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Bitcoin
A common logo from the bitcoin reference client
Unit
Symbol BTC, XBT,[1] ‎
Denominations
Subunit
 10−8satoshi[2]
Demographics
Date of introduction3 January 2009; 15 years ago (2009-01-03)
User(s)Worldwide
Valuation
Production25 bitcoins per block (approximately every ten minutes) until approximately the year 2017,[3] and then afterwards 12.5 bitcoins per block for 4 years until next halving. This halving continues until 2110-2140.
 SourceNumber of bitcoins in circulation
 MethodIncrease in the supply
This article contains special characters. Without proper rendering support, you may see question marks, boxes, or other symbols.

Bitcoin is a peer-to-peer payment system introduced as open source software in 2009 by developer Satoshi Nakamoto. The digital currency created and used in the system is also called bitcoin[note 1] and is alternatively referred to as a virtual currency, electronic money, or cryptocurrency.[6] The bitcoin system is not controlled by a single entity, like a central bank, which has led the US Treasury to call bitcoin a decentralized currency.[7] Economists generally agree that it does not meet the definition of money.

Bitcoins are created as a reward for payment processing work in which users who offer their computing power verify and record payments into a public ledger. Called mining, individuals engage in this activity in exchange for transaction fees and newly minted bitcoins.[8] Besides mining, bitcoins can be obtained in exchange for other currencies, products, and services.[9] Users can buy, send, and receive bitcoins electronically for a nominal fee using wallet software on a personal computer, mobile device, or a web application.

Bitcoin as a form of payment for products and services has seen growth, and merchants have an incentive to accept the currency because transaction fees are lower than the 2–3% typically imposed by credit card processors.[10] The European Banking Authority has warned that bitcoin lacks consumer protections.[11] Bitcoins can be stolen and chargebacks are impossible.[12] Commercial use of bitcoin is currently small compared to its use by speculators, which has fueled price volatility.[13]

Bitcoin has been a subject of scrutiny amid concerns that it can be used for illegal activities.[14] In October 2013 the US FBI shut down the Silk Road online black market and seized 144,000 bitcoins worth US$28.5 million at the time.[15] The US is considered bitcoin-friendly compared to other governments, however.[16] In China, new rules have restricted bitcoin exchange for local currency.[17]

Overview

The most important part of the bitcoin system is a ledger that records financial transactions in bitcoins. Recording transactions is accomplished without the intermediation of any single, central authority. Instead, multiple intermediaries exist in the form of computer servers running bitcoin software. These form a network by connecting over the Internet that anyone can join. Transactions of the form payer X wants to send Y bitcoins to payee Z are broadcast to this network using readily available software applications. Bitcoin servers can validate these transactions, add them to their copy of the ledger, and then broadcast these ledger additions to other servers.[18]

The block chain ledger

Just as a ledger can be used to record transfers of conventional money like dollars, all bitcoin transfers are recorded in a computer file that acts as a ledger called the block chain. Where a conventional ledger records the transfer of actual dollar bills or promissory notes that exist apart from it, bitcoins are simply entries in the block chain and do not exist outside of it.[19]

Mining

Maintaining the block chain is called mining, and those who do are rewarded with newly created bitcoins and transaction fees.[20] Miners may be located on any continent and process payments by verifying each transaction as valid and adding it to the block chain.[20] As of 2014 payment processing is rewarded with 25 newly created bitcoins per block added to the block chain. To claim the reward, a special transaction called a coinbase is included with the processed payments.[18] All bitcoins in circulation can be traced back to such coinbase transactions. The bitcoin protocol specifies that the reward for adding a block will be halved to 12.5 bitcoins in 2017 and halved again approximately every four years. Eventually, the reward will be removed entirely when an arbitrary limit of 21 million bitcoins is reached c. 2140, and transaction processing will then be rewarded by transaction fees solely.[21] Fees are optional, but users that pay may have their transactions processed more quickly.[22] Payers have an incentive to include transaction fees because their transactions will likely be added to the block chain sooner; miners can choose which transactions to process[citation needed] and prefer to include those that pay fees.

As of 2013 mining has become quite competitive, and the process has been compared to an arms race as ever more specialized technology is utilized. The most efficient mining hardware makes use of custom designed application-specific integrated circuits, which are much faster and use less power compared to general purpose microprocessors, such as x86 processors.[23] Without access to these purpose built machines, a bitcoin miner is unlikely to earn enough to even cover the cost of the electricity used in his or her mining efforts.[24]

Mining pools

The odds of winning the reward for adding a block to the block chain decrease alongside an increase in the number of miners. Mining is a competitive process, and while many participate, the reward for each block can only go to a single miner. As of 2014 it has become common for miners to join organized mining pools to circumvent this problem.[25] Such pools split the work and the reward among all participants and make mining a less risky endeavor. Even for those who join pools, the cost of the electricity necessary to mine may outweigh the bitcoin rewards from doing so.[24]

Anonymity

The public nature of bitcoin means that, while those who use it are not identified by name, linking transactions to individuals and companies can be done.[26] Additionally, many jurisdictions require exchanges, where people can buy and sell bitcoins for cash, to collect personal information.[27] In order to obfuscate the link between individual and transaction, some use a different bitcoin address for each transaction and others rely on so-called mixing services that allow users to trade bitcoins whose transaction history implicates them for coins with different transaction histories.[28]

It has further been suggested that bitcoin payments should not be considered as more anonymous than credit card payments.[29]

Ownership

The ownership of bitcoins associated with a certain bitcoin address can be demonstrated with knowledge of the private key belonging to the address. For the owner, it is important to protect the private key from loss or theft. If a private key is lost, the user cannot prove ownership by other means. The coins are then lost and cannot be recovered. Since anyone with knowledge of the private key has ownership of any associated bitcoins, theft occurs when a private key is revealed or stolen.[13]

Buying and selling

Bitcoins can be bought and sold with many different currencies from individuals and companies. Perhaps the fastest way to purchase bitcoins is in person or at a bitcoin ATM for cash.[30] Participants in online exchanges offer bitcoin buy and sell bids. Using an online exchange to obtain bitcoins entails some risk, and according to one study, 45% of exchanges fail and take client bitcoins with them.[31] Since bitcoin transactions are irreversible, sellers of bitcoins must take extra measures to ensure they have received traditional funds from the buyer.

Wallets

File:Bitcoin-coins.jpg
Example of Casascius physical bitcoins[32]
A paper wallet with QR codes

While wallets are often described as being a place to hold or store bitcoins,[33] due to the nature of the system, bitcoins are inseparable from the block chain transaction ledger. If they must be thought of as distinct from the block chain, you can say that bitcoins are held in it. Perhaps a better way to define a wallet is something "that stores the digital credentials for your bitcoin holdings"[34] and allows you to access (and spend) them. Bitcoin uses public-key cryptography, in which two cryptographic keys, one public and one private, are generated.[35] The public key can be thought of as an account number and the private key, ownership credentials. At its most basic, a wallet is a collection of these keys. Most bitcoin software also includes the ability to make transactions, however.

Perhaps better termed physical wallets, physical bitcoins are ubiquitous in media coverage and combine a novelty coin with a private key printed on paper, metal,[36] wood,[37] or plastic. Physical bitcoins aren't widely seen outside of pictures in news articles, but for those serious about security, storing private keys on paper printouts or in offline data storage devices is the best option.[34]

Software
Electrum – sample bitcoin client

Bitcoin wallet software, sometimes called a bitcoin client software, allows a user to transact bitcoins. A wallet program generates and stores private keys, and communicates with peers on the bitcoin network. The first wallet program called Bitcoin-Qt was released in 2009 by Satoshi Nakamoto as open source code.[38] It can be used as a desktop wallet for payments or as a server utility for merchants and other payment services. Bitcoin-Qt, also called Satoshi client is sometimes referred to as the reference client because it serves to define the bitcoin protocol and acts as a standard for other implementations.[38] As of version 0.9, Bitcoin-Qt has been renamed Bitcoin Core to more accurately describe its role in the network.[39] When making a purchase with a mobile device, QR codes are used ubiquitously to simplify transactions. Several server software implementations of the bitcoin protocol exist. So-called full nodes on the network validate transactions and blocks they receive, and relay them to connected peers.[38]

Security, theft, and loss

Integral to bitcoin security is the prevention of unauthorized transactions from an individual's wallet. A bitcoin transaction permanently transfers ownership to a new address, a string having the form of random letters and numbers derived from public keys by application of a hash function and encoding scheme. The corresponding private keys act as a safeguard for the owner; a valid payment message from an address must contain the associated public key and a digital signature proving possession of the associated private key. Because anyone with a private key can spend all of the bitcoins associated with the corresponding address, protection of private keys is quite important. Loss of a private key may result in theft, which has occurred on numerous occasions.[40] The practical day-to-day security of bitcoin wallets is a concern just like the security of other forms of payment.[41] Risk of theft can be reduced by generating keys offline on an uncompromised computer and saving them on external storage or paper printouts.[42]

Bitcoins can be lost. In 2013 one user said he lost 7,500 bitcoins, worth $7.5m at the time, when he discarded a hard drive containing his private key.[43] Bitcoins can also be found. In March 2014, former bitcoin exchange Mt. Gox reported it found an "old wallet, which was used before June 2011 [that] held about 200,000 bitcoins".[44]

History

Main article: History of Bitcoin

Bitcoin was first mentioned in a 2008 paper published under the name Satoshi Nakamoto. In 2009, an exploit in an early bitcoin client was found that allowed large numbers of bitcoins to be created.[45]

The price of bitcoins has fluctuated wildly since its inception, going through various cycles of appreciation and depreciation, which have been referred to by some as bubbles and busts.[46] In 2011, the value of one bitcoin rapidly rose from about US$0.30 to US$32 before returning to US$2.[47] In the latter half of 2012 and during the 2012-2013 Cypriot Financial Crisis, the bitcoin price[48] began to rise, reaching a peak of US$266 on 10 April 2013, before crashing to around US$50.[49] In the end of 2013, the cost of one bitcoin rose to the all-round peak of US$1135, but fell to the price of US$693 three days later.[50]

In March 2013, a technical glitch caused a fork in the block chain, with one half of the network adding blocks to one version of the chain and the other half adding to another. For six hours two bitcoin networks operated at the same time, each with its own version of the transaction history. The core developers called for a temporary halt to transactions, sparking a sharp sell-off. Normal operation was restored when the majority of the network downgraded to version 0.7 of the bitcoin software.[45]

Some mainstream websites began accepting bitcoins c. 2013. WordPress started in November 2012[51] followed by OKCupid in April 2013,[52] TigerDirect in January 2014,[53] and Overstock.com that same month.[54] Certain non-profit or advocacy groups such as the Electronic Frontier Foundation allow bitcoin donations.[55] (Although this organization subsequently stopped accepting bitcoins.[56])

The first law enforcement events occurred in May 2013. Assets belonging to the Mt. Gox exchange were seized by Department of Homeland Security,[57] and the Silk Road drug market website was shut down by the FBI.[58]

In October 2013, Chinese internet giant Baidu had allowed clients of website security services to pay with bitcoins.[59] During November 2013, the China-based bitcoin exchange BTC China overtook the Japan-based Mt. Gox and the Europe-based Bitstamp to become the largest bitcoin trading exchange by trade volume.[60] On 19 November 2013, the value of a bitcoin on the Mt. Gox exchange soared to a peak of US$900 after a United States Senate committee hearing was told that virtual currencies were a legitimate financial service.[61] On the same day, one bitcoin traded for over RMB¥6780 (US$1100) in China.[62] On 5 December 2013, the People's Bank of China prohibited Chinese financial institutions from using bitcoins.[17] After the announcement, the value of bitcoins dropped[63] and Baidu no longer accepted bitcoins for certain services.[64] Buying real-world goods with any virtual currency had been illegal in China since at least 2009.[65]

The first bitcoin ATM was installed in October 2013 in Vancouver, British Columbia, Canada.[66]

With roughly 12 million existing bitcoins as of November 2013,[67] the new price increased the market cap for bitcoin to at least US$7.2 billion.[68] By 23 November 2013, the total market capitalization of bitcoin exceeded US$10 billion for the first time.[69]

In the US two men were arrested in January 2014 on charges of money-laundering using bitcoins including Charlie Shrem, the head of defunct bitcoin exchange BitInstant and a vice chairman of the Bitcoin Foundation. Shrem allegedly allowed the other arrested party to purchase large quantities of bitcoins for use on black-market websites.[70]

In early February 2014, one of the largest bitcoin exchanges, Mt. Gox, suspended withdrawals citing technical issues.[71] By the end of the month, Mt. Gox had filed for bankruptcy protection in Japan amid reports that 744,000 bitcoins had been stolen.[72] Originally a site for trading Magic: The Gathering cards, Mt. Gox once was the dominant bitcoin exchange although prior to the collapse its popularity had waned.[73]

Economics

Classification as money

Bitcoin is often referred to as a currency, but it does not conform to the definition of money. Economists agree that to qualify as money, something must be a store of value, a medium of exchange, and a unit of account.[74] Bitcoin conforms to only one of these three criteria. It is used as a medium of exchange.[75] (About 1,000 brick and mortar businesses were willing to accept payment in bitcoins as of November 2013[76] in addition to more than 35,000 online merchants.[77]) The bitcoin market currently suffers from volatility, limiting the ability of bitcoins to act as a stable store of value,[74] and it is not commonly used as a unit of account. Where people are allowed to buy with bitcoins, prices are not denominated in bitcoins.[74] The People's Bank of China has stated that bitcoin "is fundamentally not a currency".[78]

Price volatility

Bitcoin has an extremely volatile exchange rate.[75] According to Mark T. Williams of Boston University, its volatility is over seven times that of gold and over eight times that of the S&P 500.[79] The Bitcoin Foundation contends that high volatility is due to insufficient liquidity[80] while a Forbes journalist claims that it is related to the uncertainty of its long-term value.[81] Volatility has little effect on the utility of bitcoin as a payment processing system.[82]

Alternative to national currencies

Bitcoins are accepted in this café in the Netherlands as of 2013

Some in countries with problem plagued national currencies may use bitcoins to protect their savings against inflation or the possibility that governments could confiscate savings accounts. Bitcoins are used by some Argentinians as an alternative to the official currency,[83] which is stymied by inflation and strict capital controls.[84] It's been suggested that during the 2012–2013 Cypriot financial crisis bitcoin purchases rose due to fears that savings accounts would be confiscated or taxed.[85]

Speculative bubble

Bitcoin has been labelled a speculative bubble by many including Former Federal Reserve Chairman Alan Greenspan[86] and economist John Quiggin.[87] Two lead software developers of bitcoin, Gavin Andresen and Mike Hearn, have warned that bubbles may occur.[88] Nobel Laureate Robert Shiller said that bitcoin "exhibited many of the characteristics of a speculative bubble."[89] Others reject the label and see bitcoin's quick rise in price as nothing more than normal economic forces at work.[90]

As investment

One way of investing in bitcoins is to buy and hold them as a long-term, high-risk investment.[91] FINRA, a United States self-regulatory organization, warns that investing in bitcoins carries significant risks.[92] The European Banking Authority warns that the risks of investment go beyond a potential fall in the value of bitcoins.[93] Bitcoins may be of limited value to unsophisticated investors.[94] Risk hasn't deterred some such as the Winklevoss twins, who made a US$1.5 million personal investment[95] and attempted to launch a bitcoin ETF.[13] Other investors, like Peter Thiel's Founders Fund, which invested US$3 million, don't purchase bitcoins themselves instead funding bitcoin infrastructure like companies that provide payment systems to merchants, exchanges, and wallet services, etc.[95] Investors also invest in bitcoin mining.[96]

Money supply

Growth of the bitcoin money supply is predefined by the bitcoin protocol,[21] and in this way inflation is kept in check. Currently there are over twelve million bitcoins in circulation with an approximate creation rate of 25 every ten minutes. The total supply is capped at an arbitrary limit of 21 million,[8] and every four years the creation rate is halved. This means new bitcoins will continue to be released for more than a hundred years.

Value forecasts

Financial journalists and analysts, economists, and investors have attempted to predict the possible future value of bitcoin. Economist John Quiggin stated, "bitcoins will attain their true value of zero sooner or later, but it is impossible to say when."[87] In 2013, Bank of America FX and Rate Strategist David Woo forecast a maximum fair value per bitcoin of $1,300.[97] Bitcoin investor Cameron Winklevoss stated in 2013 that the "bull case scenario for bitcoin is... 40,000 USD a coin".[98] In late 2013, finance professor Mark Williams forecast a bitcoin would be worth less than ten US dollars by July 2014.[99]

Reception

Some economists have responded positively to bitcoin, including François R. Velde, a Senior Economist at the Chicago Fed, who described it as "an elegant solution to the problem of creating a digital currency."[100] Paul Krugman and Brad DeLong have found fault with bitcoin questioning why it should act as a reasonably stable store of value or whether there is a floor on their value.[101] Economist John Quiggin has criticized bitcoin as "the final refutation of the efficient-market hypothesis".[87]

David Andolfatto, a Vice President at the Federal Reserve Bank of St. Louis, stated that bitcoin is a threat to the establishment, which he argues is a good thing for the Federal Reserve System and other central banks because it prompts these institutions to operate sound policies.[102]

Free software movement activist Richard Stallman has criticized the lack of anonymity and called for reformed development.[103] PayPal President David A. Marcus calls bitcoin a "great place to put assets" but claims it will not be a currency until price volatility is reduced.[104] As bitcoins proved popular, they have been increasingly covered by comics around the world.[105]

Acceptance by merchants

Established firms which accept bitcoins include Atomic Mall,[106] Clearly Canadian,[107] Overstock.com,[54] the Sacramento Kings,[108] TigerDirect,[53] Virgin Galactic,[109] and Zynga.[110]

In November 2013, the University of Nicosia became the first university in the world to accept it.[111]

Skepticism by banks

As of 2014, bitcoin companies have had difficulty opening traditional bank accounts because lenders have been leery of bitcoin's links to illicit activity.[112] According to a co-founder of one such company, BitPay, "banks are scared to deal with bitcoin companies, even if they really want to."[112] Indeed, some banks have been bullish on bitcoin. In a 2013 report, Bank of America Merrill Lynch stated that “we believe bitcoin can become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money-transfer providers. As a medium of exchange, bitcoin has clear potential for growth and that in a long-term fair-value analysis maximum market capitalization for bitcoins could be $15 billion."[113]

Bitcoins have been evaluated and treated in various ways around the world.[114] While it may appear that a lively debate over the nature of bitcoins is occurring, the different classifications are likely more reflective of what rules apply to bitcoin in a specific jurisdiction than what bitcoin really is. In the US, the IRS classified bitcoins as a capital asset[115] and subject to taxes on capital gains. Magistrate Judge Amos Maazant of a Texas court classified bitcoins as currency.[116] A German court found bitcoin to be a unit of account.[114] The Finnish Government judged it to be a commodity.[117]

A WSJ journalist declared bitcoins a commodity in December 2013.[118] A Forbes journalist referred to bitcoins as digital collectible.[119] And University of Amsterdam researchers classified it as a money-like informational commodity.[120]

Main article: Legal status of Bitcoin

Some governments have taken a hands-off approach, but others have moved to regulate bitcoin and similar private currencies. Steven Strauss, a Harvard public policy professor, suggested governments could outlaw bitcoin,[121] a possibility that was mentioned in a 2013 SEC filing made by a bitcoin investment vehicle.[122]

According to the European Central Bank, traditional financial sector regulation is not applicable because bitcoin does not involve traditional financial actors.[123] Under other regimes, existing rules have been extended to include bitcoin and bitcoin companies.

Canada

In Canada, the federal government announced in February 2014 that it was going to regulate bitcoin under existing anti-money laundering and counter-terrorist financing legislation.[124] In Quebec, The Financial Markets Authority stated in regards to bitcoin ATMs, that it would prosecute any violation of the Securities Act, the Derivatives Act, or the Money Services Business Act.[125]

Hong Kong

Pre-existing Hong Kong law covers acts of fraud and money laundering involving virtual commodities.[126]

Japan

There are at present no laws in Japan regulating the use of bitcoins. Haruhiko Kuroda, governor of the Bank of Japan (BOJ), recently stated that BOJ was "researching issues of bitcoins, but I have nothing to say regarding bitcoins at the moment.[127] [128]

Russian Federation

On January 27, 2014, the Central Bank of the Russian Federation issued a statement entitled "On Using Virtual Currencies, Specifically Bitcoin, in Transactions." According to the statement, the Central Bank views the services of Russian legal entities aimed at assisting in the exchange of bitcoins for goods, services, or currencies as a "dubious activity" associated with money laundering and terrorism financing, and recommends that Russian individuals and legal entities refrain from transactions involving bitcoins. [129]

Singapore

The Monetary Authority of Singapore requires bitcoin intermediaries to collect personal details of their customers and report suspicious activity similar to what it requires from money changers.[130]

USA

In the US the first step of regulation occurred in July 2011, when the US Department of Treasury's Financial Crimes Enforcement Network added "other value that substitutes for currency" to its definition of Money services businesses.[131] In 2013 the Treasury issued new rules regarding virtual currencies,[132] whereby exchanges (but not users) are considered money transmitters and must comply with rules to prevent money laundering and terrorist financing.[133] Besides obtaining personal details of clients, bitcoin exchanges must verify that their customers are not on the Office of Foreign Asset Control’s Specially Designated Nationals list.[134]

The US Government Accountability Office reviewed virtual currencies upon the request of the Senate Finance Committee and in May 2013 recommended[135] that the IRS formulate tax guidance for bitcoin businesses. On 25 March 2014, in time for 2013 tax filing, the IRS issued guidance that virtual currency is treated as property for US federal tax purposes and that "an individual who 'mines' virtual currency as a trade or business [is] subject to self-employment tax."[136]

The US Commodity Futures Trading Commission stated in March 2014 was considering regulation of digital currencies.[137] As of April 2014, there are no new rules at the state level although the New York State Department of Financial Services intends to propose regulations no later than the end of the second quarter of 2014. As of 11 March 2014, it has officially invited bitcoin exchanges to apply with them.[138]

International guidance

The 2013 G7's Financial Action Task Force published guidance for Internet-based payment services that defines "exchangers buying or selling digital currency for cash (or other digital currencies) [...] as a virtual bureau de change" and warns that "Internet-based payment services that allow third party funding from anonymous sources may face an increased risk of [money laundering/terrorist financing]" concluding that this may "pose challenges to countries in [anti-money laundering/counter terrorist financing] regulation and supervision."[139]

Criminal activity

Bitcoins have been associated with online criminal behavior and so-called cybercriminals.[140] Used to obfuscate online transactions, bitcoins are seized when deep web black markets are shut by authorities.[141] Criminal activities have stigmatized the currency and attracted the attention of financial regulators, legislative bodies, and law enforcement.[142] CNN has referred to bitcoin as a "shady online currency [that is] starting to gain legitimacy in certain parts of the world,"[143] and The Washington Post calls it "the currency of choice for seedy online activities."[144] The FBI stated in a 2012 report that "bitcoin will likely continue to attract cyber-criminals who view it as a means to move or steal funds."[140] Criminal activity involving bitcoin has largely centered around theft, money laundering, the use of botnets for mining, and the use of bitcoins in exchange for illegal items or services. "Like cash, it can be used for ill as well as for good."[8] Certain nation states may feel that its use in circumventing capital controls is also undesirable.[16] Despite claims made by non-profit Bitcoin Foundation that "cryptography is the reason no one can steal bitcoins," theft is widespread.[145]

Black markets

In 2012, it was estimated that 4.5% to 9% of all transactions of all bitcoin exchanges in the world were for drugs trades on the Silk Road.[146] Speculative trading (using bitcoin as a commodity rather than currency) constituted the bulk of exchange trades.[146] Silk Road was shut by US law enforcement in October 2013, leading to a short-term fall in the value of bitcoin.[147][148] Alternative sites were immediately available, and Silk Road itself was relaunched in November 2013. In March 2014, ABC reported that the closure of the Silk Road had failed to dampen illegal online drug sales, with 10 new darknet sites replacing Silk Road, and the number of Australian vendors doubling twice within the last year.[149]

Several news outlets have asserted that the popularity of bitcoin hinges on the ability to use them to purchase illegal goods.[150] Non-drug transactions were thought to be far less than the number involved in the purchase of drugs,[151] and roughly one half of all transactions made using bitcoin were bets placed at a single online gambling website.[152] One source stated online gun dealers can use bitcoin to sell arms without background checks.[153] The bitcoin community branded one site, Sheep Marketplace, as a scam when it prevented withdrawals and shut down after an alleged bitcoins theft.[154] In a separate case, escrow accounts with bitcoins belonging to patrons of a different black market were hacked in early 2014.[155]

Money laundering

Bitcoins may not be ideal for money laundering because all transactions are public.[156] Authorities have expressed concerns, however. The European Banking Authority and the FBI have both stated that bitcoin may be used for money laundering.[157] In early 2014, an operator of a US bitcoin exchange was arrested for money laundering.[70]

Ponzi scheme

Various journalists, US economist Nouriel Roubini, and the head of the Estonian central bank have voiced concerns that bitcoin may be nothing more than a Ponzi scheme.[158] Bitcoin supporters disagree.[159] No court has judged the bitcoin system to be a Ponzi scheme. A 2012 report by the European Central Bank states, "it [is not] easy to assess whether or not the bitcoin system actually works like a pyramid or Ponzi scheme."[160]

In an alleged Ponzi scheme that utilized bitcoins, The Bitcoin Savings and Trust promised investors up to 7 percent weekly interest, and raised at least 700,000 bitcoins from 2011 to 2012.[161] The SEC charged the company and its founder in 2013 "with defrauding investors in a Ponzi scheme involving bitcoin...".[161]

Thefts

A theft is an unauthorized transfer from a bitcoin address using the private key to unlock the address.[162] Because transactions are irreversible and the identity of users difficult to unmask, it is rare that stolen bitcoins are recovered and returned. Theft occurs on a regular basis despite claims made by the Bitcoin Foundation that theft is impossible.[145] Generating and storing keys offline mitigates the risk of theft. Most large-scale thefts occur at exchanges or online wallet services that store the private keys of many users. The thief hacks an online wallet service by finding a bug in its website or spreading malware to computers holding the private keys [163]

Many high-profile thefts have been reported. In late November 2013, an estimated $100 million in bitcoins were stolen from the online illicit goods marketplace Sheep Marketplace, which immediately closed.[164] Users tracked the coins as they were processed and converted to cash, but no funds were recovered and no culprits identified.[164] A different black market, Silk Road 2, stated that during a February 2014 hack bitcoins valued at $2.7 million were taken from escrow accounts.[155] In late February 2014 Mt. Gox, one of the largest virtual currency exchanges, filed for bankruptcy in Tokyo after its computer system was hacked and approximately $477 million in bitcoins were stolen. Flexcoin, a bitcoin storage specialist based in Alberta, Canada, shut down on March 2014 after saying it discovered a theft of about $650,000 in bitcoins.[165] Poloniex, a digital currency exchange, reported on March 2014 that it lost bitcoins valued at around $50,000.[166]

Malware

Bitcoin-related malware includes software that steals bitcoins from users using a variety of techniques, software that uses infected computers to mine bitcoins, and different types of ransomware, which disable computers or prevent files from being accessed until some payment is made. Security company Dell SecureWorks said in February 2014 that it had identified 146 types of bitcoin malware; about half of it undetectable with standard antivirus scanners.[167]

Unauthorized mining

In June 2011, Symantec warned about the possibility that botnets could mine covertly for bitcoins.[168] Malware used the parallel processing capabilities of GPUs built into many modern video cards.[169] While bitcoin mining on an average computer is no longer lucrative, a botnet of tens of thousands can effectively mine bitcoins.[170]

Botnet cases

In mid-August 2011, bitcoin mining botnets were detected,[171] and less than three months later, bitcoin mining trojans had infected Mac OS X.[172]

In April 2013, electronic sports organization E-Sports Entertainment was accused of hijacking 14,000 computers to mine bitcoins; the company later settled the case with the State of New Jersey.[173]

German police arrested two people in December 2013 who customized existing botnet software to perform bitcoin mining, which police said had been used to mine at least $950,000 worth of bitcoins.[174]

For four days in December 2013 and January 2014, Yahoo Europe hosted an ad containing bitcoin mining malware that infected an estimated two million computers.[170] The software, called Sefnit, was first detected in mid-2013 and has been bundled with many software packages. Microsoft has been removing the malware through its Microsoft Security Essentials and other security software since January 2014.[175]

Malware stealing bitcoins

Some malware can steal private keys for bitcoin wallets allowing the bitcoins themselves to be stolen. The most common type searches computers for cryptocurrency wallets to upload to a remote server where they can be cracked and their coins stolen.[167] Many of these also log keystrokes to record passwords, often avoiding the need to crack the keys.[167] A different approach detects when a bitcoin address is copied to a clipboard and quickly replaces it with a different address, tricking people into sending bitcoins to the wrong address.[167] This method is effective because bitcoin transactions are irreversible.

Cases of theft

One virus, spread through the Pony botnet, was reported in February 2014 to have stolen up to $220,000 in cryptocurrencies including 335 bitcoins from 85 wallets.[176] Security company Trustwave, which tracked the malware, reports that its latest version was able to steal 30 types of digital currency.[177]

A type Mac malware active in August 2013, Bitvanity posed as a vanity wallet address generator and stole addresses and private keys from other bitcoin client software.[178] A different trojan for Mac OS X, called CoinThief was reported in February 2014 to be responsible for multiple bitcoin thefts, including one user who lost 20 bitcoins.[178] The software was hidden in versions of some cryptocurrency apps on Download.com and MacUpdate.[178]

Ransomware

Another type of bitcoin-related malware is ransomware. One program called Cryptolocker, typically spread through legitimate-looking email attachments, encrypts the hard drive of an infected computer, then displays a countdown timer and demands a ransom, usually two bitcoins, to decrypt it.[179] Police in Massachusetts said they paid a 2 bitcoin ransom in November 2013, worth more than $1300 at the time, to decrypt one of their hard drives.[180] Linkup, a combination ransomware and bitcoin mining program that surfaced in February 2014, disables internet access and demands credit card information to restore it, while secretly mining bitcoins.[179]

Security

Further information: Bitcoin network

There are two main ways the blockchain ledger can be corrupted to steal bitcoins: by fraudulently adding to or modifying it. The bitcoin system protects the blockchain against both using a combination of digital signatures and cryptographic hashes.[181]

The Addition Attack and digital signatures

Payers and payees are identified in the blockchain by their public cryptographic keys: most bitcoin transfers are from one public key to a different public key. (Actually, hashes of these keys are used in the blockchain, and are called "bitcoin addresses".) In principle, an attacker Eve could steal money from Alice and Bob by simply adding transactions to the blockchain ledger like Alice pays Eve 100 bitcoins, Bob pays Eve 100 bitcoins, and so on, using of course these people's bitcoin addresses instead of their names. The bitcoin protocol prevents this kind of theft by requiring every transfer to be digitally signed with the payer's private key; only signed transfers can be added to the blockchain ledger. Since Eve cannot forge Alice's signature, Eve cannot defraud Alice by adding an entry to the blockchain equivalent to Alice pays Eve 100 bitcoins. At the same time, anyone can verify Alice's signature using her public key, and therefore that she has authorized any transaction in the blockchain where she is the payer.[19]

The Modification Attack and mining

The other principal way to steal bitcoins would be to modify blockchain ledger entries. Eve could buy something from Alice, like a sofa, by adding a signed entry to the blockchain ledger equivalent to Eve pays Alice 100 bitcoins. Later, after receiving the sofa, Eve could modify that blockchain ledger entry to read instead: Eve pays Alice 1 bitcoin, or even delete the entry. Digital signatures cannot prevent against this attack: Eve can simply sign her entry again after modifying it!

To prevent against modification attacks, the bitcoin system first requires entries be added to the blockchain not one at a time, but in groups or blocks. More importantly, each block must be accompanied by a cryptographic hash of three things: the hash of the previous block, the block itself, and a number called a nonce. A hash of only the first two items will, like any cryptographic hash, always have a fixed number of bits (e.g. 256 for SHA-256). The nonce is a number which, when included, yields a hash with a specified number of leading zero bits. Because cryptographic hashes are essentially random, in the sense that their output cannot be predicted from their inputs, there is only one known way to find the nonce: to try out integers one after the other, e.g. 1, then 2, then 3, and so on. This process is called mining. The larger the number of leading zeros, the longer on average it will take to find a requisite nonce. The bitcoin system constantly adjusts the number of leading zeros so that the average time to find a nonce is about ten minutes. That way, as computer hardware gets faster over the years, the bitcoin protocol will simply require more leading zero bits to make mining always last about ten minutes.[19]

This system prevents modification attacks in part because an attacker has to recalculate all the hashes of the blocks after the modified one. In the example above, if Eve wants to change 100 bitcoins to 1 bitcon, she will not only have to recompute the hash of the block that transaction is in, but of all the blocks that come after it; she will have to recreate the chain of blocks. She can do this, but it will take her time, about ten minutes on average per block. However, during that time the network will continue to add blocks, and it will do so much faster than Eve alone can mine. Eve would have to recalculate all the blocks before the network could add a new one, or at least catch up with or overtake the network's miners. To do this, she would have to have roughly as much computing power as much of the existing bitcoin miners combined. This would be very expensive and, if the bitcoin network is large enough, likely infeasible. Furthermore, because of financial incentives to mine described below, it will make more financial sense for Eve to devote her resources to normal bitcoin mining instead. Thus the system protects against fraudulent blockchain modifications by making them expensive and, if the attacker is rational, unappealing because they make less financial sense than becoming a miner. The more miners there are, the more expensive and less feasible such attacks become, making the whole system even more secure.[19]

Double-spending

Bitcoin system is based on an innovative solution of a problem common to all digital currency and payment schemes: that of so-called double-spending. With paper money or physical coins, when the payer transfers money to the payee, the payer cannot keep a copy of that dollar bill or coin. With digital money, which is just a computer file, this is not the case, and the payer could in principle spend the same money again and again, copying the file over and over. With bitcoin, when Eve offers to pay Alice some bitcoins, Alice can always first check the blockchain ledger to verify that Eve actually owns that many bitcoins. Of course, Eve could try to pay many people simultaneously; but bitcoin can defend against that. If Eve offers to pay Alice some bitcoins in exchange for goods, Alice can stipulate that she will not deliver the goods until Eve's payment to Alice appears in the blockchain, which typically involves waiting about ten minutes.[182]

Types of attacks

Race attack

If the transaction has no confirmations, shops and services which accept payment can be exposed to a so-called race attack. For example, two transactions are created for the same funds to be sent to different shops/services. System rules ensure that only one of those transactions can be added to the block chain.[8]

Shops can take numerous precautions to reduce this type of attack. It is always good to consider whether you should accept transactions without any confirmation.

Finney Attack

Another type of attack. Shops or services which accept transactions without any confirmation are affected. Finney Attack is an attack which requires the participation of a miner to premine a block sending the money to be defrauded back to the fraudster. The risk of such an attack cannot be reduced to nothing regardless of the preventative measures taken by shops or services, but it does require the participation of a miner and an ideal combination of contributing factors. It is no mean feat, the miner risks a potential loss of the block reward. Just as with the other type of attack, the shop or service must seriously consider its politics concerning transactions without any confirmation.[citation needed]

Vector76 Attack

Also called an attack with confirmation. This is a combination of the 2 aforementioned attacks which gives the perpetrator the ability to spend funds twice simply with a confirmation.[citation needed]

Brute Force Attack

This attack is possible even if the shop or service is expecting several transaction confirmations. It requires the attacker to be in possession of relatively high-performance hardware (hash frequency).

The perpetrator sends a transaction to the shop paying for a product/service and at the same time continues looking for a connection in the block chain (block chain fork) which recognizes this transaction. After a certain number of confirmations, the shop sends the product. If the perpetrator has found more than n blocks at this point, he breaks his block chain fork and regains his money, but if the perpetrator has not succeeded in doing this, the attack can be deemed a failure and the funds are sent to the shop, as should be the case.

The success of this attack depends on the speed (hash frequency) of the attacker and the number of confirmations for the shop/service. For example, if the attacker possesses 10% of the calculation power of the bitcoin network and the shop expects 6 confirmations for a successful transaction, the probability of success of such an attack will be 0.1%.[citation needed]

>50% Attack

If the perpetrator controls more than 50% of the bitcoin network power, the probability of success of the aforementioned attack will be 100%. By virtue of the fact that the perpetrator can generate blocks more often than the other part of the network, he can create his own block chain until it becomes longer than the “integral” part of the network.[citation needed]

See also

Notes

  1. ^ There is no uniform convention for bitcoin capitalization. Some sources use Bitcoin, capitalized, to refer to the technology and network and bitcoin, lowercase, to refer to the digital currency.[4] The WSJ and The Chronicle of Higher Education advocate use of lowercase bitcoin in all cases, however.[5] This article follows the latter convention.

References

 This article incorporates text available under the CC BY-SA 3.0 license.

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  180. ^ Gibbs, Samuel (21 November 2013). "US police force pay bitcoin ransom in Cryptolocker malware scam". The Guardian. Retrieved 7 March 2014.
  181. ^ Bondi, Richard. "How Bitcoin Works: A guide for the digitally perplexed". Retrieved 5 April 2014.
  182. ^ Wallace, Benjamin (23 November 2011). "The Rise and Fall of Bitcoin". Wired. Retrieved 4 November 2013. One of the core challenges of designing a digital currency involves something called the double-spending problem.
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