Bitcoins may 21st Century electronic snake oil, according to reports emerging from the sudden collapse of the Japan-based Mt. Gox Bitcoin Exchange. The world’s largest bitcoin exchange went dark Tuesday, as the company shut down its website and deleted its Twitter account amid rumors that the company had “lost” 744,408 bitcoins thought to be worth between $367 and $45o million.
The other major players in the bitcoin industry issued a joint statement reassuring worried customers that their bitcoins were safe, while private messages circulating on the Bitcoin Foundation’s website characterized Mt Gox CEO Mark Karpeles as a “spoiled and arrogant child” for whom the other members of the foundation have very little sympathy. Nor do they have much sympathy for Mt. Gox 1 million customers, implying that they deserved to lose their money for doing business with a “bad actor.”
Bitcoins have been touted as a safe way to conserve wealth in the face of inflation, transfer funds across national boundaries and protect your money from the manipulation of fiat currencies by national governments. Other, less savory selling points include keeping financial transactions private for both buyers and sellers, skirting inconvenient laws, and staying invisible to taxing authorities. As recent events have shown, none of the presumed benefits of bitcoin ownership have turned out to be true, but there are very real risks that are now coming to light.
Details about what happened at Mt. Gox are still very sketchy, because no one is talking. Many believe that hackers chopped their way into Mt. Got computer systems and made off with the missing bitcoins. The problem with this scenario is that it is supposedly impossible in the bitcoin world.
A bitcoin is a few lines of computer code that includes the entire history of that specific bitcoin, from when it was minted through the entire chain of ownership. The bitcoin code itself is protected by heavy weight encryption that prevents anyone, include the bitcoin’s owner from manipulating the code.
A bitcoin can be downloaded and stored on any device equipped with an electronic memory. It can be transmitted through the internet as an attachment, or it can be stored on an exchange like Mt. Gox for safekeeping, but all bitcoins are also recorded in a database called the “blockchain” which list the origin, history, value, and present location of everyone bitcoin in existence. The blockchain was considered immune to hacking because multiple copies of the strongly encrypted database that contains the blockchain are stored in thousands of computers all over the world,. The databases are constantly being checked against each other to insure that they haven’t been corrupted. Every time a bitcoin changes hands, that transaction is instantly transmitted to the worldwide network of databases, which are updated to reflect that transaction.
The whole system is protected by a sophisticated encryption program that is constantly under attack….by the system itself. Entrepreneurs called “bitcoin miners” are constantly attempting to break the encryption code and, when they do, they are rewarded with newly-minted bitcoins. The database is then updated, and that generates a new encryption code that then goes back out to the bitcoin miners who are waiting for the opportunity to break the code and earn more coins.
The purpose of the bitcoin exchanges such as Mt. Goxis to facilitate the transfer of bitcoins from buyers to sellers around the world. Bitcoin owners simply “deposit” their bitcoins with the exchanges electronically, to be stored and retrieved upon request.
What happened at Mt. Gox should not have been possible because there should not be a way for anyone to liquidate 745,000 bitcoins without leaving a paper trail in the blockchain that records all transactions. The missing bitcoins simply could not evaporate…but they did and, until someone figures out how that was done, bitcoins cannot be considered safe. Customers have only two recourses: go back to the company with whom you have the problem, or try your luck in court.
Mt. Gox has been the target of several previous attacks. In June of 2011, a hacker invaded Mt. Gox computers and made off approximately $9 million in bitcoins. In February of 2013, a glitch froze the funds for several accounts for three months. Numerous other issues have plagued the operations of the company in the United States (US). The company curtailed withdrawals in US for three months. Other transactions often took more than three months to complete.
There is a Bitcoin Foundation, but it has no teeth because it lacks certifying or regulating authority.
The security of the bitcoin system, which is supposedly based upon the use of highly specialized and very expensive computer equipment to break the encryption codes, could easily be compromised by a rogue bitcoin miner using the same equipment to pilfer the system….or crash it. Access to individual coins could also be obtained by thieves stealing the actual physical device on which the bitcoins are stored.
The liquidation of bitcoins requires a partner who is willing to trade bitcoins for the local currency. The bitcoin exchanges are currently not legally obligated to report their transactions to taxing authorities, but their trading partners may be obligated by Apparent Theft at Mt. Gox Shakes Bitcoin Worldany individual country, but the people in the system remain subject to the laws of their nations and vulnerable to subpoenas for records. That was proven when the Department of Homeland Security seized Mt. Gox US-held assets because the Japanese company was not licensed by the US Financial Crimes Enforcement Network for operating as an unregistered money transmitter in the US.
On the basis of the way it was being run, Mt. Gox appears to have been a disaster waiting to happen. Based on the llaissez-faire business practices of the bitcoin industry as a whole, bitcoins may be 21st century snake oil. The Mt. Gox scandal may not be an outlier at all. It just might be a precursor.
By Alan M. Milner