Patrick Lambert looks into the tumultuous world of Bitcoins and recent threats to the virtual currency system.
If you have been following the Bitcoin landscape these past few weeks, you may have noticed the incredible spike of interest in this virtual currency. For those not in the know, Bitcoin is a virtual currency system that is not controlled by any government or central authority. Instead, it relies on algorithmic models to control the flow of new currencies coming in the market; it is completely public and as such, transactions can be verified, yet it relies on anonymous addresses in order to exchange funds, which makes it very appealing for underground movements, crime gangs, and others who want to avoid government oversight. While its use as a tax evasion tool is undeniable, it also has a lot of advantages that everyday people could be greatly interested in, such as the lack of artificial inflation, the fact that it does not rely on the performance of one nation, and the advantage of keeping your own money in a wallet instead of trusting a bank.
But while interest in Bitcoin peaked since the Cyprus financial crisis, bringing the value of a single Bitcoin from $60 just a few weeks ago to an impressive $143 right now, not everything is on the way up for the new currency. Some of its very design decisions make it vulnerable to undue influences, and the fact that it is still a brand new world means mistakes can happen. This week alone, three major stories came out that impacted Bitcoin. First, Mt Gox announced that it was fighting a Distributed Denial of Service attack. A DDoS is common on the Internet, but the problem with Bitcoin is that right now the Mt Gox site is by far the largest exchange and trading post available. If the site goes down, or is being slowed, then that has a major impact on the currency itself. Bitcoin went down almost 20% in a few days after the announcement.
Almost at the same time, another popular service had bad news to announce. The Instawallet service, a site that provides a free, anonymous way to transfer coins, announced that its server had been hacked and has suspended all activities. This means anyone who had money in those online wallets may have lost it. A message on the site has since asked people who had large sums to contact the site owner for a resolution. Finally, news also came out that botnets had new malware that were turning them into coin mining slaves. No longer are criminals interested in infecting your computer solely to send spam, but now mining coins is profitable enough to become a viable activity.
Of course, all of this is not to say that Bitcoin as a whole is something to avoid. The potential for money making is undeniable. Just three years ago a single Bitcoin was worth just a few dollars. Think how much you would have made had you bought a hundred Bitcoins then, and sold them this week at the current value, making 100x profit. But without going into a financial debate, many economists consider Bitcoin to be a speculative bubble, where the value is going up much faster than the amount of actual transactions being done.
How to protect your coins
But for us, the important concern is security. Bitcoin has some nice advantages on this front, but it does require that you understand a bit about the process, and take care to make the necessary arrangements. With normal currency, we don't of course, walk around with all of our money in our pockets - we rely on credit/debit cards, or bank statements, backed by a promise from a financial institution that your money is secure, with a further promise that it is government-insured. Bitcoin is not like that. You have to think of it like cash. Your wallet is just as important as a real life wallet, and if you lose it, then the coins in it are lost as well. Think to yourself, would you roam around with a thousand bucks in your wallet? Probably not. But if you hold just a couple of coins in your virtual wallet, this is in essence what you are doing. So you need secure it.
There are two ways to store coins. You can use an online wallet like Mt Gox or Instawallet, or you can download a desktop client and store them locally. Every Bitcoin client has the option to back up your wallet, because it's really just a file, typically named wallet.dat, in your documents folder. This is the file that contains your cryptographic key that accesses those coins. If you have any important amount in your wallet, you should back it up to a secure location like a USB key. You could even print it out. Another popular option is to use multiple wallets, one for common transactions, and one for storage.
Another important concept with Bitcoin is that your wallet can have a large number of addresses. You can create new addresses for every transaction, and make tracing impossible that way. Remember, however, that if you do not do that, because Bitcoin is public, everyone can know who you transfer money to. Finally, merchants should be careful when dealing with Bitcoins. It may be tempting to start offering your goods or services in exchange for coins, but as you saw this week, the value of this currency changes very quickly, based on speculations. Not only are coins easy to lose if you are not careful with your wallet, but the value changes quickly as well. With attacks on the various parts of the Bitcoin community that we saw recently, you should tread carefully should you want to explore the world of Bitcoins.