Why Mt. Gox, the World’s First Bitcoin Exchange, is Dying

“I think I just witnessed Mt. Gox die today. I didn’t get my bitcoin, but glad I came and tried.” - Reddit user ‘CoinSearcher’, after conducting a three-day protest at Mt. Gox’s headquarters in Tokyo.

Mt. Gox

, the world’s original and once-largest bitcoin exchange, appears to be in a state of disarray after it suspended bitcoin withdrawals to work on what it said were technical issues. Meanwhile, the clamour of angry customer voices is growing.

The exchange’s moves have had a negative impact on the bitcoin markets. The price of 1 BTC plunged from $850 at the start of the week to $681, according to the CoinDesk Bitcoin Price Index, in the wake of the Gox announcement. It has promised an update on Monday 10th February (Japan time).

The internal workings of Mt. Gox have long been the focus of discussion in the bitcoin community. Users have reported delays in obtaining a ‘verified’ account there after submitting the required identification documents.

@coindesk why do people still use mtgox after EVERYTHING. Stay the fuck away.

— Laflamme Photo (@LaflammePhoto) February 7, 2014

Frustrated bitcoin owners have also written about unresolved customer service requests after suffering delays in withdrawing funds from the exchange, with some taking to Twitter to express their opinion on it.

A CoinDesk survey of readers who use Mt. Gox has found that nearly 70% of respondents have not received their funds after making withdrawal requests from the exchange. Some 914 respondents said they were still waiting to receive their funds. The median waiting time was between one and three months, with 22% reporting wait times of between one week and a month.

About a third of respondents said they did successfully withdraw funds from Mt. Gox – many of whom had short waiting times. About half reported receiving their funds within a week.

But for everyone else, the waiting game continued. The CoinDesk survey revealed that having a ‘verified’ or ‘trusted’ account at Mt. Gox did little to reduce withdrawal delays.

The majority of CoinDesk readers polled, or more than 85%, said they had ‘verified’ or ‘trusted’ accounts at Mt. Gox. Some 68% of verified account holders, or 822 respondents, said they were still waiting for their withdrawal from the exchange. The median waiting time was between one and three months, and 78% of verified account holders polled said they had been waiting for up to three months.

The CoinDesk survey has attracted more than 2,800 responses since it went live on 4th February.

It took a lone protestor to bring the simmering dissatisfaction with Mt. Gox to a boil. Flying for 16 hours from Australia to Japan for a three-day sit-in on a quest for answers as to the fate of his large bitcoin balance, the protestor, known on Reddit as ‘CoinSearcher’, eventually confronted CEO Mark Karpeles and business development manager Gonzague Gay-Bouchery.

The protestor later posted a summary of his experiences on Reddit.

CoinSearcher appeared to alleviate some users’ fears that the top Mt. Gox executives had vanished. Gay-Bouchery’s explanation that most of Mt. Gox’s bitcoins were kept in secure, and not quickly accessible, physical cold-storage in multiple locations made sense to many.

“Because Gox is the best known of all the exchanges, we have been under the regulatory spotlight,” Gay-Bouchery told the protestor, adding:

Gay-Bouchery refuted data published by The Gox Report that the exchange had a backlog of 40,000 BTC – worth about $34m at the time – that had not been processed, saying that the figure was “not correct” (Mt. Gox subsequently altered its API to cut off real-time information to sites like The Gox Report). He reiterated the company’s claim that withdrawal problems were merely a technical issue, and that “all the coins are safe”.

After attending the weekly Tokyo bitcoin meetup on Thursday night, CoinSearcher said:

One of the clearest signs that all was not well on Mt. Gox was the exchange’s quoted US dollar price for bitcoin. Quoted prices on Mt. Gox began to diverge sharply from two other major exchanges, Bitstamp and BTC-e, last July. The initial spread shows Gox prices trading at several percentage points above the other exchanges throughout that month.

By the end of August, however, the divergence hit double-digits. Gox prices were more than 19% above BTC-e’s prices on 22nd August, for example. Although the spread oscillated in the following months, it consistently exceeded the 10% mark.

In the run-up to the freeze on Gox, on 28th January, the gap between Gox and Bitstamp’s rates stood at 20%, while the same measure between Gox and BTC-e stood at 26%.

The persistent price differences seemed to be a flagrant violation of the ‘law of one price’ – the economics concept that posits that the price of a freely traded good should be equal across all open markets.

In theory, the massive price differences between the exchanges suggested that there was a persistent arbitrage opportunity to buy bitcoin cheaply on Bitstamp or BTC-e and sell them at a double-digit premium on Mt. Gox.

But as the CoinDesk survey shows, Mt. Gox customers have consistently failed to withdraw their funds from Gox over at least the last three months, when the spread was widest. This suggests that in practice, most opportunists transferring currencies to Gox to take advantage of a higher sale price would have failed to get their funds out of the exchange.

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The seemingly incredible arbitrage opportunity and Gox’s withdrawal freeze are linked. The roots of the Gox premium can be traced back to June, when the exchange announced it was putting US dollar withdrawals on a “temporary hiatus”.

It later transpired that Gox and its founder, Mark Karpeles, had been ensnared in an operation by US federal agents as they moved against the exchange for failing to register as a ‘money service business’.

The US Department of Homeland Security and the Secret Service seized three accounts linked to Gox containing more than $5m. As research from The Genesis Block shows, the executed seizure warrant was dated 19th June, the day before Gox announced it would halt dollar withdrawals.

All the market observers CoinDesk spoke to agreed that the cause of the Gox premium was the exchange’s persistent withdrawal failures, dating back to June, when US dollar withdrawals were stopped.

As the freeze took effect, Gox customers turned to bitcoin withdrawals as they attempted to get funds out. This worked for a time, but it also increased the volume of bids for bitcoin on the exchange.

“Effectively, the Mt. Gox price reflected the inability to withdraw funds in fiat. This creates only a bid for bitcoin,” said Greg Schvey, co-founder of The Genesis Block.

As a result of the increased volume of bids for bitcoin on Mt. Gox, the bitcoin price began to rise steadily, adding to a widening divergence from prices quoted on other major exchanges.

“We can interpret [the Gox premium] as a measure of fear on the part of customers that they’re not going to get their money back. Their desperation is measured by how much they’re willing to pay for bitcoin [on Gox],” said Garrick Hileman, an economic historian at the London School of Economics.

While the exchange has posted a number of notices on its website announcing withdrawal delays, its top executives have remained silent on the matter. The company has posted a notice of delays on its main trading page since the beginning of 2014, originally citing a backlog caused by Japanese New Year business holidays as the cause.

One prominent technical member of the bitcoin community thinks he knows what’s behind the current withdrawal freeze. Andreas Antonopoulos, who recently joined Blockchain.info as chief security officer, says he has studied exchange technologies over the past 15 years. His verdict on Gox’s withdrawal freeze, as an outsider, is scathing:

Antonopoulos outlined what he believes to be the technical reasons behind the Gox freeze. The root of the problem lies in its decision to use a version of the bitcoin client it customised itself, rather than the standard client. As a result, Gox handles the protocol with some discrepancies.

One of those discrepancies, as Antonopoulos understands it, is the way transactions are propagated through the network. A miner on Gox, for example, will prematurely be credited for a new block before the network has a chance to confirm the transaction. As a result, when the transaction hits the bitcoin network to be corroborated, it is rejected. Gox’s solution is to cancel the initial transaction and resubmit it until it is approved.

“This is like putting a Band-Aid on the problem. Gox should not be generating non-standard transactions in the first place. Band-Aids like this will further exacerbate scalability problems,” Antonopoulos said.

In the case of the mining example, the cancelled and resubmitted transactions cause delays in fulfilling withdrawal requests within Gox. This doesn’t necessarily cause huge problems unless the system is under pressure from an external factor, like a spike in withdrawal requests, for example.

“When transactions increase, then there are more delayed transactions, which can cause a panic. It just snowballs,” Antonopoulos said.

A lack of detailed comment or response from Mt. Gox to users or the media has only increased customer concerns about the fate of their money. The company’s location in Japan – where outsiders’ access to information is often limited by a language barrier – has shielded the company from the kind of scrutiny a US-based operation would receive. Furthermore, Gox’s chief executive has made little attempt to address the issues publicly.

“I’ve heard that Mark [Karpeles] has rolled up his sleeves and is trying to code himself out of this mess," Antonopoulos said. "It’s clear that he lacks the expertise to fix this other than applying another Band-Aid. The things they’ve done in the past won’t get them out of this.”

Roger Ver declared last July he had looked at Mt. Gox’s books and determined it had plenty of fiat currency in the bank, and that withdrawal delays were not being caused by a lack of fiat. He was still optimistic the exchange would fulfill its obligations.

“I don’t have any special insight into Mt. Gox at the moment, but if I had to guess, I think they have the bitcoins and the fiat,” he told CoinDesk.

“I actually think, in the long run, this will be good for bitcoin because it will be clear to the world that there is an open invitation for true professionals to quickly dominate the bitcoin exchange industry.”

Bobby Lee, CEO of exchange BTC China, which actually eclipsed Mt. Gox’s trading volumes at times in 2013, said he also accepted its official explanations. While he didn’t see its immediate problems reaching China, he said negative stories about a company the size of Mt. Gox “could put a damper on the whole bitcoin ecosystem”.

“I was actually quite surprised to hear about the suspension of bitcoin withdrawals at Mt. Gox,” he said.

“Their explanation is plausible, about the need to diagnose a technical situation, which thus requires the halting of bitcoin transfers. Running an exchange is a complex job, especially with a large audience, and when dealing with a real decentralized currency like bitcoin.”

“Their restrictions and delays on fiat currency withdrawals seem suspicious to me, as there is no adequate explanation for that.”

He went on to say: “Regarding the BTC withdrawal limitations, since they promised to give everyone an update on Monday, I would give them the benefit of doubt at this point. It would also help customers understand better, if Mt. Gox can make a clear statement about their overall solvency status.”

Other prominent bitcoiners were less gentle:

In what should be a surprise to no one, mtgox has suspended operations. We Need a licensed US #bitcoin exchange. http://t.co/ygAOViFiB0

— jeremy liew (@jeremysliew) February 7, 2014

Antonopoulos’ technical appraisal of Gox may be damning, but he stops short of indicting the exchange for being fraudulent. He pulls no punches with his verdict on their business acumen, however:

CoinDesk also contacted US exchange and payment processor Coinbase, but it declined to comment.

Mt. Gox, owned by a company called Tibanne Ltd, was the largest bitcoin-fiat currency exchange from 2010 until last year. It started life in 2009 as a place for players of Magic: The Gathering to trade cards. Tibanne is run by Mark Karpeles, who acquired the exchange from founder Jed McCaleb in 2011.

In its four-year history, the pioneering exchange has suffered hacking attempts, DDOS attacks, and the same regulatory issues that have plagued other bitcoin businesses.

Along with technical issues, the glare of law enforcement’s spotlight since April 2013 has seen Mt. Gox’s US dollar market-share plunge from over 70% in April to about 19% now, significantly behind Europe’s Bitstamp and BTC-e with 30% and 24% respectively.

Mt. Gox is also the subject of a current $75m lawsuit from former partner CoinLab, which it has also countersued for $5.5m.

One of the recurring themes in Mt. Gox’s story is its ability to recover from seemingly insurmountable setbacks, be they bank account seizures or electronic theft. The media has made a habit of chronicling the ‘fall of Mt. Gox’ (Wired, Business Insider), with CoinDesk being no exception – only to be proven wrong when the exchange’s volumes bounce back. Some market watchers remain reluctant to count Mt. Gox out, even with its current freeze on withdrawals.

“Every time it’s had some seemingly crippling issue, it’s always managed to maintain market-share,” said Schvey of The Genesis Block.

Mt. Gox’s historic position as the dominant exchange in the global cryptocurrency economy appears to have helped it build a valuable brand that has linked it inextricably with the growth of bitcoin itself. As new bitcoin users flood into the cryptocurrency economy – which has grown from a market capitalisation of a $250m just 12 months ago to $8.6b today – many of these new investors start their cryptocurrency education at the foot of Mt. Gox.

“New buyers come in and they don’t know the history. There is a lot of brand recognition, and it’s going to take time for that brand to be completely destroyed through incompetence,” said Antonopoulos.

The Mt. Gox freeze may have dampened the price of bitcoin, but Schvey, for one, believes the impact has already been priced in.

“We saw major sell-offs on Gox, but the market impact looks like it’s largely been realised at this point. As soon as people get their money out, other exchanges will pick up [market-share],” he said.

In Antonopoulos’ view, however, the story of Mt. Gox isn’t one of resilience in the face of adversity. Instead, the constant breakdowns in Tokyo tell a tale of gradual disintegration, with each breakdown or withdrawal freeze jolting the firm closer to the edge. He said:

This article was co-authored by Joon Ian Wong, Jon Southurst and Emily Spaven.

Editor's note: The CoinDesk Bitcoin Price Index committee has recently been reviewing Mt. Gox’s inclusion in the BPI. Friday’s announcement from Gox about halting bitcoin withdrawals has added more fuel to the discussion. Any changes that are made will be announced on CoinDesk. Feel free to let us know your thoughts in the comments.

Praying angel image via Shutterstock