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Bitcoin Update: Bloodbath on Mt. Gox


The threat of "transaction malleability" is making the Bitcoin community anxious.

Panic. This one word sticks in the back of everybody's mind when assessing what's been going on in the Bitcoin market for the past couple of days. It might be hard to get one's head around the fact that the currency was at $900 on February 5, only to almost reach $300 today. The sell-off continues, today coinciding with news of another hacker attack.

TechCrunch reported yesterday that around 4,500 Bitcoins, worth upwards of $2,700,000 had been stolen from Silk Road 2, the successor of the black marketplace that had been shut down last year. It is perhaps no wonder that engaging in possibly illegal activities may result in problems, in this case those of a financial nature. Worrying is the fact that the hackers exploited the same bug which had earlier caused severe problems for Mt. Gox, Bitstamp, and BTC-e.

This bug, called "transaction malleability," has been known for some time, but only now did it actually become a burning issue for the Bitcoin community. The accounts of Silk Road 2 were completely wiped out. Around 95% of the coins are supposed to have been stolen by one person or entity.

Knowing that, we might be able to understand why Mt. Gox and Bitstamp put all Bitcoin withdrawals on hold. Perhaps, thanks to that, there has been no theft of funds on those exchanges. On the other hand, the bug seems to be serious. Serious enough to keep Bitcoin developers working on a resolution almost 24/7.

The news of late hasn't been particularly good for Bitcoin enthusiasts. Serious bugs have been detected, and the price has fallen dramatically. Right now, there's no telling how low the currency might plunge. It will depend on how soon amendments are made in implementation and how seriously devastating for the Bitcoin community this turn of events turns out to be.

At this time, our best bet is that Bitcoin will recover following favorable news -- for instance, announcements that transaction malleability has been fixed. The time at which a move up will take place is hard to pinpoint. We have to stay focused and look for any new news from Bitcoin developers and exchanges.

Now, let's take a look how the situation looks on the chart.

Yesterday, Bitcoin lost 15.0% compared with the previous day's close. The volume was up, and we saw a continuation of the move down. The currency was dancing around the $540 level (solid red line on the chart).

Today, we're seeing more madness in the market. The currency is already 23.5% down (this was written at around 9:00 a.m. EST) on significantly higher volume than yesterday. Overall, 48,718.9 Bitcoins have been traded so far. Right now, Bitcoin is at $345.15, below the December 18 low (the already mentioned solid red line on the chart).

Such depreciation and a move below on significant volume paint a decidedly bearish short-term picture. Yet, Mt. Gox has become increasingly decoupled from other exchanges. Bitcoin trades at above $600 on both Bitstamp and BTC-e, which have had similar problems to Mt. Gox. Bitstamp has hinted that it will resume withdrawals later in the day, which might partially explain why this is the case, but BTC-e seems to be still having problems, as evidenced on its Twitter account by comments suggesting that the exchange is interchangeably up and down.

We're waiting for news from Mt. Gox; a solution to the transaction malleability problem might contribute to a meaningful reversal, but my firm wouldn't bet on it just now. Also, betting on further declines seems particularly risky at this time.

Summing up, in my firm's opinion, no short-term positions should be kept in the Bitcoin market just now.

For the full version of this essay and more, visit Sunshine Profits' website.

Mike is a quantitative analyst focused on economic reality, not theoretical models. His investment thinking is grounded in empirical evidence and common sense. A holder of two master's degrees in quantitative methods and finance, he researches economic uncertainty, portfolio management, and investor behavior. At he develops innovative investment tools, and is the author of the Bitcoin Trading Alert service.
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