Tuesday, February 11, 2014

Did the Government Force Mt. Gox Into a Bit of a Ponzi Scheme-Type Dancing?

The recent announcement by Mt. Gox is quite curious. It has halted withdrawals of bitcoins that are headed to outside Mt. Gox Bitcoin wallets. It has not halted the withdrawal of cash or the transfer between two different Bitcoin wallets within Mt. Gox. Here's the key snippet from the Mt. Gox statement:
As you are aware, the MtGox team has been working hard to address an issue with the way that bitcoin withdrawals are processed. By "bitcoin withdrawal" we are referring to transactions from a MtGox bitcoin wallet to an external bitcoin address. Bitcoin transactions to any MtGox bitcoin address, and currency withdrawals (Yen, Euro, etc) are not affected by this issue.
Mt. Gox went on to say that the problem is not with its system but with Bitcoin system-wide:
 The problem we have identified is not limited to Mt Gox, and affects all transactions where Bitcoins are being sent to a third party. We believe that the changes required for addressing this issue will be positive over the long term for the whole community. As a result we took the necessary action of suspending bitcoin withdrawals until this technical issue has been resolved.
The Bitcoin community is objecting to this characterization. Here's a statement from the Bitcoin Foundation:
Contrary to Mt. Gox’s Statement, Bitcoin is not at fault

The issues that Mt. Gox has been experiencing are due to an unfortunate interaction between Mt. Gox’s implementation of their highly customized wallet software, their customer support procedures, and their unpreparedness for transaction malleability, a technical detail that allows changes to the way transactions are identified.

Transaction malleability has been known about since 2011. In simplest of terms, it is a small window where transaction ID’s can be “renamed” before being confirmed in the blockchain. This is something that cannot be corrected overnight. Therefore, any company dealing with Bitcoin transactions and have coded their own wallet software should responsibly prepare for this possibility and include in their software a way to validate transaction ID’s. Otherwise, it can result in Bitcoin loss and headache for everyone involved.

The Bitcoin core development team has worked to limit transaction malleability. There is broad agreement in the community that this needs to be eliminated. Finding the best and most responsible solution will take time. In the meantime, users of the reference implementation do not need to be concerned. Transactions are always tracked properly by the Bitcoin-Qt/bitcoind software.

This is a good reminder that Bitcoin is still young and experimental. There are best practices to think about and account for by those who want to build companies. To help improve both the reference implementation and third party software, the Foundation is committed to working with companies to produce best practices to help improve software.
Thus, Mt. Gox either has a poorly designed software to work around this bug, the Bitcoin Foundation is not being forthright or something else is going on. What else could be going on? Here is one theory. I want to emphasize I have no facts to back up the theory, you would need to see the internal books of Mt. Gox to know for sure, but it sure does fit the facts that are public.

Consider:, Mt. Gox may be in a cash flow bind because of previous Mt. Gox bank accounts seized by the government. Accounts with approximately $5 million dollars were seized by the USG. See, here, here.here and here.

Thus, the first question that must be asked is what happened to the Bitcoin account holders who were in the process of either getting money from Mt. Gox from a liquidation of bitcoins or who had sent money to Mt. Gox to pay for bitcoins, when the government seized the $5 million? Were these people made whole? If so, where did the money come from to make them whole? Did Mt. Gox have $5 million laying around overseas to make the account holders whole?

Here's what could be going on if the account holders were made whole and Mt. Gox didn't have $5 million on hand to make them whole: a kind of Bitcoin Ponzi scheme dance. If Mt. Gox didn't have the $5 million on hand, then what it would have to do is slowdown cash flow payments to those driving new cash into Mt. Gox. That is, those who are selling bitcoins for cash and those who are buying bitcoins. Because of the nature of bitcoins, Mt. Gox couldn't just steal bitcoins from wallets without it being noticed. But, once bitcoins are liquidated or new cash is sent in, account holders lose the ability to track the cash (Side note: cash really is a lot more anonymous than bitcoins).

So let us consider this possibility. Mt Gox wants to make whole its clients who lost money because of the USG $5 million seizure, but it doesn't have the cash to do so. BUT cash is always flowing into its coffers because of those redeeming bitcoins and those sending money in to purchase bitcoins. Thus, it could be possible for Mt. Gox to payoff those whose money was seized by using new money that was coming in from purchases and sales. The new cash generators, those who were buying or selling bitcoins, would experience a delay in seeing their transactions completed until even newer cash flow developed from new buyers and sellers.

If this was going on, you would see delays in transactions on both the buy and sell side at Mt. Gox. And indeed that is what has been going on for a very longtime.

 From April 2013:
Mt.Gox Support
posted this on Apr 03 23:10
Hello Mt.Gox Users,
"Due to slow network, bitcoin deposits are delayed at the moment.  We are working to resolve this and deposit speed should appear after 6 confirmations as usual.  Our apologies once again for the delay and inconvenience caused.  Thank you for your patience while we work to resolve this."
Made a deposit almost 8 hours ago, have over 28 confirmations and still no sign of it in my MtGox wallet. If this is what it's like trying to get funds in - I can only imagine how long it must take to get funds out - let alone cash money!

From April 18:
Hey everybody. My withdrawal from MtGox in Euros via SEPA is heavily delayed. It has been "confirmed" (e.g. cued for execution) for 14 days now. I complained and demanded a cancellation to rebuy bitcoins and sell them on Bitstamp or alike. They refused that and told me to wait "just a little longer" as the transfer is "in the middle of being processed" by their bank (which I find a completely inadequate and unprofessional - if not childish - description of whatever is happening to the transaction right now). I consider this as unacceptable. I wanted to share this experience with other users here so they are warned when considering using MtGox to sell their BTC for Euro. If you had comparable experience please share.
Again, there might be other explanations for the delays but the problems these two posters had with Mt. Gox sure fits the possibility of Mt. Gox managing its cash flow. Keep in mind  that cash flow for Mt. Gox is generated whenever there is cash coming in, but also when a sell order is given. Thus, Mt. Gox wouldn't mind sell orders under this Ponzi scheme dance theory because it generates immediate cash flow. What it would mind is bitcoins being transferred out of the control of Mt. Gox wallets, which would cause the loss of future potential cash flow and this is exactly the type of transaction that Mt Gox has stopped.

Again, this is just one theory at to what is going on at Mt. Gox. You can't really know for sure without seeing the internal books, but if I am a Mt. Gox account holder and somehow suspended in the never ever land of Mt. Gox delays, I would start demanding an outside audit by a major accounting firm. If monkey business is going down, that kind of demand is going to put you to the head of the line in getting paid.


While I was putting this post together, Bitstamp has announced that it has halted withdrawals at its exchange, which adds credibility to the Mt Gox contention that there is a serious bug in Bitcoin software---but this doesn't explain the delays earlier this year at Mt. Gox.

Bottom line: There are a lot of dark twists and turns with Bitcoin that make the risk-reward ratio of owning bitcoins dramatically weighted toward risk.


  1. There is no issue with the Bitcoin protocol. This bug/feature of Bitcoin has been known and documented for years. Any problems are with how Mt. Gox and BitStamp interact with the protocol, likely with custom implementations.

    Bitpay and Kraken are unaffected because their software is implemented to handle this feature/bug.


    As for Mt. Gox's financial condition and why it is that way; well, that is the subject of a lot of speculation.

  2. Great analysis. Yes, many of us in the community have suspected the same thing and many people who've been around a while have abandoned MtGox long ago. The technical Bitcoin issue is real and should be patched soon but MtGox's internal operations are highly suspect.

    1. Clarification: Trace is correct when he states:

      "There is no issue with the Bitcoin protocol. This bug/feature of Bitcoin has been known and documented for years. Any problems are with how Mt. Gox and BitStamp interact with the protocol, likely with custom implementations."

  3. By the way, the best source for the latest news, gossip and entertainment in "Bitcoin World" is the Reddit forum as it is hard to slip anything past the thousands of eyes that are constantly watching everything related to Bitcoin:


  4. BTC-e is also having issues, I'm not 100% positive as to the reason, although it appears to fit this same issue that other exchanges are having. It's been over 72 hours and I still can't see my bitcoin withdrawl in the block chain. Support at BTC-e tells me to have patience, I suspect that after some interviews and BTC-e saying that it was just the other exchanges and thier lack of quality developers to deal with the issue they are finding themselves in the same boat and eating crow.

  5. Robert, you said, "If Mt. Gox didn't have the $5 million on hand, then what it would have to do is slowdown cash flow payments to those driving new cash into Mt. Gox."

    There's another possibility: Hammering the price of BTC would let Gox cash out customers at a lower price, reducing the cash required for payout.
    Consider that the BTC protocol flaw is real but wasn't on the radar for the BTC developers to fix anytime soon. It could also be that Gox is highlighting a real issue, the risk of which they understood more completely than most of the rest of the BTC community, in order to drive down the price of BTC via the press.

  6. John Mack Whines About How Badly Wall Street CEOs are Treated

    The CNBC story flags the inflammatory portion, which starts at 5:23:

    He [Mack] said he would love to see people “stop beating up on Lloyd and Jamie.” He added: “I think that would make a lot of sense, and I’m in favor of that.”

    The worst is that Mack and other members of his class (elite financiers and the 0.1%) really don’t get it. They live in such a cloistered world that the fact that they’ve gotten away with abject incompetence, malfeasance, and in the case of JP Morgan, almost certain criminal conduct (among other things, as we have discussed in considerable detail, Sarbanes Oxley violations and the criminal case that the DoJ settled rather than prosecuted), according to Mack, is perfectly kosher if investors don’t mind. And why should investors mind? Last I checked, crime and predatory conduct are very lucrative businesses if you can get away with it.


  7. This gives govt., the media, those that want to either block or Co-opt any of this, a perfect opening; as they will call it unfit for consumers, and 'they' of course must step in and regulate it all.
    Cryptocurrencies may survive, but Mr. Wenzel is very correct that they will in no way, shape nor form be left to their own devices.