It's Still a Pain to Buy and Sell Bitcoins

What is a bitcoin worth? It’s not meant to be a philosophical question, the kind bandied around by intrigued economists, crypto-advocates, and grumpy skeptics as Bitcoin continues to grow. But even the simplest question about Bitcoin's value—how many dollars can you exchange a bitcoin for?—doesn't have a straightforward answer.

Based on numbers from last night, if you were to buy a bitcoin from the Tokyo-based Mt. Gox, considered the OG Bitcoin exchange, a bitcoin would cost $1168. Over in Slovenia, where the BitStamp exchange is located, the equivalent digital coin ran $1062, over $100 cheaper. On BTC China, the largest exchange in the world by volume, the last bitcoin traded at ¥6,634, which is about $1,089.

For what is theoretically a borderless currency, Bitcoin’s value is hugely impacted by its geographical location. That fact hints at an old problem still facing Bitcoin: while the currency itself may be decentralized, actually buying bitcoins largely means trading currencies through a few large exchanges.

In any developed financial system, the price of any currency, asset, or commodity is virtually the same no matter where you are. This is mainly due to arbitrage, the practice of profiting from price discrepancies between exchanges. For example, if gold is $1000 in New York, but $1200 in Chicago, you could simultaneously buy and sell gold to make an instant, riskless $200 profit. Because this indeed happens (albeit with much smaller price differentials), regional currency flucuations tend to smooth out.

So why aren’t traders doing this with Bitcoin? Well, they are, to a degree. But while bitcoins themselves can be sent anywhere in minutes with little to no fees, moving real money internationally remains costly and cumbersome.

For example, the US government essentially shut Mt. Gox out of the American market when the Department of Homeland Security seized the exchange’s funds at Dwolla, a PayPal clone that was a key source of dollar funding. The only way then to get funds into the exchange would be to utilize local Japanese banks (potentially more than one), and would likely require trading USD for yen along the way. It’s an expensive journey with fees at every step. As one Bitcoin trader who wished to remain anonymous explained to me, “those costs are priced in.”

This isn’t just an annoyance for ambitious virtual currency traders, it’s a troubling problem for anyone jumping on the Bitcoin bandwagon. Though it’s widely labeled as a currency, most people will use it like an asset or a commodity; at some point, they’re going to convert it back into their local currency. The question is, how?

If you’re in the US, good luck. Thanks in part to the feds' crackdown, all of the world's largest exchanges by volume are located outside of the US. Previously popular destinations like Tradehill have shut down “due to banking and regulatory issues." Despite registering with FinCEN in August, the exchange has no estimate on when it might reopen its doors, according to statements posted on its site.

Options like Coinbase, a service which allows users to buy and sell Bitcoin, do exist, and are relatively easy to use. But since they aren’t technically an exchange, it’s unclear how much liquidity exists. A “Level 1” user on Coinbase is limited to buying or selling 10 BTC daily.

Consequently, prominent exchanges are often located in countries with loose regulations. But being outside of the world's financial centers means transferring cash the old way. Cashing out of BTC-e, a popular exchange that trades Bitcoin and an assortment of altcoins including Litecoin, requires not only getting your money out of your account but also out of Bulgaria.

And since they’re poorly regulated, service can be unpredictable. Without needing to follow strict reserve requirements, Bitcoin exchanges are notoriously cash poor. It’s not uncommon to wait months to withdraw money from Mt. Gox due to a “large backlog,” which is one reason in particular why prices on Mt. Gox are generally 10 percent higher. Rather than cash out, impatient users are forced to buy Bitcoins so they can send them to another exchange to sell.

But trading one shoddily operated exchange for another can still pose its own problems. Bitcoin itself is only four years old. Financial institutions are built on trust and take years to mature. The New York Stock Exchange has had nearly two centuries to work things out. As BTC China’s CEO Bobby Lee pointed out, half of all Bitcoin exchanges will close within a year of operation with the average lifespan being about 380 days. The Hong Kong-based GBL exchange lasted just four months, sending $4.1 million in customer and investor funds up in smoke after it suddenly shutdown in late October. When angry users showed up at the company office listed on the website, they discovered it was fake.

Even reputably managed exchanges struggle with reliability. As the price of Bitcoin soars, the exchanges have become a prime target of malicious hackers. A popular strategy is a well orchestrated DDoS attack, which can send prices tumbling. Though unconfirmed, it’s one theory for the BTC China outage over the weekend, accompanied by a 17 percent drop in the price of Bitcoin between Saturday and Sunday. In September, the exchange was hit by a 9 hour attack considered one of the fiercest in history.

Yesterday we prevented a ~100Gbps DDoS. The attack's load was distributed across our 350Gbps network. (see image) pic.twitter.com/80lpHs9UMg

— Incapsula.com (@Incapsula_com) September 25, 2013

“This amount of firepower isn't cheap, or readily available, signifying a big step up in resources pulled together to launch this type of attack,” Incapsula CEO Mark Gaffan told The Register.

Such attacks can have a lasting impact on confidence. After Mt. Gox was hit with three successive attacks in April, the price of Bitcoin crashed 40 percent from a high of over $200 and wouldn’t recover that value until last month with this most recent bubble.

So if the US approach from a regulatory standpoint can at times feel heavy-handed, there’s merit behind the caution. There is still considerable risk in buying and selling Bitcoins, and the exchanges represent a frustratingly central point of failure. And because it remains difficult to fluidly trade bitcoins with other currencies—whether due to exchange backlogs, geographical barriers for fiat currency, or whatever else—bitcoins are worth different amounts on different exchanges.

It’s also the kind of problem that can be corrected with time and market forces, as regulations catch up and new entrants provide users with further options and security. There’s also the possibility of innovative solutions like Ripple, a Silicon Valley-backed payment protocol that promises to further decentralize the world of currency exchanges. And if Bitcoin's utility as currency continues to grow—if more people treat bitcoins as money for exchange, rather than an investment to be cashed back into dollars or euros—fluctuations will smooth out.

For now, asking about the price of a bitcoin remains sort of a trick question. As the cryptocurrency’s short history has shown, things can change in an instant. And if the last price traded is, at best, a poor indication of what you’ll actually get for your bitcoin stash, then there are more than a few Bitcoin millionaires out there who think they’re richer than they actually are. Although, to be fair, it’s still a heck of a lot of money.

@sfnuop