Bitcoin is an Internet currency with no centralized bank or agency underpinning it. I only recently heard about it and I've been trying to understand how it works and if it is safe, however this is a huge question well beyond my expertise.

There are a lot of websites that make a lot of claims about Bitcoin, some for, some against. In this question I'd like to focus on this claim putatively from a BitCoin exchange:

I wanted to make more money. The number on the exchange. A number. I could change it in the programming. Not too much, because their are other exchanges to balance, but a little would be okay to do. So I did it. I increased the Bitcoin value a little. Say from $1 to $1.05. No one noticed and many were happy to see it go up. I was making people happy and the forum enjoyed the fun times with many dreaming big money! haha.

Now I change the Bitcoin price by hand nearly everyday now. I increase the number and more people give me money. Sometimes I let the files do this. It is a miracle like I have a bank haha. I give them numbers and they give me money.

Is it possible for someone running a Bitcoin Exchange to change the exchange rate at will, in order to steal money from its users, with no consequences?

The original source of the claim is somewhat unreliable, as that site indicates, however the general conclusion of that article, and others on the site, along with many of the comments is that it is Plausible. Additionally I have not been able to come up with any mechanism in the Bitcoin system that would prevent this from happening.

N.B If this claim doesn't seem notable enough I could change it to address the whole issue of Trust regarding the use of Bitcoin - for which there is more than enough notability - however, I'm concerned that the question might be too broad. Thoughts?

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    There's a Bitcoin Stack Exchange, probably more likely to get a good answer there - bitcoin.stackexchange.com – Tom77 Mar 21 '13 at 11:06
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    @Tom77 tbh I don't really understand how Bitcoin works at all, hence why I'm asking about how safe it is. I didn't just want to ask "Is Bitcoin safe?" and post a list of sites claiming for / against, so I picked one of the specific claims and asked it. But it is entirely possible that the one I picked doesn't really mean anything at all... :S - It didn't even cross my mind to check if there was a SE network for it. I'll read through there and then decide what to do with this question, thanks. – Ian Mar 21 '13 at 11:15
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    Someone running any kind of exchange is a free agent who can set whatever prices he wishes. If I exchange a rusty 1979 Honda Civic for your $9000, are you being defrauded? If you think someone is not giving you enough dollar for bit coin, or vice versa, then you find someone else. Exchanges working with ordinary currencies have a spread. They buy for a little less an sell for a little more. If the spread is too high, traders will go elsewhere. A gaping loophole in digital currency would be this: that someone can issue counterfeit money without detection. – Kaz Mar 22 '13 at 9:45
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    It seems to me that you should ask this question to an economist, not a skeptic. What "empirical studies" can be made on this? – Sklivvz Apr 1 '13 at 22:59
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    @Ian: I understand you being nervous about BitCoin, but I don't think this is a good example. What this person is describing is not a scam. It is simply setting the price on a commodity they are selling, which is not only legal but a fundamental part of capitalism. It is like complaining that dishonest shopkeepers are raising their prices because people are willing to pay more. There is no real claim here to answer. – Oddthinking Apr 2 '13 at 0:11

There's three parts to this question, which I'll address individually:

Can the administrator of a Bitcoin exchange arbitrarily change the exchange rate?

Certainly. The exchange software is just software, with all the potential for bugs, easter eggs, back doors, and so on that software is prone to. It would be trivial to add a "Set exchange rate" function to custom-written exchange software.

Unlike real-money exchanges, which have some level of oversight by the SEC or it's equivalent in other countries, no one regulates bitcoin exchanges or their software.

Does arbitrarily changing the exchange rate steal money from users?

Here the answer is more equivocally "yes and no." In order to explain that, I need to start with how an exchange actually works. Generally, no one trades directly with the exchange. Instead:

Exchanging is done by placing "buy" or "sell" orders, which the exchange system software then matches with each other. "Buy" orders (or "bids") are offers to buy bitcoins in exchange for another currency at a maximum price-per-bitcoin which is set by the offerer. "Sell" orders (or "asks") are offers to sell bitcoins at a minimum price-per-bitcoin. If the bid price of a buy order is higher than the ask price of a sell order, an exchange can be performed and either the bid order, the sell order or both can be removed from the "order book". Thus, at any given time, there is a price above which there are no more buy orders and a slightly higher price below which there are no more sell orders.

All the "exchange rate" is is the current price where no one wants to buy any for that price or higher, and no one wants to sell any for that price or lower. In a sufficiently large exchange, this rate is always fluctuating because new buy & sell orders are being placed all the time. There are also people who buy & sell at the current exchange rate in order to have the order go through as close to immediately as possible.

Arbitrarily moving the exchange rate does nothing by itself. If you move it up, there still won't be anyone who wants to buy at the higher price, and if you move it down, there still won't be anyone who wants to sell at the lower price. However, in the sufficiently large exchange scenario, people will see the price moving up (or down) and decide to buy before it goes higher, or see it moving down and decide to sell before it goes lower. Note that these are new buy & sell orders, not existing ones. In addition, the constant flow of people buying & selling at the exchange rate are now placing their orders at the higher/lower rate.

None of this is inherently wrong. If people weren't interested in buying at the higher rate (such as if you suddenly increased the price by a factor of 1000), or weren't interested in selling at the lower rate (such as if you suddenly dropped it to a penny), then trade wouldn't happen. However, by providing false information about what other people are doing, you lead people to make bad decisions going forward.

So where does the "steal money" bit come in?

As mentioned, exchanges don't necessarily hold onto any money themselves. They make their money on exchange fees, typically a small percentage of each transaction. So by increasing the exchange rate, they're going to collect a slightly larger amount from significantly more traffic. Again, this money isn't stolen, per se. It's the fee that every trader knowingly pays. They're making decisions based on fraudulent information, but they're knowingly giving that money to the exchange.

Does this have consequences?

Well, it opens the exchange up for arbitrage opportunities, where people buy bitcoins low on one exchange and sell them high on another. If the difference is enough to cover the respective transaction fees, you can make money this way.

There's also trust issues - if you discover that the exchange rate is being manipulated, how do you know that other things aren't being manipulated? What if your trades are being blocked or delayed in favor of friends of the admin? Outright theft from your account is easy to spot, but how are fees rounded (the Office Space method)?

An exchange that no one uses won't be able to sustain itself, so manipulating the exchange rate is a risky way to make some quick money quasi-legitimately.

  • I wrote a similar answer a while back (just undeleted it). It seems consistent with yours. What do you think? (I was downvoted, but I still believe it's all correct, and that your answer is also.) – user5582 Jul 11 '14 at 23:20
  • @Articuno - I agree that the two are consistent. I think I look at the whole picture more, but you've got some better links (like the specific regulatory act and the quote on manipulation). On the flip side, I don't think your answer comes together into a coherent whole - For instance, you talk about ways to raise the market price, but not what the effects of doing that would be, and the final quote doesn't match the lead-in, since it doesn't talk about limiting manipulation. I suspect my answer is overly long-winded, though. No answer is perfect. – Bobson Jul 13 '14 at 6:41
  • You really need to reference that BitCoin exchanges are not regulated by any trade commission (whether it's the SEC is irrelevant, as BitCoin exchanges are not necessarily based in the US). – Sklivvz Jul 23 '14 at 16:34
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    @Sklivvz - When you say "reference", do you mean find a source that no one regulates them? Or just mention that they aren't regulated elsewhere either? – Bobson Jul 23 '14 at 17:15
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    You are claiming BC exchanges are unregulated, based on what source? – Sklivvz Jul 23 '14 at 18:39

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