Is anyone else fascinated by the parade of Bitcoin drama that's been going on lately?
What the hell is a bitcoin?
Bitcoin is a purely-digital currency that was invented a couple of years ago. All transactions are publicly posted and validated by a peer-to-peer network in 'blocks'. Part of the generation of blocks is the solving of a hash-function challenge, and the first node to solve the challenge (the 'mining' aspect) gets to issue the block and put 50 coins in their own wallet, and this serves as both validation of the transactions since the last block and how new coins are injected into the system. The full details of how it works are in this white paper.
The primary advantages of the system are supposed to be:
Anonymity: transactions are purely between uniquely-generated wallet addresses, with no other identifying information, and the peer-to-peer network obfuscates the network origin.
Decentralization: there's no central authority that controls bitcoins, just a purely peer-to-peer network that polices itself.
Non-inflationary: the system is designed to stop generating coins once 21 million have been created, and then that's it. It's supposed to prevent coins from losing value since you can't mint new currency arbitrarily.
No chargebacks: All transactions are permanent and irreversible unless you can convince the other party to do another transaction back to you.
It's very libertarian and largely driven by a distrust of how government, banks, and payment processors have handled currency in (in their opinion) disastrous ways.
So what's the problem?
Well, 1) Almost nobody's using it, very few merchants support it, there's relatively little traffic actually occurring and most of the generated coins are just sitting idle in people's wallets. You can probably divide Bitcoin users into three main groups: the pragmatists, who are using it mainly for its anonymity to conduct shady deals (i.e., drugs); the speculators, trading it against its US dollar value like a commodity; and the True Believers.
The True Believers are counting on how its value is deflationary. As time goes on and the usage and market expands, Bitcoins should only ever increase in value, and if they could capture even a small fraction of the US economy, Bitcoins would become worth the equivalent of thousands of US dollars each. Manage to fulfill their dreams and switch the US entirely to a Bitcoin economy and those coins will be worth millions! And you made 50 of them just by running this mining program! What an investment! So instead of actually spending their coins, increasing the flow of money and attracting more merchants, they're just sitting on their stockpile of coins, waiting for the glorious future. Even better if you were an early adopter and generated a large pile of coins when the difficulty was low.
2) It's not really as anonymous as you might think. All transactions are on public record, so you can trace them as far as you want, and if you want to actually do anything practical with the coins, you're going to have to turn it into cash or goods and create some kind of link with your identity. When it comes to things like buying drugs, it mainly protects the sellers, not the buyers that'll have to provide some kind of contact info. (And did the seller rip you off? Too bad, no chargebacks!)
3) There are various impractical aspects to using it, like how transactions are not processed immediately. You have to wait for a block to be issued for the transaction to be validated and accepted into the network, and that could take 10 minutes or more, depending on how lucky you are. Internet access is also mandatory, transactions can't be queued up for later processing.
4) And the elephant in the room is, of course, the government. Governments kinda like being able to control monetary policy through currency, and they're not going to cede that control without a fight. There may not be any central authority or critical servers to Bitcoin, but the government can still make it difficult to actually use Bitcoins in any practical way, at the points where it meets with the real economy. That they haven't intervened yet is not a guarantee that they never will.
But what happened that's so interesting?
The Bitcoin market has been chugging along for a while now, mainly driven by the pragmatists and the speculators, but a couple months ago the value of a Bitcoin shot up from around $1 to nearly $30, probably not-so-coincidentally around the same time as some big articles about the drug connections. It then quickly fell down to around the $15 mark and has been slowly decreasing since then.
Soon after, Mt.Gox, the biggest Bitcoin exchange by far, got hacked and user IDs and passwords were leaked. They managed to clean it up within a few days; there are limits on how much money can be extracted out of a Mt.Gox account per day and transactions within the exchange were reversible since they were between wallets all owned by Mt.Gox. Things continued on as normal, though still steadily declining.
And then, just within the last week or so:
1) It was revealed that Dwolla, one of the USD payment processors used by the biggest exchanges, has done chargebacks on behalf of their users against the markets, when they thought that wasn't possible. Tradehill admitted losing $37k USD, and Mt.Gox hasn't admitted anything yet, but it is speculated that their loss is much, much bigger.
2) Mybitcoin, a large 'bank' that people had been depositing their coins in rather than manage their own wallet (if you lose your wallet.dat file, those coins are gone forever) disappeared. The site owner had been incommunicado for around a month, and then a few days ago the site just vanished. Nobody knows why, nobody's heard anything, and nobody can get their deposited coins. One person admitted they had 25,000 coins in there and is...somewhat distraught.
3) The bitomat exchange, third-largest of them all, lost all of its coins. They supposedly mismanaged their Amazon EC2 server, and when they shut it down it erased everything. No external backups.
And all of that finally culminated in a massive crash in Bitcoin value today. It started off around $12.16 today, but has dipped as low as $8.xx, and is still rather unstable. I don't know if it's really The End of Bitcoin, but I think people's confidence is pretty shaken. Bitcoin users have been strangely all-too-willing to turn their coins over to unknown, anonymous third parties up until now.
Whew, I hope that was actually worth reading... (Full disclosure: out of curiosity, I ran a Bitcoin miner for about a week. I made 0 coins.)