Month: May 2012

The views expressed in this article are those of the author and do not necessarily reflect the position of Bitcoin Magazine

Over the past five months, the Bitcoin community has seen the emergence of savings funds offering interest rates far higher than any seen in the traditional economy. The most innocuous form of high-interest deposits, mining contracts, have been around for a long time, allowing anyone to financially participate in mining operations by buying shares and collecting a percentage of the profits in return, offering returns of up to 1.4% per week, or an annual percentage rate (APR) of 106%. Non-mining opportunities began to offer even higher returns than this. GLBSE assets like TYGRR-BANK return up to 2.2% per week, or 211% APR, and in mid-January a forum user known as “imsaguy” offered 6% per 2 weeks, or 357% APR, although at the cost of a somewhat long-term commitment. More recently, however, the interest rates seem to have lost all sanity. Looking at the “lending” and “securities” subforms at bitcointalk.org, we see headlines like “ShadowAlexey’s Deposits 12-18% per month“, “Savings Account, 4% Weekly“, and even “Hashking’s 6.75% Weekly Deposit Special” – a staggering 2921% APR.

The largest of these lenders, and likely the one that many of the other funds are at least partially themselves invested in, goes by the name “pirateat40”, or Pirate for short, and Pirate’s deposit operation is formally called “Bitcoin Savings & Trust”. Accounts in BST are heavily coveted, with Pirate enforcing limits on the number and size of deposits, and interest rates are very high: 4.2% for deposits of at least 100 BTC, 5.6% at 500 BTC and 7% (that’s 3313% APR) at 2000 BTC. Pirate has been unwilling to reveal much about how he is able to earn such high interest rates in the first place, although the reasons that he has given include market arbitrage and “private loans to network members”. Pirate boasts that his activities in such fields provide returns of 10.65% per week, and he pays out an average of 5.98%.

However, both of these methods of earning money are highly suspect. The prevailing interest rate on the lending forums is at about 1.5-8% per week depending on the duration and risk, and reasonably trustworthy individuals can get capital for free from the Islamic Bank of Bitcoin, so even assuming that money is shuffled from borrower to borrower at 100% efficiency with no defaults, earning 10.85% per month is impossible. Market arbitrage may sound more plausible at first glance, but the reason why it cannot explain Pirate’s earnings is that it simply does not scale. At low levels, if bitcoins are worth $4.95 on one exchange and $5.05 on another, and such a thing happens just as often in the other direction, it can indeed provide decent profits. However, the act of buying on one exchange and selling on the other itself helps bring the prices back together, so the process is ultimately self-defeating. Pirate claims that 300000 BTC passes through his accounts every month, but, at the time of this writing, selling even 50000 BTC on MtGox would push the price down to $4.99, and buying that much would push the price up to $5.38, negating any possible profits. Such a large sale on any other exchange would almost certainly send the prices there to either below the $1.992 low of November of above the $31.9 high of June. Furthermore, the idea that market trading activities are less lucrative than their most zealous proponents claim has some empirical evidence: although the activity in question was speculation and not arbitrage, the last time trading was used as a justification for extremely high returns on deposit accounts, Bitscalper, it turned out to be a scam.

The other problematic question with regard to Pirate’s deposit accounts is that of why he is willing to offer such high interest rates in the first place. Rather than offering loans within the Bitcoin community, he could have instead obtained private funding for his ventures. Even if he was unwilling to betray his proprietary financial strategies at all, plenty of lenders are willing to provide interest at rates lower than the average of 6% that he is paying no questions asked, and credit card debt bears an interest rate of less than 0.5% weekly. The response that Pirate gave when asked this question is this:

Ok lets say your business was in “pet rocks”.  Now, there’s a demand for them from an active but relatively small community (like Bitcoin) that believe these rocks are worth their weight in gold.  So you run to your bank and withdraw everything you can, hell you might even ask the banker for a loan.  You tell him it’s for some home remodeling and because he’s known you since grade school you get the loan.  With money in hand you run to the rock market and spend everything you got on certified “Pet Rocks”.

You get your business off the ground while paying off the loan but in the back of your mind you can’t shake the thought of “What happens if people find out these are just rocks or if the rock market is overtaken by nano pets?”.  You take the risk and keep building your business by reinvesting your profits back into buying more rocks.

You wake up one morning, roll over and look at your phone to see the current price of “pet rocks” to be worthless.  With a ill feeling creeping over your body you start to think about how many rocks you have in the warehouse and how much money you’ve actually creamed off the top.

Why didn’t I just borrow the rocks from the rock community and pay them a portion of my profits?  That way if something was to happen, I made good money doing it and my long time friend (the banker) still likes me.

Essentially, Pirate wishes to avoid having USD-denominated debt to secure himself against the risk of Bitcoin price fluctuations. However, this excuse does not stand up to close scrutiny for a simple reason: the possibility of shorting. Sites like Bitcoinica, and soon Kronos.io, offer the ability to deposit a small amount of bitcoins and then trade that for a large positive USD balance and a negative BTC balance, earning a profit if the Bitcoin price goes down. This would essentially give Pirate the ability to cancel out any positive USD exposure that he has with a sufficiently large and highly leveraged short. To see how this works, consider a simplified mathematical example.

In Pirate’s current setup, let us assume that he is borrowing $25000, in the form of 5000 BTC, from investors at 6% weekly and investing that 5000 BTC at 11%. His net exposure to USD is zero, and every week he has a revenue of 550 BTC and an expense of 300 BTC, for a net profit of 250 BTC, or $1250. What would happen if Pirate decided to borrow the money from a non-BTC source and short BTC to compensate? The interest rate that Pirate would have to pay would be much lower, so he might perhaps be able to secure that same $25000 loan at an interest of only 1% weekly (68% APR, still a very high rate for traditional investors). In order to short, Pirate would need to set aside, for example, $5000 of collateral balance, which he can then convert into $25000 USD and -4000 BTC (4x leverage). He can then convert the remaining $20000 into 4000 BTC and use that for his market activities. The positive $25000 USD balance in his margin trading account perfectly balances out his $25000 debt, once again giving him a net USD exposure of zero. As for his profits, however, he is earning 11% weekly on 4000 BTC, or a revenue of $2200 per week, but is paying only 1% weekly on $25000, or $250 per week. Net profit: $1950 per week.

Of course, Bitcoinica has been hacked, and Pirate would have lost $5000 this month had he done this exactly (although compensation is likely to come for Bitcoinica users in the future), but even still Bitcoinica has only shut down once in the 26 weeks since Pirate started lending, so this would only have reduced his weekly profits from $1950 to $1758. Alternatively, he could choose to avoid using Bitcoinica at all, and simply short bitcoins on his own by offering highly leveraged positive Bitcoin, negative USD accounts.

Finally, even if Pirate prefers to stay within the Bitcoin community, there is simply no reason to offer such high rates to investors. He is already forced to restrict supply for his high-interest deposit accounts, so he could easily have kept the rates at a much more reasonable 2.5% per week and gotten as much capital as he needs. Setting deliberately high interest rates to attract more depositors than one needs is a strategy that only makes sense for a Ponzi scheme.

If Pirate is indeed participating in a Ponzi scheme, something which he has repeatedly denied, there are three ways in which he could be doing it. First, he could be running the Ponzi himself. Second, he could be investing in a larger Ponzi scheme outside of Bitcoin – Sergey Mavrodi’s MMM is a likely possibility because of the heavy Russian presence in the Bitcoin community. Finally, he could be even further down the chain, investing in high-interest funds outside of the Bitcoin community which are themselves investing in a Ponzi scheme; in this case, perhaps Pirate does not even realize that he’s investing into a Ponzi scheme at all.

If the Bitcoin lending economy is indeed backed by a Ponzi, the situation is further complicated by the surprisingly large number of middlemen in the Bitcoin lending economy, which creates a complex pyramid of investors.

On the first level of the pyramid, MMM intermediaries invest in pyramids like MMM receive returns of 40-60% per month, and are offering BTC-denominated investment accounts to acquire more capital for these investments. However, because the supply in these accounts is artificially restricted, and the interest rate is kept above the level that the market requires, demand inevitably arises for some of these investors to re-lend, pocketing a portion of the profits for themselves. Pirate, a high-interest lender on the Bitcoin Forum, also encourages this by offering his highest interest rates to very high balance accounts, so the average small investor would get a better return through an intermediary than through Pirate himself.

Some of these re-lenders are actually funds, which invest partially in what are arguably more legitimate ventures, like mining contracts and Bitcoin startups, but decided to accept the risk of one of their investments turning out to be a Ponzi scheme and defaulting for greater returns. This complex web of intermediaries can often make it difficult for both individual investors and even funds to invest without accidentally exposing themselves. The re-lenders themselves, of which the openly admitting Pirate re-lenders are often called “Pirate Pass Through” (PPT) bonds, either allow customers to deposit in them directly or through the Global Bitcoin Stock Exchange (GLBSE), which itself takes a small fee for buying and selling. Each level takes a profit, but the interest rates at the end are nevertheless as high as 3-6% weekly.

However, the question that must be inevitably asked is: what happens when the pyramid collapses? The lower-level MMM investors can easily default on all their debts and disappear, having earned a substantial profit from the difference between their rates with MMM and the rates that they offer their depositors. As for the BTC lenders, if Pirate turns out to be an MMM investor and defaults explicit PPT bonds will be able to get away with a default as well, but the more diversified funds, especially those who do not realize that they are exposed to an MMM default, face a more complex situation. Some will attempt to take the losses and keep operating, while others will shut down and perhaps offer their investors partial payback for their losses, explaining that they did not realize that the funds that they were investing into were connected to MMM. The GLBSE will only benefit, because the brief period of uncertainty between rumor of a default and outright announcement may generate a large volume of panic sales, all generating the exchange fees. The investors, however, will bear the brunt of the losses, and some will likely lose thousands of dollars.

The chance exists that Pirate is engaged in legitimate activity, and if that is true the likely scenario is that interest rates will soon go down, since the Bitcoin economy cannot possibly be growing fast enough to continue to earn Pirate a 19545% APR return. Parts of the Bitcoin economy are indeed growing quickly behind the scenes, as Coinabul and BitInstant are both reporting massive growth over the past six months and BitPay is claiming a 3x growth in transaction volume processed every month, but such a rate be sustained. The high interest rates on the GLBSE and in the Bitcoin community as a whole were also justified by the currency risk, as the value of a bitcoin itself might go up or down by a factor of 2 in the space of a month, however as much of this risk, especially in the downward direction, has faded away in the past four months, forces of supply and demand will likely push interest rates down as time passes.

On the other hand, if Pirate is running, or indirectly investing in, a Ponzi scheme, a default will likely have a serious impact on the Bitcoin economy because of the sheer number and size of the deposits involved, although legitimate businesses like MtGox, BitInstant and BitPay will survive unscathed. Whatever the outcome of the present lending bubble may be, since Bitscalper and now Bitcoinica have failed to return user investments in a reasonable amount of time, there is growing awareness that anonymous investment funds are a dangerous tool, and the result of this latest round of investment opportunities will likely determine what the community’s attitude toward such practices will be for years to come.

Vitalik Buterin is the main writer for Bitcoin Magazine and a passionate advocate of safe Bitcoin investments

 

This interview can also be found on Coinabul’s official blog

A 17 year old coder and entrepreneur named Zhou Tong (pictured above) created a website last year. The growth that his website exhibited is inspirational. In less than 6 months Bitcoinica.com was home to over one million dollars in assets. That young entrepreneur sold Bitcoinica a couple months ago and the new owners are having troubles operating the site securely. Zhou Tong is one spectacular, inspiring, and very young entrepreneur and I had the opportunity to ask him about his experiences. Hopefully the questions I asked will help others achieve the enormous growth his website generated.

Q: So, let’s start out with the basics. What type of family did you grow up with? What portions of your childhood do you think contributed the most to your character and work ethic?

A: I grew up in an ordinary Chinese extended family with hard-working parents. My grandparents were the ones looking after me in childhood. Up to the age of 12, I had no pocket money at all because my family pretty much decided everything for me. The only thing that I had to concentrate on was studying. I was not good at anything else, basically.

I would say there’s nothing interesting in my childhood. No toys, no cartoons and no comic books. I stayed happy because I could always get very good results and everyone in family was proud of me, and luckily I loved most of the compulsory subjects in school – especially Math, Physics, Chemistry and English.

The greatest influence to myself happened after going to Singapore. After being posted to The Affiliated High School of SCNU, the best high school in Guangzhou city, I subsequently received a scholarship offer from Ministry of Education, Singapore. I accepted it with only a few days of consideration, without much understanding about its potential influence to me. Being completely self-independent at 14 was really challenging for a lot of people, and for a long time, I wasn’t achieving anything in life. I became lazy, passive and I fell in love.

I didn’t really know how to have fun, because I didn’t play computer games at all. So I ended up reading books. I bought a few books about PHP, Ruby on Rails, personal finance and startups. At that time, I could use PHP to program a simple meta search engine (to combine search results from different source, de-duplicate and extract keywords). Coding became my only passion because I could get the sense of achievement. I joined my classmate’s blog TechXav and started writing tech articles as well (http://www.techxav.com is still alive, but the new owner killed my design and stopped updating. You can still read my articles though.) After I started learning Ruby on Rails, I got a feel about web developers’ community and I started to explore the popular philosophy – being small, simple and lean. At the same time, I got a lot of inspiration from books about Tony Hsieh (Zappos), Robert Kiyosaki (Rich Dad) and Steve Jobs. I dreamed about a private library of all O’Reilly books too.

Every year, I learned more than all previous years since birth combined. And I aim to achieve this in the future.

Q: When you created Bitcoinica, you managed to make a very lean startup, what tips do you have for keeping costs so low?

Being a technical founder, I didn’t really need anything to get started. I didn’t have money or any partners and I didn’t know any investors either. Even though my community members dismissed the importance, I still think the cloud was what made Bitcoinica lean. I started on Heroku and spent less than $100 a month to handle million of page requests every month. I outsourced sysadmin, security, banking and everything I couldn’t handle to third parties. Early users of Bitcoinica even complained about the inability to accept Bitcoin deposits directly (since Bitcoinica handled no Bitcoin wallets at all).

Cloud computing enabled Bitcoinica to be started at zero capital and grow up quickly with a very high up-time. I couldn’t really afford a powerful dedicated server when I started running the service.

Q: A lot of community members have commented on your exemplary morals and demeanor. What things do you keep in mind to hold yourself to such a high standard. Do you have any mentors or figures you look up to?

A: I didn’t do anything much. For me it was just intuitive to behave like that. Or I can say, I was influenced by Tony Hsieh, Steve Jobs and many startup people. I always have the habit of reading Hacker News everyday so I know the usual way of handling most problems in daily operations.

Q: If you’re comfortable with the question, how much did you sell Bitcoinica for?

A: It was strictly NDA’d. I have only signed one NDA in my life and I don’t generally feel comfortable about NDAs. I signed it because I deeply understood the investor’s reasoning behind the confidentiality.

Q: What have you learned during the brief life of Bitcoinica?

a. Customer service is important.

b. A tech startup founder must be a developer.

c. Ideas are worthless.

d. The best way to make money is to generate value for others, and take a cut.

e. Never outsource core competency and always outsource incompetency.

Q: What do you have planned for the future? Will you continue working for yourself? Continue starting new businesses?

A: I have started working on NameTerrific since mid-March. It’s another solo venture. I was invited to join a few startups earlier but all of them failed before gaining any traction.

Q: I recall one time when talking to you that you denounced NDAs. What brings/brought you to that opinion?

A: Ideas are worthless. NDA results in adverse selection – only the people who care about you will talk to you. Everyone else is behind the NDA wall. You can’t learn from them if you require an NDA. If you seriously want to improve the ideas while having a capability of perfect execution, share it with the world and the real high-calibre people will care.

Q: What is the most important thing aspiring young entrepreneurs should keep in mind when starting a business?

A: Do what you love and love what you do.

Q: What do you think Bitcoin needs to grow? Do you think Bitcoin will last longer than two years?

A: Bitcoin needs a lot of professional developers. The best software people in the Bitcoin world concentrate in the open source project itself. Not many people are actually doing the killer apps. What I see is long development timeframes and low product quality (in most, not all, of these projects). That’s one of the reasons that I decide to leave Bitcoin. Honestly, I think the business environment is not up to standard.

Bitcoin will last forever. It’s the first currency or commodity or whatever that relies on Math. Math is all about making general assumptions and proving logically. It never fails under the assumptions. Also, it’s the best choice for currency for a modern Anarchist state.

Q: I heard you’ve started a new website! What’s it called and what does it do? Do you see it being as successful as Bitcoinica?

NameTerrific. It’s a domain registrar (I’m not sure if I can call it a registrar if I’m only a reseller). You can get a powerful DNS powered by Route 53. It’s extremely simple to use and set up. Currently it’s in early stage of development and I aim to launch in late August.

It’s a low-margin business so it’s not really comparable to Bitcoinica. Also it’s way more scalable than any Bitcoin business in general. So the level of success depends more on my ability to scale (including hiring people) and maintain quality. I can easily calculate the break-even conversion rates so as long as it can pass the proof-of-concept stage by the end of 2012, the business can be run very predictably.

We hope you enjoyed this interview! We’d also would like to thank Zhou for taking his time in sharing his experiences from Bitcoinica. As he moves on to new ventures, we at Coinabul wish him luck!

 

Faced with the growing need to justify the fees, delays, chargebacks and centralization of power that are behind modern fiat currencies, one argument that Bitcoin detractors are turning to more and more to attack the alternative is that Bitcoin is uninsured. As Forbes writer Tim Worstall writes, for example, “Sure, it’s true that real world banks (which is a useful analogy for Bitcoinica) get robbed all the time and this doesn’t stop people using bank notes. But banks are backed up by governments: everywhere has deposit insurance. So, if some robber were to make off with all of the cash that, say, JP Morgan had then all the depositors would be made good by the government deposit insurance as JP Morgan goes bust. Bitcoin, of course, does not have this back up.”

However, this argument is flawed in a number of ways, the largest of which is that the concept of a currency being “insured” is meaningless. Insurance is not an inherent property of a currency, it is a type of contract that can be made between any pair of individuals or organizations. The conceptual error that Worstall, and others who make this argument, are making is that of having what can be termed a hierarchical worldview: seeing “the government” as a special entity in itself, as something which is an inherently higher level process than the mere individuals and businesses that are operating in a sandbox set out by government laws. The reality is, the government is an entity just like any other, and claiming that the US dollar is fundamentally secure and Bitcoin is fundamentally unstable because one has the government backing it and the other does not is incorrect – governments are fallible too, and judging by the high bond yields of many countries on the market, investors do not have nearly the same confidence in the government debt that backs up the power of institutions like the FDIC that Worstall does. The Bitcoin investment industry has been offering insurance contracts such as credit default swaps for months now, and if you want a MtGox, Bitcoinica or any other deposit insured all you have to do is either find someone offering insurance for your deposit already or simply make a post on the Lending forum and just ask for someone reputable to sell you such a service. You can even purchase slices of insurance from multiple providers to minimize your overall risk. It is a core feature of Bitcoin as a whole that its value, its security and even its basis of existence are backed not by any centralized institution but by immutable mathematical algorithms on the one hand, and society itself on the other. Safety is found in diffusion of risk, not a rigid framework of power.

There is also a practical point to be made. FDIC government insurance is not insurance for the US dollar as a whole, it’s insurance for bank deposits. If you lose a hundred dollar bill, whether to a thief, scammer or simple carelessness, you’re out a hundred dollars; there is no insurance to protect you. If you lend money to someone and he defaults, there is no insurance to protect you. One might argue that as a consumer using US dollars electronically it’s all protected by the banking system and therefore ultimately by the FDIC, and you can do a chargeback to recover your money from accidental or malicious losses, but this is not true for everyone. If you are a merchant, for example, and you get a fraudulent chargeback from a customer there is no protection. Theoretically, you can go to court over the issue, but the costs of doing so are so high that practically it is simply not worth it. Thus, with regard to the online payments infrastructure our system does not even offer any insurance at all; instead, it simply shifts the risk from one party to the other, at the cost of delays and fees that are unacceptable in an internet-connected society. In a way, this artificial “merchant beware” system is even worse than the alternative of buyer beware: while consumers can comparison shop and refuse to deal with shady merchants, merchants cannot practically pick and choose their customers.

Lastly, Worstall is wrong in comparing Bitcoinica to a bank. Bitcoinica is a high-risk margin trading platform specially designed for people who are willing to take 100% losses over price fluctuations that take place once every two months, so the risk of losing your account balance due to platform failure is merely a small addition to a risk that is already there. If you want your money to be secure, with Bitcoin you do not need to use a bank at all; an offline or brain wallet setup (or a combination of both through multi-key transactions) is a far better alternative, and has even lower risk than a deposit in a bank account. While a bank depoit is safe unless the government collapses or the FDIC is shut down, your private key stored written down in a treasure chest will retain its value as long as there is at least one person connected to the internet who cares enough about Bitcoin to mine and support the network.

Bitcoin as it stands is indeed more risky and unstable than the US dollar, but most of this risk can be attributed to Bitcoin’s small scale, not any inherent weakness of the currency. As Bitcoin continues to gain in popularity, and attracts a more and more mainstream audience, its banking industry will continue to develop to meet the needs of its customers, and eventually even traditional insurance companies will be willing to set up arrangements with institutions like Bitcoinica to compensate depositors in the event of bankruptcy or theft.

Of course, keeping your bitcoins stored at a third party investment or speculation service is not risk free. But nothing is. It is a basic law of economics that every investment that generates a profit (or interest rate) also carries a risk, and any system that claims to offer one without the other is guaranteed to be either a pyramid scheme or a Martingale-like setup that is mathematically designed to hide risk away by concentrating it into a small chance of total collapse. Bitcoin gives you the freedom to invest your money in whatever way you want, and accept the risks that go along with an investment, or store your money for personal use without relying on any institution whatsoever. It’s up to you to decide which of the available choices is right for you.

  
 

The Russian-based PiratePay startup is attempting an old, but in this application novel, strategy to help Hollywood fight against the file sharers that they claim are costing the economy 373000 jobs and $58 billion per year: DDOSing them. As Pirate Pay CEO Andrei Klimenko describes his company’s strategy, “We used a number of servers to make a connection to each and every P2P client that distributed this film. Then Pirate Pay sent specific traffic to confuse these clients about the real IP-addresses of other clients and to make them disconnect from each other.” Pirate Pay’s first testing run of their technology, helping obstruct downloads of the film Vysotsky: Thanks to God I’m Alive, appears to have been moderately successful, blocking 44845 attempted file transfers. Pirate Pay aims to charge $12000 to $50000 for their service depending on the scale of the project, and believes they can scale up their efforts to cause a much larger amount of disruption if necessary.

The question is, can this attack be used against Bitcoin as well? In terms of P2P disruptions in general, Bitcoin and BitTorrent already have a very similar cryptographic hash mechanism that prevents attackers from feeding in false data, making it impossible to force P2P users to download corrupted or malicious file segments or Bitcoin users to download blocks that are invalid or attempt to rewrite history without paying a cost a thousand times higher than what PiratePay is offering, but neither protocol has any built-in protection against IP-based attacks. It is entirely conceivable that an attacker will attempt to disrupt Bitcoin confirmations by preventing nodes from connecting to each other, and even have some success in disrupting P2P functionality. Indeed, there is one vulnerability which was fixed recently which attempted to do exactly this, and it is indeed possible that doing short term harm to certain parts of the network will be feasible once in a while in the future because of errors in the implementation of specific clients. However, in the long run such a strategy will find its efficacy limited by one feature that Bitcoin has that BitTorrent does not: DNS bootstrap. While BitTorrent is designed to work in a 100% decentralized way with no node being trusted more than any other node, making it vulnerable to attacks where thousands of malicious nodes introduce themselves into the system, the standard Bitcoin client has a bootstrapping system where it connects to a number of hardcoded nodes and gathers a list of trusted addresses from there, making it much more difficult to confuse nodes about where the other nodes’ addresses are. Even all peer-to-peer contact becomes impossible, the Bitcoin network could gracefully decay into a centralized block download service.

Also, it’s difficult to imagine that PiratePay’s disruption system will be able to effectively prevent file downloads for any significant length of time. Internet technology has shown itself to be rapidly advancing, and if PiratePay achieves any prominence whatsoever then it’s almost inevitable that someone will develop a slight modification to the protocol that will quickly render this attack obsolete. Possibilities include a decentralized IP reputation system, where clients connect to IPs that have been faithful to them (or other nodes that they already trust) in the past, an obfuscation system that makes it hard to tell what torrent users are sharing or even what protocol they are using, forcing PiratePay to risk arousing the ire of Blizzard, Skype (now part of Microsoft itself) or even governments, or defenses targeting specific aspects of the attack that PiratePay is currently not revealing but which will become public once the attack becomes widely implemented. It’s even conceivable that organizations like Anonymous will try to use various forms of denial of service attacks against PiratePay itself.

Finally, even if some disruption scheme is able to prevent some clients from connecting to the Bitcoin network even through the bootstrap system, unbroken network access is not nearly as necessary to participate in Bitcoin as it is in file sharing protocols. If you are attempting to download Vysotsky and PiratePay successfully disconnects you 99.9% of the time, it will take you 1000 times longer to download the file – increasing the download time to several months, making it a compelling proposition for many to either buy the movie instead or ignore it outright. If you are trying to send a Bitcoin transaction, however, and you experience 99.9% disruption, it will simply take a few hours for the transaction to get across the network rather than a few seconds. All it takes is one message to send a transaction from one node to another. There will of course be heavy blockchain splitting, and transactions may take a day to reliably confirm, but the transactions will eventually be relayed somehow.

Neither this attack nor any other will arrive at anything close to the end of copyright infringing file sharing, and Bitcoin has the advantages of far higher protocol efficiency and less need for secrecy that counteract even most attacks that may succeed against BitTorrent. Decentralized systems have proven themselves to be more reliable than centralized ones, but Bitcoin’s combination of the two paradigms is even stronger still. The best strategy to protect Bitcoin right now is not to worry about attacks against other protocols that may not even be used against Bitcoin at all, but rather to promote adoption of Bitcoin in general to help increase the size of the network and buffer it against any attacks or disruptions that attackers may try to implement no matter what their specific form.

  
 

The internet and the blockchain that power Bitcoin are unique in that they make any significant events in the Bitcoin ecosystem public, even if the identities carrying out the acts may sometimes be pseudonymous. Anomalies like the so-called “mystery miner”, large buys and sells on MtGox and SatoshiDice causing the Bitcoin network to exceed its all-time transaction record are available for all to see and comment on. The recent Bitcoinica theft, however, takes this form of publicity to a whole new level.

The Bitcoinica theft, like all others in the Bitcoin world, is visible on the public blockchain, but this time the thief has decided to exploit this functionality for a novel purpose: to send us a message. The idea of using the blockchain for this purpose is not new; a proof of concept has been demonstrated by one individual putting up one of Shakespeare’s sonnets, and block chain message services appearing online since 2011, but this is the first time this technique has found a use in practice. The message comes in the form of a transaction using the decimal places of the value spent to encode the text in binary:

12ukfPXZXf1c9BAA1mnEJx3di3wHFRgate - (Spent)   1.01100101 BTC
12t7J13pGkQRw1fqmXCAC6AtcgMt6WuQ11 - (Unspent)   2.01111 BTC
1BvF2mAT1wJBRk1RQdevKr9Y86xJU1xC7r - (Unspent)   3.0111 BTC
18Dw1jXWmSN5kc6Ss892LvnjaR7fGmEM4e - (Unspent)   4.01100101 BTC
1B45M5U8LEf6SjyKcYhNabRhfTZf7XuFRi - (Unspent)   5.01100011 BTC
13uGxhXa7vSgsCVL8k9iAPKnHMT8GNmCN4 - (Unspent)   6.011101 BTC
17Q8E5ja1vcPV1iButAiRnL8wP3egWWWDf - (Unspent)   7.001 BTC
18mNvmHKWnEDswhY1a4jGRVdnMyLn2S2vq - (Spent)   116.4569963 BTC
17ReQJWabDWG3MCYRfv48huZX6BvGc8NQX - (Unspent)   8.01101101 BTC
116FM8p14RTPmUE9hPga2fN1M5W314ACNV - (Unspent)   9.01100001 BTC
1JzwRdeeCnPRvBWTJWjmeD1CKAHcfmVZ3N - (Unspent)   10.01110011 BTC
1CH62vfy7JsP1CyDAcdVNAeW8ojQvcnGaV - (Unspent)   11.01110011 BTC
1A7m74Bak6YXfh4S3zZXrGgStCXbcnE49E - (Unspent)   12.001 BTC
1J8vS5HfGFHYDdRaT6Qc6GKYXNzgqFnHLe - (Unspent)   13.011011 BTC
1PA5AfAnbZsmZSZsihGfBvR1pHLVXb1vi6 - (Unspent)   14.01100101 BTC
1FdQpjwo5vYwgo1D3Rx8QusrzUfisPzJbY - (Unspent)   15.01100001 BTC
1CWVQ9itPYo8AAmGtfNXPJPyA2byY3QrcY - (Unspent)   16.01101011 BTC
1Hax1B8LY4gJQgC8i6LKkCWtQ8ptshTGEC - (Unspent)   17.001 BTC
1Hbru1fBYjE8Bp29L9vVCZUDkf84EHPbXW - (Unspent)   18.01110011 BTC
1M2EZg1YzhRo4CvS2dd4CeYHGGCCHwLRQc - (Unspent)   19.01101111 BTC
15aiB25xw3JSpaoV5pit4BBxpVQwhF2Mwn - (Unspent)   20.01101111 BTC
15ArtCgi3wmpQAAfYx4riaFmo4prJA4VsK - (Spent)   21.0110111 BTC

The decimal places give binary ASCII codes for the individual letters of the message, which spell the cryptic “expect mass leak soon”.

Also of interest is the thief’s generosity. The last 21 bitcoin transaction was sent to the address of the Bitcoin faucet, which gives every Bitcoin user 0.005 bitcoins, and the faucet has distributed these coins to over a thousand people since then. The thief also generously gave out bitcoins on the Bitcoin IRC chat, handing out over thirty in total.

There are many possible motives for these actions. Clearly they were in part motivated by a simple desire to have fun, but the generosity may also have ulterior motives behind it. After the previous 43000 BTC Bitcoinica Linode theft, MtGox responded by freezing any accounts which contained coins that came from the original 43000 BTC transaction, reopening the accounts only in exchange for identification documents. It’s likely that the same will happen as a result of this theft. Thus, by distributing the coins so widely what the thief is trying to do is get as many people flagged as being connected to the theft as possible. While a Joker-like desire to wreak havoc for its own sake could be the end of the thief’s motives, and it fits perfectly well with the “expect mass leak soon” message, there is another reason why the thief would want to do this. By flagging so many people as potential thieves, the thief is diluting the value of the blockchain as a forensics tool in the first place. When he himself gets around to cashing out on his remaining 17200 bitcoins, if he gets caught at any point he can simply claim to be one of his lucky recipients.

The long-term strategy of the thief seems to be to hold on to most of his loot. While the perpetrator of the 25000 BTC theft in June 2011 quickly spread the wealth, mixing it in with large, active pools of money that likely represent major services and exchanges, both the Linode thief and this thief instead spread the coins out slightly, but were then content to keep their loot untouched. There are many reasons why the thieves would want to do this; one is the much stricter policy now compared to last June on the part of MtGox, leading the thieves to embark upon a more slow and steady strategy of cashing out by mixing coins a few at a time with various laundry services and accounts. Another is that the thieves are Bitcoin users just like everyone else, and optimistically believe that Bitcoin will have a higher value in the future. Unfortunately, at this point it’s impossible to know. While the more recent thief may be eager to hand out bitcoins and send messages, he has not yet released any kind of manifesto, and unless he does such a thing we have no information to go on; the blockchain may tell us what is happening, but it says nothing as to who or why.

 

This article was originally written on March 28, 2012

Following the recent Linode theft, in which over 43000 total bitcoins were stolen from Bitcoinica, MtGox enacted a new policy in an attempt to help stop the thief get away with his illicit gains: they began freezing accounts with bitcoins that could be traced back to the theft and demanding that they submit identification to regain access to their accounts.

MtGox has admitted that they are cooperating with the Japanese CyberPolice in an attempt to determine the identity of the thief, and it is possible that their strategy will help achieve such a goal. Even if someone trying to sell the tainted bitcoins through MtGox is not the seller himself, a fact that even MtGox themselves have admitted is almost certainly true in every case, they would likely know something about the person who sent the coins to them, and the police, working with MtGox and other Bitcoin services, could theoretically trace their way back through each link, asking the receiver of each transaction who sent it to him, until they arrive at the original thief. It’s hard to tell how practical such a strategy actually is, although if it is possible at all it is the largest heists, those whose value swamps any mixing pool that the thief tries to use, that would be the easiest to unravel.

However, some suspect that there may be motives at play beyond simply wanting justice for Bitcoinica. Over time, MtGox has built in more and more authentication features, first requiring email addresses for accounts since last June, and later requiring identification for accounts handling large amounts of bitcoin, and this too may be part of a long-term plan to slowly get the Bitcoin community used to accounts being linked to their owners’ legal identities. Anti-money laundering law requires businesses transferring significant quantities of money to “know your customer”, and MtGox may have realized that they are bound by such laws and are currently not in compliance with them, so they are doing their best to become legal without clamping down too hard all at once. During the security crisis and the media attention on illegal uses for Bitcoin last June, MtGox stated their willingness to work with law enforcement authorities to track down criminals and resolve legal issues, so it has for a long time been known that those interested in using Bitcoin as a tool to fight against government surveillance and probihitions should not look to MtGox for aid. And this is arguably the most logical position for them to take; since they are such a central entity to the Bitcoin economy it would hurt the economy, both legal and illegal, far more if they were shut down than if they enacted some authentication requirements that can still be bypassed simply by going through less prominent exchanges instead.

Others accuse MtGox of simple theft, but this seems highly unlikely. MtGox has no way of knowing if a frozen account will ever be claimed, so if they were to cash out on their gains they would effectively be operating under a fractional reserve, a policy which, if it were ever leaked or otherwise revealed, would effectively destroy MtGox’s reputation and seriously hurt Bitcoin’s public image, both of which they have already demonstrated a willingness to sacrifice short-term profits for when they bailed out the hacked exchange bitomat.pl in August.

MtGox’s move raises other concerns too. The most common is that it undermines the fungibility of bitcoins; the idea that one bitcoin is one bitcoin, no matter which bitcoin it is and where it came from. By flagging 43000 BTC as tainted, MtGox is substituting this model with one where some bitcoins have more value than others. Some have suggested that this is a good thing, and the Bitcoin community can expand upon the idea and adopt a self-policing mechanism by which most clients are configured to reject bitcoins that have been confirmed as stolen. However, there are many ways to criticize such a system. First of all, such a scheme would rely on a centralized authority, which Bitcoin was designed to avoid. A polycentric system may be possible, but if one authority becomes accepted by the majority of users the system will fall into a stable equilibrium of centralization which is so hard to get out of that it would be easier to create a new currency. Once the mechanism is in place, governments can easily take it over and gain the power to penalize whomever they want and make any bitcoin-handling service unusable. Second, the thief will most likely exchange his stolen coins immediately, before the community even finds out what’s going on, and it would be average users, not the thief, who are inconvenienced when they discover that a fraction of their money is suddenly worthless. The system would essentially serve as a chaotic transaction tax, not affecting those who simply hoard their bitcoins but adding an element of fear to every transaction as the coins that the receiver received may suddenly become worthless. The end result would be an undermining of the trust and integrity of the Bitcoin system as a whole.

Fortunately, MtGox is not confiscating tainted coins or declaring them worthless; for now they are simply requiring identification for a few accounts. The move should be interpreted not so much as MtGox asserting themselves as a government of the Bitcoin world, but as a step toward the legitimatization of the currency. MtGox is not mandatory; those who prefer not to be tracked in their bitcoin usage can always go to one of the many secondary exchanges or even arrange a physical transaction and throw potential investigators even further off their tracks by depositing and withdrawing their coins through Silk Road. If we want to restrain MtGox’s power to decide how the Bitcoin economy functions, perhaps it is most appropriate look not at each specific move that they are making, but at their near-monopoly 86% market share, and question why they have so much power in the first place.

  
 

The last few days have unfortunately brought one piece of grim news after another to the Bitcoin community. As if the 43000 BTC Linode theft in March was not enough, another 18457 BTC was stolen from Bitcoinica’s reserves, and Zhou Tong was barely able to prevent the thief from getting his hands on 30000 more. Unfortunately, given the financial stress that Bitcoinica was already in after the Linode theft two months ago, even this smaller loss turned out to be the straw that broke the camel’s back. The site was immediately shut down for security reasons, and less than one day later Zhou posted another message compounding the bad news: “It’s more serious than we thought. We need some additional time to come up with a compensation proposal – Likely we will either shut down the platform or re-develop entirely (which will take months instead of days).”

Bitcoinica users who have a balance in the service are likely safe. Bitcoinica’s staff is building an account claim page, and the latest news is that users will receive all of their money back, with their US dollar balance liquidated at a settlement price of 4.94-4.98. Bitcoinica itself has, as of two weeks ago, been taken over by Intersango, and the use that the new leadership will put the platform’s code to, if any, is not yet certain.

As for Zhou Tong himself, he has decided to leave Bitcoin entirely. The main reason that he gave for leaving is not any lack of confidence in Bitcoin itself – as he himself writes, “I always believe in Bitcoin, or simply anything that brings people financial liberty. I have heavily invested in Bitcoin (I purchased one 1,000 BTC gold coin from Casascius and will keep it for as long as I can).” Rather, he is leaving because he feels that Bitcoin is not his destiny. “I failed at one thing though,” he writes, “that is generating value for the society. Bitcoinica did create a place for people to trade more efficiently and provide liquidity to the market. However, speculation is a zero-sum game (or negative-sum, strictly saying). I know there can be many justifications for Bitcoinica’s value, but all of them are against my intuition and values. With the confidence and the innate intuition to build wonderful things for a better world, I decided to move on.”

Many will disagree with him about the social utility of financial speculation services; there is an argument to be made that it promotes price stability and, as the wide array of Bitcoin casinos shows, even negative-sum gambling has value in itself. But where Bitcoinica and Zhou brought the most value to the community has nothing to do with the service itself. Rather, Zhou showed us that the world of Bitcoin is a world where freedom and opportunity reign supreme, and where even a 17 year old with no prior connections can make a difference by virtue of his talent alone. In many ways, he represents Bitcoin’s everyman; the largely self-educated, highly independent individual with a wide variety of interests ranging from computer science to finance and economics to politics to philosophy seizing upon a chance to apply his talents to the world. One could even argue that he is an echo of Satoshi himself.

Despite his position as the creator of a financial speculation service and his strong belief in libertarian capitalist ideals, Bitcoinica to him has never been about the profit. “Bitcoinica is not a money making machine,” he writes. “It’s just a product that sets a high standard for the Bitcoin community.” This is something that we all lose track of from time to time. The polarized political dialogue that we are forced to listen to every day on the mainstream media often forces those of us who support financial freedom to at least subconsciously align ourselves with the likely nonexistent ideal type of an individual who cares about nothing but short term wealth, but ultimately, as none other than Ayn Rand pointed out, money is only a tool. It is indeed a very good tool, allowing us to enjoy the products that come out of a highly specialized economy characterized by the division of labor, command services from individuals halfway across the world with whom we have had no prior contact whatsoever and invest for the future without tying ourselves down to a specific project, but it cannot replace the personal drive and vision that is at ultimately the core of both great businesses and projects like Linux, Wikipedia and even Bitcoin itself.

Zhou Tong has often been reviled as a scammer, and this crisis has, predictably, only amplified such cries. But his actions over the past eight months do not paint the picture of a man who consciously set out to defraud the public with a Ponzi scheme or an arcane system of liquidation rules; rather, they paint the picture of a teenager, still uncorrupted by the rigidities of the status quo, ready to discover the world and find a place where he can make a difference. Of course, Bitcoinica’s history is marked by security blunders and telling signs of Zhou’s inexperience. However, failure is an inevitable part of learning and innovation, and if the Bitcoin community begins to treat failure as an unforgivable sin and every blunder as proof of moral turpitude, then it will cease to be a community that values learning and innovation at all. Instead, it will become yet another manifestation of the inflexible and bureaucratic status quo. The Apollo program killed three people before it got a single one on the moon, and Socrates’ contributions to philosophy would never have appeared had he listened to his detractors’ complaints that he was corrupting the youth. Rather than disparaging Zhou for being too inexperienced to succeed, we should be praising him for daring to try. While his first endeavor has now failed, and even his second may fail too, perhaps his third might succeed, and in our world of unlimited growth and infinite possibility the amount that we all gain from one great success outweighs the disappointment of even a hundred failures.

Lastly, although this first implementation of Bitcoinica may have died, the idea has not. The demand for a service like Bitcoinica has been proven to exist, and it’s only a matter of time until it resurfaces in some other form. Ringcoin’s new Kronos.io will soon provide an even more secure alternative by using its ZipConf instant Bitcoin transfer technology to remove the need to have a potentially vulnerable “hot wallet” at all, and more competition may be around the corner.

  
 

Присоединившись к последнему всплеску в основных СМИ новых статей, связанных с Биткойном, BusinessInsider опубликовал статью, выражающую точку зрения против Биткойна. Однако, статья, к сожалению, содержит довольно много ошибок, заявлений, которые одновременно кричаще неверны и способны ввести в крайнее заблуждение, и неуместных опасений по поводу потенциальных “проблем”, которые уже более года как разрешены сообществом Биткойн.

• “На данный момент, средняя оплата сделки с Bitcoin равна 0,99%, в то время как Сквэр и PayPal берут 2,75% за обработку приложений и 2,7% за чтение кредитной карточки.” – Согласно статистике сайта blockchain.info, в день пересылается около 150000 BTC с общей суммой операционных выплат 4 BTC, исходя из чего, “средняя” плата за сделку на самом деле составляет 0,00267%. Операционные сборы в сети Bitcoin полностью добровольны и нужны только для того, чтобы обработать вашу транзакцию чуть быстрее.
• “В отличие от кредитной карты, Bitcoin в настоящее время не обеспечивает защиты или компенсации в случае мошенничества”, – я обратил подробное внимание на эту проблему в статье об экономиках с не-западным потребителем, и в течение года было найдено её решение. Решение называется эскроу (передача денег через третье лицо). В общих чертах, если сторона В хочет продать продукт стороне А, но у обеих сторон низкий уровень доверия друг к другу, они могут найти поставщика услуги эскроу С, которому обе стороны доверяют, для посредничества в сделке. Затем, вместо оплаты напрямую В, А вышлет деньги С. Получив продукт, А пошлет С сообщение о том, что операция прошла успешно, и С переправит средства В. Если продукт оказывается некачественным или не приходит, С возвращает средства А, оставляет их себе или жертвует на благотворительность (практика показывает, что первые два варианта дешевле для сторон, но третий гарантирует отсутствие порочной мотивации у А и у С, понуждающей их солгать, чтобы претендовать на деньги). Новейшие транзакционные возможности Биткойн, вообще говоря, предлагают улучшения по сравнению с описанной ситуацией, которые ещё больше снижают уровень вовлечённости третьего лица и необходимого доверия к нему. Так что качество услуг эскроу будет только улучшаться со временем, по мере появления большего числа коммерсантов, принимающих оплату в биткойнах.
• “Недавно один хакер сумел пройтись рейдом по нескольким «банковским» счетам Биткойна – по кредитным и дебетовым счетам «богатых» пользователей Биткойна в разных точках мира, и «ушёл» с уловом в $ 228 845”Этот вопрос я тоже уже рассматривал в подробностях. Стандартной рекомендацией для пользователей Биткойном является хранение подобных больших сумм в автономном режиме или мозговом кошельке, и даже разбитие кошелька на несколько частей, чтобы снятие средств требовало значительных усилий. Если обеспечить должную надёжность этим образом, то снять чьи-то пожизненные сбережения будет в лучшем случае невозможно, а в худшем для этого потребуется вломиться в дом к их обладателю и предпринять обыск его личного имущества и жёсткого диска или применить пытку. В Биткойнике такие потери стали возможны только потому, что фирма – бизнес-поставщик финансовых услуг, а это означает, что большое количество её денег должно находиться в доступе для автоматического снятия со счёта. И даже эта фирма может внести, и уже внесла, такие улучшения в систему безопасности, что даже атаки хакеров, подобных Linode, теперь невозможны.
• У разработчиков “есть отмычка, которая дает им контроль над всей машиной, в любое желаемое время” – Описанная “отмычка” – механизм предупреждения, введённыйпервоначальным разработчиком Биткойна Сатоши Накамото в официальный клиент Биткойна в версии 0.3.11. Система позволяла Сатоши (и Гэвину Андресену после ухода Сатоши), отправить сообщение, подписанное с помощью своего закрытого ключа, которое бы побудило клиенты вывести предупреждающее сообщение и перейти в безопасный режим, не принимая и не отправляя сделок, пока безопасный режим не будет отключен. Идея заключалась в том, чтобы иметь механизм для быстрой задержки распространения ущерба, причиняемого сбоем или злоупотреблением, прежде чем кому-то удастся опустошить с их помощью тысячи Биткойн-кошельков. Однако описание этого механизма как своего рода хозяйского ключа ко всей машине пользователя некорректно с четырех позиций:
  1. Ключ никогда не давал разработчикам контроль «над всей машиной»; наивысшим проявлением его власти могло быть лишь временное отключение Биткойн-клиента.
  2. С самого начала было предусмотрено право коррекции. Запуск Биткойна кнопкой disablesafemode позволял вашему клиенту работать в нормальном режиме независимо от желания Сатоши или Гэвина или любого менее чистоплотного посредника, которому удалось бы захватить ключ в управление.
  3. По большей части из мотивации опасения, что эта функция может быть интерпретирована как выключатель с чёрного входа, отключающий механизм был удален из версии 0.3.19. Теперь все, на что способна “отмычка”, – это отображение предупреждений.
  4. Официальный клиент Биткойна не является его единственным наличным клиентом. Пользователям доступен большой выбор вариантов кошельков, и некоторые из них даже совместимы с файлом официального клиента wallet.dat, так что вы можете мгновенно переходить из одного в другой.
• “В США печать и регулирование курса доллара управляются Федеральной резервной системой. Если Биткойн станет общепринятой мировой валютой, потребуется более сложный и всеобъемлющий регулирующий орган”. – Положение, что такие центральные банки, как Федеральная резервная система, вообще необходимы, гораздо более спорно, чем подразумевается в этом утверждении. Противники централизованности системы банков считают, что махинации центральных банков являются реальной причиной большей части наших текущих финансовых неурядиц. Они припоминают тот факт, что большинство центральных банков возникло не в целях помочь стабилизировать денежную систему на благо людям, а через закулисные политические маневры торговых и банковских элит, ищущих закрепить за собой законное право на извлечение выгоды. Описывая основание Банка Англии, Дэвид Грэбер пишет в статье Долг: Первые 5000 Лет: “В 1694 году консорциум английских банкиров дал королю кредит на £1,200,000. Взамен они получили королевскую монополию на выпуск банкнот. На практике это означало право распространять долговые расписки на часть королевского долга среди подданных королевства, желающих взять у банка взаймы или поместить в него деньги, – по сути, обращать или “монетизировать” только что созданный королевский долг. Для банкиров это была великолепная сделка (им была дана возможность взимать с короля 8 процентов годовых от первоначального займа и одновременно начислять проценты на те же деньги с клиентов, которые их заимствовали). Но сделка могла функционировать только до тех пор, пока первоначальный долг не был погашен. До сего дня этот долг так и не был возвращён”.
• “Рыночная цена на Биткойн резко падает, начиная с 2011 года”, – – Утверждение перестаёт быть верным с ноября 2011. Фактически, с поры последнего крупного падения биткойна 14 февраля его цена была лишь в два раза неустойчивее цены золота.

Кроме того, ложным, к сожалению, является заявление в статье о том, что биткойны сейчас используются в Африке в качестве альтернативы ненадежной местной валюте. Рудигер Кох пытается внедрить принятие Биткойна в Африке, но пока ещё очень рано говорить о каком-либо успехе. Тем не менее, Биткойну находится более широкое применение, нежели лишь в теневой экономике. Он используется в торговле игровыми кодами на Ogrr.com , существуют такие неофициальные эксперименты как Биткойн Сходит с Ума, а некоторые даже пользуются им, чтобы избежать оплаты и задержек международных денежных переводов. Мы можем только предполагать, что в будущем появятся пути более официального хождения Биткойна.

  
 

Martingale betting is a class of betting strategies that originated in 18th century France which can turn any game, whether blackjack, roulette or anything else, ideally something played in short, discrete rounds with a roughly 50-50 win/lose ratio, into one which gave the gambler an almost certain chance of success. The way the algorithm works is like this. Imagine that you are playing a simple slightly biased coin toss game where you can bet any amount of money and if you land heads (49% chance) you win and if you land tails (51% chance) you lose. First, you bet one dollar. If you win, rejoice and go back to step one. If you lose, next turn bet two dollars. If you win, once again go back to step one, but if you lose increase your bet to four dollars. If you are unlucky enough to keep losing, you double your bet each time. Eventually, you are guaranteed to win at least once, at which point no matter how many times you lost you come out having gained one dollar.

However, a strategy that turns a game with a slightly negative expected value each round into one with a guaranteed positive reward each time is mathematically impossible, so there must be some hidden flaw. And the flaw is this: your money is not unlimited. If you are playing with 1 million dollars, once every 705661 rounds you will encounter 20 tails in a row and go bankrupt. Thus, the expected value of a round is in fact -$0.41, negative as expected. However, the strategy is neverthelss a good one to show off to your friends: the 7056 out of 7057 times that you can demonstrate a hundred-round streak of guaranteed profits you will not only gain a small amount of money but also gain the social reward of appearing to your friends to be a mathematical genius.

But there is one circumstance in which the Martingale betting system is hugely successful: if you can count on someone to bail you out if you are in trouble. If you can convince someone that you are systematically important and that allowing you to go bankrupt would lead financial armageddon, your expected value function changes – if, for example, you can expect to only foot half the bill of a crisis in the form of hastily conceived and relatively mild after-the-fact penalties, your expected value each round goes up from -$0.41 to +$0.29, making the losing game a profitable one through artificially externalized costs.

What’s most deceptive of all about the Martingale strategy is just how stable it appears to be. Your profits are guaranteed to be exactly $1 each and every round no matter what happens behind the scenes. Standard deviation: zero. To the outside world, you’re an unstoppable profit-making tycoon. And herein lies the problem. I mentioned earlier that it is, in an informal sense, rational to go play blackjack in a casino because if you win you’re also gaining a reputation among your friends as a mathematical genius. But for hedge fund managers and traders in the financial industry, gaining a reputation as a mathematical genius is not fun and games at all; rather, it’s how they get promoted. If a manager appears to be earning constant above-market returns per year, every year, banks and hedge funds everywhere will look to hire him as an advisor and investors everywhere will eagerly buy up copies of his book is he decides to release one. And if he fails he will simply fade into the background and, if worse comes to worst, may have to find a job elsewhere. Ninety percent chance of a 7% return, ten percent chance of bankruptcy becomes a ninety percent chance of eternal glory and a ten percent chance of simple mediocrity.

It’s human nature to want to soften the harshest blows of what seems like random chance. We see people speeding to get to work faster, but the one in a million times that it doesn’t work out and they end up in an accident we say that they don’t deserve to die for something so trivial. The only way we can maintain such a position and not create perverse incentives, however, is by softening the profits as well, in most healthy societies throughout history through a culture that imposes public shame on such acts. The financial system as it stands, however, is a master of exploiting this tendency. Shame, to them, has no meaning; it cannot be bought or sold, longed or shorted, and has no place on the quarterly balance sheet. Every time we give them the message that we got their backs in case something truly unprecedented happens, what we are giving them at the same time is an unlimited license to print money. Also, by not letting them fail, we are in effect playing a Martingale game of our own. We may avoid having to suffer a moderate amount of pain now, but every crisis where the banks get off scot free, they emerge stronger, and the same incentive structures and the same kind of thinking that led to the crisis in the first place is allowed to remain at the helm and breed new disciples. As with any Martingale game, however, there will eventually be a final round, and I dread to think of what might happen if we lose it.

 

Many of us are familiar with BitInstant, the micro-credit provider that allows anyone to deposit money through bank wire transfers or even cash deposits at the local bank and get the deposit at any major Bitcoin exchange in less than an hour. However, what many do not realize is that, despite the name, BitInstant does not deal with Bitcoin at all; rather, it focuses purely on the fiat currency side of the Bitcoin exchange system. While BitInstant is undoubtedly very useful, helping people get their bitcoins faster, facilitating efficient international fiat money transfers using Bitcoin as an intermediary, and even being credited by some for Bitcoin’s recent price stability as people can easily and immediately buy in whenever the price drops, it does not quite solve the whole problem of transaction delays. Now, Jonathan Ryan Owens and his company Ringcoin is seeking to do just that by introducing Zipconf, a service that he calls “the other side of instant” – instant deposits into exchanges on the Bitcoin side.

While the prospect of instant Bitcoin transactions of any sort rightfully arouses suspicion among many, Jonathan is confident in his system’s ability to prevent or detect attempts to defaud his service by double-spending. The basic principles behind how his system works make sense. Double spend attempts on instant transactions work by first sending a transaction as directly to the receiver as possible and then soon after that sending the same transaction but with yourself rather than the receiver as an output to as many other nodes as possible. The attacker is hoping that the receiver will see the first transaction and accept it as payment but then the second transaction will drown out the first throughout the network as a whole, and ultimately get included in the blockchain, rendering the first transaction invalid. Zipconf’s software stack attempts to prevent this in two ways. First of all, it broadcasts the first transaction as loudly as possible as soon as it gets it, reducing the chance that a double spend will be successful. Transactions also always include a small fee to encourage miners to quickly confirm the transaction into the blockchain, adding a further line of defense. Second, Zipconf is willing to compromise slightly on being instant, waiting 5-10 seconds after receiving a transaction to listen for double spend attempts before finally accepting it. By then, the transaction will have spread to much of the network and it is nearly impossible for a second, conflicting transaction to get a foothold.

There are of course many special cases to deal with as well, but Jonathan believes that his software stack will be able to handle them. Code is in place to deal with block reorganizations and occasional glitches in the network, and he has been working with the owner of Slush, the third largest mining pool, to ensure that his transactions will always be included in blocks. “We’ve been developing this based on edge cases for 6 months,” Jonathan reassures, “including extensive testing ourselves, trying to break it. We’ve found some very simple, and also some very clever ways to avoid risk.” At the moment ZipConf is in private beta testing and will be officially launched around next week. For private beta testing access you can contact [email protected] .

As for use cases for such a service, there are several possibilities. Arbitrageurs and speculators, Bitcoin investors catching market swings and earning a profit by correcting price differences between different exchanges, will of course be Zipconf’s most profitable customers. Aside from that, there is a partner API through which sites which hold bitcoins for their users (eg. wallets, commerce/auction site accounts) will be able to allow their users to instantly withdraw to Bitcoin exchanges. And, finally, Jonathan admits, “the most important use case is impatience.”

Although the service does not have nearly as solid a footing of compelling use cases as BitInstant as it stands, what may be its salvation is that it simply does not need to. While BitInstant must deal with money services licensing and relationships with banking partners across many countries, Zipconf stays entirely within the Bitcoin economy, and will thus be able to keep its costs much lower. The upfront work is already done; the core software stack is well-tested and Zipconf has already signed up multiple arbitrageurs and potential partners, so even if users turn out to be less impatient and arbitrage less lucrative than Jonathan had hoped and no other use cases reveal themselves to pick up the tab the service will still keep operating at a profit even with very minimal volume. But there is cause for hope too, as plans to expand Zipconf’s range of services are already underway. Finally, perhaps where Zipconf shines the most is not even in the practical applications that its current implementation lends itself to facilitating, but rather as a proof of concept, a demonstration of the principle that whatever limitations Bitcoin may have are not fatal – Bitcoin is merely a bottom layer protocol, and whether the issue is speed, consumer protection, anonymity or whatever else the community demands, it can always be overcome by adding another layer on top.