Bitcoin Scrutinized After Mt. Gox Downfall

Popular Bitcoin exchange shuts down as millions of dollars vanish. 

A pile of Bitcoins are shown here after Software engineer Mike Caldwell minted them in his shop on April 26, 2013, in Sandy, Utah.

There are 12.44 million Bitcoin in existence, according to Bitcoin Charts, a ticker for virtual currency.

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Bitcoin is viewed as a speculative investment in how the Internet might change finance, but the virtual currency seemed particular risky Tuesday as Japan-based exchange Mt. Gox went dark online, freezing approximately 6 percent of the coin in the world, and with it more than $300 million in customers’ funds.

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Mt. Gox, founded in 2010, was one of the earliest exchanges of the virtual currency, which is not controlled by any government. This lack of consumer protection struck fear into customers of the Japan-based exchange Monday when an apparently internal Mt. Gox “crisis strategy” report was leaked online by Ryan Selkis, a Bitcoin entrepreneur based in San Francisco.

The report states approximately 744,408 Bitcoin are missing from Mt. Gox due to “theft which went unnoticed for several years,” according to the report published by Selkis. That is a big chunk of the estimated total of 12.44 million Bitcoin in existence, according to Bitcoin Charts, a ticker for virtual currency.

“The reality is that Mt. Gox can go bankrupt at any moment, and certainly deserves to as a company,” according to the report, which Selkis said in a blog post he has verified as authentic.

If that’s true it could mean millions of dollars worth of Bitcoin lost to investors worldwide. Part of the crisis strategy detailed in Mt. Gox document called for the exchange website to shut down for one month, for the company’s CEO Mark Karpeles to step down, to bring in transition advisers and launch a re-branded website in a new country, perhaps Singapore.

That strategy appeared underway as the website’s home page was offline as of Tuesday, replaced with a message from the company.

“In light of recent news reports and the potential repercussions on Mt. Gox’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,” the company said. “We will be closely monitoring the situation and will react accordingly.”

The shutdown of Mt. Gox has already secured regulatory scrutiny for Bitcoin. In response to the shutdown of Mt. Gox, Senate Homeland Security and Governmental Affairs Committee Chairman Tom Carper, D-Del., said in a statement his staff is “working closely working with relevant federal agencies to determine what lessons can be learned from this failure to help ensure this does not happen here in the United States.”

“If today’s news is true, it is a sad violation of consumer trust, whether through malicious action or simple incompetence,” Carper said.

Any company accepting the digital currency still needs to stay on the good side of regulators, as seen when the Department of Homeland Security cut off its access to one of the U.S.-based accounts in 2013. Mt. Gox registered as a money-services business in the U.S. in June, after the Treasury Department’s Financial Crimes Enforcement Network expressed concern that businesses exchanging Bitcoin for dollars do so to ensure Bitcoin does not become a venue for money laundering.

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Bitcoin exchanges based in the U.S. are a more secure investment than Japan-based sites like Mt. Gox because Americans can cash in their Bitcoin easier for dollars through the domestic bank accounts owned by the companies, says Gil Luria, a financial technology analyst at Wedbush equity research firm. This loss of funds at Mt. Gox apparently occurred because the exchange did not update its accounting technology to keep track of their funds, Luria says.

“If the exchanges are domiciled outside of the U.S. that is a risky proposition,” Luria says. “I would not say that the other exchanges are as robust as they need to be but they have held up. I would say there will be a new generation of exchanges well-funded by venture capital that will be more secure. They will have better technology staff and infrastructure.”

A group of other Bitcoin exchanges including Kraken, BTC China and Circle issued a joint statement on Tuesday promising better investment in security technology to protect customers.

“In order to re-establish the trust squandered by the failings of Mt. Gox, responsible Bitcoin exchanges are working together and are committed to the future of Bitcoin and the security of all customer funds,” the statement said. 

Bitcoin is designed to exist in a controlled supply through an algorithm that generates and manages the virtual currency based on how often it is used. Bitcoin is growing as a means of payment for online goods and even some brick-and-mortar shops like the New York City bar Evr. The virtual currency’s value has fluctuated since its founding in 2009, but investors have boasting about its booming value that skyrocketed to a high of $1,200 in November. However, its value plummeted following the news of Mt. Gox shutting down and the currency traded below $500 on Tuesday, after trading around $600 on Sunday.

The Mt. Gox crisis report appears authentic because “if it were bogus I would have expected Mt. Gox to say that,” says Dan Friedberg, a financial services attorney at Seattle-based law firm Riddell Williams.

Several of Friedberg’s clients invested Bitcoin in Mt. Gox and moved their currency to other exchanges in recent months after they noticed the exchange lacked funds, he says. Anybody who invested their Bitcoin in Mt. Gox “should consider it lost, at least until we receive more information,” he adds.

“Bitcoin is a very speculative investment,” Friedberg says. “This Mt. Gox report is a blow to the industry but I do think these types of things are expected. This is a new technology and these companies operated in an unregulated fashion, not on the standards they should have.”