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Will Mt. Gox’s crisis lead to a Bitcoin collapse?

Bitcoin is suffering a major outage over the past week, as Mt. Gox, one of the first Bitcoin exchange services, has put a stop to withdrawals, citing ‘technical difficulties’.

Bitcoin coin

Japan-based Mt. Gox is a leading name in Bitcoin exchanges, being the original exchange service for the crypto-currency, and at one time being the largest. With this, Mt. Gox has often been cited as an authority when it comes to Bitcoin exchange rates, as well as a gauge of how well Bitcoin is doing in the market.

On Friday, February 7th, Mt. Gox announced that it was suspending all Bitcoin withdrawals, pending the resolution of some “technical issues”. There are speculations that Mt. Gox is experiencing a liquidity problem — something that is likely due to the meteoric rise in value of Bitcoin against currencies like the US dollar. However, Mt. Gox has historicaly experienced difficulty in processing transfers before due to regulatory concerns in some jurisdictions like the U.S., as well as legal disputes with partner institutions that service withdrawals.

As of writing, users who have initiated withdrawal transactions in the recent week had been refunded their Bitcoin balances back to their wallets. However, the supposed fall of Mt. Gox has shed some doubt on the reliability of Bitcoin as a means of monetary exchange and holding value. For the past months, Mt. Gox customers have complained of slow customer service turnaround, as well as long delays in processing withdrawals. While most withdrawals were serviced within a week’s time, a survey by CoinDesk found that many users had to wait one to three months to withdraw their funds from the exchange.

This has led to a fall in the value of Bitcoin, from $850:BTC1 at the start of last week to $684 as of this writing, as the market worries about the viability of exchange service in general. However, Andreas Antonopoulos, a security expert from wallet service Blockchain.info says Mt. Gox’ problems have arisen from its use of non-standard technologies that are resulting in discrepancies in Bitcoin transactions and reporting. Therefore, Mt. Gox’ “band-aid” solutions are “exacerbating scalability problems.”

In fact, Antonopolous says that users are likely  to start abandoning Mt. Gox because of the company’s lack of scalability and reliability. As for Bitcoin itself, there is still optimism: “As soon as people get their money out, other exchanges will pick up,” in terms of market share.

Bitcoin’s banking crisis

Some analysts have pointed out similarities with a “bank run” in traditional banking parlance. In the financial systems, banks often hold a “fractional reserve”, which means financial institutions are only liquid up to a certain point. Resources (in banks’ case, cash) that clients deposit into the system are loaned out for interest or invested for profit. However, the problem is when the amount of withdrawals or withdrawal requests grows to a point that the bank can no longer service these. In this scenario, we have the classic bank run.

In the case of Mt. Gox, instead of being a digital “vault” where all Bitcoins and other currencies are held, it is likely arbitraging these resources in the aim of profit, too. But with the sheer number of withdrawal requests, it has no choice but to cease all redemptions.

Still, this is not a fundamental problem of Bitcoin, as pointed out by the Mises Economics Blog. “Here we have an example of a purely unregulated currency succumbing to the same problems that have plagued money users for hundreds of years.”

Mt. Gox is on the decline. Will this foreshadow a similar decline by Bitcoin in general, or should the crypto-currency be resilient enough in itself and in relying on the numerous other services that users turn to for exchange and conversions? Perhaps while the world rethinks the concept of money with Bitcoin, we should also rethink the concept of banking and move away from fractional reserve systems. Otherwise, Bitcoin will run into the same problems as cash and government-issued currency.

J. Angelo Racoma
J. Angelo Racoma has written extensively about mobile, social media, enterprise apps and startups. Angelo develops business case studies for Microsoft enterprise applications and services. He is also co-founder at WorkSmartr, a small outsourcing team.

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