Month: March 2013

Note: there is some disagreement as to whether the term “market capitalization” can legitimately be used to refer to the figure that is the subject of this article. The term is typically used to refer to the total value of all shares in a company, although some Bitcoin users also use it to refer to the total value of all bitcoins in existence, which others believe is incorrect because bitcoins are not “shares” in anything. To avoid confusion, I have decided to avoid using the term entirely.

The night before March 28, the Bitcoin price shot up another six dollars, leading Bitcoin to hit a crucial milestone: the total value of all bitcoins in circulation reaching one billion dollars. The price first reached the barrier at 05:15 GMT, surging past the critical price level of $91.251 with 10,958,700 bitcoins in circulation. The jump followed one and a half weeks of rapid growth that many believe was precipitated by an announcement on March 16 that a Eurozone bailout of Cyprus would be partially funded by a 6-10% levy on all Cypriots’ bank account savings. In other countries troubled by the Euro financial crisis such as Spain, many quickly became concerned that their own savings will be next – a worry that the Spanish government has only heightened, and as a result Spanish interest in Bitcoin is going through the roof. Another reason why the Bitcoin price may have shot up is a recent guidance report released by FINCEN, in which the US regulatory agency wrote that mere users of Bitcoin are not subject to federal money transmission regulation, although exchanges are – a strong step toward resolving legal worries that have acted as a chilling effect on business adoption for the past two years.

Psychologically, the milestone is a hugely important one. If the day that Bitcoin broke past $31.91 can be seen as the day that Bitcoin proved to the world that it did not die in 2011 and is only getting stronger, today is the day that Bitcoin officially joined the big leagues. Joining the so-called billion dollar club places Bitcoin above over 2000 out of 2677 companies trading on the NASDAQ, all but a few dozen non-publicly traded startups in the US, and even the money supply of 20 countries around the world – making claims that all national currencies are somehow legitimate while Bitcoin is not rather specious. Regardless of any comparisons, one billion is the point at which, according to some definitions, a company moves from being considered “small cap” to “mid-cap”, and one billion the mark at which many institutional investors start to see a particular market or investment as something to be taken seriously.

This fundamental shift is happening in more places than just the market charts. In February, Coinlab announced a deal with leading Bitcoin exchange MtGox in which Coinlab would take over MtGox’s US and Canadian customers, and Teri Buhl writes: “there is a hint in their new deal that shows they are working to find a way to get liquidity to Forex broker dealers or private wealth managers to help high net-worth individuals invest long-term in bitcoins.” In March, the Malta-based Exante announced a Bitcoin hedge fund targeted to institutional investors primarily in the EU. Finally, two weeks ago Tradehill, a Bitcoin exchange that operated between June 2011 and February 2012, came back from the shadows to offer a new product: Prime, a Bitcoin exchange specifically suited to high net worth, accredited investors. The exchange already has 75 accredited investors signed up, adding more every day. Tradehill’s Jered Kenna, who has spent the past year cultivating relationships with such individuals to make Prime a reality, said: “Bitcoin has really grown in the past year and a half. There is a lot more institutional money coming in, as well as regulatory attention. In the next year or so, I think you’re going to see a lot of conventional mainstream businesses adopting Bitcoin. You’re going to see a lot more venture capitalists moving in, and a lot of startups. You’re also going see a lot more people endorsing Bitcoin, with many public faces.”

On the non-financial side of the Bitcoin economy, the situation is similar. When Silicon Valey investor Ben Davenport recently invested into BitPay, he wrote: “Bitcoin businesses, until recently, have largely been bootstrapped. The reason is, until recently, when an angel or VC has looked at Bitcoin businesses, they saw a currency with a total market cap of about $150 million. That’s too small a total addressable market to be interesting. And if an investor is savvy enough to see the potential for Bitcoin itself, then they also realize they can capture that upside without the business risk, simply by buying bitcoin. Now though, we’re getting to the size where an investment in an amazing, well-positioned team like the guys at BitPay makes a lot of sense, and will also ultimately help increase the overall Bitcoin adoption rate. I predict we’ll see the VC flood gates open within 12-18 months — I’m just trying to be a little bit ahead of the curve there.”

More and more, institutional investors are becoming interested in Bitcoin from all sides: Bitcoin the financial asset, the Bitcoin community as a customer base and the Bitcoin economy and its startups, and the three feed on each other. As the Bitcoin price goes up, Bitcoin receives more media attention and therefore more new users, as Bitcoin receives more new users existing Bitcoin businesses get larger and new ones appear, and as the Bitcoin economy booms so does its price. Many believe that the current rise in the Bitcoin price is simply a bubble, and certainly at some point, whether now, in three months or in two years, a bubble is bound to come. However, there is also genuine adoption rising rapidly behind the scenes; recently, BitPay announced that the company had processed over $2 million worth of payments over the first twenty five days of March.

From here, it is hard to say just how far Bitcoin will go. In August 2011, Roger Ver made a bet that Bitcoin would outperform gold, silver and the stock market by a factor of 100 – “this means, Ver clarified, “if silver is up by 100% over the next 2 years, I think Bitcoin will go up by 10000%.” Right now, the top performer out of all these investments is the stock market, with the Dow Jones going up by 28% from 11372 to 14559 so far – meaning that Bitcoin would need to go up to $296 by August 4 for Ver to win his bet. Even in August 2012, the thought that Bitcoin could possibly climb so far in only a year was pure fantasy. Now, anything seems possible. But this is also a good time to be cautious. It is often said that past performance in no way guarantees future results, and Bitcoin users who have seen their Bitcoin portfolio grow to over half of their net worth should seriously consider partially cashing out, lest Bitcoin crashes back to $30 and they lose everything they gained. Ultimately, Bitcoin users should well remember that regardless of whether Bitcoin will be at $30 in four months or $300, its underlying value is the same: Bitcoin lets you instantly, securely, and anonymously send digital payments from anywhere in the world to anywhere in the world without any governments, corporations of banks, and for negligible fees. This is the true promise that Satoshi worked so hard to bring to us all, and it is a promise that all of the developers, advocates and businessmen of the Bitcoin community have worked so hard to deliver. Now, with Bitcoin at $1 billion, our job as a community is simple: don’t lose track of what we’re really here for, and keep on going.

Although it was nowhere near the earliest in Bitcoin history, Tradehill was one of the largest exchanges in the Bitcoin economy when the currency had its first brush with public prominence in 2011. When the exchange first launched in June 2011, MtGox was by far the dominant player in the market, with a market share approaching 95%, and Bitcoin users were eager to see some competition. Following a marketing blitz over the next two weeks, attention on Tradehill increased rapidly, and the exchange was further helped along by a security breach at MtGox which caused the Bitcoin price to appear to crash down to less than one cent. Over the next few months, the exchange continued to grow, and it seemed that if anyone would ever displace MtGox it would be them. However, soon Tradehill’s luck turned for the worse. Near the end of 2011, Tradehill’s main payment processing partner, Dwolla, made a sudden change to their policies: they started processing chargebacks. The move was a highly deceptive one; before then, “no chargebacks” had been a key part of Dwolla’s sales pitch, and when the change was made Dwolla made no effort to inform its customers. Instead, Tradehill only found out that anything was wrong when $94,000 worth of transactions were essentially reversed without warning, and Tradehill’s account frozen when they tried to move the remaining $70,000 to a safer location. Because of that loss, as well as increasing worries about the status of Bitcoin exchanges under US regulations, Tradehill shut down on February 15, 2012, and launched a lawsuit against Dwolla to attempt to recover its losses. From the point of view of most Bitcoin users, the exchange was never heard from again.

That is, until now. Two weeks ago, Tradehill’s Jered Kenna announced that the company was back, and would soon be revealing a number of new Bitcoin exchange-related products. “Ever since I shut the original Tradehill down,” Kenna relates, “I was still getting calls on a regular basis from customers. In April 2012 I met a man at the future of money and tech conference, Ryan Singer.” Singer continues, “In July and August we started talking about bringing Tradehill back. The goal was to be regulatorily certain where we stood, as well as from a security and technical perspective. Jered was really proud of his reputation for never losing any customer funds [a reputation that, of all other major exchanges from 2011, only BitStamp still retains]. We hired a new team from Google and Cloudflare, staffed up with designers and built a new product.”

The first product that Tradehill is releasing is called Prime: a Bitcoin exchange specifically designed for the wealthy. So-called accredited investors, a classification open only those with a net worth of at least one million dollars not including their primary residence, are in fact much easier to deal with regulatorily than most other individuals. For example, while companies that would like to offer stock on public stock exchanges such as NASDAQ must go through a lengthy compliance process and have millions of dollars of capital, there are also specialized exchanges like SecondMarket where even lowly startups can register – but only accredited investors can trade. Also, dealing only with a small number of extremely high-value customers allows Prime to provide a much higher quality of customer service. “We can establish deep trust relationships,” Singer adds, “and even offer direct integration with automatic trading bots.”

Prime is not the first business to come up with such an idea; the Malta-based Exante has created a fund with a similar purpose of targeting institutional investors earlier in March. However, thanks to the way international financial regulation is currently set up the two are unlikely to be competitors. The United States government recently passed a law called the Foreign Account Tax Compliance ACT (FATCA), requiring any foreign financial services dealing with US customers to extensively report on their customers’ activities to the US government. The law imposes a 30% withholding tax on any institution that deals with US customers but does not comply, and, furthermore, as Mike Hearn put it, the law is “viral” – institutions outside of the US that comply must also impose the 30% withholding tax themselves on other institutions that do not. “Because the financial system is a fully connected graph,” Hearn explains, “this essentially means that US law spreads through it like an infection and eventually every financial institution will be forced to comply or face crippling sanctions from other financial institutions they interact with.” With this in mind, the majority of foreign financial institutions, including non-US-based Bitcoin businesses like Bitcoin Central, are choosing a much easier way out: stop dealing with US customers at all. This is the path that Exante will most likely take, leaving Prime in the United States, at least for now, all by itself.

Although Prime and Exante’s BitcoinFund are similar in spirit, they are quite different in implementation. Kenna explains: “[Prime] is more of an investment club than a fund – people are trading bitcoins with each other, we just write software to facilitate.” The company intends to offer the highest possible level of customer service, including personalized assistance from a professional accountant for all of their clients, as well as integration with automatic trading bots, instant extremely high value bank deposits and withdrawals, and more. An investor seeking to buy $500,000 of BTC through MtGox would likely have a hard time getting their money in; with Prime, the banking integration systems are designed to do just that. For sellers, Prime has another proposition to make: above-market prices. The demand from institutional investors looking to get into Bitcoin is highly asymmetrical, and so it is quite likely that the market price on Prime will slightly exceed the price everywhere else. Given the rate at which the Bitcoin price has been moving over the last two months even a 5% surcharge is worth less than a single-day delay, so even to buyers Prime’s offer will still be extremely compelling.

Prime has already found 75 customers, each with over $10,000 worth of bitcoin, and is gaining more every day. Kenna says, “people are saying to me, ‘I want to sell $500,000 worth of Bitcoin'” Given recent announcements from Coinlab, Exante and increasing numbers of Silicon Valley investors looking at Bitcoin businesses, institutional investor interest into Bitcoin is at an all-time high, and is only going to become greater over the next year.

For the curious, the old Tradehill is still involved in the dispute with Dwolla, and the new Tradehill was formed as a separate company. But Prime is only the first of many offerings that Tradehill has in store. Kenna is primarily in the business to help Bitcoin grow, and he realizes as well as anyone else that it is ultimately the average users that will drive Bitcoin to success. A traditional Bitcoin exchange for the masses is soon to come, although Tradehill is unwilling to reveal too much just yet. The main delays are regulatory, ensuring that the exchange will not be blindsided by a sudden change in policy from governments or payment processors again. “Tradehill has been dedicated to being fully compliant with US laws,” Singer adds, “and not being murky about it.”

On 26 March 2013 the renowned BBC Newsnight produced a 9:20 segment for about 700,000 viewers on the new decentralized virtual currency Bitcoin. Veteran journalist Jeremy Paxman hosted Daniel Knowles, a writer for The Economist, and Trace Mayer of Run To Gold and How To Vanish.

Being a professional journalist myself, although mostly contained to the written word, I know how difficult it is to research a story, craft an engaging script and then produce a segment all under the extremely tight deadlines imposed by current events. Being a long-time fan of the BBC, it must be the accents!, I jumped at the opportunity to provide the counterweight in the Bitcoin segment and am grateful to the very professional team at the BBC that made this segment a well produced piece of content. And having it follow the hair raising piece on the Cyprus debacle shows they have an open mind towards a potential solution for their viewers.

[youtuber youtube=’UA5_paH__q0′]

BACKGROUND

In this case and under the circumstances, I think the BBC produced a fine piece on Bitcoin. There are some within the Bitcoin community who are constantly impugning the motives of the professional media outfits. But with regards to this piece I hope some background information may be found useful.

With the bank seizures in Cyprus coupled with recent FinCEN guidelines being issued for decentralized virtual currencies there has been a flurry of activity in the Bitcoin price which makes for a very compelling story. But Bitcoin is extremely complicated. And to make matters worse, it seems that many of the knowledgeable voices on the subject have spent too many of their bitcoins on Silk Road instead of saving them.

On 25 March I was freezing in London and headed to Heathrow so I could join some people for an event in the Southwest United States and since I had a few days free in the schedule preferred to spend it in the sun instead of the frigid drizzle. Around 10:30am I received a call from a blocked number, which I normally do not take, but because I had been tipped off that the BBC may call therefore I answered. They were crafting a Bitcoin story, looking for a proponent and after some conversation I was battlefield promoted to backup.

You see they wanted someone in London, where ironically I had just been, to be live in studio. Plus, it would have been a higher quality piece of content, technically more controlled and were working under an extremely tight deadline with this very complicated subject matter. Had I known I would have extended my stay in London a couple days to accomodate them since I am such a fan of the BBC and this would be my first appearance. But we are all played the cards we are dealt and while they searched for someone local I told them I would be as flexible as possible as a backup.

But finding high quality and reliable guests is difficult! So a few hours before airtime I got the call and began making the 45 minute drive to the remote studio. Once there the studio had some technical difficulties so the poor BBC staff had to make several contingency plans and modifications. I am sure the uncertainty was problematic for scheduling. But about three minutes before airtime the technical difficulties got resolved and it was go time. The show must go on.

And it did go on and I think turned out pretty well all things considered.

REBUTTALS TO MR. KNOWLES

It is evident that Mr. Knowles has done significant research on Bitcoin. He raised a few issues that it would have been nice to respond to. However, given the remote studio nature of the appearance and time constraints that made it impossible to do on air without potentially disrupting the show in an unprofessional manner. So, I suppose this will have to do.

First, For money laundering Bitcoin is not a very useful tool, compared to others available, and that activity is largely kept within the fiat currencies like USD and EUR anyway. Even the European Central Bank’s Bitcoin report concluded on page 25, ‘Therefore, the real dimension of all these controversies [money laundering] still needs to be further analyzed.’

Users should keep in mind that Bitcoin is not anonymous by pseudo-anonymous. Additionally, all transactions are permanently stored in the blockchain which anyone can review. This leaves a tremendous amount of digital footprints that a competent forensic accountant can follow.

Consequently, I think Mr. Knowles is attributing to Bitcoin’s censorship-resistant nature a property which it does not have. Just because a payment cannot be stopped does not mean it cannot be traced.

Second, Bitcoin is not deflationary because inflation is an increase in the money supply and deflation is a decrease in the money supply. With Bitcoin there is a predictable amount of new bitcoins issued on a regular basis, currently 25 bitcoins about every six minutes. Therefore, Bitcoin is inflationary.

So, I am not sure what Mr. Knowles criticism is since it is premised on a substantively incorrect premise and misstatement of fact. Perhaps he can rephrase it?

Third, I am not sure I understand his criticism about why it is bad for one’s savings to increase in value. As illustrated in an infographic I put together on potential Bitcoin prices the saving of bitcoins is the starting point of a virtuous cycle for the Bitcoin economy.

Plus, for those of us who have been saving bitcoins, unlike Mr. Knowles who if he is saving at all is doing so in a fiat currency that is constantly losing purchasing power, those in Bitcoinland have a lot more wealth to spend on consumer products and as Bitpay’s recent records show, with $2m of transactions processed in March, those bitcoins are being spent. And that increased wealth is the result of a massive wealth transfer that is benefitting holders of bitcoins.

Fourth, the size of the Bitcoin money supply is starting to get pretty substantive in size and larger than about 40 nation states. It seems Bitcoin nation is growing. For example, the Central Intelligence Agency’s World Factbook would place the Bitcoin money supply around the 150th largest nation.

COUNTRY	M1	BITCOIN PRICE
Rwanda	$673,200,000.00	$61.65
Montenegro	$749,000,000.00	$68.59
Fiji	$794,600,000.00	$72.77
Djibouti	$798,100,000.00	$73.09
Turkmenistan	$828,800,000.00	$75.90
Aruba	$868,500,000.00	$79.54
Togo	$954,500,000.00	$87.41
Bitcoin	$955,000,000.00	$87.50
Maldives	$974,900,000.00	$89.28
Congo, Dem. Rep.	$1,016,000,000.00	$93.05
Niger	$1,064,000,000.00	$97.44
Cambodia	$1,094,000,000.00	$100.19
Spain	$775,200,000,000.00	$70,993.24
United States	$2,318,000,000,000.00	$212,283.70
European Union	$6,205,000,000,000.00	$568,257.27
Japan	$6,735,000,000,000.00	$616,794.96

BitPay, the world’s largest Bitcoin payment processor, has announced that they have processed over $2 million in payments in the first 25 days of March. The company also reports that the rate of transactions is also accelerating, with 3,600 processed this month, and the total number of merchants that the company serves has now increased to over 4,000 – more than triple what it was in November before WordPress’s announcement.

As a sign of Bitcoin’s greater adoption, this news is very significant. As the Bitcoin price has now shot up by a factor of five since it first started its meteoric rise since the beginning of January, many people are becoming increasingly concerned that Bitcoin is entering another bubble, a cycle of self-reinforcing price increases and media attention that is not backed by any underlying adoption. If that is the case, then it means that the price could easily crash back down just as quickly, much like it did in 2011. Now, however, the opposite is clear; although Bitcoin’s price and visibility have increased drastically over the past two months, at least for now adoption seems to be keeping up. Other data corroborates this; Bitcoin transaction counts are also going up, although not as quickly.

It should be noted that BitPay is far from the only payment processor in the Bitcoin economy; Reddit and Mega, two of the largest businesses to accept Bitcoin, use Coinbase and Zipbit, respectively. Thus, the Bitcoin economy is a lot larger than even the $2 million per month that BitPay reports. For a long time, critics of Bitcoin have claimed that the currency’s primary use case is buying illicit goods such as drugs, citing statistics such as Silk Road’s estimated revenue of $2 million per month from August 2012, but the new statistics clearly show that even if those claims were true in 2011 and early 2012, the “legitimate” Bitcoin economy is now much stronger.

Merchants using BitPay also have another reason to rejoice. As a result of the company’s success, CEO Tony Gallippi has announced that fees for all merchants, including those who are converting their earnings to any local currency that BitPay supports, will be reduced to 0.99% across the board. “We chose to celebrate this milestone by rewarding all merchants, large and small, with an across-the-board fee reduction, instead of offering tiered pricing which rewards only the largest merchants,” Gallippi writes, “We want our merchants to use this fee reduction to offer discounts and incentives to their customers for paying with bitcoin.” This price decrease in particular is very significant. With the new fees, if a buyer buys bitcoins through Coinbase, pays the money to a merchant in exchange for a product, and the merchant cashes out through BitPay, the round-trip fees add up to a total of 1.99% – less than the 2.90% + $0.25 charged by Visa and Mastercard. However, from the customer’s point of view at most Bitcoin merchants buying with Bitcoin is still 1% more expensive, and so, at least for now, the buyer has no financial incentive to participate in the currency switch. This is why Bitcoin business advocates are now increasingly calling for Bitcoin businesses to pass on the savings through a discount, and some large players have already done so. The Bitcoin Store, for example, has been successfully offering its customers prices for electronics lower than what can be found almost anywhere else because of their savings from using Bitcoin, and they have already gotten more than $300,000 in purchases.

Of course, fees are not the only savings with Bitcoin that businesses can make. Many merchants, including small businesses in particular, accepting credit cards are often forced to spend a significant portion of their time looking at customers’ personal data to attempt to verify that the purchase is legitimate. With Bitcoin, merchants do not need to worry about fraudulent customers, resulting in savings of both loss to fraud and investigative effort that is potentially much greater than 2-3%. Discounts as high as 5 or even 10 percent may be justified on these grounds.

For businesses selling digital goods such as games and software, there is a strong case to make that the discounts that Bitcoin users should receive are even greater. To see why, it is important to understand that digital goods have a zero marginal cost of production – that is, when someone buys a movie, program, book or song the vendor must only pay a fraction of a cent transmitting the data to the buyer, pocketing the rest as pure profit. However, there is a hidden tax involved: the effort that the buyer needs to make to complete the transaction. In the case of credit cards, this involves filling in a form including credit card number, validation code and a full set of personal information – a process that may take the buyer several minutes to complete. In the case of Bitcoin, all it takes is copying an address or scanning a QR code. Now, imagine that a given song or mobile application is available for sale to two different groups using these two different methods for $1. A credit card user might value the time wasted filling in the form at an additional $1, while for the Bitcoin user the streamlined process of buying through Bitcoin would only “cost” $0.20. Consider what would happen if the price was increased to $1.60 for both groups. To credit card users, the total cost would go up from $2.00 to $2.60 – a 30% increase. To Bitcoin users, however, the cost would go up from $1.20 to $1.80, or 50%. Under normal circumstances, the 50% increase would deter a larger percentage of customers from buying the product than the 30% increase, and so it may well make economic sense to increase the price for credit card users and not Bitcoin users. Applying this effect across the board, it becomes clear that the optimum price for a digital good for Bitcoin users will often be much lower than that for credit card users.

At this point in Bitcoin’s development, encouraging more merchants and customers to start using the currency is crucial for its continued growth. Potential Bitcoin users looking at Bitcoin need to see a reason to start using it to buy products and services, and at the same time merchants looking to start accepting Bitcoin need to see a sufficiently large potential customer base for accepting Bitcoin to be worth it. One of Bitcoin’s major advantages is its low fees, but until now for most users and merchants that advantage has not been realized; merchant processing fees from BitPay were almost as large as those charged by Visa and MasterCard, and combined with Bitcoin exchange fees on the buyer’s side it was Bitcoin that was the more expensive option. Now, merchant savings with Bitcoin have finally become a reality, and if merchants reciprocate by providing discounts, even if only 1% off the original price, both sides will be able to share in the savings. All in all, BitPay has just laid the groundwork for an even greater wave of adoption in the months to come.

Bitcoin Magazine’s Issue 8 is now available for sale on our website, covering most of the exciting news that we’ve seen happen to the Bitcoin world in the past two months including extended coverage of Mega, BitcoinQt 0.8, Ripple, Bitcoin nonprofits such as PositiveMoney and the Internet Archive and more. In addition, we have also brought back our Bitcoin FAQ from issue 4 in a revamped form. Bitcoin has expanded massively in the past few months, growing for a premature child desperate for its first signs of real adoption to a veritable economic and social powerhouse in its own right, and we at the magazine intend to continue improving the quality of our products and service as we go along this great journey with it.

Since issue 6, Bitcoin Magazine has drastically improved the speed and reliability of its shipping through integration with Amazon services, and with this latest release we are continuing the trend. Issue 8 is now available for purchase on Amazon shipping from the US, UK and Germany, ensuring much faster and more reliable shipping to all of our customers around the world. As usual, the issue will be available in Barnes and Noble starting April 2.

We would also like to give special thanks to BitcoinStore for joining us starting from this issue as an advertiser.

Government regulation has for a long time been a gray area for Bitcoin, both in the United States and elsewhere. Although we have seen a number of disparate government reports either simply talking about Bitcoin or providing a regulatory opinion on some aspect of Bitcoin exchange, to date we have not seen anything close to a conclusive statement on digital currencies from any government organization in any country in the world. The problem is a difficult one; nearly all laws to date that attempted to regulate online payments of any form have all assumed a central issuer, and in the case of Bitcoin it could be just as easily argued that everyone is an issuer or that no one is. Today, however, we have gained a much clearer picture of what regulation for Bitcoin will look like, as FINCEN just released a paper clarifying their position on virtual currencies, touching on the concept of “decentralized digital currency” in detail with Bitcoin clearly in mind.

The paper starts off delineating a clear definition of what virtual currency is: “FinCEN’s regulations define currency (also referred to as “real” currency) as “the coin and paper money of the United States or of any other country that [i] is designated as legal tender and that [ii] circulates and [iii] is customarily used and accepted as a medium of exchange in the country of issuance. ” In contrast to real currency, “virtual” currency is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction.” It then breaks digital currencies down into three forms: e-currencies and e-precious metals, centralized digital currencies and decentralized digital currencies. Although the document does not explicity define an e-currency and what differentiates it from any other virtual currency, a footnote makes the likely intended meaning clear: “Typically, this involves the broker or dealer electronically distributing digital certificates of ownership of real currencies or precious metals, with the digital certificate being the virtual currency.” That is, e-currencies are essentially certificates for what FINCEN calls “real” currencies – that is, currencies that are, somewhere in the world, legal tender. Centralized virtual currencies are digital currencies that have a “centralized repository”; this is likely intended as a catch-all term for any virtual currencies which are not simply tokens for “real” currency or precious metals but rather a currency in their own right, Second Life’s Linden dollars is perhaps the existing canonical example, although a hypothetical Bitcoin-like unbacked currency backed by a central repository would also fall into the scope. Finally, there are decentralized digital currencies. A decentralized digital currency is one “(1) that has no central repository and no single administrator , and (2) that persons may obtain by their own computing or manufacturing effort” – Bitcoin being right in the crosshairs. Interestingly, Ripple fits one half of the definition but not the other – although Ripple itself is decentralized, or at least will be once the server is released, all 100 billion XRP that will ever exist have already been created. If Ripple succeeds, perhaps FINCEN will be forced to release yet another clarifying guidance paper in two years’ time.

The paper also describes three roles that virtual currency users can have: user, exchanger and administrator. The concept of administrator is very narrow; the document states: “An administrator is a person engaged as a business in issuing (putting into circulation) a virtual currency , and who has the authority to redeem (to withdraw from circulation) such virtual currency” – the latter condition specifically excluding anyone in the Bitcoin economy, as Bitcoin has no concept of redeeming bitcoins in any meaningful way; even transaction fees are instantly transferred over to a miner in the next block. The definition of exchangers is simple: “An exchanger is a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.” Finally, a user is simply someone who uses virtual currencies to buy and sell goods and services.

The major boon from the document for Bitcoin is this: users get off lightly. In fact, FINCEN does not intend to touch mere users of virtual currency at all; the document states, “a user who obtains convertible virtual currency and uses it to purchase real or virtual goods or services is not an MSB under FinCEN’s regulations. Such activity, in and of itself, does not fit within the definition of “money transmission services” and therefore is not subject to FinCEN’s registration, reporting, and recordkeeping regulations for MSBs.” The document also offers protection from “prepaid access” laws that regulate gift cards and the like, saying that “a person’s acceptance and/or transmission of convertible virtual currency cannot be characterized as providing or selling prepaid access because prepaid access is limited to real currencies.” Finally, even exchanges are safe from “foreign exchange” regulation, the set of rules governing businesses that offer exchange between two or more national currencies.

The document continues:

A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter. By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter. In addition, a person is an exchanger and a money transmitter if the person accepts such de – centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.

The first two sentences clearly have to do with miners. What they state is simple: miners that use their bitcoins to buy goods and services are not regulated. However, miners that sell their bitcoins are. That is to say, interpreting these words literally, miners have to register as money transmitters if they are selling their bitcoins. But there is also another interpretation, hinging on the phrase “to another person”. Bitcoin developer Jeff Garzik writes on Reddit, In my non-legal opinion, it seems like miners are ok if they (a) exchange for fiat via a licensed bitcoin exchange, or (b) buy goods and services for bitcoins, staying inside the bitcoin economy. That is, “to another person” may simply refer to selling bitcoins over the counter directly, and if they are selling through a licensed Bitcoin exchange then that Bitcoin exchange’s license carries over to both sides of the transaction. But even if the first interpretation is the one FINCEN intends, it is trivial to bypass; miners can simply spend their earnings instead, using Bitspend to purchase goods in the USD economy with Bitcoin if the Bitcoin economy proper does not satisfy their needs.

The last sentence, however, is quite troubling. Although seemingly tautological, the sentence includes two key words: “money transmitter”. Money transmitter is in fact a technical term used by FINCEN that has a very specific regulatory meaning – a money transmitter needs to get a money transmitted license. These licenses require tens of thousands dollars of capital to acquire in each state, and a money transmitter must get a license in each state whose residents they intend to provide services to; all in all, a very serious roadblock to the United States’ big four exchanges: BitInstant, Coinlab, Coinbase and now Tradehill. The recent Bitcoin ATM project may also fall under the radar. So far, it is not clear what the owners of these services intend to do, and the rate of Bitcoin’s growth in the United States in the months to come will very significantly depend on just how both the exchanges and FINCEN itself will proceed.

Fortunately, payment processors such as BitPay are exempt. BitPay is legally classified as a payment processor, not a money transmitter. Gallippi points to 31 CFR § 1010.100(ff)(5)(ii)(A)–F, a set of FINCEN rules which clarify that “the term money transmitter does not include a person who only … (ii) Acts as a payment processor to facilitate the purchase of, or payment of a bill for, a good or service through a clearance and settlement system by agreement with the creditor or seller.” Becuase BitPay deals financially only with sellers, CEO Tony Gallippi explains, and not with customers, BitPay is in the clear.

Although the requirement for exchanges to get a money transmitter license is highly problematic, for the most part this guidance paper is a positive sign for Bitcoin for one simple reason: Bitcoin itself is now unambiguously legal, and that will not change any time soon. Even though the document does place Bitcoin exchanges under a very significant burden of regulation, what it also means is that nothing worse is going to come. Many organizations, including the popular independent video game collection Humble Indie Bundle, have been hesitant to accept Bitcoin over legal uncertainty, but now that the matter is settled they have no reason to fear; as long as they are not acting as money transmitters for BTC as well, under the new rules they are now fully protected. Although the document does not specifically mention the act of paying salaries in Bitcoin, the words that are there strongly imply that that is nothing more than mere usage as well. On the whole, FINCEN has just cleared the way for previously hesitant businesses and organizations to start experimenting with Bitcoin on a much larger scale.

Yesterday, the Bitcoin network experienced one of the most serious hiccups that we have seen in the past four years. Starting from block 225430, the blockchain literally split into two, with one half of the network adding blocks to one version of the chain, and the other half adding to the other. For the next six hours, there were effectively two Bitcoin networks operating at the same time, each with its own version of the transaction history. The split lasted for 24 blocks or 6 hours, finally resolving itself when one version of the chain conclusively pulled ahead of the other at block 225454, leaving the other chain largely abandoned, with only a small number of miners that are incapable of recognizing what has now become the main chain still mining it, while the bulk of the network quickly returned to normal.

The fork was first noticed at about 23:30 GMT on Monday, March 11, when “thermoman” on the bitcoin-dev IRC channel mentioned that “some client told my client it (the other host) had 225431 blocks, but blockexplorer says that currently the block count is at 225430”. Some other blockchain resources also showed 225430 blocks. Over the course of the next thirty minutes, other users started reporting more strange reports from Bitcoin client logs. Bitcoin developer Peter Wuille (“sipa” on IRC) claimed that he was on block 225435, and then soon 225439, while other sources were still reporting 225431. At 00:00 GMT March 12, sipa posted “I wonder if there’s something that triggered it on the network, a large reorganization or so”. It turned out that a blockchain reorganization, an event that happens when a client discovers a new blockchain longer (and therefore more likely to be valid) than the one it was working with before, and switches to it, was indeed what happened, and over the next few minutes everyone realized what was going on: a blockchain fork.

What had happened was the following. The latest version 0.8 release of bitcoind, by far the most popular implementation of Bitcoin used by miners, switched the database that it used to store blocks and transactions from BerkeleyDB to the more efficient LevelDB as part of an effort to reduce blockchain synchronization time. However, what the developers did not realize at the time was that by doing so they also accidentally introduced a change to the rules of the Bitcoin protocol. In order to make an update to the database, the database process must make a “lock” on the part of the database which stores that particular item of information, a mechanism implemented to prevent two changes from occurring simultaneously and accidentally corrupting the database. In a b-tree, the data structure used by BerkeleyDB to store objects, two locks are required per update. However, BerkeleyDB requires its users to set a limit to the number of locks that can be made at the same time; “If the values are too small,” the FAQ page warns, “requests for locks in an application will fail. If the values are too large, the locking subsystem will consume more resources than is necessary.” In the case of Bitcoin, the limit was 10,000. What happened in block 225430 was that a single block simultaneously affected the status of over 5,000 transactions, requiring more than 10,000 locks on the b-tree to be made at the same time. As a result, the BerkeleyDB failed, and so the older bitcoind 0.7 (and earlier versions) could not read the block. In the case of bitcoind 0.8, LevelDB has no such restrictions, so it could accept such blocks just fine. Because the Bitcoin protocol builds up the transaction history, used primarily to calculate and agree on everyone’s account balances, by creating new blocks representing roughly ten-minute time intervals’ worth of transactions on top of existing valid blocks in a chain (hence, “blockchain”), miners using bitcoind 0.8 started building up a version of the blockchain that included the offending block, while miners using bitcoind 0.7 rejected it and started working on a another blockchain of their own. Ordinary users using BitcoinQt 0.7 or platforms that rely on bitcoind 0.7 as a server saw the 0.7 fork, and everyone else saw the 0.8 fork.

With the fork in progress, the Bitcoin developers had a choice: do they support the 0.8 fork or the 0.7 fork? Ultimately, there could only be one; a monetary system cannot function if there are two different databases of how much money each person has. The 0.8 fork had much more computing power behind it, and was already eight blocks ahead by the time the community could muster any effort toward fixing the problem, and upgrading to 0.8 is something that will have to be done eventually. On the other hand, if the 0.8 fork took over, thousands of users on 0.7 would be forced to upgrade in order to use Bitcoin at all, something which would not happen if the 0.7 fork took over since both versions of bitcoind can read it. The developers quickly settled on 0.7, and the community set to work on the next task: notifying major miners and mining pool operators of what they need to do.

Over the next few hours, nearly every major Bitcoin developer and mining pool operator joined the bitcoin-dev IRC channel. Major mining pools that were using bitcoind 0.8 shut down, downgraded to 0.7, and switched back on. Merchants were also notified; most large businesses, including BitcoinStore, BitPay, SatoshiDice and MtGox, shut down deposits to protect themselves from double spend attacks. BitPay quickly turned themselves back on once their servers were on the 0.7 fork; “safe mode alerted us there’s a problem,” BitPay’s Tony Gallippi writes. “That’s when Steve jumped on IRC to see where the consensus was going, and we were back in business very quickly.” Progress on switching hash power to 0.8 appeared to be slow at first, and at block 225451, the 0.8 chain was 13 blocks longer than 0.7. But that was the furthest that the 0.8 chain would get ahead. By then, the two chains were growing roughly in lockstep, and at about 03:30 the tipping point came. The 0.7 chain quickly caught up to being only 10 blocks behind, then 8 blocks, and at 06:19 both chains converged to the same length at block 225454, leading to nearly all remaining miners abandoning the other.

This incident will go down in history as one of the closest moments that we have come to the underlying Bitcoin protocol actually failing. But it is not the most serious breach ever made. In August 2010, a transaction in block 74638 contained two outputs summing to over 184 billion – just over 2^64 satoshis. The result was an integer overflow bug, the digital equivalent of a mechanical odometer wrapping around to zero after the car drives 999,999 kilometers. The overflow caused the software to think that the transaction contained only a small amount of BTC while in reality the outputs together had thousands of times more than the 21 million that should ever exist. A new version of the Bitcoin software had to be published, the blockchain was forked, and a new, valid, chain overtook the old one at block 74691 – 53 blocks after the original fork. This time, it only took 24 blocks, and it was not even a life-critical threat to the system – if the developers had done nothing, then Bitcoin would have carried on nonetheless, only causing inconvenience to those bitcoind and BitcoinQt users who were on 0.7 and would have had to upgrade. The economic damage was significant, but fairly small; the only monetary losses that have been reported are the $26,000 USD worth of mining block rewards from the 24 mined blocks of 25 BTC that are now forever lost in the now abandoned chain, as well as a $10,000 double spend against OKPay. Aside from the lost mining revenue and this double spend, transactions were not affected and no bitcoins were “lost”; any transaction that was included in the now abandoneded chain was included in the new chain as well, so any bitcoins that were spent during the fork are now at their proper destinations.

In a way, this was the best possible time for such a thing to happen. The Bitcoin price was on a steady uptrend, and so the 24% drop in price that occurred at the time of the incident was quickly reversed, and as of the time of this writing Bitcoin stands at $44-$46, down from $48 the day earlier but up from $36 one week before. Public media attention on Bitcoin is very much positive, and rather than attacking Bitcoin as they would have in 2011 many journalists actually praised the Bitcoin development team on their rapid response. Ars Technica’s Timothy B Lee wrote a neutral piece on the event, writing that “the incident will be an important test of the cryptocurrency’s decentralized governance structure”, and an article at ecurrency.ec on the subject was entitled “Bitcoin software bug has been rapidly resolved”.

However, the incident opens up serious questions about the nature of the Bitcoin protocol, and puts into the spotlight some uncomfortable facts about Bitcoin’s notion of “decentralization”. Most security protocols, including encryption algorithms, hash algorithms and full-scale protocols, have dozens of implementations in many different programming languages, and the protocol specification is determined by a clear standard against which any individual implementation can be checked for compliance. In the case of Bitcoin, however, things are different. Although there is technically a standard on the Bitcoin wiki pages, it has at times been poorly updates, and the reality is that the bitcoind implementation is the standard, and nearly all miners on the Bitcoin network are using some version of it. There are a few alternative implementations, the most complete one being Amir Taaki’s libbitcoin, with Mike Hearn’s BitcoinJ (written in Java) close behind, but so far they have gained very little traction in use with mining, and, what’s more, there is a small portion of the Bitcoin development community which is actively against the idea of using multiple codebases.

Fortunately, most Bitcoin developers do not support this viewpoint, although many have come out in favor of keeping a healthy level of prudence. Mike Hearn wrote the following on the Bitcointalk forums in June 2011:

Gavin wrote to me only days after the BitCoinJ release to tell me how happy he was to see an alternative implementation. Satoshi expressed very similar sentiments. Nobody is against alternative implementations.
What some people, especially Satoshi, have said is that there’s an unusual amount of risk involved with reimplementing the full system and using that reimplementation to mine. Bitcoin is very complex and if you aren’t skilled and very thorough you are likely to diverge from its behavior in small, hard to detect ways. This can fork the chain and split the economy. It’s one of the few things that could instantly kill Bitcoin beyond legal harassment of its users.

Lead Bitcoin developer Gavin Andresen replied to another poster in the same thread: “Really? I’ve been encouraging alternative implementations, who is the power-hungry core developer?”, and in November 2012 he wrote in a Bitcoin Foundation update that “part of the solution is to encourage alternative implementations that make different trust/convenience tradeoffs than the reference implementation. There has been a lot of behind-the-scenes work on cross-implementation testing (the “testnet3″ blockchain contains hundreds of transaction validation test cases, for example), and new features are being added to the protocol to support alternative implementations”

But alternative implementations are not just useful for supporting different trust/convenience tradeoffs. They are also crucial in making Bitcoin’s claim of decentralization a reality. If there had instead been five distinct Bitcoin implementation in use at the time of the fork, what would have happened is that one of the five would have recognized the wrong blockchain and forked off, leading to a loss of revenue for a small number of miners and requiring the users of clients using that implementation to upgrade. The aberrant implementation’s fork of the blockchain would end up much weaker than the others right from the start, so the risk of double spend attacks would be minimal. One can argue that there will be a greater number of forking incidents with more implementations, but each one will be smaller in effect, and testing all implementations together on the testnet before release would reduce the number of bugs that slip into production software to about the same frequency as we see today.

The other aspect of Bitcoin’s decentralization that this incident calls into question is that of mining pools. The reason why the controlled switch to the 0.7 fork was even possible was that over 70% of the Bitcoin network’s hash power was controlled by a small number of mining pools and ASIC miners, and so the miners could all be individually contacted and convinced to immediately downgrade. Another article on the fork reads [Russian]: “the real problem is not even in the code supporting the Bitcoin network; bugs are everywhere. Rather, it’s the matter of who controls it. This event clearly showed that even such a well thought-out system is controlled by the will of a very small number of people – particularly, the operators of mining pools. Over 70% of new blocks right now are being found on pools, and not on individual solo miners. The underlying idea of the system was that the benevolent majority can stop a small number of attackers, but in the present time it is simply not working. The winner in a possible takeover will be the one with greater computing power, and no one else.” Bitcoin is clearly not at all the direct democracy that many of its early adherents imagined, and, some worry, if a centralized core of the Bitcoin community is powerful enough to successfully undertake these emergency measures to set right the Bitcoin blockchain, what else is it powerful enough to do? Force double spends to reverse million-dollar thefts? Block or even redirect transactions known to originate from Silk Road? Perhaps even modify Bitcoin’s sacred 21 million currency supply limit?

However, a strong argument can be made that such fears are very unlikely to materialize. The reason why has nothing to do with the specific identities of the Bitcoin mining pool operators or the cohesiveness of the Bitcoin mining community; rather, it’s the fact that Bitcoin mining is still in fact quite decentralized; it simply is decentralized in a different way. Taking a political analogy, the closest equivalent would be a liquid democracy: a hybrid of direct and representative democracy where people can either vote for individual bills by themselves or assign politicians – with the proviso that if they do not like what a given politician is doing they can switch to assigning their voting power to someone else at any time. Back in the world of Bitcoin, although much of the Bitcoin network’s hash power is concentrated with mining pool operators in practice, every individual miner can switch from one pool to another almost instantly, so if a coalition of mining pool operators decides to start violating the Bitcoin protocol miners can simply switch to any pool that remains honest, instantly depriving the miscreants of their power. Although no mining pool has attempted to actively subvert the Bitcoin protocol so far, this kind of “voting” has been done before; in 2011, there were several incidents where the mining pool Deepbit pushed above 50% of the total network hash power, and in each case there was a mass exodus of miners toward other pools to balance things out. Although the nominal power may rest with the mining pool operators, the feedback of the community is always only one step away.

Altogether, the incident was handled very well, and all parts of the Bitcoin community should congratulate themselves for their speedy resolution of the problem and their unconditional cooperation. The Bitcoin community is not always in perfect harmony; Bitcoin gambling site SatoshiDice and a number of Bitcoin developers, notably Luke Dashjr, are usually at odds over concerns that SatoshiDice’s large transaction count is bloating the Bitcoin blockchain, but yesterday differences were laid aside as the community worked together to solve the problem. We also learned a lot, and merchants are likely to be much more prepared for such incidents in the future, perhaps implementing techniques like automatic fork detection to handle forks and avoid double spends without immediate manual intervention. Before today, many people knew that some test for the Bitcoin network would come, whether at the 1 MB block size limit or else where, but just how the community would handle such a thing was an unknown. Now, the test has come and gone, and how the Bitcoin community handled the test is known to everyone: we passed with flying colors.

One of the greatest technical challenges in working with Bitcoin has always been finding an effective way to secure it. Although financial security is a serious and complex issue regardless of the underlying financial system that is being used, warranting billions of dollars of spending on the part of major banks every year, in the case of Bitcoin the scale is tipped in favor of the attacker even more than it normally is. There are two key factors that contribute to this: irreversibility and anonymity. Irreversibility means that transactions, once completed, cannot be reversed, so if a Bitcoin exchange is hacked there is no way to force the money back automatically as might be possible under a centrally controlled banking system. Anonymity means that there is no way to tell who or where the thief is physically through the financial system, leaving investigators with very little evidence to work with (although on one prominent occasion a $310,000 thief was caught through other means). Although Bitcoin is technically far more secure than most other financial systems available, in practice its digitally slippery nature means that even the tiniest security flaw in implementation is magnified greatly, and so it is only with services that are quite secure by themselves do Bitcoin’s advantages truly shine through And, over the past two years, we have seen a number of very painful reminders that we are simply not there yet. A list of top 20 Bitcoin heists exists on the Bitcointalk forums, showing a number of incidents in which tens or even hundreds of thousands of dollars were suddenly whisked away, leaving entire companies nearly, or totally, bankrupt in an instant.

Even more so than black market activity, such security breaches have arguably been the largest stain on Bitcoin’s reputation. A MtGox hack in June 2011, in which the currency’s price appeared to drop from $17.50 to $0.01 within a day (although it is highly misleading to say that it actually did drop to $0.01), is one of the most often cited incidents by journalists attacking Bitcoin, and for many the various security incidents of 2012 have only strengthened the negative impression originally set by the series of security breaches that the summer of 2011 brought. Even Bitcoin’s core developers admit that the currency won’t be truly ready for the masses until the security problem is solved.

In the past two weeks, however, three incidents took place which provide a convincing argument that we are well on the way to getting there. The first is, perhaps counterintuitively, another theft. On March 4, BitInstant announced that an unknown intruder had gained access to their VirWox account and made a series of withdrawals to three unknown addresses, presumably their own. The total amount lost: $12,480. Not $1.1 million, like the MyBitcoin scam of 2012, not $90,000 to $310,000 like the four major 2012 thefts from Bitcoinica and BitFloor, and not even the $15,000 that was the size of the February 2012 Bitcoinica theft that almost no one has even heard of, but simply $12,000 – only a rounding error for a corporation of BitInstant’s size. But it wasn’t just the fact that the incident was small that is surprising, but rather what the attacker did to get the money.

BitInstant writes on their blog:

The attacker contacted our domain registrar at Site5 posing as me and using a very similar email address as mine, they did so by proxying through a network owned by a haulage company in the UK whom I suspect are innocent victims the same as ourselves. Armed with knowledge of my place of birth and mother’s maiden name alone (both facts easy to locate on the public record) they convinced Site5 staff to add their email address to the account and make it the primary login (this prevented us from deleting it from the account). We immediately realized what was going on, and logged in to change the information back. After changing this info and locking the attacker out, overnight he was able to revert my changes and point our website somewhere else. Site5 is denying any damages, but we suspect this was partly their fault.
After gaining access, they redirected DNS by pointing the nameservers to hetzner.de in germany, they used hetzner’s nameservers to redirect traffic to a hosting provider in ukraine. By doing this, he locked out both my login and Gareths’s login and they used this to hijack our emails and reset the login for one exchange (VirWox), enabling them to gain access and steal $12,480 USD worth of BTC. No other exchanges were affected due to either Mult Factor Authentication, OTP, Yubikey’s and auto lockdowns.

BitInstant have since learned their lesson, and are now using multifactor authentication for their VirWoX account as well.

Now, compare what it took to steal $310,000 from Bitcoinica last July:

Unbeknownst to us, Tihan was using the mtgox api key as the password for a website called LastPass … Whoever is responsible for the latest theft used the MtGox API key as a password in LastPass hoping that simple security measures were not followed in the setting up of the LastPass. They gained access to MtGox. They transferred a third of the refund money, presumably to themselves.

The MtGox API key was made public in a source code leak a few days before the hack, an enterprising digital hacker decided to try the key as a password on LastPass, and, voilà, the thief earned himself a small fortune. In the case of BitInstant, on the other hand, it took a complex procedure including a form of domain spoofing and social engineering to get anywhere, and the profits were over twenty times smaller. The flaws that the attacker used were not unique to Bitcoin; these are attacks that can be used against businesses no matter what industry they happen to be in, and in the case of social engineering even those that have nothing to do with the internet are not secure. If BitInstant’s defenses after this hack represent anything less than top-notch security, then it is safe to say that pretty much no one is secure.

The second development in Bitcoin security comes from Exante’s recently announced Bitcoin Fund, a Malta-based hedge fund that intends to open the door for institutional investors to enter the Bitcoin markets. The fund will also be the first professionally developed way for investors to trade bitcoins on margin, long and short, and the shorting functionality in particular may turn out to be a significant boon for Bitcoin’s stability.

But the maintennance of such a fund poses a significant security challenge. Exante is in possession of $3 million worth of bitcoins, and if the bitcoins are lost or stolen the fund will have no choice but to shut down in an instant. Exante, however, has risen up to the challenge, and the security measures that they describe are impressive. First of all, the private keys themselves, stored in a BitcoinQt wallet.dat, are encrypted with AES256. The data is then stored in a TrueCrypt container on three flash drives. The container password is then split into three parts using a mechanism known as Shamir’s Secret Sharing. The way basic 2-of-3 sharing works is this: suppose you are trying to hide a secret value, x. Pick a random y, on about the same scale as x. Write down three numbers in three separate places: x-y, y and x+y. Obviously, no single piece by itself will help you find x. However, if you have any two of them, it’s very easy to combine them in order to get x back, either directly by adding or subtracting y or indirectly by taking (x-y)+(x+y)=2x and then dividing by 2 to find x. Shamir’s Secret Sharing is a clever mathematical generalization of this; for example, you can “split” a number into 15 pieces such that any 9 of them (but no 8 of them) are enough to get the original number back. This provides security against theft and redundancy of loss at the same time. Strictly speaking, SSS is unnecessary; multisignature transactions accomplish the same thing using the scripting power of the Bitcoin protocol directly. However, it is effective, and is used to store critical data like root SSL certificate authority private keys, which can cause millions of dollars of damage if leaked. Finally, each flash drive is duplicated several times and the pieces are stored in three separate jurisdictions.

This is the security setup that the team at Exante has deemed strong enough to store millions of dollars of bitcoins securely. This is the gold standard that all major Bitcoin businesses that handle such large quantities of customer funds can aspire to, and it provides a level of security comparable to that used to store data or physical objects tens or even hundreds of times greater in value. Most businesses will, of course, not need nearly so much protection; this level of security is reserved for high-level financial services, but what is important is that, for the first time, a group of professional, internationally trusted and established hedge fund managers has decided that Bitcoin can be made secure enough to be taken seriously.

BIPS tape archival unit

Finally, we also have another development in Bitcoin security, this time coming from within the existing Bitcoin community: BIPS. The new merchant platform from WalletBit includes a number of upgrades, including significant improvements in usability and, in some cases, lower fees than BitPay, but where BIPS truly stands out is in its security. Like all other major merchant services and exchanges, BIPS keeps most of its funds in cold storage. Its cold storage platform, however, is one of the most advanced that have ever been implemented for use with BTC. BIPS’ Kris Henriksen writes, “without revealing to much of our infrastructure, we backup to 1 SAN (12 WD Red harddrives), 2 NAS (5 WD RED drives) all running raid 6, and then from there to the robotic tape library”, and director of marketing Adam Harding adds “BIPS follows the same security practices as WalletBit and even more so. This includes regular tape backups of every server stored in a fire proof faraday cage under lock and key. This is the same feature we offer for our cold storage with an additional password only the user knows but in the event of a global EMP, the bitcoind is backed up every hour.” Tape backups are a method of data archival that, Harding adds, “is the most reliable backup method out there and still used by every major organization.” The tapes themselves are stored in a datacenter in Denmark, although the hard drive backups ensure that there is no single point of failure against loss. BIPS’ security scheme is not quite as impressive as that created by Exante; a form of secret sharing is technically used in the RAID 6 implementation, but multi-jurisdiction or even multi-location storage is not yet something that BIPS have implemented. However, for the tiny startup that BIPS is, the setup is quite impressive.

What all of this shows is that Bitcoin security is now being taken very seriously, and established Bitcoin businesses have developed comprehensive security policies and physical systems that are proving increasingly effective against attack. There are still details to be ironed out; two months ago, another Bitcoin exchange lost its funds primarily due to a disappeared shareholder with sole access to the cold storage USB, and mechanisms for Bitcoin exchanges to demonstrate solvency and possession of full reserves to their customers are another improvement that may be needed in the future. However, what Bitcoin users, detractors and journalists need to realize is that we are no longer living in 2011 or 2012. Most of the businesses that were insecure have now been weeded out by natural selection and, as for those that remain, the greater attention to Bitcoin paid by established players like Exante and the Silicon Valley investors in Coinbase and BitPay is ensuring that services run by trustworthy individuals with established reputations on the line are available. Over the course of this past year, although the size of the Bitcoin economy has grown by a factor of ten the total volume of hacks and thefts has actually considerably gone down. Although security will never be a solved problem either in the world of Bitcoin or anywhere else, the crippling hurdle that turned so many away from Bitcoin in 2011 and 2012 is now well past us.

Adam Harding and Kris Henriksen, the two people currently in charge of the popular Bitcoin payment processing platform WalletBit, have come up with a new and improved merchant platform: BIPS. BIPS brings a number of improvements over WalletBit including a new user interface, an easy-to-use REST API for interacting with the service automatically and, most importantly, no fees for the basic Bitcoin service. Instead, BIPS will make its money on a variety of complementary services, including user-encrypted cold storage, having fees automatically deposited to one’s bank account, and having one’s funds automatically converted to USD on MtGox to insure against sudden drops in the Bitcoin price.

BIPS is not the first service to make such an offer; basic Bitcoin payment processing with MtGox or Coinbase has been free for months, and using MtGox directly will be cheaper than doing so through BIPS and paying its 0.89% fee. BIPS will be cheaper than BitPay for merchants [NOTE: On 25 March 2013 BitPay lowered their fees to 0.99% for both processing bitcoins and if the funds are converted into fiat currencies] converting to fiat currency, with a conversion fee of 2.50% internationally (although not cheaper than Coinbase’s 1% in the US), but for merchants who intend to receive Bitcoin directly it may be difficult to see why merchants should use BIPS instead of Coinbase or MtGox. But where BIPS intends to make up for the costs that it does have is ease of use. Its API services are very easy to work with; BIPS shows on their front page how to construct a URL to create an invoice, and in the merchant section it features a simple form in which you enter a callback URL and an optional “secret” parameter, and any payments that a customer makes will automatically lead to a notification being sent to the URL. Actually handling callback URLs and knowing when to make invoices is still the responsibility of the merchant, but BIPS makes the merchant integration side as easy as possible. More features will soon be added, including API calls to send money to a Bitcoin address, phone or email address, and aside from the planned API upgrades there will also soon be options like exporting transactions to an Excel spreadsheet. Like WalletBit, BIPS also provides an e-wallet, and there too it intends to make the experience as easy as possible. Users can sign in using Google, Twitter or Facebook and be logged into their wallet already as they browse the internet. For merchants, BIPS has a mobile checkout application available already. “We hope to provide the best checkout experience for customers using bitcoin to pay,” Henriksen writes, “and the best experience for merchant as a merchant bitcoin gateway.”

BIPS brings the same level of security as WalletBit, and in many cases even greater. Multifactor authentication is available in the form of Google Authenticator and WalletBit’s SecureCard, a matrix of letters and numbers that can be printed out on a piece of paper that the login process asks for a specific cell from. On Monday, BIPS will also add IP guard, limiting account access to specific IP addresses. On the server side, BIPS will store the majority of merchants’ funds in cold storage, backing it up to over a dozen hard drives running RAID 6 as well as archival tape, and the rest on a hot wallet to handle withdrawals. The exact percentage of funds placed into cold storage is based on an algorithm first used at WalletBit, which attempts to predict how much money merchants are likely to withdraw. Currently, Henriksen is unable to give an exact number for the percentage of merchants’ bitcoins that will be placed in cold storage, although the more merchants BIPS can sign up the closer to 100% this value will be. There is also another option of 100% user-encrypted cold storage, at a cost of 0.89%, in which you supply a password with which your wallet is encrypted client-side, and then stored by BIPS in the same cold-storage facility as that used by regular cold storage with the added protection that even they cannot access your funds. Starting Monday, merchants will also be able to have your merchant revenue sent directly to this cold storage.

WalletBit is not disappearing; the old service is still available at walletbit.com for those who want to use it. However, for new merchants there is no reason to use it instead of BIPS and Henriksen hopes that users will see the benefit in switching to BIPS. WalletBit’s eWallet, however, will soon be removed, although it will not be missed by many; the 0.89% fee on the wallet unfortunately turned most potential users away. BIPS’s wallet service is free, so it will hopefully find much more usage. BIPS already has several merchants in the works, and further announcements from BIPS on the topic are soon to come.

Bitcoin’s largest payment processor, BitPay, has announced that they have added a new feature to their array of merchant services: integration with Fulfillment by Amazon. Fulfillment by Amazon is a service which allows any business with inventory in Amazon’s warehouses the ability to sell the products on their own website, and then have Amazon automatically ship them to the buyer’s address. The service is available to merchants in the USA, UK, Germany, France, Italy, and Spain, although it can be used to ship worldwide.

Services like FBA are rapidly closing the gap between small businesses and large ones, giving even merchants with only a few thousand dollars of annual revenue access to world-class shipping services of the same quality as that available to major retailers. FBA merchants’ customers even benefit from programs like Super Saver Shipping. Amazon also handles customer support, freeing small business owners to work on their product, and not their logistics. The program is quite expensive, but FBA users argue that without FBA they would be paying high costs on shipping and customer service anyway, and doing a poorer job at the same time.

What BitPay is now offering is direct integration with the platform – that is, whenever an order is paid through BitPay, BitPay automatically notifies Amazon of the order. Thus, Bitcoin businesses no longer need to deal with Amazon integration themselves. Bitcoin Magazine itself has been using the service for weeks, and has been very satisfied. “Adding BitPay’s plugin to our webstore, which is based on WordPress, has dramatically improved our logistics,” Bitcoin Magazine’s Mihai Alisie reports. “When orders get paid through BitPay, Amazon’s servers are automatically notified, and our admin screen is updated with the correct status. PayPal does not offer the same service that BitPay can, so we have to manually process any orders which are paid through PayPal.”

PayPal may well add FBA to their offerings soon, but what this shows is that Bitcoin businesses like BitPay are now advanced enough to be competitive with their non-Bitcoin offerings. BitPay is not the first business to have come this far; Bitcoin precious metals seller Coinabul has been known industry-wide for months for its speed and reliability. “Conventional gold dealers are terrible at building websites,” Coinabul’s Jon Holmquist explains. The Bitcoin community’s technical skill has proven to be a very valuable asset, and for both Coinabul and BitPay it appears to be paying off. Thanks to its latest two rounds of venture capital funding, BitPay has been able to considerably expand its staff, and will be expanding its range of offerings quickly in the months to come. For now, this is yet another small step toward making Bitcoin possibly even the preferred payment method for e-commerce businesses to start accepting payment.

Today, Namecheap has announced that they, like WordPress, Reddit and Mega before them, are now accepting Bitcoin as payment for their services. Namecheap is most well-known as a domain name registrar, offering domain registration services for as low as $3.99 per year (compared to GoDaddy’s $10-$15 per year), but they also sell a number of other web services, including web hosting, virtual private servers and SSL certificates, and are ranked by Alexa as the 927th most visited site in the world, making them the fifth most popular website after WordPress, Reddit, the Internet Archive and 4Chan to accept Bitcoin.

Just like WordPress, Namecheap’s reasons for accepting Bitcoin are primarily political in nature. As Namecheap community manager Tamar Weinberg wrote, “We’re a freedom loving registrar. We donated over $100,000 to the Electronic Frontier Foundation to help keep the fight for internet freedom alive with the introduction of SOPA and CISPA. Our pride is our customers, and we are completely focused on doing what it takes to make you happy That’s why we’re integrating Bitcoin: you’ve asked, and we’ve answered.” The domain registration business may appear to be too low-level and utility-like to support such ideological preferences, but the industry took a decidedly political turn in December 2011 when the US government attempted to pass the Stop Online Piracy Act (SOPA), a law which, detractors argue, would have effectively made sites hosting user-generated content like Reddit and YouTube illegal. GoDaddy was discovered to be one of the supporters of the law, and so a grass-roots, large-scale internet-organized boycott ensued. GoDaddy was quickly forced to backpedal on its support of the law, with CEO Warren Adleman expressing the non-committal position that “fighting online piracy is of the utmost importance, which is why GoDaddy has been working to help craft revisions to this legislation – but we can clearly do better.” However, the damage to GoDaddy’s reputation was irreversible. At the same time, the potential for domain takedowns to be used as a mechanism for governments like that of the United States to enforce laws outside of its own borders quickly became clear, and “freedom-friendly” businesses in a number of internet-related industries have either emerged or gained considerable publicity since then – Namecheap included.

Namecheap is not the first company to offer domain registration services or web hosting and virtual private servers for Bitcoin; Zhou Tong’s NameTerrific and the VPS provider VPS6 have been providing those two services, respectively, for nearly a year. However, the fact that existing businesses that already have a significant foothold in their respective industries are now starting to accept Bitcoin is something completely different. In a small, but rapidly growing number of fields, Bitcoin is already a force to be reckoned with. Several days ago, TorrentFreak released an article that showed that over half of all major VPN providers are now accepting Bitcoin. Although market-leading domain registrar GoDaddy will likely be one of the last companies to accept the “currency of online freedom”, Namecheap is an official reseller of the second largest registrar, eNom, and so through Namecheap Bitcoin is now accepted by the second largest registrar in the market. Far from a scattered collection of hobby businesses, this represents serious market penetration in industries that matter. If WordPress was Bitcoin’s first foothold in the mainstream, the web services industry may well become its first fully conquered territory.

Bitcoin’s largest payment processor, BitPay, has announced that they have received another round of funding from a group of angel investors. The investors include Trace Mayer, well known in the Bitcoin community for his reporting on economics and finance, as well as his privacy guide and ebook How to Vanish, Ben Davenport, co-founder of Beluga Inc and angel investor, and A-Grade Investments, a venture capital firm co-founded by Ashton Kutcher. This latest investment will bolster another round of funding made two months previously, in which private venture capital investors Barry Silbert, Shakil Khan, Jimmy Furland and Roger Ver brought a total of $510,000 into the company. BitPay has chosen not to disclose the size of this latest round, although CEO Tony Gallippi has stated that the money will be used to expand the company’s hiring in Atlanta.

This is only the latest in a series of investments into businesses in the Bitcoin community, continuing a trend that started roughly one year ago with a $500,000 investment into Coinlab in April 2012, soon followed by $600,000 for Coinbase in September. As Ben Davenport explains, this is not a coincidence.

“Bitcoin businesses,” Davenport writes, “until recently, have largely been bootstrapped. The reason is, until recently, when an angel or VC has looked at Bitcoin businesses, they saw a currency with a total market cap of about $150 million. That’s too small a total addressable market to be interesting. And if an investor is savvy enough to see the potential for Bitcoin itself, then they also realize they can capture that upside without the business risk, simply by buying bitcoin. Now though, we’re getting to the size where an investment in an amazing, well-positioned team like the guys at BitPay makes a lot of sense, and will also ultimately help increase the overall Bitcoin adoption rate. I predict we’ll see the VC flood gates open within 12-18 months — I’m just trying to be a little bit ahead of the curve there.”

Late 2012 has been a pivotal period for Bitcoin. Although the main indicator of the “financial” size of Bitcoin, the Bitcoin price, is now barely higher than it was at its peak in the beginning of June 2011, the key difference between Bitcoin’s rise in price now and its bubble then is that in 2011 the Bitcoin markets’ trade volume was backed almost entirely by speculation. The rise to $31.9 in June was triggered by a massive spike in public attention following a series of news articles in the mainstream media introducing many thousands of people to Bitcoin for the first time, and genuine adoption was slow to catch up. The June 2011 bubble quickly popped, but at the same time a number of Bitcoin businesses, BitPay included, began to emerge, and about one year later many of them finally started to come to fruition. In parallel, grassroots adoption of Bitcoin continued to grow, and now, slowly but surely, investors are starting to notice. Davenport’s words are thus a very positive sign for Bitcoin; investors interested in Bitcoin are starting to look beyond the Bitcoin markets, and are instead increasingly focusing their eyes on the underlying Bitcoin economy – substituting mere speculation with increasing investment into the businesses that make both Bitcoin adoption and the Bitcoin price go up in the first place.

BitPay themselves now have over 3,000 merchants, and the company is continuing to develop both their core product and a number of peripheral offerings, including plugins, applications for specific industries and a platform to help businesses and organizations pay employees in Bitcoin. The company’s new office in Atlanta is located at the heart of one of the major financial capitals in the United States, allowing them to hire developers experienced in dealing with online payments, and with a larger staff the company will be able to recruit merchants as an even higher rate than they are currently. The company appears to have a very bright future ahead.