Negative Consequences of Centralization

Decentralization and distribution of an immutable ledger are the key concepts that make Blockchain technology so incredibly valuable. Yet, ironically, most cryptocurrency exchange platforms are centralized. The security of blockchain technology doesn’t exist in the architecture of centralized exchange platforms. Centralization introduces the Single Point of Failure (SPoF) problem into the system. More specifically, centralized databases and ledgers within the architecture of centralized platforms make the whole system vulnerable to both digital and physical attacks.

The meaningful contribution of a centralized exchange system is that they possess the power to control the outcome of a transaction in the advent of a financial mistake or error within the system's internal programming. This leads users to feel as though that central body would be held accountable for the loss of one's digital assets and be able to correct that mistake. However, time and time again, centralized exchange platforms fail to provide clear accountability for assets stolen from their users. Answers to questions regarding security protocols, safety of digital assets and customer service are usually obscure, if not nonexistent. Centralized exchange platforms hold user keys and control the leverage and movement of their funds.

Centralized exchange platforms often store funds in online hot wallets and many have failed to protect the private keys of user wallets, which is why they have fallen victim to many hackers. More than 980,000 BTC have been stolen from these centralized exchanges (nearly $40 billion USD at current rates). Few of these exchanges were insured or regulated. Centralization in any system introduces security vulnerabilities and on centralized exchange platforms can accommodate fraudulent behavior. The following list provides information about some of these events:

• Silk Road

  • When: October 2013

  • Amount stolen: BTC 171,955 (USD ~270,000,000)

  • Comments: Silk Road was a marketplace that accepted cryptocurrencies, not an exchange. Still, users had BTC linked to their accounts, and keys were stored in a centralized manner. After the FBI took Silk Road down, all BTC was confiscated and users lost their assets.

• MtGox

  • When: March 2014

  • Amount stolen: BTC 850,000 (USD ~700,000,000)

  • Comments: The biggest hack in the history of cryptocurrencies, with one of the most popular exchanges at the time. MtGox failed to protect the private keys of user wallets, and hackers drained funds away. The amount of stolen BTC is currently worth more than 6 billion USD.

• Cryptsy

  • When: January 2016

  • Amount stolen: BTC 13,000 + LTC 300,00 (USD ~9,500,000)

  • Comments: A Trojan malware was inserted into Cryptsy's code, and the attacker was able to transfer BTC and LTC out of the exchange's wallets.

• Mintpal

  • When: December 2014

  • Amount stolen: BTC 3,894 (USD ~3,200,000)

  • Comments: Mintpal was one of the most popular trading platforms. Customers were told the company was going to have new ownership. The new owner failed to detect and patch the vulnerabilities that led to the platform being hacked, and many believe the acquaintance and the hack were nothing but an inside job.

• Bitstamp

  • When: January 2015

  • Amount stolen: BTC 19,000 (USD ~5,100,000)

  • Comments: Bitstamp employees received a malicious file that infected the company's infrastructure.

• Bter

  • When: February 2015

  • Amount stolen: BTC 7,000 (USD ~1,750,000)

  • Comments: Bter had been previously hacked, so it was not the first incident in this centralized exchange.

• Bitfinex

  • When: August 2016

  • Amount stolen: BTC 120,000 (USD ~72,000,000)

  • Comments: Bitfinex is famous for the creation of Tether and sharing executives with Lux project. They advertised as having multisig wallets for each customer, which still did not prevent them from losing users BTC.

• NiceHash

  • When: December 2017

  • Amount stolen: BTC 4,000 (USD ~60,000,000)

  • Comments: NiceHash is not an exchange but a cloud mining service. In December 2017 their servers were hacked and miner wallets were emptied.

• Coincheck

  • When: January 2018

  • Amount stolen: NEM 523,000,000 (USD ~534,800,000)

  • Comments: Coincheck used cold wallets for its BTC trading operations, but neglected security measures on Asian currency NEM. All NEM deposits were stored in a single wallet, that was emptied during the hack. This could have been avoided by securing hot wallets with greater levels of encryption standards.

• BitGrail

  • When: February 2018

  • Amount stolen: NANO 17,000,000 (USD ~195,000,000)

  • Comments: BitGrail failed to secure it's new 0-fee cryptocurrency NANO storage. NANO used the recently introduced block lattice, and the fact that a centralized exchange was adopting such infant and unvalidated technology might have influenced this episode.

• CoinSecure

  • When: April 2018

  • Amount stolen: BTC 438 (USD ~3,300,000)

  • Comments: After the hack, CoinSecure's owners filed a lawsuit against one of the exchange's employees claiming it was an inside job.