A MtGox Bankruptcy May Be Good News for Bitcoiners

Account holders at MtGox, the massive Bitcoin exchange that abruptly shut down this may not be left completely empty-handed. If the Tokyo company files for bankruptcy, its customers could retrieve some of the funds it is holding hostage.

An alleged internal document from MtGox states that thieves stole 744,408 Bitcoins from the exchange — about $365 million at current rates — and that the theft “went unnoticed for several years.”  But if MtGox proceeds to file for bankruptcy and the court system finds the company insolvent, it will rule that the exchange must pay customers with the assets it still has, says Jerry Brito, a senior research fellow at the Mercatus Center at George Mason University.

The MtGox document says the exchange could go bankrupt at any point, but it plans on rebranding with a new business model, new advisors and location.

Bitcoin is a digital currency designed for near-anonymous, irreversible transactions. These traits are often praised by Bitcoin devotees, but they also leave the currency's users with little recourse now that MtGox has all but vanished.

Because MtGox has creditors, it can't legally keep the funds it still has, Brito says.

The court would also rule on how to value bitcoins on the exchange and who gets paid first. For example, in the U.S., bondholders get paid out before shareholders and any individual or company that has a contract with the business also gets paid first, Brito says.

But even under this scenario, not many customers would get repaid, he says.

Because MtGox is a business registered in Japan, the bankruptcy proceeding would happen there, and while Japan's insolvency regulations are similar to those of the U.S., there are some key differences.

The MtGox webpage appeared as a blank page this morning, but has been updated with a curt letter to customers. "In the event of recent news reports and the potential repercussions on MtGox' operations and the market, a decision was taken to close all transactions for the time being in order to protect the site and our users. We will be closely monitoring the situation and will react accordingly," the note says.

The company could not be reached for comment.

"Gox is the exact opposite of TBTF (too big to fail) capitalism because they are not being propped up by government," says Jon Matonis, executive director of the Bitcoin Foundation, in a text message. "In a way they are similar to Lehman [Brothers]. Other exchanges will be set to prosper."

In the immediate aftermath of MtGox's disappearance, Bitcoin will take a reputational hit, marked with price depressions, Brito says. But in the long run, removing a bad actor is good for the ecosystem, he says.

MtGox was one of the biggest Bitcoin exchanges, and its departure will allow new players to enter the Bitcoin ecosystem, including U.S.-based SecondMarket, which has allowed people to buy and sell stakes in private companies and recently started allowing people to buy and sell bitcoins. 

Since the Bitcoin protocol makes digital currency payments irreversible, recent hacks and thefts have gone unpunished. But MtGox is a big enough target that it may face consequences. "Consumer lawsuits are probably in the works now," Brito says.

Foreign government agencies such as the U.S. Consumer Finance Protection Bureau may not have the jurisdiction to take action, Brito says.  

On Feb. 24, Japan's financial authorities told the Wall Street Journal that they will not intervene with MtGox, stating, "The FSA is in charge of currency-based services. Therefore, Bitcoin exchanges are not a subject to our regulatory oversight."

MtGox's Twitter account has been wiped clean, and MtGox CEO Mark Karpeles resigned from his position at the Bitcoin Foundation this week.

MtGox had already halted withdrawals for the past few weeks, prompting outrage among its customers. MtGox blamed the Bitcoin protocol itself for many of its issues, which stemmed from the currency's transaction malleability, a feature that could allow duplicate transactions if it is not properly accounted for.

MtGox has been quiet about its efforts to fix the problem.

"The lesson is not that Bitcoin is broken. Bitcoin is fine," says Erik Voorhees, co-founder of Coinapult, a Panama-based Bitcoin processor, in a post to the discussion website Reddit. "Similarly, the lesson is not that security is impossible. Those who know what they are doing can achieve it and help others to do so."

Other Bitcoin companies—Coinbase, Kraken, BitStamp, BTC China, Blockchain.info and Circle—have come together to make a statement about MtGox's "tragic violation of the trust of users."

This situation "does not reflect the resilience or value of bitcoin and the digital currency industry," the joint statement says. "As with any new industry, there are certain bad actors that need to be weeded out, and that is what we are seeing today.  MtGox has confirmed its issues in private discussions with other members of the bitcoin community."

The Bitcoin community has faced other bad news in recent weeks. Charlie Shrem, the former CEO of a now-defunct Bitcoin exchange company, was arrested on charges of conspiring to launder funds. Shrem resigned his position on the Bitcoin Foundation's board after his arrest.

These incidents may prompt further activity by federal and state regulators.

"While all the facts surrounding the situation at MtGox in Japan are not yet clear, these developments underscore that smart, tailored regulation could play an important role in protecting consumers and the security of the money that they entrust to virtual currency firms," says Benjamin Lawsky, superintendent of the New York State Department of Financial Services, in an emailed statement.

Lawsky has been a proponent of specifically-tailored digital currency regulation at the state level. In January, he held BitLicense hearings where he declared Bitcoin to be a catalyst for modernizing payments regulation.