The curse of Mt Gox

What caused the great crypto crash of 2018?

An exchange going bankrupt in 2014.

The exchange in question is the infamous Mt Gox. And four years after it first tanked Bitcoin markets, the curse of Mt Gox is back – with a vengeance.

Is the bloodletting now over? Well, that remains to be seen. But the signs are hopeful.

In today’s essay I’m going to explain exactly what happened, and then you can make up your own mind.

How a 2014 bankruptcy case tanked crypto markets in 2018

Crypto markets run on speculation and hearsay.

If you’ve read my FOMO vs FUD essay, you’ll know it’s unusual to be able to point to a direct cause for anything. But that all changed on Wednesday.

This Wednesday court documents were released from the ongoing bankruptcy case of Mt Gox, which started back in 2014.

If you’re not familiar with Mt Gox, it was the world’s biggest Bitcoin exchange back in 2014. It was badly run and it got hacked. The hackers got away with 740,000 Bitcoin.  Six percent of the total bitcoin supply at the time, worth an estimated $570 million.

At today’s prices – even after the crash – those 740,000 Bitcoin are worth $7.4 billion. At Bitcoin’s all-time high, back in December, they were worth double that.

Some of those stolen bitcoin were recovered after Mt Gox went out of business. And therein lies the problem. A problem, it turns out, that was big enough to wipe half a trillion dollars off the crypto market.

Surely recovered funds are a good thing, though? Not in this case. As you’ll see, they would have been better off staying with the hackers.

A lawyer walks into the crypto market…

Mt Gox was hacked and bankrupt in February 2014. This one incident tanked Bitcoin and forced it into obsolescence for over two years.

On the day Mt Gox suspended withdrawals – 7 Feb 2014 – Bitcoin’s price was $725. It didn’t hit $725 again until 16 June 2016.

Now the curse of Mt Gox is back. And thanks to how the legal system works, it may have some way to go yet.

So remember those recovered Bitcoin? There are 200,000 of them, currently worth around $2 billion.

In the bankruptcy case against Mt Gox, the creditors are asking for around $400 million.

So, between December and February the court trustee for Mt Gox decided to sell enough of those recovered Bitcoin to pay off the creditors.

Here is the part of the court report that states it (emphasis mine):

Sale of BTC and BCC Between the 9th creditors’ meeting and this creditors’ meeting, with the permission of the court, I sold a certain amount of BTC and bitcoin cash (“BCC”) that belonged to the bankruptcy estate. The quantities sold and the amount paid into the bankrupt trustee’s account are shown below.

As a result of the consultation with the court, I considered it necessary and reasonable to sell a certain amount of BTC and BCC at this point and secure a certain amount of money for distribution resources, and thus, I sold the amount of BTC and BCC above.

I made efforts to sell BTC and BCC at as high a price as possible in light of the market price of BTC and BCC at the timing of sale. I plan to consult with the court and determine further sale of BTC and BCC.

And here’s a link to the full report if you want to read it for yourself.

Mt Gox comes back from the dead to take one last swipe at crypto

Because of the nature of blockchain it is possible to track down the exact wallets the trustee used and see when the sells came in.

And boy, did the trustee time their sells well…

Reddit user, riverflop handily mapped the sells and their amounts against the Bitcoin price chart. You can see it below (click for bigger image).

Source: reddit, riverflop

The first sale comes in at Bitcoin’s all-time high on 18 December. And every subsequent sale take place when Bitcoin hits a major support level.

If you’re trying to maximise your money with huge sells in a very short amount of time, this is the way to do it.

Just look at that chart. I know charts aren’t usually the most exciting of subjects, but this chart solves a huge piece of the puzzle on why Bitcoin has tanked.

Yes, it was overbought, and yes its price ran up very fast. But, this was the trigger that made it crash. There is no doubt about that.

The Korean ban FUD and the Chinese New Year FUD and the Bitcoin futures FUD and the India ban FUD all helped. But the root cause was Mt Gox’s lawyer.

Now, you may be wondering how $400 million of sells can tank an $800 billion market. It’s actually a lot easier than most people realise.

The truth about market caps

If you’re not familiar with what a market cap is, it’s the total value of any given asset. It is calculated by taking the circulating supply of something and then multiplying that by the cost of one unit.

So, for instance, right now:

  • Bitcoin’s price is $10,000.
  • There is a circulating supply of 16,907,237 Bitcoin.
  • So Bitcoin’s current market cap is $169,072,370,000 (10,000 x 16,907,237).

This is the same way you work out the “value” of a public company like Google or Amazon.

But here’s the thing. A market cap doesn’t represent actual money in the market. It is the circulating supply times by the last buy/sell price.

So, let’s say that someone really wants 5 bitcoin. They are willing to pay over the current going rate to get their purchases through.

So they go onto a big exchange and instead of $10,000 per coin, they end up paying $15,000. Don’t forget, they can only buy if people are selling, and the sellers see a big order come in and jack up their prices.

The price of Bitcoin on that exchange is now $15,000. That is what it’s selling for. That’s what people are now willing to pay.

So if you want to buy Bitcoin, you now must pay the going rate of $15,000 per bitcoin.

The whole market cap of Bitcoin just jumped by 50%. It’s now worth $253.6 billion.

No one has added an extra $84 billion of cash into the market. The value of the Bitcoin sold to push up this price was nowhere near that. It was only $75,000.

So, you can see how $75,000 of buying can boost a market cap by $84 billion.

Obviously, the jumps aren’t this sudden in real life, and this is an extreme example. But that is how they work, just with much smaller increments.

Now, sites like aren’t stupid. The way they calculate the market cap of any given crypto is by averaging prices through a number of different exchanges.

But the thing is, all exchanges will have very similar prices.

There are thousands of bots making hundreds of thousands of trades a minute trying to take advantage of the price difference between exchanges.

So if a big sell order comes in, and send the price down on one exchange, it will also affect all the other exchanges within minutes.

This entire process works exactly the same the other way. So a few sells can seemingly wipe billions off the value of a crypto.

How much cash is really in the crypto markets?

Now we know the market cap isn’t really how much money is in any given crypto. That leads us to the question: how much of the market cap is actual money?

That’s a question a bit beyond my scope today, but thankfully, not beyond JP Morgan’s.

Last year JP Morgan calculated that $6 billion of cash inflow resulted in a $330 billion market cap.

As Zero Hedge reported in December 2017:

As JPM explains, “high trading volumes or market cap does not mean that the net flow directed into cryptocurrencies has been equally big.

Here is the bank’s punchline: “The net flow into cryptocurrencies is very much a function of coin creation which is controlled by computer algorithms and in the case of bitcoin is diminishing over time. 

Figure 6 (below) shows the net amount of money invested every year since 2009The cumulative amount has totaled around $6bn since 2009, well below the current market cap of $300bn.

For Ethereum, the number is just as stark: with a market cap of $45 billion, net inflows have been under $2 billion in the past two years. This is shown in the chart below:

If JPM is right, the implications are staggering:  contrary to expectations that bitcoin’s market cap is a rough reflection of its inflows, JPM’s calculations reveal that a mere $6 billion in net inflows since 2009 has resulted in a market cap of $330 billion.

This goes to what Mike Novogratz said last week when he said that cryptos are unique, because unlike all other asset classes, there is no corresponding increase in supply when prices surge.

This also means that as new capital flows into the crypto space as more retail and institutional investors scramble for “a piece of the pie”, the potential market cap gains are unprecedented

Going off JP Morgan’s research, we can see that the ratio of cash inflow to market cap is about 50:1.

So, at crypto’s peak of around $800bn, there was probably only really around $16bn in the market.

We can also see that flooding the market with another $400 million worth of Bitcoin would (and did) have a massive effect on Bitcoin’s price, given that there was only really around $6.6 billion in Bitcoin at the time.

And now for the final piece of the puzzle.

Why are all cryptos dragged down when Bitcoin crashes?

It’s clear that the curse of Mt Gox was the main reason behind Bitcoin’s recent bear market. But why did Bitcoin drag all other cryptos down with it?

This one is fairly simple. Most cryptos can only be bought using Bitcoin. Say you want to buy crypto x (not a real crypto, it’s just an example). In order to get crypto x, you need to first buy Bitcoin and then trade it for crypto x.

Right now, most crypto exchanges work this way. Bitcoin is the “base pair” not dollars or GBP.

So, let’s say crypto x is trading for 0.5 Bitcoin. And Bitcoin is worth $10,000.

Bitcoin then crashes to $5,000. Crypto x is still trading for 0.5 Bitcoin, but that 0.5 Bitcoin is now only worth $2,500.

This is a very simple example, but that’s basically how it works.

That’s why when Bitcoin crashes it takes everything down with it. When there are more “on ramps” into crypto, it won’t be such a problem.

In fact, most exchanges now let you use Ethereum as a base pair instead of Bitcoin.

However, the fact Bitcoin is a base pair isn’t the only problem. There is also psychology to take into account. When people see the Bitcoin market crashing, they know what’s coming for all the other coins and start to sell them too. This is self-perpetuating.

So it’s going to be hard for the market to break free of bitcoin’s chains, even with more base pairs becoming available.

In the long run, I am fairly sure Ethereum, or another platform crypto will take over the number one spot. And that will be good for the market overall. But in the meantime, it’ll be a bumpy ride.

That explains the December-February crash, but what about the crash this week?

Even though the Mt Gox trustee hasn’t sold since February, the market is still tanking. On Wednesday it took a massive hit. Why?

A couple of reasons.

  1. News of the Mt Gox fiasco came out and scared people.
  2. Binance, probably the most trusted exchange out there, was “hacked”.

It turns out Binance wasn’t actually hacked after all. You can set up your Binance account so third party apps can trade for you. This is how bot trading works. And it turns out one of these trading bots was compromised and started selling people’s crypto.

Binance quickly suspended withdrawals and revered all the fraudulent transactions. No ne ended up losing out in the end. But the news that “Binance was hacked” spread like “I can’t believe It’s not butter” and people panicked.

Here’s a statement by Binance explain what happened in more detail.

The funny thing is, the hackers actually lost money and Binance is now donating that money to charity.

People fearing a market crash turned into those same people accidentally causing an actual market crash – as it usually does. And that’s where we are today.

It doesn’t help the Binance “hack” happened right after the curse of Mt Gox resurfaced. FUD breeds FUD and so it all snowballed.

Okay, but doesn’t that Mt Gox trustee still have 166,000 Bitcoin left to dump?

That’s right. The Trustee still has 166,000 Bitcoin in their possession.

What will happen to them? It depends on the court ruling. But in a cruel twist of fate, the guy who ran and bankrupted Mt Gox, leaving thousands of people out of pocket, may get them.

Under Japanese law – where the case is happening – after the creditors have been paid off, any remaining funds go to shareholders.

And who was Mt Gox’s biggest shareholder? A company called Tibanne.

And who owns 100% of Tibanne? Mark Karpeles.

Mark Karpeles was also Mt Gox’s CEO at the time of the hack and bankruptcy. The bankruptcy case is against him.

So, although thousands of people who used the exchange and lost millions of dollars in the hack will likely never get a penny Karpeles, may well get $1.66 Billion.

Isn’t corporate law great.

Right now there is a movement going on to try get that money back to the actual people who had accounts with Mt Gox at the time of the hack. Here’s a link to it.

I’ll let you know what comes of all this, and what actually ends up happening, when it is all resolved.

On the positive side, the creditors have now collected all the money owed to them, and the Mt Gox trustee hasn’t dumped on the market for over a month.

The trustee didn’t intentionally set out to tank the market, they simply set out to get $400 million by selling as many Bitcoin as it took.

They sold at the times that would give them the biggest return for the smallest amount.

They didn’t set out just to tank the market. But by the same token, they knew their actions would tank the market. They simply didn’t care about what happened to anyone but Mt Gox’s creditors.

The hackers, or even Karpeles himself would never be so stupid as to flood exchanges with such a high quantity of Bitcoin in such a short space of time.

The correct way to do it would have been to make a private sale or auction, like the FBI does when it confiscates large quantities of Bitcoin.

It was completely idiotic to try sell all of those Bitcoin through exchanges.

It’s quite funny that this case has probably caused more damage and harmed more people than the original hack ever did. But the powers that be don’t care about fairness or the general public. They only care about corporate interests.

What does this mean for the future of crypto?

The best thing to come out of this whole affair is closure.

It is now clear what precipitated the great crypto crash of 2018. As I said, there were other factors too. But this was the fundamental cause.

Now that the creditors are been paid off, the dumping should stop. And now that everyone knows why the dumping happened, it’s not so scary anymore.

It’s like in a horror film when you finally see the monster and it stops being scary. The monster is now visible for all to see, and it was the ghost of Mt Gox.

If you still believe in the fundamentals of crypto, and if you still believe this technology will be world-changing, all this has done has created a huge discount on prices.

Nothing fundamental has changed. Perhaps, Bitcoin has been shaken a bit, and there is the question of too many Bitcoin being held in the hands of too few people.

But other cryptos, like Ethereum and other platform cryptos, should come out of this whole debacle very well.

What do you think of the curse of Mt Gox, has is shaken your confidence, or are you still “bullish”. Let me know:

Until next time,

Harry Hamburg
Editor, Exponential Investor

PS If you need a little cheering up, there’s a great Johnny Cash spoof someone made on YouTube about the recent crypto crash. It’s called, hodl. You can watch it here.

PPS Please forgive the likely large amount of typos in today’s essay. As you can see, it was a lot of writing and researching to do in one work day. And to add to that, our proof reader is away on holiday this week.

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Category: Cryptocurrency

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