Bitcoin - Turbulent Waters - Part Seven

by Dorsey & Whitney LLP

“Virtual currencies”, and bitcoin in particular, continued to attract a lot of attention. The sudden demise of Mt. Gox (Japan), one of the largest bitcoin exchanges, adds to the mystery and mistrust surrounding the virtual currency, which was just beginning to gain recognition beyond technology enthusiasts and adventurous investors. This eUpdate is the seventh part in a series of eUpdates on bitcoin-related topics. The first part of the series described what bitcoin is. The second part explained the legal status of bitcoin and how it is approached in different countries. The third part analyzed the effects of the Chinese demand on bitcoin, as well as how bitcoin is approached in China. The fourth part analyzed risks which virtual currency users may encounter. The fifth part discussed further steps taken by Chinese government towards regulating virtual currencies and their impact on the bitcoin market. The sixth part discussed continuing concerns about bitcoin and updated on developments in the bitcoin market.

Shutdown of Mt. Gox

In the beginning of February 2014, three leading bitcoin exchanges – BitStamp (Slovenia), Mt. Gox (Japan) and BTC-e (Bulgaria) – halted customer withdrawal of bitcoins and temporarily suspended bitcoin transactions due to, as it was reported, the exploitation of a flaw in the bitcoin protocol and the subsequent heist of US$2.7 million.1

Mt. Gox (Japan), one of the largest bitcoin exchanges, went offline on February 25, 2014. According to Mt. Gox, “a bug in the bitcoin software made it possible for someone to use the bitcoin network to alter transaction details to make it seem like sending of bitcoins to a bitcoin wallet did not occur when in fact it did occur”.2 Mt. Gox announced that “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”.3

On February 28, 2014, Mt. Gox applied for commencement of civil rehabilitation procedure at the Tokyo District Court.4 Mt. Gox’s announcement said that “the increase of the current liabilities over assets may be linked to a loss of bitcoins and customer funds which are now investigated by an expert” and that “all efforts are made to discover the truth”. Mt. Gox admitted that, although the extent of the problem is not yet fully known, it found out that approximately 750,000 bitcoins deposited by users and approximately 100,000 of its own bitcoins had disappeared. Mt. Gox said that the bitcoins were probably stolen by means of exploiting the “bug”, and that the causes of the problems were being investigated. As Mt. Gox confirmed, it closed its website once it discovered that it would be difficult to continue its activities normally due to the discrepancies between cash funds and deposit balances and loss of bitcoins. As earlier reports mentioned, the “bug”, if it indeed existed, was exploited by hackers and unnoticed by Mt. Gox for several years.5

Some reports suggested that Mt. Gox was in trouble ever since U.S. authorities seized US$5 million of its U.S. assets in 2013 on allegation that it was operating in the United States without proper money transmission permits. Since the seizure, customers began to report delays in receiving cash for their bitcoins.

Preet Bharara, U.S. Attorney for the Southern District of New York, sent subpoenas to Mt. Gox and other bitcoin exchanges and businesses dealing in the virtual currency seeking information on how they handled the recent cyber-attacks.6 Preet Bharara and the U.S. Federal Bureau of Investigation are also probing potential criminal activities in relation to the shutdown of Mt. Gox. Japanese authorities earlier indicated that they were probing the exchange’s shutdown as well. Mt. Gox confirmed that “it will fully cooperate with inquiries from authorities and investigations related to this matter, in Japan or overseas”.7

Several other major bitcoin exchanges, including Kraken (USA) and BTC China (China), as well as bitcoin wallet-makers, such as Coinbase (USA) and Blockchain (USA), issued a joint statement distancing themselves from Mt. Gox. The shutdown 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”, the statement read.8 It added that bitcoin exchanges were working together and committed to the future of bitcoin and security of customer funds. “We are confident that strong bitcoin companies, led by highly competent teams and backed by credible investors, will continue to thrive, and to fulfil the promise that bitcoin offers as the future of payment in the internet age,” the statement continued.

“This is certainly not the end of bitcoin,” the Bitcoin Foundation maintained. “As our industry matures, we are seeing a second wave of capable, responsible entrepreneurs and investors who are building reliable services for this ecosystem”.9 However, Mt. Gox’s shutdown did raise questions about bitcoin’s precarious status and even more precarious future. At least one commentator opined that the setback could be fatal to bitcoin’s quest for public acceptance. Fatal or not, the episode recited the risks associated with virtual currencies of a decentralized and unregulated nature.

Bobby Lee, CEO of BTC China, warned that more Mt. Gox-style problems would occur unless better regulation of the industry was introduced. “Because [bitcoin] was not created by Mt. Gox it means that it won’t drag it down with it,” he said. “This is why I have been calling for more regulation.”10

Bitcoin prices went down to an average of approximately US$425 on the news of Mt. Gox’s shutdown, but rebounded shortly afterwards. To date, the value of bitcoin remains volatile.

Bitcoin gold rush in China

For many, Mt. Gox’s shutdown was another black eye to the virtual currency that was struggling to gain legitimacy. However, Chinese investors kept rushing to buy bitcoin, seeing it as potentially undervalued after bitcoin prices fell following the shutdown.11 This led to a visible return of Chinese investors to the market, after the People’s Bank of China (PBOC) took first steps towards regulating bitcoin in December 2013.

In the beginning of February 2014, Bobby Lee announced that customers were once again able to purchase bitcoins in China by depositing renminbi directly into BTC China’s corporate bank account. BTC China also launched renminbi-based reward programs to encourage trading in bitcoin and increase its liquidity. BTC China’s decision came after the exchange stopped accepting renminbi deposits, in response to the notices given by the PBOC in December 2013 banning national financial institutions from trading in bitcoin.12 As per BTC China, it determined that it was legally permitted to accept deposits into its corporate bank account and transfer funds into customer accounts, even though banks per se were barred from engaging in bitcoin businesses and transactions. “We are definitely in compliance with the December 5 notice, but the government and the government agencies can change the rules anytime in the future. So, we are going to take a wait-and-see approach,” Bobby Lee told the Wall Street Journal.13 Moreover, the fact that the PBOC said that exchanges ought to register with the Chinese Ministry of Industry and Information Technology was viewed, at least by some, as recognition of bitcoin exchanges as a business category and BTC China as a legitimate business.

Despite BTC China’s return to the bitcoin market, the bitcoin trading platform Taobao Marketplace and bitcoin payment platforms such as Alipay, Tenpay and Yeepay continue to abstain from bitcoin transactions in response to the PBOC’s notices.14

Standard Bank, Africa’s largest bank, was recently reported to begin testing an integrated bitcoin system.15 Industrial Bank of China (ICBC) is Standard Bank’s biggest shareholder. Although Standard Bank had yet to confirm or deny the testing, should the report be true, it would be a significant development. It remains to be seen how local trends or regulations in China would determine the extent to which Chinese subsidiaries can engage in financial activities and products that are allowed in the foreign markets, but not in China.

Bitcoin ATMs in Asia

In February 2014, Singapore became the home to two of Asia’s first bitcoin automated teller machines (ATMs), following the set ups of similar machines in Canada and the United States. More bitcoin ATMs are planned for this year, including in Japan, Hong Kong, Australia and the United Kingdom.16 The announcement of bitcoin ATMs in Singapore came several days after Tharman Shanmugaratnam, Singapore’s Deputy Prime Minister and Minister for Finance, said that the Singapore Central Bank did not recognize bitcoin as a legal tender and cautioned individuals about the use of virtual currencies. The Monetary Authority of Singapore (MAS) does not regulate bitcoin and has “been advising individuals and businesses to think twice and be cautious about accepting or dealing in virtual currencies,” Tharman Shanmugaratnam, who is also chairman of the MAS, added.17

Robocoin Technologies, a Las Vegas-based bitcoin ATM manufacturer, initially planned to launch a bitcoin ATM in Hong Kong in January 2014, but its plans were put on hold for unknown reasons. In Hong Kong, bitcoin ATMs from other providers are now expected to be installed at the International Finance Centre, Wanchai Computer Centre and in Mong Kok. Hong Kong government previously stated that bitcoin is not a real currency and businesses should have proper safeguards in place to prevent money laundering and financing of terrorism. A source from Hong Kong Customs and Excise department said that the officials are considering which government department would be responsible for regulating bitcoin-related activity in Hong Kong.18



DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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