Digital Currencies Are Growing on Faltering Foundations

One of the chief strengths of digital currencies is becoming their weakness.

Freedom from regulation was the big draw of Bitcoin, Ether and their counterparts. But the exchanges set up to trade them often lack basic controls over identity, fraud, technology and even trading volume, a Reuters investigation shows.

Without fixes, such weaknesses will consign those currencies to the financial fringe.

These markets can be vulnerable to hacking. For instance, the exchange Kraken suffered a denial-of-service network interruption in May, during which the price of ether on its platform dropped 70 percent. Such reactions can be intensified by a lack of circuit breakers that halt trading.
Virtual heists are common, too, according to the Reuters special report. About 980,000 Bitcoins have been stolen in at least 36 incidents since 2011. At current rates, that’s worth $4 billion.

Some exchanges also fail to demand the most basic security checks and know-your-client procedures that more traditional venues insist on. The Poloniex exchange asked some users to supply only a name, email address and country of operation. And some Chinese exchanges have inflated deal flow to attract business, according to former employees.

Such drawbacks have not averted a marked increase in interest over the last few months. The total market value of all digital currencies was $140 billion on Sept. 18, according the research firm Sanford C. Bernstein, a more than tenfold increase over 12 months. Bitcoin accounts for around half the total value — and its price has surged 10 percent again in the last 10 days.
It smells like bubble territory, with volatility making it even riskier.

Speculators may like the wild swings, including the former Fortress executive Mike Novogratz, who is raising a $500 million digital-currency hedge fund. But that state of affairs attracts criminals, too. Digital-currency cases now account for three-quarters of the time the Federal Bureau of Investigation devotes fighting money laundering, it revealed at a recent Morgan Stanley event. The law enforcement agency also said that most ransom payments are now demanded in Bitcoin or one of its rivals.

But it is the lack of a solid market structure that worries people like JPMorgan Chase’s chief executive, Jamie Dimon, who recently argued that Bitcoin was “worse than tulip bulbs. It won’t end well.” He concluded, “It’s a fraud.”
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Dispelling that widespread notion will require the exchanges to raise their games greatly.