On Friday, Mt. Gox filed for bankruptcy protection.
This announcement doesn't surprise anyone who has been following bitcoin since May 2013, when Mt. Gox started having issues processing withdrawals. Instead of surprise we should be asking why?
Many people lost life changing amounts of money – money to pay off college tuition, money to start businesses, money to pay legal fees, money to pay off mortgages and the list of tragedies go on.
The staggering amount of money that appears to be stolen - almost $500 million at today's prices - pales in comparison to the $3 billion drop in bitcoin's market cap this month caused by Mt. Gox's bankruptcy. This mismanagement caused too much damage to be ignored.
Bitcoin was Invented to Avoid Third Party Trust
The message forever encoded in bitcoin by it's creator in the first coin's ever mined states: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” Bitcoin's reason for existence is to empower users with their own finances. The first sentence of the bitcoin whitepaper states: “Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments.” If bitcoin exists to remove a need for trust, how did users entrust $500 million with Mt. Gox?
Bitcoin is Regulated in the US
Bitcoin is regulated. Bitcoiners still have to report taxes, bitcoin exchanges need to comply with Banking Secrecy Act and SEC regulations. Those who don't risk prosecution like Trendon Shavers and Charlie Schrem.
Why Did This Happen in a Regulated Environment Designed to Avoid Trust?
Before exchanges early bitcoiners sent envelopes of cash in the mail to someone they had only met online to get bitcoins. The bitcoins they got increased in value from pennies to hundreds of dollars in a few short years. This created a high-risk high-reward culture. With business conducted globally and online, the primary way to tell a scam from a legitimate opportunity was by the operator's reputation.
See also: The Real Gox News - Do Financial Regulations Harm Americans?
This mix of newly minted millionaires, easy money, and a culture of trust made fortunes for mismanaged companies like Mt. Gox and the pseudonymous and irreversible transactions enabled outright frauds like Ponzi schemes and long cons. Assets for customers skyrocket day after day for months – until one day they vanish with messages citing hacks or legal reasons for the closure.
So why did this happen? The Siren's call of easy money prompted many to trust Mt. Gox, with their history of disasters, with large sums of money while waiting for a well run US based exchange. Regulations made running a US based exchange for an unproven digital currency expensive and high risk. Mt. Gox took advantage of lower compliance costs to setup a Japanese bitcoin exchange and customers reluctantly flocked there to make bitcoin fortunes seeing no good alternatives.
What Will Change?
Today's regulations are primarily old laws applied to cutting edge technology. There will be digital currency specific regulations forthcoming. This week US Senator Manchin began calling for a ban on bitcoin. New York Finance Regulator Benjamin Lawsky has committed to proposing a regulatory framework this year. Regulators will use facts from the Mt. Gox bankruptcy to point out flaws in the bitcoin ecosystem.
They will use heart wrenching stories of those who were unable to start companies, unable to pay for mortgages, or lost marriages to bolster the case for regulation and oversight. Regulators will make compelling arguments and there will be new digital currency regulations.
There will also be free market solutions. Decentralized currency exchanges, insured exchanges, bonded exchanges, radically transparent exchanges with realtime solvency reports are just some of the projects being worked on today. Fraudsters like Bernard Madoff show regulations can't eliminate financial crimes. Mt. Gox's collapse begs the question - can bitcoin provide more safety for consumers or are imperfect regulations the best we can do?
Whatever the eventual solutions, the Mt. Gox bankruptcy filing harshly warns investors to keep a careful eye on their portfolio allocations, the companies they trust, and to beware the siren's call of easy money. Change is coming, but today bitcoin is improperly regulated and retains some of the weaknesses as the system it was designed to replace.
(c) 2014 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
EconomicsWe share some insights on how the recent terrorist attacks in Paris could impact the economy and markets going forward.
EconomicsWill remaining calm and staying long present significant risks to your investment health?
EconomicsDue to creative measures by central banks, there is no telling when a recession will actually occur, but natural economic forces will eventually win.
InvestingAs an alternative investment, income-seeking investors may turn to dividend-paying exchange traded funds (ETFs) as a way to seek both income and growth.
Stock AnalysisThe stock market can't seem to make up its mind. Will investors end up with coal for Christmas or might their wishes come true?
EconomicsDiscover which countries produce the most oil in the Middle East, a region long known for its influence on international petroleum markets.
EconomicsDiscover which African countries produce the most oil, and learn more about which domestic and international oil companies operate in each country.
EconomicsFind out which countries produce the most oil in Latin America, and learn about some of the biggest oil companies operating in each country.
Stock AnalysisLearn about the top energy companies in Russia, a country that holds some of the largest reserves of oil, natural gas and coal in the world.
Stock AnalysisLearn which Asian countries deliver the most crude oil to market, and discover what companies are the biggest producers in each country.
An industry agency council was established by the World Economic Forum in 2014 to serve as an advisory board on the future ... Read Full Answer >>
The railroads sector is comprised of publicly traded stocks for companies that operate railroad tracks and/or trains. Railroad ... Read Full Answer >>
Biotech giant Amgen Inc (AMGN) bills itself as one of the first biotechnology firms. It was founded in 1980 and has grown ... Read Full Answer >>
Back in late August 2012, Apple’s (AAPL) stock price reached nearly $700 per share. The stock has since split but has yet ... Read Full Answer >>