Magazine article Risk Management

Making Cents of Bitcoin

Magazine article Risk Management

Making Cents of Bitcoin

Article excerpt

In a single week this winter, more than $471 million was stolen from thousands of investors around the world.

So why has no government or insurance body investigated the losses or reimbursed the victims? Because it was stolen in bitcoin. No government has jurisdiction over the digital currency--and most have no plans or desire to.

On Feb. 24, one of the biggest bitcoin exchanges, Japan-based Mt. Gox, suddenly went offline after highly public technical glitches allowed irreversible overpayments. CEO Mark Karpeles disappeared, reemerging four days later as the company filed for bankruptcy protection in Japan, confirming rumors that the exchange had lost almost 750,000 of customers' bitcoins and approximately 100,000 of its own. This figure represents 7% of all bitcoins in circulation, totaling more than $470 million.

Within a week, another "bitcoin bank," Flexcoin, was forced to close after hackers stole 896 bitcoin, worth over $590,000. Lacking the resources to recover from the loss, the site closed immediately. Smaller firm Poloniex also acknowledged a hack the same day. While 12.3% of its reserves were stolen, the company committed to operating at a fractional reserve until it makes up the losses, and the owner even pledged personal funds to help speed the process.

A Currency on the Rise

Three-quarters of Americans are unfamiliar with bitcoin, according to a study by TheStreet and research firm GfK, and almost 80% said they would not consider using it. Yet, in the six years since its introduction, the digital currency has grown exponentially, both in terms of value and marketshare. Total market capacity has reached about $10.4 billion, CoinDesk reports, which puts it on a level with smaller currency markets like the Hungarian forint. Not bad for the relatively recent invention of technophiles and libertarians.

Bitcoin is a peer-to-peer digital currency that is sent and stored in digital wallet software. It is earned in exchange for ordinary goods and services or "mined" by individuals who dedicate vast amounts of their own computer power to complete complex calculations that help monitor transactions throughout the market. In exchange, they earn a small portion of transaction fees or freshly minted bitcoins.

Public and press interest led a range of companies, from Overstock.com to Tesla Motors, to begin accepting the currency for commercial transactions. Lower transaction costs than traditional credit cards and banks increase the currency's appeal to ordinary consumers. Its meteoric rise in value has also drawn the attention of hedge funds and private investors, who have begun to purchase or mine for personal use. This is also advancing a cottage industry that seeks to build more powerful computers to complete the complex mathematical problems that earn bitcoins.

In the past year, a flurry of speculation led to tremendous price volatility. Technical glitches in the online marketplaces that trade bitcoin have created further uncertainty among prospective investors. In March 2013, a single bitcoin was worth about $30. By December, that figure had increased 3,900% to just over $1,200, then plummeted to about $550 by the beginning of March 2014. Prices also experience wild fluctuation both during the day and across different markets.

But the traits that made bitcoin grow have also inhibited its reach. Identified by unique number keys made anonymous through cryptography, each bitcoin is tracked in the marketplace. Users are not, however, allowing for anonymity that appeals to both privacy advocates and criminal enterprises. After its introduction in 2009, bitcoin quickly became a key currency for the online black market, offering international value without ties to any government's regulatory system or formal taxing authority. In October, when the FBI shut down the Deep Web drug market Silk Road, which used the digital currency exclusively, it seized 114,000 bitcoins worth $28. …

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