Everything you need to know about the latest Bitcoin crisis


Kolin Burges, a Mt. Gox customer, protests outside the headquarters of Mt. Gox and its parent company, Tibanne Co., in Tokyo on Tuesday. (Kiyoshi Ota/Bloomberg)

The once-popular Bitcoin exchange Mt. Gox has gone dark. The Tokyo-based exchange's Web site went down Monday night, and trading appears to have halted. While a vague statement has been posted on Mt. Gox's Web site, it seems likely that the exchange is in the process of exiting the market after months of problems.

So, what went wrong? And what does this mean for the broader Bitcoin economy? Read on to find out.

What is Mt. Gox?

Mt. Gox is probably the most well known bitcoin exchange on the planet...

Okay, but what is Bitcoin, and what is an exchange?

Bitcoin is a distributed digital payment system and currency that is often called a "cryptocurrency." It's a lot like Paypal, except that there's no single company that owns the Bitcoin network. Instead transactions are processed in peer-to-peer fashion using a shared, public ledger. Oh, and while Paypal transactions are based on the dollar, the Bitcoin network has its own currency unit, also known as a bitcoin. You can learn more about Bitcoin here.

To use the Bitcoin network, users first need to get their hands on some bitcoins. The most popular way to do that is to use an exchange, a Web sites that let users trade bitcoins for conventional currencies.

Mt. Gox originally started as a marketplace for exchanging Magic the Gathering cards -- the initials MTGOX stand for "Magic the Gathering Online eXchange" -- by software hacker Jim McCaleb. But McCaleb became fascinated with Bitcoin and switched the site to a digital currency exchange before selling it to current chief executive Mark Karpeles in 2011. Mt. Gox grew to become the most popular exchange around, reportedly processing 76 percent of Bitcoin transactions as recently as last spring.

So, what happened?

Mt. Gox has disappeared. Many are now calling it insolvent. Its Web site went blank overnight. Its Tweets were deleted.  Although the source code for the page once appeared to hint at some sort of buyout or acquisition, it's unclear if that was real or a bit of misdirection.

A document posted by Bitcoin enthusiast Ryan Selkis on Monday claims the company lost nearly 750,000 bitcoins over a series of years due to a glitch called transaction malleability. Bitcoin's value is volatile, but at current Bitcoin exchange rates, that's around $400 million. The document could not be independently verified but has circulated widely online and was cited by the New York Times. Local reports say there are a handful of protesters outside of the company's offices in Japan.

Mt. Gox updated its site with a vague comment in recent hours, saying "a decision was taken to close all transactions for the time being in order to protect the site and our users. We will be closely monitoring the situation and will react accordingly."

That doesn't sound good. I thought this was the most prominent Bitcoin exchange around.

Until recently, it was. But it's also been plagued with issues throughout its life. In fact, right after Karpeles bought the service it suffered a major hack. But Karpeles managed the crisis, and the exchange continued to grow. However, that goodwill has been severely tested in the past year. While Bitcoin prices exploded, Mt. Gox faced an onslaught of issues.

Like what?

The FBI seized over $5 million of the service's funds over the course of the summer due to regulatory issues, and it faced a $75 million lawsuit from an American company, CoinLab, after a business deal fell through. In June, the service suspended withdrawals in U.S. dollars for two weeks, but after the period was over users continued to complain about sluggish processing times.

After months of slow withdrawal process times that had led some to question to stability of the service, Mt. Gox halted all withdrawals on Feb. 7. Three days later, Mt. Gox announced that its problems were caused by transaction malleability.

What's "transaction malleability?" And who was at fault?

Every Bitcoin transaction has an associated transaction ID. Hackers discovered that they could trick Mt. Gox's software (and the software on some other sites) by creating a Bitcoin transaction and then modifying its ID. The result: Funds were withdrawn from Mt. Gox, but because Mt. Gox's software was looking for the old transaction ID, it didn't know it.

Mt. Gox has hinted that transaction maleability was the fault of the core Bitcoin software. But Gavin Andresen, who leads the Bitcoin development team, blames Mt. Gox. "The issues that Mt. Gox has been experiencing are due to an unfortunate interaction between Mt. Gox's implementation of their highly customized wallet software, their customer support procedures, and their unpreparedness for transaction malleability, a technical detail that allows changes to the way transactions are identified," he wrote in a statement on the Bitcoin Foundation blog.

"The bottom line is that these problem could have been prevented either by the Bitcoin designers or by the authors of the affected software," commented Princeton computer science professor Ed Felten in a blog post about the Mt. Gox situation.

In an interview with Forbes this month, Karpele defended the exchange but acknowledged that it had not kept up with all updates to the Bitcoin protocol and called on the Bitcoin Foundation to take greater responsibility. Karpele represented Mt. Gox on the Bitcoin Foundation board until he resigned Sunday.

Wait, didn't someone else resign recently?

Yes -- Karpele's was second prominent resignation from that board in less than a month. BitInstant chief executive Charlie Shrem resigned earlier this month after being charged with money laundering.

Anyhow, back to the story. Trading on Mt. Gox continued between the announcement about withdrawals and its disappearance, but prices dropped substantially -- at one point below $100 per bitcoin, while other exchanges maintained prices of around $500 per bitcoin.


Mt. Gox prices over the past month. (Coindesk)

What happens to the bitcoins people had stored in Mt. Gox?

No one knows for sure, but things don't look good. If the unverified internal document is to be believed, Mt. Gox had $174 million in liabilities against $32.75 million in assets. And that $174 million in liabilities figure is based on the Mt. Gox trading price, which is essentially divorced from reality. At the Bitstamp price for bitcoins, their liability comes in at closer to $436 million.

Plus, the 744,408 bitcoins the document says "are missing due to malleability-related theft which went unnoticed for several years" represent around six percent of all bitcoins in circulation.

That sounds like a big deal. How is the Bitcoin community responding?

Swiftly, at least. The leaders of several Bitcoin services released a joint letter Monday night distancing Mt. Gox from the market. "This tragic violation of the trust of users of Mt.Gox was the result of one company’s actions and does not reflect the resilience or value of bitcoin and the digital currency industry," the letter said. "As with any new industry, there are certain bad actors that need to be weeded out, and that is what we are seeing today." The letter also said Mt. Gox had "confirmed its issues in private discussions with other members of the bitcoin community."

The Bitcoin Foundation shared a statement with the press, saying: "We are shocked to learn about Mt. Gox’s alleged insolvency. While we are unable to comment on whether or not Mt. Gox's business operations employed operational best practices and reasonable accounting procedures, we can assure the public that the Bitcoin protocol is functioning properly."

On the congressional front, Sen. Tom Carper (D-Del.) released a statement calling the news about Mt. Gox a disturbing reminder "of the damage potentially ill equipped and unregulated financial actors can wreak on unsuspecting consumers" and called for stakeholders to "engage in meaningful dialogue to provide clear rules of the roads for entrepreneurs, investors, and consumers."

So, what happens now?

That's an excellent question. This is a major setback for Bitcoin, which was already struggling to shake off its association with nefarious activities thanks to the Silk Road bust last year. But bitcoin is no stranger to scandals, hacks, or otherwise poor business judgment. Since it was started by the pseudononymous Satoshi Nakamoto in 2009, it's gone from being worth pennies to over $1,200 per bitcoin. The market has already somewhat recovered from its overnight low, so it's possible this represents nothing more than a major growing pain.

Even as Mt. Gox appears to be imploding, other services are cropping up hoping to take its place -- like the online marketplace SecondMarket, which is reportedly spinning off its bitcoin projects into separate entities. One of those will be a New York-based exchange for the cryptocurrency.

But months before the crisis emerged, Karpeles made a a now ominous-sounding comment in an interview with Reuters -- calling Bitcoin a "high risk investment" because "there's no guarantee" behind the currency. That's certainly true, as Karpeles's own foibles make clear.

Andrea Peterson covers technology policy for The Washington Post, with an emphasis on cybersecurity, consumer privacy, transparency, surveillance and open government.
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