Bitcoins are now famous, simply because at least two ‘exchanges’ have been, er, ‘robbed’ in the sense that their bitcoins are gone, their clients are bereft, and the exchanges themselves, having no deposit insurance of any kind, simply declared themselves defunct.

This is a large post. I’ll put labels here so you can search and ‘jump’ to the part you care about.

Bitcoin facts

Bitcoin risks

Encryption potential weaknesses

How it actually works

My personal take on all of this

Conclusion

Dumb questions

Bitcoin Facts:

Bitcoins have been under some scrutiny for some time. There is a CRS Report, made available (as usual with CRS reports on this blog) via Federation of American Scientists, Secrecy News, Steven Aftergood. (CRS stands for Congressional Research Service. Such reports are requested by the US congress, and generally kept ‘secret’ even though there is little secret in them, other than the bringing together of public information. I recommend this blog and its reports. Clearly. Aftergood returns eMails. Is considered, by the US authorities, to be a definitive expert in secrecy law, process, et cetera. In short, SA is a real human being.)

The CRS report covers a lot of ground. One issue is, do/can bitcoins destabilize economies? The answer was, the amount of wealth in bitcoins isn’t large enough (now) for this to be a concern. I should note here that bitcoins’ value is determined entirely by ‘market factors’, so if they were to become the medium of choice for money laundering, their value could rise.

A second issue in this CRS report is, can bitcoins be used to launder money and/or fund illegal activities such as drug marketing. The answer here is definitely ‘yes‘.

Bitcoin Risks:

There have been at least two instances where a bitcoin exchange suddenly went, er, bit-coin-less overnight.

The value of bitcoins is, er, unclear. In this (as usual, excellent) Wikipedia article, you will find these quotes:

bitcoins are not a reliable store of value and that there is no floor on their value

Steven Strauss, a Harvard public policy professor, suggested governments could outlaw Bitcoin

bitcoins will attain their true value of zero sooner or later, but it is impossible to say when

Bitcoin investor Cameron Winklevoss stated in 2013 that the “bull case scenario for bitcoin is… 40,000 USD a coin”

In late 2013, finance professor Mark Williams forecast a bitcoin would be worth less than ten US dollars by July 2014

Encryption potential weaknesses:

Here you will find a recent paper published about breaking an encryption scheme that is similar, perhaps identical, to the Bitcoin protection protocol. By stealing a small amount of data, they were able to obtain the encryption key with frightening regularity.

How it actually works:

Here is a fairly upbeat explanation of how Bitcoins actually work.

Here is a somewhat less happy description of the protocol. In this page you will find pointers to other aspects of Bitcoin, such as mining, which I suggest you follow if your interest leads you there.

Search the original page for these phrases:

annoying thing 

it can’t be compared with a known-good signature

There are also ways that third parties can modify transactions in trivial ways that change the hash but not the meaning of the transaction

rather than any logical reason

My personal take on all of this:

Thank you for reading, scrolling, or jumping to this point. I am, as readers of this blog must have realized already, a cynic. I am (or was once) Mister Systems Architect in IBM Canada, finance industry. I worked in CIBC in many capacities, including technology steward for a conglomeration of business areas. I’ll get to my opinion in another line or two, but I want new readers to understand that I have more than a rat’s ass’s understanding of finance, programming, system design, and most importantly of all, due diligence.

Due diligence means, before you do anything, you make sure it’s ‘safe’. I did due diligence at CIBC for a number of businesses facing Y2K. I did due diligence at Bank of Montreal for over a year (as an IBM employee) vetting every single application change to their online banking system. I claim, immodestly, to understand diligence and risk assessment. Due diligences means, you can accept, or cover, or avoid, or plan how to recover from, the risks.

My take on Bitcoins is this:

• The code was distributed free by an anonymous person or group.
• The code does weird things. Go back to Ken Shirrif’s page if you doubt this.
• The code was, probably, not vetted by any single institution or person for holes.
• Holes in the code seem to have been found (go back to 161.pdf if you doubt this).
• Holes in the code seem to have been used (go back to Gox and Flexcoin, eh?)
• The value of a bitcoin is based on nothing but user expectations. (Wikipedia, eh?)

Miningis an interesting part of Bitcoins. The Ken Shirriff page has a hotlink to how that works. Basically, bitcoins are recorded by peer computers in a block chain. One of the keys for a new block chain is computed from parts of the chain, plus a ‘nonce’ value, plus other potentially varied data items. The key so computed must have a certain minimum number of leading binary zeros. It turns out that this is a hard problem requiring an astonishing amount of computing power to achieve in ten minutes. (You first try every possible nonce value, then other tweaks.) Typically a large transaction is not considered securely recorded until it has had maybe five other block chains added after the one in which it resides.

Every bitcoin peer maintains this block chain. There are mechanisms to detect and repair extension collisions. Thus there is no central record; every peer eventually has the record, up to some point, at some point in time.

Miners get bitcoins for their trouble. Apparently it’s worth about $19K USD to successfully mine a new block (actually, the key for one).

Mining creates new bitcoins. The miner’s payment rate (in bitcoins) will drop by 50% every four years. The total number of bitcoins is capped at some large number. (21 million? go check google, eh?)

Everyone who moves bitcoins as an intermediary gets a small percentage. Miners get one, as well as their fee.

Conclusion:

I think we were set up. A currency with no intrinsic value started to be exchanged, and bought/sold for real, national currencies. The value of this bitcoin has been, and could continue to be, extremely volatile.

The implementing code, open source, was imho never vetted by anyone for weaknesses. At least not until weaknesses were demonstrated two ways (theory, theft).

Some of the stolen bitcoins are now circulating, answering my question, ‘were they destroyed or were they stolen?’ It will be interesting to see what legal or other actions occur against those who now ‘own’ stolen bitcoins.

So, if you’re waiting for the dumb questions, here the are:

• Have (at least) some of us, been had? a not-understood protocol? weaknesses?
• If you had a lot of unused processing power, would mining bitcoins be a good side business?
• How did the first bitcoins get created? After some existed one could mine bitcoin transactions.
• If you were the US economy, would you make bitcoins illegal?
• would that mater, if bitcoins are exchangeable worldwide?
• and, have we been had?