Bitcoin in the limelight: Questions for buyers and investors

Bitcoin exchange vulnerability

The most high-profile vulnerable Bitcoin exchange was Mt. Gox. In April 2013, Mt. Gox was overwhelmed by a Distributed Denial of Service (DDoS) attack. The point, Mt. Gox speculated, was to destabilize Bitcoin transactions and fuel panic selling. After driving prices down, the attackers ceased the DDoS, and rushed in to buy Bitcoin at a lower price.

Life isn't fair but Bitcoin must be

Life might not be fair, but securities exchanges and currency markets require fairness. Without it, they will die. Trust is essential. Apparently, Mt. Gox was robust enough to withstand this DDoS incident. In their pursuit of unearned profits, the attackers took a selfishly short-term view. DDoS attacks and market manipulation can destabilize Bitcoin exchanges. If that happens often enough, 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 formal risk control measures. Eventually, such controls should be imposed by regulatory authorities, along with penalties and enforcement. Market manipulation and extortion are possible even when there are regulations. Market participants' own self-restraint and willingness to obey the rules are important too. The Bitcoin marketplace is rife with pump-and-dump schemes lately, which doesn't inspire confidence!

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. Bitcoin price volatility will need to diminish a lot in order for it to serve as a medium of exchange, i.e. a true currency.

Structural boundaries

If I were to trade or invest in Bitcoin, my first question would be, "What, if any, 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. (They weren't, until the European Central Bank lowered real interest rates below zero as an ineffective attempt to stimulate economic growth through increased spending due to greater demand for bank loans). Are there any limits pertaining to Bitcoin?
• Are there vagaries of the market place or the blockchain that could allow pricing power by colluding participants? That can happen in commodity markets, e.g. the three Hunt brothers buying 2/3 of the silver market. What about collusion among miners in a Bitcoin mining pool? A recent scholarly journal article about selfish miners proved that if more than 33% of any group of bitcoin miners (or any blockchain-based cryptocurrency) collude, they will succeed in earning income above their fair share.

Ebullience

The financial press and even well-known information security personalities are caught up in the thrill of Bitcoin. The odd aspect is that some don't seem to distinguish between good news and bad! The excitement is infectious. Perhaps it is a means of escape from the powerlessness most of us feel about monetary policy and government in general?