Almost Half a Billion Worth of Bitcoins Vanish; Mt. Gox Says It Lost 750,000 of Customers’ Bitcoin to Fraud

Almost Half a Billion Worth of Bitcoins Vanish

Mt. Gox Says It Lost 750,000 of Customers’ Bitcoin to Fraud

ROBIN SIDEL, ELEANOR WARNOCK and TAKASHI MOCHIZUKI

Updated Feb. 28, 2014 7:16 p.m. ET

Mt. Gox CEO Mark Karpeles bows in apology at a news conference at the Justice Ministry in Tokyo.Associated Press

Mt. Gox, once the dominant exchange for bitcoin trading, on Friday said more than $470 million of the virtual currency vanished from its digital coffers, kicking into high gear a search for the missing money by victims and cybersleuths.

Bitcoin exchange Mt. Gox said it was filing for bankruptcy protection and that 750,000 of its customers’ bitcoins had been lost. Is the end of the crypto-currency or merely growing pains? Columbia Business School assistant professor Moshe Cohen discusses on MoneyBeat.

Acting alone and in groups, the people stepped up their efforts after Mt. Gox filed for bankruptcy protection in Japan and confirmed rumors it had lost almost 750,000 of its customers’ bitcoins, as well as roughly 100,000 of its own.

Mt. Gox Chief Executive Mark Karpelès said technical issues had opened the way for fraudulent withdrawals, though he didn’t provide details.

“There was some weakness in the system, and the bitcoins have disappeared. I apologize for causing trouble,” Mr. Karpelès said at a packed news conference at a Tokyo courthouse after the bankruptcy filing.

The disappearance underscores the risks of currencies that exist only online and aren’t backed by a central bank. Mt. Gox wasn’t overseen by national regulators, so there is no entity to step in and back investors’ deposits.

It wasn’t clear whether or how the missing bitcoins would be found. Bitcoin’s underlying software code, known in developer circles as “the protocol,” is believed to keep track of every transaction using a special marker that can be traced via an online ledger.

Unlike cash, which might be difficult to track if it is stolen from a bank vault and then widely dispersed, bitcoin transactions are logged in the ledger, which essentially can be accessed by anyone with a computer.

Some computing experts believed any hackers might be capable of covering the tracks of a potential computer break-in. But if each bitcoin has a marker, it would make it more difficult for thieves to try to convert a big stash into another currency, in the same way it would be difficult for an art thief to pawn off a pilfered Matisse painting quickly.

Those factors are giving hope to the wave of Mt. Gox victims and treasure hunters who have fanned out in search of the missing bitcoins. The virtual currency that disappeared represents nearly 7% of all bitcoins in circulation.

Devon Weller, a 40-year-old freelance Web developer in Nashville who said he had a “small amount” of bitcoins stashed at Mt. Gox, tossed aside his regular work Friday morning to start looking for missing bitcoins. He tapped into the public ledger from his home office and started following the trail of large transactions.

“I haven’t gotten very far, but it’s one of those things that is going to eat away at me,” said Mr. Weller.

The exchange’s bankruptcy filing capped a tumultuous stretch for the five-year virtual currency. One bitcoin traded at about $549 late Friday, based on the CoinDesk price index of two leading exchanges. The value of a bitcoin started 2013 at about $13, soared above $1,100 in December and has since lost about half its value.

The price swings have hit some investors hard. Fortress Investment Group FIG +1.40%LLC on Friday recorded an unrealized loss of $3.7 million from its purchase of $20 million worth of bitcoins last year. The asset-management firm held $16.3 million worth of bitcoins at the end of 2013, according to a filing with the U.S. Securities and Exchange Commission.

Mt. Gox halted customer withdrawals three weeks ago, saying a “bug in the bitcoin software” allowed some users to alter the ID on transactions and fraudulently claim that bitcoin transfers hadn’t been sent. Other exchanges also had problems but were able to provide patches so activity could resume.

Mt. Gox didn’t recover, and it shut down operations Tuesday.

The defunct exchange is the target of an investigation by the U.S. attorney’s office for the Southern District of New York. The scope of the probe isn’t clear, but prosecutors have subpoenaed the company, ordering it to preserve certain documents, according to a person familiar with the matter.

Mt. Gox also faces lawsuits from customers. On Thursday, a customer who claims to have $25,000 worth of bitcoins tied up at Mt. Gox filed a lawsuit seeking class-action status against the exchange. Gregory Greene, who filed the claim with an Illinois District Court, is seeking damages, an injunction, restitution and other remedies.

The claim alleges that Mt. Gox, its holding company and Mr. Karpelès are guilty of consumer fraud by engaging in “unlawful, deceptive, and unfair conduct that is immoral, unscrupulous, and causes substantial injury to consumers.” It claims Mt. Gox falsely represented to its customers that it would “protect their bitcoins and fiat currency and safely and quickly allow them to buy, sell, trade, or withdraw the same at any time.”

The company didn’t immediately respond to a request for comment.

Because Mt. Gox was unregulated, customers might not have much recourse unless they hunt down missing bitcoins on their own. By contrast, customers of MF Global Inc., a regulated brokerage, have nearly been made whole after they lost an estimated $1.6 billion in its 2011 collapse. U.S. customers who traded on U.S. exchanges have received about 98% of their funds, while U.S. customers who traded on foreign exchanges have received about 78%.

Federal regulators have encouraged bitcoin companies to follow money-laundering rules, but beyond that have generally been silent on whether they have legal authority to regulate companies like Mt. Gox in the future or set up rules that would protect bitcoin users. The Consumer Financial Protection Bureau and the Federal Trade Commission have held meetings in recent weeks to study the issue.

Market regulators including the SEC are still evaluating whether bitcoin falls under their jurisdiction. Agencies that oversee banks and payment systems are monitoring bitcoin, but Federal Reserve Chairwoman Janet Yellen said this past week that the Fed has no authority to regulate the virtual currency as long as it “doesn’t touch” banks the Fed oversees.

Bitcoin enthusiasts are teaming up to pursue the cybertrail of the missing cash. Among them is Charles Shrem, a prominent bitcoin advocate and entrepreneur who was arrested in January and charged with money-laundering in connection with his bitcoin company.

Mr. Shrem, who worked with four others, said they might have discovered 90,000 of the missing bitcoins that still appear to be in the Mt. Gox coffers, despite the exchange’s claim that the money is gone. He added, however, that it is a working theory and still speculative.

“We did it for the community,” said Mr. Shrem, who is under house arrest and has pleaded not guilty.

Gavin Andresen, chief scientist for the Bitcoin Foundation, a trade group, isn’t hopeful that amateur sleuthing will turn up the missing bitcoins. The best results, he says, might come from a far more traditional source.

“I wouldn’t be surprised, if there is a theft involved here, that eventually law enforcement does figure out, using the subpoena powers, where the bitcoins went,” he said.

But Adam B. Levine, who worked with Mr. Shrem, said he is optimistic. “There’s lots of threads to follow, and if you start pulling on one thread, it exposes another, and eventually you start building a map,” he said.

Mr. Levine, a writer at Letstalkbitcoin.com and a self-taught bitcoin sleuth, said his team formed its plan during “a 36-hour Skype call.”

He was supposed to appear at a conference on March 6 but has decided to cancel his appearance.

“I should been preparing to give my speeches,” he said, “but this thing is taking all day.”