The MtGox Bitcoin Scandal Explained

If you’ve followed the news today, chances are you’ve come across multiple reports that there’s trouble in Bitcoin land.

MtGox, a Bitcoin exchange, has mysteriously disappeared, putting at risk millions and millions of dollars and in some cases, the livelihood of many. This certainly sounds ominous, but what does it really mean? How does this affect the Bitcoin economy? The answers to these and other questions can be found below.

What is Bitcoin?
If this the first time you’ve asked yourself that question, then chances are that everything else below will be over your head. But, if you insist on reading along, here’s a quick explainer.

It’s also worth noting that there are currently just over 12.4 million bitcoins in circulation, with a market capitalization of just over $6 billion. As of this writing, the average price of a bitcoin according to Coindesk—an index for the cryptocurrency—of $517 (earlier this morning, the price had dipped below the $500 threshold but it appears to be bouncing back some).

What is/was MtGox?
MtGox is—or was, depending on what actually happen (more on that later)—a bitcoin exchange where individuals can buy and/or sell bitcoins. It is the oldest exchange and, up until yesterday, it was the largest and most popular.

What Happened?
MtGox is now completely offline. This development came after the exchange had halted all withdrawals because of technical issues on Feb. 7. The company cited a transaction malleability as the reason behind the transactional freeze, or, to be more specific:

“A bug in the bitcoin software [that] makes it possible for someone to use the Bitcoin network to alter transaction details to make it seem like a sending of bitcoins to a bitcoin wallet did not occur when in fact it did occur. Since transaction appears as if it has not proceeded correctly, the bitcoins may be resent. MtGox is working with the Bitcoin core development team and others to mitigate the situation.”

This answer, however, was not enough for MtGox users, many of whom had been waiting weeks to have withdrawals completed.
On Sunday, after much criticism, MtGox CEO Mark Karpeles stepped down from the board of the Bitcoin Foundation, a nonprofit group that advocated the use of Bitcoin and its technology.

The following day, MtGox vanished into thin air.

Wait, why?
This is where we get into speculative territory. The truth is no one knows what happens. The prevalent theory right now is built on an alleged leaked internal document from MtGox itself. The document, entitled “Crisis Strategy Draft” and made available by Bitcoin blogger and evangelist Ryan Selkis, reveals that MtGox had been the victim of a multi-year hack that syphoned off more than 744,000 bitcoins from its coffers, including bitcoins that were supposedly in “cold storage,” funds that were kept in an offline computer so as to be protected from hacks.

“The reality is that MtGox can go bankrupt at any moment, and certainly deserves to as a company,” the document, which is embedded below, reads.
“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 government 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.”

The leaked memo also detailed a strategy to address the situation. One of the points is to shut down MtGox for a month and rebrand itself as Gox.
Those 744,000 bitcoins, by the way, make up roughly 6 percent of all bitcoins currently in circulation. At the current going rate, that equals to roughly $368 million. The actual damage could also be worse, depending on whether people who have their bitcoins in the exchange will be able to retrieve them or not.

MtGox Situation: Crisis Strategy Draft by twobitidiot

How legitimate is the document?
It’s really hard to say, but there are a lot of things that make it seem legitimate. For starters, Ryan Selkis is well known and trusted in the Bitcoin community. Secondly, the supposed years-long hack isn’t too far fetched. MtGox was known just as much for being vulnerable as it was for being the most popular. Also, the claim that the exchange was planning a rebranding and name change has some legs given that Karpeles bought the domain Gox.com recently.

Are there any other theories?
Yes, of course. If you sift through the comments over at r/Bitcoin, the Reddit subsection devoted to the cryptocurrency, there are many who believe that this was an inside job, that it was a heist and Karpeles (or his associates) have taken the money and ran. At this moment, however, there hasn’t been any evidence to back that claim up.

In truth, anything beyond the fact MtGox is offline is mere speculation. The exchange hasn’t helped their cause either. They released a statement earlier today—seen below— that doesn’t really shed any light into what might have happened:

Dear MtGox Customers,

In the event of recent news reports and the potential repercussions on MtGox’s operations and the market, a decision was taken to close all transactions for the time being in order to protect the site and our users. We will be closely monitoring the situation and will react accordingly.
Best regards,
MtGox Team

What does this mean for Bitcoin?
If you’ve read coverage of this in the media, you’ll likely think that this is a serious blow to the Bitcoin economy. It is. 744,000 Bitcoins is a lot of cryptocurrency. But it seems unlikely that this will be the final nail on Bitcoin’s coffin. Many thought that the shutting down of Silk Road, the online and secretive Amazon for drugs, would be a devastating blow to Bitcoin. The cryptocurrency bounced back.

A joint statement was also issued by Blockhain.info, Coinbase, Kraken, Bitstamp, BTC China, and Cirlce—six leaders of the Bitcoin industry—denouncing MtGox for their action.

“This tragic violation of the trust of users of MtGox was the result of one’s company actions and does not reflect the resilience or value of bitcoin and the digital currency industry,” the statement declared.

“As with any new industry, there are certain bad actors that need to be weeded out, and this is what we are seeing today.”

Other Bitcoin luminaries also publicly spoke up. Erik Vorhees, who in 2013 sold his Bitcion-based gambling site SatoshiDice for over 126,000 bitcoins—took to Reddit to plead that Bitcoiners not lose faith in the cryptocurrency.

“For all you who lost money, my heart goes out to you. Some people lost a little, some lost a fortune,” Vorhees said.
“The proper lesson,” he added, “if I may suggest, is this: We are building a new financial order, and those of us building it, investing in it, and growing it, will pay the price of bringing it to the world. This is the harsh truth. We are building the channels, the bridges, and the towers of tomorrow’s finance, and we put ourselves at risk in doing so.”

Many are also trying to find the silver lining in this debacle. “>As Peter Spence of City A.M. notes, the demise of this particularly exchange could end up being a good thing. MtGox was as vulnerable as it was big, and now other businesses—and bitcoin users—can learn from these mistakes.

So what’s the takeaway?
The takeaway is that if you invest in an unregulated, truly free market, you can either make a lot of money, or as appears to be the case in this situation, you can lose a lot of it. This won’t kill Bitcoin, but it will certainly make anyone who’s looking to jump in the game think twice. And, if you do decide to jump on the Bitcoin wagon, make sure your money is spread across multiple exchanges. Diversify!

Fidel Martinez is an editor at Fusion.net. He’s also a Texas native and a lifelong El Tri fan.