This document discusses the recent disruption in the bitcoin market due to transaction malleability issues at major bitcoin exchanges Mt. Gox and Bitstamp. It explains that transaction malleability refers to an inherent flaw in the bitcoin protocol that allows the transaction ID of a bitcoin transfer to be altered, causing problems for exchanges trying to keep track of withdrawals and deposits. While Mt. Gox blamed transaction malleability for suspending withdrawals, core bitcoin developers said the real issue was how Mt. Gox handled transaction IDs and customer support. The document concludes that regulation of bitcoin and virtual currencies is inevitable as these emerging technologies are exploited.

1. BITCOIN MARKET DISRUPTION
TRANSACTION MALLEABILITY
MARK MCKENZIE
REGULATORY GOVERNANCE & COMPLIANCE EXPERT
MARK MCKENZIE CONSULTING
FEBRUARY 18, 2014

2. Objective of Presentation

To discuss recent disruption of Mt. Gox and
Bitstamp

To explain Malleability

3. Order of Presentation

Recent Bitcoin Market Disruption

Explain Transaction Malleability

4. Known Exchanges Affected

Mt Gox

Bitstamp

BTC-e

5. Bitcoin Market Disruption

Denial of services attack (DOSC)

Suspended withdrawals

Inability to handle the volume of traffic created by
customers

Inherent flaw with the way bitcoin transactions
work

Resulted in a plunge in bitcoin rates across the
globe.

6. A graph of the transactions and prices of bitcoin on the virtual currency exchange
MtGox. Courtesy MtGox

7. Who Is Really At Fault?





MtGox Blames Bitcoin For Withdrawal
Suspension
Blamed the bitcoin source code for the
temporary stoppage of withdrawal power on its
site.
The protocol for the currency has an inherent
problem
The problem identified is not limited to affected
exchanges
Affects all transactions where Bitcoins are being
sent to a third party

8. Who Is Really At Fault?
Transaction malleability has been around for a
while
 It was first identified in the bitcoin code in 2011.
 This fault in the code, according to the bitcoin
exchange, is why they were forced to suspend
all withdrawal transactions since late last week.
“MtGox has detected unusual activity on its
bitcoin wallets and performed investigations
during the past weeks. This confirmed the
presence of transactions which need to be
examined more closely,” MtGox stated.


9. Who Is Really At Fault?


Core Developers Say Otherwise:
The Bitcoin Foundation
 a coalition of bitcoin businesses intent on propagating the virtual
currency

“The issues that MtGox has been experiencing are
due to an unfortunate interaction between MtGox’s
implementation of their highly customized wallet
software, their customer support procedures, and
their unpreparedness for transaction malleability, a
technical detail that allows changes to the way
transactions are identified,” Gavin Andresen, chief
scientist at the Bitcoin Foundation who is also a
bitcoin core developer, said.

10. How Does Bitcoin Work?

From a user perspective:
◦ Bitcoin is nothing more than a mobile app or computer program
◦ Provides a personal Bitcoin wallet
◦ Allows a user to send and receive bitcoins with them.


Behind the scenes:
The Bitcoin network is sharing a public ledger called the "block chain".
◦ This ledger contains every transaction ever processed,
◦ Allowing a user's computer to verify the validity of each transaction.

The authenticity of each transaction is protected
◦ By digital signatures corresponding to the sending addresses,
◦ Allowing all users to have full control over sending bitcoins from their own Bitcoin
addresses.

11. How Does Bitcoin Work?

In addition, anyone can process transactions using the computing power of specialized hardware and earn a reward in
bitcoins for this service.

This is often called "mining".

Approximately 11 million Bitcoin have been mined, 21 million Bitcoin in total.

“Miners” – supply Bitcoin network with computing power needed to maintain the security of the block chain (a
distributed technology that acts as Bitcoin’s ledger)

Every single Bitcoin carries the entire history of the transactions it has undergone, and any transfer from one owner to
another becomes part of the code

Bitcoin is stored in such a way that the new owner is the only person allowed to spend it.

Miners are rewarded with “blocks” of issued bitcoins (a “block” currently contains 25 bitcoins); this is how currency is
issued

Price of Bitcoin fluctuates wildly. As of April 23, 2013, 1 bitcoin is worth $130 USD

12. How Difficult Is it To Make Bitcoin
Payment?

Bitcoin payments are easier to make than debit or credit card purchases

Can be received without a merchant account.

Payments are made from a wallet application, either on your computer or
smartphone, by entering the recipient's address, the payment amount, and pressing
send.

To make it easier to enter a recipient's address, many wallets can obtain the address
by scanning a QR code or touching two phones together with NFC technology.

13. Bitcoin Block Chain

Acts like a giant general ledger for the whole of the bitcoin network

It keeps records of which bitcoin addresses sent funds to other bitcoin addresses,
and when.

This gives it a complete record of how many bitcoins can be attributed to which
addresses on the network at any one time.

When a bitcoin transaction is made, it includes information such as the addresses
that the bitcoins came from (the inputs),

Where they are going (the outputs), the amounts transferred, and

Which addresses sent those funds to the sender’s address.

14. Bitcoin Block Chain

Bitcoin can also be seen as the most prominent triple entry bookkeeping system in
existence.
◦
Momentum accounting and triple-entry bookkeeping is an alternative accountancy system developed by Yuji
Ijiri
◦
Changes in balances are the recognized events.
◦
E.g. an acceleration in revenue earning, such as a $1,000 per period increase of revenues from $10,000 per
month to $11,000 per month, is a recordable event that would require three entries to implement.

15. Transaction ID (TX ID)
Hashing
 Each transaction must be uniquely identified - Transaction ID (TX ID)

◦
For reference in the block chain
Produced by taking the information in the transaction, and
 Running it through a hash function

◦
A mathematical procedure that takes different pieces of data and
◦
Combines them to produce a shorter piece of information, known as a hash.

Component of Transaction Hash
 The user’s digital signature
 Proves that the transaction came from them
 Allows user to digitally ‘sign’ the transaction.


16. Transaction ID (TX ID)
Key qualities of a hashing function
 It is impossible to tell what the original information was simply by looking at the
hash
 It is also impossible to predict what the hash will be, based on the pieces of
information that you start with.
 If any small detail changes in any of those pieces of data, it will change the hash in a
completely unpredictable way.

Benefits of TX ID
 Hashing makes transaction IDs practically impossible to spoof.
 Each transaction should only have one possible hash.
 You can prove that a transaction is valid by simply running all of the pieces of
information that made up that transaction through the hashing function, to check
that you get the same hash.


17. How does transaction malleability
work?

The user’s digital signatures used as part of the hash to ‘sign’ the
transaction are meant to be in a certain format.

That format wasn’t always properly checked.

This meant that a badly-formatted one could be introduced, and still
accepted.

Altering the signature in this way makes it possible to create different
hashes for the same transaction.

18. Conclusions

Bitcoin and other virtual currencies has given rise to emerging risks in
the global financial including being exploited by criminal elements.

The recent Bitcoin market disruption is one more reason why state
intervention in the form of formal regulations imminent.

Benjamin Lawsky, New York's financial services superintendent, said he
believes regulation could add credibility to the still nascent, unstable
currency.

Regulation is inevitable and imminent

19. Sources
•
Bradbury, Danny. “What the ‘Bitcoin Bug’ Means: A Guide to Transaction Malleability.” February 12, 2014.
http://www.coindesk.com/bitcoin-bug-guide-transaction-malleability/
•
Felten, Ed “Understanding Bitcoin’s transaction malleability problem.” February 12, 2014. https://freedomto-tinker.com/blog/felten/understanding-bitcoins-transaction-malleability-problem/
•
Fuller, Cameron. “MtGox Blames Bitcoin For Withdrawal Suspension, Core Developers Say Otherwise: Who Is
Really At Fault?” February 11 2014. http://www.ibtimes.com/mtgox-blames-bitcoin-withdrawal-suspension-coredevelopers-say-otherwise-who-really-fault-1554512
•
Matthew, Jerin. “Singapore's ItBit Capitalises on Transaction Malleability Issue at Other Bitcoin Exchanges.” February
17, 2014. http://www.ibtimes.co.uk/singapores-itbit-capitalises-transaction-malleability-issue-other-bitcoin-exchanges1436680
•
Neal, Ryan W. “Silk Road 2 Hacked: Entire Bitcoin Wallet Drained, $2.7 Million Stolen.” February 13 2014.
http://www.ibtimes.com/silk-road-2-hacked-entire-bitcoin-wallet-drained-27-million-stolen-1555433
•
https://bitcoin.org/en/faq

20. Mark McKenzie
Regulatory governance and compliance expert
markymmckenzie@rogers.com
1-647-406-4622