Bitcoin was designed to be a currency free from the corrupting influence of government or any other centralized authority. Now, though, with the value of a single electronic unit hovering around $1,000, the battle to control emission of Bitcoins is on.
The developers of Bitcoin created an ingenious system to regulate the currency's supply: Independent "miners" earn new currency by using their computers' processing power to perform the mathematical operations needed to make transactions in Bitcoin possible. The operations become more difficult as the amount of Bitcoins issued approaches a limit of 21 million.
Initially, a home computer was all one required to become a Bitcoin miner. As the market grew, high-performance graphic cards became the tool of choice. Nowadays, most of the mining is done by dedicated devices called application-specific integrated circuits, and miners form pools that allow them to earn a regular, small profit instead of the occasional and improbable big payoff.
One mining pool, known as GHash.io and run by an outfit called CEX.io, went a step further by selling something akin to shares in a high-tech operation with lots of specialized hardware. Would-be miners simply pay for their piece of the computing power, then sit back and collect income.
Last week, some independent miners noticed that GHash.io had grown so large that it controlled 45 percent of the Bitcoin network's processing power -- in other words, one organization was on the verge of dominating the emission of Bitcoins. Commentators on Bitcoin forums began to worry that if GHash.io gained a 51 percent share, it would be able to reverse transactions and make it possible to pay twice with the same Bitcoins. Such centralized power could render the currency useless.
GHash.io quickly declared that it had no intention of executing a "51 percent attack." It stopped accepting independent miners and said its users would be allowed to mine for other pools. By Monday, GHash.io's share of the network's processing power was down to 34 percent, according to the website Blockchain.info. Bitcoin miners are no fools: Allowing one pool to dominate would devalue their holdings. That said, a large farm controlling a lot of equipment, even if it is used to mine for different pools, could still quietly accumulate and abuse a majority without killing the entire market.
CEX.io is a secretive company whose spokesman and chief information officer calls himself Jeffrey Smith. His LinkedIn profile lists him as a graduate of the International Christian University in Kiev, Ukraine, and a Ukrainian resident. Far from the center of the financial universe, Ukraine is a lawless place where world-class programmers often earn U.S. poverty level salaries and are therefore willing to take risks. Entrepreneurs in Hong Kong and China, among Bitcoin's biggest markets, are also building mining farms that could present a centralization threat. Theoretically, competition among such operations should make it difficult for any one to control Bitcoin emission, yet there is always a potential for collusion within an oligopoly, or a successful hacking attack on a few large organizations.
So far, about 12.2 million Bitcoins have been mined. The more the currency grows, the stronger becomes the big farms' grip on emission. With billions of dollars at stake, the virtual currency no longer works in ways envisaged by its founders. They did not mean for it be a commodity for Chinese speculators, nor as a product to be turned out by industrial-sized specialized operations. Bitcoin is now less a currency than a kind of risky bond for which the issuers bear no responsibility. Investors should be aware that the situation is ripe for abuse.
(Leonid Bershidsky is a Bloomberg View contributor. Follow him on Twitter.)