Regulators and hackers put Bitcoin to the test

Worries cause Bitcoin prices to swing, bigger declines expected from high of $1,200

Bitcoin is facing significant growing pains as it struggles to move beyond a stormy adolescence.

After months of hype and hysteria that have driven up its price at a dizzying pace, Bitcoin recently encountered several hurdles that are likely to determine whether it makes it out of its early speculative phase to become a currency that people actually use, is supplanted by a rival or falls apart altogether.

The most fundamental threat was a bug in some basic software that determines how bitcoins are moved between digital accounts. That forced several of the largest Bitcoin exchanges to shut down for most of last week and raised questions about the sturdiness of the programming underlying the currency.

At the same time, the system proved vulnerable to a hacking attack, creating doubts about the strength of the network’s security. Regulators also indicated last week that they were moving ahead with new rules for virtual currencies, leading to some fears that burdensome laws could halt Bitcoin in its tracks.

These worries sent the price of Bitcoin swinging between a high of about $700 Feb. 10 and a low of $530 on Friday, with some expecting even bigger declines. The current prices are down from highs of about $1,200 in December.

“We are at this inflection point where the hard questions are being asked and will hopefully soon be answered,” Benjamin M. Lawsky, New York State’s top financial regulator, said in an interview.

Bitcoin has already survived several bouts of volatility that were even wilder than the one last week. But during those crises, nearly everyone involved was a speculator and the currency was much further from real-world success. Now that Silicon Valley and Wall Street have begun to buy in, and everyday uses for Bitcoin are becoming more common, the stakes are much higher.

In the same week that Bitcoin was besieged by hackers,, one of the largest companies to accept Bitcoin as payment, said it was nearing $1 million in purchases made with the currency.

Lawsky has been leading efforts to write regulations for virtual currencies, in part to improve confidence in the system. At an all-day event last Tuesday at the New America Foundation, a nonprofit public policy institute, Lawsky said he hoped to “put forward, during the course of 2014, a proposed regulatory framework for virtual currency firms operating in New York.”

The same day, Canada’s finance minister, Jim Flaherty, announced his plan to create national rules for what has been a largely lawless space.

These efforts are more encouraging for Bitcoin’s future than Russia’s recent decision to declare virtual currencies illegal. But the Bitcoin Financial Association started a petition to Lawsky titled “Please Do Not Regulate Bitcoin,” in which it argued that Bitcoin was too young and vulnerable to be able to survive significant regulations.

Other supporters, however, have recently been pressing for closer cooperation with both regulators and banks.

One of the most contentious efforts by some Bitcoin entrepreneurs has been a proposal to tag the digital coins to make it possible to determine if a particular coin had been used for illegal activities.

Such a system would make banks more comfortable in handling Bitcoin transactions. But the effort has faced intense opposition from early Bitcoin adopters who were drawn to the virtual currency because it allowed them to avoid scrutiny from governments and banks.

This is only one of the disputes dividing the community of Bitcoin supporters. The winners will determine whether the virtual currency will simply be absorbed into the existing financial system or whether it will remain a new tool for people who want to circumvent the government and Wall Street, occasionally for illegal purposes like buying drugs or weapons.

Susan Athey, a professor of economics at Stanford Business School, pointed to several potential outcomes. It is possible, she said, that banks will simply adopt some of the best elements of the Bitcoin program that allow money to be transferred almost instantaneously. Other alternative virtual currencies could also rise up without Bitcoin’s perceived flaws, like the limit on the number of bitcoins that can ever be created.

Athey is assuming that “some of each of these things happen,” she said.

“Once you look at it,” she added, “you say, ‘How is it we are still using these archaic financial rails?’”

But if Bitcoin is to have any chance of success, its digital architecture is going to have to prove its sturdiness under increasingly difficult conditions.

The most recent doubts were raised when a Bitcoin exchange that was once the largest in the world, Mt. Gox, almost shut down after discovering that customers could make transactions disappear from its records.

While this initially appeared to be a problem limited solely to Gox, it spread to several other large exchanges last week, and the Bitcoin Foundation acknowledged that it was a flaw that developers had long been aware of. With the issue out in the open, hackers began an attack on the main exchanges.

All of this put the developers who work on Bitcoin’s open-source computer code into a frenzy of programming. The chief scientist at the foundation, Gavin Andresen, posted his activity on Twitter on Thursday: “Today was about ignoring people and Deep Coding.”

By Friday, it appeared that the problem was largely under control, and the largest exchange, Bitstamp, reopened. That helped the price of a bitcoin rise to $660 on Friday evening from $532 in the morning.

Jeff Garzik, one of the currency’s longtime developers, said that the problems exposed last week should not be a long-term issue for the network. But he acknowledged that Bitcoin would still face significant tests.

“We’re still a very young ecosystem,” said Garzik, who now works for the Bitcoin company Bitpay. “I’m certain that bigger and much more devastating attacks will occur in Bitcoin’s lifetime. That’s the nature of the beast.”

Garzik expressed his confidence in Bitcoin’s ability to survive attacks because of the collaborative nature of the programmers working on it. At the same time, he said that he was drawn to Bitcoin not because he thought it would take over the world but because it was a “fascinating experiment at several levels.”

The last year, he said, was a year of “increasing visibility.” The next year, he said “will be the year of action.”