Bitstamp halts transactions. Is Bitcoin too Libertarian to succeed?

Bitcoin's bad week rolls on, with Bitstamp, another major exchange, being targeted by hackers and halting transactions. Can Bitstamp and Bitcoin at large, which was conceived as a way to sidestep government currency controls, succeed without federal regulation? 

Bitcoin’s bad week? It’s only getting worse.

Tuesday, the Bitcoin Foundation, the cryptocurrency’s main trade organization, admitted that prominent Bitcoin exchanges are being hit by hackers, who are sending mutated lines of code through their system and preventing transactions from being processed.

The issue halted transactions from the Slovenia-based exchange Bitstamp Tuesday, after shutting down Japanese-based Mt. Gox over the weekend.

"This is a denial-of-service attack," Bitcoin Foundation spokeswoman Jinyoung Lee Englund said in a press statement. "Whoever is doing this is not stealing coins, but is succeeding in preventing some transactions from confirming. It's important to note that [denial of service] attacks do not affect people's Bitcoin wallets or funds.”

That means users can’t make Bitcoin transactions for the time being, though Ms. Englund added that a team of software developers were working to fix the problem quickly.

Midday Wednesday, Bitcoin’s value was down 4.62  percent on the news, to $660.60.

The cyberattacks mark the latest episode in a series of price swoons, reputation hits, and infighting that have plagued the Bitcoin world in recent days. The spate of bad news begs the question: Are these temporary hiccups, or signs of fundamental problems with virtual currency?

"We are at a critical crossroads,” says Mark T. Williams, a finance lecturer at Boston University and a former risk examiner for the Federal Reserve. “Bitcoin is losing a lot of credibility in the marketplace.”

On Feb. 7, Mt. Gox, the biggest Bitcoin processor, halted transactions due to a “bug in the Bitcoin software” which it said was intrinsic to the virtual currency’s protocol and not limited to Mt. Gox. Bitcoin prices plunged 21 percent on the news Monday, before recovering slightly. The Bitcoin Foundation shot back, arguing that the problem was Mt. Gox’s fault, not Bitcoin’s.

“The issues that Mt. Gox has been experiencing are due to an unfortunate interaction between Mt. Gox’s implementation of their highly customized wallet software, their customer support procedures, and their unpreparedness for transaction malleability, a technical detail that allows changes to the way transactions are identified,” foundation spokesman Gavin Andersen said in a statement Monday.

But the Bitcoin Foundation has its own credibility problem. Its vice chair, Charlie Shrem, was arrested two weeks ago and charged with money laundering and selling bitcoins to users of Silk Road, an online black marketplace. 

Those reputational issues only serve to compound Bitcoin’s inherent volatility – absent any true regulating body, its value hinges entirely on speculation and public perception. Amid recent troubles, Bitcoin’s value has been nearly cut in half over the past few weeks.

 What’s Bitcoin’s future?

Mr. Williams argues that if Bitcoin is to succeed, it will have to abandon the feature that made it so appealing to many investors in the first place: a lack of regulation. After the 2008 financial crisis, he says, many of the world’s Central Banks were seen as mismanaging their nations’ currencies. “Bitcoin is regulated by a computer and not tied to any sovereign nation, and that idea has appeal” to Libertarians and others with anti-government leanings. “It’s gained a following partly because it seems to show us how we can do without money issued by the state,” he says.

The catch, is that national governments are a driving force in keeping money stable. “Any force that tries to corrupt that is going to meet resistance unless they are willing to be regulated,” he says.

Bitcoin “has potential to benefit the financial markets, but it has to do it in a way that’s beneficial to society as a whole, not just speculators. I don’t think the creators ever thought they’d get to this level of acceptance and awareness so quickly. But to be successful they’re going to have to be regulated, brought under sovereign power, and under the direct control under central banks. To be successful, it’s going to have to come under the power it has railed against.”

That regulatory push to either stamp out virtual currency or tighten controls so it is less attractive for criminal use is already underway in several countries. National banks in Russia, China, and Finland have already banned merchants from accepting Bitcoin payments. Canada announced yesterday that it will be tightening its rules surrounding virtual currencies, and in the US, regulators are drawing up rules to help govern virtual currency investments and prevent money laundering.

"I see [virtual currencies] offering great opportunities for improving the efficiency of our capital markets, but they need to be regulated and tightly controlled,” Williams says.