This November, The Fintech Times is looking to broaden the understanding of digital currencies, ranging from blockchain’s use outside of crypto to CBDCs, in an attempt to replace the notion that digital currencies are a synonym for crypto.
Adoption of digital assets, such as cryptocurrencies and tokens has grown exponentially since the start of the pandemic and does not seem to be slowing down. But as they grow in popularity and become more than a niche commodity, the risk grows with them as they become a target for fraud.
“The two main risks are custody management and asset volatility,” said Vanessa Pestritto, Partner Programs Director at Agoric. “Newcomers to the crypto space still have to deal with these two risks when wanting to begin participating in crypto communities. Self custody runs risks of private key management and correctness in executing transactions. When using hosted custody solutions, there are associated fees for the provider and loss of control when accounts are locked.”
Digital Growth Means More Digital Risks
“Digital tokens carry many of the same risks as fiat currencies and tangible pieces of art. They derive value from being unique products incapable of being identically replaced, and just as with US Dollars, they are transferrable and capable of being stolen, misplaced or subject to fraud. As such, digital tokens (including cryptocurrencies and NFTs) are only as safe as the wallet or account they are kept in,” Explains Daniel Maland, a partner at Mark Migdal & Hayden.
The pandemic’s impact on cryptocurrency has skyrocketed the value of a variety of coins. This is as a result of the fact they can be traded from anywhere in the world, alleviating to some extent, potential liquidity constraints that arise should local governments restrict trading activities as part of a lockdown.
“Analysts have begun to show an appetite for digital tokens as a reliable store of value and as a safe haven during times of financial uncertainty. The risk for some of these tokens is a lack of tangible assets backing their value.” Said Cormac Kinney, founder and CEO of Diamond Standard. “For the first time, Diamond Standard has created a liquid market for diamonds as a commodity. This is an example of leveraging blockchain technology to support asset-backed tokens. Since the commodity is transacted with a token, we were able to extend this to a commodity currency called Bitcarbon, which is launching soon. This commodity currency can be used in the same capacity as Bitcoin but includes both a tangible asset (diamonds) and blockchain technology backing it.”
The Human Factor
Blockchain being used to process payments has some huge benefits for companies as it is immutable and can be used by anyone, cutting out a lot of waiting time for customers. However, as humans are the ones who interact with digital assets and tokens through the blockchain, there is always an element of human error that could take place.
Alan Chiu, the CEO of Boba Network explains, “All systems built by humans are subject to human errors, whether they are blockchains or banking systems. One of the security benefits of digital tokens transacted on a blockchain is that anyone can inspect the open-source code for security vulnerabilities. Security incidents are analysed in the open, allowing the rest of the industry to learn from it immediately. This drives the whole ecosystem to evolve and become increasingly resilient more rapidly than traditional closed-source systems.”
There are two ways in which the human factor can impact the risks associated with owning digital tokens and assets:
- Sophisticated digital token investors drive a price through promotion before selling at a high value leaving unsophisticated investors out dry.
- Poor handling by an owner – falling victim to fraud.
Poor handling often takes place due to inexperienced owners. “There’s no third party to telephone in order to reverse a transaction you make, so the key is triple checking,” should a mistake be made by someone trading said Chris Trew, CEO of Stratis. This can happen for a multitude of reasons, fraud, deception or simple fat finger mistake.
DeversiFi Case Study
This is exemplified by an example given by Bitstamp‘s Chief Product Officer, Miha Vidmar, who discusses DeversiFi‘s mistake:
“Transactions are incredibly reliable, as they will be executed exactly as instructed. This means should any human error occur, they will be executed as instructed because there is nobody there to stop you from making that specific transaction or sitting alongside you to check that what you are doing is right, if made from your own private wallet.
“This can be seen in a recent incident when a case of human error caused one exchange to pay $23.7million in transaction fees for a $100,000 deposit. This making it a fat-finger error for the record books.
“From this perspective, blockchain’s great benefit of being immutable and censorship-resistant can also become a disadvantage: in case of errors, the losses can be permanent and irreversible.”
A glitch in some little-tested software code left the London-based exchange wearing the charge when a user made an unremarkable $100,000 deposit. Within days, the recipient paid it all back. To true believers in the emerging arena of decentralised finance – or DeFi – the return of the fee shows a generous ethos a world away from Wall Street and the City. “In the decentralised finance space there is a real desire across teams and communities to build and co-operate for mutual benefit,” said Will Harborne, Chief Executive of DeversiFi. “But having survived Monday I wouldn’t personally recommend to anyone else that they rely on the goodwill of strangers on the internet to return their $24million.
Vidmar explained how fraud exposes the blockchain, “Immutability makes it hard to stop fraud, but there are certainly measures that help prevent it. For example, there are blockchain analytics tools that track stolen funds, making it difficult for attackers to launder crypto, or there are hardware wallets that make theft from private wallets nearly impossible.
“However, at the end of the day, a lot of the responsibility – the same as the power – lies in the hands of users. It’s important that they utilise the measures that all the players in the crypto space, such as exchanges and wallets, have already put in place and are trying to educate people about.”
Should someone fall victim to fraud, the recovery of stolen assets is exponentially more complicated in the crypto-sphere, as all transactions are anonymised through cryptographic code and there is no centralised third-party intermediary used to control or legitimise transactions, making them virtually untraceable. However, companies are implementing internal teams to tackle this problem.
One example solution comes from Carl Dawkins, Marketing Manager at Koda Cryptocurrency: “Each user now has the ability to have full control over their digital assets. With this power, comes great responsibility. It’s now easier than ever to get set-up and make transactions. Unfortunately, in the same way you have banks warn you about scammers, the same is with crypto. The most common user error is someone giving out their seed phrase. This is something you should never give out as it is there as your recovery. It’s the most common user error we have logged here at Koda. We have a department called the KodaTrusties, whose main task, is to assist our community and holders. Unfortunately, that is the most common error they encounter. We promote T(trust) E(education) E(ease -of use) to our community and to make sure educate the masses, or ‘crypto the uncrypto’d’.”
The idea of human error being the cause for the majority of fraud is further supported by Kevin Tai, CEO and Co-Founder at Linear Finance, as he says, “For all the times I have seen users being personally hacked or have lost funds, about 99% of the time it’s because their private keys are compromised. In this instance, it’s about storing your private keys safely and never putting them in the digital realm for hackers to find. In other instances, use safety measures such as 2FA on all your accounts or if you want to go the extra mile in security, put funds in a multi-signature account in Gnosis Safe. It’s free and one of the best custody solutions on-chain.”
Where human decision making is needed, there will always be room for error, especially if people are not careful and double-checking what they are doing. As seen by the DeversiFi case study, an innocent error can be costly and can have severe consequences. Ultimately, it is down to the user to ensure they do not put themselves at risk. Making a rash decision based on social media views, like the Squid Game scam, could save many users money and disappointment. Companies are developing new UX to ensure customers are clear in what they are doing, but the key is treating the digital asset like a physical one.
Daniel Maland from Mark Migdal & Hayden explains this idea by saying, “Just like misplacing a physical wallet or letting it sit in the wrong person’s hands, losing a password to a digital wallet or giving it to the wrong person can result in the loss of whatever was held in that wallet. Fortunately, many wallet platforms require complex passwords and some form of two-factor authentication which provides a beneficial level of added protection and security.”