How China Took Center Stage in Bitcoin’s Civil War

https://www.nytimes.com/slideshow/2016/07/03/business/dealbook/mining-for-bitcoin-in-china.html

A delegation of American executives flew to Beijing in April for a secret meeting just blocks from Tiananmen Square. They had come to court the new kingmakers in one of the strangest experiments in money the world has seen: the virtual currency known as Bitcoin.

Against long odds, and despite an abstruse structure, in which supercomputers “mine” the currency via mathematical formulas, Bitcoin has become a multibillion-dollar industry. It has attracted major investments from Silicon Valley and a significant following on Wall Street.

Yet Bitcoin, which is both a new kind of digital money and an unusual financial network, is having something of an identity crisis. Like so many technologies before it, the virtual currency is coming up against the inevitable push and pull between commercial growth and the purity of its original ambitions.

In its early conception, Bitcoin was to exist beyond the control of any single government or country. It would be based everywhere and nowhere.

Yet despite the talk of a borderless currency, a handful of Chinese companies have effectively assumed majority control of the Bitcoin network. They have done so through canny investments and vast farms of computer servers dispersed around the country. The American delegation flew to Beijing because that was where much of the Bitcoin power was concentrated.

At the time of the meeting, held at the Grand Hyatt hotel, over 70 percent of the transactions on the Bitcoin network were going through just four Chinese companies, known as Bitcoin mining pools — and most flowed through just two of those companies. That gives them what amounts to veto power over any changes to the Bitcoin software and technology.

China has become a market for Bitcoin unlike anything in the West, fueling huge investments in server farms as well as enormous speculative trading on Chinese Bitcoin exchanges. Chinese exchanges have accounted for 42 percent of all Bitcoin transactions this year, according to an analysis performed for The New York Times by Chainalysis. Just last week, the Chinese internet giant Baidu joined with three Chinese banks to invest in the American Bitcoin company Circle.

But China’s clout is raising worries about Bitcoin’s independence and decentralization, which was supposed to give the technology freedom from the sort of government crackdowns and interventions that are commonplace in the Chinese financial world.

“The concentration in a single jurisdiction does not bode well,” said Emin Gun Sirer, a professor at Cornell and a Bitcoin researcher. “We need to pay attention to these things if we want decentralization to be a meaningful thing.”

The power of Chinese companies has already come to play a major role in a civil war that has divided Bitcoin followers over the last year and led to the departure of one of the top developers of the virtual currency. The dispute has hinged on technical matters as well as on bigger questions of what Bitcoin should look like in 10 or 20 years.

New data on Bitcoin’s use reveals that most of the transactions come from exchanges — most of all, exchanges in China — where people speculate on the value of the currency. People using Bitcoin to buy or sell products or services are a small proportion of all transactions. Chainalysis assembled the data for New York Times.

*Mining: Bitcoins flowing from companies that “mine” new Bitcoins by solving computational problems and offering computing power to the Bitcoin network. Mixing services: Services that mix Bitcoin transactions together to obscure the source or the transactions, like a money laundering service. Dark markets: Bitcoins flowing to black market services that sell illegal goods for Bitcoin, inspired by the Silk Road online drug market. Wallets: Bitcoins coming to and from online services that hold Bitcoin wallets for individuals.

New data on Bitcoin’s use reveals that most of the transactions come from exchanges — most of all, exchanges in China — where people speculate on the value of the currency. People using Bitcoin to buy or sell products or services are a small proportion of all transactions. Chainalysis assembled the data for New York Times.

Network Bottleneck

The American companies whose executives journeyed to the Grand Hyatt — including venture-capital-funded start-ups like Coinbase and Circle — are fighting to make Bitcoin bigger. They hope to expand the capacity of the Bitcoin network so that it can process more transactions and compete with the PayPals and Visas of the world.

The current size of the network goes back to the early days, when Bitcoin’s founder, Satoshi Nakamoto, limited the amount of data that could travel through the network, essentially capping it at about seven transactions a second. As Bitcoin has grown more popular, those limits have caused severe congestion and led to lengthy transaction delays.

The American delegation in China had a software proposal, known as Bitcoin Classic, that would change all that.

The Chinese companies, though, had the ultimate decision-making power over any changes in the software, and they did not agree with the American delegation. The Chinese had thrown in their lot with another group of longtime programmers who wanted to keep Bitcoin smaller, in part to keep it more secure. The Americans hoped to persuade the Chinese to switch sides.

In a hotel conference room, the American team of about a half-dozen people cycled through its PowerPoint slides, in English and Chinese, arguing for expansion of the network, most notably pointing to the long delays that have been plaguing the system as a result of the congestion. The Chinese representatives listened and conferred among themselves. The group took a break for a lunch of lamb and dumplings at a nearby mall.