Does this $350m disaster spell the end for bitcoin?

MtGox was the world’s first and largest bitcoin exchange. At one stage it handled some 70% of global bitcoin trades.

But a couple of days ago the site was taken down. Its Twitter feed was deleted. Trading was halted (not for the first time). Withdrawals were frozen. And a rumour began circulating that some 744,408 bitcoins – over $350m worth – had been stolen.

It’s a publicity disaster for bitcoin and a nightmare for anyone who had their money in the exchange. Bitcoin’s value has plunged on the news.

Does this spell the end for bitcoin?

The story behind the world’s biggest bitcoin exchange

If you used MtGox to buy and sell bitcoins, you would have two sub-accounts – one for US dollars (or another national currency), and another for bitcoins. You bought bitcoins with your deposited national currency and, if you sold them, the proceeds would be deposited in your national currency sub-account.

Jed McCaleb – who Wired described rather disparagingly as ‘an unemployed computer hacker’ – founded MtGox in 2009. At first, it was an exchange for the trading cards game, ‘Magic: The Gathering’. Hence the weird name ­– MtGox is an acronym of ‘Magic The Gathering Online eXchange’.

In July 2010, McCaleb saw a post about bitcoin on the website Slashdot. It was the first to draw attention to bitcoin to an audience beyond the handful of computer programmers developing the code. McCaleb thought it looked like a good idea, and quickly turned MtGox into an exchange for bitcoins.

The site had huge first-mover advantage. It became the portal for buying and selling bitcoins. But McCaleb lost interest and in March 2011 sold MtGox to the Japanese company Tibanne, run by Mark Karpeles.

But, despite bitcoin’s stratospheric rise, with MtGox riding on its coattails, the exchange has always been dogged with problems.

In June 2011, its database was compromised: 60,000 usernames, emails and passwords leaked. A few days later, some 600 account holders at MyBitcoin had their balances stolen. Not long after, someone hacked into MtGox and issued sell orders for hundreds of thousands of fake bitcoins, briefly driving the price down from $17.50 to $0.01.

In May 2013, around $5m was seized by US authorities on the grounds that MtGox was operating a money-transmitter without being properly registered. It also faced a $75m lawsuit from Coinlab over breach of contract.

US dollar withdrawals suspended

In June 2013, it suspended US dollar withdrawals. Withdrawals were reinstated in July, but the internet is rife with people complaining that they were unable to get their money out.

In short, MtGox can hardly have ever been described as reliable.

This year, before the shutdown, withdrawals were halted, then restarted, then halted again. At one stage, the MtGox-quoted bitcoin price was about a quarter of that on other exchanges, so weak was trust in the exchange. People were flying to Japan to demonstrate outside the company’s offices. An extremely wealthy tech-millionaire told me on Monday night that Karpeles had been on the phone to him last week asking for financial help.

At the weekend Karpeles resigned from the Bitcoin Foundation. Yesterday all you got when you visited the MtGox site was a blank screen. Today there’s a message which reads:

Dear MtGox Customers,

In light of recent news reports and the potential repercussions on MtGox’s operations and the market, a decision was taken to close all transactions for the time being in order to protect the site and our users. We will be closely monitoring the situation and will react accordingly.

Best regards,
MtGox Team

Anger and repercussions

Other exchanges have been quick to distance themselves. One said that the “tragic violation of the trust of users of MtGox was the result of one company’s actions and does not reflect the resilience or value of bitcoin and the digital currency industry”.

But a lot of people will lose a lot of money from this. They’ll be angry and there’ll be repercussions.

Many will demand the authorities take some kind of action. But what they can do, I’m not sure – apart from ban it. The whole point of bitcoin is that it has no governance. It is open source and decentralised.

The BBC’s Robert Peston has called this “bitcoin’s life-or-death moment”. James Titcomb in the Telegraph says “bitcoin is under threat”.

But I’m not sure that this is the end of bitcoin. It’s just the end of one bitcoin company that was at best out of its depth, and at worst, a scam.

Why bitcoin technology won’t just vanish

As you may know, I have begun work on a new book on bitcoin. (My timing is impeccable).

For all the extremists who have associated themselves with this digital cash, there is no doubting the technology. It is the easiest and most practical way to make digital payment, large or small, particularly over long distances. It bypasses the costs of the banking and credit card system.

I often get small jobs from clients overseas. Sometimes 20% or more of a £250 job gets swallowed in forex and money-transfer costs. If somebody sends me a bitcoin, it’s just so much easier. The efficiencies in terms of cost and time-management are irresistible, particularly for micro-payments.

And that’s why I don’t think this is the end. The technology is too good. It might be that bitcoin must fail so that others succeed. But, on the other hand, there is now a great deal of vested interest in bitcoin. Large investment has come in from venture capital funds and elsewhere. The currency is already very evolved.

Ultimately, this is rude capitalism at work. MtGox was badly run. If the rumours are true, how can anybody run a company and not notice $350m-worth of its core product go missing? My sympathies are with those who have lost money, very much so. But these kinds of losses will force better practice on all participants in the future.

If bitcoin is to succeed, it will need better institutional practice. Failure is how you achieve that.

If you’re thinking of taking a punt – just be very, very cautious

As for buying into the sector: as this episode makes very clear, crypto-currencies are the Wild West. If you want to play the game, fine. But the same rules as with any highly speculative venture apply – only risk money you can afford to use; do your own due diligence; and store your bitcoins somewhere safe. Many keep theirs off-line, unless they’re planning to spend them.

In recent months we have seen: the downfall of the revamped second Silk Road; the ban of bitcoin in Russia; the arrest of high-profile member of the Bitcoin Foundation for money-laundering; and now the problems at MtGox.

Yet the bitcoin price remains around $500. That’s indicative of some strength. My guess is that we’re reaching a bad news peak and this may be some kind of low. There’s certainly blood in the streets. Perhaps now is a good time to speculate. Others might feel is better to wait for some kind of clear upward trend.

If you want to buy bitcoins, you deposit money with an exchange such as Bitstamp, Bitpay, Coinbase or Bittylicious, and then buy bitcoins with it. You can download a wallet from Blockchain.

But it all rather makes you long for the relative calm of gold.

Interested in bitcoin? Back my new book

Finally, I’ve begun work on another book, which tells the amazing story of bitcoin and the crypto-currencies. I am crowd-funding it with Unbound and I’m pleased to say it is already funded. But you can still support the project and get your name in the book. If you ‘d like to, I’d be very grateful – just click here.

• Life After The State by Dominic Frisby is available at Amazon. An audiobook version is available here.

• Follow @dominicfrisby on Twitter.

Category: Investing in Bitcoin