How Modern Crypto Exchanges Protect Users Deposits
Cryptocurrency trading is becoming more and more popular with joint crypto trading volume exceeding billions of dollars. Just imagine all this money being moved, exchanged, transformed… And almost all of it is in constant danger!
In this article, we will explore what dangers you face when depositing cryptocurrency to crypto-exchanges and what security measures are implemented by modern platforms to protect your money.
The scope of the problem
But before we dive into the world of deposit security, lets put the problem into perspective.
Since the emergence of cryptocurrency over 980,000 million Bitcoins have been stolen from crypto exchanges. That’s over 7 billion dollars at today’s exchange rate! What’s more, the hacks just won’t stop accruing!
Cryptocurrency market is very young, unregulated and it is developing so fast many are not able to keep up with it. In order to stay on top of the trend, many cryptocurrency exchanges neglect security issues or don’t pay enough attention to them. At the same time, there is no security standard, making it possible for anybody to create an exchange, grow it into a popular platform and then… Get all the funds lost to a cyber attack.
Why are crypto-exchanges vulnerable?
You may ask, well, but isn’t blockchain this super-secure technology and didn’t I read somewhere that only quantum computers that don’t even exist yet can hack it? Well, that’s generally correct, but there is a but. Most crypto exchanges don’t use blockchain, instead, they rely on centralized architecture which allows them to increase the speed of operation in exchange for security. Combine this with the possible incompetence of the developers in the security department, rushed coding, unprofessional management and you’ve got yourself a perfect recipe for disaster.
However, recently emerging companies are implementing cutting-edge technology that will allow traders to rest assured that their deposits are perfectly safe. Let’s take a look at some of the things crypto-exchanges do to secure your deposits!
If the main security weakness of the centralized exchanges is, well, centralization, then is the logical way to overcome it? That’s right, with the opposite! Recently a lot of exchanges introduced a decentralized design, where an exchange allows users to conduct peer-2-peer trades without storing their funds on a single, vulnerable account.
However, decentralized exchanges have their own set of problems. They are not as scalable as centralized ones and have other limitations that make them frustrating to use.
For example, Bitsquare requires users to be online, otherwise, the trade won’t be listed.
Another major problem of decentralized exchanges is that they are not scalable enough. With the current level of technology, it is near impossible to imagine them operating at a scale of NASDAQ or even reaching the scale of most popular centralized exchanges for that matter. At least with retaining the same transaction processing speed. That’s why this type of exchanges are still not very popular.
Top centralized exchanges like Huobi use cold wallets to store capital. A cold wallet is a cryptocurrency wallet that is disconnected from the internet, therefore it is impossible to compromise it. The problem with this approach is that it impacts liquidity. That’s why a small percentage of funds is held in hot wallets and even if an attack happens, hackers would only be able to still a little portion of crypto controlled by the exchange, that would then be refunded to investors without making the exchange go bankrupt.
Semi-decentralized exchanges are a new trend that is becoming more and more popular. No wonder, because this approach allows combining the best of both worlds. Exscudo is one example of a semi-decentralized exchange where user deposits are stored in a cold wallet, but instead of using real cryptocurrency for transactions, so-called colored-tokens are issued. Colored tokens are created to mirror the real crypto stored in a safe place and allow to protect “different” coins by a single blockchain. What’s more, even if an exchange goes down in a cyber-attack it would be possible to roll it back to the state before the attack and restore user balances. In this manner, semi-decentralized exchanges implement a multi-layer protection while preserving operation speed.
So, what’s next?
With decentralized and semi-decentralized exchanges still being an innovative technology that hasn’t had time to win a substantial portion of the market. Hence, the majority of the exchanges that support the liquidity of the multi-billion cryptocurrency market remain as potential targets for cyber attacks.
However, if there is something that we know about the blockchain industry – is just how quickly it evolves. It is not long before we start seeing experimental security protocols becoming mainstream and a fear of losing our cryptocurrency to hackers will become a thing of the past.