When exchanges fail: Mt. Gox and FTX

Two exchange collapses, eight years apart, bracket the history of the industry. They failed in different ways, and together they explain why traders who have been around a while are strange about withdrawals.

Mt. Gox, 2014: the hack you find out about later

Mt. Gox was a Tokyo-based exchange that at its peak in 2013 handled the majority of all bitcoin trades in the world. In February 2014 it halted withdrawals, went offline, and filed for bankruptcy protection, announcing that roughly 850,000 BTC, about 750,000 belonging to customers and 100,000 its own, were missing. Around 200,000 were later found in an old wallet. At the time the loss was worth about $450 million; at later prices it was tens of billions.

What went wrong, as far as investigations established: the exchange's hot wallet had been leaking coins to thieves for years through a flaw in how it handled transactions, and internal accounting was poor enough that nobody noticed the hole growing. The exchange was insolvent long before it admitted it. Customers who had left coins there for convenience discovered they were unsecured creditors of a bankrupt company. Repayments to creditors did not begin until 2024, a decade later, and were made in a mix of coin and cash at amounts set by the bankruptcy process.

Lessons:

• An exchange can be insolvent while its website still shows your balance.
• "It is the biggest exchange" is not a safety argument. It was the biggest.
• Recovery, if it happens, is measured in years.

FTX, 2022: the fraud you find out about all at once

FTX was, by 2022, one of the three largest exchanges, with celebrity endorsements, a stadium name, and a founder treated as the industry's responsible adult. In the first week of November 2022 a news report showed that its affiliated trading firm, Alameda Research, held much of its balance sheet in FTX's own exchange token, FTT. A rival exchange announced it would sell its FTT holdings. Customers began withdrawing. Within days FTX could not meet withdrawals, a rescue acquisition fell through in a day, and on 11 November the company filed for bankruptcy. The hole was later put at around $8 billion of customer funds.

The mechanism was simpler than Mt. Gox: customer deposits had been lent to Alameda, which lost them on bad trades and illiquid investments. The founder was convicted of fraud in 2023. Withdrawals were not slowly leaking; the money was never there, and the "balance" shown to customers was a number in a database backed by promises.

Lessons:

• Regulation, sponsorship, size and a likeable founder are not proof of solvency.
• An exchange whose own token is a large part of its reserves is circular: when the token falls, the reserves fall.
• Bank runs in crypto take days, not weeks. By the time you read the news, withdrawals may already be closed.

Key idea: Every exchange balance is an unsecured loan to a company you cannot audit. Mt. Gox failed by negligence and FTX by fraud, and in both cases the website showed customers a balance right up to the moment it stopped.

Warning signs, from both collapses

None of these is proof of anything, but each is a reason to reduce what you leave on an exchange:

• Withdrawals slowing, being capped, or "under maintenance" for particular coins.
• The exchange's own token being a large part of its stated reserves.
• Unusually high yields on deposits (the money has to come from somewhere).
• Executives publicly reassuring everyone that everything is fine, unprompted.
• Opaque corporate structure, with affiliated trading firms and offshore entities.
• Auditors resigning, or "proof of reserves" that shows assets but not liabilities.

Proof of reserves, and what it does not prove

After FTX, many exchanges began publishing "proof of reserves": cryptographic evidence that they control wallets holding a certain amount of coin, sometimes with a way for you to check your own balance is included. This is better than nothing. It is not proof of solvency, because it shows assets without liabilities: an exchange can prove it holds 100,000 BTC while owing 150,000, and the proof looks identical. Treat it as one signal, not a guarantee.

The practical rule

Keep on any exchange only what you are actively trading, and withdraw the rest to a wallet you control. If that feels like a hassle, set a threshold (say, anything above two weeks of trading capital gets moved) and a weekly reminder. Spread active capital across two exchanges rather than one if your size justifies it, so a freeze at one does not stop you trading.

And do periodic withdrawal tests, not just when moving to a new address: once a month, withdraw a small amount from each exchange you use and confirm it arrives on time. An exchange that quietly starts delaying small withdrawals is telling you something before it tells everyone.

Try it: Write down every exchange you hold a balance on and the amount. For each, answer: what is the most I would leave here if I assumed a one-in-twenty chance it froze withdrawals next year? Move the difference this week and put a monthly withdrawal-test reminder in your calendar.

Recap

• Mt. Gox (2014) lost around 850,000 BTC through years of undetected theft and poor accounting; creditors waited a decade.
• FTX (2022) collapsed in days when it emerged customer deposits had been lent to an affiliated trading firm and lost.
• Size, endorsements, regulation and confident executives are not evidence of solvency.
• Proof of reserves shows assets, not liabilities; it is a signal, not a guarantee.
• Keep only active trading capital on exchanges, split it across venues, and run monthly withdrawal tests.