Once the most important Bitcoin exchange, Tokyo-based Mt. Gox ultimately went into bankruptcy in 2014. Why did the exchange blow up?
What Happened to Mt. Gox?
Mt. Gox was launched 2010 and was, at one point, handling almost three quarters of all Bitcoin transactions. In February, 2014, it filed for bankruptcy after losing 850,000 Bitcoin in a hack, which would be worth nearly $6 billion at today’s prices. Even at the time it was a substantial amount, worth around $450 million. This resulted in catastrophic losses for the exchange’s users.
The exchange was only to recover 200,000 Bitcoin in its vaults. But courts are still working through the incident. Creditors (customers who lost their money) still have not been remedied for their losses.
The 2011 Breach
The exchange was founded by Stellar Development Foundation co-founder and former Ripple CTO Jed McCaleb in 2010. McCaleb sold Mt. Gox to French national Mark Karpeles in the following year.
An early breach in June 2011 occurred in which a hacker used a compromised Mt. Gox computer to transfer Bitcoin to himself, causing a flash crash of the price from $32 to one cent. A few months later, a number of suspicious transactions occurred, sending 2,609 BTC to invalid addresses, rendering them forever lost.
This is only the first round of damage Mt. Gox’s reputation endured. It only gets worse.
The 2011-2013 Troubled Era of Growth
By 2013, Mt. Gox had grown into the most significant cryptocurrency exchange in the world, processing around 70% of all Bitcoin transactions. Bitcoin was worth around $100, at the time, and Mt. Gox was handling roughly 150,000 daily transactions.
But May 2013 was a tumultuous month for the exchange. Coinlab filed a $75 million lawsuit against the exchange. Previously, Coinlab entered into agreement with Mt. Gox to bring the exchange’s services to the United States, shortly after Coinbase was founded.
However, Coinlab allegedly did not execute on any of its promises, and failed to start a meaningful U.S. Bitcoin exchange business. Nevertheless, Coinlab raised its demands to $16 billion, but courts dismissed those claims, and awarded the company $4 million.
In the same month, the U.S. Department of Homeland Security commenced proceedings against Mt. Gox’s U.S. subsidiary, seizing over $5 million, because it had failed to register as a money transmitter with FinCEN.
2013 was really the year things began to sour for Mt. Gox. As well as the lawsuit and the enforcement activities from U.S. authorities, the exchange’s strained relationship with banking partners meant customers were having problems withdrawing cash from their accounts.
Mt. Gox had “effectively been frozen out of the U.S. banking system because of its regulatory problems,” according to some reports,
Mt. Gox Files for Bankruptcy in 2014
Customers were unable to withdraw their cash for months. Mt. Gox then officially suspended withdrawals, its Twitter account disappeared, and it finally announced it had filed for bankruptcy in February of 2014.
The exchange claimed it was insolvent, and had been suffering from hacks for some time. Apparently, they weren’t aware of this until it was too late.
As Gonzague Gay-Bouchery, Karpeles’ deputy would describe it, a hacker had been changing transaction identifiers to steal funds from the exchange’s hot wallet. Karpeles was unwittingly refilling the wallet from their own cold wallet, essentially going straight into the hacker’s palms. That had been going on for months, if not years.
After Mt. Gox announced its closure, competitors Bitfinex and BTC-e were overwhelmed with sell orders, dragging BTC down from over $600 to around $100 within seconds. Faith in the then-fragile Bitcoin ecosystem imploded. Mt. Gox claimed liabilities of $64 million, resulting in their collapse.
Karpeles was widely seen as incompetent and negligent. As a person close to the exchange, who sought to remain anonymous, told Techcrunch:
“I couldn’t believe what I was hearing. I thought I was going to black out. You would at least reconcile your books regularly. You would have had to screw up on so many levels for something like this to have happened.”
Post Mortem on What Happened to Mt. Gox
Since the exchange’s bankruptcy, Karpeles was charged with embezzlement and data manipulation. He was acquitted on those charges, but found guilty in 2019 of falsifying data. He was sentenced in Japan to a two and a half year suspended prison sentence.
The bankruptcy proceedings continue to play out as the bankruptcy trustee for Mt. Gox attempts to work out a way to compensate users for their losses using the Bitcoin that remains in the exchange’s possession.
Under Japan’s Civil Rehabilitation process, the trustee is able to handle the management of redressing customer losses more flexibly than under stricter bankruptcy proceedings. The date for reimbursement has most recently been pushed back to 2020.
Creditors are seeking to be paid in Bitcoin, rather than a fiat value of the Bitcoin they lost at the time. The 200,000 Bitcoin recovered is now worth around $1.5 billion, which would easily recover the $450 million lost at 2014 prices.
Mt. Gox: The Cautionary Tale
In many ways, Mt. Gox mirrors Bitcoin itself. The infrastructure was still immature, and it lacked the infrastructure to address the enormous security risks that came with cryptocurrency. These risks were magnified by the newness of the technology—none of the exchanges had experience dealing with crypto, at the time.
But there is a silver lining to the eruption. In the wake of Mt. Gox, a host of new, more secure exchanges came into being. This greater decentralization of exchanges meant that subsequent heists didn’t have anywhere near the same impact on the cryptocurrency ecosystem.
Moreover, those who held their coins on exchanges were, for the first time, taught the important less of “not your keys, not your Bitcoin.”
Mt. Gox left the ecosystem wounded. But, over five years on, Bitcoin has more than fully recovered, and continues to gain momentum as a challenger to traditional finance.