Crypto exchanges have come under pressure. Security issues and a bear market have already resulted in the shutdown of several exchanges. More will follow in 2019. Investors need to be aware of these developments.
2018 was a record-breaking year for the crypto-industry. Too bad they were not the kind of records we want to see.
The number of cryptocurrency exchange hacks and the amount of assets that were stolen were at all-time highs. Tokyo-based cryptocurrency exchange Coincheck has experienced what appears to be the largest exchange hack of all times.
What has started in 2018 continues in 2019. The Canadian cryptocurrency exchange QuadrigaCX announced last week that roughly $145 million worth of cryptocurrency funds were frozen in the exchange’s cold wallet.
54% of exchanges have security vulnerabilities
Flashback into the year 2017: When the Bitcoin price approached $19,000 and the crypto-hype was at its peak, a new crypto exchanged emerged every other week.
Back then, crypto was a largely unregulated space – in most countries that’s still the case today – and most newly founded exchanges were unprofessional ventures with low security standards.
Even today, many crypto exchanges still store funds on hot wallets, which are connected to the internet (more information on wallets HERE). All exchanges need hot wallets to ensure their customers can make regular deposits and withdrawals, but the amount of funds some exchanges hold in hot wallets is alarming, to say the least.
A report from ICO Rating has examined the security standards of 100 exchanges all of which have a 24-hour volume of over $1 million. The study found that 54% of these exchanges had serious security vulnerabilities.
Neglection of security best practices
The recent scandal around QuadrigaCX is one more example. CEO Gerry Cotton died in December 2018. He was the only one who had access to the company’s cold wallet, where customers’ funds were stored.
While storing funds in a cold wallet is a good idea in principle, there should be a multi-signature system allowing several people to access these funds. But there wasn’t. Despite Cotton’s death, and the exchange’s inability to access the funds, QuadrigaCX continued operating for nearly a month without informing its customers.
The exchange had hired an IT consultant to decrypt Cotton’s laptop and “locate and secure” the cold wallet funds. But these efforts have shown no results so far. And it’s unlikely they ever will.
QuadrigaCX is one of those examples where users lost money and it’s not because of hackers or a scam. It’s simply because the exchange has not followed best practices.
More exchanges will close in 2019
The market will change in 2019. More and more security scandals and an ongoing crypto-bear market have created enormous pressure on crypto exchanges.
Regulators have also begun to act and increased regulatory requirements. As a result, exchanges have to ramp up their security standards and allocate additional resources to their exchange security, which further increases cost pressure.
In other words, survival of the fittest is on full display in the industry. We will see more small and unprofessional exchanges closing over the coming months. Only the best exchanges with a solid liquidity blanket will stay in business.
Moreover, established stock exchanges have started to develop their own crypto ventures. Those are government-regulated exchanges with decades of operational experience. Most retail investors, and institutional investors in particular, will prefer to give their funds to those players, instead of younger and more unexperienced crypto exchanges.
Investors be aware
Crypto traders have to be aware of these developments. Nobody knew what was going on at QuadrigaCX until it was too late. Similar issues could appear on any other crypto exchange.
Thus, investors always need to be prepared for the worst case and should only keep as much funds on the exchange as needed for trading. All other funds should be stored in a secure cold wallet.
But in sum, these developments might be good news for investors. Increased competition means exchanges will have to speed up their game regarding security, regulatory compliance and customer service. That’s little solace for those who have already lost money, but it’s good for the sector as a whole.