How Mt. Gox Imploded
Behind the scenes during the final days of the Bitcoin exchange.
For about four years, Tokyo-based Mt. Gox was the largest and most important Bitcoin exchange. Despite having numerous flaws, many considered it the default option for buying and selling Bitcoin using real world currencies. But in early 2014, Mt. Gox collapsed and its customers' money vaporized. It entered bankruptcy shortly afterward. Its assets have been acquired by Kraken, a San Francisco-based competitor, which is now refunding Mt. Gox customers. This is what happened behind the scenes of the collapse.
Mark Karpeles, the CEO of the Bitcoin exchange Mt. Gox, was spending many of his days in early 2014 turning the ground floor of his Tokyo office into the Bitcoin Café, a real-world showcase for Bitcoin.
Mark was working out the details of the café, down to the programmable LED lighting on the ceiling, recipes for the pastries that would be served, and a point-of-sale system he had been designing. It was almost ready to open, with wine on the shelves and light blue Bitcoin Café mugs next to the register.
As he puttered around the café, Mark did not look like a man responsible for a financial company that was in the throes of an existential crisis.
For most of January, the price of a Bitcoin on Mt. Gox had been almost $100 higher than on any other exchange, due to the difficulty that Mt. Gox was having in transferring withdrawals to customers outside Japan.
Then, something even more worrisome started happening: a growing number of Mt. Gox customers reported that they had requested withdrawals of Bitcoin and never gotten the coins.
The 30 or so Mt. Gox employees knew little about what was going wrong. When Mark wasn't working on the café, he was in his office, behind a locked door on the eighth floor, far from the second- and fourth-floor offices where most of his staff was located. They were as surprised as customers when Mark decided, on Friday, February 7, to shut off all withdrawals from Mt. Gox.
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The panic that this caused only got worse on Monday when Mark provided the first explanation: the exchange had run up against a flaw in the Bitcoin protocol. The flaw, known as transaction malleability, allowed devious users to request a withdrawal, change the code, and then successfully request the same withdrawal again.
This immediately sent the price of Bitcoin plunging on every exchange around the world. A flaw in the Bitcoin protocol could jeopardize everything.
What Mark didn't mention was that all the other major Bitcoin companies had known about the issue for years and had designed around it. Meanwhile, Mt. Gox remained closed—creating a growing fear that something bigger was wrong.
A combination of fear and sickness slowly overtook him as each one of the wallets he scanned in showed up on his computer screen as empty.
Mark would later say that during this time he was spending his daylight hours at the office and his nights at his apartment, alone with his cat Tibanne, furiously working his way through hundreds of pieces of paper containing the private keys to Mt. Gox's Bitcoin wallets.
He had driven around in his car and collected the papers from the three locations in Tokyo where he had stored them (he had kept the keys on paper so they would not be vulnerable to hackers). Once he was back in his apartment with the QR codes, he began scanning in the private keys one at a time with his computer's webcam. A combination of fear and sickness slowly overtook him as each one of the wallets he scanned in showed up on his computer screen as empty.
It would be hard for others to verify Mark's narration of what happened during those days because he kept such tight control over all the exchange's accounts. And as time went on, fewer and fewer people believed anything Mark said. Ten days after Mt. Gox shut off withdrawals, Mark announced that the problem was fixed.
Of course, it wasn't.
When the Winklevoss twins landed in London for a weekend appearance at Oxford University, they turned on their phones to find a worrisome email from Mark's deputy, Gonzague, with whom they had dealt in the past.
"I would like to talk to you urgently regarding the situation with MtGox," he wrote.
When Cameron Winklevoss called him later that night on Skype, Gonzague got right to the point. Some 650,000 Bitcoins—essentially all the company's customer holdings—were gone, along with 100,000 coins that belonged to the exchange.
Cameron was stunned. Doing the most basic math in his head, he knew that Gonzague was talking about hundreds of millions of dollars worth of Bitcoins.
"How is that possible?" was all he could ask.
Gonzague said that someone had been stealing from the company's online, or hot, wallet by changing the transaction identifiers. When the hot wallet was empty, Mark had unwittingly refilled it with coins from the cold, offline wallets, over and over again, until all the offline wallets were empty. The whole thing had been going on for months, or even years.
Gonzague sounded oddly upbeat. He explained that Mark had "burned himself" and was agreeing to step aside so Mt. Gox could reincorporate under new owners, with the twins being obvious candidates. Gonzague thought it would be possible to do this without telling anyone what had happened. If the exchange could get an infusion of coins the business could make up the missing money over time, from fees. If this wasn't done, Gonzague said ominously, it could set Bitcoin back years.
The twins were not the only people to whom Mark and Gonzague were looking for a lifeline. But essentially everyone told the Mt. Gox team the same thing: there was nothing to do but admit the losses and declare bankruptcy.
Ordinary Bitcoin users got some indication that something was wrong when Mt. Gox's Twitter account suddenly disappeared. But Gonzague and Mark continued to hold out hope that someone would come in and bail them out. Mark told Cameron he was planning to begin talking with a bankruptcy judge. But, he emphasized, "Our current goal is to try to save MtGox before filing for bankruptcy—in which case filing wouldn't be required anymore."
The growing bubble of uncertainty over how this would all play out finally burst on Monday night when a popular Bitcoin blogger, known as the Two Bit Idiot, posted a leaked copy of Mt. Gox's 12-page internal Crisis Strategy Draft.
It was clearly a draft document, with typos and inconsistencies, but it pulled no punches about what had happened:
The reality is that MtGox can go bankrupt at any moment, and certainly deserves to as a company. However, with Bitcoin/crypto just recently gaining acceptance in the public eye, the likely damage in public perception to this class of technology could put it back 5~10 years, and cause governments to react swiftly and harshly. At the risk of appearing hyperbolic, this could be the end of Bitcoin, at least for most of the public.
As it began to circulate and the Bitcoin masses tried to determine if it was legitimate, there was a sense of suspended motion on the forums and message boards, with everyone waiting for the bottom to fall out. When no one came forward to dispute the document, the price of Bitcoin began to go into free fall.
And then, amazingly, the free fall started to slow.
Within a few hours, Bitcoin's price began to stabilize. Many people seemed willing to believe the idea that there was nothing wrong with Bitcoin; there was talk that the disappearance of the most disastrous company ever to touch Bitcoin could end up being a good thing for the technology. If nothing else, people had invested enough time and money that they couldn't stomach selling out of a trough. Within two days, the price was back up where it had been when the Mt. Gox news came out.
Still, under the apparently calm surface, there was immense and largely unseen damage. As the enormous figures from Mt. Gox suggested, tens of thousands of people had kept their money with the exchange despite all the warnings, and those holdings, estimated at over $400 million the week before, had now disappeared in a mysterious puff of smoke.
The same week as the collapse, lawyers in Chicago and Denver filed a lawsuit seeking class-action status to represent all the victims, and federal prosecutors were sending out subpoenas to aid in the criminal investigation they launched.
Even many of the victims blamed Mt. Gox rather than Bitcoin. Nothing had gone wrong with the Bitcoin protocol. Mt. Gox had long been held up as an example of the dangers that arose when Bitcoin users relied on central institutions, rather than the system of private keys and personal wallets that Satoshi Nakamoto, the currency's pseudonymous creator, had designed.
An academic study in 2013 had found that 45 percent of the Bitcoin exchanges that had taken money had gone under, several taking the money of their customers with them. Mt. Gox was hardly the first. It was just the biggest.
This is an excerpt from Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires, a new book by New York Times reporter Nathaniel Popper. Reprinted courtesy of Harper, an imprint of HarperCollins Publishers.