With bitcoin's value rising, expect more stories of lost wallets and forgotten passcodes

By Michael Carney , written on November 29, 2013

From The News Desk

With the price of bitcoin averaging $1,125 across the globe, many have minted a small fortune. But the massive run-up hasn’t been so positive for everyone, as a number of people have lost nearly as much. Given the anonymous nature of bitcoin's community, it's unlikely we'll ever know how much wealth has dissapeared.

You can’t short bitcoin, so how can you lose money while a market is on the way up? Selling early is one way, of course. But that’s not really “losing money.” The real heartbreak are the stories of people who have simply lost their bitcoin wallet with material wealth inside.

Bitcoin wallets are designed with military grade encryption, making them nearly impossible to hack. They are also designed with two keys, one public and one private. The public key is used as an address for receiving bitcoins. The private key is required to remove bitcoins from the account. Obviously the private key is more important. As the price of bitcoin has skyrocketed in recent months and the crypto-currency has become a regular topic of discussion in the news and online, stories are beginning to emerge of people who lost this private key, and with it, all chances of accessing their newly created wealth.

The most public and gut wrenching story is that of British IT worker, James Howells, who accidentally threw away an old hard drive containing the key to 7,500 bitcoins. When he realized his error earlier this month, they were worth £4 million ($6.5 million), but, adding insult to injury, that figure continues to rise.

Like a number of other (self-inflicted) victims of lost bitcoin wallets, Howells obtained his bitcoins several years ago when they were worth effectively nothing, pennies each. In these early days, when bitcoins were little more than digital monopoly money, people tossed them around as such and, in the process many were lost and forgotten. Howell simply forgot about his wallet and the concept of bitcoins all together, and went about his life. That is, until bitcoin caught on.

By the time he remembered his stash, the hard drive containing his bitcoin wallet had been carelessly discarded and was at the bottom of a landfill. Working with the landfill operators based on the timing of his spring cleaning, Howell has narrowed the area containing his hard drive down to the size of a football field. But given the time that has passed, it is now below approximately 4 feet of trash. The likelihood of finding his missing fortune is basically nil.

Reddit and bitcoin forums are full of similar stories of misplaced wallets. Some end with the wallet owners finding and accessing forgotten riches, but many end like Howells’ with heartache.

Services are emerging to help users recover lost wallet keys, but these are only effective in a fraction of cases. The strength of bitcoin’s encryption means that brute force attacks on unknown passwords are ineffective. Only if a user knows the majority of his passphrase, but can’t remember the capitalization or punctuation or believes they originally entered a known phrase with a typo, can these services help.

These stories of lost bitcoin wallets beg the question, what happens to the coins stored inside? The number of bitcoins is mathematically fixed and can never exceed 21 million. Today there are just over 12 million in circulation, a number will rise ever more slowly based on increasingly difficult mining algorithms. When coins are lost, they don’t disappear, they simply become inaccessible. In this way, it’s better to think of a bitcoin wallet as a keychain. When you lose your keys, your car and house don’t disappear, you simply can’t access them. Thus the bitcoin world is full of “parked” or “abandoned” coins. Nothing short of recovering these lost pass codes will change this.

It’s impossible to know exactly how many lost coins are out there, because it’s impossible to distinguish between a lost coin and a coin that simply hasn’t been moved or traded. Lost coins contribute to the supply and demand imbalance that has fostered the current run-up in price, but likely not to a significant extent.

Longer term, once the demand side stabilizes, these lost coins will have little impact on bitcoin price and liquidity. That is because bitcoins are divisible to the ten millionth (0.00000001), meaning they can be traded in minute fractions. Thus, if a total of 5 million bitcoins ultimately go missing – an unlikely number – it would simply be as if the maximum number of coins available to be mined was reduced from 21 million to 16 million  – which again is more than exist today.

Bitcoin is often compared to cash in that a single bill can’t be in two places at once. If I hold one bitcoin, no one else can hold or spend that same coin. It can’t be counterfeited or duplicated. This helps ensure the trustworthiness of counter-parties in a bitcoin transaction. Unlike cash, bitcoin wallets require this secret passcode to access. Meaning a pile of bitcoins can be sitting in plain sight, but without the key, they are worthless.

If you’re considering entering the bitcoin game, treat your wallet passcode with extreme caution. First, choose a passcode that is sufficiently long and difficult to guess. If it is a code that you believe you can personally remember, reliably, consider never writing it down. This will make it impossible for anyone to steal your bitcoin wealth. If you do need to record your passcode, do so either on paper or on a USB thumb drive and store that in either a locked safe or a safety deposit box.

As more people experiment with bitcoin, and the alternative currency receives more public attention, it’s likely that we’ll encounter more stories of lost digital wealth. Some may view the wallet and password structure as a “bug” or a flaw in the design of bitcoin. The currency’s (mysterious) creator(s) and those who understand cryptology would argue that it is simply a feature. Regardless, it’s not something that’s changing any time soon.

If you’re going to play the game, you have to know the rules.

[Image courtesy Zach Copley]