Throwback Stories #2: The Case Of Mt. Gox

Dominik Olech
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The cryptocurrency history, despite being a living symbol of freedom, unfortunately, has some not so bright pages too. One of them is especially worth mentioning, because of its scale.

Mt. Gox was once one of the leading exchanges on the cryptocurrency market. Back in those days, it was an example of the fulfilled crypto dream. But now it is known only for its tragic end. And at the time when exchanges have problems with their security, it is worth taking a closer look at Mt. Gox case.

The Magic of Bitcoin

The beginning of Mt. Gox is especially interesting. Most people are not aware that the name of an infamous exchange came from…a card game. It’s an acronym from Magic: The Gathering Online Exchange. It began as an idea of a trading hub for people who want to trade with their gaming cards for this famous franchise. What is even more interesting, Mt. Gox was created by Jed McCaleb – the same McCaleb who is a co-founder of Stellar – . So, the exchange wasn’t so far away from crypto after all.

Although I would love to make here a separate paragraph about that part of exchange history (but let’s be honest, it’s a blockchain-oriented website after all, and not everyone has to be such a nerd like me), those times ended relatively quickly. In 2010 McCaleb learned about the bitcoins and decided to use domain for a cryptocurrency exchange. Our future Stellar CTO sold it to Mark Karpeles in March 2011. Since that moment, he became the CEO and the face of Mt. Gox. 

We have the year 2011. The Bitcoin has achieved not only a historical price of $1, but it also reached the value of $31. We’re in the prologue of ultimate cryptocurrency rush. And the Mt. Gox will play a significant role in it.

The highest mountain in the crypto world

Later on, Mt. Gox became the leading cryptocurrency exchange on the market. It was handling over 70% of all bitcoin transactions worldwide at the moment of its peak at the beginning of 2014 – only to be closed two months later. 

In fact, Mt. Gox’s problems started shortly after Karpeles had taken the company over. The first security breach happened on 19th June 2011. An unidentified hacker managed to change the nominal value of bitcoin to 1 cent, probably by using one of company auditor’s computer. It allowed him to purchase more than 2,000 bitcoin for the unbelievable price of 20 dollars. After the first security breach, Karpeles decided to move part of the assets to cold wallets, to ensure the exchange safety. But this event was only a taste of further Mt. Gox problems.

The cryptocurrency market kept developing, alongside with Karpeles exchange. At least that what the situation looked like from the outside. Mt. Gox became the leading institution in the cryptocurrency world. Maintaining around 70% of worldwide bitcoins’ trade by one exchange create a situation when the market designed to be decentralized is, in fact, monopolized.

The bigger they are, the harder they fall

The position of the leader on the cryptocurrency market was prestigious for sure. But the real trick is not to claim the throne, but to hold it. The market was still growing, and Mt. Gox was slowly losing control over the situation. The excellent example of the overall climax of that time was the infamous “market cooldown”. In an attempt to stop price increases, the exchange suspended trading from 11–12 April. And since more than half of the worldwide transaction were handled there, such actions allow Mt. Gox to significantly influence the market.

But the rising Bitcoin popularity wasn’t the only problem of Mark Karpeles. CoinLab, a firm which was to handle Mt. Gox’s North American services, sued the exchange for breach of contract. As if that was not enough, the US Department of Homeland Security started an investigation. There was a suspicion that a subordinary of the exchange was not licensed in the USA. In the result, DHS seized more than $5 million from the Mt. Gox bank accounts. 

The problems in North America forced Karpeles to suspend withdrawals in US dollars on 20th June 2013. Although it lasted officially only until the 4th of July, many users still had problems with withdrawing their money.

The end of an empire

The end for Mt. Gox came at the beginning of the year 2014. On 7th February the exchange suspended all bitcoin withdrawals, due to a bug in the bitcoin software which had occurred at this time. But when the problem was solved, and other exchanges resumed transactions, Mt. Gox still kept them halted. Through the next days, Karpeles issued few statements regarding the works over the security measures. But it was only playing for time. 

On 24th February 2014, the exchange suspended all trading, and its website was shut down. After this moment, a leaked document claimed that Mt. Gox had lost almost 750,000 bitcoins in various hackers attack during all years of its activity. At that moment, such sum was worth around $350 million. Karpeles exchange problems caused the price of bitcoin declined by 36%.

The company officially declared bankruptcy. Officially, they lost 750,000 customers and 100,000 own bitcoins. Mt. Gox tried to blame the hackers for this tragic situation, but it didn’t help them in any way. In March, the exchange informed about 200,000 bitcoins found on an old wallet, which decreased the loss to 650,000.

Karpeles was arrested one year later, by Japanese police. On 14th March 2019, the Tokyo District Court sentenced him to 30 months in prison, suspended for four years. The court found Karpelès guilty of falsifying data to inflate Mt. Gox’s holdings by $33.5 million. Despite that, he still kept claiming he was innocent.

“Gox is the worst-run business in the history of the world”

This Roger Ver’s words which appeared in one of the articles on Wired clearly described the case of Mt. Gox. It was a disaster on many levels. The exchange wasn’t ready for the rapid growth of interest in cryptocurrency, and since the very beginning, it had serious problems with the security. But probably the most significant is the attitude of Mark Karpeles. The Japanese court’s verdict says he “abuses his status and authority to perform clever criminal acts”. And it’s hard to disagree with it.

Mt. Gox still cast its shadow over the cryptocurrency world. Most of the lost money could not be reclaimed to this day. The exchange former clients are still waiting for some sort of compensation for their loss. Some of them create a movement called “Gox Rising”, which is aimed to reclaim as much as it is possible using civil rehabilitation law – a solution available in Japan which gives a chance to solve bankruptcy cases.

But probably the most significant thing in this tragedy is the influence on Bitcoin reputation which Mt. Gox has caused. Many people affected by it turned away from cryptocurrencies. For public opinion, crypto was linked with a high risk. 

It also shows that cryptocurrency decentralized nature may not apply to centralized exchanges. From the bright side, the cryptocurrency market has changed a lot since that day. None of the current exchanges is holding as much of the overall transactions as Mt. Gox used to. The overall transparency of their activity has also increased. But still, the history of Mark Karpeles is a valuable lesson for our industry.

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