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Gospel of Bitcoin Faces Test of Faith

As Bitfinex, the digital-currency exchange that suffered a hack this past week, struggles to reopen, a wider question is again being asked about bitcoin: Is it really a better mousetrap?

On Tuesday, cyberthieves stole about 200,000 bitcoins, valued at roughly $65 million, from Hong Kong-based Bitfinex’s digital vaults. It was one of the largest hacks in the currency’s history.

A hack this week at Bitfinex is raising questions about bitcoin’s infrastructure and its ability to repel hacks and fraud. PHOTO: BOBBY YIP/REUTERS

Bitcoin has lost 12% of its value this week, according to bitcoin tracker CoinDesk. The exchange was forced to halt operations and is working to retrace the theft and recover the funds. A spokesman for the exchange said it expects to reopen the site on a limited basis on Friday.

For the bitcoin industry and investors curious about it, a more fundamental question is emerging: Has bitcoin’s original premise been compromised?

The idea was to give society a secure currency that couldn’t be tampered with by governments or banks. But for the general public, it looks like bitcoin and the army of anonymous technologists behind it can’t guarantee funds are secure. That is a problem for a platform striving for mainstream acceptance.

“It’s an understatement to say this doesn’t help,” said Jerry Brito, the director of Washington-based Coin Center, a digital-currency advocacy group.

Bitfinex, meanwhile, is wrestling with the issue of whether its custodial business model may have aided the hacker or hackers. The company had said it used higher-level security measures, but like all bitcoin companies it must deal with the irreversible nature of bitcoin transactions that makes it a target for hackers.

Bitcoin was launched in 2009 as an alternative currency, one that didn’t require government support or financial middlemen to clear and confirm transactions. It does this through an open ledger that also serves as an official record that can’t be altered after the fact.

During the financial crisis, bitcoin gained attention as an alternative to a system that many believed to be broken. But its own growth over the years has been hampered by a string of frauds, Ponzi schemes and thefts.

Bitfinex, founded in 2013, is the fifth-biggest bitcoin exchange and the largest outside of mainland China, according to bitcoinity.org.

In 2014, Tokyo-based exchange Mt. Gox collapsed after a yearslong series of attacks resulted in the theft of about 850,000 bitcoins, at the time valued at about $450 million.

All entities that operate online—from bitcoin businesses to J.P Morgan Chase & Co., Target Corp. and the U.S. government—have to worry about getting hacked. The central bank of Bangladesh lost $81 million in February when hackers compromised its accounts at the Federal Reserve Bank of New York.

More than the details of the security breach, though, the Bitfinex hack illustrates one stark difference between bitcoin as a store of value and traditional banks. For bitcoin, the immutability of the public record is paramount. Once a transaction is recorded, it is set in digital stone, no matter what. It is a core principle of the people who developed the idea.

That may build trust, but the problem is thefts can’t be undone as easily. In the traditional finance world, consumer-fraud transactions are routinely reversed and errant trades erased, with the victim not having to shoulder the financial burden.

Traditional banks also offer one backup that bitcoin doesn’t: deposit insurance ultimately backed by the federal government.

Bitcoin doesn’t have that and almost certainly won’t soon.

One bitcoin exchange, Coinbase, has private insurance, but the idea of a public, Federal Deposit Insurance Corp.-style insurance plan doesn’t sit well with bitcoin’s libertarian fans.

Reversing transactions is technically feasible, but also politically toxic. A bitcoin rival, Ethereum, in June implemented a “fork” of its software to reverse a theft of $60 million of the digital currency, but the controversial measure has riven the platform's supporters in two.

The challenge for bitcoin remains building an infrastructure sturdy enough to repel hacks and fraud, while maintaining the currency’s independent roots.

“We need standards set by the industry that take into account the regulatory and cultural environment,” said Joseph Colangelo, executive director of Consumers’ Research, a consumer-focused trade group involved in bitcoin. “There are a hundred different ways to skin the cat here.”