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Think Big. Move Fast.

For there to be a deep and liquid exchange marketplace in Bitcoin, the primary Bitcoin exchange needs to be robust and performant, with millisecond trade execution timeframes under heavy volume. Right now, Mt. Gox, the primary place where people can exchange dollars for Bitcoin, is neither. It has suffered under repeated DDOS attacks and has seen protracted outages and trade execution times that stretch into minutes and even hours when it has stayed up. Trade capacity is reputed to be in the 10s per second, several orders of magnitudes short of what is needed for a future proofed exchange. This is not an acceptable long term situation if the Bitcoin ecosystem is to grow.

Mt. Gox understands this. In an FAQ in response to the DDOS attacks on April 24th, the company said:

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“Mt. Gox has been working overtime since February to build a new trading engine which

will be implemented by the end of June. Additionally, since early March we have been

building a new IT infrastructure which will be completed by the end of May.”

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This is pretty exciting news. Here we are at the end of April, so a new trading platform that could potentially support much higher volumes and more robust to hackers attacks may be only weeks away.

But there are many disgruntled Bitcoin traders who are approaching the limits of their patience with Gox’s poor performance, poor service and restrictive limitations on transfer of funds. Will they wait a few weeks for a fix, especially if we see continued outages? It not, the window is short before they look for a new alternative.

One possible future holds that in the next couple of weeks, Gox suffers another  major attack and goes dowm for a protracted period of time. Some group of traders grows impatient and moves en mass to another exchange, creating a new nexus for liquidity. Although there are a number of startup Bitcoin exchanges, the only ones that could reasonable handle the volume in the next few weeks are likely the ones already up and running, btc-e and BitStamp.

Another potential vulnerability might be if Gox comes under investigation by FinCEN or some other regulatory body. In a recent interview on Let’s Talk Bitcoin, Bradley Jansen of Freebanking.org (start listening at 17,14) says:

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“Jensen: “I have heard through the grapevine that FinCEN has prosecutions in the works for Bitcoin broadly speaking.  My guess, based on the timing of the guidance, and what I had heard previously from the rumor mill about the prosecutions, is that FinCEN put out the guidance sort of ex post facto to justify the prosecutions that they’re about to launch.”

Interviewer: “So you expect this to happen within in the next couple of months…”
Jensen:  “Again, I’ve heard different rumors, it’s difficult to predict, but yeah.  We knew that the prosecutions were in the works, and then later the guidance came out, it seems like a sort of CYA approach to how they’re doing it.””
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I don’t know Jansen, but from his writing he does not come off as someone who is completely impartial; he is an ex regulatory aide to Ron Paul and can definitely be described as “anti governmental control”. But if what he reports is right, then it is reasonable to assume that FinCEN might target Gox. Just due to its market share and longevity, there is a pretty good chance that if any financial crimes have been committed with Bitcoin (and there have been many), that Gox has touched that tainted Bitcoin in some way.

If Gox gets targeted by FinCEN, then this would open the door for a new exchange to capture share. In fact a new exchange with no prior trading history, and hence no risk of prior financial crimes, may be advantaged as it can start from scratch with squeaky clean AML and KYC practices, money transmittal licenses and so on.

But if Gox keeps its liquidity through the period of instability before it can ship a new trading platform, and it is not targeted by FinCEN, then life gets a lot harder for new exchanges. They would need to extract liquidity from a well functioning Gox, a much harder proposition than taking on Gox today. This is not an impossible task as Gox is essentially a “single item” exchange, which is much more vulnerable to loss of market share than an exchange that trades in many different items. But a new exchange will require a well thought through strategy to take liquidity away from Gox. It can’t just rely on a better product.

I’d love to hear what readers think about these scenarios, other scenarios, and possible strategies to extract liquidity from Gox.

  • Tim Swanson

    After FinCEN begins prosecution I think the chances of starting a brand
    new Mt. Gox-style exchange in the US will fall close to zero in the near to medium future. There may
    be ways to bootstrap an exchange service to existing banks, but it is hard to
    imagine any enterprise that will find the necessary capital to scale a new infrastructure in the US due to regulatory risks. Did a podcast that briefly discussed that here: http://www.ofnumbers.com/2013/04/14/interview-david-veksler-and-tim-swanson-discuss-bitcoin-litecoin-cryptocurrency-cybersecurity-in-china/

  • http://www.asoftwarestartupguy.com/ David Miller

    I don’t know what will happen to Gox, but I think Bitcoin is to currency what Napster was to music. Coincidentally, wrote about it here today: http://bit.ly/YbfC3M

  • BitcoinOz

    A new exchange would need to be massively capitalised and liquid to have any hope. And have deep reserves of funds to become a market maker.

  • Tim

    the problem is with bitcoin itself, not the exchanges. doesn’t matter how many exchanges you have – they will mostly provide liquidity within the markets. there are much larger problems that need to be solved first.