As the blockchain space continues to evolve towards mainstream adoption, the complexity of issues associated with blockchain-based technologies continues to grow. Given the vast number of uses for blockchain technology and the likelihood that it will continue integrating into the world around us, it is important to understand the nature of decentralized technology and its basis of operations.
Blockchain’s first application, cryptocurrency, has continually gained attention over the past decade, resulting in many new individual players and corporations entering the space. This influx of users has lead to rapid growth in a market lacking regulations.
Fig. 1. Bitcoin Price (USD): coinmarketcap.com/currencies/bitcoin/#charts
Fig. 2. Cryptocurrency Market Capitalization (USD): coinmarketcap.com/charts/
The benefits associated with blockchain technology are vast, as evidenced in the growth of the cryptocurrency industry, along with the development of many other applications of blockchain technology. However, the rapid growth in this industry – along with the decentralized nature of the technology – has opened users up to immense risk.
QuadrigaCX case
The most recent controversy revolves around the now-defunct Canadian cryptocurrency exchange QuadrigaCX. Following the death of founder and CEO Gerald Cotten in December 2018, it became apparent that Mr. Cotten had sole access to the exchange’s cold wallets, leaving funds worth over an estimated $250M CAD irretrievable. Given that users had the ability to store funds on the exchange either fiat or cryptocurrency, this value has surely increased following recent rises in cryptocurrency prices. As such, any users storing funds on the exchange are at a loss and are being forced to go through a claims process that is sure to be lengthy and costly.
Following Mr. Cotten’s death, suspicions arose surrounding many of the details in this case. As the investigation played out, the exchange proved not to be in possession of the amount supposedly held in cryptocurrency, as funds had been moved to other exchanges to engage in trading activities. In addition, large amounts were transferred to Mr. Cotten and his wife, Jennifer Robertson. A recent report from E&Y estimates that Mr. Cotten lost nearly $80 million by margin trading user funds on other exchanges. Additional suspicions have surfaced, suggesting that Mr. Cotten may have faked his death as a ploy to flee following years of embezzling funds.
While this is surely the largest event of this sort in Canada, it isn’t the only issue that has arisen regarding cryptocurrency exchanges. Over the last decade, exchanges have been prone to hacks, targeting the mass amount of funds held by these centralized entities. The most infamous incident was the Mt. Gox hack from 2014, which resulted in over 700,000 Bitcoin being seized, a value of over $8 billion USD at the time of this writing.
Exchanges have been – and will continue to be – a vital part of the cryptocurrency ecosystem, in ways that affect this space both positively and negatively. For those purchasing cryptocurrencies, exchanges serve as the main source. As such, massive amounts of fiat funds flow to exchanges with the intent to purchase various cryptocurrency, making them a target for fraudulent activities.
Mitigating risk
The damaging events over the past decade coupled with the unique capabilities of cryptocurrency have brought to light the differentiation among traditional and cryptocurrency markets, the risks associated with unregulated or decentralized markets and with the lack of practical knowledge among users. These problems contributed to the scale of events such as the QuadrigaCX case. Those who took precautionary measures (such as storing assets in cold wallets) to mitigate risk were sheltered from much of the disastrous impact.
Understanding the immutability that backs blockchain-based technologies along with the decentralized nature of this technology is crucial to mitigating risk. Cryptocurrency transactions occur in a much different manner than traditional transactions such as e-transfers or typical cash transactions. This differentiation stems from a level of assurance that is inherently built into regulated transactional systems, protecting those who fall victim to fraudulent activities. In the case of cryptocurrency, there is no institution that oversees transactions. Instead, the market utilizes a blockchain to conduct, confirm and secure transactions that take place, leaving responsibility to the user, who must perform due diligence on the transaction at hand.
Given the lack of regulations present in the cryptocurrency industry – largely due to its decentralized nature – users inherit the responsibility to handle their funds appropriately. It is crucial to understand when you have sole control of your funds and when you do not. Leaving funds on an exchange results in substantial risk, as you are not in possession of your funds, the exchange is. In the QuadrigaCX case, user funds left on the exchange were moved to other exchanges to be used in margin trading. To mitigate any risk associated with exchanges, be sure to store any funds in a wallet where you are the sole owner of your private key. Only add funds to an exchange to conduct desired transactions, moving funds back to your secure wallet after the desired transaction is conducted. The inability to take these steps could put your assets at risk.
Moving forward
In spite of the instances where blockchain-based technologies display their limitations, these technologies have the potential to revolutionize current means of exchange. More generally, as technology continues to drive evolution – socially, economically and politically – blockchain-based technologies will offer solutions to emerging problems related to privacy, security and transparency.
These technologies exhibit vastly different traits than those we are accustomed to, encompassing a much higher degree of technological complexity. Understanding the premise on which these technologies operate prior to entering the space aids in mitigating risk. As you prepare to enter this industry, be sure to perform due diligence and ensure your assets are securely stored by educating yourself on the potential risks and taking appropriate measures to mitigate your exposure.
Related content
