Digital Gold (12 page)

November 2011

S
uccess was also testing the big ambitions and grand ideas with which Ross Ulbricht had started Silk Road.

After getting overwhelmed by new users in June 2011, he had brought the site back online, but on a more limited basis—with new registrations halted. His friend Richard, who had been helping him write the site's code, asked him:
“Have you ever thought about doing something legitimate, something legal?”

Ross, in fact, had considered alternatives, and he began collaborating with Richard on a Bitcoin exchange—not a silly idea given the troubles that Mt. Gox was having. They began designing a prototype for their exchange while Ross continued running Silk Road.

In the fall, Ross was forced to consider his options seriously after a friend of his ex-girlfriend—the only other person who knew about his involvement with Silk Road—posted a revealing message on Ross's Facebook page:
“I'm sure the authorities would be very interested in your drug-running site.”

Ross immediately deleted the post and unfriended the woman
who had posted it. But he was terrified and went over to Richard's house to talk with the only other person who knew his secret.

“You've got to shut the site down,” Richard told him, after Ross had arrived and explained what had happened. “This is all they need. Once they see this, they can get a warrant and it's over. This is not worth going to prison over.”

Ross told Richard that he had, in fact, already sold the site to someone else, but Richard could tell Ross was still very shaken. And there was good reason for him to be: Ross had not sold the site.
He lied to Richard as one part of his effort to cover his tracks. He was, in fact, still firmly in charge of Silk Road.

Looking at the numbers made it easy to see why Silk Road was a hard business to turn away from. In August alone,
the site had generated $30,000 in commissions. There was so much business that
in September Ross hired his first staff member to help him out—a user of the site who went by the name chronicpain.

More was involved than the money, though. Ross's site was actually accomplishing the big things he'd been dreaming about a year before—fulfilling both his ego and his ideals. On the Silk Road forums, he was able to give his grandiose aspirations free rein:

“We've drawn a line in the sand and are staring down our enemies. Like it or not, if you are participating here, you are standing on that line with us. This is not about making money. This is about winning a war. Look how far we've come in 8 short months. We are JUST getting started.”

The notion that a site dedicated to selling heroin and forged passports was a moral cause would seem to many in the outside world an exceedingly bold claim. But for Ross, Silk Road was an application of the ideas advanced by the philosophers and economists whom Roger Ver and Erik Voorhees also loved—the ones who prized freedom above all else. According to this moral code, people should be allowed to do anything they please as long as it
didn't hurt others. Freeing people from the constraints that held them back was an achievement of the highest order, even when all that it allowed was a junkie to get his fix.

The emphasis on freedom did not mean that Silk Road was an entirely lawless place. If a product, such as child porn, required the victimization of someone else, it was banned from the site—and immediately removed by Ross—following the one rule that all the anarchists and libertarians tended to agree on. When Ross created a category called forgeries, there were also limits: “Sellers may not list forgeries of any privately issued documents such as diplomas/certifications, tickets or receipts,” he wrote on the Silk Road forums. But documents created by governments were fair game.

The success of Silk Road was certainly offering Ross a freedom unlike anything he had experienced before. In late 2011,
he sold his pickup truck and moved to Sydney, Australia, where his sister lived. All he needed for his job was his Samsung laptop.
He would fit in his work around trips to Bondi beach, where he surfed and hung out with a crew of friends he quickly fell in with. As always, his cool gravelly voice and good looks made it easy for him to meet women. But he had, by now, learned his lesson about discussing Silk Road with anyone. When people asked what he did for a living, he would explain that he was working on a Bitcoin exchange. But for someone involved in such a bold and transgressive enterprise, Ross was a surprisingly fragile and sensitive soul. After a day of walking around Sydney with a girl he liked, just before the New Year, Ross explained how difficult his double life was becoming in the one forum where it was possible—the diary on his computer.

“Our conversation was somewhat deep,” he wrote of his walk with the girl. “I felt compelled to reveal myself to her. It was terrible. I told her I have secrets. She already knows I work with Bitcoin which is also terrible. I'm so stupid. Everyone knows I am working on a Bitcoin exchange. I always thought honesty was the
best policy, and now I don't know what to do. I should've just told everyone I am a freelance programmer or something, but I had to tell half truths. It felt wrong to lie completely so I tried to tell the truth without revealing the bad part, but now I am in a jam.”

It was, though, the norm for Ross to fluctuate between self-doubt and hubris. The unusual combination seemed to actually be one of the keys to his success. His self-reflectiveness led him to question everything and constantly rework his site, while his confidence kept him going when he got down on himself.

Keeping his spirits up was becoming easier in late 2011 because Silk Road had attracted a lively community of users. Ross had also found someone he trusted on the site—a vendor on Silk Road who became a staff member and went by the name Variety Jones. Ross described him as
“the biggest and strongest willed character I had met through the site thus far.” Variety Jones, or vj, as Ross referred to him, pointed out flaws in the site's design and helped Ross figure out how to fix them. More important, he became a sort of confidant and even a friend to Ross, helping him think through the best way to run the site, and to feel less lonely.

When Ross was worrying about the people who might compromise him,
Variety Jones came up with a clever idea: Ross could change his name on the site from silkroad to Dread Pirate Roberts. The name carried a swashbuckling panache that Ross liked, but it also provided something more important: an alibi. In the movie
The Princess Bride
, Dread Pirate Roberts was a name that was passed along between vagabonds. This could allow Ross to later say that the job of running Silk Road had been done by different people at different times.

“start the legend now,” Variety Jones told him in a chat.

“I like the idea,” Ross wrote back. “goes along with my captain analogy.”

Variety Jones also helped Ross hone his public pronouncements
on the site, which never showed any of the insecurity that Ross had in his real life. In his “State of the Road Address,” posted on the Silk Road forum in January 2012, Ross explained that the site was “never meant to be private and exclusive. It is meant to grow into a force to be reckoned with that can challenge the powers that be and at last give people the option to choose freedom over tyranny.”

If nothing else, Silk Road was indeed providing a good showcase for how anonymous markets and decentralized currencies could work in practice. In early 2012 Silk Road was still essentially the only place where people were regularly using Bitcoin to make real online, anonymous transactions—and the system was working as well as the Cypherpunks might have hoped. Silk Road customers were regularly sending payments of thousands of dollars—or hundreds of Bitcoins—to vendors on the other side of the world. In early 2012 there were
vendors in at least eleven countries and many of them were willing to send their products across international borders. All of this was done using Bitcoin addresses and private keys that did not require either side to provide any personal information. There were essentially no complaints on the site about the Bitcoin payment system, and many users who came for the drugs grew to admire the ways in which the virtual currency improved on existing payment systems. It turned out that when the incentives were high enough, lots of people, even those in altered states, could use Bitcoin as intended. The only occasional gripe was about the volatile price of Bitcoin, which made it hard to know how much a vendor would be charging a week later. But Ross dealt with this by creating a clever hedging program that allowed customers and vendors to lock in a price.

Silk Road was also providing a demonstration of how the market could work to keep an unpoliced community in check, even one where the members of the community went by screen names like nomad bloodbath, libertas, and drdeepwood. The primary
tool that brought accountability to this anonymous market was the same sort of feedback mechanism used by eBay and Amazon. When a customer received a Silk Road product through the mail, he or she was asked to rate the transaction on a scale from 1 to 5. Even if no one knew the real name of a seller, the reviews attached to a seller's screen name would allow customers to determine if that particular vendor was trustworthy. A few bad reviews could sink a seller's business.

This feedback loop created a remarkably engaged online community in which pot and heroin highs were discussed with the same level of analytical detail that
Consumer Reports
brought to its toaster reviews. And it injected accountability into this apparently lawless land.
An academic study of Silk Road later found that nearly 99 percent of all reviews gave the maximum score of 5 out of 5. This helped keep Silk Road growing, from 220 vendors in late 2011 to around 350 in March 2012. The value of all sales in the spring of 2012 was around $35,000 a day. Ross was taking between 2 and 10 percent of each purchase as a commission, depending on the size of the order.
In March, that amounted to nearly $90,000 in commissions, collected in Bitcoins.

There was, however, an often unspoken irony in the success of Silk Road, and of Bitcoin for that matter. The site and the currency, which aimed to circumvent the power of the government, were largely built on technology that had been created by the government or through research sponsored by tax money. The Internet itself was an outgrowth of several government research programs, and the Tor network that served as a backbone of Silk Road had been created by the Office of Naval Intelligence. Bitcoin, meanwhile, relied on advances in cryptography that had been built thanks to government funding. Ross himself had gained the expertise to build his government-eluding site after attending one of the best-funded public high schools in Texas and two public
universities. It was no coincidence that these technologies did not emerge from a place with a weak government and bad educational systems. But Ross focused on the wrongs the government committed and ignored the advantages it had provided.

That same government was, of course, not going to sit by idly while the technology was used to support an online drug bazaar. Ross didn't know it, but in the fall of 2011 the Baltimore office of Homeland Security Investigations, or HSI, the law enforcement arm of the Department of Homeland Security, had opened accounts on Silk Road and began making small-scale purchases. This led federal agents, in January, to the doorstep of a young man in one of the poor suburbs of Baltimore who was known on Silk Road as DigitalInk.
In real life, DigitalInk's name was Jacob George and he had been buying drugs—including methylone, bath salts, and heroin scramble—on the streets of Baltimore and reselling them online, becoming one of the most popular vendors on Silk Road after joining the site in July 2011.

After DigitalInk was arrested in early 2012, he immediately agreed to cooperate with the police. His record of Bitcoin transactions provided only limited information about the identity of his customers, owing to the lack of personal information connected to Bitcoin addresses. But it was a first strand of loose yarn for the officers to start pulling at. And in March the HSI bureau in Baltimore got approval from local prosecutors to form a task force, with other federal agencies, that would aim to burrow further into the cryptographically secured drug bazaar. The task force was given the name Marco Polo in deference to the man who explored the original Silk Road and all the new wonders it contained. A short while later, the agents in Baltimore created an undercover identity for themselves on Silk Road, with the screen name nob, and set out to build a relationship with a man they knew of only as Dread Pirate Roberts.

February 2012

A
fter running away from the United States government to pursue his antigovernment vision, Roger Ver had chosen to live in a place that was uniquely unreceptive to his brand of antiauthoritarian politics. Japan was a country that was still deeply wedded to traditional hierarchies with an educational system that taught its citizens from a young age to obey authority. This was evident in the country's rigid business traditions—the bowing and exchanging of cards—and in the spiky-haired punks in Tokyo, who waited patiently for walk signals, even when there were no cars in sight.

Roger had picked Japan, not because it would allow him to be around other like-minded people, but because he liked the orderliness of Japanese culture—and the women. He had met his longtime Japanese girlfriend at a gathering in California and even she had almost no interest in politics. As Roger discovered, the deferential culture made Japanese people uniquely skeptical about a project like Bitcoin that aimed to challenge government currencies. Japan was the only place Roger had encountered where people's
response, when he described Bitcoin, was to call it scary—rather than interesting or silly. This was due, Roger believed, to the way in which the virtual currency broke from the government's mandates about how money should work. One of the only people with whom Roger had gotten any traction in Japan was a local pornography tycoon.

Luckily for Bitcoin, Roger's job and wealth allowed him to wander far beyond Japan. In early 2011, he commenced his effort to renounce his United States citizenship so that he would not have to pay another dollar of taxes to support a government he considered immoral. Japan, with its sense of tradition and history, made it almost impossible for foreigners to gain citizenship, so Roger made plans to travel to Guatemala to start the process of applying for citizenship there. He was also traveling constantly for his work with Memory Dealers—looking for cheap hardware—and everywhere he went he would talk about his new passion. While visiting the Chinese manufacturing hub of Shenzhen, he held the first-ever Bitcoin Meetup in China and paid for the group meal himself. Whenever he ended up in a taxi, he would set up his driver with a smartphone wallet and try to pay his fare in Bitcoin. When Roger began looking for an engagement ring, he promised the online diamond merchant BlueNile that he would buy a $50,000 diamond if the company began publicly accepting Bitcoin (BlueNile ultimately demurred). He continued using his own company, Memory Dealers, to promote Bitcoin by offering discounts to people who paid with Bitcoin, and by selling the popular “physical Bitcoins,” known as Casascius coins, manufactured by a man in Utah. Bitcoins, of course, have no physical quality—they are nothing more than an entry on a digital ledger. But the creator of the Casascius coins printed the private key for an unspent Bitcoin on the inside of a hologram, attached to a specially manufactured coin with the Bitcoin emblem. A person could spend the Bitcoin by peeling
off the hologram and using the private key. These Casascius coins would later become the most widely used image of Bitcoins when news organizations needed a picture of something to accompany stories about the virtual currency.

When Roger got into conversations about Bitcoin, he had a few stock lines he would deliver, always with the same crisp elocution and conviction—almost as if he were in a reverie.

“I'm pretty confident that Bitcoin is
the
most important invention since the Internet itself. The world is changing because of Bitcoin right in front of our eyes and it's such an exciting time to be a part of this,” he liked to say. “I've been spending just about every waking moment focusing on Bitcoin.”

Roger had always been a good salesman in part because of his ability to communicate his own conviction, but also because he had an intuitive sense for what people wanted and knew how to meet them at their level, without demanding agreement with his beliefs. His pitch for Bitcoin to the antigovernment activists emphasized the ability to buy drugs with Bitcoin, even though Roger himself was an abstainer who had never smoked a cigarette. When other Bitcoiners said that Roger's talk of drugs and dodging taxes could tarnish Bitcoin's reputation, he replied that he always adjusted his arguments to his audience.

“If I was going on the Oprah Winfrey show, I should certainly use a different list of talking points,” he explained on the Bitcoin forum.

Roger, then, had the rare resources and abilities to help sell Bitcoin beyond the small fringe communities where it had so far been cloistered. And he was dedicating his life to doing just that. In addition to the personal pitches and purchases, he was eagerly supporting any companies he could find that might help expand Bitcoin's appeal beyond libertarians and heroin addicts. He gave $100,000 to Jesse Powell, his old friend who had come to Tokyo to help out with Mt. Gox. Jesse had been so struck by Mark
Karpeles's weaknesses that he decided to start his own exchange. But Roger's most significant investment early on would prove to be the one he made in a young New Yorker named Charlie Shrem. Roger had first seen Charlie talking about his company, BitInstant, on Bruce Wagner's
The Bitcoin Show
. A small, cherubic twenty-two-year-old, with a Brillo Pad of curly hair and a slight Brooklyn accent, Charlie pitched BitInstant as the easy way to get money into and out of Bitcoin without wiring funds internationally to Mt. Gox's bank account in Japan.

Roger quickly reached out to Charlie by Skype, and asked how much money he needed. Charlie offered him 10 percent of the company for $100,000. Roger sent over a wire payment for $120,000.

T
HE YOUNG MAN
Roger had invested in was, outwardly, an unlikely candidate to become the entrepreneurial leader in a futuristic global movement like Bitcoin. He had grown up in the Midwood section of Brooklyn, in a Syrian Jewish community where all the kids went to the same religious schools. From early on, Charlie had struggled with social acceptance. He had been born cross-eyed and, after surgery to fix the problem, had to wear thick glasses. He was almost always the shortest one in his classes. As with so many other techies, Charlie's real-world struggles led him to cultivate an active life online, where he knew many of his friends by their screen names.

But a surprising confidence lurked beneath Charlie's anxious exterior. As the oldest child and only son in a family with four sisters, he was treated like a prince by his mother. He had discovered that while other kids could be difficult to win over, grown-ups were generally an easier audience. He was the one kid at his synagogue who would go up and shake the rabbi's hand after services and his energy and good spirit generally appealed to adults. As he
grew up, he found his personality lent itself naturally to business, which was highly valued in his community and in his family; his parents ran their own jewelry businesses. When he was a freshman at Brooklyn College, he and a few friends had founded an online deals site, somewhat like Groupon. He blossomed into a confident salesman when pitching his ideas.

Charlie had initially learned about Bitcoin through an article about Silk Road. He had gone on the forums and found another user who was thinking about launching a deceptively simple startup: a company that would make it easier to get dollars into and out of Mt. Gox. The man, Gareth Nelson, lived in Wales and had already programmed a prototype. Charlie confidently pitched what he could bring to the project, telling Gareth that he knew people at PayPal—“very high-up”—and would call to get their support. In reality, though, the first people Charlie got help from were his parents. Still living in the basement of his childhood home in Brooklyn, Charlie asked his mother if she would be willing to give him a seed investment. Charlie's mom, who ran the jewelry company Bangles by Kelly, rarely said no to her only son and didn't disappoint him this time, transferring $10,000 to him.

Charlie was a departure from the idealists who had been driving Bitcoin development so far. His first-ever post on the Bitcoin forum was not about the power of decentralization but an offer to sell JetBlue airline vouchers for Bitcoins. Over the next months he would offer magazine subscriptions, “Fuzzy Toe Socks,” and throwing knives.

It turned out that Charlie's willingness to throw things at the wall, to see if they would stick, was not a bad thing at this point. The idealists who had been driving the Bitcoin world often got caught up in what they wanted the world to look like, rather than figuring out how to provide the world with something it would want. The business model being pursued by Charlie and Gareth
was designed with the very practical aim of making it easier for customers to get Bitcoins than it was to get them from Mt. Gox, which required wiring money overseas and placing orders on the exchange. Just as Charles Schwab dealt with the New York Stock Exchange so that its customers didn't have to do so, BitInstant handled all the dealings with Mt. Gox, making the process of acquiring Bitcoins faster and easier.

Charlie's swagger led him to generate ideas, and act on them, in a way that was still unusual in this young industry. But his confidence also came with a recklessness that would become a liability. On the Bitcoin forum, Charlie advertised his love of marijuana and offered Silk Road users help and advice. Less publicly, he began working with a Florida man who helped Silk Road users get Bitcoins to buy drugs. Charlie was smart enough to include a section on the BitInstant site about the company's intolerance for anybody using Bitcoin illegally and he chose not to advertise his own company on Silk Road. But when a Florida man, who went by the screen name BTC King, approached Charlie about privately exchanging large amounts of money for Silk Road customers, Charlie devised a way to do it without attracting notice. When Charlie's programming partner in Wales questioned Charlie about the deals with the man, Charlie argued that they wouldn't be a problem.

“He has not broken any rules and silk road itself is not illegal,” Charlie wrote to Gareth. Besides, he said: “We make good profit from him.”

W
HEN
R
OGER
V
ER
invested in BitInstant, he could tell that Charlie was a raw talent and offered himself as the company's marketing director to help steer Charlie's idea. He then connected Charlie with Erik Voorhees. Erik, who was still living in New Hampshire, was more ideological than Charlie, but he was also more careful and
grounded, and Roger thought they would complement each other. The month Erik joined BitInstant, the company processed $530,000 in transactions, up from $250,000 just two months earlier.

As they began working together, Roger and Erik jokingly gave Charlie the nickname “Statist” for his more traditional politics and respect for government. But that didn't stop BitInstant from becoming a popular service among all the ideologically motivated people whom Roger and Erik were winning over, who were looking for the easiest way to get their hands on Bitcoin.

In February Erik appeared at Liberty Forum—one of the Free State Project's two major annual events—to speak about Bitcoin's appeal to anyone opposed to the American government. The room was packed and Erik was mobbed afterward by interested people wanting to get involved. The price reflected that interest. After bottoming out in late November at around $2, by February the price of a single Bitcoin was stabilizing around $5. It didn't hurt that Bitcoin made its first serious foray into popular culture in January 2012 when an entire episode of
The Good Wife
was based on a plot about Bitcoin.

In April Erik traveled from New Hampshire down to New York to meet Charlie in person for the first time and to make a presentation at the first-ever New York Tech Day, an event designed to connect startups and investors. Charlie and Erik spent the morning setting up their booth at the storied Park Avenue Armory with slick BitInstant banners and branded key chains.

Soon after the doors opened, two older gentlemen with the casual whiff of money approached Charlie. He launched into his elevator pitch for Bitcoin, leaving out anything about central banks, and focusing on the ability to transfer money around the world free. The two men had never heard of Bitcoin, but one had worked in the import-export business and knew how expensive it could be to move money across international borders. What's
more, they liked Charlie's irrepressible energy, which was immediately evident, and recognized from his last name, Shrem, that he was a member of the tight-knit Syrian Jewish community that they belonged to.

On the spot, the two men offered Charlie a free space to work at The Yard, an office for startups they had recently opened in Brooklyn. They also suggested they would be interested in making an investment in BitInstant. That same afternoon, Charlie visited The Yard, built out of an old industrial building in the hip neighborhood of Williamsburg. Bitcoin was quite literally moving out of the basement and into the real world.

W
HEN
C
HARLIE HAD
begun BitInstant less than a year earlier, it was a response to a very specific and narrow problem—the difficulty of getting money into Mt. Gox's bank accounts to buy Bitcoins. But Charlie's conversation with the two potential investors at New York Tech Day illustrated his growing awareness that his company could also help ordinary people take advantage of a much more practical service than Bitcoin could offer the world. Thanks to his upbringing in a community of entrepreneurs, Charlie knew that in 2012 businesses still had few good ways of instantly transferring money to pay for goods and services. A normal bank payment took several days, and a wire transfer moved faster but cost $30 to $50 each time.

Charlie's practical bent had led him, unwittingly, to an issue that had rarely been a part of the Cypherpunk discussions but that was perhaps the most widely acknowledged problem with the existing financial system: the creakiness of the old payments system.