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David Drake

October 3, 2018 Article

Another Hacking Incident Forces Japan to Beef Up Crypto Regulations

Cryptocurrencies and their underlying technology, blockchain, have made it possible for developers to innovate solutions for pressing problems in different sectors. This has caused an emergence of startups such as Gath3r that makes digital monetization easier, HFC Coin that provides blockchain backed solutions in the mortgage industry and LiveTradr that is focused on portfolio optimization.
At the same time, blockchain technology is changing the way people interact and how businesses market their products or services. Startups such as ONe Network enhances social media security that and URAllowance that improves family interactions using smart contracts are transforming the social space. In the marketing space, Noiz Chain is enhancing interactive marketing while Qupon is making it possible to market digital coupons. Despite these innovations, the cryptocurrency roller coaster ride has reached an incline. In Asia, Japan is boosting its security measures in a bid to prevent further hacking after Zaif was hacked early last month. Investors have lost more than $60 million dollars in this most recent incident, which has forced the Japan Virtual Currency Exchange Association (JVCEA), a self-regulatory body comprising some of the major exchanges in the country, to institute self-imposed regulations.

The JVCEA plans to mitigate future losses by restricting the management of online cryptocurrencies to anywhere between 10 and 20 percent of customer deposits. It is also going to coerce exchanges into managing only a limited number of digital assets at any given time. Of the over $60 million dollars stolen from Japanese crypto exchange, Zaif, $40 million was managed exclusively online. This made it an easy target for sophisticated hackers.
Back in January, Coincheck, another Japanese based exchange, suffered a staggering loss to the tune of $523 million to hackers. The nature of cryptocurrencies is to provide a decentralized service, and to offer customers quick and easy access to their digital assets. As such, majority of deposits were held in virtual accounts, making them prime targets for bad actors. With the new measures in place, it will be a little bit more difficult for exchanges and customers to hop onboard.
The Financial Services Agency (FSA) has increased by fourfold the questions used in the screening process to register as an exchange. Customers will also be thoroughly vetted to ensure that the integrity of cryptocurrency exchanges is upheld.

The Effects
The overall aim of imposing restrictions is to sustain usage of this new digital asset as well as make the process as seamless and as hacker-free as possible. However, according to Jack Bensimon, Chief Compliance Officer of Blockvest, it is difficult to make the industry completely free of cryptocurrency theft.
He says, “No exchange is ever likely to be completely free of hacks or crypto theft. Hacks are likely to get more severe and sophisticated as this industry matures, while proactive measures by exchanges and regulators will also evolve and be enhanced. Like criminals, hackers are usually a few steps ahead of exchanges and regulators."
Japan seems to be realizing the ever present risk of hacking and taking steps to build confidence in the industry. "Japan's forward thinking in shoring up regulatory guidance and firm position on crypto exchanges, helps to build trust and confidence in the buying and selling of crypto on exchanges. Anything to secure mass adoption of crypto, including enacting legislation to reduce the incidence of exchange hacking of tokens, is a major step in the right direction," Bensimon adds.
In addition to responding to questions during the screening process, applicants are required to provide detailed reports of board meetings to ensure they have done their due diligence in managing digital assets online. Whether these measures will aid in curbing online hacking is yet to be seen. So far, they have only contributed to the evolution of cryptocurrencies from being a decentralized form of financing to a more regularized and centralized one.
“It certainly looks like centralized crypto exchanges will soon be treated under the same regulations and controls as other monetary institutions. Then again, did that ever prevent large scale fraud (Madoff), irrational exuberance (Lehman) or simply human mistakes (think of flash crashes)? The blockchain promise is really a different one: that of decentralization, governance by code, making government influence and control unnecessary. The future of exchanges is decentralized, with no institution answering to governments,” said Simon Cocking, Editor in Chief at Cryptocoin. The JVCEA was formed shortly after the Coincheck hacking in January, but was still unable to prevent Zaif from being subject to the same early in September. The new measures that regulators in Japan have initiated may not be sufficient to rid cryptocurrency exchanges of hacking attempts. But, if everything goes according to plan and the FSA approves the plans submitted by the JVCEA in July, the overall loss from potential future hackings will be significantly less.

 Disclaimer: David Drake is on the advisory board for most of the firms mentioned or quoted in this article.

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