Bitcoin, etc.: What Can We Learn from Flooz and Beenz

by Vincent Violago and Nikko Quevada, Ph.D.

Our story begins with two pre-Internet bust companies Flooz.com and Beenz.com. These two companies provided online currency that could be used to reap rewards or make purchases online [1]. The currency flooz was attractive to customers who either did not have credit cards or were reluctant to use them to buy items online. Flooz received more than $35 million in venture capital funding. To persuade online merchants to use flooz currency, Flooz.com promised to pay the merchants for all sales that used flooz, whether or not the transactions were genuine. Dozens of merchants, several of which were well-known, adopted it. Within just about one year, the amount of flooz currency the company sold increased more than eightfold from $3 million in 1999 to $25 million in 2000.

Beenz.com was an online rewards company that started doing business in 1999 and was a recipient of an $86 million financing. The currency beenz was offered as a redeemable reward that customers could collect when they browsed or made purchases through websites that used the currency. The rewards could then be used to shop in other online stores that accepted the currency. About six million were supposed to have earned or redeemed beenz.

Beenz.com was an online rewards company that started doing business in 1999 and was a recipient of an $86 million financing. The currency beenz was offered as a redeemable reward that customers could collect when they browsed or made purchases through websites that used the currency. The rewards could then be used to shop in other online stores that accepted the currency. About six million were supposed to have earned or redeemed beenz.

Accordingly, Flooz.com was one of the many e-businesses that went kaput during the internet bust at least partly because of the following:

  • Flooz.com didn’t have deep-enough cash reservoir to weather early e-commerce challenges.
  • Its biggest corporate clients cut spending, which contributed to the loss of many customers.
  • Internet fraud probably hastened its collapse.

Also, Beenz.com folded because many e-commerce sites that used the beenz currency were presumably financially unstable, badly mismanaged, or both, which lead to their eventual crash.

So, we learn that having financially-wobbly companies as customer base or conduits to your customer base is risky, especially in a volatile market. Also, customer anonymity made possible by use of generic, cash-equivalent digital currencies magnifies the risk of fraud because anonymous transactions makes it difficult, if not impossible, to trace parties to a fraud.

But there’s nothing here we don’t already know. We have certainly learned our lessons because from Internet boom through bust and back to boom again, we must have finally grasped how to do e-commerce properly.

Let’s see what’s happening now with Bitcoin and other cryptocurrencies (referred to by some as altcoins).

Hackers are Making Fabulous Money Through Cryptocurrency (Except Most Exchanges, Traders, Miners, and the Rest of Us)

There are many different cryptocurrency in existence, and their number is climbing. For example, beginning with a pioneering cryptocurrency in the 1980s, Digicash [2], followed by the publication of Satoshi Namoto’s Bitcoin paper in 2008, there are now more than a thousand cryptocurrencies As of January 30, 2018, there were already what appeared to be 1,497 cryptocurrencies listed on just one cryptocurrency exchange (Digitalcoin) alone [3]. Among these cryptocurrency Bitcoin, Ethereum, Ripple, Dash, and Litecoin are among the better-known ones and they thus tend to be more heavily-traded than others. By January 3, 2018, the total cryptocurrency/blockchain market capitalization has reached a high of about $707 billion, but then fell by more than $200 billion just eight days later [4] [5].

Between 2013 and 2014, the Bitcoin exchange Mt. Gox reportedly handled more than 70% of all global Bitcoin transactions. Founded in Japan in July 2010, it filed for bankruptcy and underwent liquidation in 2014 after losing $460 million from hackers and missing an additional $27 million from its bank [6][7].

In addition, several other cryptocurrency exchanges were hacked within a short span between November 2017 and January 2018.

Sources: [8][9][10][11][12][13][14]

If we include the loss from Mt. Gox’s hacking with those from thefts that occurred between Dec. 2017-Jan. 2018, the total loss would amount to more than $ 1billion. But if we also assume that all those cryptocurrency exchanges will compensate all their customers who lost money, the total amount lost by the exchanges could exceed more than $2 billion dollars (Youbit customers will only get 75% initially [15]).

What do we learn from all these?

Security breaches in the cryptocurrency markets are rampant: Fraud probably did accelerate Flooz’s demise. Unfortunately, the former remains a constant and major source of public and private menace. In fact, it has only grown. It already is being committed on a global scale, sometimes in a concerted and frequently in a breathtakingly effective and efficient way. Apparently, hackers also stand guilty of cultural misappropriation as they have now deeply embedded constant innovation, non-stop learning, unwavering persistence, and unerring efficiency into their business model.

Cryptocurrency can be and are being exploited to commit fraud: The problem is not only hacking but also exploitation of cryptocurrency for illicit purposes. For example, it has been suggested that cryptocurrency might have been used for a Ponzi-like scheme to illegally prop up the value of a cryptocurrency to prevent it from collapsing. This would artificially inflate the CC’s value and perhaps induce some to plunk down their money on what is essentially a worthless investment [16].

Hype downplays the risks: Hype in cryptocurrency markets across the globe is running high unabated. This is causing many individual clients to ignore or misunderstand the risks inherent in cryptocurrency/blockchain systems because those risks are seldom mentioned, highlighted, or clearly explained. For example, everyone is told that any attempt to alter data in a previously validated and encrypted transaction data stored in a block in a blockchain that supports a cryptocurrency will trigger an alarm among all users of the blockchain. So, a blockchain must be impossible to hack, or so it seems. But this misleading because it fails to mention that there are other easier ways for hackers to steal your cryptocurrency from an exchange. As illustrated in one hacking case, hackers do not need to attack the blockchain itself. They could, for example, directly hack a vulnerable website that hosts a cryptocurrency exchange, steal a customer’s private key used to login into the site, or hack their way into the user’s digital wallets where the cryptocurrency are stored [17].

Many cryptocurrency exchanges fail to implement strong security systems: The multiple incidence of several successful hackings clearly implicates failure by cryptocurrency exchanges to install sound security protocols. In fact, the South Korean Communications Commission initiated a study involving cryptocurrency exchanges in the country to determine compliance with data protection standards. Eight exchanges were sanctioned based on the results of the investigation [18]. The Japanese government is also now demanding that cryptocurrency exchanges in the country improve their security systems after the theft of about $530 million by hacking, which eclipsed Japan’s now defunct cryptocurrency exchange Mt. Gox’s loss of $460 million from a previous hacking incident around 2014 [19].

There is an urgent need for a radically different way to protect data: Importantly, network security ultimately relies on who (or whose AI) is first to discover a network vulnerability and figure out a way to exploit or plug it. So, the problem is only going to turn into an escalating cat-and-mouse game with both sides continually inventing increasingly more sophisticated and deadly effective hardware and software hacking tools and defense systems. This is an untenable and unacceptable scenario. We definitely need to come up with a fundamentally different way to protect data from hackers.

Three Cryptocurrency Roads to Choose From

At this point, we know there are three major ways one can make money from CC: trade, steal, or protect those who trade. If you cannot stomach the inherent risks and current volatility of cryptocurrency perhaps you would want to invest some more of your money on cyber security business, something anticipated to grow from $105 billion in 2015 to a projected market size of between $165 billion by 2023 and $182 billion by 2021 [20][21]. You probably won’t make as much money compared to what hackers can steal at any time, but you’re investing on products that protect you, the public, businesses, and governments against ever present hacking threats. Who wouldn’t want that?

Wild Ride’s the Name of the Game (at least for now)

If you’re tempted to jump into the cryptocurrency/blockchain market, be prepared for a dizzying ride. Here is a snapshot of recent cryptocurrency market headlines.

Sources: [22], [23], [24], [25]

As with Beenz.com’s company clients, we are also seeing serious financial instabilities among companies and exchanges dealing in cryptocurrencies but on a more extreme wildly-galloping scale.

But here’s the thing: even though this has caused grave concerns among potential investors, it’s not entirely unexpected nor is it expected to last. Many financial experts and veterans would probably agree with the European COO of Bitcoin exchange BitFlyer when he said that the prevailing volatility of Bitcoin is a natural part of its evolution and is temporary. He added that as Bitcoin matures towards becoming a mainstream digital currency, we can expect its volatility to tamp down [26]. The same can be said for other cryptocurrencies.

The stage where cryptocurrency is in right now is probably what Steve Case described as the hype phase when he described the different phases of the Internet boom-bust-boom cycle:

“This sudden surge in interest led to the hype phase (late 90s), when people came out of the woodwork to be part of the Internet gold rush. Hundreds of companies were started, and everybody wanted to invest. Valuations shot up. Me-too companies became prevalent. Crazy ideas that had no business model and no realistic chance of success were viewed as the next big thing. As millions of people decided to go online virtually overnight, companies like AOL expanded rapidly. We were literally getting America online), adding 1 million new users every month or two. Our market value soared, from $70 million at the time of the 1992 IPO to $150 billion in early 2000 [27].”

Bearing all these in mind, it would be virtually impossible for most of us to ignore the adage that says incredible rewards belong only to those who brave unimaginable risks. But before you sell your house or lay siege to your pension fund, bear in mind that they were probably referring to those who have deep pockets to cover substantial losses in case an investment turned sour.

What Do Some Experts Say

Warren Buffet said any money you make from Bitcoin is based on speculation, so he predicts it is not going to be here for long [28]. Calling Bitcoin a fraud, JPMorgan Chase CEO Jamie Dimon echoed Warren Buffet’s comment and said Bitcoin will eventually disappear [29]. Later, he said he regrets calling Bitcoin a fraud, but he emphasized that he is still not interested in cryptocurrency [30].

Note that Warren Buffet was referring specifically to Bitcoin in his comments above. As previously mentioned, there are now more than a thousand different types of cryptocurrencies (a few or more variants are supposedly based on a mechanism that avoids one of Bitcoin’s major downsides, e.g., extreme energy resource hogging by Bitcoin miners) by last count, and that number is expected to keep climbing. Also, Jamie Dimon merely said he still was not interested in cryptocurrency He did not say he is never going to be interested or never going to get involved in cryptocurrency trading. Most likely, he (just like the rest of us) is just waiting and seeing to find out what happens next when all the seeming pandemonium has subsided a little bit.

Action Speaks Louder than Words: What Actions are Some Companies and Financial Institutions Taking Now?

According to Campbell Harvey, a professor of finance at Duke University, central bankers have now realized the need to establish their own cryptocurrencies. One example she gave was Fedcoin, which is a proposed U.S.-government-backed cryptocurrency [31][32].

Also, the following companies, financial institutions, and law firms have recently made public their foray into the cryptocurrency market:

Sources: [33], [34], [35], [36]

Clearly, some big names are now coming out and moving forward to stake their territories in the cryptocurrency market. But many probably remain uncertain about their plans or are being tightlipped as to what their intents are. There are many possible reasons for this.

For many companies, cryptocurrency has nothing to do with their core business nor do they envision it becoming such. If cryptocurrency eventually becomes widely adopted, they see it for what it basically is: merely as one of the many forms of currency for transacting business.

Another reason why many companies are taking a wait-and-see attitude with regards to cryptocurrency is there are too many cryptocurrency-based quick-rich schemes and other questionable cryptocurrency use cases that contribute to the pervasive security and fraud concerns. There is also worry that cryptocurrencies could become go-to vehicles for other and more serious illicit transactions. If this issue festers, it is likely to spook many potential investors, businesses, customers, and other potential adopters of the technology. This, in turn, could significantly delay CC’s becoming mainstream.

In addition, there are too many existing cryptocurrency variants, and many still are continuing to emerge. There are also several existing and emerging blockchain versions, which form the operational backbone that make possible cryptocurrency trading and mining.

Too many choices are bound to confuse many potential clients. Too many choices will also lead to market crowding and the inevitable profit thinning. So, having too many competing players is unsustainable because they bring with them a bewildering array of differing features, options, approaches to security and fraud protection, etc. This, in turn, will give birth to other issues such as interoperability, increased inconvenience factor, elevated complexity of having to deal with too many possible options, increased transaction errors, etc.

Thus, the multiplicity of cryptocurrency and blockchain variants magnify the already many serious concerns hanging over the cryptocurrency market, as well as reinforce lingering doubts about the feasibility and longevity of many of the cryptocurrency and blockchain variants. For sure, it is too soon to tell which ones will survive or eventually prevail during the inevitable culling process that will lead to some degree of market stabilization.

What we can make out from all these is that global adoption of a stable cryptocurrency of one form or another is already pretty much a given at this point. It is just a question of how soon.

Government Side: Invisible Hand or Regulatory Arm, Probably Both

Where do governments stand on all these? [37] [38]

“Securities and Exchange Commission chairman Jay Clayton has warned 
of the risks surrounding cryptocurrencies...”

“Chinese officials banned digital currency exchanges and initial coin
offerings.”

“South Korean policymakers have mentioned the idea of banning trading
via CC exchanges, after also banning ICOs.”

“Jerome Powell, confirmed as the next chairman of the Federal Reserve. . . ,
has expressed interest in blockchain technology, although he isn’t
necessarily a fan of Bitcoin or any other cryptocurrencies.”

As can be deduced from the above, governments at some point are expected to impose regulations on cryptocurrency markets across the globe. This is necessary to ensure protection of consumers and businesses, help establish some degree of market stability, and enforce business security standards in the still mostly, if not entirely, unregulated cryptocurrency markets. Government agencies across the globe are most likely being careful not to intervene prematurely and are obviously carefully monitoring how the various cryptocurrency market scenarios will play out once the wild gyrations of the cryptocurrency markets begin to settle down towards more reasonable and tolerable fluctuations.

SUMMARY

  1. Fraud remains a stubborn and grave problem that urgently needs to be addressed through a paradigm shift in the way we protect data from hackers.
  2. Hype, lack of regulations, and glaring absence of consumer education on cryptocurrency markets are causing unwitting consumers to jump into the cryptocurrency bandwagon while they ignore warning signs of fraud, financial instabilities of many cryptocurrency exchanges, lack of adequate if not strong financial and security safeguards, preponderance of quick-rich schemes, etc.
  3. Many cryptocurrency exchanges are being set up and run by individuals across many countries who have only bare bones or no experience and knowledge of (or are simply ignoring) practices grounded on sound business management, best practices, fiscal discipline, and business models based on strong fundamentals.
  4. Say all you will about how cryptocurrency are a fool’s gold, but they’re already here, and at least some of them will likely be here to stay. It’s just a question of how many will survive the pruning stage of the business cycle after we get past the hype stage.
  5. Before jumping into the cryptocurrency market in the hopes of making it big, do your homework as if you’ve got everything to lose.
  6. Because many others have lost their arms and legs from ignoring this one because some things are just too lip-smackingly good to ignore, we’ll repeat it here: If it looks too good to be true…

Originally published in https://www.linkedin.com/pulse/bitcoin-etc-what-can-we-learn-from-flooz-beenz-vincent-paolo-violago/

About the authors

Vincent Violago is the Founder and CEO of Parola Analytics. He has previously worked for Ernst & Young and Article One Partners.

Nikko Quevada, Ph.D. is currently the Lead Scientific Advisor at Parola Analytics. He was previously scientific advisor and law clerk at Pennie & Edmonds LLP in New York City and Brinks Hofer Gilson & Lione in Chicago. Dr. Quevada holds a PhD in Physical Chemistry from the University of Chicago.

About Parola Analytics

Parola Analytics is New York City-based patent research company, which offers a wide-array of services ranging from prior art searches, competitive intelligence to complex patent landscape projects.

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