Can Bitcoin survive? Debate rages, but experts say regulation is possible.

The closure of Bitcoin exchange Mt. Gox has rattled the market for the crypto-currency and sharpened the debate over whether it can be regulated without tarnishing its appeal.

Once again, the doomsayers are hovering over Bitcoin, the crypto-currency that has attracted the attention of both federal and New York State regulators in the past four months.

Tuesday’s closure at Mt. Gox, the currency’s largest exchange, shook the market, sending prices downward.

Wednesday saw prices rebound, however, leading some analysts to suggest that a little bit of good, old-fashioned market regulation is all the upstart digital cash really needs to move it into the mainstream. But, say others, this very respectability could compromise the essence of its appeal, namely its freedom from government oversight.

Bitcoin's days need not be numbered, says Peter Zaleski, economics professor at Villanova University in Philadelphia, but  “regulation would kill rather than help Bitcoin.”

If it were regulated, then it wouldn't be Bitcoin, he says via e-mail. “Bitcoin was created by and for risk-loving individuals. The everyday risk-averse person, which describes most people, should rightly be concerned and stay away,” adds Professor Zaleski.

A balance is possible, say financial experts, one that would put in place tools that have proved useful in protecting against fraud while retaining the desired freedom from the heavy fees and delays in many traditional financial transactions. 

Regulation is inevitable, if the cyber-currency is to endure, says Jason Hogg, founder of the financial services company Revolution Money and a professor at Cornell University in Ithaca, N.Y.  “Look at all the many regulations that have evolved over the years in our current markets,” he says, and they protect consumers against fraud and stabilize against volatility.

Officials have responded to Tuesday’s meltdown with calls for an investigation, both in Tokyo and the United States. 

In a statement, as reported by Bloomberg News, Benjamin Lawsky, superintendent of financial services for New York state, said, "Tailored regulation could play an important role in protecting consumers and the security of the money that they entrust to virtual currency firms."

This is not the first time Bitcoin has drawn official attention. Congress held hearings on virtual currency back in November, and New York officials held them in late January.

Without some sort of regulation, it is hard to see how Bitcoin can retain the trust of its users and investors and remain viable, says Richard Grossman, an economics professor at Wesleyan University, in Middletown, Conn.

“If the most technically savvy on the planet couldn’t protect against losses at a major exchange, how can the currency go on?” he asks, via e-mail.

History provides a few lessons, notes Professor Grossman. During the free banking era in the 19th century, many banks issued their own money. “They frequently issued a lot more than they could redeem and, as a result, failed,” he says, adding that this is why countries generally entrust the issuance of money to a central bank or some other quasi-governmental agency.

The current meltdown only highlights the damage that can occur without strong regulations, says Mark Williams, a former Federal Reserve Bank examiner and commodities trader who teaches finance at Boston University’s School of Management. “What was the largest exchange is now a collapsed tower of toxic sludge. This could spark a Lehman Brothers-like cascade through the Bitcoin market,” he adds.

Indeed, the Mt. Gox failure is a black eye on the face of the alternative currency experiment, says New York financial analyst Peter Leeds, adding that there will be no real threat from prosecutors and law enforcement agencies, “as they have no authority internationally.” The funds are lost, he says, “and will never be reclaimed.”

But, says Bruce Fenton, president of the Bitcoin Association, the issue is not really one of regulation, but function. Bitcoin’s appeal is less for its lack of regulation, he says, and more for its absence of third parties involved in transactions. Few people are active in Bitcoin are doing so because it's unregulated, “they are active because they believe Bitcoin is a better mouse trap.”

The Mt. Gox exchange failure says little about the Bitcoin community’s ability to self-regulate, says Mr. Fenton. Mt. Gox was not a leader in technical standards for handling Bitcoin. The exchange was originally designed to trade trading cards for a fantasy game with wizards and dragons, he says, noting that the site added Bitcoin at a time far before the currency’s dramatic increase in price and trading activity. It ended up becoming a large exchange, by happenstance.

“The tech and management side never caught up, and this is the prime reason for the challenges,” he says, noting that today's best practice exchanges are far more technically advanced.

Nevertheless, the call for regulation is a good sign for Bitcoin, says Stephen Brecher’s, senior adviser at WeiserMazars.  “Regulators see value in Bitcoin,” he points out, adding, “if they didn’t they wouldn’t be moving to regulate it.”