The rise of the bitcoin

The rise of the bitcoin: Virtual gold or cyber-bubble?

LONDON — A currency surging in value at a breathtaking rate this week belongs to no nation and is issued by no central bank. It can be used to buy gold in California, a hamburger in Berlin or a house in Alberta. When desired, it can offer largely untraceable transactions.

The coin in question now has a global circulation worth more than $1.4 billion on paper. Yet almost no one, it seems, knows the true identity of its creator. In the United States, this mysterious money has become the darling of antigovernment libertarians and computer wizards prospecting in the virtual mines of cyberspace. In Europe, meanwhile, it has found its niche as the coinage of anarchic youth.

The currency is bitcoin, a kind of cyber-money initially traded among hackers and cryptologists, and increasingly traded on Web sites and exchanged for goods and services. Two years ago, one bitcoin was worth less than $1. Two months ago, the price for one unit surged above $20 on a proliferation of cyber-exchanges from Tokyo to Moscow. A sudden burst of new interest sent its value soaring to a record $147 on Wednesday.

It has since fallen back after a series of hacker attacks. Yet, as of Thursday, bitcoin was still trading above $130.

Will all that crash and burn in a cyber-version of a financial bubble? Critics say it quite possibly will. Will authorities — already concerned about the use of bitcoins to buy drugs and launder money online — step in to regulate it? There are signs that may already be happening. But for now, its diverse group of users ranging from the Free State Project and WikiLeaks to environmentalists and professional gamblers, call its surge a revolution in “financial free speech.”

The cyber-currency has skyrocketed in value, but is it a sign of a new paradigm or speculative bubble? The Post’s Anthony Faiola fills us in from London. (The Fold/The Washington Post)

For Jonathan Harrison — a former gold trader who ditched his London flat to join a group of virtual currency obsessives living in a dilapidated commune on the wrong side of Waterloo Station — what matters most is a sense that bitcoin is making him a fortune.

Some call it the purest form of capitalism: a version totally unfettered by monetary policy and politically driven economics. On a recent afternoon, Harrison constantly checked the value of his holdings in bitcoins and other cyber-currencies such as litecoin on his glowing smartphone. In less than 20 minutes, his portfolio’s value had surged by about 7 percent.

“Some people say it’s anticapitalist, but it’s more nonconformist,” Harrison said. “It can’t be manipulated by governments, changed by monetary policy. I call it digital gold.”

Mysterious origins

In January 2009, Satoshi Nakamoto unveiled bitcoin to a mailing list of computer super-geniuses. He (or she, or them — Nakamoto is a pseudonym for a programming whiz or whizzes whose identity remains one of the great mysteries of hackerdom) effectively put a free software program on the Internet and invited the group to form a network of bitcoin “miners.” They could excavate bitcoins by using computers to solve complex mathematical puzzles, with units of the cyber-currency seen as a reward for the electricity spent on the algorithms.

Nakamoto seemingly emerged from nowhere a year earlier, uploading a white paper on bitcoin to an obscure e-mail discussion group. The writings suggested political motivations — a response to a global financial crisis in which Western governments reached into the banking sector as never before. But Nakamoto also showed little interest in promoting bitcoin beyond an inner circle of global geekdom.

In the 1990s and 2000s, various visionaries attempted to launch cyber-currencies with little success. Yet Nakamoto succeeded where others failed through the elegance of bitcoin’s design. More bitcoins are created all the time. But over time, fewer and fewer will be generated. The finite number — bitcoins will max out at 21 million by 2140, compared to the roughly 11 million in circulation today — makes them a commodity that increases in value as more and more users fuel demand.

To avoid counterfeiting, bitcoins are accounted for on public ledgers. Holders of bitcoins — which are stored using electronic “wallet” software downloaded from the Internet — are kept anonymous unless they choose to disclose their identities. Yet there is no centralized authority that regulators could home in on to shut the system down. Though government- and bank-free, the users pay a certain price for that freedom. U.S. bank deposits, for instance, are insured up to $250,000 by the FDIC. But this week, when hackers struck bitcoin wallet provider Instawallet, the company issued a statement saying it would refund clients holding more than 50 units only on a “case-by-case and best-effort basis.”

Nakamoto seemed to vanish more than a year ago, leaving other developers to advance the technology. A year later, initial waves of publicity and word of mouth created a surge in value that sent the price of one bitcoin soaring from less than $5 to almost $30.

There were now two ways of getting bitcoins — mining them yourself or, more commonly, buying them from current owners using real-world currency. However, after a series of high-profile hacker attacks — including a hit on the computers at Mt. Gox, the Tokyo-based exchange site that is the cyber-currency’s largest — its value collapsed, falling back below $10 and increasing only modestly until a few months ago. Another wave of attacks hit the exchange house this week but have thus far not caused equal damage.

No one knows what, exactly, is behind the currency’s staggering climb that started earlier this year and accelerated in recent weeks. Some cite a change in the network’s programming in December that cut the number of bitcoins released each day. Others say new interest from Russians and others looking for safe havens after bank account seizures in Cyprus is behind the climb.

Bitcoin promoters credit new interest by venture capitalists. Yet Wall Street analysts who follow bitcoin say there is still no indication that major investors are seriously dabbling in them. Critics say those paying hefty fees for bitcoins are investing in a ghost currency whose value is fictional.

“What’s behind that billion-dollar value? Nothing, except some people would claim a billion dollars worth of burned electricity,” said Ben Laurie, a software engineer and visiting fellow at Cambridge University.

Though critics warn current buyers will themselves be burned if the price collapses, bitcoin’s rise already has early merchants ruminating about what might have been. George’s Famous Baklava in New Hampshire, for instance, sold a pan of dark chocolate pastry online for 14 bitcoins in 2012 — a sum worth about $1,890 today. “I’m already looking back on that and smiling,” the company’s owner, George Mandrik Skouras, wrote in an e-mail.

A growing marketplace

The antiestablishment nature of bitcoin has also made it the preferred currency of antigovernment activists. Harrison, the bitcoin trader, for instance, first learned about the currency after watching a viral video made by Amir Taaki, a former online poker player turned freelance software developer who now organizes bitcoin conferences. Taaki’s conferences have drawn interest from everyone ranging from money laundering experts to the likes of Cody Wilson, the American crypto-anarchist who is pioneering 3-D printing technology to create plastic guns.

The marketplace that accepts bitcoins is small but growing. At Room 77 in Berlin, you can use your smartphone to digitally pay for a hamburger in bitcoins. More often, you can shop online for a range of items including, as bitcoin enthusiasts admitillegal drugs.

Once the province of hobbyists rigging together off-the-shelf computer parts, bitcoin “mining” is also rapidly evolving. The math puzzles that award bitcoins have become harder as more and increasingly powerful computers mine them.

It has led cyber-thieves to hijack computers via viruses that help them mine bitcoins. Legal miners such as Bennett Hoffman, a California-based bitcoin enthusiast who once hunted them on his gaming computer, are joining up with business partners to invest in new professional bitcoin-mining machines costing $30,000 each.

“Obviously there’s always going to be a ton of risk involved,” Hoffman said. “I just really like the idea of bitcoin.”

Last October, the European Central Bank issued areport on the topic. Last month, a branch of the U.S. Treasury concerned with money laundering issued guidance to online exchanges in the United States, warning that they must report large cash transactions and suspicious activity on their systems.

“In a way it is like . . . Monopoly money being used rather than your respective currency, not knowing who owns the bank and who is the dog, the car, the top hat or thimble," said Rusty Payne, a spokesman for the U.S. Drug Enforcement Agency. “Bitcoins are virtually untraceable.”

Farnam reported from Washington. Eliza Mackintosh in London contributed to this report.

Jonathan Medved: The venture activist

When it comes to Israel, Jonathan Medved has no interest in watching from the sidelines. 

A former political activist and UC Berkeley alum, Medved, a Los Angeles native and Jerusalem resident, was named by The New York Times in 2008 one of the most influential Americans impacting the Jewish state. His life has been one of identifying opportunities — starting small and growing fast.

As a college student in 1973, Medved returned to the San Francisco Bay Area one week before the start of the Yom Kippur War and found a campus awash in anti-Israel sentiment. Motivated to do something, the young Zionist became a campus activist for Israel, eventually becoming the Jewish Agency for Israel’s director of university services in the United States.

Although he’s still an ardent and outspoken supporter of Israel, Medved has come a long way since his undergraduate days, finding a less political means of supporting his beloved country — venture capital crowdfunding. 

Speaking in December in Santa Monica on what was the second leg of a whirlwind, worldwide tour, the uber-energetic, 58-year-old entrepreneur showcased his latest adventure in the financial world: OurCrowd. 

It’s a year-old “equity-based crowdfunding platform” that allows accredited investors to put as little as $10,000 — small for the venture capital world — into a select number of approved and vetted Israeli startups, all of which need cash to grow, and stay afloat, until business operations kick into full gear.

“You are able to take the best of venture capital — the professionalism, the diligence, the protection you get — and combine it with the fun, and discretion, and the freedom, and the low entry price of being an ‘angel’ [who invests after falling in love with a company],” he told a group of 80 at Cross Campus, a shared work space in Santa Monica. 

Here’s how it works: An Israeli startup in the early stage of fundraising applies to be listed as a company backed by OurCrowd. Then, a team of analysts studies the ins and outs of the business: When can it expect positive cash flow? How much debt does the company anticipate accumulating? Is the entrepreneur’s vision realistic?

If the startup is brought under OurCrowd’s wings — something that Medved said happens to only 2 or 3 percent of the 100-plus monthly applicants — it may find itself with a potential gold mine of capital. Since Medved launched the company in February 2013, he has helped 31 startups raise $30 million from about 3,000 investors. 

During his Dec. 13 presentation, he introduced local entrepreneurs and venture capitalists to several Israeli startups, including Takes and Easy Social Shop. Last year, OurCrowd investors raised $250,000 for Takes, a camera app that allows users to convert a series of photos into video. And since being funded by Medved’s group in 2012, Easy Social Shop, which makes it easy for e-commerce retailers to set up virtual storefronts on Facebook, has gone on to facilitate 80,000 shops listing more than 8 million products.

Jon Warner, a local venture capitalist who came to do some preliminary research on OurCrowd’s startups, said he was most intrigued by Easy Social Shop and “its potential to monetize” Facebook’s user base.

Not just anyone can invest through OurCrowd. Because many countries, including the United States, legally require investors in startups to already have plenty of their own cash, the players putting skin in the game tend to be experienced in identifying people and ideas that have serious potential.

This wasn’t a career Medved sought out. Born in San Diego, but raised in the Brentwood neighborhood of Los Angeles, he is one of four brothers in a family that seems to have a flair for jumping head-on into the public square. Michael, who lives in Seattle, is a best-selling author and nationally syndicated talk-show host. Harry is a spokesman for the movie Web site Fandango and lives in the Los Angeles area.

Kicked out of Sinai Temple’s Hebrew school as a youngster, Medved attended Palisades High School and was raised in what he termed a traditional Jewish family.

“This was an idyllic childhood,” he said, reminiscing about his Westside days. “Where I grew up was like ‘Leave It to Beaver.’ ”

Having no clue what he wanted to do professionally — just knowing that he didn’t want to be a spectator — Medved visited Israel for the first time in 1973. The Jewish state had the “Birthright effect” on him long before there was Birthright, and seven years later he made aliyah. 

“When everybody saw me going off to live in Israel, they said, ‘OK, well, he’s an idealist, he’ll be poor,” recalled Medved, who has a thick beard and wears a kippah.

In 1980, he said he still had no direction, other than knowing that he wanted to be “an actor and a player” in the Israeli experiment. Then, in stepped his late father, David Medved, a physicist who, in the 1950s, developed technology to destroy midflight intercontinental ballistic missiles. 

Trying to get a fiber optics communications startup off the ground, the elder Medved couldn’t have known that asking his son for help would lead to a successful venture capital career for the latter.

Even while working with his father, Medved thought his future would be in activism. That is, until an Israeli scientist he was dealing with on the project spoke to him like a fellow Israeli — no subtleties, no nonsense.

“What a waste,” the scientist remarked in Hebrew after speaking with Medved about his activist hopes.

Surprised, Medved shot back, “Ani boneh et ha medinah” (I’m building the country).

“What your father is doing is real Zionism,” responded the scientist. “Go build a factory for fiber optics.”

And in 1982, the father-son duo did just that, subleasing space in a Jerusalem building used by glassblowers. 

“People didn’t know what fiber optics were,” Medved said. “They’d see the glassblowers and figure that must be [fiber optics].”

For the next eight years, Medved built up the company, Meret Optical Communications, eventually selling it in the early 1990s to Amoco Corp., which later merged with BP.

A few years later, he started the venture capital fund Israel Seed Partners in Jerusalem. It went on to invest nearly $300 million in startup Israeli tech and life-science firms, and proved to be great preparation for OurCrowd. 

By the time Medved temporarily exited the venture capital world to found the mobile social apps company Vringo in 2006, he had invested in more than 100 Israeli startups, helping 12 of them reach a net worth of more than $100 million each.

“To sit and listen to people’s dreams and then to be, in a small way, able to help them make it come true is the most wonderful job,” he said. 

Unfortunately, he admitted, helping businesses grow, sometimes, means doing some less pleasant things.

“God forbid, if the business is not meeting its projections, you’ve got to cut the budget, which means fire people.”

Medved sits on the boards of many of OurCrowd’s startups, and for those that he doesn’t, he helps recruit experienced mentors, doing the best he can to make sure all of his companies succeed.

Medved knows that playing in the Israeli financial world also means factoring in risks unknown to many investors around the world, namely the volatile nature of the region.

“People have learned to discount this,” he said. “I’m not the only one who has somehow just learned to live with this kind of existential risk. It’s Microsoft; it’s Cisco; it’s Google; it’s Facebook.”

Following the event in Santa Monica, Medved was able to sum up his philosophy succinctly by referring to Pirke Avot:

“Who is wise? [He] who sees the yet-to-be.”

The Internet's Original Sin

The talk is hilarious and insightful, and poignant precisely for the reasons Carlson’s story is. The internet spies at us at every twist and turn not because Zuckerberg, Brin, and Page are scheming, sinister masterminds, but due to good intentions gone awry. With apologies to Carlson:

What we wanted to do was to build a tool that made it easy for everyone, everywhere to share knowledge, opinions, ideas and photos of cute cats. As everyone knows, we had some problems, primarily business model problems, that prevented us from doing what we wanted to do the way we hoped to do it. What we’re asking for today is a conversation about how we could do this better, since we screwed up pretty badly the first time around.

I use the first personal plural advisedly. From 1994 to 1999, I worked for Tripod.com, helping to architect, design, and implement a website that marketed content and services to recent college graduates. When that business failed to catch on, we became a webpage-hosting provider and proto-social network. Over the course of five years, we tried dozens of revenue models, printing out shiny new business plans to sell each one. We’d run as a subscription service! Take a share of revenue when our users bought mutual funds after reading our investment advice! Get paid to bundle a magazine with textbook publishers! Sell T-shirts and other branded merch!

At the end of the day, the business model that got us funded was advertising. The model that got us acquired was analyzing users’ personal homepages so we could better target ads to them. Along the way, we ended up creating one of the most hated tools in the advertiser’s toolkit: the pop-up ad. It was a way to associate an ad with a user’s page without putting it directly on the page, which advertisers worried would imply an association between their brand and the page’s content. Specifically, we came up with it when a major car company freaked out that they’d bought a banner ad on a page that celebrated anal sex. I wrote the code to launch the window and run an ad in it. I’m sorry. Our intentions were good.

Cegłowski’s speech explains why Tripod’s story sounds familiar. Advertising became the default business model on the web, “the entire economic foundation of our industry,” because it was the easiest model for a web startup to implement, and the easiest to market to investors. Web startups could contract their revenue growth to an ad network and focus on building an audience. If revenues were insufficient to cover the costs of providing the content or service, it didn't matter—what mattered was audience growth, as a site with tens of millions of loyal users would surely find a way to generate revenue.

There are businesses, Cegłowski notes, that make money from advertising, like Yahoo and Gawker. But most businesses use advertising in a different way. Their revenue source is investor storytime:

Investor storytime is when someone pays you to tell them how rich they’ll get when you finally put ads on your site.

Pinterest is a site that runs on investor storytime. Most startups run on investor storytime.

Investor storytime is not exactly advertising, but it is related to advertising. Think of it as an advertising future, or perhaps the world’s most targeted ad.

Both business models involve persuasion. In one of them, you’re asking millions of listeners to hand over a little bit of money. In the other, you’re persuading one or two listeners to hand over millions of money.

The key part of investor storytime is persuading investors that your ads will be worth more than everyone else’s ads. That’s because most online ads aren’t worth very much. As a rule, the ads that are worth the most money are those that appear when you’re ready to make a purchase—the ads that appear on Google when you’re searching for a new car or for someone to repair your roof can be sold for dollars per click because advertisers know you’re already interested in the services they are offering and that you’re likely to make an expensive purchase. But most online advertising doesn’t follow your interest; it competes for your attention. It’s a barrier you have to overcome (minimizing windows, clicking it out of the way, ignoring it) to get to the article or interaction you want.