Bitcoin needs to grow out of its obsessive adolescence

Newsweek’s flawed attempt to expose a 64-year-old Californian called Dorian Nakamoto as Bitcoin’s mysterious inventor has come at an opportune moment for exponents of the cryptographic currency. It has distracted from a crisis of trust caused by the failure of Mt Gox, the Tokyo Bitcoin exchange.

By rights, Bitcoin’s community of enthusiasts, venture capitalists and start-up companies should now be occupied with how it can re-establish credibility after a series of unfortunate events. Instead, much of its energy over the past week has been taken up by fulminating about the magazine’s treatment of Mr Nakamoto, who denies being Bitcoin’s architect.

Online forums have filled with virulent criticism, and a lot of sexist abuse, of Leah McGrath Goodman, the reporter who found the man she believes (but has not yet proved) is “Satoshi Nakomoto”, author of the original Bitcoin paper. Devotees have condemned her attempt to “dox” him – expose his identity – whether or not he is their man.

The hysteria undermines Bitcoin’s chances of graduating from a hobbyists’ obsession to a mainstream technology. You cannot challenge fiat currencies and disrupt the global payments industry while reacting to any uninvited scrutiny like an adolescent whose parent has opened the bedroom door without knocking. It does not work that way.

I say this as a believer in the potential of cryptographic currencies (whether or not Bitcoin survives) to become cheaper and more efficient means of payment and exchange than banks and card companies provide. As I wrote in a previous column, the technology could also permit the exchange of other types of digital contracts.

Whatever its underlying potential, Bitcoin faces an immediate crisis. As some 15-minute celebrities have found, the only thing worse than too much attention is no attention at all. Unless it can restore its reputation rapidly, the media and consumers will lose interest.

Mt Gox is not the only Bitcoin exchange to have mislaid Bitcoins – several others have suffered from a software loophole known as “transaction malleability” – but it is by far the most serious. It filed for bankruptcy in the US this week, having lost about 745,000 Bitcoins ($472m at Wednesday’s exchange rate), and still has not clearly explained what happened.

To the aficionado, Bitcoin’s credibility remains intact. “There has not been a loss of confidence in the technology, but people are newly cautious about trusting Bitcoin companies,” says Edward Felten, professor of computer science at Princeton University.

In the case of other exchanges, and perhaps Mt Gox, Bitcoin payments were settled as intended but hackers then altered identifying information on the transactions to fool exchanges into believing that Bitcoins had not changed hands. Mt Gox, the argument goes, was a victim of its own sloppy online bookkeeping rather than a Bitcoin flaw.

To the average consumer, this is a distinction without a difference. Being able to trust “Bitcoin” as a technology but not to be sure that your own Bitcoins are safe does not mean much. The basic function of a bank is to store its depositors’ cash more securely than keeping it under the mattress and if Bitcoin cannot match it, little else matters.

The currency’s more reflective supporters recognise this. “I have met a lot of depressed people, even if they did not lose money themselves,” says Pamir Gelenbe, a partner of Hummingbird Ventures, one London-based Bitcoin investor. “This is a bad event for the ecosystem.”

Fixing it will demand both technological and cultural changes. Mt Gox embodied the slapdash, enthusiast phase of Bitcoin. It was founded as an exchange for trading virtual cards in an online game called Magic: The Gathering (from where the Mt Gox name came). Even after it switched to trading Bitcoins, its software was notoriously flawed and accident-prone.

The $100m of venture capital invested in Bitcoin in the past couple of years (including $25m in Coinbase, the San Francisco-based digital wallet company in December) has brought professionalism and an experienced group of technology executives to the field. They look on Bitcoin more dispassionately than the earliest adopters.

“The recurring theme of Bitcoin is that it is exciting but it has been difficult to find good entrepreneurs. There is a set of guys who got lucky by setting up companies in the early days before it really took off. They were in the right place but were the wrong people,” says one venture capitalist.

Some of the new entrants are now trying to fix the flaws that Mt Gox exposed, such as requiring two digital signatures for each transaction (an approach taken by BitGo, a Seattle start-up), rather than letting a hacker who obtains a single signature steal the money. Elliptic, a London-based company, is offering storage of Bitcoins backed by banklike deposit insurance.

Such changes raise the possibility of Bitcoin becoming more expensive as safeguards are added (Elliptic charges 2 per cent for its deposit insurance). Goldman Sachs estimated this week that Bitcoin transfers cost 1 per cent of the amount, compared with 2.5 per cent for Visa-type card payments, and adding costs could erode that edge.

But Bitcoin’s backers do not have much choice. As a “crisis strategy draft” that circulated at Mt Gox in its last days put it: “At the risk of appearing hyperbolic, this could be the end of Bitcoin, at least for most of the public.” A crisis sometimes makes you grow up fast.


John Gapper


FT