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On April 10, 2013 I was watching the live trading of Bitcoin at bitcoin.clarkmoody.com and saw the high was $266. Then I watched it go down, and down, and down faster, and down even faster, then faster still….$250….$240….$210….$190…..$160……$150……$105. It actually traded from $260 down to $105 within just a few hours. It seemed a full meltdown was underway and there was no telling where it would bottom. But why?

At first it was reported that the Mt. Gox exchange and Bitstamp exchange were under attack called a DDoS attack. This stands for Distributed Denial of Service. There are many different forms of DDoS but the  nutshell explanation is that a website, network, or computer become so bogged down by so many computers trying to access it that it is no longer functional for real business. It reminds me of a Jack-In-The-Box restaurant on the beach in California. It had the only restrooms around and on a hot summer day, there would be 1,000 people crowding in and around this Jack-In-The-Box with the only intention of using its restrooms, not to buy food. If you actually wanted to by food you had to fight your way to the register. That’s essentially what a DDoS attack is. The website is still functional but all of the extra traffic coming in prevents it from doing its real job. A DDoS attack is usually initiated from an illegal botnet. A botnet is a collection of computers infected by a virus or other type of malware that allows someone, somewhere, out on the Internet, to take control of those computers at will and make them do his bidding, like attacking a website. I don’t know if people do this for fun, revenge, or if there is monetary gain, but they are a real nuisance affecting many businesses on a daily basis. There are steps a company can take to reduce its chances of an attack or loss of service, but it is impossible to completely eradicate DDoS attacks as long as people let their personal computers become infected. Unfortunately, too many people are running without sufficient malware protection, do not take proper precautions against phishing, Trojan Horses, or keep their systems updated with the latest security patches.

Any website is ultimately vulnerable to a DDoS attack. A large number of large companies with large IT departments have been attacked this way. Large banks, Amazon.com, the New York Stock Exchange and NASDAQ, even the US Department of Defense, have all been attacked by DDoS. So Mt. Gox is not entirely to blame for being the victim of DDoS. However, it should be standard operating protocol that the exchange shut down the minute it knows it is under attack.

As the price was dropping I noticed a point where it seemed to somewhat stabilize at about $150. I could see the number of outstanding orders of asks and bids and noticed the price was fluctuating wildly but there were very little open orders near these prices and the spread was huge. I saw that the lowest ask was $155 and the highest bid was $105. I figured if I could sell at $150 I ought to get sold right away and I could immediately put in a bid for $110. If these transactions go went then I would be able to turn my 14 bitcoins into roughly 19.75 very easily. So I put in the sell order. It sat in the open orders queue but did not get filled, even though my ask was apparently lower than anyone else. Then I noticed the price dropping even lower down to about $136. I tried to cancel my ask of $150 but it wouldn’t go through. Now I was panicking.

Thankfully, my ask was eventually cancelled and, luckily, I did not sell at $150 and I still own my 14 bitcoins. But this is exactly what was going on throughout the day with all sellers and buyers and really threw a monkey wrench into the whole trading system. There wasn’t actually anything wrong with the fundamental value of bitcoin based on public demand, but rather a loss of faith in the exchange causing panic selling. The extreme lag was causing wild fluctuations in the price, people got scared and put in sell orders. Those sell orders did not go through right away and some got hung in the system. Low bids started getting filled and there didn’t seem to be anything anyone could do about it.

I am writing this the day after the attack. Mt. Gox has now stated that the initial problem was not a DDoS attack but simply a case of too many customers. They state that in the entire month of March, 60,000 new accounts were created. But in just the first few days of April, 75,000 new accounts have been created. And they say that 20,000 new accounts are being created daily. They claim their system reached a point of critical mass and lag times increased, causing the panic. As a computer guy, I can see how something like this could happen. If a server has enough memory, then adding a few users, or even a few thousand users, won’t really cause too much of a slow down. But as soon as the line of not having enough memory is crossed, the computer starts using the hard disks as overflow memory. The hard disks are many thousands of times slower than RAM and the system now has to try to move memory back and forth between RAM and hard disk. This is called “thrashing” and once it starts it is a disaster. I have seen this happen before in my real job. It is likely that Mt. Gox saw it coming but, because it came on so fast over just a few days, they may not have time to come up with a strategy to deal with it and schedule the downtime to implement the fix. However, if what Mt. Gox says is true, then that is a very good sign for Bitcoin and shows that there is incredible demand, which should continue to drive the price upward.

This morning, Mt. Gox’ website is very slow and, apparently, they now admit they are under a DDoS attack. Go figure.

All of this underscores the biggest vulnerability in the current Bitcoin system. It is not the mechanism of Bitcoin that is bad, but the method by which they are bought and sold. It is very likely that if Mt. Gox continues on this path and cannot meet the demand that a new company will quickly emerge as the “largest and most trusted exchange”.

In the meantime, no one really knows the true value of Bitcoin. My opinion is that we are definitely in a speculative bubble. Prices are either higher than the true value of Bitcoin at this time, or they are rising faster than they should. This is not necessarily anything to worry about unless you are a day trader. Bubbles happen all the time in commodities trading and Bitcoin is affected the same way. In 2007 for example, the price of crude oil went from around $65 to around $140. Then in 2008, it dropped to around $45. An event may trigger a rise in price, such as a revolution in Libya, but investor greed will drive the price much higher than it should. Then at some point, the price gives way and panic sets in driving the price down to even below where the bubble started. Today, oil is back up to around $110, far above the bottom of that bubble, yet far below the peak.

I bought my first home in 2001 for $260,000. In 2004, I sold it for $460,000. It sold again in 2006 for $605,000. I knew in ’04 that we were in some kind of bubble but that bubble did not burst until several years after that. There is no telling how long the Bitcoin bubble will go on, or if it burst yesterday and found it’s true current value of around $160. Don’t get caught up in the bubble mania. Don’t quit your job when Bitcoin goes up to $1,000 and you own a few hundred of them. And don’t panic when Bitcoin drops to $20. In fact, if it ever gets down to $20, I am buying as many as I can. That is unless, of course, something real drives it down such as the US government declaring Bitcoin illegal or some other real world factor. But if it is strictly a matter of speculators driving the price based on fear/greed, then I would buy.

If you do decide to buy on the way up, say at $200, don’t do it because everyone else is and you want to cash in too. This is what pyramids and ponzis are all about. When you buy, do so because you believe in the fundamental value of Bitcoin. Know that the price may drop to even below $200 but it is likely the price will bounce back even higher and that in the long run, you haven’t gained or lost anything until you’ve actually sold.

The current bubble is doing Bitcoin a favor. It is drawing worldwide attention to Bitcoin. That is what is needed more than anything right now. The public needs to start using it, smart people need to start coming up with new ways of getting and using Bitcoin, increasing demand for it, and the true value of Bitcoin will soar on its own. We are still very much in the beginning of the Bitcoin Revolution. Opportunities are staring us in the face. All we need to do is act on them. Even the smallest gesture like buy just 1 whole bitcoin could change your life in just a few short years. That’s not much to risk losing at this point, but the gains would make it all worthwhile.

 

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