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There's a Bank Run on Bitcoin. Here's Why Customers Will Never Get Their Money Out of Mt. Gox

By John Maxfield - Feb 24, 2014 at 12:34PM

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Yet another piece of bad news hit the bitcoin market this weekend. What does this mean for investors in the virtual currency?

The homepage for Mt. Gox proclaims its customers can "trade with confidence on the world's largest Bitcoin exchange." The only problem, of course, is that beginning last summer, Mt. Gox is no longer allowing customers to withdrawal funds from their accounts.

While Mt. Gox may be at the forefront of a currency revolution, it can't shake the scourge that's haunted banks for centuries; the online exchange is in the midst of a bank run.

A short history of the Mt. Gox debacle
The problems at Mt. Gox came to light last June, when the online exchange announced it had suspended cash withdrawals in U.S. dollars in order to make upgrades amid rising customer use.

It explained by saying that an increase in deposits and withdrawals "has made it difficult for our bank to process the transactions smoothly and within a timely manner. [...] This is especially so for those in the United States who are requesting wire transfer withdrawals from their accounts."

The company then doubled down earlier this month by halting the withdrawal of all customer funds irrespective of currency. According to a Mt. Gox statement dated Feb. 7:

In our efforts to resolve the issue being encountered by various bitcoin withdrawals, it was determined that the increase in the flow of withdrawal requests has hindered our efforts on a technical level. To understand the issue thoroughly, the system needs to be in a static state.

In order for our team to resolve the withdrawal issue it is necessary for a temporarily pause on all withdrawal requests to obtain a clear technical view of the current processes.

We apologize for the sudden short notice. All bitcoin withdrawal requests will be on pause, and the withdrawals in the system will be returned to your Mt. Gox wallet and can be reinitiated once the issue is resolved. The trading platform will perform as usual for the needs of our customers.

Two weeks later, on Feb. 20, it provided an update regarding the "temporary pause" on withdrawals by saying that:

In addition to the technical issue, this week we have experienced some security problems, and as a result we had to relocate Mt. Gox to our previous office building in Shibuya. The move, combined with some other security and technical challenges, pushed back our progress.

For the record, as a strand on Reddit pointed out, its new office is, in fact, not a physical office at all. "It belongs to a company called 'The Executive Centre,' which is a business that offers virtual offices."

And finally, over this past weekend, it was reported that Mt. Gox's chief executive officer had resigned from the board of the Bitcoin Foundation, an industry group committed to promoting, standardizing, and protecting bitcoin.

According to The Wall Street Journal, "It is the foundation's second high-profile resignation in the past month. Board member Charles Shrem stepped down in late January after being arrested and charged with money laundering in connection with his bitcoin company."

So, what's going on at Mt. Gox?
The reason for the company's relocation was simple. It turns out Mt. Gox customers had begun stationing themselves outside its Japan-based headquarters to personally demand the return of their money.

In financial parlance, this is what's known as a bank run -- or, it's as close as you can get to one in the world of virtual currency exchanges. And for the record, bank runs are almost impossible to stop on their own -- this is essentially why the Federal Reserve and the FDIC were established in the early part of the 20th century.

You can see the pessimism regarding the state of Mt. Gox in the chart below, which shows that bitcoins on its exchange are trading for a 72% discount to that of CoinDesk's Bitcoin Price Index, which "represents an average of Bitcoin prices across leading global exchanges."

At the end of the day, there's no way to sugarcoat this. While Mt. Gox could and, in theory, should be able to restore customer withdrawals -- it is, after all, just an exchange -- the odds are stacked against it. And even if it does, the outflow of customer money is likely to be so rapid and violent that Mt. Gox will be lucky to make it out alive.

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