Fraud at this Chinese bitcoin exchange cost clients $4.1M. Here’s why the broader market barely noticed

Fraud at this Chinese bitcoin exchange cost clients $4.1M. Here’s why the broader market barely noticed

ON NOVEMBER 11, 2013

Bitcoin has come a long way in the last year, but it’s still the wild west in terms of regulation and market stability. China, too, has come a long way economically in recent decades, but remains largely unregulated and could be described as the wild east. So it’s not surprising that the recent surge in popularity (and price) of bitcoin in China would be accompanied by fraud.The latest news came earlier today when Taiwan’s Want China Times newspaper reported that Chinese bitcoin exchange GBL shut down unexpectedly on October 26 and took ¥25 million ($4.1 million) worth of client funds along with it. The surprising end to this saga may not have been so shocking had GBL’s 1,000 plus users taken note of multiple red flags that popped up in the company’s short history.

Ultimately, this incident is a black eye for the bitcoin community. While it may negatively affect other small, unproven companies looking to find a foothold within the larger bitcoin ecosystem, it shouldn’t have a significant or lasting impact on bitcoin as a whole.

Bitcoin’s has been surprisingly stability in the face of several far more prominent and potentially destabilizing incidents recently, including, the US Department of Homeland Security seizure of Mt. Gox bank accounts and the FBI’s shutdown of digital black market Silk Road. Similarly, it will take more systemic threats than a single, and relatively small rogue exchange to take down Bitcoin. Seemingly proving this point, the price of Bitcoin is up in most markets today. Mt. Gox opened the day at $345 and is currently trading above $360 as of 3:45pm PST. Closer to home for GBL clients, BTC China – now the world’s largest exchange – opened the day at ¥2,120 (~$348) and has climbed to ¥2,230 (~$366).

Now onto those red flags. GBL was founded in May 2013, just six months before its shut down. The service was initially marketed as a Hong Kong-based exchange targeting mainland China consumers, presumably in an effort to instill consumer confidence. Digital detectives quickly uncovered the fact that the company’s servers were, in fact, based in Beijing, posting this information to a Chinese language BitcoinTalk forum. A subsequent report from the Southern Weekly Chinese newspaper notes that GBL registered with Hong Kong authorities on June 10 but was never granted a financial services license.

So this was an entirely new company, that misrepresented its country of origin and was unlicensed to do business in any relevant jurisdiction. Not a good start.

To be fair, many bitcoin exchanges based or operating in the US operate in a similar state of regulatory ambiguity, a fact that, for example, saw Tokyo-based Mt. Gox have its US-based bank accounts seized by the US Department of Homeland Security for failure to register as a Money Transmission Business (MTB). But Mt. Gox was always transparent about its domicile and simply claimed that it did not qualify as a MTB under US law, and was thus exempt from registration – authorities obviously disagreed. GBL’s deception should have sent a more troubling message to potential exchange clients, had they been diligent (and skeptical) enough to uncover this fact before turning over funds to the young company.

Coindesk reports that in September GBL started issuing stock to its clients (presumably shares in GBL, although this is unclear) in lieu of cash redemptions, speculating that this may have been in an effort to maximize the cash it could retain before ultimately shutting down. Yet, for several weeks leading up to the late October shutdown, it appears that there were no police reports filed and users continued to transact on GBL. Only after the shutdown did a subsequent investigation by burned GBL clients and Hong Kong authorities reveal that the address the company listed on its website was a fake.

Consider that a posthumous strike three against a company that was already ejected from the game for unsportsmanlike conduct.

It’s unclear at this point exactly what type of scam GBL was running. Was the company a Ponzi scheme in which its founders pocket most or all of the $4.1 million in missing client funds, or was it just a poorly run (and somewhat deceptive) business that operated at a deficit and quickly ran out of funds, taking some clients down with it? Neither answer is good for the affected clients, but the former is obviously more nefarious than the latter. Regardless, given the difficulty in identifying the owners of bitcoin wallets, it’s hard to imagine a scenario where GBL clients are repaid.

The above forum that first raised questions of GBL’s integrity now reads in bright red letters, “版主HorseRider警示:小心骗局,” or “Moderator HorseRider warning: Be careful scam.” GBL is hardly the first scam to affect the bitcoin market. Another BitcionTalk thread started in May 2012 features an ongoing list of 30 such “Major Bitcoin Heists.”

The key takeaway from this and other incidents like it is that while bitcoin might hold great long term potential as an alternative currency, it’s still a buyer beware environment. Like cash, once the cryptocurrency is exchanged, there are no charge backs or refunds. It’s up to consumers to determine the reliability of any counterparty, including exchanges. At the same time, it’s up to each individual country and jurisdiction to outline a regulatory framework under which virtual currencies must operate. Hong Kong has yet to enact such regulation, meaning that GBL’s victims may have less legal recourse than they would in other jurisdictions.

The US, while vocal on the need for bitcoin exchanges doing business in the country to register as MTBs, still faces its own uncertainties. The US Senate Committee on Homeland Security and Governmental Affairs will meet on November 18 to discuss bitcoin and other cryptocurrencies. While a step in the right direction, this hearing is at the same time a reflection that there is much progress to be made in regulating bitcoin. Other US agencies like the Securities and Exchange Commission(SEC), the State Department(s) of Financial Services, and Department of Homeland Security have also each weighed in, adding further complexity and uncertainty to the situation.

We’ll keep an eye on the GBL saga to see how it unfolds in the coming weeks. Hopefully, those affected find some resolution, be that a return of their missing funds or those responsible put to justice. But bigger picture, bitcoin steams ahead with nary a ripple. As hard as it to believe, this risk premium is widely understood by sophisticated bitcoin investors and has largely been priced into the market.

In some sense this is disconcerting, but it’s also an indication that bitcoin is a large and rapidly maturing marketplace. There will be more incidents of fraud in the future, just as there are around credit cards, cash counterfeiting, stock market manipulation, and other long-standing financial markets.

As famed thief “Slick Willie” Sutton famously answered when asked why he robbed banks, “Because that’s where the money is.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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