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After Government Raid, Jittery Future for Bitcoin

Bitcoins
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Bitcoins

With news last week that U.S. authorities had seized assets of the world's largest bitcoin exchange, traders and other people interested in the digital currency are looking nervously at the future.

Bitcoins have always operated outside of the established financial system, so does the action by the Department of Homeland Security signal the start of a movement to regulate the field? And if so, how will the people who use the virtual currency react?

Financial experts said they don't expect the action to throw the bitcoin world into chaos—and if regulation is coming, it might actually be welcomed. Some, though, think the government might be acting in a knee-jerk fashion.

"It is a little bit of a hysterical reaction from the U.S. authorities," Jon Rushman, former managing director at BlackRock and a professor at the University of Warwick in the U.K. said in a statement

"There are concerns of bitcoin being used in illegal ways, but unless there is more substantial evidence of this, I don't think there is any reason to shut down the main bitcoin exchange. U.S. dollars, Russian rubles and euros have all been used by criminals, but nobody is suggesting their central banks should be closed down and their governors imprisoned."

(Read More: Bitcoin Is Gold 2.0: Venture Capitalist)

The DHS seized Mt. Gox's account with the payments processing service Dwolla Wednesday, saying Mt. Gox did not properly register as a money services company two years ago when it opened a U.S. bank account. (Dwolla was used by Americans to exchange cash with Tokyo-based Mt. Gox, rather than wiring money.)

The action comes after the Financial Crimes Enforcement Network issued guidance around the currency in March, which required intermediaries (like Dwolla) that handle bitcoins to register as money services businesses.

The bitcoin has traditionally been a very rocky investment—and prices dropped about 10 percent on news of the raid. The exchange rate has since risen higher than it was before the action, however.

"Investors with bitcoin positions clearly believe that the worst scare stories around the increased government scrutiny will be proved false," Rushman told CNBC.com. "For the rest of us, the price volatility underlines just how driven by investor sentiment the relatively small bitcoin market is. The price in the medium term will be driven far more by sentiment about the bitcoin's viability than by anything more fundamental, and unfortunately this makes forecasting practically impossible."

The raid came right before the kickoff of Bitcoin 2013—the annual conference for those interested in the virtual currency. The sentiment there was one of cautious optimism, said those in attendance. Many of those people (who range from economists to CEOs of bitcoin-related companies) feel the issues need to be resolved—and the seizure could be an important milestone for bitcoins.

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"There's a perception of the community that it's anti-regulation," said Alex Ferrara, a partner with Bessemer Venture Partners. "Personally, I think [regulation] is a very good thing. And there are a growing number of people around the community who agree. My personal view is it's not about regulating bitcoins per se, but it's about the businesses and business models surrounding bitcoins. As long as regulation evolves around those lines, that's going to be a very good thing. It will increase confidence. It will attract business and capital. And it will allow bitcoins to flourish."

Regulation, notes Ferrara, will likely focus on three areas—which he says could all be growth businesses: exchanges, wallet companies (which hold users' bitcoins) and merchant service providers (which allow companies to accept bitcoins as payment).

"I think exchanges are the most interesting area right now because they represent the biggest problem," he said. "It's very difficult to convert dollars to bitcoins. [Exchanges] represent the biggest pain point in the ecosystem. And as exchanges grow and attract more funds, you'll get a deeper, more liquid market."

At present, roughly 85 percent of the world's population does not have access to electronic payments, said Ferrara. Bitcoins can become a method that facilitates commerce for those people.

While the exact ramifications of the asset seizure won't be clear for some time. Many experts believe, however, that Mt. Gox will strive to quickly ensure the problems are resolved. And the action is bound to spark a larger conversation about how bitcoins evolve moving forward.

"Bitcoin is very attractive because it offers inflation protection," Rushman said in the statement. "The fact it is limited to 21 million bitcoins makes it an inflationless currency, something central banks can't guarantee. ... The bitcoin is testing our perceptions in so many ways and it is challenging regulators. It crosses and pushes boundaries and I would like to see a rational debate on how to use it in the future."

_ By Chris Morris