Bitcoin Drama: Mt. Gox's Lost Coins, Another Failed Exchange, and a New Champion

There's no shortage of Bitcoin drama these days. Mt. Gox's implosion, hacks at other exchanges, and a flurry of castigation from Warren Buffett, analysts at Goldman Sachs, and FINRA (Financial Industry Regulatory Authority) have all cast a gloomy shadow over the future of the top cryptocurrency.

The consensus is that Bitcoin should not be considered a currency due to its volatility, its shady exchanges, and its lack of effective regulation. As a result, the price of Bitcoin has fallen from $690 earlier this month to $575 -- but has still retained a hefty 569% gain over the past 12 months.

Source: Flickr.

Yet the Bitcoin drama rages on. Recent developments include Mt. Gox's mysterious discovery of 200,000 "missing" Bitcoins in an old wallet, another Bitcoin exchange failure, a false report from China that caused a sudden crash, and the introduction of new derivatives as hedges against Bitcoin's volatility. Meanwhile, Marc Andreessen, best known as the co-founder of Netscape, disclosed his massive bets on the virtual currency.

Let's take a look at what all these big headlines mean for the future of Bitcoin.

The million-dollar trust issue
I've previously noted that the lack of trust is one of Bitcoin's biggest problems. Without appropriate regulation, there's no insurance for Bitcoins lost through hacks and thefts. Bitcoin exchanges have promised to install more robust security measures, but these have proven to be ineffective against legions of hackers emboldened by the collapse of Mt. Gox.

Mt. Gox's failure shouldn't have surprised anyone who follows the industry. Last April, a study conducted by computer scientists Tyler Moore and Nicolas Christin found that 45% (18 out of 40) of Bitcoin exchanges end up closing. Four Bitcoin exchanges, including Mt. Gox, had suffered serious attacks but remained open.

Mt. Gox became insolvent after reporting the cyber theft of 850,000 Bitcoins (worth approximately $480 million at the time) in late February. It was later hit by hackers, who reportedly uncovered evidence that Mt. Gox CEO Mark Karpeles had stashed away a personal balance of 950,000 Bitcoins ($600 million) while his clients were left penniless. Then just when we thought the Mt. Gox debacle couldn't get more ridiculous, the exchange reported that it had "found" 200,000 Bitcoins ($115 million) in an unused wallet.

Since the Mt. Gox disaster, two other Bitcoin exchanges -- Flexcoin and Vicurex -- have fallen to hackers. A third exchange, Poloniex, lost more than 10% of its Bitcoins and temporarily froze its accounts.

Industry watchers have suggested that Bitcoin exchanges must team up to create a community-backed Bitcoin FDIC, but it's doubtful that these exchanges, located all across the world, will be willing to pitch in when a weak link snaps. Yet until some sort of internal or external regulation arrives, Bitcoin can't be considered a currency due to the lack of trust and transparency between clients and exchanges.

Could derivatives solve Bitcoin's volatility problem?
The other big issue with Bitcoin is its volatility. Nobody wants to be the guy who bought two pizzas for 10,000 Bitcoins ($5.8 billion today) in 2010. A recent erroneous report from microblogging site SINA Weibo claimed that China's central bank would halt all Bitcoin transactions by April 15, causing prices to plunge on March 21.

To guard against that kind of volatility, a new start-up known as Tera Group wants to introduce Bitcoin derivatives to the market. Tera wants to set a futures price for Bitcoin, in the same manner as stocks and commodities. The company has drafted documentation for a 25-day swap transaction between U.S. financial firms, which freezes the value for Bitcoin at a mutually agreed underlying price for the period. However, Bitcoin is never actually used in the transaction -- the firms only promise to pay each other a fixed cash amount based on Bitcoin's value in the derivatives contract.

While this could stabilize Bitcoin volatility during the contract period, this could create an even riskier market of trading Bitcoin derivatives. In other words, Tera could be building an even riskier market on top of an already unstable one.

Marc Andreessen becomes Bitcoin's latest champion
Marc Andreessen's venture capital firm Andreessen Horowitz recently disclosed that it had already invested roughly $50 million in Bitcoin investments from a $1.5 billion fund. The firm also announced plans to invest hundreds of millions of dollars over the next few years from additional funds. Andreesen stated that he was "completely unfazed" by the Mt. Gox debacle, according to The Wall Street Journal.

Web pioneer Mark Andreesen. (Source: Wikimedia Commons)

Although Andreessen is best-known for the rise and fall of Netscape, the web browser that was crushed by Microsoft's Internet Explorer, many of his past investments have been shrewd and highly rewarding. He invested millions in Digg, Netvibes, and OMGPOP -- all of which were acquired for big premiums. He invested $5 million in Twitter in 2007, becoming one of the company's earliest investors.

Therefore, when Andreesen believes in something, he certainly deserves more attention than early Bitcoin backers such as the Winklevoss twins, who were best known for "almost inventing" Facebook .

But the publicity circus continues...
In a previous article, I stated that Bitcoin is a publicity tool above all else. It's a free way for businesses of all sizes to attract free media coverage for Bitcoin transactions that may or may not ever take place. Recent Bitcoin business includes an individual who bought a €500,000 luxury apartment in Berlin on All4BTC.com and California-based wineries that now accept Bitcoin payments.

Yet the key problems that I have discussed with Bitcoin -- the need for regulation, more trustworthy exchanges with transparent business operations, and less volatility -- remain far from solved. In my opinion, Bitcoin remains far too risky for everyday investors, and has a lot to prove before it can be considered a viable digital currency for the 21st century.

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The article Bitcoin Drama: Mt. Gox's Lost Coins, Another Failed Exchange, and a New Champion originally appeared on Fool.com.

Leo Sun owns shares of Facebook. The Motley Fool recommends Facebook, Sina, and Twitter. The Motley Fool owns shares of Facebook, Microsoft, and Sina. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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