Mt. Gox hack: The full story of a fallen giant

Mt. Gox, which represents Magic: The Gathering Online Exchange, was a crypto exchange situated in Tokyo. It functioned from 2010 to 2014 and handled more than 70% of all Bitcoin transactions by 2013. However, in 2014, it petitioned for financial protection in Tokyo and the USA.

Initially, it was a site where card game fanatics, “Magic: The Gathering,” could trade their cards on the internet. In 2007 programmer Jed McCaleb bought the mtgox.com domain, then in 2010, he changed it to a Bitcoin market. In March 2011, he sold it to Mark Karpeles in return for a half year’s earnings.

The Trouble Begins

The exchange suffered two distinct hacks, one in 2011 and another in 2014. The first one in 2011 was minor and controllable. Hackers gained access by hacking into one of the auditor’s records and stole private keys to the hot wallets from the wallet.dat file.

Through their acquired administrator privileges, the hackers could randomly allocate themselves a significant number of Bitcoins. They sold the Bitcoins, which caused a value decrease from 17 USD to 1 cent. Thus, selling about 650 BTC to Mt. Gox clients. Afterward, they pulled out almost 2000 BTC.

Additionally, the Mt. Gox organization was reasonably handling the hack. Mark Karpeles delivered a proclamation revealing insight into the hack and the recuperation strategies and processes. Moreover, the recovery activities included compensation for the 2000 embezzled Bitcoins and moving an ample amount of BTC into cold wallets. It recovered and went on to become the top-notch Bitcoin trading platform in 2013.

Regardless of its achievement in 2013, Mt. Gox was facing internal challenges. For instance, in May 2013, Coinlab, which operated in the United States on its behalf, slapped it with a lawsuit. It had breached the contract by offering direct service to American clients. Also, their failure to convey fundamental data formed an extra clause to the accusation. Thus, Coinlab sought $75M from Mt. Gox. Later that year, the US authorities demanded that Mt. Gox paid a fine of $5M for carrying on financial operations without a permit.

750K BTC Stolen, accounts frozen for 10 days

In 2014, Mt. Gox suffered its first significant crypto hack. It started with the deficiency of more than 850000 Bitcoins. From the total amount, 750000 Bitcoins belonged to Mt. Gox investors. Some reports revealed that the hackers used the credentials obtained from the initial hack.

The attackers introduced a bug to the operating system that made it possible to modify the exchange IDs. Subsequently, customers experienced problems pulling out assets, and the organization experienced issues getting a handle on exchange subtleties. They couldn’t tell whether Bitcoins got transferred to customers’ digital wallets.

To comprehend what was happening, Mt. Gox closed all Bitcoin trading activities on February 7, 2014. They froze all the accounts and stopped operating for ten days, after which they distributed an explanation. They proclaimed to have solved the matter, and they were in the process of addressing the misfortunes and resume business. However, that was far from the truth. Toward the month’s end, Mark Karpeles left the establishment.

On February 7, 2014, the exchange blocked Bitcoin withdrawals and deactivated the website on the 24^th day of the same month. Additionally, the exchange was declared insolvent four days later. The following month, it petitioned for financial protection in the United States. Consequently, it filed for insolvency and selected the prolific lawyer Nobuaki Kobayashi as the administrator for liquidating Mt. Gox’s resources as the insolvency agent.

Subsequent Legal Proceedings

After declaring financial insolvency, creditors including Coinlab petitioned for compensation claims. Coinlab demanded $75M from the 2013 lawsuit for breaking the contract agreement. During the bankruptcy procedures, some creditors documented a request for civil recovery against Mt. Gox. Subsequently, the Tokyo based court stopped the bankruptcy proceedings, granting the appeal the opportunity to start civil restoration procedures. As a result, the creditors had to reapply their claims. However, Coinlab didn’t make a fresh application but upped its previous one to 16 billion USD.

When the insolvency procedures began on March 20, 2014, Mt. Gox affirmed that they had recovered about 200,000 BTC in the old-style wallets. However, Mt. Gox could still not account for 650,000 BTC. There were suspicions that the exchange was not cautiously observing the cold wallets. Hence, making it easy for hackers to intrude and move funds into hot wallets.

In 2019, McCaleb was accused of negligence and fraud. The accusation comprises cases of giving false information about the exchange and keeping the site’s security issues away from the public. Moreover, in the same year, crypto mogul Brock Pierce started a movement called Gox Rising. It aimed at lending a helping hand to Mt. Gox’s creditors to hand in a civil restoration proposal to the Japanese Court. The movement still had another idea of bringing Mt. Gox back to its feet.

Over time, the restoration cycle has endured many augmentations. Towards the start of 2020, the restoration plan was due on March 31, 2020. But then the court prolonged the submission deadline to July 1, 2020. The court later pushed it to December 15, 2020. The reason given for the shift of the deadline was that Kobayashi had asked for more time for the recovery strategy.

The Court Cases Against the Suspects

Three years after the mysterious hack of Mt. Gox, the US authorities released a statement that they believed Alexander Vinnik, a cyber scammer of Russian origin, was involved.

The United States grand jury charged Vinnik for concealing money sources and running a currency business without a permit. According to the jury, Vinnik was the digital currency recipient from the hacks and had covered the money trails through other exchanges. The jury claimed that he used the BTC-e and Tradehill crypto exchanges in the laundering process.

Through his attorney, Vinnik pleaded not guilty to the charges. He served a brief jail term in Greece in 2017. What followed was extradition to France, where the court sentenced him to five years in jail for Bitcoin laundering.

Mt. Gox’s CEO at the time of its hack, Mark Karpeles, was also suspected of having had a hand in its mysterious slump. The Japanese government arrested him in 2015. The judges handling his case accused him of stealing funds and malicious alteration of financial data.

Karpeles Transfers $3 million

The court provided a detailed explanation of how he accessed Mt. Gox’s server and increased the amount in his account by 1 million USD. The court further accused Karpeles of initiating a 3 Million USD transfer from an account holding investors’ money to his own in the last quarter of 2013.

Although the Karpeles attorneys didn’t dispute the transfer, they were against the idea that the transfer amounted to misappropriation.

Karpeles swore in God’s name that he was innocent. The court later released him on bail in 2016.

In March 2019, he was proven guilty of the data manipulation accusation but not guilty on the other charge of funds misappropriation. The partial guilty indictment earned him a suspended jail sentence of two and a half years.

Nobuaki Kobayashi’s Involvement

In April 2014, a Tokyo based court gave the green light for the liquidation of Mt. Gox. It had submitted a petition to be declared bankrupt, claiming it was crumbling under a financial burden of 64M US dollars in liabilities.

Soon after the early 2014 hack, the exchange had pondered restructuring through civil rehabilitation but suddenly discarded that idea and sought liquidation.

Nobuaki Kobayashi, an experienced bankruptcy lawyer from Japan, was nominated by the same court to fill a trustee’s slot in the insolvency procedures.

One of Kobayashi’s primary tasks was to supervise the repayment of Mt. Gox creditors. However, there was an initial preparation phase of soliciting and reviewing the creditors’ claim applications. The court also expected the lawyer to bring to record all assets belonging to the dysfunctional exchange.

The court also expected him to manage the assets during the insolvency period. In so doing, the final value payable to creditors would be protected and kept as high as possible.

Kobayashi took up the responsibility of holding bi-annual meetings to update the creditors waiting to process their claims. The trustee had the first session in July 2014. Besides the meetings, he also provides online reports on the milestones reached in the process.

The lawyer also took charge of Mt. Gox’s website’s administrator duties. He uses it to update its investors on the liquidation process.

Moreover, in a bid to safeguard Mt. Gox’s assets, the lawyer asked the same court to declare Tibanne Ltd. and Mt. Gox’s former CEO Karpeles bankrupt. Mt. Gox Ltd. was a subsidiary of Tibanne Ltd.

Kobayashi Holds 150K Bitcoins

An estimated 150,000 BTC is in the lawyer’s custody for the refunds. However, he is yet to pay any creditor. Speculations were rife that the claimants would receive partial or full refunds of October 15, 2020.

Five years later, he is yet to complete the exercise of refunding Mt. Gox’s investors their lost funds but instead asked for two more months from October 14, 2020. The creditors anticipate Kobayashi to give a progress report on the repayment plan on December 15, 2020.

The Mt. Gox Creditors

The submission deadline for creditors’ claims was on March 31, 2020. However, it took Kobayashi two years to conclude the review process in May 2016. The evaluation procedure was vital to get rid of those applications that failed the legitimacy test.

The accepted applications totaled 24,750. The total claim value was equivalent to 432 million USD. In a move that angered the creditors, the trustee chose to price the Bitcoin at its historical value of 483 USD. That is the value of a single BTC when the exchange went down in 2014. Currently, the value of a single Bitcoin has out-grown that value by more than ten times.

Although Kobayashi has managed to recover cryptocurrency valued beyond 1.6 billion USD, the ratified claims are stuck at 400M USD based on the historical April 2014 value of 483USD for a single Bitcoin. The harsh restriction from Japanese law requires creditors to get paid at the value just before a company’s liquidation.

Claimants to Get 3X More

The restriction means that they will only get a small share of the retrieved money, which is enough to pay each claimant three times more than what they applied.

According to the same law, the surplus after paying the creditors’ refunds belongs to the shareholders. 88% of Mt. Gox’s shares belong to Tibanne, and the remaining 12% by an anonymous shareholder.

However, Mark Karpeles, the former CEO of the exchange, owns all the shares in Tibanne.

Some investors are irked because Karpeles stands to receive the lion’s share of the surplus. Some creditors believe he was behind the hack. He has been attending court proceedings in Tokyo on the accusation of stealing funds belonging to the exchange and changing accounting figures. He, however, didn’t plead guilty to the charges leveled against him.

Karpeles himself said that he doesn’t want the share since he is wary of plunging himself into more lawsuits.

The Delayed Refunds

A series of court cases leveled against the Mt. Gox estate have delayed the creditors’ repayments.

For instance, Peter Vessenes, the pioneer of United States Company Coinlab, filed a 16 billion USD claim, surpassing what each creditor has applied for in their claims.

The dispute possibly arises from a 2012 Coinlab versus Mt. Gox partnership. The latter granted the former its rights to the US and Canadian investors. However, Coinlab failed to secure permits to run businesses in the said regions, thus failing to honor the contract.

Karpeles had earlier claimed that the creditors would be very lucky to receive their refunds before 2020.

Although his projection has already turned out to be accurate, 2020 seems to provide some hope. In the same year, the lawyer released a statement that the repayment plan will assume a formal liquidation process. According to Kobayashi, the creditors would get their payments through BTC, BCH, and Yen currencies.

If the trustee pays refunds through cryptocurrency, creditors will need to sign up for wallets on a crypto exchange.

It’s now approximately two years since the court gave a green light for the exchange’s civil rehabilitation. The plan was to pay investors in the cryptocurrencies they held when bankruptcy took place rather than the corresponding cash value.

However, by now, no creditor has received any payment. Unfortunately, it is still uncertain when the trustee will pay them.

Though some creditors endure the frustratingly slow goings-on, some have run out of patience and traded their claims at a lower value.

The Sold BTC and BCH

Between March and September 2018, Kobayashi traded off some of Mt. Gox’s coins in exchange for fiat currency while the price was still high. The number of Bitcoins liquidated was 24,658. On the other hand, the figure for Bitcoin Cash was 25,331.

The trustee got approximately 230 million USD from the sales. After the sale, the trustee’s account had secured an optimal amount of money to live up to its obligation to protect Mt. Gox’s investors’ interests.

Conclusion

Though promoters of Bitcoin argue that the falling apart of Mt. Gox is an isolated case, one cannot refute that the downfall of the exchange marred the reputation of cryptocurrencies.

With the creditors enduring a painful wait for their refunds due to ever-shifting deadlines, the final destiny of Mt. Gox is hard to predict. Moreover, with the number of legal suits against the exchange, it remains unclear what the creditors will take home.

Once paid, there is the worry that many creditors will rush to sell their Bitcoins and crash the market. For this, we also have to wait.

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