MtGOX once ruled the world of BTC as its biggest exchange. Then it became its biggest headache. Years after casting a shadow over bitcoin’s reputation, both MtGOX and Mark Karpeles are on the mend, having found some sort of redemption after court findings shed light on one of crypto’s biggest mysteries.

Source: Mark Karpeles Twitter page (MagicalTux)

 

On Friday the 15th, a panel of Tokyo judges found the ex-CEO of what was once the world’s largest bitcoin exchange, MtGOX, innocent of major charges of embezzlement and breach of trust, and guilty of improper management of electronic funds. Somewhat against all odds, Mark Karpeles received a suspended sentence of 4 years – far less than the 10 years prosecutors had expected him to receive.

Japan’s prosecutors in cases involving large-scale financial crimes have a successful conviction rate of 99%, which puts Karpeles in the 1% lucky enough to have avoided being found guilty on all charges brought against him. As a result, he will serve no time for the crime of which he was convicted unless he commits additional offenses over the course of the next 4 years.

Though he stepped down his role of CEO in 2014, Karpeles had been the main person in charge of MtGOX since March 2011, converting it from trading Magic the Gathering playing cards to trading bitcoin. Karpeles is said to have acted not only as CEO, but CFO and COO as well, perhaps taking on too many responsibilities at once, which led to snowballing problems introduced by mismanagement. The exchange was taken over by ex-Bitcoin Foundation member and childhood actor-turned- bitcoin businessman Brock Pierce in 2018. Pierce came on board with plans to reopen and revitalize the exchange by helping to slowly re-credit users who had lost BTC during its bankruptcy in 2014.

Karpeles was first arrested by Japanese police on August 1st, 2015, on suspicion of having accessed the MtGOX computer system to falsify data on its outstanding balance. He was later released, only to be re-arrested shortly afterward and charged with embezzlement. After serving 11 months in prison, Karpeles was released on bail in July 2016, but was forced to remain in Japan per the conditions of his release.

A Review of the MtGOX Downfall

On February 7th, 2014, the world’s biggest bitcoin exchange, MtGOX, suspended bitcoin withdrawals, soon after citing “security concerns” as the reason behind their decision. Weeks later it is revealed that MtGOX was insolvent and that about 750,000 BTC had gone missing months or even years earlier, causing the price of bitcoin to plummet 36% in less than 4 weeks’ time. This total accounted for approximately 6% of all bitcoins produced at the time, worth close to $600 million at the time of the suspension of withdrawals.

According to a leaked draft of MtGOX’s Crisis Strategy in how to deal with the missing bitcoins:

“At this point 744,408 BTC are missing due to malleability-related theft which went unnoticed for several years. The cold storage has been wiped out due to a leak in the hot wallet.”

In the draft, a total of 624,408 BTC was deemed to be liable to its customers, as well as approximately $55 million. The meager 2,000 BTC that remained in the company’s hot wallet – even when combined with the $22.4 million spread across different fiat currencies in their bank account – was hardly going to suffice, and indeed the fallout that proceeded was brutal. Thousands of customers were totally locked out of their accounts, with no way to withdrawal their bitcoins. Some users lost millions of dollars in BTC, which would be worth close to 5 times more today than they were during GOX’s closure.

The Crisis Strategy document also outlined the steps to be taken by Karpeles, and specifically stated in a list of steps to be taken that the blame was to be put on a flaw in bitcoin, and not the company itself:

GOX’s statements left many bitcoin experts scratching their heads. First off, what did “malleability-related theft” actually mean? Second off, how could a cold storage wallet be “wiped out” due to a leak in a hot wallet?

Transaction Malleability?

Before rising to prominence as Ethereum’s lead developer, Vitalik Buterin penned an extremely well-written op ed for Bitcoin Magazine which clearly explained the nature of the term “transaction malleability,” and also explained why the Bitcoin network itself was not to blame:

“The bug that MtGox faced is as follows. First, user A requests a withdrawal from MtGox, and waits for MtGox to send the transaction, say T1 with TXID H1. Then, A adds a leading zero to T1 to make the equivalent, but different, transaction T2 with TXID H2. A then quickly pushes T2 to as many mining pools as possible, hoping that T2 would get included. Meanwhile, MtGox is watching the blockchain to see if a transaction with TXID H1 gets included; of course, no such transaction ever does because T2 gets in instead. Then, MtGox ends up mistakenly thinking that the withdrawal never got through and sends the bitcoins again to the withdrawer.

From the press release, it might easily be thought that the bug is a new and unexpected vulnerability in Bitcoin, and the price dropped by roughly 20% as a result of the news. However, the price has since regained nearly all of the drop, and for good reason: the bug is not a fatal new Bitcoin bug at all. This counterintuitive property of Bitcoin transactions has been known since 2011, and most Bitcoin wallets already deal with it by watching for any transaction spending the outputs of certain previous transactions, rather than watching for a transaction with a specific ID. MtGox, with its custom Bitcoin implementation, does not. The problem is thus entirely a result of programming failures on MtGox’s part.” – Vitalik Buterin

If bitcoin’s transaction malleability issue did not ultimately result in GOX’s loss of 650,000 BTC, then the question must be posed as to why the company would make up such a story. The idea was floated that Karpeles was actually under a “gag order” placed on him by law enforcement agencies investigating drug operations connected to the Silk Road busts, an investigation which may have seized the bitcoins in GOX’s cold storage. Over the years, a more likely scenario has emerged: MtGOX was actually the victim of thefts which exploited the “transaction malleability” issue outlined by Vitalik Buterin.

The BTC-e Connection

In July 2017, the U.S. Department of Justice brought charges against Alexander Vinnik, who ran the now-defunct BTC-e exchange, after he was captured in Greece. Among the charges in the 21-count indictment were money laundering, computer hacking, fraud, identity theft, and drug trafficking. The indictment also states that Vinnik knowingly helped launder bitcoins illegally removed from MtGOX through his exchange in an effort to hide their association with GOX and himself. He was extradited to Russia where he is currently facing similar charges. If a clear association between Vinnik and GOX is established in court, it would certainly be hailed as a vindication for Karpeles, though such association has yet to be proven.

In June 2018, bankruptcy proceeding against failed exchange MtGOX were suspended by the Tokyo District Court so that “civil rehabilitation proceedings” could occur in their place, as it came to light that bitcoin allegedly held by the exchange could be worth 5 times the amount of total amount being sought by creditors in a lawsuit.

The only problem is that MtGOX’s bitcoins were “lost by hackers” (of which Vinnik was one) according to Karpeles and have yet to be recovered. However, if they were somehow located, the court’s decisions allow for claimants to be credited with bitcoins instead of the cash amount of their worth during the time of GOX’s collapse. This means they could be the recipients of a 5-fold gain in their net value if the original coins were ever to be recovered.

Lessons Learned and the Future of GOX

The downfall of MtGOX proved to be a warning of the dangers of perhaps too much freedom and deregulation; price manipulators (such as the trading bots that brought the price of BTC over $1,000 for the first time shortly before the collapse of GOX) may not be as closely monitored as they should, and thus the Japanese government’s recent efforts to curb potential bitcoin fraud through regulation are not by any means surprising. Regardless of GOX’s woes, a rather large contingency of merchants continue to accept bitcoin as payment in Japan, making it one of the most bitcoin-friendly countries in the world.

As for old customers with outstanding claims against the company, not all hope is lost. Brock Pierce’s plans to reopen the exchange with the help of a serious rebranding effort may eventually help them recover at least some of their losses. The exchange will generate revenue to pay off outstanding claims not covered by its current holdings with the help of exchange fee revenue and the issuance of their own cryptocurrency, “Goxcoins,” to be distributed to victims of its bankruptcy. To legally operate as an exchange, MtGOX must first obtain a license from Japan’s Financial Services Agency, which might prove to be a slow-moving process, as the conditions surrounding GOX’s revival are complicated and bogged down with legal matters.

As for Karpeles, he is now (more-or-less) a free man, having achieved some level of vindication with the outcome of Friday’s trial. By avoiding conviction of embezzlement charges by some of the world’s most successful prosecutors, he is now less likely to be the recipient of accusations that he had been personally stealing from MtGOX. Blame for mismanagement, however, will still rest squarely on his shoulders, as the duty of providing a comprehensive and competent withdrawal process while being aware of the risks of his system was always his own.