Security breaches undermine cryptos, and that's a good thing

Security breaches undermine cryptos, and that's a good thing
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News reports about security breaches at cryptocurrency exchanges and subsequent thefts highlight yet another risk of investing in cryptocurrencies. Hopefully these reports will boost investor skepticism about cryptocurrencies.

The recent decline in cryptocurrency prices is possibly due partly to the Jan. 26 hack of the Coincheck cryptocurrency exchange, which led to the theft of 500 million NEM tokens, also known as XEM.

That theft cost 260,000 Coincheck users $533 million, based on the value of NEM tokens at the time. Following the hack, Coincheck promised to reimburse its customers a total of $420 million while it works to recover the stolen tokens. Whether Coincheck will recover those tokens or cover its customers’ losses are open questions at this time.

The Coincheck hack and subsequent theft of tokens is only the latest such occurrence. The 12 biggest cryptocurrency hacks combined for total losses of $1.2 billion. The largest loss prior to Coincheck was the Mt. Gox hack in 2014 when $473 million in bitcoin was stolen.

These hacks of cryptocurrency exchanges, which give the crypto thieves access to the “hot wallets” in which customers’ tokens are stored electronically and directly accessible from the internet, are comparable to thieves breaking into a bank vault and stealing the contents of safety deposit boxes. 

The bank does not suffer any loss, but the box holders do, unless they can recover the stolen contents or get a financial reimbursement for the theft from the bank or an insurance company equal to the value of what was taken.

Due to previously known security weaknesses, the Coincheck hack may have been an inside job, which Coincheck denies.

In any event, cryptocurrency hacks are bound to continue as cyber thieves constantly search for vulnerabilities in the computer software used by the cryptocurrency exchanges. Ironically, the much-touted procedures for verifying cryptocurrency transactions to deter the counterfeiting of cryptocurrency tokens do not prevent theft resulting from hacks.

Even if stronger security at the cryptocurrency exchanges reduces hacking and the consequent thefts, investors still should question the wisdom of investing in cryptocurrencies. 

As I have explained in previous op-eds, almost all cryptocurrencies lack any substance or intrinsic value, i.e., there is no “there” there because they rarely are linked to anything of substance.

Worse, they cannot function effectively as money or a currency — they are not a good medium of exchange because their prices, expressed in dollars, euros or yen, often fluctuate dramatically from hour to hour and certainly from day to day. Consequently, very few goods and services are priced in bitcoin, XRP and the like. 

Additionally, processing fees and delays in executing transactions magnify the impracticality of using cryptocurrencies for transactional purposes.

Cryptocurrencies are terrible stores of value because their prices vary so greatly and unpredictably. Additionally, in recent months, there has been a steady, if bumpy, decline in the price of the major cryptocurrencies. 

For instance, at 9 a.m., Eastern Time, Monday, according to CoinMarketCap, bitcoin, the most valuable cryptocurrency in terms of the current market value of its outstanding tokens, was trading at $7,699, down 62 percent from its all-time high on Dec. 17, just 50 days ago. 

Ethereum, the second most valuable cryptocurrency after bitcoin, was down 46 percent from the peak price it hit just 23 days before. Ripple’s XRP, the third most valuable, had declined 80 percent from its peak price 32 days earlier.

Although the price of all three cryptocurrencies popped up when the NEM theft was announced (possibly a flight to quality?), for all three, that price pop lasted just two days. Then they resumed their downhill slide.

Obviously, it would be wise of the cryptocurrency exchanges to tighten their security procedures to minimize future hacks. They may do so in response to regulatory pressures. 

Those steps, though, will not negate the simple fact that cryptocurrencies make no economic or transactional sense, except for those folks for whom conventional currencies — the dollar, euro, pound, etc. — either cannot be obtained or their transactions reflect illicit intent. 

For example, it makes eminent sense for Venezuelans to hold their wealth in cryptocurrencies rather than their debased currency, the bolivar. In addition, drug dealers, terrorists and kidnappers obviously favor transacting in a currency that cannot easily be traced back to them. 

But most folks and businesses are better off sticking with one of the nation-state currencies, such as the dollar or euro.

Bert Ely is the principal of Ely & Company, Inc., where he monitors conditions in the banking industry, monetary policy, the payments system and the growing federalization of credit risk. Find his other pieces on cryptocurrencies herehereherehere and here.