Why Bitcoin Lovers Better Get Used To The Idea Of More Rules And Regulations

CREDIT: AP Photo/Kaori Hitomi

One of Bitcoin’s largest exchanges, Mt. Gox, filed for bankruptcy Friday after losing nearly half a billion dollars worth of the cryptocurrency. The devastating setback could push the currency to accept at least some level of government oversight.

The cryptocurrency’s decentralized model thrives on being unregulated, but the Tokyo-based Mt. Gox’s bankruptcy filing clearly signals that this same model is hindering its chances at survival. Bitcoin isn’t considered a currency in Japan or the U.S. and can’t be legally regulated.

Mt. Gox’s bankruptcy is likely the start of a trend: Bitcoin exchanges and holders will turn to regulation to keep from losing too much money and failing completely. In response to the collapse of Mt. Gox, global financial authorities and even members in the Bitcoin community are considering strategies to regulate — and therefore, perhaps, stabilize — the virtual currency.

On top of the missing 850,000 bitcoins, Mt. Gox lost about $55 million of its own assets in the suspected hack and cannot cover its $64 million outstanding debt. Mt. Gox’s bankruptcy falls under a Japanese law akin to the U.S.’s Chapter 11 bankruptcy, which allows the company to restructure itself and pay back creditors over time. The U.S. is the only country that has taken regulatory action involving Mt. Gox, which registered as a money-services business last year. Moreover, Japan hasn’t asserted any authority to regulate Bitcoin and doesn’t plan on going at it alone. Any regulation should be an international effort, Japan’s vice minister of finance, Jiro Aichi told Reuters.

Bitcoin’s volatile price fluctuations mean that its value can drop to nothing just as fast as it can soar past its $572 exchange rate at press time. It’s also not backed by a resource, like gold, so its value can’t be recouped. Bitcoin’s worth is solely based on supply and demand, with the price rising as more people want to invest in its future. But as hacks that result in Mt. Gox-like massive losses become more prevalent, it won’t be in Bitcoiners’ best interest to allow large swaths of its community to lose money.

To combat that risk, Bitcoin advocates have talked about implementing their own bailout, where coin holders contribute to a fund to save the failing Mt. Gox. That strategy would keep government oversight at bay and stave off the exchange’s demise. But because a bailout smacks too much of the traditional finance system, opponents to the idea would rather see it fail at the mercy of a free market, and later rebuild. For that to happen, Bitcoin would have to sacrifice either one of its key tenets, anonymity, or Mt. Gox.

Mt. Gox was a horribly run business, and it’s bad for Bitcoin’s reputation and longevity, according to Barry Silbert, the CEO of SecondMarket in New York. The company failed to keep up with “the responsibility that it had as a leading exchange,” Silbert told The Washington Post. In fact, this isn’t the first time Mt. Gox has suffered a major security breach; hackers stole nearly $9 million in bitcoin three years ago and sent the cryptocurrency into a tailspin. Touting his own Bitcoin business, Wall Street veteran Silbert suggests that the currency’s future relies heavily on structure similar to the stock market and work in concert with banks and regulators.

To prosper, Bitcoin needs a transparent legal framework that guarantees coin holders some solace when their investment is hacked. Without it, consumers are left without any recourse if their assets are seized by hackers. For example, when banks fail in the U.S., the government backs individuals’ deposits up to $250,000. Instead of going the government route, Bitcoin could turn to a member-funded option similar to what the Securities Investor Protection Corporation does for brokerage firms.

For alternative currencies to survive, they have to mimic traditional ones, says Forbes’ Bill Frezza. Bitcoin’s untraceability alone is already eliciting concern from U.S. agencies investigating possible financial crimes, which could bring on heavy regulation. That’s what happened to eGold, a gold-backed digital currency born in the 1990s that succumbed to Secret Service regulations.

So, it seems, regardless of whether it’s a reorganization of Mt. Gox’s business structure, a community-led bailout or a free market failure, Bitcoin’s future will be dependent on rules and regulations — self-imposed or otherwise.