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Summary:

Bitcoin, the virtual peer-to-peer currency that was launched last year, had a meteoric rise in the last few weeks-but after a hacking attack…

Bitcoin 2

Bitcoin, the virtual peer-to-peer currency that was launched last year, had a meteoric rise in the last few weeks-but after a hacking attack on the premier bitcoin exchange, the currency today appears to have had a near-death experience. What happened? How did one of the web’s boldest financial ideas spread from a small group of geeks, to the mainstream-and then plummet to such depths?

Bitcoin is a virtual online currency powered by peer-to-peer technology, so no central authority controls its use or monitors transactions. (For a simple explanation of some of Bitcoin’s advantages, see this video.) Bitcoins are created by “miners,” computers running special programs that solve complex math problems at a predictable rate, and are rewarded with bitcoins. Ultimately, there will be 21 million bitcoins in existence.

The currency isn’t backed by any government or organization, so its only value lies in the fact that various individuals and organizations are willing to accept bitcoins as payment. The currency was created by Sakoshi Nakamoto, a name some believe is a pseudonym.

Bitcoin was launched in 2009. Up until a few months ago, it cost less than a dollar to buy a bitcoin (chart). The price crawled steadily upward over April and May, to around $8 per bitcoin.

So what made bitcoins absolutely explode in value earlier this month? Probably the black market. On June 1, Gawker published an article on Silk Road, an anonymous website for buying illegal drugs that used bitcoin. Within two days, the price of bitcoin doubled; within a week, the price had quadrupled, and buying a bitcoin on the major U.S. exchange, Mt. Gox, cost more than $30.

Since that heady high, though, bitcoin traders and users have been hit with a few pieces of seriously bad news.

»  The Gawker article on online drug buying set off Sen. Chuck Schumer (D-NY) right away; just a few days after the Silk Road website was publicized, Schumer condemned bitcoin, equating its use with money laundering.

»  Last week, a prominent bitcoin miner reported that he had been ripped off to the tune of $500,000 worth of Bitcoin after the file that comprised his digital “wallet” was broken into.

»  More seriously, the premier U.S. bitcoin exchange, Mt. Gox, was hacked over the weekend. Mt. Gox employees emphasize that the hacker only got away with $1000 worth of bitcoin. (Mt. Gox places a daily limit on account withdrawals-just like banks generally do with ATM cards.) But news about the hacking caused a massive bitcoin sell-off, and early Monday morning, the price plummeted from about $17.50 USD per bitcoin down to just pennies in a matter of minutes.

Mt. Gox has said it will invalidate those post-hack trades and restore the price of bitcoin to where it was at before the run on the exchange.

But for now the whole exchange continues to be offline; Mt. Gox says it is restoring accounts as it verifies them one at a time.

»  A few prominent early adopters of bitcoins were groups that promote digital privacy and anonymity rights, including the Electronic Frontier Foundation and the Free Software Foundation. But this week, EFF stopped accepting bitcoin donations, saying that the legal implications of the new currency are “very unclear.” In a blog post, EFF legal director Cindy Cohn wrote that “Bitcoin raises untested legal concerns related to securities law, the Stamp Payments Act, tax evasion, consumer protection and money laundering, among others.”

Bitcoin will surely survive all this-there’s too many people too deeply invested in it to allow it to fail. But it’s unlikely that its users will have the same level of confidence that they did a month ago.

  1. It is a little premature to claim Bitcoins have collapsed, given they’re still selling for $15USD on a number of other exchanges. You could have also written a similar article about the rise and fall of silver:http://uk.finance.yahoo.com/q?s=SLV

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  2. Gary, thanks for your comment. The “fall” of bitcoin here just refers to the post-hack crash in prices. As I say at the end of the post, I _do not_ think bitcoin is going to disappear. 

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    1. ‘The “fall” of bitcoin here just refers to the post-hack crash in prices’
      Due to the rollbacks, this ‘crash’ should really just be considered a display artifact.
      It didn’t occur on other exchanges trading in bitcoin – and in effect, nobody got to trade at the ‘pennies’ level during this incident. 
      If you were to graph the price of bitcoins vs USD during the period covering the attack on mtgox – it wouldn’t make sense to include those low values. The price at which trading occurs is a better reflection of what actually happened to the value of bitcoins over time.

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    2. Of course people read headlines and not everyone makes it to the last line where you subtly cover your ass by saying you don’t think they will disappear.

      But doesn’t matter … with BTC/USD trading back at $18 USD perhaps on its way much higher, your audience will remember your title and remember you as being one of the doubters.

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