Blockchain

Bitcoin's no good, horrible, very bad few weeks

February 11, 2014: 12:09 PM ET

The arrests, price drop, and demise of a major exchange don't signal the end of the cryptocurrency, just some growing pains.

By David Z. Morris

140117173247-bitcoin-620xaFORTUNE -- On Monday, Jan. 27, Charlie Shrem, a founding member of the Bitcoin Foundation board and CEO of the BitInstant exchange, was arrested on money laundering charges. The two weeks since then have not been kind to the digital currency, with Apple (AAPL) removing the last native bitcoin wallet application from the App Store, and now the apparent demise of venerable bitcoin exchange Mt. Gox, unfolding under extremely troubling circumstances. That last piece of news in particular rocked markets, with bitcoin prices dropping more than 20% in 24 hours before rebounding to just under $700 by Monday evening.  That's a truly stomach-flipping drop from highs of over $1,100 in early December 2013.

Some have said this is the death of a fad, with longtime skeptics revving up the schadenfreude. And obviously, more than a few bitcoin holders are selling. But the details of this string of bad news don't match the sense of doom. There's no indication that the power of the ideas, technology, or growing industry behind bitcoin have been seriously weakened. Instead, what bitcoin is going through right now is exactly what you'd expect of a powerful new idea transitioning from the fringe to the mainstream.

Let's start with Shrem's arrest. The complaint against him has almost nothing to do with bitcoin itself. The legal complaint and news stories about Shrem depict a man who cavalierly flouted existing law to knowingly aid in narcotics trafficking. Bitcoin has deep roots in communities of both technocratic programmers and hardcore libertarians, some of whom occasionally move from disagreeing with unjust or inefficient laws to breaking them outright. But, while small-time money launderers will continue to use bitcoin as part of their arsenal, the increasing awareness of compliance regulations in the bitcoin community, and the increasing amount of fully legal profit at stake, mean fewer and fewer high-profile bitcoin entrepreneurs and advocates will be interested in working outside the law.

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This is part of the professionalization of what started out as a hobby or sideline for most current players. Nothing illustrates that transition quite like the ongoing fall of the Mt. Gox exchange. The name Mt. Gox originally stood for "Magic the Gathering Online Exchange," and its original owner intended to set the site up as a place to buy and sell cards from the popular game. It ended up the world's first Bitcoin exchange almost by accident.

Then it turned into a multi-million dollar business, and the volume outpaced its founders' skill-set. These were neither experienced businessmen nor, it has emerged, very talented developers. They have blamed the site's temporary shutdown on a small quirk of the bitcoin code that has been well known to every other exchange developer for nearly two years -- so we can add spin management to the list of things they're not very good at. Bitcoin veterans have been sounding warnings about Mt. Gox for months. Like Shrem's arrest, its fall will remove a bad actor from the landscape, and despite the temporary shock, the players left behind will be better off.

The silver lining is only slightly more hazy in the news that Apple has removed the Blockchain wallet application from the App Store. Apple has been steadily removing wallets over recent months, and with Blockchain gone, iOS users have no ability to send and receive bitcoin from their devices. Apple has offered no explanation of its decision, made after nearly two years of allowing Blockchain to operate freely within iOS.

But there has been widespread speculation and ample precedent for the idea that Apple is engaging in anticompetitive gatekeeping, in this case to protect its own proprietary mobile payment systems. From this perspective, the removal of Blockchain can be taken as a perverse stamp of approval for bitcoin -- Apple has also blocked Google (GOOG) services from its devices in the past, putting bitcoin in pretty sterling company. Meanwhile, bitcoin developers are hard at work on web-based solutions to put bitcoin management back in IOS users' hands.

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The real obstacles facing Bitcoin haven't changed -- primarily, regulatory uncertainty and the unwillingness of U.S. banks to work with bitcoin exchanges. But even the day after Shrem's arrest, New York regulators and bankers hosted upbeat fact-finding sessions, so those problems may be on the way to resolution.

Regardless, the most important things that haven't changed are bitcoin's fundamental innovations and the ripeness of its market. Though there is still the distinct possibility that some other cryptocurrency will out-innovate bitcoin itself, the basic cryptocurrency model solves problems for so many constituents that its eventual adoption is something of a fait accompli. It is vastly more efficient and secure for online payments than the current maze of credit cards and ACH systems, promising to reduce merchant fees and fraud losses. It allows true peer-to-peer payments, with near-zero costs. And it finally enables the micropayments model that has been dreamt of since the dawn of the Internet, opening up potentially huge new revenue streams for writers and other content creators.

We are sure to see more steps backwards and forwards before all of this comes to fruition. But five years from now, a few ethical faults, management catastrophes, and protectionist Hail Marys will barely merit footnotes.

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