How to Avoid the Next Mt. Gox Incident

Mt. Gox was a shadily run bitcoin exchange that collapsed in 2014. While the exchange was the target of a brazen hacker, other problems contributed to its demise. After it collapsed, investigators discovered evidence of fraud going back at least three years. The crisis at Mt. Gox created a lot of uncertainty about the future of bitcoin.

Three years later, we can all learn from the problems that led up to the collapse Mt. Gox. Here are some lessons that we should all learn from it.

Flaws in Blockchain Need to Be Carefully Examined

Blockchain technology is responsible for tracking and recording all bitcoin transactions. Unfortunately, the model isn’t entirely foolproof. A month after Mt. Gox collapsed, a team of open-source developers that contribute to the bitcoin community began analyzing the flaws that made it possible for hackers to falsify bitcoin transactions.

Back in March 2014, Venture Beat reported that they had discovered some of the problems and taken steps to guard against a similar catastrophe in the future.

“Malformed transactions appear similar to legitimate, previously processed transactions, fooling the Bitcoin software. Those illegitimate records didn’t sync with the Bitcoin blockchain, leaving a disparity between the actual location of the funds and the exchange’s records. But now, thanks to tightened transaction rules, those “mutated transactions” can’t be relayed or mined. The new version also includes functions that report conflicting wallet transactions and instances of double-spending.”

Unfortunately, some flaws may not have been identified. Developers will need to continue looking at the blockchain infrastructure and addressing problems they uncover.

Diversification Among Exchanges is Important

Many experts have repeatedly emphasized the importance of storing bitcoins offline, where they are less susceptible to hackers. While this is good advice, it isn’t entirely feasible.

In the future, it may be possible to keep your bitcoins entirely offline. Unfortunately, that isn’t possible yet, so people need to take some risk by storing and transferring bitcoins through the exchanges.

The good news is that there are over 70 major bitcoin exchanges around the world, which minimizes the risk of another exchange going bankrupt again. Members of the bitcoin community should have accounts with at least a few of them to minimize their exposure to security and fiscal risks.

Stricter Regulatory Scrutiny is Necessary

Former Mt. Gox CEO Mark Karpelès was recently indicted for fraud. If convicted, he will face up to five years in prison.

The type of conduct that Karpelès allegedly committed wouldn’t have gone unnoticed in a traditional financial institution. Government regulators in every country have strict protocols to guard against it.

Bitcoin was originally developed as an alternative currency for libertarians and others that wanted to avoid government scrutiny. The underground nature of the currency was part of the appeal in the past, but it isn’t feasible now that over 10 million people own bitcoin.

As bitcoin gains more popularity, more regulation will be necessary to protect people. The same regulatory scrutiny that applies to banks will likely be implemented to bitcoin exchanges.

Samuel Gibbs reports that Japan has already developed new regulations to mitigate the risk of fraud at other bitcoin exchanges.

“The exchange’s bankruptcy also prompted Japan’s government to decide how to treat bitcoin, and preceded a push by local regulators to license cryptocurrency exchanges. Japan became the first country to regulate cryptocurrency exchanges at the national level this year, part of a government effort to exploit financial technology as a means of stimulating the economy. The Japanese regulations help prevent misuse of bitcoins and other cryptocurrencies for terrorism or other illegal activities, including requiring banks and other businesses to verify identities, keep records and report suspicious transactions. The regulations implemented in April require cryptocurrency traders to keep customers’ assets separate from their own.”

The Japanese government has been under the most pressure to regulate bitcoin exchanges, because Mt. Gox went bankrupt under their watch. However, other countries will need to take similar precautions to prevent a similar catastrophe from arising.

Steps Need to Be Taken to Protect Bitcoin Users from a Repeat of Mt. Gox

The collapse of Mt. Gox was one of the biggest problems in the history of bitcoin. People all over the world wondered whether their bitcoins were safe on other exchanges.

Fortunately, a similar incident has not occurred so far. Nonetheless, it is important to learn from the problems that contributed to the collapse of Mt. Gox to ensure they don’t arise again.

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