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.

Related Articles
  1. Stock Analysis

    How Much Coca-Cola Spends on Advertising

    Learn about Coca-Cola's ad spending and why the company has decided to spend the amount of money it does. Understand comparable companies and industries.
  2. Investing

    Welcome Back, Volatility

    Volatility is likely to resurface as the Federal Reserve gets closer to adjusting its monetary policy stance, even if that adjustment is a measured affair.
  3. Economics

    What Is The Labor Market Conundrum?

    We are facing a conundrum with investment implications: Why are wages still stagnant, when jobs are being created at the fastest pace since the late 90's?
  4. Investing

    Why Are Consumers In Hesitation?

    Diverging monetary policy globally and a stronger dollar continued to be key drivers of the recent underperformance and last week’s tumble in U.S. stocks.
  5. Economics

    Bulk Shipping Companies Struggle As Markets Soften

    The "soft" dry bulk shipping market that confronts shipping companies is a result of lower demand from China, and an excessive amount of bulk ships.
  6. Stock Analysis

    Sierra Wireless Benefits From These Megatrends

    We take a closer look at how Sierra Wireless' transition from 2G to 3G and 4G technologies, has impacted its business today, and the future expectations.
  7. Stock Analysis

    3 Growth Opportunities For ARM Holdings

    ARM Holdings highlighted several growth opportunities in its most recent roadshow presentation. Here are three of the large opportunities it talked about.
  8. Stock Analysis

    Is Cheniere Energy Still On Track For 2016?

    The energy boom in the U.S. has opened up a huge range of opportunities in the oil and gas industry.
  9. Stock Analysis

    What’s The Key To Costco’s Extraordinary Success?

    Costco has been one of America's most successful companies: It's growing, efficient, profitable and its long-term shareholders have benefited a windfall.
  10. Stock Analysis

    Can American Capital Agency Maintain Its Dividend?

    Dividend investors know that real estate investment trusts with REITs that invest in mortgage-backed securities produce double-digit dividend yields.
  1. Fractal Markets Hypothesis (FMH)

    An alternative investment theory to Efficient Market Hypothesis ...
  2. Core Durable Goods Orders

    New orders for U.S. core durable goods, which are the total durable ...
  3. Investopedia

    One of the best-known sources of financial information on the ...
  4. Market Depth

    The market's ability to sustain relatively large market orders ...
  5. Closing Tick

    The difference between the number of stocks that closed higher ...
  6. Institutional Brokers' Estimate ...

    A system that gathers and compiles the different estimates made ...
  1. What is the long-term outlook of the metals and mining sector?

    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 >>
  2. What is the railroads sector?

    The railroads sector is comprised of publicly traded stocks for companies that operate railroad tracks and/or trains. Railroad ... Read Full Answer >>
  3. Who are Amgen Inc.'s (AMGN) main competitors?

    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 >>
  4. What's the most expensive stock of all time?

    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 >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!