Recent Happenings in the Digital Coin World

This past Monday the US Marshals auctioned off the “Silk Road” Bitcoin wallets at a higher than expected price to a single bidder.  The Bitcoin market strengthened coming into the auction and has held on to most of the price gains.

In the alternative coin market, on the other hand, we saw panic selling of an alternative coin (but only on one site!) and aggressive selling across the spectrum of “scrypt” based coins.  “scrypt” is one of the cryptographic algos that is used to validate transactions in some of the alternative coins such as Litecoin and Dogecoin.  Bitcoin uses a different algo called SHA256.

Zerohedgers know that algos are subject to attack by other algos and that the name of the game in the HFT space has been faster-faster-faster.  This is also true in the coin space.  Coins are produced by looking for rare sets of numbers that work out to be valid using the coin’s algo.  This is called mining.  Initially people mined with their PC computer.  Then a faster level of mining was achieved using graphics cards.  A new level of speed arrived when special purpose ASIC integrated cicuit chips were designed to process the digital coin algos.  There are rumors of even higher speed mining using a different type of integrated circuit called an FPGA.

The faster miners are able to gain economic profits over the slower miners and dump coins on the market.  The depressed coin prices further damage the profitability of the smaller miners.

Of more concern is the pooling of this faster crypto algo power in the hands of a smaller group of high speed coin traders.  One of the vulnerabilities of a coin network is the so called “51% problem”.  The coin networks operate by consensus – a transaction is valid if most of the network calculates it to be valid.  If a small group of high speed coin operators reach the 51% level they can tamper with the consensus.  This could break a coin – ruining the slower players that are holding it.

Fortunately Bitcoin seems to be actively working to prevent this.  The alternative coins, particularly the ones that use the “scrypt” algo, are much more vulnerable to the “51% problem”.  I think this explains most of the price action of the past two weeks in the alternative coin market.  The market is making the transition from an abstract maybe-someone-could concern to a real maybe-someone-is concern.  Fortunately there have been nice bounces in the affected coins so perhaps the concerns are overblown.

In response new coins have been created which use a different cryptographic hashing algo that is much more difficult to implement in specialized hardware.  One of these is called x11 (an unfortunate name choice which has been in use for decades as the Unix windows software).  The hope is that x11 will inhibit the bigger faster guys from being able to kill the coin.  It is not an encouraging sign to see an x13 algo hit the streets before the x11 coins have had a chance to make it out of the nursery.

From the perspective of hindsight it seems that the choice to use the faster and simpler “scrypt” algo was a bad choice for the early alternative coins.  Bitcoin’s use of the slower and more complex SHA256 algo keeps it relatively safer for longer but as always technology marches forward.  The marching is faster when money is on the line.  Satoshi’s great invention was to protect the little guy from the too big to trust institutions but now we see a glimer that even Satoshi is/was only human.

Thanks Zerohedge!
Mark Hittinger
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