How I'm dodging bitcoin's flaw

Bitcoin, the elegant elixir for our fractured financial system, is actually flawed. It's vulnerable to attacks. There is, however, a fix — something I had installed on my own coin experiment. Here's how it works:

The bitcoin software produces a mathematical equation that should take a miner ten minutes to solve. Every two weeks the software looks back at the average time it has taken to solve the equation and if the miners have solved it in less than ten minutes, the equation is made more difficult. If the equation is taking longer than ten minutes to solve, then it is made easier. The purpose of this difficulty adjustment is to control the release of coins at a steady pace and to guard against inflation caused by a rapid expansion of the money supply.

Brian Kelly

Mining attacks occur when the computers used to solve the complex mathematical problems are faster than the software. Miners can hoard coins before the software has a chance to make the equation more difficult.

As mining became more profitable, miners turned to application specific integrated circuits (ASIC) and multipools.

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ASIC computers are purposely built to solve an equation much faster than every ten minutes and a computer arms race began as miners fought to be the first to solve the equation and receive free bitcoins. At the current rate, a fast and lucky miner can earn up to 25 bitcoins every ten minutes, or about $10,000. Profitability fostered fierce competition which made many miners turn their machines onto other coins and develop multipools.

Multipools are groups of miners who work together to mine the most profitable digital currency. For example, if the price of Dogecoin (an alternative to bitcoin) climbs, the multipools mine this coin and then dump the currency on the market. This mass inflow of supply reduces the price and by extension the mining profitability. Once profitability drops, the miners turn to another coin. The risk is that, without miners, transactions cannot be confirmed or conveyed — a coin without miners is a dead coin.

Newer digital currencies like Dogecoin were vulnerable to a multipool mining attack. Miners hoarding coins would immediately dump them on the market in order to make a quick buck — or bit, if you will. In order to guard against such acts the developers at Dogecoin turned to DigiByte (Digibyte.co). DigiByte is an alternative-digital currency with a unique defense against multipool mining.

The developers at DigiByte created DigiShield which adjusts the difficulty each time a new coin is produced as opposed to every two weeks. This means that with a coin like DigiByte, every 60 seconds the equation is adjusted. When DigiByte first tested DigiShield they witnessed over $1 million in computing power thrust at the coin in the first minutes of its life. Typically, coins would be hoarded and within 24 hours, the coin would be dead — but not with DigiShield. This algorithm adjusted to the miner's computing power so that transactions could be verified and miners would still make money.

I created my own bitcoin-like currency, Nautiluscoin (www.nautiluscoin.com), as an experiment. I wanted to learn about the technology and create awareness about digital currencies.

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Initially, I had big plans for Nautiluscoin — it was to be the first digital currency with a stabilization mechanism designed to reduce volatility. As the project approached launch, its vulnerability to a mining attack was discovered by the team at Austin Global Exchange (www.agx.io).

From the time I conceived the coin and was ready for launch the mining technology had advanced well beyond the software. Bitcoin mining had become so profitable that miners were paying $20,000 for a $1,500 computer, just to be the first to have the latest technology for bitcoin mining. The rationale was that the $20,000 spent on the machine would probably be recouped within 90 days of mining.

I was fortunate to meet the team at DigiByte and have them install DigiShield on Nautiluscoin. This upgrade will not only protect Nautiluscoin from an attack, but it will allow Nautiluscoin to processes transactions ten times faster than bitcoin. It has also made the currency robust enough to implement the original plan of creating a stability fund.

So why have the developers at bitcoin not implemented a solution like DigiShield? The simple answer is that it's not needed — yet. Bitcoin mining is so competitive that it makes mining other digital currencies more profitable, but if (or when) the profitability drops, miners could turn away from bitcoin. As the competition fades, bitcoin could become susceptible to a multipool attack.

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With the multipool protection from DigiShield and the stabilization fund, I have decided to re-launch the coin and implement the original plan. Nautiluscoin will be traded on the Austin Global Exchange, which will serve as the official rate-setting exchange. Once I have established a liquid trading market for Nautiluscoin the next step is acceptance.

In addition to being able to use the coin online for purchases, I believe there is a fertile market for small business. As the technology advances, the road map will include pre-loaded Nautiluscoin cards which could be used at your local merchant. Further down the road, I hope to have a market established to trade Nautiluscoin for gold.

With any digital currency the value comes from acceptance — my job now is to steward this acceptance.

Brian Kelly is founder and managing member of Brian Kelly Capital LLC, a global macro investment firm catering to high net worth individuals, family offices and institutions. He is also the creator of the BKCM Indexes, benchmarks for multi-asset money managers. Kelly, a CNBC contributor, often appears on "Fast Money." Follow him on Twitter @BrianKellyBK.

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