What happened to World’s once largest cryptocurrency exchange? – The Mt. Gox story

Jed McCaleb, a programmer and aficionado of the card game ‘Magic: The Gathering’ built a website for trading cards online in 2007. Mt. Gox was created as an acronym for the platform ‘Magic: The Gathering Online Exchange’. On envisioning the scope of cryptocurrency, McCaleb launched Mt.Gox.com as a Bitcoin Exchange in 2010 which by 2013 became the world’s largest cryptocurrency exchange handling about 70-80% of all bitcoin transaction. However, came 2014, Mt. Gox permanently shut its operations and went into liquidation after its four years stride.


Cryptocurrency:

Type of digital currency that exists only electronically. Bitcoin is the pioneer and most prevalent cryptocurrency. Cryptocurrencies work in a decentralized fashion on the blockchain using the distributed ledger technology.

Cryptocurrency Exchange:

Digital platforms facilitating the exchange of digital assets, they allow exchanging one cryptocurrency for another, buying and selling of cryptocurrencies and the exchange of fiat money into cryptocurrency.

Trading in cryptocurrency :

Fiat money such as Rupee, Dollar etc can be used to purchase cryptocurrency using cryptocurrency wallets. These crypto-wallets have a designated address. In order to be able to trade, for example, bitcoins with altcoins, one would require opening a trading account with the exchange platform. The coins would have to be transferred from the wallet to the corresponding cryptocurrency address on a trading account. These coins can thereafter be traded on the exchange for other coins. Like the traditional stock exchanges, traders can opt to buy and sell coins by placing market order/ limit order.

Models of cryptocurrency exchanges:

Most cryptocurrency exchanges are centralized, requiring the custody of digital assets in order to make trades. This model raises concerns related to custody of the purchased assets. Decentralized exchanges are in talks, these do not rely on any third party service to hold customer’s funds. Instead, trades occur directly between users (Peer to Peer) through an automated process.

Pricing on cryptocurrency exchanges:

The exchanges can set prices, the prices differ on each exchange as each exchange gauges the price of bitcoin based on its own volume of trades, as well as supply and demand of its users. Thus, the larger the exchange, the more market-relevant the price.

Mt. Gox

Mt. Gox was transferred to Mark Karpeles in 2011. Its massive market share gave it a significant role to play. As stated above, it saw 70-80% traffic of all cryptocurrency transactions. However, it became victim to a massive hack and lost about 740,000 bitcoins (6% of all bitcoins then in existence)[1]. This loss was valued at over USD 3 billion besides the additional USD 27 million found missing from Gox’s bank accounts. Out of these, 200,000 bitcoins were eventually recovered, the remaining 650,000 remained lost.

Following is the timeline of the hack to complete suspension of trading at Mt. Gox.

DATESEVENTS
June, 2011 Hack attributed to compromised computer belonging to company’s auditor. Hacker used the access to Gox to artificially alter the nominal value of the bitcoin to one per cent and then transferred an estimated 2,000 bitcoins from customers’ accounts on the exchange, eventually sold. Approximately 650 bitcoins were purchased from the exchange at an artificially low price by Gox customers, none of which were recovered. Gox thus went offline and substantial amount of its bitcoins were held in cold storage.
February 07, 2014 Halt of all bitcoin withdrawals due to transaction malleability. A bug in the bitcoin software making it possible for someone to use the bitcoin network to alter transaction details to make it seem like sending of bitcoins to a bitcoin wallet did not occur when it in fact did occur.
February 17, 2014 Withdrawals continued to be halted and steps laid out to address security issues.
February 23, 2014 Karpeles resigned from the Board of Bitcoin Foundation.
February 24, 2014 Suspension of all trading and Website went fully offline.
February 25, 2014 Website reported that ‘a decision was taken to close all transactions for the time being’ citing ‘recent news reports and the potential repercussions on the exchange’s operations.
February 28, 2014 Bankruptcy Protection filed in Tokyo.
March 09, 2014 Bankruptcy Protection filed in the U.S.
March 20, 2014 Website reported that it had found 200,000 bitcoins in old-format digital wallets that had been used by the exchange prior to June 2011. Company held these in trust for creditor while remaining under bankruptcy protection.
August, 2015 Karpeles was arrested and charged with fraud and embezzlement although none of these charges directly relate to the theft. He was imprisoned until July 2016 in Japan and was later released on bail.

650,000 bitcoins remained unaccounted after the hack. One of the theories is that the hacker was able to access the bitcoins because of storage having been compromised by an individual with on-site access. Another theory is that the cold storage coins were gradually deposited into the Mt. Gox Exchange system when a hot wallet ran low and that lack of accountability among staff simply meant that there was no awareness about the wallets being drained by hackers.

Implications

With a massive number of claims from early Bitcoin holders, the fall of Mt. Gox was almost as shaking as Lehman, in the cryptocurrency domain. It raised bankruptcy and anti-money laundering concerns while also claims from international exchanges which held Bitcoin loomed under uncertainty. Interestingly, Gox Rising was launched as an alternative to Mt Gox bankruptcy trustee Nobuaki Kobayashi’s civil rehabilitation effort.

MANAL SHAH


[1] https://blockonomi.com/mt-gox-hack/

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