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Bitcoin needs to grow up if it wants to survive Mt. Gox collapse

Aaron Task
Editor in Chief
Daily Ticker

Bitcoin's future was called into question this week due to the collapse of Mt. Gox, which filed for bankruptcy in Japan on Friday. Once one of the largest exchanges for the virtual currency, Mt. Gox was the victim of either a security flaw or an inside job -- or a combination of both.

Whatever the cause, nearly $500 million worth of bitcoins have disappeared into the virtual ether, leaving clients of Mt. Gox with little or no recourse to recoup their losses. That's because bitcoin, by design, is beyond any government control or regulatory oversight.

"Bitcoin is a payment innovation that’s taking place outside the banking industry," Federal Reserve chair Janet Yellen said Thursday during her Senate testimony. "So the Fed doesn’t have authority to supervise or regulate Bitcoin in any way.”

Other regulators, both in the U.S. and abroad, have drawn similar conclusions; in the past, such statements have caused temporary fluctuations in bitcoin prices but generally cheered its libertarian advocates.

But the crypto-currency's biggest draw for its supporters -- its lack of government oversight -- could now prove to be its undoing, or at least prevent it from going mainstream. Consumers who may have been curious about bitcoin before this week are now going to be very wary about making transactions or investments in the virtual currency. 

If a U.S. bank fails, deposits of up to $250,000 are guaranteed by the U.S. government via the Federal Deposit Insurance Corp. If a brokerage firm like MF Global fails, clients can turn to the Securities Investor Protection Corp., which is funded by its members and aims to protect each customer account for up to $500,000.

Again, nearly $500 million of bitcoin assets were lost due to Mt. Gox's collapse and its former clients have virtually no options -- no regulator nor law enforcement agency -- to turn to in the hopes of getting their money back.

At this moment, it seems clear bitcoin needs some kind of regulation to protect consumers, or it will remain at best a fringe way to conduct transactions and, at worst, a venue that continues to attract shysters and criminals. 

"At least for now, more government involvement is needed to prevent further failures of bitcoin exchanges," writes Ezra Galston, a venture capitalist with Chicago Ventures, who continues:

"Mt. Gox's largest failure was a technical one, with an alleged shortfall in bitcoins caused by improper accounting and oversight of reserves. Real-time digital signature verification can solve this problem, bypassing the need for traditional auditors. But implementation of such cutting-edge technology will need to be fully stress-tested. Meanwhile, exchanges would need to depend on either regulators or outside auditors to ensure that their digital signatures are accurate and not susceptible to manipulation."

The good news for bitcoin is that prices of the virtual currency have stabilized in the wake of Mt. Gox's fall. After falling below $430 earlier this week, bitcoin was recently trading at $556.65, according to CoinDesk. That's a far cry from its November peak above $1200 but this week's recovery in bitcoin price suggests the currency will survive the Mt. Gox disaster.

But surviving is not thriving and "bitcoin needs to decide what it wants to be when it grows up," as my colleague Rick Newman says in the accompanying video.

If bitcoin remains unregulated, it will likely remain appealing only to pure libertarians, technologists and bad actors. "When you don't have a regulatory framework, who benefits most?," Newman asks rhetorically. "Thieves and black-market types. It's a world for speculators and not people seeking...a store of value."

By eschewing regulation, bitcoin has indeed attracted bad actors and criminals, which in turn has drawn the attention of law enforcement. Most notably, the FBI seized about $28 million worth of bitcoin when it shut down Silk Road last summer and the SEC alleged that Trendon Shavers defrauded investors out of $4.5 million in a bitcoin Ponzi scheme.

These are but just two examples of law enforcement investigations and negative headlines about missing millions that are going to continue to dog bitcoin until and unless its community of supporters and legitimate related businesses decides it's time to grow up. 

Aaron Task is the host of The Daily Ticker and Editor-in-Chief of Yahoo Finance. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com.