Bitcoin’s failure ruins future for all cryptocurrencies

I don’t want to say we saw this coming. But we did.

Bitcoin’s meltdown following the sudden disappearance of one of its largest exchanges is the clearest sign yet that the economy isn’t ready for this virtual currency – or any virtual currency.

Bitcoin’s value lost over 20 per cent of its value yesterday after the MtGox exchange went dark, a day after its CEO, Mark Karpeles, abruptly quit the Bitcoin Foundation board.

Most ominously, reports circulated that over 744,000 bitcoin -- worth US$365 million at current exchange rates and representing 6 per cent of the 12.4 million bitcoins in circulation globally -- has disappeared. An unpatched vulnerability that had been identified as early as 2011 is suspected as the weak link that allowed suspected hackers to break in.

The Tokyo-based exchange’s offices are empty, and all tweets have been removed from its Twitter feed. Its website, which had been unavailable since Tuesday, was updated Wednesday with messages from both Karpeles and the MtGox Team. Karpeles wrote despite speculation regarding MtGox and its future, he is “still in Japan, and working very hard with the support of different parties to find a solution to our recent issues.”

MtGox had already been on the ropes after announcing earlier this month that it would cease withdrawals because of persistent delays in converting bitcoin holders’ currency. U.S. federal authorities seized $5 million from the exchange last May, forcing MtGox to stop U.S. money transfers entirely.

More than a bitcoin problem

The bitcoin community blamed MtGox for the debacle, insisting the currency itself still has a bright future. Unfortunately bitcoin’s fundamental flaws transcend any one exchange, and casual observers – the mainstream consumers who could, in theory, represent bitcoin’s future – see it as yet another reason to remain on the sidelines.

As the mystery around MtGox’s difficulties deepens, it fails to mask the fact that bitcoin remains a highly-speculative instrument that lives well outside the traditional financial system’s world of asset-backed currencies and regulatory oversight. This may appeal to those who oppose the shackles of central bank-controlled finance – to seamlessly buy and sell things, or hide from the law – but it does little for typical businesses and consumers who simply want to pay and get paid in a consistent manner without worrying that the entire system will implode without warning. Balancing the budget is difficult enough without the risk of sudden devaluation, conversion delays or outright theft.

For now, a limited-availability currency subject to double-digit swings in valuation on the whims of speculative investors has little mainstream appeal. Bitcoin’s complete disconnection from monetary or fiscal policy dooms it to the fringe of an economy that still doesn’t know whether to classify it as a de facto currency or a somewhat promising new payment technology. Until the sharp edges of cryptocurrencies are filed down somewhat – and until governments figure out a way to bring it under some form of regulatory oversight without killing what makes virtual currency appealing in the first place – the space will remain the domain of risk-tolerant speculators.

Ignoring the greater need

The MtGox public-relations pickle unfortunately deflects attention away from why virtual currencies are needed in the first place.  Technologically advanced currencies like bitcoin, litecoin, namecoin and others could – and should – drag the financial system into the 21st century.

Instead, mismanaged exchanges and opportunistic hackers are turning bitcoin, the cryptocurrency poster child, into a no-fly zone for anyone who doesn’t want to get burned. The MtGox flameout is damaging enough to bitcoin’s brand that virtual currency as a whole will take that much longer to become a factor in the broader economy.

Carmi Levy is a London, Ont.-based independent technology analyst and journalist. The opinions expressed are his own. carmilevy@yahoo.ca

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