Carlos Martins: Time to action for the crisis of cryptocurrency theft

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Carlos Martins *believes because up to now the space of cryptocurrencies has been mostly unregulated and also presents a threat to the status quo, regulatory packages in larger markets like the US or the EU take a no risk approach to these financial instruments, both trying to protect their citizens from the abuses perpetrated by greedy and unlawful actors and to quell any idea of radical change.

Asr-e-Ertebat as the first and oldest weekly ICT Area in Iran had an interview with  him about the future of virtual currencies due to numerous thefts of virtual currencies

by Farahnaz Sepehri

– First of all, how do you predict the future of virtual money?

 The future of money itself is already quite difficult to predict – without a crystal ball, it’s impossible to answer this question. Agreeing upon what money actually is would be a good starting point though.

The etymology of the word comes straight from the latin word moneta (meaning coin or, in french, monnaie, which is the actual source of the english version of the concept). Originally money represented a commodity (a defined weight of wheat, for instance): it was commodity money, represented as a certain weight of metal in the form of a coin. From there it evolved to representative money, adding a layer of abstraction to the concept : the receipt of depositing commodity money in the equivalent of a bank became accepted as a method of payment, as it was more convenient to carry around. All this information is easily accessible so enough history lessons. Nowadays we live in an epoch of fiat currency as money.

Money has a few characteristics that are considered as essential for its acceptance:

  • it functions as a medium of exchange
  • it functions as a unit of account
  • it functions as a store of value

These have been satisfied in our world mostly by currencies like the dollar and the euro, to name just two. These currencies circulate all over the world either in coin or bank notes, as physical objects, but exist mostly in bank ledgers, as representations of complex debt relations among actors in financial markets, from retail users to gigantic hedge funds. This last method of representation could already be called “virtual money”, as it has no physical existence.

Yet in today’s world, when we speak of virtual money, we’re thinking of crypto-currencies, representations of value based on a decentralised ledger technology infrastructure. The most well known examples would be Bitcoin (BTC) and Ether (ETH), although there are many many others.

Originally developed to brake the shackles imprisoning individuals in monetary systems controlled by authorities and entities that allowed situations as the 2008 financial crash, these virtual or digital currencies were subversive and did not respect any kind of regulation existing in financial markets, as they were built and designed to disrupt them, allowing usage without recognition of international borders and resisting to censorship by nation states.

Increasing adoption brought them mainstream exposure if not adoption. Arguably, some crypto assets may function as a medium of exchange or a store of value – but up to now only eth functions as a unit of account and that only to finance the cost of transactions within the ethereum network. It’s worth noting all cryptocurrencies suffer from very high price volatility, with the exception of so called stablecoins, usually backed up with financial assets such as short term bonds, fiat currency or even other cryptoassets. These stablecoins are the on and off ramps to speculative applications of other, more volatile crypto-currencies.

Mainstream exposure means that now regulators and legislators are also aware of their existence and of the erosion brought by these assets to financial control tools.

Because up to now the space has been mostly unregulated and also presents a threat to the status quo, regulatory packages in larger markets like the US or the EU take a no risk approach to these financial instruments, both trying to protect their citizens from the abuses perpetrated by greedy and

unlawful actors and to quell any idea of radical change. Stablecoins in particular have been the object of carefully laid out regulation, as they are issued by private actors that have to comply with legal frameworks designed by regulators.

Simultaneously, many countries in the world have been dabbling in the concept of CBDCs or Central Bank Digital Currencies, which are inspired by crypto assets but turn the concept on its head, going from decentralised forms of money to a virtual or digital form of fiat, completely under the Central Bank control and inheriting novel characteristics brought by crypto-assets, like full transparency and programmability (which many of the detractors of the concept point out as extraordinarily risky to individual liberties).

We can now draw a spectrum of forms of virtual money, going from more decentralised to fully centralised:

Cryptocurrencies ==> Stablecoins ==> CBDC

So, to finally answer the question of “how do I predict the future of money?”, I’ll offer a few possibilities:

  • CBDCs are the future: China already has a pilot project deployed. Many other countries are working on this very concept, including the EU. Yet there are significant questions that will likely not pass the exam of public scrutiny because of the threat this tool presents to individual liberties, placing citizens under the financial oversight of the Central Bank and whomever presides to its decisions;
  • Stablecoins are the future: the issuers of stablecoins have as much power over the coins they issue as a Central Bank would have over a CBDC. Yet the fundamental distinction of not having the State presiding over the application of this form of surveillance, having to do so via a 3rd party, makes this model very similar to what is in place today – “our” banks know everything about the way we use our money, as long as we’re paying online or using credit cards or bank cheques. The only situation where this knowledge vanishes is when cash is used, but at least in western countries there’s a trend showing a significant rise in electronic payment methods.
  • Cryptocurrencies are the future: there’s much debate about this possibility among crypto enthusiasts. Each project pretends to be the one permitting such an utopia to actually happen. Yet none of the projects out there address inequality of opportunity for the participants, all have a cost expressed in fiat currency, all seem to be based upon a speculative mentality and greed, just forms of ultra-liberalism. A project that solves for these issues, allowing anyone to participate on equal footing is the only hope for widespread grass-roots adoption in areas of the globe where regulation is not as enforceable as in big modern economies – maybe, just maybe, from there a chance to become a de facto standard for economic transactions could be achieved.

– Considering the theft and hacking of digital currencies during this period, do you think the future is still bright for digital currencies?

 2022 has been an eventful year in the world of crypto assets, in all of its components: cryptocurrencies, DeFi, Play2Earn, NFTs… There’s been loss of invested capital in all of these fields. These events separate into two large groups:

  • Technological hacks;
  • Criminal behaviour (outright theft or unethical behaviour).

On the tech side, hacks have always been performed on bridges, wallets or smartcontracts, never on the digital ledgers (blockchains) themselves. The fundamental tech seems sound – what is built around it seems a lot flakier.

As for the criminal behaviour, it’s inherently human : someone took action to defraud someone else of their money, abusing their trust – and this in a system that is supposed to be trustless, or without the need to trust! Yet it’s always necessary to trust the team that develops the projects and that’s mostly where grifters and scammers have been extremely active.

The consequences of this type of behaviour and of the technical improvements required for everything to work fluidly in a manner that is safe for investors create an extremely bad press around crypto-assets and its mostly speculative ecosystem.

For the public at large, the ones that haven’t yet manifested interest in this space, it is difficult to imagine how to attract them now that in the space of a year value destruction has largely surpassed a trillion dollars.

Yet all sort of financial institutions and governments manifest interest in developing solutions and projects based on these very same concepts and technology.

This can be construed as the maturing of the space, where the pioneers, the visionaries, the builders are now ceding their places to institutional actors which perform at an entirely different scale.

So while for many of the original projects 2022 was the year the sound of death bells was heard, other projects adapted and new ones are being developed right now.

– Do you think that countries continue to turn to this market to improve their economy due to these threats? Is this market still profitable?

Looking at the cryptosphere and asking oneself if it’s still profitable might not be the best way to consider the situation. Decentralised Ledger Technology (of which Blockchain is part) has many different applications, from Identity systems, to public record keeping and, of course, as a payment rail or as the basis for new, tokenised, asset classes.

So I think that private actors will continue working, building and developing projects using among other things these tools – and maybe countries will opt for them for record keeping or to build CBDCs.

As pure digital assets or virtual money, though, I think the promise of the space is significantly inferior to what it was at the beginning of 2022.

–  In your opinion, what were the reasons for these thefts?

  • As it shows because of variety and decentralization of digital currencies, security issues became a major problem and there is no center and responsible to improve security problems of digital currencies. What is your opinion and solutions for this issue?

 Thefts and scams happen in any situation because their perpetrators think they can get away with them – be it in the digital assets space or in any other.

The reason is opportunity and the possibility to perform these acts with computers as the only tool. Previously I distinguished two sorts of thefts: those around the technology (mainly malevolent or broken smartcontracts, poorly written wallets) and those around the individuals behind projects in the space.

Blockchain technology is supposed to be highly decentralised, which prevents any particular individual from gaining control of the ledger, ensuring its immutability.

Cases like the FTX scandal have nothing to do (in their execution) with blockchain technology – they just predate on people with money invested in the space.

A centralised entity offers convenience of use of the complex systems allowing to participate in the space, thus gaining your trust. Then proceeds to abuse that trust and block their clients from accessing or controlling their money. Because using the original decentralised tools was too complicated, a gatekeeper acting in an unregulated industry was allowed to take control over assets not their own. The consequences are visible in the multiple 2022 cataclysm.

Yet not all is lost, as blockchains record all transactions – which means assets stolen can now be traced and their new holders (and presumably thieves) may be identified using sophisticated forensic analysis tools.

Plus, more and more individuals are claiming regular audits not only of assets but also of code, thus increasing security in the space.

One thing I found very interesting after the FTX debacle was the rapid rise of the Proof of Reserves concept, where Centralized Exchanges (the ones with an easy path to fraudulent behaviours) started publishing blockchain audits proving they where holding X amount of assets, recorded on chain.

Yet users kept pushing for more, saying that those proof of reserves were not conducted in the most transparent of manners and that without information about liabilities, the proof of reserves concept is not enough. But this took weeks, not decades or almost a century, as per the incumbent financial sector.

So, independently of the nature of the thefts or scams, multiple solutions are being developed as we speak to minimize theft s and reduce risk:

  • Code audits are becoming more common and projects that do not present proof of these audits are immediately red flagged;
  • Governance mechanisms for projects are also being audited, to ensure that a faulty design does not allow a malevolent actor to abuse these mechanisms, thus stealing investors assets;
  • Proof of Reserves or even more accurately Proof of Liquidity (Reserves – Liabilities) concepts are being built, designed and deployed in many projects.

For centralised projects, regulatory frameworks such as the European MiCA and its equivalent in the US are also increasing the level of responsibility of these actors, with clear obligations now defined.

– As North Korea day by day is developing its abilities to successful attacks and thefts of digital monies, do you think it can be used by more government and hackers?

Ours is an always connected world.

What one player, be it North Korea or any other, can do, others can reproduce if they choose to do so.

Some countries will opt to develop and weaponize groups of individuals with these skill sets – the only thing that can be done to mitigate their impact is to strengthen protective mechanisms and be ever more demanding when designing governance systems or writing properly audited code.

This is not a digital assets specific problem, though, but an IT one.

These decentralised projects might even become the more resilient to this type of attack, who knows?

This leads my to one last observation: to any country working on a CBDC with whatever goal… how strong are your cyber defences? Are you ready to protect that specific bit of technological infrastructure from attacks from adversarial forces or even from sophisticated, maybe state sponsored, criminals?

———–

*About Carlos Martins

Hi is consultant about Blockchain | Web3 | DeFi | Tokenomics | DAO

Also has Cross-functional leadership experience of 20+ years in Strategy, Market Intelligence, Marketing, Product Management and Business Development across multiple industries and countries.

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