Brainwallets and Why You Shouldn’t.

One of the most complicated aspects of Bitcoin and cryptocurrency security is that of maintaining your wallet security. Sadly, there is a lot of conflicting and non-intuitive information out there and it can be difficult to find information about what to do and how to remain safe.

One way of handling wallet security is through a method called brainwallets. In short, these are wallets that use a memorized word, phrase, or sentence to generate a secure key for an address.

Unfortunately, it’s not as easy as just coming up with a good phrase. To understand why, you need to understand a bit about wallets, addresses, and keys. Don’t worry, it won’t be very complex, and I’ll write a more extensive article later on deeper details.

Wallet and Key Primer

The first thing you need to know is that a wallet, in cryptocurrency terminology, is more like a collection of addresses than a store of money. It is the addresses that store the coins, not the wallet. The wallet is really little more than a list of the private keys for those addresses.

Each address is a unique string of characters that is derived from a public key. It is not the public key as such, but rather the result of some mathematical juggling.

At this point, you may be wondering what these private and public keys are, so let me give you a brief overview.

Modern cryptography often utilizes a private and public key pair. Each of these private and public keys in a pair are linked so that a certain public key always corresponds to a certain private key, but in such a way that knowing one part of the pair does not give you the other part.

For example, and very simplified, let’s say you have a public key ABC that corresponds to the private key DEF. You can validate that the key DEF corresponds to ABC and the other way around, but you cannot find DEF simply by looking at ABC.

In fact, you want people to have your public key in many situations. You can share the public key with anyone as long as you keep your private key, well, private. This is essentially what you are doing when you publish your cryptocurrency address, although it’s technically difficult to get from a Bitcoin or Dogecoin address to a public key.

By sharing your public key, or really the address derived from your public key, you accomplish two things. First, you allow people to send coins to your address, which at least in my book is a very compelling goal. Second, you create the ability to sign messages using your private key so that anyone can verify that you control the address. This allows you to send coins as well.

Note: You can even use this in reverse to create encrypted messages that only whoever has the private key can open, but that’s for another article.

Having the the private key part of a public/private key pair means that you can use the key DEF to sign a message, and anyone seeing that message can, knowing the ABC public key verify that it was indeed signed with the corresponding DEF key without knowing what the DEF key really is.

Note: Signing a message is really just creating a unique sequence of numbers or signature as it is usually called, using the private key and the message. Because the private key DEF always corresponds to the public key ABC, anyone who knows the ABC key can verify that it was indeed signed with the DEF key, again without knowing the DEF key.

Cryptocurrencies utilize this key pair method too by creating a unique address derived from the public key ABC. The private key DEF remains in your care, and this is what you need to guard to care for your wallet security. Your wallet essentially contains the private keys for any address (and thus public key) you have added to your wallet.

Anyone can verify that any message, such as a transaction, derived from a public key is indeed signed by the private key that corresponds to the public key. So, as long as you control the private key corresponding to the public key used to generate the coin address, nobody but you can sign a message that sends money elsewhere using that address.

So, with that primer out of the way, let’s look at brainwallets and why they are a bad idea.

Brainwallets: Just Say No!

Every transaction in Bitcoin, Dogecoin, Litecoin, or any cryptocurrency rely on two keys only; the public key, used to generate a coin address, and the private key, used to sign messages to control the coins held by that address.

This is what creates the semi-anonymous nature of cryptocurrencies. Nobody knows who controls the private keys, and whoever controls the private keys control the money. There is no other identifying properties such as address names, usernames, passwords, or anything like that. If you have the private key, you have everything you need.

However, remembering a private key can be very difficult. Here’s an example of a private key:

5KJvsngHeMpm884wtkJNzQGaCErckhHJBGFsvd3VyK5qMZXj3hS

This key corresponds to the address 1JwSSubhmg6iPtRjtyqhUYYH7bZg3Lfy1T, which is a fairly well-known and quite insecure address used as an example for a brain wallet.

Instead of trying to remember the private key, or having to keep it secret and possibly losing the medium used to store it, a brainwallet instead uses a phrase or sentence that is much easier for people to remember.

The above example is the brainwallet key for the phrase “correct horse battery staple” which is from a well-known XKCD comic that explains an aspect of passphrase security called entropy.

A brainwallet uses similar cryptographic number crunching to turn that phrase into a private key for a cryptocurrency address. Seems genius, right? You don’t need to memorize any cryptic strings and you don’t even need to store your wallet or private keys anywhere. Simply remember the passphrase and you’re golden; you can always recreate the private key from the passphrase.

But there’s a problem.

A Brilliant Idea Tainted

Because the only thing you need to get access to funds is the private key, and the passphrase can be used to recreate the private key, you end up with a situation in which anyone who uses the same passphrase as you will get the same private key.

The above example, using “correct horse battery staple” is an example of this. It is a common phrase that, while easy to remember, is also known to everyone and also fairly easy to guess.

In short, you end up with a security solution that relies solely on a passphrase that must be globally unique and extremely difficult to guess to have any meaning.

The XKCD comic is still right, but not in the case of cryptocurrency and wallet security. In a website login, a passphrase may work fine because you can add a bit of difficulty by having to combine the username and the passphrase, but also because you cannot simply brute force a billion attempts every second to try to log in using every conceivable combination of words. The server would either overload or there would likely be some kind of lockout after a few failed attempts.

With cryptocurrencies, however, you can try combinations of words as many times as you want. You don’t log in anywhere; you simply create a private key from the combination of words.

To create a secure brainwallet, then, you need to have a passphrase that is guaranteed to be unique and very difficult to guess.

You may think you can outsmart the system by using something that is unique to you. For example, add your spouse’s middle name to your phrase to create something like “correct horse denise battery staple”. However, you’d fail on the ‘difficult to guess’ part, and you’d fail in the globally unique part because, well, other people have spouses named Denise too.

You may use a longer passphrase but again, with the power available to modern computers these days, trying billions of combinations take seconds at most and if the attacker knows even basic information about you, such as the languages you use, your family names, your birthdates, and so on, it wouldn’t take very long to outsmart you by simple brute force.

Even if you managed to find a unique and difficult to guess pass phrase, you’re still stuck with a couple of problems.

One such problem is that you also need to remember the passphrase. The longer the passphrase, the more difficulty you’ll have remembering it.

Note: Writing it down is… not good.

“Great, “ you think, “I’ll use the first paragraph of the national anthem” and you’d fail in the difficult to guess and globally unique aspects again. “So, what about the combined names of all my kids, my parents, and my own, in random order?” For a password, it would be great, but for a brainwallet, it is not sufficient.

But let’s give you the benefit of the doubt and hope you remember your 28 word passphrase perfectly, and that it is both difficult to guess and globally unique.

Now you need to remember such a passphrase for every unique address you control. in cryptocurrencies, new addresses are cheap and used extensively. I’ve had hundreds if not thousands of unique addresses in just the year or so I’ve been involved with cryptocurrencies and remembering a passphrase for even a fraction of these would be impossible. And I do have great memory.

So, Any Good News?

You may think that based on what you’ve read so far, brainwallets have no use at all. That’s not entirely true, but like any tool, you need to know in which situation it makes sense to use it, and not try to force the situation to fit the tool you want to use.

For example, in cold wallet strategies, having a brainwallet may work great. Rather than storing the private keys in clear text, you can store a passphrase as part of something else. For example, you can put a book in a safe, and remember that the passphrase is the second paragraph on page 238. Whoever breaks into the safe won’t know the secret to finding the passphrase, and you just need to remember a few items of data. It isn’t practical for every day use, but then again, the purpose of cold wallets is to be long-term storage, not day-to-day payments.

Note: I’ll write about cold wallets and cold wallet strategies in a later article

For most normal uses, however, brainwallets aren’t as cool as they initially sound, and you need to be very careful before you rely on them for your security. With the knowledge you’ve gained here, though, you may be better able to determine when to avoid them and how they may be used as part of an overall security strategy.

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MtGox Bankruptcy: The Bad and the Good News

MtGox filed for bankruptcy protection on February 28, 2014, after losing control of almost 6% of all ‪‎Bitcoin‬ in existence at the time. You should be worried and excited at the same time.

Bitcoin is inherently a fixed supply currency. If a coin is lost, it cannot be reprinted ever. It is not mathematically possible so it’s not just a matter of attitude either. When you give someone a coin to hold for you and they lose that coin, there is no way to recover it. It is lost forever and you can jump up and down from anger as much as you want.

In essence, unless you can make 2+2 equal something else than 4 in traditional math, it won’t matter.

So, the loss of those coins, if they are indeed actually lost, is quite a blow to MtGox users. Even if you go to court and get a ruling saying you should get your money back, the money, for all intents and purposes, do not exist anymore. It would be like getting a ruling saying that you are entitled to be part of a historical event that happened centuries ago; it’s just not possible to enforce the judgment.

That’s the “why you should worry” part of this.

There’s good news, though, especially if you have followed the advice from virtually everyone who know how to tie their own shoelaces, and have kept coins in different accounts.

Imagine this: Tomorrow, the US government (or your local government) announces that 6% of the entire money supply is gone, and it’s not coming back. The money printer burned down, taking the only templates with them, and for some odd reason, it’s not possible to create a new template. You may think that this is a disaster, but it can be quite the opposite.

You see, the economy isn’t measured in number of coins, dollars, euros, or whatever. The economy is still exactly the same. You still buy the exact same amount of food, gas, electricity, and midget porn.

The means that, because there are fewer dollars in circulation, each dollar is worth more than it was prior to the accident. 6% more, actually. That means prices measured in US dollars will drop, so the money you have will last longer.
In a perfectly balanced world, where everyone kept an equal amount of money in MtGox, cold wallets, hot wallets, and other storage services, the loss of one of these services will not in any way affect the purchasing power of each individual. You can wipe out MtGox and it won’t mean a thing to Bitcoin, in the grand scheme of things.

To understand how this works, again imagine that every dollar in the world, except one, was gone in some freak accident. Suddenly, that dollar now represented the entire US economy, so it would be worth the entire supply of food, gas, electricity that the US consumes. And midget porn. A cent would suddenly be worth 1% of the entire US economy.

Similar to Bitcoin, of course, that won’t matter for those who lost all their money and it will make whoever holds that remaining dollar very rich. For those who did not lose anything on MtGox, their remaining coins are worth more. If you held a perfect balance across all your accounts, it won’t matter much.

So, it’s not all bad news, unless, you know, you just lost your entire life savings in which case… Well, you should have listened to the hundreds and thousands of community people that warned you against keeping all your eggs in one basket.

And you’ve learned.

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Understanding Bitcoin Malleability

Here’s an explanation of the malleability issue of Bitcoin and what it really means for you.

Let’s say you hire Jane Plumber to fix your sink for $100. After Jane completes her work, you write a check for $100, sign it, and send to Jane, thinking nothing of it.

CheckOriginal

Upon receiving the check, Jane annotates the check in some insignificant manner, for example by stamping it or writing a note that it has been received. She then sends the check to the bank to get the $100 deposited.

 CheckNew2

In Bitcoin, the check is analogous to a transaction. It is a signed statement from you that you want to transfer an amount to someone else. To declare that you intend to do so, you publish a cryptographically unique signature, or in this analogy a unique image, so that anyone can see that you intend to pay Jane $100.

All of these images or transactions are stored in the Bitcoin blockchain which is a public ledger of all transactions made by anyone. In this analogy each transaction is a picture of a check, a check signed by you, but that can be published to the public ledger by anyone who has that check.

BlockChainOriginal

As such, when Jane annotates the check, she can also publish the annotated image of the check. The annotated check does exactly the same thing; it withdraws $100 from your account and transfers to Jane. However, because of the annotations, the image that Jane publishes is different from the one you publish.

Although there are two check images published, only one of the images will be accepted by the bank or in this case the Bitcoin network. The details of how this happens is beyond the scope of this explanation, but involves a transaction history which ensures that you cannot give away the same dollar twice.

However, a malicious attacker can exploit this if you are a bit naive. If Jane’s image is the one accepted, Jane can call you and say that she never received the check. When you then go into the public ledger and search for your original image, it is nowhere to be found because it was Jane’s image that got accepted.

BlockChainHighlight2

If you are naive, you may then write Jane a new check, and she can withdraw your $100 twice, once for each check you sent her.

If this happened outside of Bitcoin, it would be very simple to check whether Jane was telling the truth. You can simply check your bank statement and see whether the charge for the personal check has been posted to your account. If so, Jane is lying and you can simply ignore her request.

BankStatementHighlight

In fact, even in Bitcoin, if someone claims that they have not received the funds you sent, it would be easy to check the balance of your address to see whether the funds are gone and thus have been sent. You may not find your original transaction, but you will find the transaction that sent the money and you could present that to Jane as evidence that the money has left your account and has been received in her account.

The malleability component of Bitcoin is the protocol’s ability to interpret the intent of the check, so to speak, even if it has been annotated with certain pieces of information or decoration. It is still the same check designed to do the same thing, but it looks a bit different than when you originally signed it.

Please also note that although you can make simple changes to a check or Bitcoin transaction, any change that is of importance, such as the sum you want to pay or to whom you send the money, can not be changed. If you attempt this, Bitcoin requires a new signature from you, and it’s not as easy as just copying the signature from a paper check.

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Give the Gift of Bitcoin Mining This Season

If you want to give a gift that is both a useful, educational, and benefits society, why not give someone Bitcoin mining as a gift? Here’s the idea.

CEX.IO, and I’ve written a couple of articles about them earlier (and links in this article are affiliate links; check the end for direct links), have the ability to generate vouchers that you, or someone else, can redeem for cloud mining power at CEX.IO. You buy the hashes for your own account and then create the voucher to give away some or all of that mining power to someone. Those that receive it can simply register and redeem the hash power and start watching their Bitcoin income grow.

I think this would be an awesome gift to someone who is interested in learning about mining and Bitcoin and are some reasons why.

Bitcoins are often difficult to get

One major obstacle to wide-spread Bitcoin adoption is that right now, getting traditional currencies into the system is a major hassle. By giving mining as a gift to someone, they get Bitcoins without the hassle and risk of sending money through wire transfers or buying in person.

Learning about mining is fun and exciting

For a lot of people, Bitcoin mining seems almost magical. However, it can be fun and exciting to follow and learning how it works is a great first step towards gaining a better understanding of Bitcoin.

Bitcoin mining at CEX.IO is redeemable instantly

Mining can be an exciting and educational, but some may not want to keep doing it for any number of reasons. That’s fine, at CEX.IO they can sell their cloud mining power any time they want and withdraw the Bitcoin to a normal account.

Investing in Bitcoin mining can be risky

Buying a Bitcoin miner means a lot of maintenance, electricity cost, and the risk of hardware failure. Of course, there’s also the risk that the miner won’t work at all or that the vendor doesn’t deliver or simply runs away with your money.

With CEX.IO, there’s little risk of hardware failure because CEX.IO is responsible for keeping the miners operational and replaces faulty hardware for free. They also take care of electricity and setup for you.

Getting a miner takes time

Buying a Bitcoin miner yourself will at best take a long time because miners are usually sold out way in advance of general availability. By the time you get your hardware, difficulty may have shot through the roof. Additionally, almost every vendor has been delayed with deliveries.

CEX.IO allows you to get Bitcoin mining power immediately; you can buy now and have your mining power start generating Bitcoin in a matter of minutes.

Physical Bitcoin miners are expensive

Getting a Bitcoin miner can often mean investing thousands of dollars. That’s a huge amount of money to give as a gift. Of course, you can’t just give parts of one either.

However, CEX.IO allows you to buy Bitcoin mining power for exactly the amount you want, whether it is $100, $1000, $1, or even $0.10 worth of hashing.

Note: You do pay in Bitcoin, though, so perhaps it is better to say 0.1, 1, 0.01, or 0.001 BTC.

Now that prices of Bitcoin has fallen, at least at the time of this writing, buying a few GHs of Bitcoin mining power isn’t half bad anymore, and it would make a great gift to introduce someone to the wonderful world of cryptocurrencies.

Please note: The links in this article are affiliate links, which means I get a small reward if you use those to sign up and make purchases. If you prefer to not use an affiliate link, just go directly to http://cex.io/.

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Why Altcoins Show the Future of Cryptocurrencies

I have previously written about how I think alternative coins like Litecoin, Namecoin, and Primecoin are important to the cryptocurrency community and to Bitcoin itself. My argument is that evolution is awesome and we should embrace it. A multitude of coins can keep cryptocurrencies from falling prey to the single point of failure.

Don’t get me wrong; Bitcoin is awesome on its own. For serving its purpose, it is almost perfect and there is no realistic alternative right now. If all we wanted to do with Bitcoin is what we currently do, alternative coins are a waste of time.

However, alternative cryptocoins, or altcoins as they are often called, have completely different uses too, and uses that Bitcoin cannot possibly expect to cover. In fact, although these uses  are incredibly useful (and I start to realize the overuse of the word use), adopting them into Bitcoin would be a huge mistake.

Let me show you some examples.

Litecoin

The biggest altcoin by far, Litecoin has been argued as being nothing but Bitcoin with a few minor changes and thus not adding anything of value. In fact, where some coins actually have useful features, the argument goes, Litecoin is simply Bitcoin with a slightly different algorithm. Faster transaction times isn’t really required and it isn’t really that much more secure, if at all. Nothing new to see here, move on.

However, look at what’s happening with the community. Over the previous few months, the Litecoin developers have given Bitcoin a completely new wallet program. The Bitcoin developers probably couldn’t have done this without inciting confusion, but Litecoin has been experimenting with this for a while and gave the result to Bitcoin for use as it sees fit.

In fact, being so close to Bitcoin in terms of features allow Litecoin to be the perfect test bed for new features for Bitcoin. Not only that, but other coins can also learn a lot from what Litecoin does, which may in turn yield even better alternatives than this current more-or-less replica.

Still, Litecoin is probably the coin that is easiest to just write off as a nice idea but not really required. Let’s move on, though.

Namecoin

Believe it or not, but a big problem today is the control that the US has over the domain name system. By court order, the US government can shut down or take over a .com domain, and because .com is operated by a US entity, that is a concern for those most paranoid about privacy and liberty.

It doesn’t even affect .com domains either; pretty much any country in the world has similar laws that allow someone to take over the operation of their domain names. This is one reason why you see a lot of ‘weird’ domain extensions; it is often an attempt of someone to gain some kind of protection from the scrutiny of governments.

Namecoin proposes to change all that by decentralizing the distribution of domain name management.

It has failed so far, but the potential to completely revolutionize and democratize the internet is there. Namecoin may be the first version of something that will eventually take domain names out of the control of government or ‘big corporations’ to democratize the process of managing domain names.

Primecoin

If you’ve read my articles on understanding Bitcoin mining difficulty, you may know that what Bitcoin and Litecoin miners generate is essentially thrown out the window. You may say that they are turning electricity into money, but for absolutely no other benefit beyond heating the room.

Primecoin is another example of how cryptocurrencies can have real life impact. If you don’t know, Primecoin is an attempt to turn the power generated by mining into something useful. In the case of Primecoin, it is generating chains of prime numbers, which is way beyond what I currently understand about math, but is potentially useful.

So far, Primecoin is only potentially useful, though, but it shows how cryptocurrencies can have the potential to yield real scientific benefit. Distributed computing, like the Folding at Home or SETI at Home projects, could be completely revolutionized by efforts like Primecoin.

Bitmessage, Colored Coins, and Mastercoin

Don’t like alternative coins at all? Fine, Bitcoin itself can also be utilized for other purposes than just as a store of value.

Three examples are Bitmessage, Colored Coins, and Mastercoin. Bitmessage is, or was, an attempt at building a messaging framework on top of Bitcoin. Colored coins can be used to make special Bitcoins that represent a different value like stock in a company, a car loan, or other valuables. Mastercoin can potentially allow anyone to create their own currency that is propagated through the Bitcoin block chain.

Bitmessage failed, or at least haven’t succeeded yet, because it simply doesn’t scale well, but imagine a messaging system where all messages are seen by everyone but encrypted so that only the intended recipient can decode the message. It may not replace email, but it could serve as a public verification and records of things like contracts, bids, agreements, and so on; an open and free notary public if you will.

Colored coins hasn’t been implemented by anyone yet, but imagine a system where a special Bitcoin could represent the shares in a company. Suddenly, you have an ability to trade that coin, or fractions of that coin, just like you trade shares in a company at a stock exchange today, except it would be open and transparent and not controlled by anyone.

Mastercoin is a new undertaking that seeks to build a protocol on top of Bitcoin to create custom currencies. Imagine a chain like Wal-Mart or Trader Joe’s issuing their own currency that you can buy and trade and use in their stores only. Governments could give custom coins for social welfare for use at a certain store only to prevent recipients from using them for drugs or gambling. Parents could give allowance money to kids without fear that they would use them for nefarious purposes. Airlines could give bonuses in terms of tradable currencies rather than ‘points’.

Version 0.1

At this point, cryptocurrencies are in its most basic infancy. We think of Bitcoin as just another form of money, albeit issued through mining rather than by a central bank.

However, this is akin to looking at the web in 1994. It was extremely basic and rudimentary. The ability to submit a form via a web page was considered a major breakthrough. Animating GIFs were considered the multimedia of its day. You could easily wait a minute or two while your browser loaded a web page. Much of the web was just text. It was awkward for most normal people and a niche thing for geeks and crazy people.

Today, we can barely imagine a world without the web. Not just did it pave the way for awesome communication across web pages, but it brought the internet to all those normal people, spawning a range of additional services, like online games, real-time video conferencing, secure communication for the masses, YouTube, and all the other things we now can barely live without.

Imagine, if you will, what the world can look like in a few years, the equivalent of the web in 2000, when cryptocurrencies have been around long enough for the mainstream to adopt them and build awesome services, products, and features.

Embrace the Future.

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Use Namecoin (NMC) to Purchase Bitcoin Mining Power

Disclaimer: Don’t take any financial advice from one source only. Always research multiple opinions. The CEX.IO links in this article are affiliate links. If you prefer a non-affiliate link, look towards the bottom of the article. Finally, do not under any circumstance invest more money than you’re comfortable throwing out the window. You can lose everything overnight. don’t say I didn’t warn you!

I’ve previously written about CEX.IO, which is a new way of investing in mining power where you purchase Bitcoin mining hashrate as a commodity on an open market. In short, if you can’t be bothered to read the original article, this is a great way of getting started with Bitcoin mining without having to risk more than exactly the amount you need and with the added security that you can sell your hashrate back to the market whenever you want. Oh, and you start mining the moment you purchase the mining power.

A nice feature of Bitcoin mining is its ability to do merged mining with other coins. Without getting too technical, this means that Bitcoin miners can mine several other cryptocurrencies at the same time using the same mining hash rate. Effectively, you get multiple coins from the same mining effort.

One of the most widely known merged mining coin is Namecoin, or NMC. Namecoin is a cryptocurrency that is built to support anonymous domain (DNS) names. Right now, however, the use of Namecoin is limited and due to the fact that there is a huge amount of Namecoin in circulation, a lot of miners have spare NMC in their wallets.

Note: If you want to read my opinion on why we need multiple cryptocurrencies, here’s my take.

CEX.IO supports merged mining, so you get several merged mined coins as part of your output, currently Namecoin, Devcoin, and IXCoin. That is fine and all, but unless you can actually use those coins for something, they’re pretty much useless for anything but trading to other speculators for Bitcoin.

Now, however, CEX.IO has started selling Bitcoin mining power for NMC, so suddenly all those Namecoins can be turned into something useful. The GHS price is pretty much the same as it is for hashrate bought with Bitcoin, but because there’s huge amounts of Namecoins out there that is pretty much only used for trading with other cryptocurrencies, the ability to turn them into Bitcoin mining power at CEX.IO is pretty cool.

You can also trade your NMC in your CEX.IO account for BTC directly so you don’t need to transfer it to a different exchange, sell them for Bitcoin, and then transfer them back. The exchange rate hovers at around the same exchange rate as for other exchanges, but because the transaction is instant, you save significant time even if you can’t speculate in the difference between exchange rates.

I’m still hoping that CEX.IO will also support buying hashrate for the other two merged mined coins you get, though, because it would greatly increase the value of these coins to the cryptocurrency miners.

Want to get started with Bitcoin mining using your Namecoins? Here’s my affiliate link to CEX.IO. If you prefer to have the plain link, though, here it is: http://cex.io/.

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Why I Sold My ASICMiner Shares

DISCLAIMER: As always, do not take financial information from me or anyone without doing proper research yourself. Always assume that anyone giving you such information has ulterior motives that benefit them rather than you.

A few months ago, I posted an article on how to acquire ASICMiner shares. Since then… interesting things have happened in the cryptostock community and you’re now left with Havelock Investments as your only reliable option.

At the time, ASICMiner traded at around 0.8BTC per share. I have put a, to me, considerable amount of my BTC into ASICMiner and say a huge rise in value. And then I sold.

Yeah, I sold at 1.8BTC per share. The price later rose to over 5BTC per share, but I was happy to have gotten out when I did, and here’s why…

Fundamental Investing

I don’t know too much about investment strategies. In fact, I started with investments when I got into Bitcoin, mostly as a learning experience. I’ve since read tons of material about how people construct their strategies and discovered to my amazement that I was following an already established strategy of investing based on fundamentals.

What is that you ask? Well, it’s a fairly simple strategy. Find out what something is really worth. Buy at a price that is lower than that and sell at a price that is higher than that. Simple, right? Like anything that is simple, though, there is a lot of homework required to get to that real worth number.

For example, in a mining company, you need to look at what is the long-term outcome of the mining operation. It doesn’t matter than a mining company churns out cash like it’s going out of fashion because if they follow the pattern of most mining operations, that churning will quickly diminish and will do so long before you get your share price back.

Finding the fundamental value of a share requires a lot of research, a lot of calculation, and a fair amount of guessing, at least in a market that is as volatile as Bitcoin mining. However, once you find that value, investing is mostly a numbers game; a cheap share is a certain value so you buy (or don’t sell) and an expensive share is another certain value so you sell (or don’t buy).

What fundamental investing doesn’t take into account, though, is people. Crowds tend to follow the moment of the crowd and that drives prices up or down regardless of what the fundamental value really is. In fact, all investors tend to bet on this to a certain extent.

ASICMiner Fundamentals

At the time, which was early April 2013, I looked at a few important factors of ASICMiner. First and foremost, I looked at their ability to deliver long-term. In April, the mining scene looked like a giant vacuum, and any ongoing mining operation was cash cows for their owners.

Friedcat had estimated that ASICMiner would hold an average of 15% of the total network hashrate throughout 2013. This was an awesome amount, but even that seemed too low as they were in the process of reaching the famed 51% limit and had to start selling their blade miners to keep below that limit.

15% of the network for 9 months is the equivalent of 864,000 BTC. Deduct a modest 10% in operational costs, salaries, and so on, and you end up with 777,600 BTC. Divided by just 400,000 shares and you’re looking at profits of almost 2 BTC per share, and that’s just for 2013.

However, the big question remained: would ASICMiner actually be able to keep this share of the network? A lot of people seemed to think so, and it’s easy to understand why. ASICMiner kept up with the growth in the network and had kept their promises and even exceeded them considerably.

In hindsight, it is equally easy to see why it had to fail. With the insane amounts of money ASICMiner generated, other companies and investors would want a piece of the cake. That meant huge investments into Bitcoin mining, leading to much higher pressure on ASICMiner.

Those investors also learned from another mistake ASICMiner made. ASICMiner was using outdated technology, which meant that even if they could produce huge amounts of hash power, that technology also required huge amounts of power and facilities, which were very expensive and difficult to operate. The competitors opted to use more modern technology and eventually rode in circles around ASICMiner in terms of performance.

In fact, this lack of updated technology and the vacuum created by ASICMiner’s initial success continues to create problems for ASICMiner. Their strategy of sticking with cheaper and faster to produce chips hasn’t given them much in terms of catching up, and right now, ASICMiner is just a few percents of the total network hashrate, diminishing by the day.

When considering any long-term investment in Bitcoin mining, one needs to take into consideration the halving effect. In short, the halving effect comes as a result of the halving of the Bitcoin block reward for miners, that happens sometime in 2016. At that point, a ballpark estimate is that miner income drops to 50% of what it is now. In effect, any mining investment loses half its value overnight.

To account for this effect, investors should calculate how much that effect is and increase their expected output each month so that they get enough back to counter the halving when it occurs.

Note: I’ve written an article that explains the halving effect in more detail.

The bigger the profit, the higher the impact of the halving effect. ASICMiner was slated to be one if not the biggest player, so the impact of the halving would be massive. This effectively reduced the dividends by several percentage points each month, so although ASICMiner at times had expected ROIs of 75-80% in a year, the real number was much closer to 30-40% over time.

Based on this, I estimated ASICMiner’s real value to be somewhere around 1.20-1.35BTC per share, depending on how optimistic I was. Of course, I wanted to make a profit on my investment at 0.8BTC, so I sold when I saw the price climb to 1.8BTC.

Before you run off to buy ASICMiner shares now, and thinking that the current price of around 0.6BTC must be an awesome bargain, keep in mind that at the time, I was estimating ASICMiner’s share of the network for 2013 to be 5-10%. Right now, it is not even 2%, and it’s dropping every day.

I’m not going to make a prediction at what I think the price will be, but you may want to consider that I haven’t bought back into ASICMiner at this point.

DISCLAIMER: As always, do not take financial information from me or anyone without doing proper research yourself. Always assume that anyone giving you such information has ulterior motives that benefit them rather than you.

CEX.IO – A New Way of Investing in Bitcoin Mining

Disclaimer: As always, do not take any financial advice from anyone without proper due diligence. Also not that link to CEX.IO in this article are affiliate links. If you prefer not to use the affiliate link, check the bottom of the article for a direct link. Oh, and please read the caveats and possible dangers before making any investment decisions.

With the rapid increase in Bitcoin mining power during the previous few months, most Bitcoin mining investments are not profitable. Investors seem to be gambling that somehow, mining will be less popular and thus more profitable for those that stick around.

Of course, this is an impossible dream; mining investments are driven by profitability, and once profitability is high enough, mining investments will increase, thus reducing profitability. In fact, the whole system is beautifully designed to create a balance where mining is barely profitable.

A big problem with investing in traditional mining equipment is that once you’ve placed your final order, you’re stuck with the equipment until you either sell it or take it offline. There are no partial refunds and it is complicated to sell parts of your equipment.

This is one of the reasons why group buys are popular. A group buy is essentially a person or entity that buys the mining equipment and then sells parts of that equipment to others. Shares of a group buys are easier to move around by selling or buying more to or from others.

Group buys are cheap and easy ways to get into mining, but has some serious drawbacks. First, the equipment must be bought, and when time is money, waiting for the group buy to fill up so the equipment can be bought can cost a lot of money. Then there is the question of trust; do you really trust the operator to pay diligently? Finally, you’ll always run the risk of hardware failure or operator death, especially when the group buy is run by a single person.

Similar to group buys are mining bonds. With a mining bond or contract, you get the output of a certain hashrate paid at regular intervals. Although most asset exchanges are now closed down, reselling outside of an exchange is certainly an option if you can find buyers. The operator does not necessarily have a certain piece of equipment but may fund the bonds or contracts through any means available, including other assets or multiple pieces of equipment.

Sadly, due to the rapid increase in network hash rate, most mining bonds and contracts have also turned out to be unprofitable, including my own BFMines (at least when bought at the IPO price).

However, a new option is now available for investing in Bitcoin mining without these drawbacks. CEX.IO allows investors to buy Bitcoin mining power by the GH/s.

CEX.IO appeals to me for several reasons.

Rather than wait for hardware to arrive, CEX.IO offers immediate mining start because the equipment is already in place. The operators have built, installed, and operate a huge mining farm so there’s no wait. I’ve bought capacity on CEX.IO and seen returns within hours of purchase.

There are no long-term commitments either, you can sell your hashrate back to the market whenever you want. This is quite unique as it allows you to enter and leave the market at a moment’s notice. You can even trade at fractions of a GH/s if you just like to get involved in a smaller scale.

In fact, this market is a very appealing feature. The hashrate available at CEX.IO is driven by traders just like yourself. That means that when the market thinks the hashrate price is going down, prices will go down, and when the market thinks rates will remain high, prices go up. I’m a proponent of market driven trading like this because it allows a larger group of people to decide what is a fair price.

Beyond just hashrate, however, CEX.IO also allows trading in Bitfury chip prices. This is like a traditional commodities market like oil or gold where you speculate in what prices the market is willing to pay for that commodity.

A great addition to the pro side for CEX.IO is that you also get merged mining alt-coins as part of your mining reward. Right now, you get Namecoin, IXCoin, and Devcoins as part of your profit, so effectively you are mining several coins at a time.

Finally, if you wish to operate your own equipment, you can actually redeem your owned hashrate into a physical miner sent to your home. When you own a certain minimum, you contact CEX.IO support and discuss shipping and handling costs, but you can thus turn your virtual asset into a physical Bitcoin miner.

Are there any drawbacks? Well, there are several risk factors.

First and foremost is determining whether your mining investment will make money at all. It is difficult to predict this and I’ve certainly failed in the past when I thought BFMines would turn a profit at IPO prices. Using a calculator like the mining.thegenesisblock.com may provide you with better insights. Keep in mind, though, that calculators such as these are available to everyone so their usefulness as a secret weapon are limited.

Second is the risk that the operators of CEX.IO may not be legitimate. The Bitcoin world continues to see large amounts of fraud and scams, even from the most seemingly trustworthy entities. We don’t know whether CEX.IO is a giant scam or legitimate, and it is very difficulty to prove either.

Finally, prices are driven by the market, and the market tends to be very well informed and wishing to make money. If you’re looking to beat the market, you need to beat the entire knowledge of the market, and that can be very difficult.

All in all, however, assuming CEX.IO is a legitimate operation, I think this platform is an excellent way to get involved in mining.

If you’d like to sign up and try, you can use my affiliate link, which will give me a small benefit from your investment too. If you’d like to do so, click this link.

If you’d rather just go directly without using my affiliate link, you can do so too here.

New Bitcoin Client – From the Litecoin Developers

A few months ago, I wrote about why I believe Litecoin has a place in the cryptocurrency community. In short, one of the main reasons is that diversity strengthens a community, and Litecoin certainly offers a contribution to that diversity.

To show this, the Litecoin developers, lead by Warren Togami, just announced they have released a Bitcoin client called Bitcoin OMG. Yup, that’s right, the Litecoin team working for the “enemy”, making Bitcoin a better coin.

The new client introduces several interesting features that are sure to make an impact. For example, the new client allows watch-only addresses. What this means is that you can monitor any address and see it’s account movements as if it were your own address. Obviously you can’t do anything with the money in those remote wallets, but due to Bitcoin transactions being public, you can see what goes on in any address.

Another interesting feature for those managing multiple addresses (like myself) is coin control. If you don’t know how a wallet works, it is essentially a collection of Bitcoin or Litecoin addresses. Although your wallet will show the complete balance for all those addresses (including watch-only addresses with the new client), each address actually was its own balance independent of each other.

Let’s say you have ten addresses where you’ve received 1BTC each. Your wallet balance now shows 10BTC and you want to send 3.5BTC to someone.

The default client will “kinda randomly” chose from which of those 10 addresses funds will come. This may be a problem if you are managing addresses for multiple entities, for example if you have an address for a company, your spouse, or perhaps set aside for a specific purpose.

With coin control, the new Litecoin-based Bitcoin client allows you to control from which addresses you send money so you can keep certain addresses completely out of touch if you like.

A final feature worth mentioning is for miners; you can now disable the wallet functionality completely and use the client as a relaying or mining station only. This reduces RAM usage considerably and makes the impact of running a client much smaller.

There seems to have been a hitch with the first release of Bitcoin OMG, though, so the developers have pulled it for now, but you can follow its progress in the Bitcoin OMG thread over on Bitcointalk.org.

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Understanding DMS

Disclaimer: This article contains information about investments in cryptocurrency assets. Investments such as these are extremely risky and you should carefully read and understand all aspects of investment and what makes cryptocurrency investments even more risky. Also, the author is an issuer of a cryptocurrency asset and may (or probably does) have vested interests.

So, you’ve become interested in the Deprived Mining Speculation, or DMS, securities have you? DMS.Purchase, DMS.Selling, and DMS.Mining seem to get a lot of attention these days, but can you quickly tell me which asset does what?

Well, you’ll be forgiven for not fully understanding how it all works because this is a very complex set of assets that confuse seasoned investors to no end. Add to the situation that a lot of community participants have very wrong ideas about what these assets do, and you’re pretty close to a guarantee of misunderstanding what you’re actually buying.

Note: Please read the update at the end of the article as it reveals how deceptive these assets can be.

Don’t worry, though, because in this article, I’ll explain it as easy as I can. I’ll take some shortcuts around the math as usual by using some silly numbers, while maintaining the integrity of the idea behind this security. Also, I’m assuming you have a fairly good understanding of what Bitcoin mining is, so I’ll skip the basics of explaining that.

An Executive Overview

DMS is a set of three correlating assets that works most of all like a bet. The three assets are DMS.Purchase, DMS, Selling, and DMS.Mining, and each work as a separate investment opportunity.

The bet is on whether mining investments will ever make money at all. The buyers or holders of DMS.Selling believes mining investments will never make back what their buyers have paid. The buyers or holders of DMS.Mining believes that mining investments will be profitable.

DMS.Purchase is a bit different because it is the entry point of each of these bets. Buyers of DMS.Purchase gets one share of each of DMS.Selling and DMS.Mining and would be smart so sell the share against which they bet.

However, unlike what many people seem to think, though, there’s no Bitcoin mining involved. The confusion stems from the fact that under certain conditions, DMS.Mining may appear to act like a mining bond and people seem to want to compare it to other mining bonds and contracts based on this fact. Doing so, however, is at best a bit naïve and at worst deceptive; there’s no mining involved, simply a dividend payment that mimics that of a bond under certain conditions. In fact, as I’ll show you later, there’s no way you can reap the benefits of being right in your bet on DMS.Mining.

What’s more confusing is that DMS.Selling, which is the bet against DMS.Mining ever making more than 100% return-on-investment, only pays out if the situation is such that DMS.Mining keeps acting like a mining bond. If that situation stops, DMS.Selling won’t get any more money and shortly thereafter DMS.Mining will shut down.

Confused yet? Let me see if I can clarify, one asset at a time.

DMS.Purchase

The DMS.Purchase asset is by far the easiest to explain because it is simply the way new shares are issued onto the market.

The purpose of a DMS.Purchase share is to give you one share of DMS.Selling and one share of DMS.Mining. In other words, the price of DMS.Purchase should always be the sum of one DMS.Mining and one DMS.Selling.

For the sake of the example, and silly numbers, let’s say that DMS.Selling and DMS.Mining both sell for 1BTC each. The price of DMS.Purchase will thus be 2BTC.

You can exchange one DMS.Purchase into one DMS.Mining and one DMS.Selling at any time, and really, this is usually the only thing that makes sense. The funds received will be invested in a very conservative way with just a few investment options being on the approved list. Considering the low-risk returns from investment and the management fee of 3%, the return from holding DMS.Purchase would be lower than simply investing in the underlying investment options directly.

DMS.Purchase receives dividends equivalent to what both DMS.Mining and DMS.Selling gets. However, because the price and thus resale value of DMS.Purchase options are defined by the price of DMS.Mining and DMS.Selling, which in turn is designed to go down as dividends are paid out, the price of DMS.Purchase will not rise.

DMS.Mining

Contrary to what many seem to believe, DMS.Mining is not a mining asset. However, it does represent a bet that Bitcoin mining assets will make money.

The way this bet works is that DMs.Mining pays dividend as if it were a mining bond with 5mhs hashing power, at least based on a formula for what an average of mining output would be, sans transaction fees, miners luck, and pool fees.

Note: This isn’t the same as a 5mhs mining contract or operation. Read more in my comparison of PMB and mining contracts.

The first question you should ask yourself is this; if there is no mining going on, from where do the funds come to pay the dividends?

The answer to this, as I eluded previously, is that the money comes from people buying DMS.Purchase, which may mean you if you got your DMS.Mining shares from swapping in a DMS.Purchase.

This may sound a bit sneaky, but it works as a way to speculate. After all, you pay 2BTC, get one share of DMS.Mining and one share of DMS.Selling. If you want the mining equivalent income, you can just sell your DMS.Selling for 1BTC.

You can, of course, also buy 1 DMS.Mining directly from the market and skip the DMS.Purchase route; the effective price you pay is the same. Regardless of which path you choose, DMS.Purchase has received the funds from someone and those funds will later be used to pay out dividends.

DMS.Selling

So now that we’ve explored DMS.Purchase and DMS.Mining, the rest should be easy, right?

Sorry to disappoint, but there is a major twist on the last leg of our exploration, and that is DMS.Selling.

You see, the entire DMS portfolio is a bet on whether Bitcoin mining assets will ever make money. Those that buy DMS.Selling believe that this will not be the case, so they should get some for of reward if they are correct, right?

Well, they do, and here is how it works.

The dividends paid to DMS.Mining goes down as Bitcoin mining difficulty goes up. That means that the price paid for DMS.Purchase may never be exhausted if the mining difficulty goes far enough up. In other words, if difficulty rises so much that a DMS.Mining share will never get back more than you paid for it plus what someone paid for DMS.Selling, then those excess funds will be paid out as dividends to DMS.Selling share holders.

In theory, this makes payments very difficult because who can say whether DMS.Mining will ever get paid enough to get all the funds paid in? After all, eternity is a very long time.

In practice, DMS solves this by introducing several steps of coverage. This coverage is determined by how many days of DMS.Mining dividends are available.

For DMS.Selling dividends, as long as the funds from sales of DMS.Purchase exceeds 400 days of dividends to DMS.Mining, any excess funds are paid out as dividends to DMS.Selling.

To understand how this calculation works, let’s imagine that 500 people buys DMS.Purchase for 0.4BTC each for a total of 200BTC and the immediately converts those DMS.Purchase shares to DMS.Mining and DMS.Selling shares.

If each DMS.Mining should get 0.001BTC per day, for 400 days, this amounts to a funding requirement of exactly 200BTC (500 shares x 0.001/share x 400 days). Because this is the same amount paid for buying the DMS.Purchase shares, no dividends are paid.

However, if difficulty then rises so that the payments drop by 10% to 0.0009 per day, the funding requirement for DMS.Mining is now just 180BTC. The excess 20BTC are thus paid out to DMS.Selling share holders, for a total dividend of 0.05/share.

The numbers aren’t quite so easy to understand, though, because the funds available obviously goes down as DMS.Mining dividends are paid out. Also, dividends to DMS.Selling won’t be paid out until there is more than 410 days of DMS.Mining dividends available.

In short, however, as long as difficulty goes up and does so by a certain amount, DMS.Selling will get dividends.

Now that we’ve explored the assets, let me explain why this becomes a very tricky investment.

Where’s The Catch?

You may have several questions at this point, and if you don’t, you have either cheated and read the contract already or you’re far smarter than me.

For the rest of us mortals, however, let’s consider some of the consequences of this bet. I’ll also show you why DMS.Mining isn’t a mining asset and is doomed to lose, regardless of whether you are right in betting that the difficulty rise will slow down.

First, what happens if difficulty doesn’t go up or even goes down? After a relatively short time, the 400 days will expire, especially if difficult goes down because this will increase the dividends to DMS.Mining.

Well, if the funds available in DMS.Purchase at any point gets below 100 days worth of dividends to DMS.Mining, all the funds will close immediately and DMS.Mining gets whatever remains in a lump sum payment. In other words, you won’t get any more dividends but you get just over three months of dividends paid out right away.

This may sound generous but there’s a catch. You see, if you buy or keep DMS.Mining, it is likely because you believe mining will be profitable. If DMS.Mining closes, and it would do so because mining has become too profitable, you’ll probably want to move your funds into a different asset.

However, the situation that may make mining profitable is a stop in the rise of mining difficulty. If that happens, all mining assets suddenly becomes vastly more profitable and thus prices will rise rapidly.

At the same time, everyone will know that DMS.Mining will stop operating and pay out a lump sum but will have no chance of reaping the potential huge rewards that a stop in rise or even a drop in mining difficulty will cause.

There’s no reason for anyone to pay more than dividends for whatever time remains until DMS.Mining closes plus 100 days, so prices for DMS.Mining will not rise. Thus, the funds you get from selling or liquidating DMS.Mining will certainly not be enough to buy an equal share of hashing power in a different asset, which by then will have risen dramatically because they can reap rewards from lower difficulty forever.

Let’s run a thought experiment again, where the funds in DMS.Purchase is now 1BTC and only one DMS.Selling and DMS.Mining exists. Dividend payment for DMS.Mining is 0.0025 so the DMS.Purchase funds are enough to secure 400 days of dividends. The price of a DMS.Mining share is 1BTC and a competing asset ACME Mines also cost 1BTC and pays exactly the same dividends.

Then, disaster strikes. Godzilla lays waste to Tokyo and several Chinese cities and takes out 50% of the Bitcoin mining network. This means that the profitability of mining for the remaining network doubles immediately and in a rational market, that would also double the prices. Of course, if ACME Mines is backed by hardware located in Tokyo, the hardware will also be lost, but that is a risk of any hardware based mining.

However, because the funds in DMS.Purchase are limited to 400 days (and now 200 days due to the drop in difficulty) a buyer knows that there is no possible way to get more than 200 days worth of dividends out of a DMS.Mining share. Even if dividends are paid out immediately, the maximum that can be paid is 1BTC.

For ACME Mines, however, the drop in difficulty means that long-term profitability will skyrocket. In fact, the return on investment (ROI) of ACME Mines bought for 1BTC is now 91.25%, which is an insane return for any investment (NASDAQ Composite usually does 4-7% per year).

In two years, someone buying an ACME Mines share will not just have gotten back everything they invest but a healthy 82.5% interest on their investments on top of that, and they can keep reaping that reward until they retire. Prices on shares like that go through the roof and probably double overnight.

Why DMS.Mining Will Always Lose

For DMS.Mining, however, well, there’s no such future. In just three months, the fund will forcibly close and you’d get another three months and a bit worth  of dividends plus probably a pat on the back and a ‘thanks for playing’ from Deprived. You’ll at most get 200 days or just over six months of dividends, representing just 1 BTC.

ACME Mines shares on the other hand, and assuming its hardware is not residing in the bowels of Godzilla, now cost 2BTC. Effectively, you’ve lost 50% of your mining investment even if you were right in your bet.

Note: Keep in mind, I’m using silly numbers to exaggerate the example to show how DMS.Mining is not a mining asset and only behaves that way if you are wrong in your bet on mining profitability.

The idea behind the DMS assets is that DMS.Selling should represent a bet that difficulty will go up and that DMS.Mining should represent a bet that difficulty will not rise by too much. Both assets reward investors who are right. In other words, if you believe mining to be a profitable undertaking, you’ll want to buy DMS.Mining shares.

This is correct, as long as you only consider DMS and not what happens in the rest of the Bitcoin investment world. If you believe in mining profitability and you’re right, you’ll want to reap the rewards.

However, as I’ve just explained, this won’t happen. If you are right, you’ll get a fairly small amount in payment from DMS.Mining and may even be stuck the shares because nobody will want to pay a dollar now for a dollar in the future so you’ll probably need to sell for less than you’ll get in dividends and lump sum over the next months.

Other mining assets will rise, though, so your ability to cash out and earn from being right is limited at best and completely gone at worst.

So, the brutal result is this: If mining difficulty keeps going up, DMS.Mining will lose the bet. However, if mining difficulty goes down or even flattens out, DMS.Mining will also lose the bet. There’s actually no way that DMS.Mining can win this game.

It is very important to understand this catch. DMS.Selling is the only asset that in reality can actually make money in DMS. If DMS were the only assets available in the world, then yes, DMS.Mining could earn money, but in a world where other mining assets exist, the loss in rising prices of those other assets will quickly and brutally cancel out any earnings from DMS.Mining.

So, DMS.Mining is not a mining asset and doesn’t behave like one, except when you are slowly losing money by holding it due to difficulty increases. If difficult slows down, you’ll only lose money faster.

Sounds harsh? Indeed it may be, but now at least you know. You also know why I really don’t consider DMS.Mining a mining asset and thus don’t want to compare it to BFMines.

Update August 10, 2013:

Deprived, the issuer of DMS, was apparently being less than completely honest about the outlook of his assets and in several drunken posts on Bitcointalk admitted that there is no way that DMS.Mining would ever make money and anyone investing in DMS.Mining were idiots. Interestingly, his claim is that there was no way DMS.Mining would make money until now so if you believe him this time, you should definitely run over and buy.

If you believe this article, of course, you wouldn’t.

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