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article imageOp-Ed: Online exchanges in Lehman terms, eBay to the rescue?

By George Arthur     Mar 9, 2014 in Business
2014 has kind of sucked for Bitcoin but that doesn’t mean that the digital currency is dead in the cyber-water. No, Bitcoin is just fine. And thanks to eBay, the most pressing problem with digital currencies may soon be solved.
The problem, to be clear, has to do with the fact that online digital currency exchanges are terribly insecure, entirely unregulated and completely uninsured. The result is that the collapse of and theft at Mt.Gox, the hacking of Flexcoin, and the breach at Poloniex have all served to damage Bitcoin’s young reputation. This for no good reason – Bitcoin is not in any way to fault for the recent problems. But you wouldn’t know it by listening to some popular voices; most are all too happy (and quick) to dump on Bitcoin. For example, Bill Maher.
During the New Rules segment of the most recent Real Time with Bill Maher, Maher said:
“If you invested all of your money in virtual currency, don’t be surprised when it virtually disappears. Who could have predicted this? Virtually everyone. Yes, the internet’s biggest Bitcoin exchange collapsed after hackers stole all the Bitcoins. Oh no! And I was saving for a unicorn! You know, I’m no fan of Citibank but I trust it more than three guys in a basement playing Dungeons and Dragons.”
Actually, Bill, they were playing Magic: The Gathering… Okay? Alright, that’s neither here nor there…
On the ultra-libertarian website “The Prudent Bear”, writer Martin Hutchinson gleefully wrote, “Bad luck Millennials. Your new and clever scheme to replicate the old-fashioned virtues of gold in the cybersphere appears to have fallen apart.”
Wrong, both of you! Wrong, wrong, wrong!
This is part of a larger narrative, one that hides in the statistics of Bitcoin and other digital currencies; the people who use them are really young! Hell, more than 90% of Bitcoiners are male and between 20-30 years old. As a result, this means that just about every person in mainstream media and economics – who have an average age of, what, roughly 3000 – have no bloody clue about Bitcoin.
In the end we’re left with half-baked thoughts on the subject, like Maher’s… I mean, to Bill Maher: you trusted Lehman Brothers not too long ago… How did that work out for you? Was Mr. Fuld more trustworthy than three kids in a basement, or less?
And given that Bill’s real money really disappeared with no real charges against real people, I wonder if he – like those who lost their Bitcoin on Mt. Gox – feels like a real idiot?
I'm off-track again...
To move in the right direction, it’s important to first understand that Bitcoin is not to blame for the recent screw-ups at Mt. Gox, Poloniex, and Flexcoin; and in order to do that it only makes sense to understand why and how Bitcoin works.
So let’s have at it – why and how does Bitcoin work? And what makes it so special?
The most direct answers come from the initial information paper on Bitcoin which was authored by the currency’s enigmatic inventor, Satoshi Nakamoto. Titled “Bitcoin: A Peer-to-Peer Electronic Cash System”, the paper asserts a desire to eliminate large financial institutions from internet commerce.
In essence, Nakamoto views the use of third party institutions as an unnecessary expense in the age of online business. To this point Nakamoto writes, “The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions.”
Bitcoin, then, was to serve as “an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”
And hell, the system has worked amazingly well in this capacity. While it’s easy to point to the Colossus-level disaster at Mt. Gox, Bitcoin’s impact on global remittance (i.e. when someone who is working abroad sends money home) has been astonishing. Did you know that global remittance totalled between $400-520 billion USD in 2012, that most major financial institutions charge between 9-20% for money transfers, or that most Bitcoin transfer services charge 3%, or a flat rate (typically $3 USD or so) for the same service?
But this still doesn’t fully explain how Bitcoin works. Sure, we’ve scratched the surface of why it’s useful, but how does it work?
Articles abound, I would suggest starting with the most basic primer, available on Bitcoin.org, or if you’re willing to read a somewhat long, slightly biased explanation of Bitcoin, check out the article on HowStuffWorks.com. What every article is essentially explaining though is that the Peer-to-Peer structure of Bitcoin (and, in theory, digital currencies using similar code,) solves what is called the Byzantine Generals’ Problem (also called the Two Generals’ Problem or Byzantine fault tolerance).
By allowing computers all over the world to assist in providing hashes (essentially transactions stamps) which are then sent to what is called the block-chain (a massive public ledger of all Bitcoin transactions), the decentralized system works to ensure that each transaction between a Bitcoin holder and Bitcoin recipient is unique. As well, the nature of the relationship between the Peer-to-Peer network which is providing hashes to the block-chain is such that the ability for hackers to every disrupt the network grows more difficult as time passes.
In short, Bitcoin – through the use of cryptographic stamps, provided by a decentralized peer-to-peer based network – successfully solves the Byzantine Generals’ Problem thus creating an entirely decentralized and secure network for direct business-to-consumer interactions; in theory this serves to eliminate the need for financial institutions that act as third-party operators in online commerce.
What Bitcoin doesn’t do, though, is address the issues that arise when tens, hundreds, or thousands of digital currencies are on the market and people want to trade those digital currencies for other digital currencies, or for fiat currencies... And that makes a hell of a lot of sense. Bitcoin is Bitcoin; it is not every coin… To say it again, Bitcoin eliminates the need for trusted third-party institutions as far as a transaction that deal exclusively with Bitcoin.
For example, if a person mines Dogecoin, then wants to trade it in for Bitcoin, then trade the Bitcoin for Mooncoin, then to Litecoin, then back to Bitcoin, they're going to need third-party operator to help out.
Enter online exchanges.
Unlike Bitcoin, online exchanges are not decentralized; just the opposite. Online exchanges have physical and permanent addresses, physical and accessible servers, employees who maintain the security of those servers, profits and expenditures. Unlike a Bitcoin wallet that is hosted on a laptop or USB stick – to which only the user has access (decent security measures assumed) – a wallet on an online exchange is, fundamentally, in the possession of the online exchange, and accessible to people with admin privileges or the technical capacity to breach them.
So what has happened at these fast-falling exchanges? Well, no one really knows. The best explanations available explain what clearly did not happen. If anything, the conclusion that Bill Maher came to may be closest to correct: The people running these exchanges can be shadier than Slim.
The best read I’ve found on the subject, “What Did Not Happen at Mt. Gox” by hacker and Cornell Professor Emin Gün Sirer, came to this fantastic conclusion; “What Nigerian scams are to your grandfather, Bitcoin exchanges are to the 20-30 semi-tech-savvy libertarian demographic.”
In other words, it’s incredibly easy to be taken for a ride by the ‘Nigerian princes’ that run these exchanges. The theft at Flexcoin, wherein $600,000 US went missing, saw the funds transfer to just two Bitcoin wallets. At Poloniex, 12.3% of Bitcoins were stolen overnight. A few people are suggesting that the breach at Mt. Gox could have been an inside job.
However, if legitimate online exchanges are able to codify a clear system by which they can assure security (or better yet, insure), this problem, like the Byzantine Generals before it, will fall.
And it looks like eBay is about to tackle the issue.
As reported on eCommerceBytes.com, eBay has filed an application that seems to hint they may be getting into the online exchange business. To quote from the patent application:
"...{We have created a system for} digital currency processing. In example embodiments, the transaction request indicating an amount in a first currency and a desired second currency is received by the currency module. A non-exhaustive and example list of currencies capable of being exchanged may include frequent flyer miles, loyalty and reward points (e.g., credit card reward points, hotel loyalty points, retail loyalty points), virtual currency, cash, Bitcoins, Facebook credits, eBay bucks, cash-equivalent currency (e.g., gift cards, travelers checks, cashier's checks), and any other form of currency…"
Wouldn't that be interesting to see? My bet is that if a mega-firm like eBay launches an online exchange and markets it well, a horde of new and eager digital currency users will quickly get involved. And that bodes very well for Bitcoin, along with the countless other digital currencies out there. More legitimacy, more publicity (of the positive sort), and more opportunities to use digital currencies will all serve to increase their value.
Of course, it's worth noting safe exchanges already exist provided that you use them properly. A great first step in ensuring safety is to remember that online exchanges are not banks. It's silly and dangerous to think of them as anything other than places to make quick trades; a place where you can take your privately stored currency, trade it for another, and then return your new currency back to a private, backed-up, offline wallet.
After what has been a rough few months for Bitcoin, it's great to see that there might be huge and positive advances with regard to online exchanges in the near future; eBay or otherwise, digital currencies need better, trustworthy exchanges in order for current and future users to better trust the currencies themselves.
This opinion article was written by an independent writer. The opinions and views expressed herein are those of the author and are not necessarily intended to reflect those of DigitalJournal.com
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