Mt. Gox Goes Dark

Vaporization in Bitcoin-Land

It is still not quite clear what exactly happened at Mt. Gox in Tokyo, the formerly biggest bitcoin exchange in the world. According to the exchange, the so-called 'transaction malleability' problem allowed hackers to initiate countless bogus transaction, stealing some 744,000 bitcoins. Even at the recently somewhat lower price of $600 per bitcoin (at non-Mt. Gox exchanges), this sounds like a lot of money. In fact, it sounds as if the exchange has essentially been bankrupted/vaporized, and no amount of 'trying to fix the problem' can actually, well, fix it. Mind, this is just a hunch on our part based on the fact that about $450 m. are said to have disappeared.

In spite of no longer allowing withdrawals (whether of bitcoin or any other forms of currency) since February 7, trading actually continued at Mt. Gox until February 25. During that time, bitcoin prices crashed on the exchange, and a two-tier price system developed. There have always been slight price differences between the various bitcoin exchanges, but our impression was that arbitrage transactions kept prices at most exchanges for the most part quite closely aligned. However, after it became clear that withdrawals from Mt. Gox were no longer possible, the price of bitcoin traded there decoupled rather noticeably. While the currency weakened at other exchanges as well, it did so to a far smaller extent.

This week, trading at Mt. Gox finally stopped and the site became inaccessible shortly thereafter. Access has beenrestored in the meantime, but all the site does at resent is display the terse message that can be seen on the chart below:

The final hours of trading at Mt. Gox.  Bitcoin had crashed to a mere $130 at the exchange, almost a 90% decline from last year's high. The above message from its CEO Mark Karpeles has been displayed since trading was halted – click to enlarge.

Given other news that are making the rounds in the meantime (see further below), our advice to Mr. Kerpeles would be to better call Saul.

For comparison purposes, here is an hourly chart of bitcoin from Bitstamp, an exchange that has seen trading volume soar since the shutdown of Mt. Gox:

Bitcoin traded at roughly $600 at Bitstamp and other exchanges as of Wednesday – click to enlarge.

At the other bitcoin exchanges, prices continue to closely track, so the Bitstamp exchange's price is representative for where the currency actually trades. Bitcoin's decline from the high thus amounts to about 50% at present (the last traded price at Mt. Gox isn't relevant). This is still well within the range of the major corrections seen in bitcoin over the past two years. Note that prices for the same goods will always tend to equalize across the economic system, and with something that involves no transportation and very little transaction costs, this should be all the more obvious.

Regarding Mt. Gox, from what we have read about the technical problem, it could surely be overcome. The theft of 744,000 bitcoins seems to be a far bigger hurdle. Others in the bitcoin industry are convinced that Mt. Gox is insolvent, and they are probably correct. Here is an interesting post by Andreas M. Antonopoulos, who points out that the manner in which Mt. Gox implemented the administration of customer funds made it easy for both outsiders and insiders to commit theft. Apparently problems have been in evidence for some time before the recent suspension of withdrawals. What happened at Mt. Gox can be likened to a bank run actually.

Regulators Begin to Circle Over Mt. Gox and Other Exchanges

Meanwhile, Manhattan attorney Preet Bharara, otherwise best known for pursuing insider trading cases, has set his sights on bitcoin exchanges and sent out subpoenas, evidently motivated by the news about the Mt. Gox debacle:

“Manhattan Attorney Preet Bharara has sent subpoenas to Mt. Gox, other bitcoin exchanges, and businesses that deal in bitcoin to seek information on how they handled recent cyber attacks, a source familiar with the probe said on Wednesday.

In the attacks – known as distributed denial of service attacks – hackers overwhelmed bitcoin exchanges by sending thousands of phantom transactions. At least three exchanges were forced to halt withdrawals of bitcoins on February 7, including Mt. Gox, which was the largest at the time.”

Japanese authorities are also getting involved, but appear resigned to the fact that there is actually little they can do:

“Japanese authorities are looking into the abrupt closure of Mt. Gox, the top government spokesman said on Wednesday in Tokyo's first official reaction to the turmoil at what was the world's biggest exchange for bitcoin virtual currency.

"At this stage the relevant financial authorities, the police, the Finance Ministry and others are gathering information on the case," Chief Cabinet Secretary Yoshihide Suga told a regular news conference when asked about Tuesday's shutdown of the Tokyo-based exchange. Speaking shortly after The Wall Street Journal reported that Mt. Gox had received a subpoena from federal prosecutors in New York, Suga declined further comment.

Japan's Financial Services Agency and Finance Ministry told Reuters on Tuesday that they do not have jurisdiction over Mt. Gox after the exchange's website went down and efforts to reach company officials failed. The Bank of Japan said it had nothing to add to a comment by Governor Haruhiko Kuroda that the central bank was "very interested" in bitcoin.”

The 'we have no jurisdiction over Mt. Gox' comment is interesting. Japanese authorities have no jurisdiction, but US authorities have? The exchange is based in Tokyo, so this seems rather strange. If fraud has been committed at Mt. Gox, it seems unlikely that no-one in Japan has jurisdiction. We also wonder why Haruhiko Kuroda is 'very interested' in bitcoin -  after all, he can't inflate it.

We're not quite sure yet what to make of these recent events, but apparently it has proved fairly easy for someone to steal a great many bitcoins, a fact that is not exactly reassuring. However, supporters of the currency insist it is all part of bitcoin's growing pains, and that one cannot judge its merits by the irresponsibility and misdeeds of one bad apple.

We would note though that there are practically no barriers to entry in the crypto-currency business. Bitcoin has what it known as 'first mover advantage', and the protocol limiting its supply is undoubtedly a major attraction. However, the supply of crypto-currencies as such is not limited and it remains to be seen whether the first mover advantage makes a difference in the long term.

Conclusion:

In spite of the setback the Mt. Gox shutdown no doubt represents, we strongly suspect that bitcoin is here to stay.Transactions certainly continue at a fairly heady pace.