Mt. Gox Meltdown Spells Doom for Bitcoin

The meltdown at the Mt. Gox Bitcoin exchange will only hasten the day when governments will regulate Bitcoin out of existence.
Take a good look at it while it lasts. Photographer: Tomohiro Ohsumi/Bloomberg

The first thing to point out about the meltdown of the Mt. Gox Bitcoin exchange is that this is hardly the first time that massive amounts of currency have been stolen, or that a financial firm has shut down and left its depositors with basically nothing. This is not somehow unique to Bitcoin, or a fatal flaw in its design.

The second thing to point out about the meltdown of the Mt. Gox Bitcoin exchange is that no matter how much cheerleaders continue to insist that it doesn't matter, it does. It matters a lot.

Think of Bitcoin as a new product, one with a lot of network externalities. Fax machines are the classic example of this: The first fax machine wasn't much use to the person who owned it. The second fax machine, however, was useful -- if you wanted to transmit documents to the other guy who owned a machine. The more machines in offices around the world, the more useful they became.

Similarly, Bitcoin is useful as a store of value and a medium of exchange only if lots of other people believe that it is useful as a store of value and a medium of exchange. The more people think so, the more likely this new product is to succeed.

Bitcoin does not yet have enough users to continue its survival; unless more people start using it, it will go the way of laser discs and eight-track tapes. The reason Bitcoins are currently so pricey is that the people buying them believe that, eventually, a lot more people will want to use them, and their limited-edition currency will become even more expensive than it is now.

The Mt. Gox failure highlights some of the major drawbacks of Bitcoin.

The first is that, as with old-fashioned gold coins, thefts are nearly impossible to trace. In this respect, Bitcoins are inferior to plain old dollar bills, which at least have serial numbers that can be monitored and tracked. Of course, if you're trying to keep government eyes off your transactions, untraceable currency has its advantages. But most of us don't do transactions that the government much cares about, so the fear of theft outweighs the benefits of anonymity.

The second is that there is, as yet, no currency exchange like the ones we use for regular currency -- backed by large institutions that can be sued if things go wrong. Again, there are advantages to this for the underground economy. But for folks in the regular old economy, that's a problem. It's hard to get enthusiastic about saving in a system where hundreds of thousands of dollars can disappear overnight, leaving you with no recourse. Not every Bitcoin exchange is Mt. Gox. But for ordinary folks, it can be hard to tell the difference, which is going to make them a little jittery about buying Bitcoins.

The third is that a fledgling currency, like any fledgling product, is very vulnerable to bad publicity. Obviously, the Mt. Gox meltdown is bad publicity, on top of a lot of other bad publicity. And even if it survives this particular mess, it's got a lot of other hurdles in front of it.

I've never been very bullish on Bitcoin, because ultimately, the better it performs at evading government surveillance of currency transactions (and government ability to manage debt loads via inflation), the harder those governments are going to try to shut it down. And it turns out that governments are very good at shutting down these sorts of … call them financial workarounds … because they can order the banks and payment networks that service the vast regular economy to refuse to take Bitcoins or take payments from companies that do take Bitcoins. What governments have done to online poker and offshore banking havens, they can do to Bitcoin vendors.

What happened at Mt. Gox only helps the government make its case for much tighter regulation of these networks. Which means that after yesterday's news, I am less bullish still.

QuickTake The Rise of Bitcoin

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