This past week has been a defining moment in Bitcoin’s history. The full story may never reach the public domain, but the failure of Mt Gox to service its liabilities has raised concerns on centralisation and security threats. To combat this, other service providers have stepped up their transparency and reviewed their security measures in wake of the shortcomings of Mt Gox.
Although the alarm bells rung loud this week there has been a long history of exchanges failures. In a study by Tyler Moore and Nicolas Christin, they found that 18 out of the 40 exchanges they looked at had closed their doors. Some exchanges have reimbursed clients in the past but this remains uncertain with Mt Gox at present. In the cases where administrators absconded with the funds or hackers stole the coins reimbursement was not an option. Since their study (published January 2013), exchanges have had to become more mature dealing with a surge in volumes. However, some still remain opaque in their operating practices e.g. BTC-e.
As services to users of Bitcoin have proliferated, it has been accompanied by an increase in the concentration of holdings. Currently, addresses with over 1000 BTC contain approximately half of all bitcoins in circulation. The concentration highlights the degree to which there are large holders of the currency or the amount of centralised services. However, this was not always the case see picture below.
In the beginning there was Satoshi and some friends. There were mining coins but always using a different address in the coinbase transaction. Amalgamation started 16th Jan 2009 with some of the mining rewards being pooled into single addresses. By March 2009, there was an address with over 10,000 BTC in it. In September 2009, there was an address with over 50,000 BTC owned by the same person (Satoshi).
In 2010, there is an increase in amount of amalgamation that took place on the network. The decline in the proportion of total Bitcoins held in wallets containing between 50 and 100 BTC meant that miners were consolidating their holdings and selling them on exchanges. As the block reward only halved in November 2012, the increase in holdings in wallets with less than 50 BTC mark the beginning of pooled mining and trading on Mt Gox.
Post 2012, the amount of coins held in addresses containing between 50 to 100 BTC are above my expectation and raises the possibility that a large number of these coins are lost. This conjecture is backed up by Bitcoin days destroyed evidence. There remain approximately 4 million coins that have never been spent, many of which are probably contained in the red section.
By the time that the reward halved in November 2012, mining pools accounted for approximately 85% of computing power. The halving of the reward and the structure of mining meant that there was not a pronounced increased in the amount of coins stored in addresses with 25 BTC.
Alongside these trends was an increase in concentration in addresses with over 1000 BTC. This increases the risk that a large amount of coins could be lost or stolen. In the eyes of the protocol there is no distinction between possession and ownership. Many people hold claims to Bitcoin that are stored in these addresses and could in our society be said to “own” those Bitcoin. However, in the eyes of the protocol the possessor of the private key is the legitimate owner. As Mt. Gox has demonstrated this week the protocol provides little protection for disgruntled investors as their ownership claims are discarded. While, good operators should be able to resolve ownership claims by their customers effectively, the nature of the blockchain cannot change.