Bitcoin virtual currency is on verge of collapse

It was supposed to revolutionize the global monetary system. Instead, the bitcoin virtual currency that has captured the imagination of investors and financiers is on the verge of collapse.

In a stunning blow to a novel way to buy products and services, the world’s largest exchange for trading bitcoin currency shut down Tuesday, triggering a massive sell-off and sending many prospective investors away — perhaps for good.

“This is extremely destructive,” said Mark Williams, a risk-management expert and former Federal Reserve Bank examiner. “What we’re seeing is a lot of the flaws. It’s not only fragile, it’s fragile as eggshells.”

The mysterious circumstances that triggered the failure of the exchange, Mt. Gox in Tokyo, is only adding to the renewed anxiety over the virtual currency, which just a month earlier had been gaining momentum and supporters.

After saying users could not withdraw their funds, Mt. Gox suddenly ceased all operations, including shutting down its website. Mt. Gox users may have lost more than $300 million worth of bitcoins in what was the latest and biggest in a series of recent setbacks for the virtual currency.

The currency exists only online, and its value is based on an algorithm. Investors buy bitcoins with dollars, euros and other real currency. A purchase with bitcoins typically involves transferring an amount from the buyer’s bitcoin “digital wallet” to the seller’s wallet on the Internet.

The blow to bitcoin’s credibility has highlighted all the fears critics have been trying to raise. Because it is unregulated and anonymous, there is probably no way for users to know who may have seized the thousands of missing bitcoins — and no way to recover them.

This sudden reversal of fortune is particularly painful for enthusiasts who believed just a few weeks ago that bitcoin was on the cusp of mainstream acceptance because of growing support from venture capitalists, banks and regulators.

Instead of triumph, the bitcoin community is now focused on repairing the damage. Mt. Gox is nothing more than a “collapsed tower of toxic sludge,” said Williams, who is also a finance professor at Boston University School of Management.

The recent weeks have been troubled ones for bitcoin. In late January, the chief executive of another bitcoin exchange was arrested on money-laundering charges, Russia banned the virtual currency, and Apple Inc. pulled a popular bitcoin app from its App Store over concerns about its legality.

But the fall of Mt. Gox trumps all of these stumbles in size and scope, and has clearly left many in the bitcoin community stunned and confused. Although there are other exchanges where people can buy and sell bitcoins, Mt. Gox was the biggest.

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“Having Mt. Gox shut down is to bitcoin what having the New York Stock Exchange shut down is to our equity market,” said James Angel, a professor of finance at Georgetown University.

Problems at Mt. Gox first surfaced earlier this month when the exchange stopped letting users make transactions because of what appeared to be a glitch that was also affecting other exchanges. But although the other exchanges came back online, Mt. Gox remained dark through last weekend.

On Monday, users noticed that the site seemed to be disabled and the home page was blank. Later that day, a “Crisis Draft Strategy” document was obtained by somebody and posted online, purporting to be from Mt. Gox.

The document, whose authenticity has been questioned, raised further alarms because it indicated that Mt. Gox may have lost 744,000 bitcoins to theft over several years. It also explored whether to shut down Mt. Gox completely or re-launch it under a new name.

What really happened? Mt. Gox issued only a short statement Tuesday: “In light of recent news reports and the potential repercussions on Mt. Gox’s 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.”

Across the bitcoin community, Mt. Gox faced swift and harsh criticism for its handling of the crisis.

“This tragic violation of the trust of users of Mt. Gox was the result of one company’s actions and does not reflect the resilience or value of Bitcoin and the digital currency industry,” read a joint statement from several bitcoin companies posted on the Coinbase blog. “As with any new industry, there are certain bad actors that need to be weeded out, and that is what we are seeing today.”

Created in 2009 by a programmer using the pseudonym Satoshi Nakamoto, bitcoin is based on a software standard that runs across a wide number of servers around the world for regulating the creation and trading of bitcoins. It is not controlled by any nation, governing body or business.

The original computer code established the number of bitcoins in circulation and tracks ownership of the currency. The absence of government or corporate interference made bitcoin popular among technophiles with strong libertarian views.

But the same attributes that made Bitcoin so appealing to some may be its greatest weaknesses, critics say.

“Concerns regarding Mt. Gox’s potential insolvency highlight the fact that one of bitcoin’s most attractive qualities — rapid transactions that are non-reversible — are also flaws,” said Alex Ferrara, a partner at Bessemer Venture Partners, who has been exploring possible investment opportunities over the last year in the bitcoin industry. “If Mt. Gox or any of the exchanges are hacked and bitcoins are stolen, they cannot be replaced.”

That bitcoin’s reputation has been so badly battered is all the more painful for backers who had been seeing venture capital starting to flow to bitcoin start-ups.

Silicon Valley venture capitalist Marc Andreessen recently revealed his venture firm had invested about $50 million in bitcoin start-ups. Bitcoin incubators and accelerators had begun popping up around the country. On the very day Mt. Gox appeared to collapse, SecondMarket, a New York City firm, announced plans to create a new exchange with some major banks as possible partners.

Many Bitcoin backers insisted there was a silver lining to the collapse. Bad firms like Mt. Gox would be weeded out and replaced by trustworthy ones that would make bitcoin more credible and secure, they argued.

“It’s a shame that many people lost money, but when underperforming businesses are replaced by innovative ones, the economy grows stronger,” said Jordan Kelley, chief executive of Robocoin, which makes bitcoin ATMs, in a statement. “It’s a good day as Bitcoin continues to grow up — a few blemishes along the way are natural and healthy. We expect Bitcoin to grow even faster in the days ahead.”

But before it can do that and search for new converts, it’s going to have to find ways to reassure the faithful. Ryan Galt, a bitcoin blogger, wrote a post expressing his fear that this could be a fatal blow.

“This is catastrophic, and I am sorry to share this,” he wrote about Mt. Gox’s problems. “I do believe that this is one of the existential threats to Bitcoin that many have feared and have personally sold all of my Bitcoin holdings.”

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O’Brien reported from San Francisco and Tangel from New York