Transaction malleability - is bitcoin fatally flawed or is it buying opportunity of the year?

bowskill
By bowskill on Sat, Feb 15, 2014 - 12:35am

What a week it has been. Bitcoin is going through a massive stress test on several fronts taking us on a rollercoaster ride. It's far from over. So much has been written and reported this week and I will try and summarise it. 

Firstly as I wrote last week, Mt Gox having suffered from delays and failures for months finally ceased allowing bitcoin withdrawals. They fell victim to a an inherent bitcoin transaction malleability issue/bug (known about since 2011 and previously considered non-pathogenic). They blamed the bitcoin core developers. Gavin Andersen (chief bitcoin dev) fired back that Mt Gox were at fault for poorly implementing a custom wallet and being sloppy in their internal procedures - especially in automatic issuance of customer refunds. Mt Gox said it was a problem that could affect all exchanges. Bitcoin devs said no it can't. Everybody hated Mt Gox. The next day it did indeed affect all exchanges! Bitstamp stopped bitcoin withdrawals. People started to think maybe Mt Gox had a point.

The malleability issue highlighted by Mt Gox had actually been taken advantage of by hackers who used it to initiate a monumental denial of service (DDOS) style attack on all bitcoin exchanges.

The bitcoin price has taken a big hit, the naysayers are having a field day.

Today exchanges have implemented measures and are back up and running, except Mt Gox.

It seems that Mt Gox has lost some bitcoin. Nobody knows how much. Hackers have been able to exploit a combination of their weak wallet implementation, the transaction malleability issue and their habit of automatically refunding bitcoin to customers with reportedly failed withdrawals. The hackers were able to make duplicates of transactions. The blockchain only allows one transaction. If the hacked mutant transaction happened to make it into the blockchain, the original transaction failed and Mt Gox happily gave the customer their bitcoin back - without adequately checking what had really happened.

Are they still solvent? Can they still back the bitcoin accounts of their customers? Nobody knows because their PR and communications are abysmal. A second dismayed customer has traveled around the world to confront the Mt Gox CEO David Karpeles. He gave nothing away and seemed to have no care for the concern of his customer. I worked in IT for 10 years during the boom time in the 90's. I recognise him as the typical gun programmer with no people skills who got elevated to great responsibility without the ability to manage it. Tens of millions of dollars of customers savings at stake and just a poker face from the inept CEO. I believe he personally is coding the patches to his own software.

This is where things get more interesting. Mt Gox has continued to operate as an exchange even since they closed bitcoin withdrawals. This means you can trade with other Mt Gox customers internally by selling your Mt Gox BTC for Mt Gox USD and vice versa. So there is now an internal price of BTC on Mt Gox that represents whether customers believe they are more likely to get cash or BTC out of Mt Gox if it goes bankrupt. Currently the internal price is $360 while the Bitstamp price is $651. Mt Gox customers (sadly I am one) are panicking.

So yet another market has sprung up. It is like a black market where you can buy locked Mt Gox BTC for regular BTC or USD. There is also an informal market on reddit.

Maybe Mt Gox is broke. But if they do fix their problems and allow bitcoin withdrawals then buying discounted Mt Gox BTC right now is the deal of the year. You could buy BTC for under $400 now that will be worth perhaps $900 (if there is a price rebound and over-shoot in a few weeks time).

Reasons Mt Gox might actually re-open and allow BTC withdrawals (eventually):
1. David Karpeles IS still going to work. He has not taken off to the Bahamas.
2. Roger Ver (known as "Bitcoin Jesus") is offering to trade regular BTC for discounted Mt Gox BTC in lots of at least 100. This is a guy with connections to Mt Gox. He would not give BTC away if he was not pretty certain of getting more back.
3. Many others are advertising their willingness to buy Mt Gox BTC via reddit and elsewhere.
4. Andreas Antonopoulos believes Mt Gox will reopen (he is a well known cryptocurrency entrepreneur and Chief Security Officer of blockchain)
5. Problems and poor communications are nothing new to Mt Gox. They have had many crises in the past and managed each one terribly. This is not exceptional.
6. A cryptocurrency journalist I have been in touch with since last week is of the belief that Mt Gox are not corrupt - just horribly mismanaged. Of course they could go bankrupt through mismanagement but my point is they don't appear to be deliberate thieves.
7. If I were David Karpeles right now and knew I was bankrupt, I would be sorely tempted to take advantage of the massive arbitrage opportunity (buying my customers BTC on Mt Gox and selling them on Bitstamp to nearly double my money) which would have the effect of greatly narrowing the price gap between the two exchanges. This is not happening.
8. There is evidence of David Karpeles actively engaged in fixing his code.

For the record, I wont be buying and I AM NOT ADVOCATING it. I will be happy to get my locked BTC out of Mt Gox. But I wont be selling at a discount either because my hunch is that Mt Gox will eventually allow withdrawals again. After that they would have trouble keeping any customers.

The alternative scenario is that Mt Gox does eventually own up to being insolvent because it gave too many BTC away to hackers. I can't predict how that would work against bitcoin but can imagine a great loss of confidence and more reason for tight regulation.

Bitcoin does not need another week like last week. Public bickering between developers and really poor communication and leadership have not been a good look, not to mention the emotional stress on holders of bitcoin.

Lets see how next week goes...

6 Comments

bowskill's picture
bowskill
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Posts: 78
David = Mark

Correction. I meant Mark Karpeles not David Karpeles.

mrees999's picture
mrees999
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Posts: 423
good riddance to Mt. Gox

I hope you get your money back out.  Coindesk poll showed many people still waiting months after their request. I agree, they are probably incompetent and I don't know how they will stay in business after this. They've ruined their name and trust. Trust is everything for their line of work. It's interesting that when they held 80% market share - when they went down, the price went down 80% as well before recovering. Now they only hold about 20%, the market went down about 20% when the shut down again. They are becoming less relevant. Now there are over 70 exchanges ready to handle bitcoin.

Watched this panel of speakers on Youtube recently. Very interesting. Some big names are being withheld from the panelists being a little coy talking about what is in the pipeline and who they are working with for major corporations. But they said with twinkle in their eye that for Walmart to be able to using bitcoin as a payment method, the price would have to increase SIGNIFICANTLY to handle the bandwidth. They mentioned the legal arrangements are being made for Wall Street firms to start buying it up - putting derivatives on it to smooth out the volatility out of it. Walmart themselves can do 2 billion a day in transactions. I've read in other places that the market cap for bitcoin will need to be between 100 billion and 500 billion to handle the bandwidth projected for the new eco system that is being built.

Also interesting watching what the lady said about the big banks inquiring behind closed door, they don't want to be the first out the door, but every major bank is studying it - and once one goes all in - the stampede will begin as no bank wants to be last either.

It is intended to be the payment rail. So there's you 10 fold to 50 fold increase right there. A lot of happenings going on. It's about to get very exciting. Check it out here:

 

Mark.

 

 

bowskill's picture
bowskill
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Joined: Mar 16 2012
Posts: 78
Mt Gox falls; big losses to be eaten

Jim asked me to let him know if I got my stuck bitcoin back. Unfortunately that will never happen.

Mt Gox is officially gone. Bitcoin withdrawals were never re-enabled and the website has now gone dark. It is rumored to have lost 750,000 bitcoin ($375,000,000) over a period of years. These were stolen by hackers who were able to claim that their withdrawals had not come through and Mt Gox automatically issued refunds without any double checking. Now it is bankrupt and people like me have to eat the losses. In my case it's 81 bitcoin. That was for a brief time in December worth A$110,000. Now about A$48,000. I will never get them back. 

But I will survive and life goes on. I knew bitcoin could go to zero but didn't expect mine to go to zero like this. I invested what I could afford to lose.

The scale of incompetence by Mt Gox is breathtaking. It has been well covered on sites like Coindesk. The lack of regulation of bitcoin and the disinterest shown by Japanese authorities means that CEO Mark Karpeles could walk away from the shambles he created with little more than a dented ego. Probably he will spend the rest of his life looking over his shoulder - but it wont be police he need worry about.

There does not seem to be much enthusiasm here at PP for bitcoin apart from Jim and mrees. Someone once posted that when things went bad, we would be conspicuous by our silence. Well things have gone bad for me and here I am to share the tale.

What has been learnt? Its been a sore lesson in "counter party risk" - which Jim has described in previous posts. I don't blame bitcoin. The Mt Gox story has unfortunately overshadowed a lot of recent positive activity. If there is a next time, I will be putting my bitcoin into cold storage. This will probably be my last post on the subject for a while. But I will be reading whatever follows with interest. Keep up the good work mrees and Jim. I enjoy your posts.

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sand_puppy
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Thanks for Posts on Bitcoin, bowskill

As a person who hasn't followed the bitcoin story closely, I appreciate the reports and enthusiasm of bowskill, Jim H and mrees to this topic.

I can empathize with the humiliation of losing an investment that I was very enthusiastic about as this happened to me in the telecommunications boom - bust of '99-'00.  I had to eat major crow and cancel my retirement plans.  Ouch.

We, as a society, are looking for ways to make monetary exchange be free from centralized control where it can be gamed by insiders for power and profit.  Bitcoin was one of those very worthwhile attempts.  I am glad that it was done and that you guys reported the story in real time from the front lines.

--------------

There are powerful interest aligned against the emergence of competing currencies.  Perhaps we will know if there is a Mt. Gox back story some day.  

Yesterday, Charles Hugh Smith wrote about the "Deep State."  One of their most valuable assets is The US Dollar.

This brings us to the U.S. dollar and the Deep State. The Deep State doesn't really care about the signal noise of the economy--mortgage rates, minimum wages, unemployment, or political circus....

 

What the Deep State cares about are the U.S. dollar, water, energy, minerals and access to those commodities (alliances, sea lanes, etc.)  [I would add: controlling the food supply--SP].  As I have mentioned before, consider the trade enabled by the reserve currency (the dollar): we print/create money out of thin air and exchange this for oil, commodities, electronics, etc.  If this isn't the greatest trade on Earth--exchanging paper for real stuff-- what is?

Jim H's picture
Jim H
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Posts: 2385
Thank you Bowskill

For telling your story...  as painful as it is.  I think that many will be learning about counter party risk first hand as the financial crisis regains steam and various Gold/Silver instruments, from "allocated" accounts, to Comex futures, to GLD, fail in their own ways.

While this might look to some like a deathblow to Bitcoin... it's not clear yet that it is.  There is still a world of fatally flawed, debt-based fiat currency out there that people are going to be increasingly wanting to exchange into something, anything else.  For me, at this time, I would rather exchange for more physical Silver.         

 

http://bitcoinmagazine.com/10377/seeing-smoke-look-good-news-bitcoin/

There can be no doubt that the Bitcoin ecosystem has been hit hard this past month. Canadian financial regulators, long held as the paragons of a light and wait-and-see approach to the Bitcoin economy, began to move towards a more active stance, and a particularly ominous passpge from the FINTRAC report even suggests that the agency can potentially “choke bitcoins oxygen (sic)” by denying Canadians access to the foreign exchange market. BMO, the last Bitcoin-friendly bank in Canada, shut down the account of Cointrader, a Vancouver-based Bitcoin exchange, soon after that, although fortunately Cointrader’s claim that this is part of a general shift to an anti-Bitcoin stance does not seem to be corroborated by reports from other Bitcoin businesses. On the other hand, somewhat less fortunately, the Russian government simply banned Bitcoin entirely.

Around the same time, Silk Road 2 was hacked, likely by its own owners, and $2.5 million worth of BTC was stolen and the marketplace shut down. An old but poorly understood property of the Bitcoin protocol, transaction malleability, led to several major Bitcoin exchanges shutting down for several days, as well as a major denial-of-service attack that caused the greatest disruption to the Bitcoin network since the blockchain fork last year in March. Finally, worst of all, MtGox, once by far the largest exchange in the Bitcoin economy, has disabled all withdrawals, and prices on the exchange have tumbled more than 85% amid fears that the exchange is insolvent. Among all this, it can be hard to see any bright future for Bitcoin whatsoever.

However, among the setbacks, we have seen a surprisingly large amount of positive news for the Bitcoin economy, much of which has been tragically unnoticed over the past few weeks. Among the important items are:

1. The January 31 CNY deadline came and went, and Bitcoin in China is stronger than ever. When the Chinese government made its first regulatory push against Bitcoin, moving to forbid banks from directly offering Bitcoin services, the government gave the banks a deadline of Jan 31 to stop working with Bitcoin. Many people interpreted this deadline as a date for when a further push against Bitcoin would be forthcoming, perhaps further banning Bitcoin trade or Bitcoin exchange. However, the deadline passed and… nothing happened. No crackdown whatsoever. Instead, when the deadline hit, BTCChina actually resumed accepting cash deposits, and soon after that China once again took first place as the country with the largest number of BitcoinQt downloads.
2. The porn industry is seizing upon Bitcoin like wildfire. Porn.com became the first major porn site to accept Bitcoin in December, and in mid-January the site announced that Bitcoin was responsible for 25% of its earnings. A week after that, porn.com was joined by Naughty America, and now very recently in February the list grew to include I Know That Girl (all links safe-for-work), a site owned by the same company that runs Pornhub. It seems like it’s actually porn, not gambling, that’s becoming the first industry to embrace Bitcoin in the mainstream.
3. Bitcoin exchange reopens in Thailand. When the Thai central bank announced that essentially any Bitcoin activity was illegal last July, many people were already skeptical, pointing out that the Thai central bank had no authority to ban Bitcoin by itself. Now, however, the main Thai Bitcoin exchange reopened its operations upon receiving another letter from the bank stating that Bitcoin exchange does not fall under foreign currency exchange regulations. The status of Bitcoin exchange is still contentious, as the Thai central bank now argues that Bitcoin exchange might be illegal because, if combined with foreign Bitcoin exchanges, it makes it too easy to bypass foreign exchange restrictions and convert Thai baht into other national currencies, but nevertheless substantial progress has been made.
4. Balanced Payments is moving to support Bitcoin. Balanced Payments, a popular credit card payment processor, has announced a partnership with Coinbase which will allow online marketplaces using their platform to easily also receive Bitcoin payments. Currently, the integration is in a private alpha mode, with Bitcoin payments only available for CrowdTilt and Gittip, but it will soon expand to other businesses as well.
5. California just clarified that Bitcoin is legal. Recently, Bitcoin users noticed a section of California law saying that “no corporation, flexible purpose corporation, association, or individual shall not issue or put in circulation, as money, anything but the lawful money of the United States”, and became concerned that this might apply to Bitcoin. So what did the Bitcoin community do? Well, they pointed the issue out to the state legislature, and soon enough a bill came along to clarify that Bitcoin was, in fact, perfectly legally okay. And, guess what: one week later the bill was unanimously passed.
6. The Winklevoss SEC filing is moving forward smoothly. The Winklevoss twins, famous for their role in Facebook, announced last July that they would start a Bitcoin investment fund, which institutional investors could use to invest in Bitcoin as part of their portfolios. Up until this point, the process has actually been moving forward quite nicely; yesterday the Winklevoss twins made their major filing with the Securities and Exchange commission. The approval process is still expected to take several months, and perhaps longer, but this is only to be expected; normally, starting a new exchange-traded fund takes years.

mrees999's picture
mrees999
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Posts: 423
Know Your Exchange: The article.

Hi All.

The following is an article that will be printed in the Bitcoin Magazine print edition.
I hope I don't get into trouble with sharing it with this group early but the timing of it is important.
Especially with the horrible Mt.Gox situation.  During darker times, I don't want you to think I don't care or I've abounded the group. Bowskill there is still hope. I understand a buyout is in the planning and the community will likely be banding together to help somewhat - you might not be made back 100% at first but with the potential here in this new industry you'll likely find in the long run you'll do ok. Still it's early to invest more than you can loose - or still sleep well enough without worrying. These setbacks have always turned out to be very temporary and bounces back are multiples of the previous high.  It's in the whole digital currency best interest to NOT just ignore this as they are working hard at giving confidence to this new world. This is probably my most important article, I hope it is instructive for anybody that reads it.  It was originally going to be in three parts but they had me rush it into a combined full fledge story.
 

Presenting Bitcoins’ KYE (Know Your Exchange) Guide. Turn the Table on Know Your Customer (KYC) Laws.

Governments around the world have created laws and regulations that require banking services and money exchangers called Know Your Customer. This is commonly referred to as “KYC”. The intent is to safeguard against would-be money launderers, terrorists and the sort. To be compliant, the money exchangers get the requested information from the customers including the current address, photo ID, etc. However, how much do we know about the exchanges? Do you trust your thousands of dollars’ worth of bitcoins to a digital currency exchange you only know by web address with a front page that looks convincingly trustworthy with pretty graphics and official sounding financial words? For those that did not research the Hong Kong digital currency exchange known as GBL they were taken for $4.1 million worth of bitcoin at October bitcoin price. (Close to $12 million at today’s price). The so-called exchange closed shop and and took the customer wallets with them. Some experts point out that this was a shady exchange from the start with huge portions of the website copied and pasted from other sites, they had no business license, and the physical address listed was fake. Officials finally arrested the three perpetrators of the theft a short time later.

Digital currency exchanges sometimes operate as if it were the Wild Wild West. Currently, there is little to no oversight or regulation for the digital currency exchanges. As such, it is up to the bitcoin community to research and know something about the exchanges before we trust them with thousands of dollars; unfortunately it seems that very few of us actually do. There is currently little recourse for this situation and recent statements from several governments lately make the point abundantly clear; you are on your own. This report is intended to shine a bright light of inspection you may use to evaluate those places that too often go dark. We attempt to make no judgments, and consider this information as a guide for the reader to do their own diligent research. It is up to the reader to interpret this information as the reader sees fit and make actions accordingly.

Very few bitcoiners, it seems, have taken the additional effort and time to look further or deeper into an exchange rather than study its front web page and follow the actions of the bitcoin herd. Often people have been conditioned to assume the digital currency exchanges have been evaluated and held accountable to the same consumer protections provided through regulated traditional currencies. Others wrongly assume that if everybody else is using the exchange, somebody is bound to have done the research and given the green light, so they follow the herd. As a community perhaps it’s time we create our very own “Know Your Exchange” (KYE) guidelines. This article will select some of the top exchanges as examples only to dig deeper and illustrate some facts that traders might consider.

Mt.Gox. “Magic the Gathering On-line Exchange”

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Mt.Gox – The embattled and possibly now dead exchange located near Tokyo, Japan, originally was created in early 2010 to allow on-line exchange for collectables used for the fantasy trading card game “Magic the Gathering”. It quickly ceased this business plan and experimented with the new bitcoin concept. In March of 2011 the company was sold to Mark Karpeles and his company Tibanne Co. Ltd.  

The exchange only accepted bank-wire transfers from the US. There were plans to involve a banking partner in the US to help facilitate money transfers but the arrangements fell through and a legal battle between the parties ensued. The US blocked direct access to the US banking system which created difficulties with banking transactions with customers in the US. It abided by the KYC laws but was often cited at being weeks behind in approving requests for an account due to being understaffed for the amount of requests received. This caused a delay in purchasing bitcoins for up to a month or more last April as the bitcoin price soared.

Mt.Gox was the largest bitcoin exchange by volume until recently and the price quotes were considered the standard price and quoted by the press as the “official” price. Many calculations and contract settlements requiring the official bitcoin price were based on the bitcoin price found there. However, as time went on, the price difference for bitcoin on Mt.Gox diverged from the price on all of the other exchanges. Later it was discovered that the higher price found on this exchange was due to the fact that bitcoins were bought or moved there, but because of banking regulations and continuing legal reasons, bitcoin could not be converted to cash and sent to regular banking channels for many customers.

Today’s news is mostly somber: the customers of Mt.Gox have become desperate enough to accept significant discounts from those people willing to gamble that Mt.Gox will survive to allow bitcoin withdrawals. They were selling their rights to the bitcoins held on the exchange for much less than the value listed on all of the other exchanges. At one point the price dropped to below $100 per coin while all other exchanges maintained a steady price near $600.00. The price had been holding relatively stable at $800 throughout January after news from China caused some investors to flee from the height of over $1,200. In the meantime people reported increasingly longer wait times to have their bitcoin withdrawn from the exchange. Those who wanted government backed currency reported waiting months.

In what has become a pattern for Mt.Gox, they announced they would be temporarily halting withdraws due to software glitches or hacking attempts. These were the two culprits cited in the previous crashes that were tied to this exchange over the years. This has been reported as a leading cause for the latest 25% decline in price. The depth of the price drops over the last few years seems to be on relative par with the proportional market share Mt.Gox has claimed over the years. With more severe price corrections the more influence and market share Mt.Gox held. The relatively smaller 25% drop would indicate its influence proportionally would equate to about 25% market share.

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From:  http://www.tokyo-cci.or.jp/english/ibo/2353440.htm

However, due to the bad publicity and protests outside the building owner’s doors, they were forced this past week to relocate back to their former office location next door.

The Mt.Gox Bubble

Many people attempted to arbitrage the price difference between Mt. Gox and the other exchanges by selling bitcoin cheaper. This involves buying bitcoin on other exchanges for a cheaper price and then transferring the bitcoin to Mt. Gox to resell at a higher price, profiting from the difference. Unfortunately for them, when the bitcoin was moved to Mt. Gox, they found that once it sold, they could not move their converted dollars through the banking system back home as Mt. Gox had been cut off from regular banking transfers for many countries. The unlucky customers were forced to pay the same higher prices to repurchase the bitcoin to move it back out through the bitcoin network instead, although it seems many newcomers didn’t immediately understand that this was an option. The resulting confusion created an upwards spiral as news reports focused on the price at Mt.Gox which created a buzz and more people flocked to get Mt. Gox.

Latest news:

Mt.Gox trading software compounded a known minor bug in the bitcoin protocol. From technical reports, sources explained that one element of the code, though obscure, was allegedly exploited by Mt.Gox. Against warnings and best practices, they created a software solution to implement a shortcut on their trading platform that was designed to circumvent the traditional confirmation process established in the protocol as explained by the Bitcoin Chief Scientist, Gavin Andresen. With renewed attention and this protocol implementation the network became a victim of a Denial of Service attack that accomplished very little other than to slow down some confirmations and give reason for the core developers to change the priority of the various software tweaks on their schedule for implementation.  In a sense of irony, you could say, the hackers performed a valuable beta test which programmers refer to as “load testing” or “stress test”. In a network as large as bitcoin, running as an open-source project you just can’t buy that kind of help. This was perhaps incredibly valuable in software development terms. Whomever was behind it should perhaps be thanked for their help in making bitcoin stronger.

 

Whatever the current state of Mt.Gox today, the trading platform has been credited for helping bitcoin reach the market depth and relatively wider distribution we now find. It was a better trading platform than those before it. One could argue that it was a small fish suddenly finding itself in a big pool and outgrew its humble beginnings, but like many great small companies it failed to transform itself into a large company which requires an entirely different skill set.  However, for those watching closely, there have been warning signs for its viability and solvency since last summer. Many inside the bitcoin community spoke often about the dangers and in July 2013, Roger Ver, the nicknamed “Bitcoin Jesus” millionaire and early bitcoin promoter, posted a video on YouTube vouching for the solvency of Mt.Gox having personally visited the exchange; very recently offering to purchase bitcoin from unhappy Mt.Gox customers. It was announced recently that Mark would be stepping down from the Bitcoin Foundation Board.

 

BITSTAMP

Another one of the popular bitcoin exchanges is BITSTAMP. https://www.bitstamp.net/

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The address is listed in the UK.  It is owned by the parent company UK PLC which shares the same address. It was announced in August of 2011. The company once headquartered in Slovenia continues to operate some banking inside its borders. 72GvtVOhCZg1oHfhrx2J5VJMXUM-JROXOwquWrvQSR8h-anVBw2rttwzwEJGcr2vB1DMEZlpmzqMyG0iax6-iHzXkr7Okzd6hGxXkw7FdV676netZSH1Bjx7VA

The front page of UK PLC shows the expensive looking high rise end of London.  One might think of the image of BITSTAMP being a huge company found in the high-end financial district of the London elites.

fRidl5t4IcNC43CtLUcsTprxHx88Q8JLsOtI7Yn7uqLfI30-k8iWzK-yi7kbkmibOz83utN2Ks7XUwMs3Wh5BQk5LlLkyXSva5KmexdepwwDwHQVrNwwGLfvDQ

UK PLC Website

 

With the assistance of Google Maps, we find the true address location of the address here:PJByDDO0-4HHEeQ9QUKqg18dUZjuhMYe9GlQuzwmx91SWo_mcdzRIGMQwGSN31pyVeRdkqdYCUxwP8yY5JM5MZ-3r5DCy06Qmv5LsCNSgb2njCd9tvJTjOOLyA

 

BITSTAMP seems to have weathered the bitcoin exchange controversies better than others and seems to be arguably the de-facto trusted leader of bitcoin exchanges as of today. The price quotes from this exchange are now widely used and referenced by other bitcoin companies including US-based Coinbase.com. They still require bank wire transfers from the US and abide by KYC laws.

Foreign government warnings about digital currency markets: clarifying the mainstream press FUD and common misinterpretations.

Many governments have issued unusually strong caution statements that discourage their citizens from investing in digital currencies at this stage and reinforce the point that the government does not recognize the currency as legal payment. What does this mean? Not legal payment? In order to understand this, it is necessary to give some background as to what the government considers money.  If you examine your US currency dollars - there is specific statement written on each one that reads “This Note is Legal Tender for All Debts, Private and Public”. That little sentence is the entire reason government money is called “fiat” currency.

This means that in the United States, two parties are compelled to accept dollars in fair trade exchange for a good or service. The settles the matter. If brought to any court, you can prove you settled any debt once you’ve handed the other person the appropriate amount of the US backed currency. This is the meaning of fiat.  Which literally means “Let it be done”. In biblical times the Pharaoh’s complete decree was “So let it be written, so let it be done”.  Many people incorrectly think that fiat currency is only defined as currency not backed by gold, or a hard commodity. Technically this is not correct. A government could issue fiat currency and continue to allow it to be backed by gold or oil, or pickles for that matter.

The fiat is simply just a government decree that an object will be considered money. Then the people are supposed to trust it. As you are required to use it to pay your taxes, you’ll eventually have to use it. In this way the government uses its power to compel its citizens to use it. People also mistakenly call bitcoin and other digital money “fiat currencies” but this is completely inaccurate as no official issued a command or decree that these digital public ledger units have any price or that they must be accepted in payment for debt. The free market decides their value despite what the governments would like. Perhaps this misconception would be cleared up if we simply ask those that make this claim who it was that issued the fiat that gives bitcoin its value.

 

It’s quite likely that by now citizens from most countries have filed a police report or otherwise expected the government to help them fight the injustice that happened to them in a bitcoin robbery or scam. From the government’s point of view they don’t yet have laws on the books to deal with all the unique qualities that make digital currencies unlike anything that have come before. Issuing a warning to their population is a bit of an escape clause to give them time to learn, adjust and advise as these currencies weren’t big enough to be on the radar until very recently. The government financial experts come from the traditional banking world who themselves have been caught off guard and are only now taking it seriously enough to stop laughing at it.

Despite what the mainstream news headlines might have you believe, no governments have gone so far as to actually ban owning bitcoin.  Many governments did send advisories that pointed out that any money you lose will not be their responsibility as it isn’t considered legal tender. They made it clear that the banking system should not consider digital currencies as satisfactory instruments for payment of debt. This is probably wise for a government stung by over-speculation by the financial institutions. Many bitcoiners might likely prefer the government stay out money affairs since they’ve demonstrated discouraging ineptitude with our financial affairs recently. Disturbing news from Routers indicating that EU officials are considering confiscation of personal savings accounts to make themselves whole after mismanaging their citizens’ money the first time through taxes. In a disconcerting move, some banks in the UK are already making it harder for some customers to access the funds they deposited.

Just when you thought that would never happen in the US, plans of similar schemes have been uncovered that US banks have laid out plans to confiscate US depositor money as well with “bail ins” similar to Cyprus.  There is no FDIC (Federal Deposit Insurance Corporation) for bitcoins to insure your deposits. It will take a different mindset for the digital currency community to protect their digital money. New secure “hard wallets” and other off-grid storage solutions are beginning to gain popularity; including Bitcoin Armory. Nobody is going to do it for us. Understandably, citizens have begun making arrangements to protect their wealth including conversion to harder-to-reach digital currencies. For bitcoiners failing to protect their money it becomes a matter of “pick your poison”. Hackers on the left, government on the right. Interconnecting it all are the exchanges.

BTC-e

https://btc-e.com/

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One example of a hard to reach and regulate exchange is BTC-e. This exchange might be described as an enigma. Even its exact location is somewhat of a mystery. The managing company is registered in Cyprus but lists Bulgaria as its location. It appears to avoid too much government regulation and as such, the exact location is undisclosed. BTC-e is one of the primary benefactors in gaining customers leaving Mt.Gox who swelled the customer base as Mt. Gox shrank. Accounts are secured with two-factor authentication for all withdraws and has not reported being a victim of a hacking attack. The company may represent an emerging model for legitimate (read not Silkroad-like)  internet business that can be everywhere and nowhere at once. This might make it difficult to apply laws from regulators and governments that have until now relied on borders and jurisdictions to maintain their authority.

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BTC-e.com front website.

There is much confusion in the press lately about the exchange’s “war” with the Russian government. The Russian central bank boldly issued a statement which reiterates the existing laws that recognize only the ruble as the official currency. It did not make new laws or rulings but did create some “Fear, Uncertainty, Doubt” by labeling transactions as “potentially suspicious”.  It made clear that businesses using the currency are breaking existing laws.

The defiant BTC-e issued a statement in response that they are discontinuing support for the Russian Ruble on their exchange. They advised their customers that they would continue to work through alternative third party issuers like OKPAY once they’ve converted the funds to another acceptable currency. BTC-e is one of the largest exchanges to also trade with alternative digital coins such as litecoin. This writer found no reports of security issues.

BTC-e Legendary Troll Box

If one were to take you on an adventure trip around the world of “Bitcoinland” no visit would be complete without a stop at BTC-e’s front page chat window, commonly called the “Trollbox”.  Perhaps there is no better place to better understand the “Crypto-Culture” than to hang around this area for a few days. Here you can watch warring bitcoiners try to psych each other into buying and selling various currencies to their own advantage. It turns into a hotbed of hot-off-the-press news and old fashioned crypto culture jokes and more innapropriate ways to use the term “GOX” in a sentence than you can count.

Cryptsy

https://www.cryptsy.com/

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Cryptsy is one of the few exchanges based in the US. It is owned by Project Investors, Inc. which is located in Florida. They have 60 various alternative currencies (as of this writing) but complex legal regulatory restrictions do not allow them to trade in government backed currencies. They have indicated plans are in the works to allow for this in the future and are working out the regulatory side. You must fund the exchange with bitcoin or alternative currencies to do business and try your hand at predicting the next hot alternative currency of the week.  The exchange requires two-factor authentication for login.

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Photo from Cryptsy’s website.

 

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Cryptsy is run by “Big Vern”

Cryptsy is a smaller operation and sometimes exhibits computer lagginess as the infrastructure occasionally struggles to keep up with surging demand. This writer found the interface is simple and intuitive and discovered no evidence of security concerns. If having a large selection of alternative currencies is important to you, and you feel safer dealing with an American company consider looking into Cryptsy.

For many who feel like they’ve missed the boat on bitcoin while it was still under a dollar in years past, they often hope that lightning strikes twice. They hope that the new currency they’ve targeted will bring them fortune. The makers of these coins also need an exchange to get them distributed which is essential to maintain viability. The confluence has created competition and campaigns to get their own coins featured and available for sell and trade. Exchanges have become unexpected lucrative businesses. Various “write-in” campaigns have developed by various groups to petition the exchanges to include their own versions of the currency. Big Vern has indicated in an interview with Lets Talk Bitcoin that he has a method for discerning which currencies make it to market, and tries to limit the selection to those that appear to bring something unique or different rather than just a copy of a previous coin with one or two insignificant changes and a new name. For most hobbyist miners, the only profit left to be made is with the smaller alt coins where the difficulties remain relatively low and a good GPU will make a profit. Cryptsy and sites that exchange many smaller alt coins are necessary if you eventually want to trade up to bitcoin or litecoin or to eventually convert to government fiat currency. This effectively creates a “back door” to mining for bitcoin much more efficiently than competing directly against industrial sized commercial operations using ASIC hardware. Cryptsy provides this road path.

With the flood of new entrances vying for the spotlight, the exchange services are becoming increasingly important and profitable. It might be wise to select multiple exchanges for trading your currency of choice. Many security experts still advise to keep your money off the exchanges once the trade is complete. Services such as blockchain.info are seen as much safer places to store your wealth until you wish to exchange it again. It might be important to note that although various countries have issued warnings against using digital currencies and related exchange services -  the US government has not.

KYE Tools.

With over two dozen digital currency exchanges going off line and not having regulators or governments to help, bitcoiners have started to band together and fight back. The bitcoin forum discussion board on bitcointalk.org has a section devoted to routing out the bad actors and have compiled a list of fraudulent exchanges and other heists. Here you can find common patterns to watch out for. The bitcoin community has proven to be tight-knit and working together as a vigilant and powerful ad-hoc detective group. It is wise to remember the adage about prevention being easier than the cure.

There are several on-line tools available to research the various exchanges. Google Maps can help identify the building listed at their address. Other digital currency specialty websites such as cointalk.org and the bitcoin subreddit groups can provide valuable information if you can weed fact from fiction. There are various scam checking websites such as scamadviser.com. Another tool can be to simply review the comments and complaints on the company’s Facebook page. It is conceivable that bitcoin reputation systems might develop in the ways similar to “Carfax”; this may be an emerging market opportunity. There are also dedicated websites that specialize in reviewing and listing these exchanges such as “Planet.btc”. Beware that situations change quickly in the world of digital currencies and reputations can change on a dime so it takes diligence to verify that the information found on these sites are still accurate and recent. In the end, nothing replaces good old fashion detective work. As was proven by Mt.Gox, just because everybody else is doing it, doesn’t necessarily mean it’s the best or safest. Trust your own judgement and instincts.

Due diligence is advised when you research the various exchanges. By one count, over 70 digital currency exchanges currently exist but with increased popularity this figure will surely rise. Financial risk analyzers still regard digital alternative currency investment as inherently risky as would be expected for a five year old unbacked currency. Gavin Andresen, from the Bitcoin Foundation, still recommends that one should consider only investing what one is comfortable losing. This article purposely did not list “Coinbase.com” or “Bitpay.com” as exchanges. The only exchange they conduct is from US Fiat currency from your regular banking system to bitcoin and back. You cannot exchange one digital currency for another and dollar withdraws are sent back to your regular bank rather than stored as US Dollars on the exchange. Direct deposits to and from the regular banks take three days or longer because it must travel on the rails of the regular banking system which will seem like snail mail once you’ve gotten used to the bitcoin protocol. Panic selling and repurchasing once you’ve realized your haste, makes it even worse as you watch your mistake play out in slow motion. By many accounts these two money service companies are currently among the two most trusted in the world.

In general, most digital currency exchanges were started by technical people rather than experienced financial trading companies. Small startup companies naturally would have a difficult time presenting a business plan to the established banking system to get funding to open a digital currency exchange. Growing pains are naturally to be expected as the exploding popularity is often outpacing the ability for smaller exchanges like Cryptsy to keep up with demand. Alternative coins were not taken seriously by much of the digital currency world and even today feelings are still largely mixed. One side arguing that the exchanges are creating confusion and dilute the power that could be combined if it was focused all into bitcoin. Others argue that many of the alternative currencies offer inventive features and can act as a test bed for experimentation that bitcoin can no longer afford as billions in dollar terms are stored inside the block chain and must be protected without the risk of experimentation that might put it at risk.  There is likely truth in both sides. In the meantime, there are currency exchanges that will happily take their cut as the world debates and money continues to flow.

Foreign Government Risk.

Several exchanges have recently opened in the Asian part of the world. There are several unique qualities that make Asian culture somewhat different than Western cultures. Chinese citizens are more likely to be gamblers. This creates price speculation swings that may not have anything to do with the fundamentals or the potential for the currency.

 

BTC-China

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BTC-China CEO, Bobby Lee

In the autumn of 2013 the BTC-China exchange soared past Mt. Gox and became, albeit temporarily, the biggest digital currency exchange in the world. Chinese investors swarmed to the exchange with new money when BTC-China announced they were eliminating trading fees. The ensuing price of bitcoin rose from under $200 to over $1,400 USD on the exchange. This also raised the price fivefold throughout the world in just two months. Then it all came to a crash on December 5 when the Chinese central bank sent a memo to their banking system with instructions that they were not allowed to conduct official business with digital currencies. Press reports exaggerated the headlines to indicate that China had “banned” bitcoin. The price of bitcoin crashed in the ensuing days.

Bobby went to work carefully studying wording and meaning of the memo to find a solution that would keep his exchange open for business. He came up with a clever idea to sell vouchers through an E-Bay like system in China that gave the customer a voucher code that they could then redeem on the exchange. It is important to note that China could have just banned the exchanges but chose not to. This was interpreted as a move to keep banks out of the speculation and business directly through bitcoin and eliminate the ability to circumvent China’s control over their official currency. Many people inside the country have been finding creative ways to get their money out of China and into a foreign currencies they deem safer.

BTC-China eventually followed the lead set by another Chinese digital currency exchange; Huobi. The CEO of that exchange, Leon Li, first allowed depositors to send money to his personal bank account which he then flowed into the exchange on their behalf. With the success of Huobi, who then took the crown for the exchange with the largest transaction volume, BTC-China quietly began this new approach at the beginning of February.

 

 

HuoBi

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The word HuoBi means “Fire Currency” in Mandarin Chinese. It shot out of relative obscurity with its continued no-fee trading structure and is listed as one of the top exchanges by reported volume thanks in part to Leon Li, whose personal bank account funded the exchange. No outside banks issued money directly to the exchange.

There is concern that all might not be what it seems when examining the reported transaction volume numbers reported by Huobi. Another Chinese exchange, OKCoin, was accused of misreporting their trading volume when an exchange arbiter discovered the volume on OKCoin remained steady with its previous reporting even though the central bank’s ruling had stung the trading volume on the other Chinese exchanges. After inquiries were made to the exchange about these reported numbers, the numbers quietly and suddenly dropped to an expected level.

Many in the bitcoin community continuously and openly wonder if HuoBi’s numbers are to be believed. Others question whether internal computers are issuing buy\sell orders with high frequency trading without closing trades. Although there are many rumors, they are hard to prove. The Chinese government has issued warning statements about exchanges and does not regulate digital currencies. So exchanges are free to report whatever numbers they like.

The numbers representing the exchange volume are reported from the company itself. There is little transparency into the business and an exchange has incentive to fudge the numbers to get the attention of new customers. One can’t verify these trades on the block chain as they’re all done internally with only net buys or sales that exceed the in-exchange inventory needing to be purchased or sold in the open market to cover the aggregate.

This is not to say that this type of activity is happening at HuoBi. Because several questions have been raised on forum boards about the possibly of this happening, it becomes a good illustration for speculation. With the high volume numbers coming out of these exchanges, these questions repeatedly come up and have focused on some of the Chinese exchanges more than others.

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BTER, located in China, is relatively new.

English and Chinese languages are supported on the website. It can, unlike other Chinese exchanges, accept Chinese Yuan directly. The most notable difference for this exchange compared to others in China is the use of several alternative (alt) coins. Compared to Cryptsy, the trades were quicker without the lag time common on Cryptsy, and there were a few listed on this exchange that aren’t currently available on Cryptsy.

Trying to get good reliable information has proven difficult for this exchange. It was first brought up in the forums last April. This writer opened an account in January and has only slight difficulties. Its authentication procedures were tricky to navigate. Its support system relies on Skype messaging. E-mails were answered, but because of the time difference, expect sometimes 8 - 12 hours later. It may be a one-person support “team”. Navigating the site and making trades was fast and reliable with enough volume in trades to run smoothly. Actually withdrawing the funds was much more tricky than it had to be and was likely buggy. They require a “funds” password that is different than your login password. An email is then sent for your verification. It required the use of a captcha and TOTP Google authentication. The message box appeared when you put in your account name, the fund password, TOPT, and Captcha - which then incorrectly indicated that you had just selected a password change option.

It indicated several times that one of the fields was input incorrectly and reset the form so that all the fields were reset to blank. After the fifth deliberate attempt and careful review of each keystroke by a second person onhand, three more attempts were needed. It eventually allowed the funds to be transferred off site to another bitcoin wallet. This writer interpreted that the site really, really doesn’t want you to withdraw the funds. The forum chatter didn’t bring up any serious concerns other than the difficulty withdrawing funds on occasion. My litecoin withdraw took many more hours to fulfill. Only after a few hours and finally giving up - had it appear in an off-site wallet the following day.

This article is not intended to be an all-inclusive review of exchanges. The firsthand experience is only used because there currently is very little information available to form a consensus opinion for Bter.

Chinese Exchanges -  A Perspective.

Bitcoin exchanges in communist or totalitarian governments have their own challenges. Capital controls meant to keep money from leaving the country are often necessary as centrally planned currencies often get inflated to unrealistic artificial levels which get unbalanced against other currencies. Totalitarian governments by their nature discourage criticism about government injustices which cause unintended consequences of corruption at all levels. Discovered corruptions are dealt with severely when exposed but there is far too little reward for the risk involved with exposing it.  In a free market, the currency would find equilibrium as opening a window will equalize the temperature inside a house to the outside temperatures. For citizens who have to buy goods or services outside the country or to maintain buying value, foreign currency is often preferred. Bitcoin has become another path some view as  possible escape mechanisms for currency to leave the country. Other methods involve ‘fake invoicing’ from foreign purchases, and the purchase and use of gambling tokens which are accepted across borders in reciprocal arrangements between casinos. Despite China’s efforts the capital controls remain porous.

These countries can do very little against digital currency mining and having factories on hand to build the chips to do it, the digital currency mining industry has thrived. The government found an easier time controlling the exchanges. Trustworthy exchanges are at the mercy of the government’s jurisdiction in which they reside. It may be wise to remember government officials can change the rules at any time. Historically speaking, centrally planned economies used by totalitarian governments have a poor record of maintaining stability and value of money and eventually become desperate to control it. Attempts at artificial manipulations fighting against the natural law of supply and demand inevitably create bubbles and black markets. The average lifespan of unbacked fiat currency is about 27 years, and as a result when those currencies begin to self-destruct they tend to grab all the funds they can find to appropriate, including personal savings accounts, personal retirements and pensions. We can witness their financial ship sinking most recently in  Argentina, Poland, Portugal, Venezuela, North Korea, and Cyprus. One might think Western countries such as the UK and the US are safe, but plans are already set in motion to remove you from your money held in the banking system when they start to fail. History is littered with similar stories. Generally it’s not a matter of “if” but “when”.

As long as some larger countries support and foster bitcoin, perhaps it has a chance to erode the effects of corruption from various less reputable countries. Perhaps bitcoin can end the effectiveness of capital controls and break down the money barriers that governments erect in efforts to keep their own currency propped up from within. Bitcoin might prove to have an acidic effect for removing cancerous corruption from the inside out. If citizens demand transparency through the block-chain, honest money may turn out to be the only money governments can’t appropriate at will in an effort to plug the sinking ship they’ve created through corruption and oligarchy.

History has proven that every communist country’s economy eventually fails or transforms itself into a quasi capitalist economy (the China experiment). Could it be possible that the end of communism does not come from war, but from the power of digital currencies? With much talk about governments trying to block digital currencies - perhaps ironically it’s in their best interest to protect and foster its growth and acceptance. Once set in motion they simply watch as the currency transforms those governments into accountability in ways tanks and bombs never could. Could it be really that simple? Is it conceivable that nation states will themselves become the largest miners of digital currencies vying for control and protection of the blockchain? Charlie Lee, the inventor of litecoin and one of the leaders at Coinbase.com, made a quiet plug for that idea during the New York hearing of the Division of Financial Services a few weeks ago.

It might be a battle at the flashpoints between old currency and new. Those flashpoints might be at the currency exchange level. It’s important for the reader to watch for this beforehand, and realize that with just a quick memo from the central bank the exchanges could effectively be banned outright; with little or no warning. In these areas it might be even wiser for due diligence to not only know your exchange, but understand the politics of the country where it resides and ask yourself if you trust the government enough to let them hold your money. The block chain itself can be a glass house and as such it might make some very powerful officials nervous. The mighty spotlight of accountability governments shine on us might become unbearably uncomfortable when reflected back onto them. At this point we might rise up and go beyond our effort to “Know Your Exchange” - but elevate our knowledge and power that comes with the ability to “Know Your Government”.

 

Bitcoin Exchanges - In Perspective.

It’s important for the reader to remember that the marketplace for bitcoin is young and largely immature. Bitcoin investments are considered very risky by the established risk analyzers. Those who invest in bitcoin understand this, and perhaps having these unregulated and immature exchanges are just part of that accepted equation. The exchanges profiled here were not set up by established financial experts. These are essential tech companies that did not dismiss the currency out of hand as the financial establishment has done. It is prudent, perhaps, to withhold judgment as history will yet decide if these innovating pioneers were the dawn of something grand and wonderful... or a footnote. As a disruptive force, bitcoin simply could not have been born or allowed to live by the banking establishment. Logically, it had to come from the technically minded to understand its basic foundation.

Having a marketplace to distribute the currency is crucial for its development. For all the negative aspects that have been reported, it might be wise to respect the visionary pioneers who have gotten it this far. They had to maneuver tricky business factors and the lack of respect for the currency that brought with it embarrassing stereotypes to overcome. This is not unprecedented in the technology world. Bill Gates, Steve Jobs and many others had to start out in garages or houses. They had humble beginnings, but they still had to project an image that was perhaps greater than their actual achievements and stature at that time. It perhaps requires these traits to be taken seriously enough to be given a chance.

Perhaps it was inevitable that the financial world ignored it and then laughed at it. Today, as the proverb suggests, some are fighting it. However, in the land of the technical pioneering spirit - the US has not issued governmental warnings to stay away. This is not true of several governments - that seem intent on fighting it. The leaders in the high-tech sector responsible for much of the giant successes of the last two decades have begun to take the lead again. They are dragging along their big financial backers whom they’ve made wealthy. Those backers would naturally be resistant to a disruptive technology. Hedge fund managers who are the contrarians of the banking crowd are increasingly taking bitcoin seriously. They will likely be the trailblazers for the financial world eventually forcing the stodgy status-quo bankers to keep up.

New money entering into the ecosystem will demand regular regulated exchanges in the US, and with it, like it or not, established banking systems. These were often referred to as the “enemy” of bitcoin - but ironically might be its savior bringing the currency from its infancy to its toddler stage. When the Internet was still young and exclusionary to the techno-geek community, Internet idealists desperately wanted to keep the internet free from advertising commercialism. They could not have foreseen innovation such as YouTube, Facebook, Google Earth, I-Tunes, eBay and Amazon and Netflix. This is also true for bitcoin idealists. New wondrous technology will likely not be exclusionary of bankers any more than it would be to drug dealers or governments. For now however, we have these small and relatively immature exchanges pioneering the way. Rebellious and anti-establishment, they have filled a vital role that could not have come from within the establishment. Unfortunately, most may not last long when the big money rushes in and co-opts them. Some may well survive on the peripherals, for the portion of the population often ignored, disaffected, and under represented - which ironically may very well may describe their current customer base.  For now, find the one exchange you can trust and celebrate them with your business while you still can.

Disclosure: This author has an account with the some of the exchanges profiled in this article.

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