What’s Next For Bitcoin – Part 2

Bitcoins

My friend Harris Miller, in Virginia, pointed out there was a $70 million bitcoin theft, which may have gotten lost in the news frenzy over the price rise. He makes a valid point, and I would like to make some further comments about the heist in this post. The $70 million of bitcoin was stolen from a cryptocurrency mining service called NiceHash following a security breach. Some distinctions need to be made. First is bitcoin was not hacked, it was an ancillary bitcoin service which was hacked. You could think of the service as something like a check clearing service. Hackers were able to break into the website and steal some bitcoin. The important thing to note is the technology underlying bitcoin is the bitcoin blockchain. To my knowledge, a blockchain has never been hacked. 

There have also been other hacks of bitcoin exchanges. Think of bitcoin exchanges like coin shops or bank offices. In 2014, Mt. Gox company, lost almost $500 million in bitcoin. At the time, Mt. Gox was handling over 70% of all bitcoin transactions worldwide, and was the largest bitcoin exchange in the world. Once again, it was not bitcoin which was hacked, it was a failure of the exchange to properly manage security. If someone robs a bank, it is not the fault of the money. There was a lot of, I won’t call it fake but, inaccurate news coverage at the time.

Harris Miller raised the question of what insurance bitcoin holders have.  The answer is it depends. Cryptocurrency regulations are at their infancy. Mt. Gox bitcoin holders were not insured. I doubt if NiceHash provided insurance either. Some further distinction is required. First, U.S. banks also fail. Seven banks have failed so far this year, 62 failed last year, and 554 have failed since 2000. If you are interested in seeing which banks failed and in which states, look here. Bank depositors are insured partially. The FDIC insures up to $250,000 per depositor, per insured bank, as a result of the Emergency Economic Stabilization Act of 2008, which raised the limit from $100,000.

While there is no American-wide or global regulatory framework to require cryptocurrency depositor insurance, there is a lot going on in that direction. Two bitcoin exchanges in Japan have launched insurance products aimed at preventing losses. The world’s largest bitcoin exchange by trading volume is BitFlyer, based in Tokyo. BitFlyer is the fourth digital currency exchange to receive a “BitLicense” from New York’s Department of Financial Services. Coinbase, Circle, and Ripple have also been granted a BitLicense.

It is not clear to me if a BitLicense in NY requires exchanges to provide insurance, but I think it will become common practice for all exchanges. Coinbase says all digital currency they hold online is fully insured. This means if hackers were to break into Coinbase, the insurance policy would cover any customer losses resulting from a breach of Coinbase’s physical security, cyber security, or by employee theft. The insurance does not cover any losses resulting from a compromise of an individual Coinbase account. It is the customer’s  responsibility to use a strong password and maintain control of all login credentials. As always, I recommend using a password manager such as 1Password or Dashlane.

Coinbase holds less than 2% of customer funds online. The rest is held in offline storage. As a customer, you can keep bitcoin in the digital wallet or in an offline digital vault. They have a process for moving bitcoin back and forth between wallet and vault. I believe a prudent policy is to keep at least 90% of your bitcoin in the vault.

At 6:00 p.m. EDT tonight, the Cboe Futures Exchange (CFE) will begin offering traders a way to buy and sell bitcoin futures. I am looking forward to watching the action. I predict the price of bitcoin will either race to the moon, crash to the sea, make a move up or down, or stay roughly the same. Finally, I offer the advice my father once gave me about investment recommendations. He said, “Don’t give any and don’t take any”. He was a wise man.

Disclosure: I am an investor in Coinbase and in Bitcoin. I am not recommending anyone invest in cryptocurrencies or cryptocurrency futures.