Bitcoin, its most devout followers would tell you, is the future of money. Recent successes have underlined a triumphant period for the cryptocurrency. When it first emerged in 2009 from creator ‘Satoshi Nakamoto’, who may not be one person and whose real identity is unknown, few anticipated the totality of its achievements.
Bitcoin is now on the cusp of the mainstream; every week a growing number of businesses now accept payment in the currency, from beekeepers to internet service providers. One of the biggest electronic payment processing systems for Bitcoin, BitPay, has been extremely successful. The company says that over 20,000 businesses have already adopted its system to allow for Bitcoin payments.
Despite this, the currency still struggles with its reputation. High profile cases have associated Bitcoin, because of its anonymity and security, with illicit activities. When prominent online black market and drug-trafficking site Silk Road was shut down in October last year, FBI officials seized 144,000 bitcoins, worth around $28.5m at the time.
The latest scandal – the closure of MtGox, the currency’s biggest exchange – could be a turning point. The exchange’s failure is severe. It has left six percent of the entire currency, some $450m, lost or in limbo. There are, however, lessons to be learned from the scandal that, if applied correctly, could usher in a new age for Bitcoin.
Pseudo-anonymity
In late February, MtGox disappeared from the internet. The website was wiped clean and Twitter accounts were closed as one of the most trustworthy of Bitcoin’s many exchanges crumbled. A leaked memo reveals some of the story: in what seems to be an unparalleled, multi-year hack, the exchange had been made insolvent and its reserves had been pillaged.
$450m
Of Bitcoins ‘lost’ by MtGox
Nearly 850,000 bitcoins – 750,000 belonging to users and 100,000 to the exchange – vanished; spirited away and protected by the pseudo-anonymity that Bitcoin offers. It is pseudo-anonymity, as opposed to complete invisibility, because Bitcoin’s global ledger is completely transparent, allowing anyone to see transactions that have taken place between Bitcoin wallets, but diving through the myriad of data is a forensic activity in itself.
Meanwhile, the company’s CEO, Mark Karpeles, remains an elusive figure. At a press conference soon after the bitcoins were announced as lost, Karpeles resigned as the company tried to save some face. He cut an apologetic figure, bowing to the assembled press and insisting that the company would do everything to get the coins back. He has since had his assets frozen in the US by a Chicago-based judge as incensed customers seek reparation for MtGox’s failures.
MtGox had already been mired in controversy. First, in October last year, the US Government seized $5m from the company’s accounts for allegedly running a money transfer business without properly registering it with the relevant authorities. Then, for much of February, customers were unable to complete withdrawals because of so-called ‘transaction malleability’ – a bug in the software that can be exploited to mask transactions to make it seem that they did not actually occur. It is this bug that many believe has drained MtGox dry and left it unable to complete legitimate withdrawals.
Put simply, it appears that an enterprising hacker could have masked the fact they had found a backdoor into MtGox’s supposedly secure reserves. In theory, the exchange could now track the fraudulent transactions, but realistically this would achieve very little and would be very costly to attempt. If the coins had been slowly siphoned off for many years, they would now be disseminated throughout the currency’s peer-to-peer network so greatly that tracing them would be almost impossible.
One of Bitcoin’s principle strengths is that everyone has a stake in it
The recent revelation that the company has found 200,000 of the missing bitcoins in a ‘cold wallet’ – so called because it is completely offline and isolated for security – that had not been used since June 2011 has illuminated the dubious decision-making at MtGox. These malpractices, especially for a company that handles such massive sums of currency, are the opposite of what Bitcoin needs if it is to become more widely accepted.
For the customers who lost their bitcoins, in many cases worth thousands of dollars, there is little that can be done. To an outside observer, it would seem that nothing short of a miracle will bring the rest of the money back. There are now accusations that MtGox was using the bitcoins in its coffers for arbitrage by taking advantage of the volatile price environment the exchange caused at the beginning of February.
With some even suspecting that Karpeles himself made off with the money, recovery seems a long way off. Whatever has happened, many find it incredulous that MtGox’s accounts could be siphoned so comprehensively for such a long period of time without someone at the company becoming aware of the fact.
The company itself has filed for bankruptcy protection and has ceased operations from its Japanese headquarters. The company reported it had approximately $64m in liabilities and has since had to file for bankruptcy protection in the US to prevent legal action against the company by US traders. In the short term, there seems to be some indication that the company may attempt a rebranding – simply becoming ‘Gox’ – to try and regain trust, but that will be a hard pill to swallow for those who are so deeply out of pocket.
In the meantime, employees at MtGox have asserted a belief that the exchange’s collapse will take its toll on the currency. In a leaked ‘Crisis Strategy Draft’, employees wrote that “with bitcoin/crypto just recently gaining acceptance in the public eye, the likely damage in public perception to this class of technology could put it back five to 10 years, and cause governments to react swiftly and harshly. At the risk of appearing hyperbolic, this could be the end of bitcoin, at least for most of the public.”
Failing into the mainstream
Marc Andreessen, Silicon Valley entrepreneur, says claims that major reputational damage will be dealt to bitcoin in the long-term are false. Speaking to the Freakonomics website, Andreessen said that “one way to look at it is basically MtGox has to fail in order for bitcoin to go mainstream because MtGox was never set up to be able to take bitcoin mainstream, which is basically what’s happening now. The good news is we have many new companies that are much more serious and much better run.”
The short-term fallout was indeed damaging for the currency. Bitcoin’s price plummeted to a low of around $460 per coin (see Fig. 1) as customers panicked about the ramifications of MtGox’s collapse. Other exchanges were quick to heap condemnation on the company.
In a joint statement, CEOs of six of the biggest exchanges said: “as with any new industry, there are certain bad actors that need to be weeded out, and that is what we are seeing today. We are confident, however, that strong bitcoin companies, led by highly competent teams and backed by credible investors, will continue to thrive, and to fulfil the promise that bitcoin offers as the future of payment in the internet age.”
Many see the MtGox scandal as the turning point for bitcoin quite simply because the example of MtGox will preclude from it ever being repeated. The currency’s core companies will have no choice but to become increasingly transparent, trustworthy and legitimate. One of Bitcoin’s principle strengths is that everyone has a stake in it – for the currency to be successful and for businesses to make money, they have to provide the systems for it to become successful.
David Yermack, Professor of Finance at NYU Stern School of Business, disagrees with the assertion that no long-term reputational damage will be done. Speaking to World Finance, Professor Yermack warned that “for any currency to be widely used, the public would need to have confidence that it cannot be stolen, counterfeited or erased by a malevolent third party. In principle, I think that any cryptocurrency will have ongoing issues with hackers. It seems axiomatic to me that any computer code can be hacked, and as bitcoin grows more valuable, the incentives of hackers to invest in undermining it only grow larger. People seem very naive about these risks.”
Whether the furore surrounding MtGox is the death knell for bitcoin remains to be seen, and naive or not, there are still signs that the scandal will become a defining moment for bitcoin. Other exchanges have vowed not to repeat MtGox’s mistake, and there is growing clamour both for reform and also for MtGox to repay what it lost.
It does seem that the sheer drama of the collapse has made some of the cryptocurrency’s key players re-evaluate their position. One thing appears to be certain: if bitcoin cannot clean up its reputation, and if the companies upholding the currency fail repeatedly, it is hard to see it becoming widely accepted by the general public. If these things can be overcome, then the promise of a currency free from government interference could be too hard to ignore.
