Tag - mt. gox

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On Being Early and Being Right
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Why Mt. Gox May Be Headed for Bankruptcy

On Being Early and Being Right

Over the past ten years or so, I have been relatively early to three highly nascent, wild wild west style industries: online poker, daily fantasy sports and bitcoin. In two of them – poker and bitcoin – I experienced significant professional and financial successes. In the other, daily fantasy, I lost my shirt. With bitcoin’s recent rise I figured it could be instructive to briefly explore the analogies between the three and develop a framework for spotting the emerging markets of the future.

On Being Early and Being Right

Jeremy Liew, General Partner at Lightspeed Venture Partners has repeatedly said that if one wants to spot emerging modes of communication and behavioral change, look to the products and services teen and tween girls are adopting. Similarly, I would argue that when it comes to emerging professional industries or financial markets, one should look towards how college aged kids are spending their time as well as the long-tail of the internet’s forums (including Reddit).

I believe this is the case for two primary reasons: (a) college aged kids have a substantial amount of disposable time and some variable amount of disposable income and (b) they are highly incentivized to increase their amount of disposable income – at a time in their lives when losing what little they have is not a significant loss. This combination pushes college students towards higher risk, higher return opportunities, some small percentage of which will materialize into mainstream markets and industries.

For example, although I’d played poker with my friends in high school, I found my way into online poker in a professional capacity my Sophomore year of college as the World Series of Poker was beginning to expand. It was the ideal format for a college student: success demanded thousands of hours of gameplay and continual learning and discussion via online forums. Very few adults with either part-time or full-time jobs could afford that much disposable time. My first startup, Cardrunners, where I ran marketing, had thousands of college students as customers, and many of the site’s pros were poker players who had made their millions during college.

You’re seeing a similar evolution in the world of professional gaming, or eSports; except that in eSports, the pros are often even younger, some still in high school. It is for the same reason: an adult with a full-time job, even one who loves gaming, will struggle to put in the tens of thousands of hours it requires to become great. These industries that demand obsessiveness are highly biased towards youth.

I discovered bitcoin in 2012 after the poker industry’s Black Friday as it was one of the few mechanisms to deposit and withdraw money from online poker sites. From there, I gradually became more interested in the technology, and began actively writing about bitcoin in 2014 in publications such as the WSJ and Recode as well as attending and speaking at Bitcoin conferences. I was also the first mainstream writer to publicly predict Mt. Gox’s insolvency, although, by that time, it was largely too late for most customers to withdraw their money.

During my poker years, I spent hours each day learning and communicating through the Two Plus Two Poker Forums. I still frequent them occasionally although only lurk at this point. They have a thread, over 850 pages long, all about bitcoin (there is an additional long thread about altcoins). You can watch the discussion evolve throughout the years. If you’d been paying attention to the forums back then, April 2011, and made even a small investment in bitcoin, you’d surely be a millionaire by now. [I love the first response given that it’s the same thing, verbatim, that bitcoin minimalists say now, even though it’s now trading at $3,400.]

On Being Early and Being Right2

There are other gems of niche industries and markets hidden throughout the Two Plus Two forums, although none have become as mainstream as bitcoin. You’ll likely find similar insights if you scour Reddit. We all know that one day another technology market will emerge that rivals or leapfrogs the attention and excitement given to cryptocurrency. I have a strong suspicion that early adopters will discover it through forums such as Two Plus Two or Reddit. I do worry that if that discussion moves to Slack or Telegram that it will be harder for the average person to find. I wrote about that concern here.

Daily fantasy sports, where I struck out both professionally and financially, was an industry where I simply wasn’t as personally passionate. In retrospect, I feel that my interest was a bit opportunistic. I still remember discussing at length with my friend Chris, who at the time was building the first ever Daily Fantasy site, Instant Fantasy Sports (in which I invested), about how we could port the functionality from the online poker sit-n-go format into fantasy sports and make an equivalent sit-n-go draft. I thought there were a lot of parallels, but I ultimately wasn’t excited by watching sports games all day nor obsessing over player statistics. This made it difficult to be credible either as a player (gamer) or an operator. I suspect that’s the reason I failed.

When it comes to being early and being right, I believe that passion is the ultimate insight. We humans have a lot in common. If you are passionate about an emerging industry, odds are that many other people are equally as passionate, or have the potential to become passionate if awareness is raised. Not all passions will materialize globally like bitcoin, but niche industries matter – even cosplay has developed into a $5-10 billion market. These emerging interests, industries and professions will continue to accelerate as the internet increasingly democratizes communication and awareness. It’s a fun time to be alive, and if you bet on your passions, odds are that you will discover others who feel similarly.

Why Mt. Gox May Be Headed for Bankruptcy

This article was originally published on Coindesk on February 17, 2014

It has been a tough week for bitcoin: a freeze on withdrawals at Mt. Gox due to transaction malleability, multiple DDoS attacks across the exchanges, and a consequent plunge in price.

In my view, however, Gox should be everyone’s biggest focus. While their price spreads and cash-out delays have plagued the site for more than six months, I believe their current situation and recent statements belie transparency and suggest insolvency. Namely, that their business model and recent past raise a number of red flags that make comparing the company to now-bankrupt online gambling operators highly relevant.

Three weeks ago, I took to Re/code to describe how the evolution of online poker is likely to be correlated and instructive to bitcoin’s development. In it, I wrote: “I believe we could see a major exchange go under, especially if regulations and wire transfers become more complex, or if the cost of acquiring customers becomes more competitive.”

I have seen this story play out nearly a dozen times before during my tenure as an executive in the online poker world and, in this article, I want to set out why I think Mt. Gox is in big trouble.

Fund seizures

Mt. Gox had nearly $5 million in funds seized from its bank accounts in 2013. It’s unclear whether these were operating funds or customer deposits. This is highly reminiscent of seizures in the online gambling world, which deeply affected operators’ solvency.

These fund seizures, such as $115 Million from Full Tilt Poker, or $33 Million in a 2009 DOJ Seizure, were initially smoothed over by their operators. Players were typically reimbursed and withdrawals were honored.

What outsiders hadn’t realized at the time was the strain this placed on individual operators. In order to keep the business running, operators had to remove the ring-fence that protected customer deposits and borrow from customer balances to support operations.

While everyone believed that the poker sites were making billions, their overheads due to staffing and marketing was significant. More importantly, each new seizure forced the operators to move downstream to less and less reputable transaction processors and banks. These processors charged heavier fees because of the heightened risk, and often absconded with deposits, because, well, they could.

We see this with Mt. Gox as well: the company lost its relationship with reputable processors, such as Dwolla, and has never managed to integrate with Skrill or Neteller.

Phantom deposits

It appears that Mt. Gox has long known of, and suffered from, transaction malleability. As explained in this Coindesk post, if a user claimed not to have received their bitcoin (either truthfully or maliciously), Gox was likely to have re-sent the funds to avoid negative press as a result.

This process of fronting money – either in the hopes of recovering the initial transactions or to maintain positive perceptions – is a vicious cycle that depends on deposits outpacing withdrawals to be sustainable. Once that balance reverts, it’s an effective bank run, and the operator will eventually not have enough deposits to cover user balances.

It is highly analogous to the working capital model that caused the insolvency of Full Tilt Poker, once a billion-dollar industry leader. In their case, the black market ACH (automated clearing house) processors they had contracted to transfer player funds from bank account to virtual wallet struggled to convince banks to process those transactions.

Full Tilt, wanting to maintain a dominant image and not lose player liquidity to competitors, chose to credit attempted (but failed) withdrawals to player accounts, hoping to recoup those transactions as their processors improved. This backlog of ‘phantom’ deposits ultimately reached $130 million. Executives later admitted that it started small and spiraled out of control.

Although I have not seen any indication as to the scale of Gox’s equivalent phantom transactions, the ramifications are considerable – especially if malicious customers exploited the issue to their advantage.

Excuses, excuses…

Mt. Gox’s public statements have been only partially accurate, initially blaming bank/processor delays in June 2013, and now admitting a systemic technical issue. This evolution of excuses mirrors those of gambling operators who were quick to blame a difficultly in transaction processing before admitting internal issues.

Eurolinx was a popular poker site from 2006 to 2008. However, in 2009, withdrawals began slowing considerably. Initially, it claimed:

“The situation is only temporary because we have had an unusually high number of withdrawals that, in combination with increased security checks, have caused a backlog and delays throughout the system.”

Weeks later they admitted: “Most of the delays occurred due to payment processor issues we experienced in May and June. The problem has now been fixed, however, we have some withdrawal backlog to deal with.” And, months later, they filed for bankruptcy – leaving players millions of dollars the poorer – and ultimately admitting that they gambled player deposits in the stock market and lost, big time.

FullTiltPoker enjoyed market dominance from late 2006 until their DOJ indictment in April 2011. Soon after being banned from servicing US players, the DOJ gave them permission to repay all depositors, but they failed to do so.

On May 15th, FTP claimed: “Full Tilt Poker faced numerous challenges and hurdles to ensuring the smooth operation of its international business and the orderly return of US player funds. We are absolutely committed to making sure that US players are refunded as soon as possible. We apologize for the delay and the fact that we underestimated the time it would take to work through these issues.”

On May 30th, they repeated:

“We still do not have a specific timeframe for [paying back players]. There has been, and remains, no bigger priority than getting US players paid as soon as possible, and we have been working around the clock to get this done.”

However, at this point, they admitted solvency issues for the first time, saying: “We are raising capital to ensure that the US players are paid out in full as quickly as possible.” The company admitted total insolvency three months later, on August 31st.

In these cases and more, the operators cited seemingly legitimate reasons for process delays. All were rooted in industry truths – difficulty of bank processing or technical complications of implementing a mass refund – but were ultimately covers for deeper issues.

Most worrisome is that in the weeks prior to nearly every major online poker bankruptcy, the operators marketed deposit bonuses and perks – a last attempt to buy solvency and time.

This was true in the case of Full Tilt Poker and Eurolinx, as well as Ultimate Bet, Absolute Poker, GoalWin Poker, Poker in Venice and more. Mt. Gox did the same – offering discounted trading fees as recently as December 19th – a curious move for an operator clearly aware they were facing transactional hurdles.

Tell-tale pattern

I am hopeful, along with the wider Bitcoin community, that Mt. Gox can overcome its difficulties and rebuild consumer confidence.

As Mt. Gox has struggled with both bitcoin and fiat withdrawals, it should be noted that, in a public ledger cryptocurrency, it is possible to certify the solvency of reserves with digital signatures showing the location of all deposits – although no exchange currently utilizes this feature of bitcoin.

While that would solve questions surrounding bitcoin solvency, it would leave fiat concerns unresolved. That said, my experience over the past decade has shown that insolvency tends to follow a pattern, that Mt. Gox clearly fits, and I feel the company is likely to fail unless outside capital comes to the rescue.

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