Nine months ago in a Q&A session after my talk on Bitcoin, I was asked by someone from the audience how can Bitcoin be considered decentralized when only one exchange is in control of the price. The question was not strictly correct, because though MTGox — Japan based Bitcoin exchange that allows users to trade Bitcoins for US Dollars and several other currencies — certainly held overwhelming majority of Bitcoin/USD trade, it could not control the price, but I had to I agree with the sentiment there. Major problem of the Bitcoin ecosystem back then was, that whole world, from online services to media were looking at MTGox for the price and it was virtually the only place providing the liquidity for those who were in need of an exchange. We all were too exposed to risks connected to MTGox’ stability and liquidity.
Times changed and the combination of MTGox’ unfortunate position under the spotlight of US regulators leading to those stealing millions of dollars from MTGox’s accounts, breakdown of their partnership with convenient payment processor Dwolla, the constant staff shortages and series of technical issues lead to MTGox losing their majority of Bitcoin exchange volume. This was good news for everyone and by itself not necessarily bad news for the oldest exchange. It didn’t mean MTGox lost it’s business, it simply meant the cake has grown much bigger and they didn’t get much from that growth as traders used exchanges which were closer to them regionally or simply offered more reliable and seamless service.
Ongoing issues of MTGox dollar withdrawals lead to large spread between price of Bitcoin on MTGox and other exchanges when people were willing to pay premium for bitcoins on MTGox and transfer them to other exchange rather than wait for weeks or even months for their dollar withdrawal request to be processed.
This has changed in the last two weeks.
Backlog of Bitcoin withdrawals from MTGox started to pile up at the beginning of February, culminating at $50M worth of coins stuck in limbo. This lead to (as many times before) to speculations about MTGox’ liquidity and triggered big drop in price even before MTGox announced temporary hiatus in Bitcoin withdrawals on Friday, February 7th. When the update was given after the weekend on February 10th blaming “Bitcoin core bug”, price went down even further as some assumed there is really a fundamental problem with Bitcoin protocol many had feared for years and others simply assumed MTGox is going bust and is just looking for excuses. As one bitcointalk post noted, many traders realised, that if MTGox really goes down, they might get a better chance getting their funds in dollars, as it might take a lot of head scratching for any judge to decide how they should get compensated for bitcoins. As a result, all major Bitcoin indexes have dropped MTGox price from their weighted average.
The bug – or rather several bugs with similar implications – has been known since 2011 and it allows rare, but possible instances when Bitcoin transaction can be re-created with the same parameters (like inputs or “sending addresses” and ouputs or “receiving addresses”, amount, etc.), but different hash identifying the transaction in the public ledger – block chain. If this other transaction gets included in the block chain first, the original one is rejected and can appear as invalid by the originating wallet and integrated accounting software. It has to be emphasized, that this could not cause any double spending, false balances or lost funds, but it definitely could cause a lot of headaches for accountants. While it was from the most part solved in later versions of reference Bitcoin client, many exchanges and payment processors including MTGox use their own implementations, which might vary in their ability to cope with this issue.
The new transaction could have been created with good intentions automatically by other wallet to fix one of those known issues or by someone intentionally attempting to invalidate the original transaction and to point that one out to MTGox and ask for his funds to be sent again (which was apparently happening and causing MTGox some losses).
To add insult to an injury, what followed was a massive DDoS attack on Bitcoin block chain when a – quoting FYBSG – douchebag bot started creating these duplicated transactions resulting in a hiatus of Bitcoin withdrawals on most major exchanges around the world for several days.
As of now, things are getting back to normal after exchanges re-opened withdrawals. The only one whose fate is uncertain is MTGox itself. Though several well informed major characters of Bitcoin community have expressed their belief, that MTGox is liquid, price of Bitcoin on that exchange collapsed to as low as $100 dollars at the end of last week. It has recovered a bit in the meantime, but is still trading at one third of the global price, indicating market is placing 70% risk on MTGox insolvency. If MTGox will indeed recover and allow automated withdrawals, many of those who bought near the bottom are in for a nice ride – including a good friend of mine (un)lucky enough to have had some funds there and whom I advised to buy – because in that case, they will be in the same situation as before the halt when people were willing to pay premium just to get the funds out. If that premium would be the same as before, that would mean roughly 400% increase in the price on MTGox and 300 per cent to other exchanges almost instantly.
Also Read: Why Bitcoin cannot afford to be unregulated
Though MTgox has recovered from many major blows in the past, this one seems be the final one which could send it to irrelevance. It’s hard to imagine for users to keep their funds with “gox” once it allows automated withdrawals unless they would be hungry for the potential fiat (USD or JPY) profit from the returned premium. Indexes would also not be overly happy to include MTGox back because it was distorting the price even before this fiasco and this could be a good excuse to leave it out. MTGox’ communication handling of this issue was disastrous, escalating with users protesting in front of their HQ in Tokyo (to which MTGox reacted the worst possible way – by moving their office) and petition for ousting of Mark Karpeles from Bitcoin Foundation board and his own resignation on Monday.
This whole episode reminds us, that Bitcoin is still very new technology with flaws, but also shows, how quickly and decisively free market with no regulations deals with such issues. MTGox hasn’t been delivering for some time and since there are no regulatory barriers of entry for new players, competition emerged and provided more choice, better services and lead to less volatility. That competition was able to handle this issue in days and users will remember which services did not even have to halt their operations because their software architecture was ready for such events. It shows how antifragile whole Bitcoin ecosystem is since every new crisis makes it more resilient and more error-prone. It shows, why Bitcoin is so ingenious, is here to stay and ready to grow further.
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