Bitcoin or Bust

Jonathan Strickland

Mining for bitcoins. | arinahabich/iStock/Thinkstock
Mining for bitcoins. | arinahabich/iStock/Thinkstock

You've probably heard the news: The company Mt. Gox, which was the world's largest exchange for the cryptocurrency Bitcoin, has filed for bankruptcy. According to Mt. Gox, hackers managed to steal 750,000 bitcoins from customers and 100,000 bitcoins from the exchange itself. This is a serious blow to the cryptocurrency. It's supposed to be secure, untraceable and free of regulation. But is it the currency's fault?

First, let's look at Bitcoin. It's a digital currency that mimics real-world limited resources. Let's compare it with gold. There's a limited amount of gold on our planet. We value gold. Why? Mostly because it's pretty and there's not an unlimited supply of it (there are other reasons too -- gold is useful in electronic components). As long as someone wants something, it has value to at least one person.

Okay, so how do we get gold? We mine for it. If you're a 19th century grizzled prospector in California, you might stumble across an enormous deposit of gold and become fabulously wealthy. But as word gets out, other prospectors and even big companies join the frantic search. Some of them are faster than you are and get to the gold before you can. Also, the deposits begin to shrink as they are mined so it becomes harder to find more gold.

Bitcoin simulates this process digitally. Instead of physically mining for a resource, your computer essentially performs math problems. At first, the problems are relatively easy and not a lot of people are competing against you. But as more people become aware of Bitcoin, they join the search and use more powerful computers. Now your machine is competing against computers with multiple parallel processors. You don't have much chance of finding a particular bitcoin before someone else does.

There's also a finite number of bitcoins available -- 21 million, to be exact. And two factors help control how much of the currency is in circulation. The first is that those math problems get harder as more people try to find bitcoins. The second is that fewer bitcoins are released over time and eventually only fractions of a bitcoin will be found during any given mining attempt.

So who determines the value of the Bitcoin? It's supposed to be whatever the market will bear. In other words, there's no regulatory agency that sets the value. If a buyer and seller agree that a bitcoin is worth $5 US, then that's what it's worth. But in general, the value of the currency has fluctuated wildly since it debuted.

Its volatility has led some critics -- including me -- to question its usefulness as a currency. If the dollar you have in your hand has $1 buying power on day one, $20 buying power on day two and $200 buying power on day three, it's hard to let go of that dollar. Who knows what its value will be tomorrow? What if you spend that dollar only to find out it would have been worth hundreds more the next day?

Onto Mt. Gox and the hacker attack. While Bitcoin has a sophisticated format that protects it against people trying to cheat the system -- for example, by spending the same bitcoin more than once -- that doesn't necessarily protect it from hackers targeting banks and exchanges that deal with the currency. That's what happened here. The attack doesn't necessarily uncover an inherent weakness in the currency itself but rather in the institution of Mt. Gox. If you read a story about a bank robbery in which the crooks ran away with half a million dollars (the value of the Bitcoins in the Mt. Gox attack was around $480 million), you wouldn't blame it on the banknotes. You'd point to bank security.

Could the Mt. Gox attack lead to regulation? Could it even lead to a bailout? It's a very touchy subject in the Bitcoin community -- a world in which many of the customers value the currency specifically because it is free from regulation and government interference. Some of the community argue that Mt. Gox should receive a bailout to help those who lost considerable sums in the hacks. Others argue that it opens the door for the very regulation the currency is supposed to avoid.

Ultimately, I think Bitcoin will weather this storm. While the attack was considerable -- approximately 7% of the world's supply of bitcoins were stolen -- the currency itself still has its passionate devotees. Then again, if the attack leads to a loss in customer confidence, this could be the beginning of the end. Remember, it doesn't matter how "good" a currency is if no one is willing to use it.