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 transactions, 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 been restored in the meantime, but all the site does at present is display the terse message that can be seen on the chart below:

 


 

Mt.Gox-hourly

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:

 


 

Bitstamp hourly

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.”

 

(emphasis added)

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 is 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.

 

 

 

Charts by: Bitcoincharts


 

 

 

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3 Responses to “Mt. Gox Goes Dark”

  • Kreditanstalt:

    Having one’s wealth holdings reliant on a computer-dependent corporate middleman like “Mt. Gox”…?

    THAT, my friends, is something that gold & silver bullion don’t have…COUNTERPARTY RISK.

  • Vess:

    1) The “transaction malleability” excuse is pure bullshit. That problem would result in huge delays in the confirmation of the transactions – but it is not possible to actually steal funds by using it. Mt. Gox went down due to mismanagement – it outgrew the abilities of Mr. Karpeles to manage it. Mr. Antonopoulos is quite right that if funds are really missing (as in stolen and not simply misplaced), it has been probably going on for quite a while due to internal security problems and not due to any flaws of the Bitcoin protocol.

    2) Pater is quite right that this is simply the equivalent of a bank run on a mismanaged bank when its depositors have found that that it is, indeed, mismanaged. Nothing special. This is *not* a problem of Bitcoin (which has serious problems on its own – but this isn’t one of them) – it is a problem of a mismanaged company that tried to be a big exchange and was improperly trusted with large sums of money.

    3) The Japanese comment about “jurisdiction” doesn’t mean that Japanese authorities have no jurisdiction over Mt. Gox. It means that the Japanese monetary authority doesn’t have such jurisdiction, because it doesn’t think that Bitcoin is a valid currency. It is the US authorities who have no jurisdiction. That doesn’t mean that they can’t send subpoenas – but it does mean that (short of invading Japan or cooperating with the Japanese authorities) they have no means of enforcing it.

    4) Contrary to popular belief, Mr. Kuroda is not interested only in things he can inflate. :-) As a head of Japan’s Central Bank, it is his duty to be interested in anything money-related – and Bitcoin is a very interesting new form of currency (although I contend that it is not money). Among other things, it allows financial transactions to be executed much faster and much more efficiently than through the current banking system – this alone should raise the legitimate interest of anyone in the money business. There are certainly ideas that the banking system can borrow from the Bitcoin protocol. Not wholesale adoption (besides political problems, it also has some technical problems; see below) but certainly ideas.

    5) Unlike Pater, I disagree that “Bitcoin is here to stay”. Although I love the elegant idea behind it and the freedom it provides, it has way too many problems which will inevitably lead to its demise. The main problem, from my point of view, is a political one. Governments simply will not allow a free currency that they cannot control. At this point people probably expect me to cite the example of China – but China’s reaction was quite restrained. They simply said that Bitcoin is not money, so government financial institutions are forbidden from accepting it. Which is only fair – as long as the government decides what is money, it has the right to decide what to accept or not to accept. Private citizens are not forbidden from transacting in Bitcoin or anything else.

    More troubling is the reaction of Russia, which simply forbade the use of Bitcoin as money. (Many of you probably don’t know, but one of the top two Bitcoin exchanges, BTC-E, despite operating from servers based in Bulgaria and being registered as a company in Cyprus, is actually a Russian operation.) However, I don’t think that such a ban is enforceable – as long as there is Internet, private citizens can exchange bits of information that have whatever meaning they desire – which means that there is no way the government can stop private Bitcoin transactions.

    The real danger that I see is the reaction of India. They not only banned Bitcoin – they closed down the local Bitcoin exchanges. Remove the ability to officially convert Bitcoin into a mainstream fiat currency and Bitcoin is essentially dead, except for a very limited size of purely private exchanges by enthusiasts. Yes, cigarettes are used as “money” in some environments too, but nobody is taking that seriously. This is the eventual fate of Bitcoin – the governments will come down on it and will force the exchanges to close under some silly pretext like “money laundering”, “terrorist support” or whatever.

    However, I do expect the governments to take some ideas from the Bitcoin protocol and to establish some sort of (tightly regulated!) one-world crypto-currency. It will be sold to the public as something that makes transactions faster and cheaper but the real goal will be a total control over all financial transactions everywhere. They will know how everyone has spent every penny. They will know how to tax it, too. Or how to steal it completely, if you are deemed a “terrorist” or any other kind of criminal.

    Sadly, this is the future that I forsee. :-(

    Bitcoin has several technical problems, as well. For instance, transaction confirmation time is too long and unsuitable for direct real-life (as opposed to on-line) micro-payments. Do you fancy holding the line for 15 minutes while buying coffee with Bitcoins, while the seller waits for your payment to be confirmed?

    Another problem is the blockchain size. It is already in the gigabytes. Can you imaging how large it will become if Bitcoin is accepted widely?! And each Bitcoin user is supposed to have a copy of that?!

    A third problem is that transaction confirmation is performed by “mining”. That is, it is the miners of Bitcoins who actually perform the work necessary to confirm all transactions. Since the total amount of Bitcoins available for mining is limited and since the efficiency of mining decreases exponentially over time, soon we will be faced with the problem that mining will be economically ineffective (it would cost more than what it brings, no matter what the Bitcoin exchange rate is). Who will be doing the transaction confirmations then? Transaction fees will have to be imposed, which will remove one of the main advantages of Bitcoin.

  • worldend666:

    >>We also wonder why Haruhiko Kuroda is ‘very interested’ in bitcoin – after all, he can’t inflate it.

    Not so. I wondered if the Japanese invented Bitcoin for the sole purpose of creating money from thin air. since nobody knows who has which coins it would be quite simple for the BOJ to acquire a large number of coins and sit on them until they became very valuable, at which time they could be declared legal tender and added to the monetary base. Voila – debt problem solved.

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