The rise and fall of Bitcoin tells a story of greed, hope, disappointment, and fear. Bitcoin supporters aimed for a decentralized world in which payment is as simple as sending an email. They forgot that even the bitcoin network interfaces with the real world.

The history of Bitcoin illustrates that to implement a network-level innovation such as trustless payment, you need to model your business ecosystem, including its physical, social and digital aspects, and that you need to design the governance of the ecosystem. The attempt to implement an ideal solution in the digital world only, ignoring its social and physical implications, leads to total chaos.

These three lessons learned from the rise and fall of Bitcoin seem abstract, but the history of Bitcoin illustrates them in a concrete way. First, let us look at a summary of the tumultuous history of Bitcoin. The main source of information for the following account is the website but many other sources will be indicated too.


The rise and fall of Bitcoin


The Silk Road

One of the first important events in the bitcoin exchange rate is a news article published June 2011 in Gawker about The Silk Road, a website where you could buy any drug and pay anonymously with bitcoin.  The article contains a link to Mt. Gox, a bitcoin exchange based in Tokyo. The exchange rate against the dollar more than tripled in a week, to the value of around $30. Possibly, readers bought bitcoins in order to buy the drugs they liked on Silk Road. Possibly, they used bitcoins for speculation only.

The Silk Road has been shut down by the FBI in 2013 and its owner, Ross Ulbricht, has been sentenced to life in 2015. His arrest in October 2013 was widely published and was followed by a steep rise in the bitcoin exchange rate from the value of $133 on the day of his arrest to $1026 in December 2013. However, I am getting ahead of my story and I should first mention the Cyprus bailout earlier that year.


The Cyprus bailout

To solve the 2012-2013 Cypriot financial crisis, the European Union, the European Central Bank, and the IMF had decided to support the Cyprus economy with €10 billion. One of the conditions was that a sizeable levy would be collected from bank accounts with a balance over €100,000. Cyprus was a tax haven where many foreigners from outside Cyprus held considerable amounts of money.  In March-April 2013, many of them withdrew euros from their bank accounts and bought bitcoins. This caused a surge in demand for bitcoins and the bitcoin rate doubled to about $130. This massive flight into bitcoins caused server failure at Mt. Gox.


Mt Gox loses ₿850 000

In June 2011, just a few weeks after the Gawker article,  Mt. Gox was hacked. The hackers caused a flash crash, bought bitcoins for almost nothing and then sold them high.

The death blow for Mt. Gox came in January 2014, when in a massive DDOS attack ₿850 000 mysteriously disappeared. Mt. Gox went offline in February 2014 and filed for bankruptcy in Japan and the USA. Its CEO, Mark Karpelès was arrested in Japan in 2015 but released on bail in 2016. Karpelès found ₿200 000 of the lost bitcoins in a forgotten account, but the rest seems to have disappeared forever. Compensation of Mt. Gox customers using this ₿200 000 is expected to be distributed late 2019. Mark Karpelès is expected to be left with a handsome sum even after customers have been compensated.

Signs of regulatory acceptance?

The Mt. Gox DDOS attack marked the end of a few months of the meteoric rise of Bitcoin, from $130 in October 2013 to $1249 at the end of November. During that period, good news for Bitcoin arrived. On November 18, 2013, the US Senate held a hearing on Bitcoin called “Beyond Silk Road: Potential Risks, Threats, and Promises of Virtual Currencies”. To the surprise of Bitcoin community, the mood at the hearing was positive. Jennifer Shasky Calvery, Director of the U.S. Government’s Financial Crimes Enforcement Network (FinCEN), testified, “We want to operate in a way that does not hinder innovation”.

Two days later, Yi Gang, deputy governor of the People’s Bank of China and Director of the State Administration of Foreign Exchange, provided further fuel for the positive mood. He said that although it would be impossible for China’s central bank to recognize Bitcoin as a legitimate financial instrument in the near future, people were free to trade bitcoins. In other words, bitcoins will not be a valid means of payment, but people are free to speculate with it. In a few weeks, the bitcoin rate surged to $1249 on Mt. Gox.


However, the bonanza lasted only a short while. On December 5, 2013, the Chinese government banned financial institutions from using bitcoins and the exchange rate dropped again. A few weeks later, the DDOS attacks that brought down Mt. Gox started.

In April 2014, under pressure from the People’s Bank of China, Chinese banks closed down bank accounts of Chinese bitcoin exchanges. The exchanges responded by using offshore banks. However, with ups and downs, the rate declined slowly during the rest of the year.


The Bitstamp hack

On January 4, 2015, the Bitstamp exchange was hacked and almost ₿19 000 was stolen, worth at that time about $5.2 million. The hack left the exchange rate slightly under $199 for a bitcoin. But from this point on, the rate started edging up.

New signs of institutional acceptance?

Events that could possibly explain this rise are the launch by Coinbase of a licensed US exchange in February 2015, and the release of BitLicense regulations in New York State in June that year. Regulation is not popular in the Bitcoin community, but some institutional actors may have interpreted these events are early signs of the acceptance of bitcoins as a regular currency.

At the same time, the publicity around the life sentence for Ross Ulbricht in May 2015, and around the prosecution of two former Federal Agents who had stolen bitcoins when they were investigating Silk Road, may have brought Bitcoin under the attention of individual investors. Ulbricht and the two former Federal Agents may have done something illegal, but surely it is legal to speculate with bitcoins? The promise of money for nothing is irresistible. Whatever the reason, from January 2015 the bitcoin rate started rising again.

Quarrels in the machine room

There was a temporary setback when in August 2015, the Bitcoin XT fork was released. The XT fork followed on a long discussion on Reddit about increasing the Bitcoin block size to improve network performance, summarized by Mike Hearn. The community could not agree on this move so Mike Hearn and Gavin Andresen decided on a hard fork. The Guardian described the fork as a “civil war” in the Bitcoin community.

Even more signs of regulatory acceptance?

But the decline in bitcoin exchange rate lasted only a month.  In September 2015 the Commodity Futures Trading Commission (CFCT) declared that bitcoin is a commodity, and therefore subject to the commodity exchange act. This contradicted the view of Financial Crimes Enforcement Network, a branch of the US Treasury Department, which had declared already in 2013 that cryptocurrencies are money and so must provide information to the government to prevent money laundering.

This last view agreed with the ruling of the European Court of Justice in October 2015 that cryptocurrencies are money, and therefore not subject to value-added tax. Clearly, Bitcoin was under the scrutiny of regulators, and they were trying to bring it under regulatory governance.

In October too the Gemini exchange was launched, which was licensed to operate in 26 states and cooperated with a regular bank to offer Federal Deposit Insurance on deposits in US dollars. And on October 31, Bitcoin featured on the cover of The Economist. The main article presented Bitcoin as a stable currency embraced by regulators. Blockchain technology was described as a trust machine with the potential to transform our economy. All of this drove the rate of bitcoin upwards and at the end of the year, the rate was $426.

More rumblings in the machine room: The Hernia

Bitcoin XT fork never took off and in November 2015, Mike Hearn left the Bitcoin community to work for the R3 consortium of banks on developing the Corda framework for financial settlement. In a long blog, Mike Hearn explained his move by pointing out that Chinese miners had a perverse incentive to keep block sizes down. The low speed of the Chinese internet, due to the Chinese firewall, could not handle the larger block sizes of XT. So these miners voted against XT. In the long run, Hearn expected the bitcoin rate to plunge.

Hearn also complained about censorship by the admin of, who blocked any post that contained the string “Bitcoin XT”. He reports this admin as saying

“One of the great things about Bitcoin is its lack of democracy.”

It is ironic that a network with a protocol that achieves consensus among 10 000 nodes and avoids censorship of transactions, is governed by a community that is not able to reach consensus and censors some of its members.


Continued propaganda

The Hernia only caused a minor drop in the bitcoin rate and in February 2016, the rate was up again, to $439. In August that year, Don Tapscott and his son Alex published The Blockchain Revolution: How the technology behind Bitcoin is changing money, business, and the world. Don gave a widely viewed TED talk on this in August and Alex gave a TEDx talk on how blockchain is eating Wall Street in October. One of the comments on this talk was by Don, who said

“Well I’m kinda biased, but to me this talk is a tour de force. Profound, captivating, inspiring and brilliantly delivered.”

By this time, October 26, the bitcoin rate was $657.


The peak of expectation

In January 2017, the bitcoin rate broke the $1000 mark again. According to CNBC, zero interest rates made people look for alternative ways to grow their money. Also, they said,

“China is the source of the majority of trade in bitcoins and the devaluation of the yuan and fears over capital controls have contributed to the recent spike in the digital currency “.  

The election of Trump in November also had caused a boost in the bitcoin rate, as people traded their dollars for bitcoins.

In April 2017, Japan declared bitcoin as legal tender and 10 days later, the rate had grown to $1215, up from $1085.

2017 saw an explosion of 876 Initial Coin Offerings, raising over $6B, up from 29 coin offerings in 2016 that raised $90M. What exactly caused this explosion cannot be read simply from the charts. The explosion started around May 2017 and was accompanied by a steep rise in the exchange rate. The rate broke the $5000 mark in October and passed the $10 000 mark in November. Bloomberg mentioned mainstream acceptance and regulatory clarity as reasons why this is not a tulip mania. At the end of October, the CME group had announced the launch of Bitcoin futures, which boosted the rate from $6100 to $7255 ten days later. And on 11 December, the Chicago Board Options Exchange launched Bitcoin futures, further inflating the rate from $14594 to $17010.

The deep dive

By December 18, 2017, the rate hit $19 498. At that day, the mania that had pushed the rate upward had turned into a frenzy to get rid of bitcoins. The rate has ever gone down since then, with ups and downs, to reach $3509 on CoinMarketCap at the time of writing (December 18, 2018), and falling.

The dive started on 19 December 2017, when the South Korean cryptocurrency exchange Youbit filed for bankruptcy after it had been hacked, causing a loss of 17% of its assets. Customers’ cryptocurrency assets would be marked down 75%.


Hacks and losses

On January 8, 2018, CoinMarketCap dropped South Korean prices from cryptocurrency rates without warning, causing a steep drop in prices. Greg Dwyer, head of business development at cryptocurrency derivatives exchange BitMex, said

 “Every crypto is priced at a 30 percent premium in South Korea. By removing that, it looks like the market cap fell by 30 percent and so people rushed to sell because they’re not sure what’s happening.”

On January 26, 2018, CoinCheck, one of the largest Japanese cryptocurrency exchanges, reported a loss of about $400M in cryptocurrency due to a hack. This sent the rate of bitcoins down to $8775 ten days after the report.

More hacks were to follow. On April 13, the Indian exchange CoinSecure was hit by a $3.5M theft and on June 10, the South Korean exchange Coinrail was hacked, after which bitcoins lost 10% of their value.

Regulatory troubles

Early signs of regulatory trouble already appeared in 2014, when the Chinese government prohibited financial institutions to use bitcoins and closed Chinese bank accounts of Chinese bitcoin exchanges. This trend continued when in September 2017, China banned ICOs and shut down Beijing’s cryptocurrency exchanges. However, these events did not have a lasting effect on the bitcoin rate.

But ten days after the Youbit hack, on December 28, 2017, South Korea threatened to shut down at least some cryptocurrency exchanges in an effort to stamp out a frenzy of speculation. One government official said

“Cryptocurrency speculation has been irrationally overheated in Korea. The government can’t leave the abnormal situation of speculation any longer.”

In March 2018, the US Securities and Exchange Commission said that crypto exchanges must register with the agency, causing the price to drop from $11 091 to $8343 ten days later.

In May, prosecutors raided South Korea’s largest exchange, UpBit, on suspicion of fraud. The same month, the US justice department opened criminal investigations into bitcoin price manipulation. The investigation focused on illegal practices that can influence prices, such as spoofing —flooding the market with fake orders to trick other traders into buying or selling.

In June, the US Commodity Futures Trading Commission demanded trading data from bitcoin exchanges in a manipulation investigation. Ten days later, the bitcoin exchange rate was down to $6709.

In November, the South Korean Exchange Zeniex terminated its services after South Korea’s financial authorities started cracking down on unauthorized crypto funds. The exchange asked its customers to withdraw their funds before the closing date of November 23.

More bad news

As if all of this is not enough bad news for Bitcoin, Facebook banned all ads promoting cryptocurrency in January 2018, for fear of promoting fraud. Google banned advertisements promoting cryptocurrencies and ICOs on March 14, and Twitter followed suit later that month. Each of these events caused a steep drop in the bitcoin price.

A lack of consensus in the machine room

In the meantime, the quarrels in the machine room continued. The Bitcoin XT fork started by Mike Hearn and Gavin Andresen in August 2015 did not take off. Bitcoin Classic was the second attempt to increase the block size, and started in February 2016. Its use declined from March 2016 onward and it ceased operation in November 2017. In August 2017 Bitcoin Cash was launched, using a larger block size than Bitcoin does. In November 2018, Bitcoin Cash split into Bitcoin ABC (Adjustable Blocksize Cap) and Bitcoin SV (Satoshi’s Vision). The press again speaks of a civil war in the Bitcoin community.

The Bitcoin Core network also worked hard at improving transaction speed, and came up with a proposal called SegWit2x. However, this was called off in November 2017, in the midst of the cryptocurrency mania, out of fear of creating yet another hard fork.

These forks all aimed at increasing transaction speed. Another fork, Bitcoin Private, promised total anonymity, and was forked off Bitcoin in March 2018.

Yet another fork, Bitcoin Gold, had another goal, namely replacing the SHA-256-based proof of work algorithm by equihash, which is memory-hard and is mostly mined by graphics cards. As observed by Steven Hay on, the man behind Bitcoin Gold, Jack Liao, is also the CEO of LightningASIC, a Shenzhen–based company that mines mostly Litecoin and produces a multi-GPU mining unit. The forking of Bitcoin Gold would create a profitable market for LightningASIC.  In May 2018, the Bitcoin Gold network was victim of a successful 51% attack. The attacker probably stole about $18M.

Mining gets too expensive

A result of the steady decrease of the bitcoin exchange rate is that miners are reporting losses and are going bankrupt. Miners earn their income in bitcoins, but must exchange this against fiat currency to buy hardware and electricity. The lower the bitcoin rate, the harder it is for miners to pay their bills.

On November 9, the Canadian miner Hut 8 reported a Q3 loss of $8.7M. The US-based miner NGDC ceased its operations in Sweden, disappearing with $1.55M unpaid electricity bills. Another mining company abandoned its plans to establish a mining farm in Sweden and left local authorities with $55K unpaid rental fees.

On November 22, the US miner Gigawatt filed for bankruptcy and sold its inventory by the kilo. Russian miners started selling their hardware, and on November 29, the Canadian miner Fortress reported a $1.16M loss in Q3.

Chinese miners are finding creative ways to deal with the bitcoin slump, such as short-selling. A Chinese miner Jin Xin, said:

“If I mine 30 tokens in the next month, while its price may continue to fall by another 10 percent according to the current trend, I shall place a short order on the exchange to sell them at the current price but deliver one month later.”

In addition, Jin buys used GPUs miners from miners to increase the hash rate of his mining rig. Once the “shutdown price” is reached, Jin powers down the equipment, remove GPU chips and sells them to game players.

The above story is incomplete in many respects. For example, only a few of the known cryptocurrency hacks have been mentioned. But enough has been said to step back and see what we can learn from this history.

Lessons learned

To introduce new technology, design its ecosystem

The first observation to be made is that bitcoin value is based on unregulated speculation. There is hardly a real-world economic activity that demands the use of bitcoins, and there are no countries that hold Bitcoin in reserve or give out a Treasure note in bitcoins. Bitcoin exchanges are speculation machines.

This is part of a wider phenomenon, which is that the designers of the Bitcoin network have ignored the larger ecosystem of which it, like any IT system, is a part. It is useful to divide this larger ecosystem into a physical, social and digital part.

Neglect of the physical ecosystem has led to initial blindness to the need of hardware and electricity to get Bitcoin’s Proof of Work algorithm done. There has been talk of selling the heat generated by bitcoin mining, but surely this was not part of the original design goals. We wrote about the un-sustainability of bitcoin mining in an earlier blog.

It is these real mining costs that force miners out of business now. More generally, any new business idea, when implemented, encounters the constraints and possibilities of the physical world. In this age of global heating, this is as important an aspect of business ecosystems as it is of biological ecosystems.

But like any IT system, the Bitcoin network is also part of a social ecosystem. Neglect of the social ecosystem of Bitcoin has led to complete neglect in the original design of what happens at the edges of the network. Bitcoins must be exchanged against other currencies. Exchanges are the location where fraud, hacks, price manipulation, and theft occur. More elementary even, Bitcoins get lost because people lose the Bitcoin wallets — another annoying property of people in a physical world.

And the Bitcoin network is part of a digital ecosystem. The governance needed to maintain the network was ignored in the original design. The Bitcoin hard fork of March 11, 2013, forced by a software error,  was resolved amicably (event #18 on, without formal governance structure. But the discussion on block size on Reddit, also without formal governance structure, is interminable. A community of anonymous and mutually distrusting actors does not easily reach a consensus in an online social network discussion. The inability to resolve the block size issue resulted so far in 6 forks of the blockchain, not counting the recent fork of Bitcoin Cash. 

Part of the problem is that software improvements can be proposed and programmed by developers, but miners can choose whether or not to actually use these updates. And as Mike Hearn observed, miners may have other goals than software developers. This brings us to the lessons learned about governance, discussed next.

When designing an ecosystem, design its governance

Governance of an ecosystem is the way its affairs are controlled. In a decentralized system such as the Bitcoin network, it includes the way decisions about the Bitcoin protocol are made, how conflicts are resolved, and who is accountable for these decisions. Bitcoin’s designers have ignored these aspects, and the Bitcoin network illustrates that an ecosystem without governance does not exist. The result is a system with ugly governance, where discussions tend to have a who-do-you-think-you-are tone, and decision-making is inefficient or non-existent, witness the history of forks to force a resolution of an issue in a particular way.

Coordination theory tells us that decentralized coordination in an informal community is based on knowledge of the identity of the members of the community, mutual trust, shared norms, and tradition. Governance is by consensus.

 If we want to maintain decentralization of an informal community but remain anonymous, we can move to discrete market coordination, where transactions are simple and completely specified by contracts. Market participants can remain anonymous and are free to choose with whom to transact. There is no governance but there is a regulatory context accepted by all participants, which deals with breaches of contract.

 If we cannot specify contracts completely, and we do not want to rely on trust and tradition to transact, then full decentralization is not possible. We should choose some form of hierarchy, in which there is some governance of the network, laid down in decision-making structure and policies, and rules for accountability. This is what should be done for the governance of the Bitcoin network. Where the Bitcoin network itself can be fully decentralized, and facilitates completely specified anonymous transactions, the governance of the network cannot be that decentralized or anonymous. It must include some form of hierarchy, which is known, trusted, and held accountable for its actions.

Pleading for some form of hierarchy, or for governance at all, in the management of an ecosystem is anathema to the original Bitcoin supporters, who have a background in the libertarian Cypherpunk movement. The pseudonymous Satoshi Nakamoto, who proposed the design of the Bitcoin network, has been connected to David Chaum, Nick Szabo, and Robert Hettinga. According to a recent Bitcoin Magazine article, David Chaum, in turn, spawned the Cypherpunk dream. Steve Bannon has been a long-time supporter of Bitcoin and calls it “disruptive populism”. Disruptive it surely is. But it cannot abolish governance. The only alternative to good governance is ugly governance.

Aiming for a goal of total hygiene leads to total chaos

Perhaps the most general lesson of all is that the goal of total hygiene leads to total chaos. With “total hygiene” I mean the total conformance to an abstract ideal. This is a totalitarian goal, as illustrated by the gleeful remark of the admin cited by Hearn as saying that “One of the great things about Bitcoin is its lack of democracy.” The digital world sometimes creates the illusion that you can create exactly the world of your dreams and eliminate everything else.

Real-world implementation of a technological innovation requires us to step out of the digital world and include the social and physical context in the idea and its implementation. We need to consider their digital, physical and social aspects of the ecosystem in which the idea will live, and take care of its good governance.