On Wednesday, we told you why we think bitcoin will never achieve widespread acceptance as a currency or an investment commodity. Yesterday, our thesis got a measure of validation with the news that Silk Road 2 has suffered hacking and theft of $2.7 million in bitcoins, with many users convinced it was an “inside job” by the same administrators who are apologizing for their failure to prevent the loss. These incidents are quickly eroding public trust in both the currency and the websites that handle them for consumers. Reporting on a series of attacks that have shut down bitcoin exchanges, Reuters talked to financial consultant Jason Scharfman, who pointed out that bitcoin has a liquidity problem that it is not supposed to have.
“These types of attacks, they’re effectively freezing some of the accounts because the exchanges don’t want to pay out to the wrong person,” he said. “If something’s frozen or there’s a question about me being able to redeem my bitcoins, the value of them drops.”
“Does this spook financial investors?” he added. “The answer is yes.”
Scharfman said one way to mitigate the risks of such attacks would be to spread holdings of bitcoins out among several different online storage facilities. That way if one were attacked the other might still have a chance at being safe.
Scharfman said the more regulatory scrutiny that bitcoin exchanges received, the safer they were likely to be.
“Regulation will sort of normalize which exchanges are the most secure. They’ll mandate security measures and smaller exchanges just won’t be able to afford it,” he said.
But virtual currencies were invented to avoid regulation, i.e. “government intrusion,” so it is more than a little peculiar to see bitcoin exchangers asking for better regulation of what was supposed to be anonymous money. Responding to Chinese government decisions to limit bitcoin transactions in the country, the co-founder of BTC China told CNN that such regulation would help maintain the value of the currency.
As for the exchanges themselves, Lee says he is open to meeting with Chinese government officials and actually welcomes a regulated market .
“It’s the confidence in bitcoin that needs to be salvaged in China….Our objective is to develop a more sustainable bitcoin market with the support of government. We don’t want to create a frenzied environment.”
As we said on Wednesday, the virtual currency boom appears poised to have its greatest political impact on the champions of deregulation, who expect that bitcoins will provide a new “dark money ATM” for campaign contributions. Two political action committees, both linked to Dan Backer, have already sprouted up. Their instant issue is preventing regulation of bitcoin, which is ironically the very thing that bitcoin needs in order to survive.
We will continue to monitor this story.