Digital Gold Rush: The Bitcoin Boom and Its Many Risks

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In the early days, anyone could use their home computer to mine bitcoins, but now the market is dominated by professionals. Zoom
DPA

In the early days, anyone could use their home computer to mine bitcoins, but now the market is dominated by professionals.

In the midst of the euro crisis, particularly daring investors are putting their faith in the Internet currency bitcoin. A boom in the virtual coins has made some into millionaires. But central bankers are wary of its potential, and the currency is everything but crash-proof.

A somewhat different brand of speculators celebrated an unexpected bonanza last Thursday evening at Room 77, a Berlin bar. Nerds and activists in T-shirts and sneakers got together at the bar in the Kreuzberg neighborhood, which offers live music, "warm beer, cold women," according to the sign outside, and a burger called the "Fidel Castro." They paid their tabs with the source of their newfound prosperity: bitcoins, an alternative currency from the Internet.

"Almost every day, someone comes up to the bar here and pays with bitcoins," says bar owner Jörg Platzer. His bar is where supporters of the cyber currency held their monthly meeting, one day after the value of a bitcoin reached an all-time high of about $150 (€115). "Many can't stop grinning as they pay their tabs, because they remember how little their bitcoins were worth just a year ago," says Platzer.

Until now, the currency, invented in 2009, had been treated as the cute Web experiment of hackers, libertarians and anarchists. Last year, the value of a bitcoin was stagnating at €5. And now some people are suddenly getting rich, including Rick Falkvinge, founder of Sweden's Pirate Party. "I had invested all of my assets in bitcoins," he says. "Now I've converted half of it into other currencies. I've never been this rich before."

The increase in the bitcoin's value (now worth more than $190) in the midst of the euro crisis has attracted the attention of monetary watchdogs and law enforcement officials. The European Central Bank (ECB) investigated bitcoin and other previously unregulated virtual currencies in October. According to the final report, these currencies do not pose a threat to price stability at this time, although they could become a "challenge" to government authorities.

Officials at the German Finance Ministry say that they are keeping an eye on the developments. A spokesman says that bitcoins do not threaten the government monopoly on money right now. However, he adds, "acts of private currency creation" contradict the government's control of the money supply. The United States Treasury Department has already found it necessary to take action, deciding in mid-March to subject bitcoin to US money laundering regulations.

Central Bankers Keep Close Watch

It isn't surprising that governments take a critical view of the digital cash. After all, it was invented to break the monopoly of central banks. Its inventor, who is known only by his pseudonym Satoshi Nakamoto, wanted to create a direct, anonymous form of payment on the Internet that would render middlemen like PayPal or credit card companies unnecessary.

Recently, more and more reputable merchants have begun to accept and use bitcoins as a form of payment. One of the attendees at the Berlin party was filmmaker Aaron König, who pays animation specialists in India with bitcoins. However the currency is also popular among Internet criminals.

Bitcoins are not simply available at cash machines. To enter the bitcoin market, you have to download free software and create an anonymous account. Users can use dollars or euros to buy their first bitcoins for this account, or digital wallet, in markets like Mt. Gox, or they can "mine" the currency themselves with special computers called "mining rigs."

These computers, which have especially fast graphics cards, compete in a global computing competition for a single possible solution, and the winners of each round receive a set of fresh bitcoins. The system is designed to make it more and more difficult to mine bitcoins, with the global supply set to peak at just under 21 million -- a principle of "controlled supply" similar to the idea that there's a limited amount of gold in the world, whereas paper currency can be printed in unlimited amounts. In the early days, beginners with home computers still stood a chance at mining, but now professionals dominate the field.

Vulnerability to Hackers and Crashes

Because the current boom began during the Cyprus crisis, there was much speculation that it was primarily anxious Cypriots and Spaniards who were using bitcoin as an inflation-proof, safe-haven currency. Jon Matonis of the Bitcoin Foundation, which sees itself as an advocacy group for fans of the alternative currency, disagrees. "Most transactions are still coming from affluent regions, like the United States and Northern Europe," he says. "What we are seeing is not a Cyprus bubble."

Gatis Eglitis, who established the first bitcoin hedge fund with the Exante investment firm in Malta, sees growing demand from major investors. He also insists that all investors are made fully aware of the risks. "We've told our customers: Either you'll get rich, or you'll lose everything."

Just how unstable the bitcoin system is became clear, ironically enough, in its most successful week to date. At the high point of the rally, the most important exchanges and bitcoin account providers, like Mt. Gox and Instawallet, were suddenly targeted by Web attacks. The value had already dropped precipitously in 2011, after hackers looted digital wallets.

A person's own computer poses another risk. "I once lost 7,000 bitcoins, because I had forgotten to make a backup copy," says programmer Stefan Thomas. The virtual money was irretrievably gone. If he hadn't lost the bitcoins, Thomas could almost have become a real millionaire last week.

Translated from the German by Christopher Sultan

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