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Security of Crypto Exchanges and Sutton’s Law

With a large pool of investors becoming interested in cryptocurrencies, new trading avenues are being set up. Yet a pertinent question remains unaddressed, are exchanges really safe? A recent hack in Bancor, a crypto company, resulted in the company losing $23.5 million. The Israel-Switzerland based company had raised over $150 million in an ICO last year, and its services include a wallet with a built-in exchange.

Bancor said in a statement that “a wallet used to upgrade some smart contracts was compromised.” As a result, the attackers made off with $12.5 million in Ether, $1 million in Pundi X’s NPXS token and $10 million in Bancor’s BNT.

Critics on Twitter, including Litecoin creator Charlie Lee, pointed out the irony of Bancor that claims to be decentralised, yet its approach to resolving the hack was strategised according to a centralised system.”A Bancor wallet got hacked and that wallet has the ability to steal coins out of their own smart contracts.An exchange is not decentralized if it can lose customer funds OR if it can freeze customer funds. Bancor can do BOTH. It’s a false sense of decentralization.”

When the famous gangster Sutton was questioned on why he robbed banks, he answered: “because that’s where the money is”. Sutton’s law states that when diagnosing, one should first consider the obvious. It suggests that one should first conduct those tests which could confirm (or rule out) the most likely diagnosis.

With trading avenues an easy target for theft, investors require assurance over potential threats, especially those seeking third-party ventures for buying and selling cryptocurrencies. A total of $670 million was lost in crypto hacks and scam in the first quarter of 2018 alone. $9 million a day is lost in cryptocurrency scams. Many crypto exchanges like itBit, are opting for cold storage.

If the history of cryptocurrencies is analysed, it is is not very difficult to comprehend the capricious nature of crypto exchanges. In 2014 the first Bitcoin Exchange to trade large volumes, Mt. Gox, declared a hack after 850,000 BTC disappeared. The theft was fuelled by extremely negligent management. The hacks continue to sabotage the reputation of crypto markets and discourage many investors from participating.

According to CNBC, Dr. Bora Ozkan, assistant professor of finance at Temple University’s Fox School of Business, says that blockchain is at the heart of bitcoin and is quite secure owing to it being decentralised. However, she also notes that an individual storing their customer records and funds may be less safe.

If cryptocurrency exchanges can figure out an efficient and swift way to operate decentralized exchanges — let’s say, like blockchain — they can operate more securely,” Ozkan said.

Roman Sobachevsky, a California early stage investor involved in cryptocurrency ventures, offers some traditional investing advice: Don’t put all your eggs in one basket. “To minimize your risks, try not to put your money in a single exchange, and don’t store money on exchanges, Sobachevsky said. “Transfer money to an exchange when you need to do a trade. Trade, then get the money back.”

The consecutive years saw several hacks like Bitstamp in 2015,Bitfinex in 2016 and the latest being the Coinsecure fiasco which has left investors wary and cautious about trusting crypto markets and. The urgent need for reputable exchanges is the development of more transparent and robust security measures. The trading venues can be categorised into two parts, one facilitating peer-to-peer trading and those that require brokers for intermediating trades.

The major exchanges in the U.S, Kraken, Bittrex, and GDAX, account for 25% of the daily cryptocurrency trading volume. These institutions have been subjected to many trading rules as well as other consumer protection measures. The exchanges are also subject to AML provisions of the Bank Secrecy Act and Patriot Act.

With lack of regulation and yet the need to preserve customer assets, many brokers have taken different approaches to crypto trading. Coinbase’s GDAX supports only liquid cryptocurrencies (BTC, BCH, ETH, and LTC) and no margin or derivative trading.

Every hack or breach is unique. Some are due to a security loophole that hackers exploit, or an error committed by an employee when multisignature authentication is not needed for every change in the network.

If the maximum number of your cryptocurrencies are stored in a cold wallet, which stays offline most of the time and needs permission from multiple parties for any change in the wallet, you could secure most of your crypto assets away from the access of hackers.

If you compare Cold Wallet to a Savings Account which you only access in longer durations, Hot Wallet could be called as the Checking Account for the exchange. It has all the cryptos needed in the exchange for easy and quick trading. Having Hot and Cold wallet allows exchanges to keep only a small amount of cryptos exposed to the internet, again, ideally with a multisignature authentication.

Without a second thought, the cryptoverse will continue to enthral investors from every walk of life, be it an enthusiast, a technologist or a mere opportunist. With some preventive measures, the waters can be waded through with much ease. The following approach can be taken when trading with crypto assets-:

  • Be clear with your trading goals (Whether you are a risk-averse individual or representing an institution)
  • Evaluating the credibility of exchange requires the same effort when choosing a bank or any other entity handling investments.
  • Always keep an eye for clear cybersecurity protocols, regulatory compliances, and an experienced team.
  • Go through the track record of the exchange; any credible exchange would demonstrate a clean track record and assure you of investing in a good scheme.
  • It is advisable to not invest in an exchange that doesn’t follow a stringent KYC process.

The blockchain and cryptocurrency industry is still gaining maturity. Even the smallest leak or loophole in security could be exploited. Hence, it’s imperative for every exchange to take the security and past occurrences into serious consideration and take relevant measures to avoid such hacks. Yet, one should be wary of leaving a large amount of crypto holdings with just one trading avenue. Investing in any asset class will necessarily involve risk, and remedial measures are required to protect your money.

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