Bitcoin: How a Virtual Currency Became Real with a $5.6M Fraud

By Nathaniel Mott , written on August 31, 2012

From The News Desk

The first thing I thought of when I read about the Bitcoin Ponzi scheme was "Super Mario Bros”.  I had heard of Bitcoin before but had always assumed that, like a coin in the classic Nintendo game, it was relatively worthless in the real world. I was wrong. At the current exchange rate, the man responsible for the Ponzi scheme made off with the equivalent of $5.6 million.

On a basic level, Bitcoin makes sense. Many of our financial transactions are digital, and the dollar bill has almost become an anachronism used only for bribing children and the purchase of fast food. Technology has also (believe it or not) shifted from a centralized model to an “open” culture that encourages the spread of ideas and control amongst capable programmers. This free-love philosophy can only extend so far, however, and Bitcoin falls just outside of its boundaries.

In 2009, Bitcoin was created to be the premiere “alternative” currency. Operating on a decentralized, peer-to-peer network, Bitcoin’s value is determined by a number of currency exchange companies. The currency is favored by illegal gamblers, WikiLeaks, and people interested in buying Alpaca socks.

Back to the theft. A number of Bitcoin owners had their ‘coins stolen by “pirateat40” (who will henceforth be known as “Bitbeard,” my own name for him as his official moniker is a bit of a mouthful), the owner of Bitcoin Savings & Trust. Bitbeard promised a significant return on investment to anyone willing to transfer their Bitcoins, and for a while the fake hedge fund actually worked as promised. Then on August 17, Bitbeard disappeared with $5.6 million of these naive investors’ Bitcoins.

These people were practically begging to be ripped off. Not only did they fail to question how Bitbeard was able to keep up with an ever-increasing amount of Bitcoins, but they also trusted a man that they knew only as “pirateat40”. That’s a bit like asking “2timepyro” to house-sit – it’s probably not going to end well.

Because Bitcoin is an “open” currency and there is no central agency monitoring its usage, there is no official way to track down Bitbeard and demand the money back. Some of his victims have turned to Internet sleuthing to determine who he might be. But really, who are they going to call? If it were possible to call the authorities every time a digital dollar went missing, I would have called the cops on my brothers a long time ago for grabbing video game-coins that were rightfully mine.

Therein lies the problem. Because the Bitcoin-believers have determined that the digital currency has legitimate value – which is why we can say that Bitbeard made off with $5.6 million instead of simply saying 500,000 BTC – it can be used to make (some) purchases. But the currency's young status and the anonymous nature of many benefactors make it difficult to govern.

So how can someone be accused and tried for a crime and still remain shrouded in Web anonymity? Apparently, it’s not all that uncommon.

There is a pending case in California where four Bitcoin-ers are trying to get over $460,000 returned from Bitcoinica, a virtual exchange that is alleged to have stolen the Bitcoins and passed the blame on a “hacking”, but one look at the allegations is enough to make even LulzSec denounce anonymity. "Unknown form and origin" is repeated throughout, and the plaintiffs admit that they know nothing about the people they're accusing of theft except for their screen names. This anonymity makes legal battles difficult, but if it were to be removed, the gamblers, pirates, and illicit workers that have made Bitcoin popular would probably abandon the currency and strip it of all value.

Despite this tension, BitInstant – which, to clarify, is a company and not the screen-name of another Ponzi schemer – claims to be working on a Bitcoin-enabled debit card. It's hard to tell if this card will ever become a real product, as MasterCard (which BitInstant claims it is working with to create the card) has denied any knowledge of the project. BitInstant claims that of course MasterCard doesn't know who it is, because BitInstant is working with Master Card through "anonymous partners." Right.

To recap: a virtual currency with no governing body, whose main clients are the type of people that operate behind aliases like "pirateat40" – who just made off with $5.6 million, mind you –  may or may not be incorporated into a debit card that nobody but the company claiming to make it has ever seen. Sound about right?

Given the virtual hell that this currency seems to lay in its wake, the current financial system   doesn’t look quite so bad. Sure, the SEC is blackballing the JOBS Act and trying to add odd nuances and “gotchas!” to the bill, but at least there’s someone in charge of making sure our money doesn’t get thrown in the wrong direction. I’m not saying that these organizations are perfect – Bernie Madoff pulled off a much larger heist with “real” money – but those instances are the exception, not the rule.

Maybe a better way to put it is that at least there’s someone that’s supposed to make sure our money doesn’t vanish in the middle of the night. If Ponzi schemes are an issue with these groups keeping an eye on our financials, how will BitCoin ever solve its piracy problem?

[Illustration by Hallie Bateman]