Pay the Devil in Bitcoin: The Creation of a Cryptocurrency and How Half a Billion Dollars of It Vanished from Japan (Kindle Single)

by Jake Adelstein

  In its official statement, Mt. Gox said that the bankruptcy was related to a bug in the bitcoin software algorithm that was exploited by one or more persons. “We believe that there is a high probability that these bitcoins were stolen,” it asserted bluntly, blaming hackers. And since the company had a business plan that looked forward to 2017, it seemed unlikely, some felt, that its CEO had stolen his clients’ money himself.

  After filing for bankruptcy, Karpelès went on working at the same office in Shibuya. The number of employees was drastically reduced. There was a small coffee shop on the first floor that had been destined to be the world’s first Bitcoin Café. Today, it is still just a café.

  One of the former employees who believe that Karpelès did not act maliciously or for his own profit says: “He’s a workaholic and a geek, but a good-hearted geek. He just has very limited management skills, a little hubris, and didn’t pay attention to accounting. He was only twenty-seven or twenty-eight years old.”

  A colleague was more complimentary. “He wrote most of the code—he created a fantastic application interface. It’s a wonderful platform for trading bitcoin. The problem isn’t bitcoin— it’s the way Mt. Gox was run. And it was run into the ground.”

  At the time of the bankruptcy, Yoshihide Suga, a top government spokesman, stated that official organizations including the police and Japan’s Financial Services Agency were collecting information on the bitcoin trade in Japan and considering regulatory action. In addition, there were reports that US authorities had begun investigating Mt. Gox and had subpoenaed individuals who had worked for, or still work for, the company.3

  The United States was interested in Mt. Gox for many reasons. The Silk Road investigation was ongoing, and some law enforcement agencies believed that Karpelès might have been the victim of a group of cybercriminals they were looking for.

  A few days after the bankruptcy, we spoke with Karl-Friedrich Lenz, professor of German and European law at Aoyama Gakuin University in Tokyo and author of an academic paper entitled Legal Issues of the New Internet Currency Bitcoin in EU Law and German Law. Professor Lenz believes Mt. Gox should have been treated as a banking institution and not allowed to operate without a license under Japanese law at the time. He believes that because Mt. Gox accepted deposits and money could be wired to its accounts, it was more or less a financial institution. “I went to the Financial Services Agency and asked to speak with someone on this issue. After much argument, someone from the banking division accepted my report, which I hope they will review.”

  He added, “If Mt. Gox had been treated like a bank, this problem would have never happened. It would have had to have proper accounting and people with financial skills to get licensed. It is unlikely that the Japanese government would have granted such authority to a company run by a twenty-seven-year-old geek with no background in finance.”

  Karpelès recalls that, in the days following the bankruptcy announcement, things calmed down while the trustee appointed by the Tokyo District Court was figuring out what to do.

  “We had to rapidly put in place a call center, which I developed within a couple of hours, the best I could, and then things started to move along.”

  The trouble was, any hope of civil rehabilitation of the company was hampered by Karpelès’s inability to travel out of Japan, since he had to be available at any time to answer the liquidator’s questions.

  In the United States, his lawyers filed Chapter 15, which is done when a liquidation or rehabilitation process is taking place in another country. As part of routine procedure, the US courts needed to question Karpelès in person; otherwise, the filing would be impossible and the assets of the company in the United States would be threatened with seizure.

  A rumor went around that Mark was planning to travel to America, which prompted FinCEN to submit a subpoena and the DHS to dispatch a couple of agents to each airport he might use. He had become a person of interest. Of course, it was out of the question for him to travel under these conditions. And the court in Tokyo wouldn’t allow him to leave the country without a guarantee that the United States would permit him to return. So Mt. Gox wasn’t authorized to proceed to rehabilitation, and liquidation began around the end of April 2014.

  “After that, I tried to make Tibanne, my first company, work, but without great success,” Mark said.

  Karpelès noted that while the general public knew about most of the big events connected with Mt. Gox’s downfall, many details went unnoticed. “All I can say is that each and every move taken by Mt. Gox and Tibanne was done for a valid reason.”

  On March 20, 2014, the discovery of an old wallet brought the number of bitcoins still missing to roughly 650,000, down from about 850,000. A statement posted by Karpelès online said: “MtGox Co., Ltd. had certain old-format wallets which were used in the past and which, MtGox thought, no longer held any bitcoins.” This was both good news and bad. People wondered: If Mt. Gox could simply misplace 200,000 BTC, maybe they had misplaced a whole lot more. Maybe Karpelès was hiding them.

  Many mysteries remain. Independent investigators are focusing on the way Mt. Gox was bought by Karpelès from McCaleb. Some believe that the theft of the bitcoins occurred during the period when transfers to paper wallets were being made. If so, it happened precisely when detecting any theft would be the most difficult.

  After the bankruptcy, Karpelès’s lawyers filed a report with the Japanese police requesting an investigation into the hacking of the company and the missing bitcoins. Not everyone was confident, though, that the police had the skills to solve the case, and some Mt. Gox creditors launched their own probe. This was something Karpelès welcomed.

  I totally approve of there being several separate investigations. It’s generally a good idea to have different people looking into the same problem from different angles. The police don’t report in detail what they are doing, so it can seem that they aren’t doing anything. But they are actually making progress. What’s worrying, however, is recurrent evidence that innocent people have been arrested and made to confess to crimes that they didn’t commit. So I just hope they won’t do anything crazy here. There’s no guarantee, of course.

  Personally, I support their efforts to find the culprit or culprits. The method used is less important to me than the result.

  Unfortunately for Karpelès, the result wouldn’t be quite what he expected.

  CHAPTER FIVE

  THE UNUSUAL SUSPECTS

  After the shutdown of Mt. Gox, the bitcoin community and the media vilified Mark Karpelès as a clown, a con man, and a horndog. Japanese tabloid magazines portrayed him as a “beast” hiding in his “lair” and tracked him to his new address, a modest house in Toshima Ward, where he’d moved when money started to get tight.

  His reputation was damaged further when, as 2015 started, the Silk Road trial began.

  During the trial in a Manhattan federal courtroom, Ross Ulbricht’s lawyer immediately tried to peg Karpelès as the real Dread Pirate Roberts. Karpelès denied the accusation and said he had cooperated with US federal law enforcement.

  “This is probably going to be disappointing for you, but I am not Dread Pirate Roberts,” he said.

  The investigation reached that conclusion already—this is why I am not the one sitting [on] trial, and I can only feel defense attorney Joshua Dratel trying everything he can to point the attention away from his client.

  I have nothing to do with Silk Road and do not condone what has been happening there. I believe bitcoin [and its underlying technology] is not meant to help people evade the law, but to improve everyone’s way of life by offering [never-thought-of-before] possibilities.

  DHS Special Agent Jared Der-Yeghiayan, under cross-examination, said he had pursued Karpelès as the suspected owner and operator of Silk Road in 2012 and 2013. But Der-Yeghiayan acknowledged that the things Karpelès may have written online did not match the level of English skills that Dread Pirate Roberts possessed. He thought it was someon
e else close to him, a person who was working for him by the name of Ashley Barr. There is no solid proof behind this assumption, but if there had been an award for disgruntled employee of the month at Mt. Gox, Barr would probably have won it twelve months out of the year. There was certainly bad blood between him and his boss.

  Other sources close to the DHS told us that Karpelès had been eliminated as a suspect in the running of Silk Road by the end of 2013 and confirmed that he had been generally cooperative with the government. He had notified them about discovering over a hundred fake American passports being used to set up Mt. Gox accounts and debarred the clients. He also acknowledged owning a web-hosting service used by part of the Silk Road network.

  Dread Pirate Roberts, who seems to have known Karpelès was cooperating with the authorities, had tried to reach Karpelès many times in the months after Silk Road was closed down. On September 1, 2013, one month before Ulbricht’s arrest, he sent several e-mails to Karpelès’s bitcoinfoundation.org address with the header “info regarding active law enforcement investigation.” One read:

  Greetings Mark

  As the subject says, I have some information for you as well as a special request. I don’t want to say any more without PGP protection. Do you have a public key I could use?

  Dread Pirate Roberts also tried to make contact with Mt. Gox employee Ashley Barr. Karpelès didn’t respond, not being in the habit of using that e-mail link. But this didn’t stop the man from trying to contact him, presumably because he urgently needed to know how much the authorities knew about his operation.

  Someone had tipped him off that Karpelès was working with the good guys. In the uncensored version of Ulbricht’s diary, popularly dubbed The Dread Pirate Journal, Ulbricht wrote that an entity he called “French Maid” claimed Karpelès had given the DHS information about Dread Pirate Roberts. An entry for September 13, 2013, said Roberts was offering $100,000 for information about the joint investigation by the federal authorities into Silk Road.1 A day later, French Maid was paid this sum by Dread Pirate Roberts.

  Though an edited version of the diary was submitted as evidence at the trial, the prosecution had removed almost all information about Dread Pirate Roberts buying information from what may have been law enforcement sources. It was obvious they were unhappy about the existence of French Maid. But while they censored the pdfs, they forgot to redact embedded information in other files, making it possible to read The Dread Pirate Journal without official interference. Journalists and investigators rejoiced. There was enough there to allow people to figure out how to access Dread Pirate Roberts’s many e-mail accounts and see the evidence for themselves.

  So, who was French Maid? Karpelès had some idea. It was only after Ulbricht’s conviction that the world would find out.

  On March 30, 2015, the Department of Justice released documents about two federal agents with key roles in the pursuit of Silk Road who allegedly stole proceeds from the underground site in the form of bitcoin. They hid the illicit earnings while continuing their work.

  US law enforcement sources confirmed that one of the agents, in exchange for a large payment in bitcoin, also apparently leaked information to the Silk Road operators on the extent to which Karpelès was cooperating with the Silk Road investigation. In a later e-mail, Karpelès wrote: “The fact that information provided by our lawyers to law enforcement ended up being known by parties being investigated [before arrest] is a very big issue.”

  The agents, in addition, made an attempt to extort funds from Mt. Gox. They demanded that Mt. Gox do business with them, but they were refused. In response, and at their urging, the US government seized a total of $5 million from the company’s US accounts. The seizure seemed to be more motivated by personal interest and the rogue agents’ wanting to cover their tracks than by the pursuit of justice.

  These incidents raised questions about the events leading to the collapse of Mt. Gox, and they are likely to put a chill on those who might wish to cooperate with government investigations in the future.

  According to court documents and government sources, former Drug Enforcement Administration Special Agent Carl Mark Force IV, who was arrested on March 30, 2015, asked Ross Ulbricht to pay him $250,000 in bitcoin not to disclose information to the government. Force also sold Ulbricht information about Karpelès. US government sources told us that they believe the rogue agents were the first to inform Silk Road administrators that Karpelès was lining up with the investigation and had shared information on potentially illegal activities with federal authorities in the past.

  US federal court documents outlining the charges against the two agents also assert that former Secret Service employee Shaun Bridges stole more than $800,000 in bitcoins from Mt. Gox during the investigation into Silk Road.2 Supposedly, he wired the funds from a Mt. Gox account he controlled to a personal investment account over the course of nine transfers from March 6 to May 7, 2013, days before Mt. Gox’s US funds were seized—an operation in which he played a major role. Bridges resigned on March 18, 2015. He pleaded guilty in federal court in August of 2015 and was later convicted. In his plea agreement, he also acknowledged that he obstructed justice by “creating an additional incentive for Ulbricht to attempt to hire someone to kill a cooperator [with the investigation] whom Ulbricht suspected of committing thefts I had in fact committed.”3

  The US Department of Justice released a statement on August 31, 2015, in which Richard Weber, chief of IRS–Criminal Investigation, put it bluntly, “Through a series of complex transactions, the defendant [Bridges] stole bitcoins worth hundreds of thousands of dollars . . . This case is an excellent example of the financial expertise of our special agents. Through the analysis of both the block chain and data from the Silk Road servers, we were able to trace the flow of funds, which eventually led to the defendant.”

  Even the most amateur sleuth would probably see this as an opportunity for Bridges to cover his tracks. With the US accounts under the control of the investigators, it is believed that he hoped to gain access to and possibly erase any record of his transactions with Mt. Gox. But there may have been another reason the agents orchestrated the seizure of Mt. Gox funds: sour grapes.

  As early as June 2011, Karpelès had volunteered information to the DEA. In a letter received by them on June 13, he wrote:

  We are a Japanese securities exchange known as Mt. Gox. [We are] contacting you in light of the recent media excitement surrounding Bitcoin.

  It has been brought to our immediate attention that there are U.S. senators calling for quick and firm action from the DEA to shutdown illegal narcotic and international drug trafficking services that are facilitated by a website known as the “Silk Road.”

  Firstly, we would like you to be aware that we do not condone the use or trafficking of illegal substances, nor does our bitcoin exchange directly or indirectly endorse the use of such services. Ultimately, we are pursuing a goal of accepted legitimacy, both for bitcoin and our exchange. We are more than willing to comply with any court-sanctioned investigations regarding our services.

  We invite you to contact us.

  While Karpelès seemed to be doing his best to stick to the straight and narrow, however, two special agents working the Silk Road case were more concerned about exploiting the situation than indulging a well-meaning Frenchman.

  E-mails provided by Karpelès and also reported in Forbes suggest that Force attempted to establish a business partnership with Mt. Gox. Federal law enforcement sources said they checked into them and believe they are authentic.

  According to the e-mails, on April 8, 2013, Force attempted to make contact with Karpelès through a LinkedIn invitation. The message he sent to him even mentioned that he was a DEA special agent. After being ignored, Force apparently tried again on multiple occasions to do business with Karpelès. (He resigned from the DEA in May 2014.)

  On April 11, 2013, Force wrote:

  I don’t think we connected on LinkedIn?

  I want
ed to ask you if you could . . . back me on a deal for 250 Bitcoin. A sale.

  Best regards,

  Carl “Mark” Force

  On May 7, he allegedly offered to become the representative of Mt. Gox in North America. His e-mail said:

  I saw the news yesterday that you won’t be partnering with Coinlab.

  Sorry to hear that.

  If you are still looking for a U.S. and Canada representative, please keep me in mind.

  Thank you very much,

  Carl Force

  In mid-May, the DEA seized a total of $5 million worth of Mt. Gox accounts in North America without giving any explanation to the company.4

  On May 15, 2013, as if to make him regret not considering his offer, Force wrote to Karpelès: “Told you should have partnered with me!”

  Cynics would say, “No good deed goes unpunished.” In the case of Mark Karpelès, this seems true. His apparent willingness to play ball was very dangerous.

  According to court documents and reports, Ulbricht had zero tolerance for interference with his business. He was vengeful enough to have allegedly paid the equivalent of $80,000 to the rogue federal agents, without knowing that they were government officials, to arrange the murder of a person he believed had betrayed Silk Road and was working with the authorities.5 Ulbricht, however, was not convicted on murder-for-hire charges.

  Revenge may also have been behind the larceny at Mt. Gox. A cybersecurity consultant working with the Tokyo Metropolitan Police Department said, “In light of the evidence that federal agents made the Silk Road operators aware of cooperation with the investigation by Mt. Gox staff, we should have considered the possibility that the bitcoin theft at Mt. Gox was an act of retaliation, possibly with help from an insider.”