After six months of record losses, can cryptocurrencies look forward to a hack-proof future?
The case for closer regulation of digital asset trading gains ground after losses of US$1.73 billion so far this year
For the many cryptocurrency holders who care about security, the year 2018 is shaping up to be a nerve-racking one. The reported losses from cryptocurrency hacks and scams in the first half have already surpassed US$1.73 billion, or more than half of the total recorded losses since 2011, according to Crypto Aware, a community-focused advocacy initiative. Of these, 36 per cent represented losses from exchange hacking.
Cryptocurrencies are digital assets, and the exchanges are asset exchanges. All other exchanges that trade assets are regulated
The biggest exchange hack so far also took place this year. In January, more than 500 million units of the NEM token, then valued at US$547 million, were stolen from Japanese crypto-exchange Coincheck, upstaging the US$480 million loss suffered in 2014 by users of Mt. Gox, at that point the world’s biggest crypto-exchange, when 800,000 bitcoin were stolen. The hack triggered a series of legal claims and the crypto-exchange’s insolvency.
And even though Coincheck said in March it had refunded more than US$440 million to its customers using its own funds, the frequency at which exchanges are being hacked highlights an obvious question – does the current centralised exchange model, initiated by Mt. Gox and subsequently used by others, represent a security threat to digital assets?
Also, do alternative approaches, such as decentralised exchange platforms and crypto-custodian providers, represent safer ways to trade and hold digital assets, as many of them claim?
Trading IOUs rather than cryptocurrencies
Similar to traditional stock exchanges, a centralised crypto-exchange is run by an organisation that oversees its operations, maintenance and security, and grants users access to the trading platform for a fee. A centralised exchange connects buyers and sellers of cryptocurrencies, or cryptocurrencies to fiat money transactions.
And while blockchain is well known as the decentralised ledger technology that underpins various cryptocurrencies, ironically, today transactions involving these digital tokens on centralised exchanges often do not happen on blockchain.
So, despite blockchain being an immutable, tamper-proof architecture for recording data and transactions, because cryptocurrencies are being traded “off chain”, none of this data integrity benefits cryptocurrency traders.
Speed and costs are two key constraints for blockchain. Ethereum, for example, can only process about 20 transactions per second. Together with the transaction costs required for using the ethereum blockchain, this has meant many centralised exchanges today are instead using internal databases to process and record transactions.