Can nearly $450 million go missing without a crime taking place? That is only one of the questions stemming from the collapse of the Bitcoin exchange Mt. Gox that present a host of challenges for governments worldwide that are struggling to regulate virtual currencies.
Mt. Gox filed for bankruptcy protection in Japan after the disappearance of more than 744,000 Bitcoins owned by customers, along with 100,000 of its own. Unlike an ordinary robbery, this appears to be the work of hackers who exploited a weakness in the system for tracking Bitcoin transactions that allowed the currency to be diverted, perhaps over a few of years.
The number taken amounts to about 6 percent of the total Bitcoins in circulation, raising serious questions about how any virtual currency can be made safe for consumers and investors.
For law enforcement, this is like any bank robbery that requires identifying the perpetrators. DealBook reported that the Justice Department had issued subpoenas to Mt. Gox and other firms to gather information about how virtual currencies are transferred and converted into dollars.
But unlike in “Butch Cassidy and the Sundance Kid,†none of the Mt. Gox thieves are looking back at the posse and asking “Who are those guys?†One of the appeals of Bitcoin is its anonymity, and trying to find those who stole something intended to be untraceable through computer hacking may well be impossible. So the losses from Mt. Gox are unlikely to be recovered.
The question becomes how governments will monitor transactions in virtual currencies to protect owners. Doing so may be even more difficult when one of the motivations for developing Bitcoin was to avoid any official involvement.
Senator Joe Manchin III offered one approach in a letter sent last week to financial regulators, urging them “to work together, act quickly, and prohibit this dangerous currency from harming hard-working Americans.†This is the same strategy taken by China, which prohibited its banks from trading in virtual currencies.
Unfortunately, it is easier to call for a ban on virtual currencies than actually instituting one. Janet L. Yellen, the chairwoman of the Federal Reserve, responded to a question from Senator Manchin at a recent hearing that her agency “simply does not have authority to supervise or regulate Bitcoin in any way.†So if there is going to be a push to restrict, or even ban, the use of virtual currencies, it will have to come from Congress.
The history of laws created to impose onerous restrictions on popular goods is not positive. Prohibition failed in the 1920s, while the criminalization of marijuana and online gambling has started to crumble, so there is not much hope for blocking the use of virtual currencies.
Those who lost Bitcoins held by Mt. Gox have turned to the courts, but the likelihood of securing a recovery looks small. A class-action lawsuit was filed in the Federal District Court in Chicago against the exchange, claiming a number of violations of Illinois law, including consumer protection and fraud. The problem is that Mt. Gox does not appear to have any assets, so individuals are unlikely to have any legal recourse for their losses.
On the flip side, the approach taken by supporters of Bitcoin to the collapse of Mt. Gox reflects Friedrich Nietzsche’s famous comment, “That which does not kill us makes us stronger.†Barry Silbert, the chief executive of SecondMarket, plans to start a Bitcoin exchange that will be modeled after the New York Stock Exchange that can provide more reassurance to consumers.
That approach may signal how governments will go about regulating virtual currencies by adapting the structure used for trading securities and commodities. The Securities and Exchange Commission and the Commodity Futures Trading Commission already have in place extensive rules for how exchanges and dealers operate and, perhaps more important, record-keeping and capital requirements for those who will hold the property of others.
Another possible avenue for regulation would be to fit virtual currency firms into the rules for trading regular currencies. The C.F.T.C. used authority provided by the Dodd-Frank Act to create a regulated entity called a “retail foreign exchange dealer,†which is allowed to engage in retail transactions and could be expanded to cover Bitcoin trading.
The record-keeping requirements for securities and commodities exchanges would be of great help to the law enforcement authorities, which rely on a paper trail to build cases involving theft, embezzlement and misappropriation. The demise of Mt. Gox shows how difficult it is to find something that exists only in cyberspace when there are inadequate records about who actually owned the property.
To protect customers from a total loss, the government can also require an insurance program along the lines provided for bank and brokerage customers. Firms that hold virtual currency on behalf of customers could be required to pay into a fund to be used to reimburse at least part of the loss if another situation like the theft at Mt. Gox were to happen.
Needless to say, advocates of Bitcoin who cherish its anonymity and freedom from governmental oversight will not take kindly to increased regulation, along with the costs that come with it. Losing $450 million with no realistic chance of finding the thieves will inevitably spur changes in the structure of the market for virtual currency. Mt. Gox will not kill Bitcoin, but it is pushing governments to take a more active role in overseeing how it is traded.
