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24 November 2013

Bitcoin in the limelight: Questions for buyers and investors

DDoS attacks manipulate vulnerable markets

The vulnerable market was the Mt. Gox Bitcoin exchange. In April 2013, Mt. Gox was overwhelmed by DDoS. The point, the company speculated, was to destabilize Bitcoin and fuel panic-selling. After driving market prices down, the attackers can then rush in and buy Bitcoin at the lower price. Obviously, this isn't fair.

Life isn't fair but Bitcoin must be

Life may not be fair in general, but securities and currency markets require fairness and avoidance of market manipulation in order to function. Without it, they will die. Trust is essential. Apparently, Mt. Gox was robust enough to withstand this volatility. The attackers were fortunate. In their pursuit of unfair profits, they are taking a selfishly short-term view. DDoS attacks could destabilize Mt. Gox, or any other entity that serves a similar purpose. If that happens often enough, or in sufficient size, it will undermine credibility in Bitcoin.

Mt. Gox wasn't uniquely vulnerable. In the past few months, there were other DDoS related Bitcoin extortion incidents. BTC-China was brought down in September 2013, and BIPS, a European payment provider, experienced a DDoS attack two days ago, on 26 November 2013.


Regulation and volatility

Using DDoS for extortion is possible due to Bitcoin's lack of fraud control measures, which would usually be imposed by regulatory requirements. Of course, market manipulation and extortion are possible even when there are regulations! (I suspect that if one wanted to, one could DDoS forex exchanges.) Regulation and law enforcement is partly responsible for discouraging such behavior. Market participants' own self-restraint and willingness to obey the rules is equally important.

Bitcoin's current price volatility is very high. That is unsurprising for a new financial product. Volatility isn't inherently bad, but it should be caused by normal market activity, not manipulation due to DDoS-facilitated extortion. Bitcoin price volatility will need to diminish to no more than 25% in order for it to function as a viable currency.

Structural boundaries

If I were to trade or invest using Bitcoin, my first question would be, "What are the boundary values?"
  • The number of Bitcoins is fixed at 21 million.
  • Are there are price levels that have any contextual meaning, i.e. are associated with limits? For example, stock prices are always greater than or equal to zero. For fixed income markets, negative interest rates should not be possible. Is there a scenario where Bitcoin could ever have a negative value?
  • Are there are vagaries of the block chain that would cause short term price or volume discontinuity?
  • What about market dominance due to collusion? That can happen in many markets, especially commodity markets. There are scholarly articles that establish a floor beyond which Bitcoin can no longer function, specifically, if there is collusion of selfish miners such by a Bitcoin mining pool.

Ebullience

The financial press and even well-known information security personalities seem to be caught up in the thrill of Bitcoin. The odd aspect is that some don't seem to distinguish between good news and bad, as with Mt. Gox.

The excitement is infectious. Perhaps it is a means of escape from interminable and usually dreary economic news, as well as the powerlessness most of us feel about monetary policy and government in general.

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