise to mining-rig porn, as miners posted photos of their
setups. As in any gold rush, people recounted tales of uncertain veracity. An
Alaskan named Darrin reported that a bear had broken into his garage but
thankfully ignored his rig. Another minerbs electric bill ran so high, it was
said, that police raided his house, suspecting that he was growing pot.

Amid the euphoria, there were troubling signs. Bitcoin had begun in the
public-interested spirit of open source peer-to-peer software and libertarian
political philosophy, with references to the Austrian school of economics.
But real money was at stake now, and the dramatic price rise had attracted a
different element, people who saw the bitcoin as a commodity in which to
speculate. At the same time, media attention was bringing exactly the kind of
heat that Nakamoto had feared. US senator Charles Schumer held a press
conference, appealing to the DEA and Justice Department to shut down Silk
Road, which he called bthe most brazen attempt to peddle drugs online that we
have ever seenb and describing bitcoin as ban online form of

Meanwhile, a cult of Satoshi was developing. Someone started selling I AM
SATOSHI NAKAMOTO T-shirts. Disciples lobbied to name the smallest fractional
denomination of a bitcoin a bsatoshi.b There was Satoshi-themed fan fiction
and manga art. And bitcoiners continued to ponder his mystery. Some
speculated that he had died. A few postulated that he was actually Wikileaks
founder Julian Assange. Many more were convinced that he was Gavin Andresen.
Still others believed that he must be one of the older crypto-currency
advocatesbFinney or Szabo or Dai. Szabo himself suggested it could be Finney
or Dai. Stefan Thomas, a Swiss coder and active community member, graphed the
time stamps for each of Nakamotobs 500-plus bitcoin forum posts; the
resulting chart showed a steep decline to almost no posts between the hours
of 5 am and 11 am Greenwich Mean Time. Because this pattern held true even on
Saturdays and Sundays, it suggested that the lull was occurring when Nakamoto
was asleep, rather than at work. (The hours of 5 am to 11 am GMT are midnight
to 6 am Eastern Standard Time.) Other clues suggested that Nakamoto was
British: A newspaper headline he had encoded in the genesis block came from
the UK-published Times of London, and both his forum posts and his comments
in the bitcoin source code used such Brit spellings as optimise and colour.

Play Dough

Key moments in the short and volatile life of bitcoin.

Even the purest technology has to live in an impure world. Both the code and
the idea of bitcoin may have been impregnable, but bitcoins themselvesbunique
strings of numbers that constitute units of the currencybare discrete pieces
of information that have to be stored somewhere. By default, bitcoin kept
usersb currency in a digital bwalletb on their desktop, and when bitcoins
were worth very little, easy to mine, and possessed only by techies, that was
sufficient. But once they started to become valuable, a PC felt inadequate.
Some users protected their bitcoins by creating multiple backups, encrypting
and storing them on thumb drives, on forensically scrubbed virgin computers
without Internet connections, in the cloud, and on printouts stored in
safe-deposit boxes. But even some sophisticated early adopters had trouble
keeping their bitcoins safe. Stefan Thomas had three copies of his wallet yet
inadvertently managed to erase two of them and lose his password for the
third. In a stroke, he lost about 7,000 bitcoins, at the time worth about
$140,000. bI spent a week trying to recover it,b he says. bIt was pretty
painful.b Most people who have cash to protect put it in a bank, an
institution about which the more zealous bitcoiners were deeply leery.
Instead, for this new currency, a primitive and unregulated
financial-services industry began to develop. Fly-by-night online bwallet
servicesb promised to safeguard clientsb digital assets. Exchanges allowed
anyone to trade bitcoins for dollars or other currencies. Bitcoin itself
might have been decentralized, but users were now blindly entrusting
increasing amounts of currency to third parties that even the most radical
libertarian would be hard-pressed to claim were more secure than federally
insured institutions. Most were Internet storefronts, run by who knows who
from who knows where.

Sure enough, as the price headed upward, disturbing events began to bedevil
the bitcoiners. In mid-June, someone calling himself Allinvain reported that
25,000 bitcoins worth more than $500,000 had been stolen from his computer.
(To this day, nobody knows whether this claim is true.) About a week later, a
hacker pulled off an ingenious attack on a Tokyo-based exchange site called
Mt. Gox, which handled 90 percent of all bitcoin exchange transactions. Mt.
Gox restricted account withdrawals to $1,000 worth of bitcoins per day (at
the time of the attack, roughly 35 bitcoins). After he broke into Mt. Goxbs
system, the hacker simulated a massive sell-off, driving the exchange rate to
zero and letting him withdraw potentially tens of thousands of other peoplebs

As it happened, market forces conspired to thwart the scheme. The price
plummeted, but as speculators flocked to take advantage of the fire sale,
they quickly drove it back up, limiting the thiefbs haul to only around 2,000
bitcoins. The exchange ceased operations for a week and rolled back the
postcrash transactions, but the damage had been done; the bitcoin never got
back above $17. Within a month, Mt. Gox had lost 10 percent of its market
share to a Chile-based upstart named TradeHill. Most significantly, the
incident had shaken the confidence of the community and inspired loads of bad

In the publicbs imagination, overnight the bitcoin went from being the
currency of tomorrow to a dystopian joke. The Electronic Frontier Foundation
quietly stopped accepting bitcoin donations. Two Irish scholars specializing
in network analysis demonstrated that bitcoin wasnbt nearly as anonymous as
many had assumed: They were able to identify the handles of a number of
people who had donated bitcoins to Wikileaks. (The organization announced in
June 2011 that it was accepting such donations.) Nontechnical newcomers to
the currency, expecting it to be easy to use, were disappointed to find that
an extraordinary amount of effort was required to obtain, hold, and spend
bitcoins. For a time, one of the easier ways to buy them was to first use
Paypal to buy Linden dollars, the virtual currency in Second Life, then trade
them within that make-believe universe for bitcoins. As the tone of media
coverage shifted from gee-whiz to skeptical, attention that had once been
thrilling became a source of resentment.

Photo: Michael Schmelling

Illustration: Martin Venezky

More disasters followed. Poland-based Bitomat, the third-largest exchange,
revealed that it hadboopsbaccidentally overwritten its entire wallet.
Security researchers detected a proliferation of viruses aimed at bitcoin
users: Some were designed to steal wallets full of existing bitcoins; others
commandeered processing power to mine fresh coins. By summer, the oldest
wallet service, MyBitcoin, stopped responding to emails. It had always been
fishybregistered in the West Indies and run by someone named Tom Williams,
who never posted in the forums. But after a month of unbroken silence,
Wagner, the New York City bitcoin evangelist, finally stated what many had
already been thinking: Whoever was running MyBitcoin had apparently gone AWOL
with everyonebs money. Wagner himself revealed that he had been keeping all
25,000 or so of his bitcoins on MyBitcoin and had recommended to friends and
relatives that they use it, too. He also aided a vigilante effort that
publicly named several suspects. MyBitcoinbs supposed owner resurfaced,
claiming his site had been hacked. Then Wagner became the target of a
countercampaign that publicized a successful lawsuit against him for mortgage
fraud, costing him much of his reputation within the community. bPeople have
the mistaken impression that virtual currency means you can trust a random
person over the Internet,b says Jeff Garzik, a member of bitcoinbs core
developer group.

And nobody had been as trusted as Nakamoto himself, who remained mysteriously
silent as the world he created threatened to implode. Some bitcoiners began
to suspect that he was working for the CIA or Federal Reserve. Others worried
that bitcoin had been a Ponzi scheme, with Nakamoto its Bernie Madoffbmining
bitcoins when they were worthless, then waiting for their value to rise. The
most dedicated bitcoin loyalists maintained their faith, not just in
Nakamoto, but in the system he had built. And yet, unmistakably, beneath the
paranoia and infighting lurked something more vulnerable, an almost theodical
disappointment. What bitcoiners really seemed to be asking was, why had
Nakamoto created this world only to abandon it?

If Nakamoto has forsaken his adherents, though, they are not prepared to let
his creation die. Even as the currencybs value has continued to drop, they
are still investing in the fragile economy. Wagner has advocated for it to be
used by people involved in the Occupy Wall Street movement. While the
gold-rush phase of mining has ended, with some miners dumping their souped-up
mining rigsbbPeople are getting sick of the high electric bills, the heat,
and the loud fans,b Garzik saysbthe more serious members of the community
have turned to infrastructure. Mt. Gox is developing point-of-sale hardware.
Other entrepreneurs are working on PayPal-like online merchant services. Two
guys in Colorado have launched BitcoinDeals, an etailer offering bover
1,000,000 items.b The underworldbs use of the bitcoin has matured, too: Silk
Road is now just one of many Tor-enabled back alleys, including sites like
Black Market Reloaded, where self-proclaimed hit men peddle contract killings
and assassinations.

bYou could say itbs following Gartnerbs Hype Cycle,b London-based core
developer Amir Taaki says, referring to a theoretical
technology-adoption-and-maturation curve that begins with a btechnology
trigger,b ascends to a bpeak of inflated expectations,b collapses into a
btrough of disillusionment,b and then climbs a bslope of enlightenmentb until
reaching a bplateau of productivity.b By this theory, bitcoin is clambering
out of the trough, as people learn to value the infallible code and discard
the human drama and wild fluctuations that surround it.

But that distinction is ultimately irrelevant. The underlying vulnerabilities
that led to bitcoinbs troublesbits dependence on unregulated, centralized
exchanges and online walletsbpersist. Indeed, the bulk of mining is now
concentrated in a handful of huge mining pools, which theoretically could
hijack the entire network if they worked in concert.

Beyond the most hardcore users, skepticism has only increased. Nobel
Prize-winning economist Paul Krugman wrote that the currencybs tendency to
fluctuate has encouraged hoarding. Stefan Brands, a former ecash consultant
and digital currency pioneer, calls bitcoin bcleverb and is loath to bash it
but believes itbs fundamentally structured like ba pyramid schemeb that
rewards early adopters. bI think the big problems are ultimately the trust
issues,b he says. bTherebs nothing there to back it up. I know the
counterargument, that thatbs true of fiat money, too, but thatbs completely
wrong. Therebs a whole trust fabric thatbs been established through legal

It would be interesting to know what Nakamoto thinks of all this, but hebs
not talking. He didnbt respond to emails, and the people who might know who
he is say they donbt. Andresen flatly denies he is Nakamoto. bI donbt know
his real name,b he says. bIbm hoping one day he decides not to be anonymous
anymore, but I expect not.b Szabo also denies that he is Nakamoto, and so
does Dai. Finney, who has blogged eloquently about being diagnosed with
amyotrophic lateral sclerosis, sent his denial in an email: bUnder my current
circumstances, facing limited life expectancy, I would have little to lose by
shedding anonymity. But it was not I.b Both The New Yorker and Fast Company
have launched investigations but ended up with little more than speculation.

The signal in the noise, the figure that emerges from the carpet of clues,
suggests an academic with somewhat outdated programming training. (Nakamotobs
style of notation bwas popular in the late b80s and early b90s,b Taaki notes.
bMaybe hebs around 50, plus or minus 10 years.b) Some conjecturers are
confident in their precision. bHe has at best a masterbs,b says a
digital-currency expert. bIt seems quite obvious itbs one of the developers.
Maybe Gavin, just looking at his background.b

bI suspect Satoshi is a small team at a financial institution,b whitehat
hacker Dan Kaminsky says. bI just get that feeling. Hebs a quant who may have
worked with some of his friends.b

But Garzik, the developer, says that the most dedicated bitcoiners have
stopped trying to hunt down Nakamoto. bWe really donbt care,b he says. Itbs
not the individuals behind the code who matter, but the code itself. And
while people have stolen and cheated and abandoned the bitcoiners, the code
has remained true.

Benjamin Wallace (benwallace at wrote about scareware in issue 19.10

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