Mt. Gox Bitcoin Bank Run Intensifies, 1 Million Customers at Risk
February 7, 2014 1:04 PM
(Source: Liberty Films)
Exchange is refusing to give customers their money, CEO is at large, and company faces "significant losses"
Early Friday morning Tokyo, Japan-based Bitcoin exchange Mt. Gox froze customers accounts, refusing to give customers their money back. Customers were still allowed to trade the Bitcoins in their accounts for other currencies, Mt. Gox's primary function.
But this problem has been snowballing for nearly a year now. And it’s amazing that no one has recognized this for what it is -- a digital age
I. The Building is Ablaze, Get Out Now
But reports are largely missing that Mt. Gox appears to be seeing the first major digital bank run and that nearly 1 million users are at risk.
In the last day, panicked customers carried out $32M USD of transactions on the site, nearly five times the normal daily volume. And there are growing signs that customers may get only partial repayment if anything, as Mt. Gox has taken to largely refusing to give customers their money back unless they pay a withdrawal fee "to expedite the transaction".
The exchange, once the biggest converter of Bitcoins to USD and vice versa, blamed it all on a glitch in a press release. It's previously
tried to claim
that its backing bank in Japan was limiting it to 10 wire exchanges a day, hence why it was taking weeks or even months to give customers their money.
But it hasn't mentioned that claim in while. It appears Mt. Gox is trying to use whatever excuses it can think up to disguise the serious problem -- it may not be able to pay back customers unless its current owner and CEO taps into his own fortune.
A drawing depicts a banker trying to offer reassurances to customers during a bank run in Montreal in 1872. [Image Source: Wikimedia Commons]
In a post it writes:
During our efforts to resolve the issue being encountered by some bitcoin withdrawals it was determined that the increase in withdrawal traffic is hindering our efforts on a technical level. As to get a better look at the process the system needs to be in a static state.
In order for our team to resolve the withdrawal issue it is necessary to temporarily pause all withdrawal traffic to obtain a clear technical view of the current processes.
We apologize for the extremely short notice, but as of now all bitcoin withdrawals will be paused, and withdrawals in the queue will returned to your MtGox wallet and can be re-intiated once the issue is resolved. Customers can still use the trading platform as usual.
Our team will be working hard through the weekend and will provide an update on Monday, February 10, 2014 (JST).
Again, we apologize for the inconvenience, and ask for your continued patience and support while we work to resolve this issue.
But that is a highly suspicious claim, given the run on withdrawals on the site and its serious monetary losses.
Anyone with a basic economics background will recognize the shutdown for what it is -- a desperate attempt to survive in the midst of a digital age bank run. Banks typically keep only a small fraction of customer assets in liquid form, ready for withdrawals. A bank run occurs when a large number of withdrawals overwhelm a bank's capacity to liquify its holdings.
Even a relatively healthy and well-run bank can suffer a bank run in times of severe economic crisis. But bank runs can also be triggered by problems with the bank itself -- monetary losses, reputation damage, and failing to operate transparently. It appears that the Mt. Gox run falls under this category of individual run.
Some may be confused. Isn't Mt. Gox a currency trader? Indeed, it is. But Mt. Gox also stores consumers' currency and thus is acting essentially as an online bank. If anyone has doubts that a run of occurring they should read up on "suspension of convertibility" -- which is precisely what Mt. Gox has been doing for almost a year now with increasing frequency and severity. This tactic is a hallmark of a bank trying to disguise the dire crisis of a bank run.
In the U.S. banks are required to pay for insurance via the
U.S. Federal Deposit Insurance Corporation
(FDIC), which has largely prevented customers from losing the money they deposit. By contrast, Mt. Gox -- as a registered foreign money trader -- carries no such insurance. As this bank run worsened customers may be forced to turn to class action lawsuits and other mechanisms, but the reality is that Mt. Gox is likely to go under and its customers may lose a substantial part of their holdings.
A bank run in Berlin in 1931 draws a panicked crowd. [Image Source: Biln]
One thing is for sure: things appear to be going downhill fast for Mt. Gox, and its million or so serious customers may face millions in real-world USD losses as the digital bank-run and Mt. Gox's refusal to give customers back their money escalates.
II. "Where's My Money?
There's widespread media reporting on the Mt. Gox withdrawal freeze announcement from this week, but what most are missing is that the exchange in the last two months has rejected most customer withdrawals silently. This is not a new development; signs of Mt. Gox's insolvency have grown since last year.
"Nope, you can't have your money back." -- that's what Mt. Gox began to tell customers last year. [Image Source: eVoorhees]
Most serious Bitcoin veterans have already fled the exchange, but for those who are still hanging out at Mt. Gox, it's important to recognize that your assets are in extreme danger.
Users are left wondering whether this is simply minor technical glitch, the first hint at another security compromise, or signs that Mt. Gox may be treading dangerously close to insolvency.
Confidence in Mt. Gox was once strong.
Founded in 2010, Mt. Gox quickly grew to dominate a far greater portion of the overall Bitcoin trading volume than it does today. Its troubles began shortly after its original owner Jed McCaleb
the Tokyo, Japan based web portal to new owners in March 2011.
Just three months later, in June 2011, a profiteer exploited a vulnerability in the site's trading algorithm and
(reportedly) stolen administrative credentials
purchase a large amount of Bitcoins at a very low price
. An estimated 8.75 million user accounts were affected in the breach.
The 2011 hack of Mt. Gox triggered a plummet in trading prices. [Image Source: LeanBack.eu]
While some in the Bitcoin community pushed legitimacy as the cybercurrency grew in usage and values, Mt. Gox paid a steep price last year for stubbornly resisting such efforts. In February it became
embroiled in a feud with online payments firm Dwolla
over Dwolla's new restrictions that cracked down on money laundering.
Then in April 2013 Mt. Gox
the first of several "cool down" periods. Trading shut down for at least a day in April, and during another shutdown buying (order placing) was halted.
III. Mt. Gox Has Admitted to "Significant [Financial] Losses"
In May 2013 Mt. Gox's financial troubles grew when CoinLab sued Mt. Gox. Mt. Gox has previously partnered with the U.S. startup, which had allegedly promised it exclusive rights to run trade in the U.S. under the Mt. Gox brand. But to CoinLab's chagrin, Mt. Gox continued to directly trade to U.S. buyers. CoinLab
sued it for $75M USD
writing that the figure "likely underestimates the actual damages."
Meanwhile the damages to Mt. Gox were growing. In May the
U.S. Department of the Treasury
an estimated $5M USD
in accounts belonging to Mt. Gox's owners. Some of these funds were reportedly returned by the
Financial Crimes Enforcement Network
(FinCEN) -- the enforcement arm of the Treasury -- after Mt. Gox registered in June 2013 as a money exchange, agreeing to file paperwork and finally crack down on overt money laundering.
Mt. Gox CEO Mark Karpeles holds up a commemorative Bitcoin medallion.
But its woes were growing. Customers
in forum posts
that throughout mid-to-late 2013 Mt. Gox was denying their request to transfer their funds to other exchanges or back into their wallets. Customers were greeted by messages such as "your withdrawal is yet to process. we will keep you posted once it is done."
Mt. Gox further stoked the flames when it introduced a 5 percent fee for "expedited" withdrawals (which are normally free). Some users tried the service and declared it a scam, after seeing their withdrawals still languish for weeks unfilled.
In June Mt. Gox CEO Mark Karpeles -- the man who had purchased the company back in 2011 --
popular Bitcoin forums and other online sites. This was yet another troubling sign, given that previously he had been a very active participant in a number of online communities, evangelizing Mt. Gox.
After accumulating a quarter-billion dollar fortune, Mt. Gox CEO has reportedly vanished from the digital doman. [Image Source: Reuters]
In Aug. 2013 Mt. Gox
it was in serious financial trouble, saying it had seen "significant losses" from unfulfilled transactions. A release to customers at the in December 2013 noted the company had
only a million
current customers -- less than an eighth of the accounts that were registered with it in 2011.
That's not to say the company hasn't seen some gains, as well. In April 2013, it was doing about $6M USD worth of trades a day, according to
. In the past day it was average $7.8M USD in volume -- a modest growth in value driven by the
rising value of the Bitcoin
However, last April it was handling 76 percent of transactions, in the last month it handled only 19 percent of transactions. It is currently the third biggest exchange behind BitStamp and btc-e -- the first and second place exchanges, respectively, in terms of volume in the last 30 days.
IV. Bitcoin, Other Cryptocurrencies, Must Adopt Insurance or Risk Losing Everything in Bank Runs
the world's most popular cryptocurrency
. Bitcoin's basis is the SHA-256d hash;
you "own" Bitcoins via proof of work
Introduced in 2008 by a programmer or group of programmers using the pseudonym Satoshi Nakamoto, the Bitcoin was the first of its kind, turning the science fiction fantasy of a decentralized, encryption-based global currency into reality.
Despite recent largely overstated and misinformed controversy over illegal uses of the Bitcoin, the cryptocurrency is the foundation of a generally credible and secure global digital payment network. While
other cryptocurrencies have since emerged
, Bitcoin remains the most prominent with a market value of over $10B USD. Blockchain estimates Bitcoin has roughly 1.2 million users, working out to an average wallet value of around $10,000 USD.
Bitcoins are the world's most popular cryptocurrency, used by over a million people worldwide [Image Source: Bit-Square]
Bitcoins were riding high at around $850 USD/BTC earlier this week after
announced their intent
to only lightly regulate the technology
, which acts as a currency,
a speculative investment
a digital payment mechanism
depending on who you ask. But the fading exchange's announcement shook the market, introducing a sharp drop in prices down to the low $720 USD/BTC.
In this moment of need Mt. Gox CEO is oddly silent, with some sources saying he has disappeared. He has good cause to want to escape the mess, as he has plenty to lose. Fueled by Mt. Gox's fees (e.g. 10 percent for many exchanges) he amassed a fortune of $8M USD plus and 345,000 Bitcoins (at current rates: $250M USD). Even with the FinCEN seizures, he likely has a quarter of billion dollars in assets. It would not be surprising to see him disappear altogether if Mt. Gox sees a full collapse.
The good news is that a relatively small slice of the Bitcoin community will be affected by this run.
But ultimately, this somewhat unprecedented saga may affect the entire Bitcoin market. If Mt. Gox fails to pull off a miracle and show itself to indeed be soluble, the run will likely only worsen. And if Mt. Gox defaults and goes under, that will cast a dark light on the entire cryptocurrency global phenomena, perhaps forcing cryptocurrency developers to band together to introduce some form of collective insurance.
"Young lady, in this house we obey the laws of thermodynamics!" -- Homer Simpson
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