Mt. Gox has recently shut down and filed for bankruptcy, claiming that it has an outstanding debt of $63.6 million.1 The company, which was the largest Bitcoin exchange, disclosed that it had lost 850,000 units of Bitcoin, including 750,000 that belonged to customers.2 That amount is worth about $477 million, based on current exchange rates, and represents about 6% of the 12.4 million Bitcoins in circulation.3 How this happened is simple: transaction malleability, or more simply, theft.4 Due to Bitcoin being a digital and open-source network, hackers can manipulate codes and trick Bitcoin exchanges into thinking they owe the hacker money when they actually don’t.5 This tragic event has spurred some uncertainty and cynicism among early Bitcoin adopters, including venture capitalists who have invested in Bitcoin-related startups.6 However, there are indicators that give light on the hope that remains regarding Bitcoin. At the same time, U.S. regulators must be cautious of over-regulating Bitcoin to the point of driving virtual-currency companies and investors away from the US.
Before delving into that, a brief explanation of Bitcoin’s background is probably necessary. Bitcoin is an online currency invented by an anonymous programmer about six years ago.7 It is managed by open-source software, available to anyone, which supports the infrastructure of tracking transfers of wealth and new issuances of Bitcoin.8 It runs on computers all over the world and the owners of these systems generate new Bitcoins by racing to solve complex cryptographic puzzles every ten minutes.9 These Bitcoins can then be traded for real money, goods, or services, just like any other currency. Bitcoin-related startups have attracted many venture capitalists because they have a huge market size (over $10 billion) and they are undeniably a disruptive form of technology.10 Many venture capitalists have high hopes that Bitcoin will grow into an ultra-low-cost alternative to current forms of money transfer methods, such as credit cards and wire transfers.11 This is possible because the open-source nature of Bitcoin makes them different from the proprietary financial institutions we mainly use today, which limits consumers’ ability to easily switch between payment providers.12 As a result, current financial institutions limit competition, maintain higher fees, limit geographic reach, and hinder innovation.13 Because Bitcoin lacks these anti-competition features, venture capitalists have invested $97.5 million into Bitcoin companies, with $68.1 million of it coming from U.S. venture capitalists.14 Bitcoin has spurred the popularity behind the concept of digital currency in general, inspiring many people to create newer forms of digital currency. For example, venture capitalists recently offered $500,000 to the founder of Dogecoin, a new digital currency that started off as a joke, inspired by the doge meme.15
Despite the fall of Mt. Gox, there are several reasons why venture capitalists should still have hope with their investments. First, Bitcoin will keep growing even if individual participants fail.16 Bitcoin, as an open network, is similar to the concept of email in the way that no single entity controls and manages it.17 Just like email has many different service providers, such as Gmail or Yahoo!, Bitcoin has many exchange websites, with no single exchange possessing any control over Bitcoin.18 This generates competition and allows effective providers to flourish, while ineffective providers lose customers and fail.19 In fact, for many investors, the downfall of Mt. Gox was not a surprise, since the delay of fiat withdrawals from last summer indicated a misbalance of assets and liabilities.20 Nevertheless, the point is that the tragic event at Mt. Gox was the result of one company’s actions and does not reflect the entire Bitcoin industry as a whole.21 Second, all forms of new technology take time to mature.22 Just like email providers have developed defenses against attacks via spam and phishing emails, Bitcoin will also gradually evolve by developing its defenses against transaction malleability, such as the one seen at Mt. Gox.23 Third, the acceptance of Bitcoin as currency has expanded explosively, increasing its liquidity.24 Many companies, law firms, merchants, and even restaurants have begun to accept Bitcoin from their customers, realizing the benefits of lower fees and instant transactions as well as acquiring new customers.25 And fourth, the fall of Mt. Gox has encouraged Bitcoin companies to cooperate in the security of customer funds.26 For example, Coinbase and Blockchain’s Andreas Antonopoulos, which are competitors, worked together last week to conduct an independent security review of their customer funds.27
The demise of Mt. Gox suggests that the amount of risk associated with the digital currency shows the need of some form of regulation to ensure Bitcoin’s security for consumers. Currently, especially because of what happened at Mt. Gox, the lack of clarity regarding U.S. regulation towards Bitcoin has scared away many Bitcoin companies and venture capitalists to look elsewhere for investment.28 U.S. consumers have been forced to transfer their money to foreign countries such as the U.K. or Japan, where there is little recourse in the case something goes wrong.29 However, the U.S. government must be careful not to overregulate Bitcoin to the point where U.S. Bitcoin companies seek other countries to call home.30 Many Bitcoin companies are small startups with a team of three or four individuals operating just a few hundred thousand dollars in seed funding.31 Thus, it would be unreasonable for the government to regulate Bitcoin companies the same way they regulate large U.S. banks with thousands of employees such as JP Morgan Chase.32 If this happens, Bitcoin startups will struggle to meet regulatory requirements, venture capitalists will lose interest in such companies, and innovation would be hampered.33 Bitcoin investors/lobbyists and government regulators must now face the difficult task of finding the golden mean between no regulation and no innovation.
Realizing this, a Bitcoin company called SecondMarket has figured out compromising solution that might work. SecondMarket’s plan is to create a Bitcoin version of the New York Stock Exchange, where only large and regulated institutions, including the world’s largest banks, can join and trade.34 For the most part, many U.S. banks have held negative views regarding Bitcoin, but recently a number of banks have released reports that reflected a more positive impression.35 In December, Bank of America reported that “virtual currencies could become an important new part of the payment system, allowing money to move more cheaply than it does with credit cards and money transmitters like Western Union.”36 If SecondMarket can successfully recruit enough regulated financial institutions as members on its exchange, Bitcoin may be able to reestablish the trust squandered by Mt. Gox; the future of Bitcoin looks bright.
Catherine Shu, UPDATED: Mt.Gox Files for Bankruptcy Protection, Says 850,000 Bitcoin Lost, TechCrunch (Feb. 28, 2014), http://techcrunch.com/2014/02/28/mt-gox-files-for-bankruptcy/. ↩
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Id.; Nathaniel Popper & Rachel Abrams, Apparent Theft at Mt. Gox Shakes Bitcoin World, N.Y. Times (Feb. 25, 2014), http://www.nytimes.com/2014/02/25/business/apparent-theft-at-mt-gox-shakes-bitcoin-world.html. ↩
Joshua Brustein, Where Did the Bitcoins Go? The Mt. Gox Shutdown, Explained, Bus. Wk. (Feb. 26, 2014) http://www.businessweek.com/articles/2014-02-26/where-did-the-bitcoins-go-the-mt-dot-gox-shutdown-explained. ↩
Id. ↩
See Popper & Abrams, supra note 3. ↩
Tyler Durden, Bitcoin, or Betacoin? What the Venture Capitalists Are Thinking, Zero Hedge (Apr. 22, 2013), http://www.zerohedge.com/news/2013-04-22/bitcoin-or-betacoin-what-venture-capitalists-are-thinking. ↩
Id. ↩
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Matthew Boesler, Here’s Why Venture Capitalists Want to Make Bitcoin the ‘Next Big Thing’, Bus. Insider (Apr. 23, 2013), http://www.businessinsider.com/why-venture-capitalists-love-bitcoin-2013-4. ↩
The Times Editorial Board, Let Investors Ride Out Bitcoin’s Booms and Busts, L.A. Times (Feb. 27, 2014), http://www.latimes.com/opinion/editorials/la-ed-bitcoin-mt-gox-20140227,0,6907789.story. ↩
Brian Armstrong, What’s Not Being Said About Bitcoin, Tech Crunch (Feb. 28, 2014), http://techcrunch.com/2014/02/28/whats-not-being-said-about-bitcoin/. ↩
Id. ↩
See Garrick Hileman, Following the Money: Geographic Dispersion of VC Bitcoin Investment, CoinDesk (Feb. 24, 2014), http://www.coindesk.com/following-money-geographic-dispersion-vc-bitcoin-investment/. ↩
Aaron Sankin, Dogecoin Doesn’t Need Venture Capitalists to Get to the Moon, Says Co-Creator, Daily Dot (Feb. 17, 2014), http://www.dailydot.com/business/dogecoin-venture_capital-rejected-jackson_palmer/. ↩
Armstrong, supra note 12. ↩
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Id. ↩
Tyler Winklevoss, Digital Darwinism, Winklevoss Capital (Feb. 27, 2014) http://www.winklevosscapital.com/posts/78045275170. ↩
Popper & Abrams, supra note 3. ↩
Armstrong, supra note 12. ↩
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See Id. ↩
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Id. ↩
Winklevoss, supra note 20. ↩
Id. ↩
Id. ↩
See Christine Lagorio-Chafkin, Regulators and Investors Clash on Bitcoin, Inc. (Jan. 28, 2014), http://www.inc.com/christine-lagorio/bitcoin-investors-and-regulators-clash.html. ↩
Id. ↩
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See Id. ↩
Popper & Abrams, supra note 3. ↩
Id. ↩
Id. ↩