Yesterday, the most prominent online bitcoin exchange Mt. Gox completely shut down. According to the New York Times, approximately 750,000 bitcoins were lost as a result of the shutdown – a notional value of around $430 million at today’s current market price and nearly 12% of all outstanding bitcoins. As the news came out yesterday, the bitcoin community and financial press was buzzing with rumors and predictions about “the end of bitcoin.” While this may be bitcoins “Lehman Brothers moment” as Mark T. Williams, a finance professor at Boston college told the Wall Street Journal, this is not the end of the cryptocurrency. Bitcoin still has many challenges to cement its legitimacy into the future but it also has several strengths that will likely allow it to rebound and become a successful electronic currency.
In light of the Mt. Gox collapse, the most important thing worth noting is that this problem stemmed from one company’s incompetency and ultimate failure – it was not a failure in the underlying bitcoin protocol. Mt. Gox, while the most popular and highest volume bitcoin exchange, had a reputation for incompetency and problems. Trading was halted several days before the site was taken offline and users had experienced similar issues in the past. Bitcoin as an electronic currency protocol, however, has proven to be incredibly resilient and effective throughout this whole ordeal and throughout its ascent. Saying that bitcoin is doomed because of Mt. Gox’s failure, it like saying paper currency was doomed after the fall of Lehman Brothers – a failed institution does not make a failed system.
Bitcoin, however, does face several key challenges to regain its tarnished legitimacy. The Wall Street Journal quotes a research note out today from Citigroup that outlines bitcoins three biggest challenges:
- Bitcoin traders and potential investors lose confidence in the security and safety of Bitcoin transactions and holdings.
- Other digital currencies start eating into Bitcoin’s market share, taking away some of the first-mover advantage.
- Competition emerges from conventional financial institutions using generic bitcoin technology, without the decentralization and within the conventional regulatory framework.
The essential problem is that Bitcoin’s value is entirely reputation based. Like fiat paper currency, there is no intrinsic value. Unlike fiat paper currency, however, there is no implicit government backing, the value is derived from faith in the decentralized peer-to-peer network that accounts for individual bitcoins. A major negative event such as the failure of Mt. Gox creates the type of negative perception that can ruin bitcoin.
The reason while I do not believe Mt. Gox’s fall will not ruin bitcoin is that the community supporting the cryptocurrency have proven resilient and adaptable. Many are hackers, programmers, and other tech savvy individuals. While many lost a great deal of money in Mt. Gox, they also seem determined to push forward. As entrepreneur and bitcoin enthusiast Erik Voorhees described in a Reddit post yesterday morning, many believe that bitcoin is about more than making money – it is about creating a system that is outside the government’s realm of supervision where libertarians can flourish. If the community embraces this idealism, it will have the strength to innovate through the challenges and create a more stable and accessible system for all.